“the effects of regulatory agencies of sub-saharan electricity companies on social welfare,” by...

8/10/2019 The Effects of Regulatory Agencies of Sub-Saharan Electricity Companies on Social Welfare, by Henri Atangana

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THE JOURNAL OF ENERGY

AND DEVELOPMENT

Henri Atangana Ondoa and

Achille Jean Baptiste Nsoe Nkouli,

The Effects of Regulatory Agencies

of Sub-Saharan Electricity Companies

on Social Welfare ,

Volume 39, Number 1

Copyright 2014


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THE EFFECTS OF REGULATORY AGENCIES OFSUB-SAHARAN ELECTRICITY COMPANIES

ON SOCIAL WELFARE

Henri Atangana Ondoa and Achille Jean Baptiste Nsoe Nkouli *

In Sub-Saharan Africa, regulation of the post-reform energy sectors is a prioritysince regulatory agencies for the electricity sector have been established in*Henri Atangana Ondoa earned his Ph.D. in economy at the University of Yaound e II (Cameroon)

in collaboration with the African Economic Research Consortium (AERC). He is a lecturer at theFaculty of Economics and Management of the University of Yaound e II and a researcher at theUniversitys Centre of Studies and Research in Economics and Management (CEREG). His research

specializations include public economics, econometrics, impact assessments, effectiveness/efficiency, and development economics. The author has taken part in numerous impact assessments (with the UNDP,International Development Research Centre, Economic Commission for Africa, AFROBOTER, and RioTinto Alcan) in addition to holding internships with the International Monetary Fund, UNCTAD, and AERC. He worked with SECOR Canada on the estimation of socio-economic effects related to theexpansion of ALUCAM group activities in Cameroon and on the UNDPs capacity assessment of Cameroonian institutions. His articles have been published in Economics Bulletin, African Development Review, African Journal of Economic Policy , and UNCTAD Virtual Institute Quarterly Newsletter .

Achille Jean Baptiste Nsoe Nkouli obtained a masters degree in economy, mathematics, and econometrics from the University of Yaound e II; his Ph.D. thesis was on the performance of the electricity

industry in Sub-Saharan Africa. He is an economist in Cameroons Ministry of Economy, Planning and Regional Development, where he evaluates the power sectors investment climate, improvement factors,and transaction costs as part of the ministrys competitiveness committee. Previously, the author wasresponsible for economic and statistical studies at Cameroons power utility (AES-SONEL) and worked as a consultant on several energy projects at the national level (Electricity Sector Development Plan inCameroon) as well as at the sub-regional level (the Central African Power Pool) and continent-wide. Theauthor was Cameroons focal point during the consolidation of the Association of Power Utilities of Africa database. He holds professional certificates from SNC LAVALIN/Hydro QUEBEC in the field of electricity planning and pricing and is an associate researcher at CEREG.

The Journal of Energy and Development , Vol. 39, Nos. 1 and 2Copyright 2014 by the International Research Center for Energy and Economic Development(ICEED). All rights reserved.

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various countries. These regulatory agencies were created because it is still be-lieved they improve performance by leading to higher investment, productivity,and service coverage and quality. Another reason is that effective regulation, in-cluding the setting of adequate tariff levels, is the most critical enabling conditionfor infrastructure reform. Through regulatory agencies the governments protectthe interests of both investors and consumers and attract the long-term privatecapital needed to secure adequate, reliable infrastructure services and to gainsocial support for reforms. Regulation agencies clarify and allocate propertyrights, sensibly assuming that private investors would not be subject to regula-tory opportunism. 1 However, some authors have shown that regulation alwaysleads to socially sub-optimal outcomes because of inefficient bargaining be-tween interest groups over potential utility rents. 2 Regulation is also subject topolitical capture; indeed, political capture may cause a much greater threatthan the capture of producer groups outside of the political system. Where po-litical capture occurs, the regulatory goals are distorted to pursue political ends.Under political capture, regulation becomes a tool of self-interest within gov-ernment or the ruling elite. 3

In the electricity market, the focus of regulation is to prevent anti-competitiveabuses of market power, i.e., to balance the interests of suppliers with those of their captive customers. 4 For instance, they should satisfy both suppliers and customers. Indeed, prices should be set at a level that allows energy providers to

recover the long-run marginal cost of delivering the service, including a fair return on investment. 5 More specifically, regulatory agencies are expected to settariffs that are in line with efficient costs, to ensure that minimum quality-of-service standards are met, and to enforce the targets for connection of newcustomers imposed by the governments. According to F. Steiner, electricitymarket reforms generally induced a decline in the industrial price while the pricedifferential between industrial customers and residential customers increased;this indicates that industrial customers benefit more from the reform. 6 Electricitymarket reforms must also encourage an increase in electricity access rates in

rural areas.Despite the reforms undertaken in the energy sector, electricity crises are one of the main problems in Africa. For instance, Sub-Saharan Africa has an electrifi-cation rate of 30.7 percent and by far the lowest rate (66.2 percent) in urban areas.The situation is worse in rural areas where the rate of electrification is 16 percent.In addition, according to the World Bank, only 50 percent of the Sub-SaharanAfrica population will have access to electricity by 2030. 7 The consequences of this energy shortage on social welfare are very dramatic. Indeed, the proportion of people in Africa still depending on inefficient traditional energy sources is higher

than in any other continent. The dominant source of fuel in low-income Africanhomes is wood, which women and children spend many hours searching for and collecting. Electricity could extend study hours for these school children and free

THE JOURNAL OF ENERGY AND DEVELOPMENT74


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up time for other activities for women. Deforestation associated with land erosionand desertification continues to worsen the desperate need for firewood.

The aim of this paper is to assess the effects of regulatory agencies on socialwelfare in 17 African countries for the period 20002010. Of course, the reg-ulator is of limited value to the users if improvements on the supply side do nottranslate into improvements in the service received by the users. To track this,we adopt the approach developed by A. Estache and M. Rossi. 8 Indeed, theseauthors used three dimensions of social welfare: service coverage, quality of service (frequency of interruptions), and residential tariffs to assess the effectsof regulatory agencies on social welfare. The remainder of the paper is orga-nized as follows: in the first section we present the literature review, next is anoverview of the methodology, and in the last section the results of the study areoffered.

Literature Review

Economic regulation is premised on the existence of significant market failureresulting from economies of scale and scope in production due to informationimperfections in market transactions, the existence of incomplete markets and externalities, and resulting income and wealth distribution effects. It has been

suggested that market failures should be more pronounced and, therefore, makethe case for stronger public regulation in developing countries. 9 J.-J. Laffont has provided a model of regulation for network industries that recognizes the partic-ular structural and institutional characteristics of developing countries and hashighlighted the role of effective regulation in achieving equitable and sustainableexpansion of infrastructure services in the poorest countries of the world. 10 Moregenerally, it is to be expected that both the process and outcomes of a regulatoryregime will be determined by the specific institutional context of an economy, asreflected in its formal and informal rules of economic transacting. 11 By setting the

rules of the game, institutions affect economic development.12

M. Pollitt sug-gests that independent incentive based regulation is the best way forward. 13 For thecompetitive stages of electricity production, requirements are increases in thenumber of firms (perhaps up to five or more actual or potential competitors) and reductions in entry barriers (especially via the removal of legal restrictions onentrants and the monitoring of discrimination in entry conditions set by other stages of production). Increased market size (e.g., through the formation of re-gional markets) and the creation of an independent system operator facilitatecompetition by immediately increasing the number of competitors, reducing entry

barriers, and eliminating the scope for discrimination.Effective regulation achieves the social welfare goals set down by the gov-

ernment for the regulatory authority. In developing countries, the social welfare

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objectives of regulation are likely not to be concerned simply with the pursuit of economic efficiency but with wider goals to promote sustainable developmentand poverty reduction. Efficient regulation achieves the social welfare goals atminimum economic costs. The economic costs of regulation can take two broad forms: the costs of directly administering the regulatory system and the com- pliance costs of regulation. 14 For instance, in the United Kingdom because of regulatory agency there has been a large price reduction in regulated transmissionand distribution charges (30 percent and 50 percent, respectively, between 1993 and 2005) and a trend reduction in overall prices toward the European Union average.Additionally, there has been significant customer switching in all market segments but, particularly, among households where 1.5 percent of households switch per month. The cost of regulation remains low in relation to the total electricity bill and is subject to a revenue cap of retail price index (RPI)-3 percent for each year. 15

The establishment of regulatory agencies before liberalizing the electricitysector results in the easy influence of political powers of such bodies and questions arise regarding the transparency of the existing regulatory frame-work. J. Cubbin and J. Stern show that, in those countries where an independentagency has been set-up, generation capacity has been improved, confirming therelationship between performance of the utility sector and the governance of regulatory institutions. 16 C. Cambini and L. Rondi find that the inception of anindependent regulation agency has a positive impact on the investment de-

cisions of a large panel of public utilities, including energy, telecoms, trans- port, and water companies. 17 The existing literature shows that, the diffusion of independent regulatory agencies (IRAs) in developing countries, coincidingwith the liberalization of utilities, is a case of effective regulation. The es-tablishment of IRAs signals the intention to implement sector reforms, while providing the entity legitimacy with legal backing increases the regulatoryreputation of a country. 18 Strong and effective regulators have control over tariff setting, network access terms, issuing of licenses, setting of deliveryterms, and settling disputes and enforcing punishments, as opposed to having

any of these functions left to government ministers. An important element of independence is the tenure and terms of appointment of heads of regulatoryagencies or commissioners. 19

Development of economic regulation of the power market that is applied transparently by an agency that operates independently from influence of thegovernment, electricity suppliers, or consumers is fundamental. In the whole-sale market, the focus of regulation is to prevent anti-competitive abuses of market power. In the retail market, the focus of regulation should be on bal-ancing the interests of suppliers with the interests of their captive customers. 20

In addition, in a sample of Latin American countries, L. Andres, V. Foster, and J. Guasch find important increases in quality, investment, and labor productiv-ity and a decrease in employment in electricity, telecommunications, and water



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distribution services. 21 Some studies find that the quality of governance and institutions is important in explaining rates of investment, suggesting that oneway in which better governance can improve economic performance is byimproving the climate for capital creation. 22 M. Olson et al. find that pro-ductivity growth is higher in countries with better institutions and quality of governance. 23

However, regulation of markets may not result in a welfare improvementas compared to the economic outcome under imperfect market conditions. In-formation asymmetries, in particular, can contribute to imperfect regulation. Theregulated agent holds the information that the regulator needs to regulate optimallyand the regulator must establish rules and incentive mechanisms to coax this in-formation from the private sector. Given that it is highly unlikely that the regulator will receive all of the information required to regulate optimally to maximize socialwelfare, the results of regulationin terms of outputs and pricesremain second best to those of a competitive market, which centers attention on barriers to en-try. 24 C. Shapiro and R. Willig argue that state ownership provides more infor-mation to regulators than private ownership. 25 So that contracting should be less problematic when the state both owns and regulates. Welfare-improving regu-lation assumes that the regulatory authoritys actions are motivated by the public interest. This has been criticized by public choice theorists who arguethat individuals are essentially self-interested in or out of the public arena and

it is necessary, therefore, to analyze the regulatory process as the product of relationships between different groups. 26 This has been refined in the conceptof regulatory capture, which involves the regulatory process becoming bi-ased in favor of particular interests. L. Andres, V. Foster, and J. Guasch find anambiguous effect of privatization and regulation on prices. 27 This result isalong the lines of theoretical predictions, which point to two effects of reforms:a reduction in price due to an improvement in efficiency and an increase in price due to the elimination of explicit and implicit subsidies and cross-subsidiesoften present in the sectors analyzed. Which of these two effects will dominate

depends on the initial situation and the regulatory environment. Y. Zhang et al.demonstrate that in developing countries privatization and regulation do notnecessarily result in any enhancement of performance without competition. 28

Generally, privatization is associated with greater access to services and lower prices;although, it is sometimes coupled with an increase in competition and in the presenceof independent regulation. C. Fink et al., using International TelecommunicationUnion (ITU) data for 86 developing countries from 19851999, again found that the largest increases in quality appear when privatization is coupled withindependent regulation. 29

Concerning the effects of regulation on prices, F. Steiner found that regulationis not associated with lower prices but is associated with a lower industrial toresidential price ratio and higher capacity utilization rates and lower reserve



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margins. 30 T. Hattori and M. Tsutsui found that, first, certain reforms like regu-lations are likely to lower the industrial price, meanwhile they increase the pricedifferential between industrial and household customers. 31 They also concluded that the unbundling of generation did not necessarily lower the price and may have possibly resulted in higher prices. According to these authors, a large share of private ownership lowers the industrial price but may not alter the price ratio be-tween industrial and household customers. In addition, although liberalization asa form of regulation lowers prices, costs, price-cost margins, and provides reliableand secure supply, liberalized markets increase price volatility. 32 Other factors, not properly accounted for, such as fossil fuel price movements, technological in-novations, and changes to regulatory practices are more likely to lead to pricereductions than if reforms had not taken place. 33 C. Fiorio et al. rejected the pre-diction that privatization and regulation lead to lower prices or to increased con-sumer satisfaction. 34 They also found that country specific features tend to havea high explanatory power and the progress toward the reform paradigm is notsystematically associated with lower prices and higher consumer satisfaction.Furthermore, state ownership is associated with inadequate incentives to gather and use this information to maximize economic welfare. In other words, there tends to be a tradeoff between state ownership reducing the information asymmetries and,hence, transaction costs of regulation plus the relative incentives under statecontrol and private ownership for agents to maximize economic efficiency. 35

In the context of Africa, it was found that regulation is being examined as partof individual sector initiatives, but these efforts are uncoordinated, and imple-mentation is being left to follow privatization instead of being put in place con-currently. 36 A similar pattern of regulatory weaknesses can obviously be discerned for individual countries. South Africas proliferation of regulatory bodies is as-sociated with a lack of clarity about roles and responsibilities and with theadoption of policy-making roles independent of government. 37 In Malawi, theelectricity industry regulator remains closely connected to the state electricityindustry, compromising any notion of real regulatory independence and en-

couraging capture. Furthermore, in many countries and especially in Africa,incumbent firms remain dominant for both generation and supply markets and further structural reform seems necessary if the theoretical conditions uponwhich successful reform is based are to be achieved in electricity markets. 38

A. Estache and M. Rossi analyzed the impact of change in ownership on labor productivity and prices in Latin America. 39 They also evaluated how the differentregulatory environments affected these outcomes. They found that private firmsuse significantly less labor to produce a given bundle of output than public firms inthe region. Using similar data, M. Rossi also analyzed the firms operating and

maintenance expenses.40

He found that these costs did not change significantlyafter the reform and argued that outsourcing, in part, might bias the results for thedecrease in labor usage and labor productivity.



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Methodology

Two main strategies have emerged for estimating the effect of regulation onsocial welfare. For the first strategy, W. Megginson et al. used differences inmeans and medians before and after reforms and then tested the statistical sig-nificance of those differences. 41 This strategy attempts to isolate the effect of reform over time using panel data techniques. 42 These studies correct for omitted-variable bias and consider initial conditions of companies. These authors an-alyzed several partial measures of social welfare: employment, output, and coverage. 43 The strategy stems from the treatment literature. 44 This method uses a dummy variable equal to 1 for the post reform period and then tests thestatistical significance of the coefficient on the dummy variable as well as thatof different interaction terms that include the dummy variable. In the context of a panel, most impact studies use a difference-in-differences technique to ac-count simultaneously for the difference between periods before and after anevent and for one between treatment and control groups. 45 The second strategyis the general method of moments that uses lagged levels of the dependent and predetermined variables as instruments for the differenced equation becausecertain independent variables are endogenous. For this reason, we will use thesecond approach in this study.

Data Source and Descriptive Analysis: Data used in this study come from theAssociation of Power Utilities of Africa (APUA) and the World Bank. The APUAdataset provides statistics on the main variables used in this study for 17 Africancountries for the 20002010 period: Angola, Benin, Botswana, Cameroon, Republicof Congo, C ote dIvoire, Ethiopia, Gabon, Ghana, Kenya, Mozambique, Nigeria,Senegal, Sudan, Togo, Zambia, and Zimbabwe. Table 1 provides an overview of theelectricity situation in these nations as of 2010, along with a comparison to their North African neighbors. One can see the challenges facing many nations, par-ticularly in regard to their low levels of rural electrification.

We will now be presenting the descriptive statistics of the situation for our panelof countries (see table 2). The estimates show important improvements in the servicequality. In fact, although the growth rate of the number of service interruptions per month has increased (0.4 percent), the growth rate of waiting times to be con-nected has decreased (69 percent). The descriptive statistics also show theexpansion of the network (6 percent) but the operational installed capacity hasdecreased (2 percent). The consequences of the network extension on energy pro-duced are very positive since the growth of energy losses is 14 percent and 6 percentfor energy sold. The consequences of the growth of energy produced on social welfare

are also positive since the net increase in the number of connections is approximately6 percent and the average annual increase of electrification rate in rural areas is8 percent during the period 20002010. It is also important to note that the average



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Table 2DESCRIPTIVE STATISTICS FOR 17 AFRICAN NATIONS, 20002010 a

Variable Obs. Mean Std. Dev. Minimum Maximum

Energy losses 187 1.01e+09 1.31e+09 7.45e+07 8.09e+09

Operational installed capacity 187 689,024.7 637,124.6 7,191.8 2,981,849

Length of distribution network (in kilometers) 187 294,027.9 320,014 3,500 1,687,972

Number of employees 187 3,399.6 5,570.7 147 30,642

Number of customers 187 9,204,519 1.57e+07 557,022 8.06e+08

Total electricity sold (in kilowatthours) 187 5.13e+09 4.40e+09 5.00e+08 2.16e+10

Average residential tariff (in U.S. dollars?) 187 814.17 4,934.72 1.41 39,454.28

Number of interruptions per month 187 20.77 12.21 3.24 56.46

Waiting time to be connected (in days) 187 111.74 53.26 55 270

Pools 187 0.59 0.49 0 1

Tax rate on energy sold 187 56.47 61.31 14.4 339.7

% of electricity produced by petroleum (EP) 187 0.42 0.34 0.08 100

% of electricity produced byhydropower (EH) 187 0.60 0.34 0 99.92

GDP per capita (in U.S. dollars) 187 1,419.16 1,966.67 104.81 10,021.87

Independent regulatory agencies(IRAs) 187 0.53 0.50 0 1

IRAs for electrification in ruralareas 187 0.41 0.49 0 1

Privatized companies 187 0.53 0.50 0 1

Electrification rate in rural area 187 10.39 10.18 1 51

Number of energy sources 187 2.29 0.96 1 5

(continued)



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growth rate of installed operational capacity are estimated at 8 percent and 1.7

percent, respectively, for the electricity companies under the control of IRAs.These two growth rates exceed those of electricity companies under the control of ministries. But, the effects of IRAs on employment are negative: 6.8 percent of

Table 2 (continued)DESCRIPTIVE STATISTICS FOR 17 AFRICAN NATIONS, 20002010

a


Corruption index 187 2.78 0.54 2 4

Respect of environmental index 187 5.41 9.63 2 63.2

Growth rate of electrification inrural areas 170 0.08 1.57 3.93 3.47

Growth rate of electricity produced by hydropower 170 0.02 0.16 0.71 0.52

Growth rate of electricity

produced by petroleum 170 0.01 0.44 2.88 2.70Growth rate of GDP per capita 170 0.04 1.43 3.95 4.36

Growth rate of tax on energy sold 170 0.06 0.09 0.29 0.37

Growth rate of number of employees 170 0.02 1.97 3.24 5.06

Growth rate of network length 170 0.06 0.31 0.02 2.47

Growth rate of installed capacity 170 0.02 0.16 0.71 0.52

Growth rate of energy losses 170 0.14 0.68 5.86 1.58

Growth rate of number of connections 170 0.06 0.06 0.07 0.32

Growth rate of energy sold 170 0.06 0.30 1.02 2.37

Growth rate of tariffs 168 0.08 1.00 1.82 4.11

Growth rate of electricityinterruptions 170 0.004 0.308 0.991 1.482

Growth rate of waiting time to beconnected 170 0.69 4.63 0.193 30

a The 17 countries include Angola, Benin, Botswana, Cameroon, Republic of Congo, C ote dIvoire,Ethiopia, Gabon, Ghana, Kenya, Mozambique, Nigeria, Senegal, Sudan, Togo, Zambia, and Zimbabwe;Obs. = number of observations; Std. Dev. = standard deviation; and GDP = gross domestic product.

Source: Authors estimations.



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Table 3THE EFFECTS OF INDEPENDENT REGULATORY AGENCIES ON CERTAIN INDICATORS

OF PERFORMANCE AND SOCIAL WELFARE FOR 17 AFRICAN NATIONS, 20002010 a


Presence of independent regulatory agency



Growth rate of network 90 0.080 0.190 0.556 0.534

Growth rate of employees 90 0.068 0.084 0.201 0.271

Growth rate of connections 90 0.046 0.033 0.024 0.129Growth rate of energy sold 90 0.058 0.083 0.120 0.303


Growth rate of number of interruptions 90 0.004 0.263 0.991 1.077

Growth rate of waiting time to be connected 90 0.359 3.933 17 20

Growth rate of electricity rate in rural areas 90 0.088 0.223 0 1.299

Absence of independent regulatory agency



Growth rate of network 80 0.048 0.377 1.019 2.367

Growth rate of employees 80 0.072 0.110 0.455 0.399

Growth rate of connections 80 0.066 0.071 0.075 0.323

Growth rate of energy sold 80 0.066 0.102 0.299 0.373


Growth rate of number of interruptions 80 0.003 0.346 0.806 1.483

Growth rate of waiting time to be connected 80 0.986 5.481 19 30

Growth rate of electricity rate in rural areas 80 0.073 0.142 0 0.693

a The 17 countries include Angola, Benin, Botswana, Cameroon, Republic of Congo, C otedIvoire, Ethiopia, Gabon, Ghana, Kenya, Mozambique, Nigeria, Senegal, Sudan, Togo, Zambia,

and Zimbabwe; Obs. = number of observations; and Std. Dev. = standard deviation.Source: Authors estimations.



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employment growth for the electricity companies under the control of IRAs versus7.2 percent for the others. By having an independent monitoring of the performanceof operators, the creation of a regulatory agency increases the accountability for thequality and quantity of service, thereby reducing the scope for inefficient employment levels. Thus, the creation of a regulatory agency allows public operators torun employment decisions much more in line with a profit-maximizing criteria,which leads to a reduction in labor requirements. The introduction of a regulator would push private operators to minimize costs and, hence, to reduce employment.

However, the effects of IRAs on social welfare are negative. In fact, the elec-trification rates are relatively low in countries that have created IRAs. In addition,the quality of service is improving slowly in these nations while it is improving athigher rates in other countries. It should be noted that the price of electricity isrelatively high in nations that have an IRA. The result can be explained by the factthat regulatory agencies are expected to set tariffs that are in line with efficient costs,to ensure that minimum quality-of-service standards are met, and to enforce thetargets for the connection of new customers.

Econometric Analysis: In this study, our variable of interest is regulation and inour sample certain countries (9 in 17) that have created independent regulatoryagencies. The countries with IRAs are Cameroon, C ote dIvoire, Ethiopia, Kenya,Senegal, Sudan, Togo, Zambia, and Zimbabwe; those without are Angola, Benin,

Botswana, Democratic Republic of Congo, Gabon, Ghana, Mozambique, and Nigeria. In this perspective, we consider that the governments choose whether tointroduce a regulatory agency and that choice may be correlated to unobservablefactors that also affect social welfare. If Y it is the natural logarithm of the outputsof interest (an indicator of coverage, the quality of services) for firm i; X it is a set of regressors; Dit is a dummy variable that takes the value of one if firm i operates under the control of a regulatory agency during period t ; a i is a time-invariant firm effect;u t is a time effect common to all firms in period t ; and e it is a firm time-varyingerror distributed independently across firms and time, and independently of all a i

and u t . The parameter of interest, F , is the difference-in-differences estimate of theaverage effect of introducing a regulatory agency on the outputs of interest; therelation is given in equation (1).

Y it F Dit l X it a i ut e it 1

Following A. Estache and M. Rossi, we use three indicators of social welfare: 46

First, the quality of services are approximated here by two variables: the fre-quency of interruption of the electricity service (number of interruptions per

month) and the number of days spent while waiting for a connection = number of days that elapse between the date of application for a connection and the effectivedate of connection.



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Second, the access to the service is measured by the coverage rate, approxi-mated here by three variables: total electricity sold (in kilowatt hourskWh), totalnumber of connections or customers, and electrification rate in rural areas.

Third, the last indicator is the average residential tariff (giving a sense of theaffordability of the service provided).

The use of energy sold as a measure of output might bias our estimates if the presence of a regulatory agency is correlated with energy losses. Indeed, network losses reflect the quality of the network system in terms of how much power is lostin the transformers and during distribution and how much power is uncounted dueto other reasons, such as illegal use. Technical losses are related to the square of the distance transmitted and, hence, our econometric model captures them. Our main concern is related to non-technical losses associated with illegal use. In order to address the problem of whether including network losses have any impact onthe estimated coefficients, we replace sales by sales + energy losses.

For the regressors, we use the length of distribution network in kilometers(km), the total number of employees, the operational installed capacity, a dummyvariable that takes the value of one if the firm is under the control of a regulatoryagency, a dummy variable that takes the value of one if the firm is privatized,a dummy variable that takes the value of one if the firm is in a pools market, and a dummy variable for a regulatory agency for rural areas. We also have infor-mation on a set of country-level covariates including corruption, as measured by

the corruption index produced by the International Country Risk Guide, whichranges between six (for highly clean) and zero (for highly corrupt). We includecountry-level corruption and its interaction with the regulatory agency as addi-tional controls. But even after controlling for corruption, a concern is that theremay be other country characteristics that are correlated with both labor efficiencyand the presence of a regulatory agency. To address this concern, we control for a number of observed country-level time-varying characteristics such as the per-centage of electricity produced by petroleum, the tax rate on energy sold, and the percentage of electricity produced by hydropower sources. The summary statistics

are presented earlier in table 2.To estimate equation (1), one can use the generalized method of moments(GMM) of several variables (number of employees, installed capacity, length of distribution network, and other endogenous factors). However, there are twoimportant points to be made about using the system GMM. First, because systemGMM uses more instruments than the difference GMM, it may not be appropriateto use system GMM with a dataset with a small number of countries. Moreover,one must recall that when the number of instruments is greater than the number of countries, the Sargan test may be weak. In this study, we have only 17 countries.

Second, in a panel with fixed effects, including the equation in levels requiresa new assumption that the first-differenced instruments used for the variablesin levels should not be correlated with the unobserved country effects. Linear



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dynamic panel-data models include lags of the dependent variable as covariatesand contain unobserved panel-level effects, fixed or random. By construction, theunobserved panel-level effects are correlated with the lagged dependent variables,making standard estimators inconsistent. M. Arellano and S. Bond derived one-step and two-step GMM estimators using moment conditions in which lagged levels of the dependent and predetermined variables were instruments for thedifferenced equation. 47 R. Blundell and S. Bond show that the lagged-level in-struments in the ArellanoBond estimator become weak as the autoregressive process becomes too persistent or the ratio of the variance of the panel-level effectto the variance of the idiosyncratic error becomes too large. 48 Building on the work of M. Arellano and O. Bover, R. Blundell and S. Bond proposed a system esti-mator that uses moment conditions in which lagged differences are used as in-struments for the level equation, in addition to the moment conditions of lagged levels, as instruments for the differenced equation. 49 A useful feature of Blundelland Bond/Arellano and Bover is the ability to specify, for GMM-style instruments,the limits on how many lags are to be included.

Results

The econometric results are presented in table 4. They do not present any

problem since the Wald statistic is high as are the Sargan test numbers; the timedummies are statistically significant in all models.The coefficient of the regulatory agency is negative and statistically significant.

The countries that have created an IRA connect about 12 percent fewer customersfor a given level of electricity (column I) and have 5 percent more electricity in-terruptions (column II). In addition, the rate of electricity in rural areas is relativelylow in countries that have created an IRA. The coefficients of privatization (anaspect of regulation) are also negative (column I), i.e., the private participation hasa negative impact on the electrification rate. In particular, the regulatory agency

remains positively associated with high tariffs and waiting time for the first con-nection. Furthermore, corruption may divert managerial effort away from the productive process, and the way for firms to meet their service obligations is to usemore inputs. Additionally, a regulatory agency might have a different impactaccording to the countrys level of corruption. For instance, in column IV, thecoefficient of the interaction variable corruption and IRA is positive, indicating thatmore corruption in the country is associated with poor quality of services. Theseresults suggest that regulatory agencies have a negative impact on social welfare,a result that is likely to weaken improvements in cost-recovery efforts and tariff

rebalancing associated with the typical mandate assigned to independent regulators.Several studies have justified these results. For instance, S. Wallsten showed

that privatization is associated with greater access to services and lower prices,



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Table 4ECONOMETRIC RESULTS OF THE EFFECTS OF REGULATION ON SOCIAL WELFARE a

(Dependent variables: I = number of connections; II = number of interruptions per month; III = energy produced; IV = waiting time to be connected;

V = tariffs; and VI = electrification access in rural areas)

Variables I II III IV V VI

L.d Number of customers 0.229**

(0.122)

% of electricity produced by hydropower

0.0031 0.0381 0.191* 0.0674 0.704 0.0827(0.0113) (0.133) (0.108) (0.0866) (0.506) (0.339)

% of electricity produced

by petroleum

0.0052 0.0068 0.0117 0.253* 0.399***

(0.0405) (0.0241) (0.0230) (0.136) (0.0852)

Gross Domestic Product0.0103 0.141* 0.133*** 0.0356 0.733*** 0.229

(0.0077) (0.0776) (0.0497) (0.0477) (0.272) (0.166)

Tax rate 0.0078 0.248** 0.206*** 0.166*** 0.0848 1.162***(0.0125) (0.102) (0.0423) (0.0629) (0.172) (0.133)

Number of employees0.0132* 0.224*** 0.114*** 0.0415** 0.0971 0.0454(0.0068) (0.0549) (0.0253) (0.0186) (0.109) (0.0773)

Operational installed

capacity

0.354*** 0.460*** 0.0102 0.418*** 0.119

(0.0690) (0.0286) (0.0270) (0.141) (0.0944)

Pool 0.0711 0.0167 0.183*** 0.321 1.098***(0.125) (0.0735) (0.0679) (0.402) (0.271)

Corruption 0.0863 0.497** 0.783*** 0.192 1.008***(0.218) (0.199) (0.0999) (0.400) (0.228)

Independent regulatoryagency (IRA)

0.120*** 0.055*** 0.565** 0.388*** 0.0282** 0.218***(0.0302) (0.0306) (0.254) (0.133) (0.052) (0.407)

IRA for rural areas(IRARUA)

0.0509* 1.760** 0.360*** 2.047*** 0.573 0.417(0.0271) (0.723) (0.101) (0.284) (0.598) (0.375)

(corruption)* (IRA)0.241 0.565***

(0.288) (0.115)

(corruption)*(IRARUA)

0.529***(0.202)

Privatization 0.144*** 0.0164 0.0144

(0.0484) (0.0276) (0.0256)

_Ianne_20040.0088 0.530*** 0.296** 0.979 1.061**

(0.0327) (0.128) (0.129) (0.700) (0.435)

(continued)



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Table 4 (continued)ECONOMETRIC RESULTS OF THE EFFECTS OF REGULATION ON SOCIAL WELFARE

a

(Dependent variables: I = number of connections; II = number of interruptions per month; III = energy produced; IV = waiting time to be connected;

V = tariffs; and VI = electrification access in rural areas)

Variables I II III IV V VI

_Ianne_2005 0.0544* 0.893*** 0.622*** 0.0131 2.210*** 0.188(0.0287) (0.291) (0.131) (0.126) (0.822) (0.479)

_Ianne_2006 0.0029 1.436*** 1.029*** 0.153 2.710*** 0.560(0.0272) (0.293) (0.124) (0.103) (0.809) (0.399)

_Ianne_20070.0174 1.176*** 1.284*** 0.0201 2.581*** 0.176

(0.0286) (0.291) (0.141) (0.112) (0.809) (0.411)

_Ianne_20080.280 1.039*** 0.0757 1.586 0.0675

(0.315) (0.169) (0.152) (1.020) (0.591)

_Ianne_20090.0148 0.244 0.879*** 0.186 2.694*** 0.137

(0.0346) (0.292) (0.155) (0.139) (0.925) (0.539)

_Ianne_2010 0.0398 0.857** 1.247*** 6.203***(0.0380) (0.371) (0.120) (0.712)

L.d Number of

interruptions per month

0.350***

(0.0844)L.dlenergy (energy

sold+energy losses) 0.601***

(0.0631)

L.dlwaiting time to beconnected

0.460***(0.0454)

L.ltariffs 0.206***

(0.0423)

L.dlrate of electrification

in rural areas

0.166*

(0.0853)

Constant0.124*** -0.454 7.977*** 2.539*** 10.95*** 0.243(0.0400) (0.807) (2.098) (0.663) (3.692) (2.280)

Observations 170 170 170 170 170 170

Number of pay 17 17 17 17 17 17

Wald Chis2 305(.000) 3296(0.00) 393(0.00) 1253(0.000) 255(0.000) 591(0.00)

Sargan test 40(0.016) 56(0.000) 58(0.00) 68(0.000) 51(0.01) 60(0.000)

a *** = p < 0.01; ** = p < 0.05; and * = p < 0.1.Source: Authors estimations.



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although only when privatization is coupled with an increase in competition and inthe presence of independent regulation. 50 In Africa, certain countries have IRAs, but the electricity market is open to competition. Additionally, in the electricitysector, operational control is transferred to private operators in certain countrieswhile ownership of the assets remains with the state. One reason for the lack of divestitures in the electricity sector may be that selling public energy assets tothe private sector is politically sensitive. Another is that energy, in particular, isunderpriced relative to the marginal cost of supply; investors may well be awareof this and, therefore, be reluctant to take on the full risk of ownership, given thehistoric reluctance of governments to pay or to allow cost-recovery tariffs. 51 Thequality of IRAs is also questioned in Africa since R. Bacon and J. Besant-Jonesfind few good agencies in this continent. 52 Furthermore, only a few countries(South Africa, Ghana, Cameroon, and Nigeria) introduced a substantial reform program in their electricity industries.

Concerning the control variables, our estimations show that GDP per capitais positively associated with energy produced and the number of electricityinterruptions but negatively associated with tariffs. There are two possibleexplanations for these results. First, the positive correlation between GDP per capita and interruptions of electricity can be explained by the fact that coun-tries with higher levels of GDP per capita are relatively industrialized and these industries exert a significant pressure on the network. Second, in certain

African countries, where below-cost pricing of essential utility services is welldocumented, higher tariffs for all but the poorest households are often recom-mended as part of reform, to give a utility adequate resources to address shortfallsin service. The result may point to the economic and political difficulties of aligning tariffs with the costs of service provision. Its implications for revenuestreams call into question the sustainability of private involvement unless there areexplicit subsidy payments.

Operational capacity increases tariffs and energy sold but the frequency of interruptions decreases with operational capacity. One possible explanation is

that services are initially so underpriced that even significant efficiency gainsdo not produce a financial equilibrium or justify lower prices for certain privateelectricity companies. Instead, the efficiency gains translate into better oper-ational performance, such as reductions in distribution losses, and the gov-ernment spends less subsidizing its utilities. Another explanation may be thatthe private operator reaps all the gains through profits. Given the young reg-ulatory environments in developing countrieswhich often lack sufficientcapacity for supervising public-private contractsthis possibility needs to beconsidered.

In this study, it is shown that the electrification rate in rural areas is posi-tively associated with regional integration and the percentage of electricity produced by petroleum. Indeed, in African rural areas, electricity is mainly



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produced by thermal power plants that use oil as the main source of electricity.This mode of production is more expensive. This justifies why tariffs increasewith the percentage of electricity produced by petroleum compared to wind energy. However, despite the positive trends and Africas potential supply of wind energy, installed capacity of wind-based electricity in Africa was onlyabout 1.1 gigawatts in 2010, which does not exceed 0.5 percent of globalcapacity. The disparity between the potential and the extent of exploitationraises questions about constraints to development of wind energy on thecontinent. 53

Regional integration via the creation of an integrated market of electricityshould reduce tariffs and increase the rate of electrification in rural areas. Indeed,regional integration is capable of bringing about additional benefits in terms of reduced capital expenditures, lower electricity supply costs, and the enhancementof the systems reliability compared to the autarkical strategy. 54 Nonetheless, H. Nagayama suggests that neither unbundling nor the introduction of a wholesale pool market on their own necessarily reduces electricity prices. 55 In fact, contraryto expectations, there was a tendency for the prices to rise. He argued, however,coexistent with an independent regulator, unbundling may work to reduce elec-tricity prices.

Conclusion

In this study, we assess the effects of regulatory agencies on social welfare in 17African countries for the period 20002010, with the data of the Association of Power Utilities of Africa (APUA) and the World Bank. Two main methods have been used: descriptive analysis and econometric analysis. The results show that theeffects of regulatory agencies on social welfare are negative because regulation isnot coupled with an increase in competition. But reforms like regional integrationand control of corruption can improve social welfare in the electricity sector. For

these reasons, it is important to note that liberalized markets need regulators, whosecentral task is to make certain that market actors can operate on a level playingfield, have non-discriminatory access to the market, and that abuse of market power is prevented. Regulatory bodies should be free from governmental and politicalinterference as well as the avoidance of capture-seeking behavior by market actors.In this context, transparency is certainly a central aspect. Mobilizing private-sector investment in Africas power sector will strengthen supply conditions in the in-dustry. African authorities need to undertake reforms to dismantle obstacles thatconstrain private investment in the electricity sector. In particular, the regulatory

bodies should reform the tariff structure and remove the subsidies to public power utilities to allow for competitive price setting in the market. Regional integrationcan also be beneficial. Indeed, regional integration creates economies of scale,



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permitting lower costs across all aspects of infrastructure, including the power sector. Finally, African governments should collaborate with their development partners in order to build a reliable power sector.

NOTES 1 F. Bourguignon, M. Klein, and N. Talaat Shafik, Reforming Infrastructure Privatization,

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2 D. Newbery, Privatization, Restructuring and Regulation of Network Industries (Cambridge,Massachusetts: MIT Press, 1999).

3 J. Stiglitz, Private Uses of Public Interests: Incentives and Institutions, Journal of Economic Perspectives , vol. 12, no. 2 (1998), pp. 322.

4

R. W. Bacon and J. Besant-Jones, Global Electric Power Reform, Privatization and Liber-alization of the Electric Power Industry in Developing Countries, Energy and Mining Sector Board Discussion Paper Series no. 2, Washington, D.C., The World Bank, 2002.

5 World Energy Council, Energy Markets: The Challenges of the New Millennium, 18thWorld Energy Congress, Buenos Aires, Argentina, October 2125, 2001.

6 F. Steiner, Regulation, Industry Structure and Performance in the Electricity Supply Industry,OECD Economics Studies no. 32, Paris, OECD, 2001.

7 World Bank, Africa Electrification Initiative (Washington, D.C.: World Bank, 2012).

8 A. Estache and M. A. Rossi, Regulatory Agencies: Impact on Firm Performance and SocialWelfare, World Bank Policy Research Working Paper Series no. 4509, Washington, D.C., World Bank, 2008.

9 J. Stiglitz, op. cit.

10 J.-J. Laffont, Regulation and Development (Cambridge, United Kingdom: Cambridge Uni-versity Press, 2005).

11 D. C. North, Institutions, Institutional Change and Economic Performance (Cambridge,United Kingdom: Cambridge University Press, 1990).

12 World Bank, World Development Report, 2002: Building Institutions for Markets (Wash-ington, D.C.: World Bank, 2002), and D. Rodrik, A. Subramanian, and F. Trebbi, InstitutionsRule: The Primacy of Institutions over Geography and Integration in Economic Development, Journal of Economic Growth , vol. 9, no. 2 (2004), pp. 13165.

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15 M. Pollitt, op. cit.



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16 J. Cubbin and J. Stern, The Impact of Regulatory Governance and Privatization on ElectricityIndustry Generation Capacity in Developing Countries, The World Bank Economic Review , vol.20, no. 1 (2006), pp. 11541.

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19 A. Larsen, L. H. Pedersen, E. M. Sorensen, and O. J. Olsen, Independent Regulatory Au-thorities in Europe, paper presented at the Sustainable Energy Specific Support Action (SESSA) Con-ference on European Regulation Forum on Electricity Reform, Bergen, Norway, March 34, 2005.

20 R. W. Bacon and J. Besant-Jones, op. cit.

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27 L. Andres, V. Foster, and J. Guasch, op. cit.28 Y. Zhang, D. Parker, and C. Kirkpatrick, Electricity Sector Reform in Developing Countries:

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30 F. Steiner, op. cit.

31 T. Hattori and M. Tsutsui, Economic Impact of Regulatory Reforms in the Electricity SupplyIndustry: A Panel Data Analysis for OECD Countries, Energy Policy , vol. 32, no. 6 (2004), pp. 82332.



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32 Ernst and Young, Final Report Research Project: The Case for Liberalisation (London: Ernstand Young, 2006).

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37 E. Schwella, Regulation and Competition in South Africa, Manchester Centre on Regulationand Competition Working Paper no. 18, Manchester, United Kingdom, University of Manchester,2002.

38 T. Jamasb and M. Pollitt, Incentive Regulation of Electricity Distribution Networks: Lessonsof Experience from Britain, Electricity Policy Research Group (EPRG) Working Paper no. 0701,Cambridge, United Kingdom, University of Cambridge, 2007.

39 A. Estache and M. A. Rossi, Have Consumers Benefited from the Reforms in the ElectricityDistribution Sector in Latin America? World Bank Policy Research Working Paper Series no.3420, Washington, D.C., World Bank, 2004.

40 M. Rossi, op. cit.

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45 M. Ravallion, The Mystery of the Vanishing Benefits: An Introduction to Impact Evalua-tion, World Bank Economic Review , vol. 15, no. 1 (2001), pp. 11540.

46 A. Estache and M. A. Rossi, Regulatory Agencies: Impact on Firm Performance and SocialWelfare.

47 M. Arellano and S. Bond, Some Tests of Specification for Panel Data: Monte Carlo Evidenceand an Application to Employment Equations, Review of Economic Studies , vol. 58, no. 2 (1991), pp. 27797.

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