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Book Reviews

Author(s):
International Monetary Fund. External Relations Dept.
Published Date:
June 2007
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Harnessing the market

José A. Gómez-Ibáñez

Regulating Infrastructure

Monopoly, Contracts, and Discretion

Harvard University Press, Cambridge, Massachusetts, 2006, 448 pp., $26.95 (paper).

Network utilities—such as electricity, telephones, transport, and gas—have undergone wide-ranging reforms over the past decade, with many governments restructuring, and sometimes even privatizing, entire infrastructure industries. The reforms have aimed at securing private participation in industries that have traditionally been dominated by the public sector. These changes have been accompanied by the creation of regulatory agencies and supervisory frameworks to manage the provision and quality of services and pricing policies. Sector performance has thus become intrinsically linked to the effectiveness of the regulatory framework and to contract design. Using a combination of theory and practice, José Gómez-Ibáñez evaluates the impact of these changes.

In the first part of the book, the author describes the relationships between the government, regulators, firms, and users and analyzes how these often complex dynamics shape the regulatory frameworks and the behavior of the participants. Using case studies, he assesses the effect of regulatory capture (when state laws give rise to monopolistic behavior), contractual problems, and asset expropriation on prices, quality, and investment. In one example, he recounts how uncertainty over contracts led to a series of renegotiations in the privatization of Argentina’s railroad industry, resulting in serious delays—and in some cases even cancellation—of vital investments. He also discusses how the threat of expropriation may deter private sector investment, using examples of both direct and indirect expropriation in Latin America’s electricity industry to illustrate this set of problems.

In the second part, Gómez-Ibáñez examines the circumstances under which three principal regulatory strategies—concession contracts, private contracts, and discretionary regulation—are likely to be successful. He also explores the circumstances under which private contracts might substitute for government regulation, concluding that private contracts can be an effective—even superior—substitute for government regulation in certain circumstances.

The last section of Regulating Infrastructure studies the consequences of network unbundling—forcing a supplier to give competitors access to its infrastructure—and the related trade-off between competition and coordination. Here, Gómez-Ibáñez uses the examples of the British railroad industry and Argentina’s electricity sector to demonstrate that competition can lead to better service and lower prices. However, he also notes that market power may remain an issue even after unbundling has taken place. One challenge in this respect is to establish a mechanism for dealing with access charges and network congestion.

This clearly written book by one of the most distinguished economists in the field describes the roles played by the different stakeholders in utility reform and evaluates their impact on the efficient regulation of natural monopolies. The author’s use of examples from the real world, combined with a modern microeconomic approach to transactional cost and incentive regulation, makes this a book any serious thinker or practitioner in the field of utilities regulation must read.

Daniel A. Benitez

Economist, World Bank

A wakeup call for Europe

Alberto Alesina and Francesco Giavazzi

The Future of Europe

Reform or Decline

MIT Press, Cambridge, Massachusetts, 2006, 186 pp., $24.95 (cloth).

“A wakeup call.” The title of the last chapter captures the thrust of this very readable book on Europe’s need for reform. In the book, Alberto Alesina and Francesco Giavazzi cast aside the academic genre—though not their academic grounding—to better convey a sense of urgency. They focus on a short list of core issues and in each case identify the broad direction of reform. Their tone is incisive, even militant, and the book proceeds at a brisk pace with many original insights.

Some of the problems have received a lot of attention elsewhere. The continuing decline in working hours belies the increasing old-age dependency ratio. The labor markets in many European countries protect insiders at the expense of the unemployed. Monopolies and other forms of protection reflect the large rents enjoyed by existing firms and the weakness of independent regulatory agencies. And the judicial system fails to provide for the cost-effective enforcement of contracts.

The authors look at other important issues as well. They rightly recognize immigration as “one of the important questions for Europe in the next decade, if not the most important issue.” While mindful of the social problems associated with ethnic and racial diversity, they advocate a selective immigration policy, attuned to the needs of the labor market in each country.

They also roundly denounce conflicts of interest in the financial system and, interestingly, trace them to the resistance of national central banks to their loss of power following the introduction of the euro. And they convincingly argue that the main cause of the decline in the quality of advanced education and research is not a lack of resources but a lack of competition.

But the book’s most original contribution is its focus on the role of European institutions. The authors argue that policy coordination is beneficial when government activities present significant economies of scale, which is the case in areas such as the European Union’s (EU’s) single market, its common foreign policy, and its fledging common defense policy. But policy coordination can also lead to excessive intervention when it pointlessly tries to override country-specific preferences, for instance in the fields of social policy or even fiscal policy (the authors suspect that the EU’s “stability and growth pact,” which sets rules for the conduct of fiscal policy, has gone too far in that direction). Failure to properly allocate the prerogatives of “Brussels” and of individual member states may sharply undermine the effectiveness of European institutions in promoting badly needed reforms.

This is a useful and even enjoyable book, though it is frustrating that the authors—like others in this field—do not address the key question of why the rigidities they denounce are so prevalent in Europe. A deeper understanding of their social function would surely help in designing reform strategies. It is also unfortunate that the authors pin the differences in social models between Europe and the United States on different attitudes toward inequality.

Rather, different attitudes toward the role of government in the economy stand out as a general thread across the diverse reform areas discussed in the book. In each case, the need for reform arises because insiders have captured the authority of government to prevent competition—what is known among economists as “regulatory capture” is, unfortunately, a common occurrence in Europe. The proliferation of public and semi-public enterprises, curiously not discussed in the book, is an important manifestation of this phenomenon. The authors could have noted its rollback in the past two decades as a welcome development, but plenty remains to be done.

“It is frustrating that the authors—like others in this field—do not address the key question of why the rigidities they denounce are so prevalent in Europe”.

Pierre Dhonte

The IMF’s former Special Representative to the EU

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