Regulatory governance and Chile's 1998-99 electricity shortage

In the early 1980s Chile reformed its electricity sector, introducing a regulatory framework that became influential worldwide. But in 1998 and 1999 La Ni?a brought one of the worst droughts on record, causing a price system collapse, random power outages, and three-hour rotating electricity cuts. The authors study the interaction between regulatory incentives and governance during the 1998-99 electricity shortage, showing that the supply restriction could have been managed without outages. The shortage can be blamed on a rigid price system, which was unable to respond to large supply shocks, and on deficient regulatory governance, which led to a weak regulator unable to make the system work. The authors also show that the regulator's weakness stemmed not from lack of formal powers but from vulnerability to lobbyists and a lack of independence. Moreover, the regulator seems not to have fully understood the incentives in the price system during supply restrictions. The authorsconclude that the Chilean shortage shows the limitations of a rigid price system requiring heavy regulatory intervention. This suggests that countries whose governance structures are ill suited to dealing with loopholes left by the law should rely as much as possible on market rules that clearly allocate property rights ex ante and leave the terms of contracts to be freely negotiated by private parties.Water Conservation,Environmental Economics&Policies,Economic Theory&Research,Markets and Market Access,Labor Policies,Environmental Economics&Policies,Markets and Market Access,Access to Markets,Economic Theory&Research,Montreal Protocol

Liquidity and the Simple Industrial Organization of Stock Exchanges

It is usually thought that network externalities, which are inherent to liquidity, make it desirable to concentrate transactions in one stock exchange. This paper shows that when the value of liquidity stems from the ability of potentially reach as many traders as possible, the market is integrated when every broker meets every other broker in at least one exchange. Thus, fragmentation is not about trades being executed in different exchanges but of connectedness among brokers. An implication of this distinction is that in an integrated market the network externality created by liquidity becomes pecuniary and the optimal number of exchanges depends only on the shape of the (physical) technology to execute trades—whether it exhibits increasing, constant or decreasing returns to scale—as in any standard industry. We characterize the planner’s allocation and compare it with that reached by a monopoly. It is shown that when exchanges are natural monopolies a particular ownership structure of the exchange and allocation of voting rights over the exchange fee achieve the planner’s optimum. With decreasing returns to scale the Walrasian allocation is eficient, provided that the market is integrated. Nevertheless, with few exchanges the price-taking assumption is suspect. If exchanges are not price takers, there are many other equilibria, all of them ineficient. Moreover, there are reasons to doubt that the market will become integrated. Fragmentation softens price competition between exchanges and may help a monopolist exchange to erect a barrier to entry even when he has no cost advantage.Brokerage, exchange fee, fragmentation, liquidity, network externality

The Basic Public Finance of Public-Private Partnerships

Public-private partnerships (PPPs) cannot be justified because they free public funds. When PPPs are desirable because the private sector is more efficient, the contract that optimally trades demand risk, user-fee distortions and the opportunity cost of public funds is characterized by a minimum revenue guarantee and a cap on the firm's revenues. Yet income guarantees and revenue sharing arrangements observed in practice differ fundamentally from those suggested by the optimal contract. The optimal contract can be implemented via a competitive auction with realistic informational requirements; and risk allocation under the optimal contract suggests that PPPs are closer to public provision than to privatization.Bundling, cost of public funds, subsidies, minimum revenue guarantees,revenue and profit caps, Demsetz auctions

Competition In or For the Field: Which Is Better?

A principal, who wants prices to be as lowas possible, contracts with agents who would like to charge the monopoly price. The principal chooses between a Demsetz auction, which awards an exclusive contract to the agent bidding the lowest price (competition for the field) and having two agents provide the good under (imperfectly) competitive conditions (competition in the field). We obtain a simple sufficient condition showing unambiguously which option is best. The condition depends only on the shapes of the surplus function of the principal and the profit function of agents, and is independent of the particular duopoly game played ex post. We apply this condition to three canonical examples -- procurement, royalty contracts and dealerships -- and find that whenever marginal revenue for the final good is decreasing in the quantity sold, the principal prefers a Demsetz auction. Moreover, a planner who wants to maximize social surplus also prefers a Demsetz auction.Demsetz auction, Double marginalization, Franchising, Joint vs. separate auctions, Monopoly, Procurement, Dealerships, Royalty contracts

The economics of infrastructure finance: Public-Private Partnerships versus public provision

We examine the economics of infrastructure finance, focusing on public provision and Public-Private Partnerships (PPPs). We show that project finance is appropriate for PPP projects, because there are few economies of scope and because assets are project specific. Furthermore, we suggest that the higher cost of finance of PPPs is not an argument in favour of public provision, since it appears to reflect the combination of deficient contract design and the cost-cutting incentives embedded in PPPs. Thus, in the case of a correctly designed PPP contract, the higher cost of capital may be the price to pay for the efficiency advantages of PPPs. We also examine the role of government activities in PPP financing (e.g. revenue guarantees, renegotiations) and their consequences. Finally, we discuss how to include PPPs revenue guarantees and the results of PPP contract negotiation in the government balance sheet.Fiscal accounting; PPP premium; Project finance; Renegotiations; Revenue guarantees; Special Purpose Vehicule

Renegotiation Without Holdup: Anticipating Spending and Infrastructure Concessions

Infrastructure concessions are frequently renegotiated after investments are sunk, resulting in better contractual terms for the franchise holders. This paper offers a political economy explanation for renegotiations that occur with no apparent holdup. We argue that they are used by political incumbents to anticipate infrastructure spending and thereby increase the probability of winning an upcoming election. Contract renegotiations allow administrations to replicate the effects of issuing debt. Yet debt issues are incorporated in the budget must be approved by Congress and are therefore subject to the opposition’s review. By contrast, under current accounting standards the obligations created by renegotiations circumvent the budgetary process in most countries. Hence, renegotiations allow incumbents to spend more without being subject to Congressional oversight.Build-Operate-and-Transfer (BOT), Concessions, Renegotiation, Public-Private Partnerships

Toll Competition Among Congested Roads

A growing number of roads are currently financed by the private sector via Build-Operate-and -Transfer (BOT) schemes. When the franchised road has no close substitute, the government must regulate tolls. Yet when there are many ways of getting from one point to another, regulation may be avoided by allowing competition between several franchise owners. This paper studies toll competition among private roads with congestion. The paper derives two main results. First, we find sufficient conditions for the existence of an equilibrium in pure strategies with strictly positive tolls. Equilibrium congestion is less than optimal, which runs counter to what is expected form price competition. While a lower toll reduces the out-of-pocket cost paid by a user, it increases the congestion cost thereby reducing the drivers' willingness to pay for using the road. Franchise holders partially internalize congestion costs when setting tolls, which softens price competition. Second, when demand and the number of roads increase at the same rate, tolls converge to the socially optimal level -- that is, in the limit equilibrium tolls are just enough to make each driver internalize the congestion externality.

Highway Franchising and Real Estate Values

It has become increasingly common to allocate highway franchises to the bidder that offers to charge the lowest toll. Often, building a highway increases the value of land held by a small group of developers, an effect that is more pronounced with lower tolls. We study the welfare implications of highway franchises that benefit large developers, focusing on the incentives developers have to internalize the effect of the toll they bid on the value of their land. We study how participation by developers in the auction affects equilibrium tolls and welfare. We find that large developers bid more aggressively than construction companies that own no land. As long as land ownership is sufficiently concentrated, allowing developers in the auction leads to lower tolls and higher welfare. Moreover, collusion among developers is socially desirable. We also analyze the case when the franchise holder can charge lower tolls to those buying her land ('toll discrimination'). Relative to uniform tolls, discrimination decreases welfare when land is highly concentrated, but increases welfare otherwise. Finally, we consider the welfare implications of subsidies and bonuses for proposing new highway projects.Demsetz auctions, highway concessions, private participation in infrastructure

Renegotiation without Holdup: Anticipating Spending and Infrastructure Concessions

Infrastructure concessions are frequently renegotiated after investments are sunk, resulting in better contractual terms for the franchise holders. This paper offers a political economy explanation for renegotiations that occur with no apparent holdup. We argue that they are used by political incumbents to anticipate infrastructure spending and thereby increase the probability of winning the upcoming election. Contract renegotiations allow administrations to replicate the effects of issuing debt. Yet debt issues are incorporated in the budget, must be approved by Congress and are therefore subject to the opposition's review. By contrast, under current accounting standards the obligations created by renegotiations circumvent the budgetary process in most countries. Hence, renegotiations allow incumbents to spend more without being subject to Congressional oversight.Build-operate-and-transfer (BOT), Concessions, Renegotiation, Public-private partnerships