Regulated services represent between 14% and 26% of households’ expenditures in all economies and are costly to operate and maintain. They demand heavy investments for extensive periods of time. Funding them is a challenge: investment needs in infrastructure average 1– 2% of GDP, and 4– 8% of GDP in developing economies. The technological characteristics of these services justify their production by monopolies or quasi-monopolies. Moreover, their demand being inelastic, there is a risk of abuse of market power, which drives the original case for the regulation of the price of these services. When setting them, the regulator needs to address multiple goals: financial or fiscal viability, efficiency, equity, institutional viability and political viability. It implies trade-offs, which reflects the fact that regulation is not only an economic decision but also a political one. It needs to account for the specific institutional context in which the decision is taken. For many of the key decisions, economic theory provides useful guidelines, but in some dimensions, theory still has some way to go to become fully operational in the practice of regulation. This book aims to bridge part of this gap.

The ability to appreciate and account for the magnitude and complexity of the interactions of efficiency and viability, on the one hand, and social concerns (including equity), on the other, continues to be a major regulatory challenges. One of the keys to effective targeting is to distinguish between lack of access and lack of affordability. For both challenges, regulators can rely on large menu of pricing, direct and cross-subsidies, technological or quality options or service obligations to reduce or eliminate the undesirable social biases. The optimal choice depends on the local preference, on the local fiscal capacity and on the implementation capacity of the regulators. And this requires a specific institutional diagnostic. Regulators should pay more attention to the costly default options often found in menus of service levels, and push for these to be reset so as to maximize the odds of helping those who need it most. To ensure that regulation delivers on the social goals to be addressed, regulators must make the most of the growing volume of data available and use it with more rigour to refine the social targeting efforts.

Finance theory and practice drive the translation of the theoretical approaches to regulation into operational guidelines. The guidelines define a financial model to assess the net present value of all allowed costs and demand-related variables and the resulting allowed rate of return. The cost component accounts for the expenditures needed to meet all services, investments and quality obligations, net of any possible subsidies. Costs can be assessed at either their observed or their efficient level depending on the regulatory guidelines adopted.The demand forecast is typically based on long-term needs to be able to identify the investment requirements of the sector.The discount rate used to assess the net present value of costs and revenue is the cost of capital allowed by the regulator.The cost of capital is estimated as a weighted average cost of capital (WACC) of equity and of debt, with the weights reflecting the relative importance of the two sources of financing. This cost of capital is used to set the upper bound for the allowed rate of return. The average price for the regulated service should be set to ensure that the allowed rate of return is consistent with the allowed cost of capital.