Paul Seabright, IDEI, University of Toulouse ABCDE, 23 May 2005

1. Regulation and incentives in poor countries:the legacy of Jean-Jacques Laffont for development economics Paul Seabright, IDEI, University of Toulouse ABCDE, 23 May 2005 seabrigh@cict.fr

2. Outline of presentation • Some fundamental ideas • The revelation principle & information rents • Imperfect enforcement as an equilibrium outcome • Collusion • Poor countries as enclaves of informational monopoly • Applications to regulatory policy • Applications to institutional design • The research agenda

3. Fundamental ideas (I): The revelation principle and information rents • The revelation principle shows that (under appropriate conditions) mechanisms that induce truth-telling do at least as well as mechanisms that do not • This is not a naively optimistic conclusion: it says that we cannot avoid rewarding those who have private information to induce them to reveal it • So asymmetric information creates a cost of incentives, which must be balanced against the shadow cost of the funds used to provide them • Developing countries have less efficient tax systems (so cost of funds higher) but also more monopolies of information

4. Fundamental ideas (II): Imperfect enforcement as an equilibrium outcome • The fact that “ideal” policies do not work as planned is not due to Murphy’s Law, but to strategic behavior by those affected • Imperfect enforcement maybe due to combination of • Non-benevolence of regulators and politicians • Unobservability of some key variables (eg costs) • Renegotiation of contracts • Infeasibility of some incentives (eg negative payments) • Collusion • These factors may all play a different role in poor countries compared to rich countries

5. Fundamental ideas (III): Collusion • See Waly Wane’s contribution to this symposium • Basic idea: collusion between agents affects outcome of any allocation mechanism • But this collusion is endogenous: depends on gains to agents involved, relative to costs • More general insight: information flows between agents are not a given feature of organizations, but change in response to the incentives of the agents • Normal incentive constraints on mechanisms need to balanced by collusion-proofness conditions, otherwise incentive constraints will be invalid • But “mutual monitoring” can sometimes offset this

6. Fundamental ideas (IV): Poor countries as enclaves of informational monopoly • Communication costs are relatively high in poor countries • Often due to the lack of the very infrastructure whose provision is in question • Partly due also to lower level of marketization (eg individuals’ creditworthiness harder to assess) • This increases the cost of creating incentives for information revelation • It also raises the stakes in collusion • An important goal for regulation: find ways to contest information monopolies

7. Applications to regulatory policy • Price-cap versus rate-of-return regulation • Price cap gives large rents that poor countries can ill afford • Rate-of-return depends on auditing that poor countries often cannot carry out • 3-stage model according to income level: PC  RoR  PC • Access prices for essential facilities • Poor countries should not use them to undo network monopoly power (investment is more important) • Universal service obligations and network investment • Creates conflict of interest between rural consumers • Connected consumers are favoured by low prices • But network is smaller than without USOs, so many consumers remain unconnected • General lessons for cross-subsidies

8. Applications to institutional design • How centralized/functionally specialized should regulation be? • Usual trade-off – accountability vs spillovers/scale effects • Poor countries often have a shortage of regulatory expertise • But enforcement may be more dependent on local accountability (version of “mutual monitoring” argument) • Yardstick competition may be more necessary to contest informational monopolies • Separation of powers and development • Separation of powers more valuable in poor countries to contest information monopolies • But risks of collusion are higher (so would duplicate costs without real benefits)

9. The research agenda • Corruption – when does separation of powers increase hold-up problems? • Depends whether different regulatory interventions are complements or substitutes • The trade-off between pricing and enforcement • Cost recovery may worsen enforcement problems (eg theft) • Mutual monitoring – when can enforcement be decentralized? (cf role of the press & media) • The evolution of informal institutions in poor countries (cooperatives, NGOs, “civil society”) • How can IT investments be most fruitfully used in poor countries? • Where is the greatest return to information storage/processing?

10. An example: water theft in Tunisia(preliminary work with W. Mattoussi) • Attempts to set cost-based prices for water increase incidence of theft (interference with water meters) • Organizing water cooperatives appears to help • Water authority can monitor total use, not individual use • Thieves steal from other members, not from water authority • Econometric evidence shows theft is lower when: • Cooperatives are smaller (so mutual monitoring stronger) • Economic incentives for theft lower • Monitoring costs are lower (eg distance to land) • Education and past experience with cooperation both strong • Geographical/social instruments help to control for the endogeneity of coop size, choice of punishments etc. • First-hand evidence of the evolution of social institutions according to the constraints of asymmetric information

11. Conclusion • Jean-Jacques Laffont was not a remote theorist, uninterested in the specificities of the countries to which his models would be applied • He saw at first hand how poor countries suffered from the problems of asymmetric information • His work is a subtle blend of accepting the constraints imposed by asymmetric information, and seeking where possible to change those constraints • It provides both • A positive understanding of how institutions evolve to make use of valuable information • Normative advice for making the best use of scarce information, in the interests of the most disadvantaged