The aim of the paper is to examine alternative methods of regulating prices and/or profits of privatised utilities in low‐income countries with a view to identifying their strengths and weaknesses.
The economics of regulation literature has favoured the use of a price cap over rate of return or cost of service regulation because of its greater incentive effects. A third alternative, sliding‐scale regulation, has been put forward as a compromise between the price cap and a controlled rate of return, which is said to combine the merits of both methods. This paper considers the operation of a price cap, rate of return regulation and sliding‐scale regulation in the context of low‐income economies by reviewing the theory in relation to the conditions likely to be found in low‐income economies.
It is concluded that the case for the use of a price cap is much reduced in low‐income economies. This is because of its information requirements, need for regulatory expertise and, more broadly, the institutional endowment found in many low‐income countries.
It is recognised that this conclusion is tentative and deserves further research, comparing theory and practice.
Countries need to consider carefully which method of regulation will work best in the context of the institutions of the country, rather than simply copy a method from the developed world.
This is one of the first papers to challenge the prevailing belief that price cap regulation is superior to rate of return regulation in the context of economic development.
