51. The more that is privatized and outsourced, the more crucial is the supervisory role of government in ensuring that the enlarged private sector, in following its private interests, is also meeting the requirements of society as a whole. A market economy requires clear and stable laws and regulations which are no more intrusive than necessary. The reform of the framework involves deregulation to free up activity and allow the emergence of self-regulating capacity in markets and civil society.
52. Regulation by government intervention in the free working of business and markets is traditionally justified by various well-known forms of market failure. There is a growing appreciation that market failure is not a sufficient justification, since intervention has an administrative cost. Also it may be misguided and result in stifling the emergence of competition. In fact, it is extremely difficult to establish a regulatory regime which is both expert and independent of capture by well-endowed enterprises (who may be supported by strong ministers), nor perverted by short-term political interests.
53. In the 1970s and 1980s there was great interest in regulation because of public discontent with the price, quality and cost performance of regulated firms. In the 1990s, strong trends to liberalization and demonopolization have ended the need for administrative regulation in some markets, because competitors (or potential competitors in a "contestable" market) do a much better job than governments of restraining unwarranted price increases and improving quality and variety. In competitive markets, the customer is king. Some traditional "natural" monopolies, such as telecommunications, are also becoming competitive, even with regard to basic line networks, by the development of new technologies, such as wireless telephony and optic-fibre cable. Other natural monopolies can be subjected to competition by periodically auctioning each franchise to the highest bidder or, in a consumer-friendly variant, to the bidder who offers to supply at the lowest price.
54. However, the need for administrative regulation continues in markets dominated by monopolistic or oligopolistic suppliers. Regulation is moving up the political reform agenda because of privatization. Unfortunately, regulation is not popular in a time of privatization by disinvestment. When a government is trying to entice the private sector into bidding for public enterprises, it tends to postpone anything, such as regulation, which may dilute private interest. State enterprises, which normally carry with them monopoly powers inherited from an import-substitution and economies-of-scale era, will attract more bidders and fetch a better price if the new owners are allowed to continue their monopolies. Governments are often driven more by short-term fiscal considerations than efficiency arguments, so they avoid tackling this issue, promising themselves that they will return to it later, when everything is safely sold. By then, of course, enterprises are in a position to lobby for the maintenance of the protection and privileges which they paid for in the price. Where shareholdings are broadly based, it is politically difficult to reduce the dividend expectations of large numbers of voters.
55. On the other hand, there are two strong arguments in favour of regulation: (a) investors will prefer the security of pricing rules which are fixed and out of reach of arbitrary political interference; and (b) governments are worried about the distributional effects of monopolies, more so than their efficiency effects. Higher prices to poor electors are politically more damaging than the less visible effects of low efficiency. It is generally recommended that, since privatization is intended, inter alia, to increase efficiency and since it is important to keep prices of essential items to a minimum, competition must be promoted and, until it exists, it must be simulated by a system of regulation (Jones 1993). The general maxim is: competition where possible, regulation where necessary.
56. The current issues are concerned with choices between a cost-plus regime (typified by many United States utilities) or a price cap (typified by the RPI-X formula started in the United Kingdom); between a single regulator, a regulatory board, or sectoral regulatory agencies; whether to break up a national monopoly into regional monopolies; the rate at which competitors should be licensed, bearing in mind the need for the incumbent enterprise to finance major expansion as far as possible from internally generated surpluses; etc.
57. The choice between a cost-plus pricing formula and a price cap is usually represented as though cost means actual historic cost (in which case managers have no incentive to reduce costs), while a fixed price motivates managers to reduce costs (since this maximizes profit). In fact, the contrast is not so clear cut. If cost means future estimated or target cost (as in United States utilities) and if successive period price caps can be adjusted based on past profits (as in the United Kingdom), there is no difference in the incentive effects of the two bases. Cost-cutting incentives arise only by virtue of the period of time for which managers can operate before the next review (the longer the period, the stronger the incentive to cut costs).
58. The institutional form of monopoly regulation is a current issue in many developing and transitional countries. The United Kingdom and Argentina created a regulatory agency for each industry, but the recent trend is towards multi-sectoral agencies, as in Jamaica and Malaysia, which can pool cross-sectoral skills such as financial analysts, economists and lawyers. These also have advantages in standardizing regulatory systems, valuation methods, etc. and reducing cross-sectoral inconsistencies and inequities, as well as minimizing the transaction costs and delays inherent in setting up multiple institutions. Regulatory boards are more often preferred to single regulators in order to reduce the burden of individual accountability and opportunities for corrupt practices. In many countries, the corruption issue is very serious and regulatory regimes must be designed to keep regulatory discretion to a minimum, e.g. by relying more on potential competition, by making regulations very simple and automatic, and making regulatory decisions transparent (reasons to be given) and justiciable. Autonomous anti-corruption agencies, such as in Botswana, Sri Lanka and Singapore, can contribute to clean regulation.