Edited by Gerald R. Faulhaber, Gary Madden and Jeffrey Petchey
Chapter 4: Incentive Regulation, Investments and Technological Change
4. Incentive regulation, investments and technological change Ingo Vogelsang INTRODUCTION This chapter is about network industries, which are characterized by nontrivial investment challenges. They generally exhibit economies of scale persisting over a wide range of output and leading to lumpiness of investments. Lumpiness refers to the large size of capacity increments, which can be associated with capacity shortages, excess capacity and (wasteful) duplicate investments. Furthermore, lumpiness refers to long lead times and durability of the investments. A common feature of network investments is sunkness, which implies risks associated with real options. Both the option to delay investment and thereby learn about the future and the option to have capacity available when it is needed can be valuable and thereby influence investment risk. In addition, competitive risks, for example from duplicative investment, play a major role in investment decisions. Examples of regulated network industries with (currently) weak competitive risks include electricity transmission and distribution networks, while strong competitive risks characterize broadband telecommunications access and backhaul and nextgeneration networks (NGN). In the 1970s the main problem tackled by industrial organisation literature was that of regulatory incentives for excessive investment under rate-ofreturn regulation (Averch-Johnson effect). The incentive-regulation movement of the 1980s and 1990s was a reaction to this type of rate-of-return regulation tradition (Vogelsang, 2002). In contrast to the previous emphasis on potentially excessive investment, incentive regulation put the emphasis on (short-term) productive efficiency and low consumer prices. Has therefore investment been neglected? What about the over-investment in telecommunications fibre networks before 2000/2001...
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