Column: AAP powers off regulators

Written by Rajat Kathuria | Updated: Dec 30 2013, 10:02am hrs
While there is much to credit and cheer the Aam Aadmi Partys electoral success in Delhi on the back of several promises to improve governance and transparency, there is one disquieting element among their uppermost priorities. That is the promise to reduce electricity tariffs by 50%, conceivably for targeted customers. This piece is, however, not on the widely debated difficulty to achieve and absorb such a significant reduction. In theory, there are several time-honoured ways to bring down tariffs to a select class of residential customers through internal cross subsidies (i.e. charging more for usage beyond a certain threshold or by increasing the price for commercial establishments) or just by way of an outright subsidy either financed through a non-distortionary tax on the sector or through the general budgetary process. Undoubtedly, there are complexities in getting it right, but it can be done, albeit at a pinch. The more subtle question is who should do it, the political organisation of the state or an independent regulator charged to specifically execute tariff determination using all the tools at its disposal, namely expertise, skill, stakeholder consultations and, above all, independence.

Beginning with the economic liberalisation of the 1990s, the state in India started to vacate some of the commanding heights of the economy, in which state responsibility for provision of infrastructure and services was synonymous with ownership. The new thinking on provision along with technological progress allowed competition to be introduced in erstwhile state-driven monopolies. Unbundling of the power sector into generation, transmission and distribution is one example among many where reform made space for private participation in generation and distribution. The command and control model has thus given way to a new mode of regulatory governance where private sector participation requires governmental priorities to be achieved through independent regulation and the law of contract.

In India we now unambiguously acknowledge that introducing private sector participation accentuates the role of effective regulation and regulatory institutions, especially because sectors such as electricity distribution will remain local monopolies. For much of its early existence, the Telecom Regulatory Authority of India (Trai) focused on tariff regulation since last mile connectivity initially remained a knotty and intractable problem. The arrival of mobile technology accompanied with deregulation destroyed the damaging last mile monopoly almost unrecognisably. Wireless obviated the need to reach homes via the expensive digging and rights of way to lay underground cables. Today, there are cities where 10 different operators compete to supply last mile connectivity through wireless technology. While one could question whether it requires so many operators to produce efficiency enhancements, the excessive last mile competition allowed Trai to withdraw from regulating retail tariff, letting the market be the arbiter. Such a situation was unthinkable a few years ago and is certainly unthinkable for electricity distribution. Unless, of course, the last mile monopoly in distribution receives the same favour from technology that telecom did in the past.

For the foreseeable future, though, the market for power will suffer from pervasive and profound market failures. There will be limits to competition in all unbundled segments, especially in distribution due to the high initial and lumpy investment in fixed facilities, necessitating regulatory intervention to address the underlying market failure. The problem of market power in provision combined with the temptation for political interference means that the unfettered market will inevitably lead to socially suboptimal outcomes if pricing and investment decisions are left unregulated. Yet it is not clear that where the market has failed, government through its several instruments will be able to improve the outcomes. That fear gains currency when, for example, a minister announces that tariff for all telephone calls in India will be R1 per minute or when promises to reduce power tariffs are made bypassing specialised institutions created specifically for the purpose.

One of the main goals of regulation is to induce firms to produce at the lowest possible cost, to align prices with costs so that firms do not make super normal profits which they could in the absence of appropriate regulation. Designing good regulatory institutions is, however, a non-trivial task. Desirable attributes such as independence, transparency, accountability, expertise and legitimacy are challenging, but awfully important to establish for their effective functioning. Regulatory aims often conflict and balancing them is as much science as it is art. Thus, credibly signalling to investors who incur large sunk costs that their interests will be safeguarded, while at the same time protecting consumers from excessive prices and poor-quality service as well as creating the means for affordable universal service is what regulators agonise over across the world.

Indias limited experience with independent regulation since 1991 confirms what has been known for many yearsdesigning effective regulatory frameworks and enforcing them is highly complex and requires strong political commitment, skilled personnel, and a well designed incentive structure. The experience also demonstrates that the independence of regulatory agencies may not be easy to create. It necessarily takes time and attributes such as independence and credibility are established on the basis of both legal foundations and actual behaviour of the institutions when faced with difficult decisions that involve substantial interest group controversy. Independence, according to one definition, is the ability to implement policy without undue interference from politicians or industry lobbyists, a test that institutions charged with governance in India have frequently failed to satisfy. As we embark on a new era of promised transparency in governance, it is as much incumbent on politicians to let the regulatory institutions they created to perform their role (albeit with safeguards), as it is of the institutions themselves to resist the temptation of being captured by political or private interests. If not, I am afraid, we will continue to undermine the credibility of our institutions, this time on the back of a seemingly honourable cause. The road to hell, as they say, is often paved with good intentions.

The author is director and chief executive, ICRIER. He can be reached at rkathuria@icrier.res.in. Views are personal