Both the lessons from regulatory changes forced by contract renegotiation and a better conceptual understanding of the relevant drivers of the optimal regulatory choices (Laffont, 2005; Armstrong and Sappington, 2007; Hiriart and Martimort, 2009) show, however, that the same model for incentive compatibility will not apply in all settings. At different stages of development and for different distortions in politics, it makes sense to have different “degrees” of incentives built into the optimal regulatory regime, and hence into the average tariff level and structure. How well this is done will influence the scope for biased sector decisions—with potentially harmful impacts on the framework conditions for financial, social, and operational performance of the sector. In principle, pricing properly will help reduce the scope for distortions because it will reduce the scope for residual political interference in the process.

Policy advisors often recommend that the use of subsidies in infrastructure be followed by _a program to ensure transparency_ about how targeted they are so that errors of inclusion and exclusion of specific categories or users can be minimized. Increasingly policy advisors are recommending more transparency about subsidy programs that have lasted for a long time. In practice, this should imply “subsidy budgeting processes.” Obviously, such budget-related processes would increase accountability if implemented correctly. Consider how this was done in Colombia in the 1970s and is being done in Canada today, for instance. Just as obviously, politicians hate such budget-related processes since they reduce the scope for discretionary ways of buying votes or buying favors. Increasingly also, as theoreticians start to fully internalize the empirical relevance of information asymmetries, ordeal mechanisms are being recommended to ensure that users who do not really need the support do not try to benefit from these subsidies (see Gruber, 2008). These ordeal mechanisms are actually increasingly popular across sectors. By reducing the relevance of these subsidies for significant tranches of actors, it reduces the value of subsidies and to some extent of pricing manipulations for non-benevolent politicians.

**_Oversight and regulation:_** For over 15 years, the creation of _independent regulatory agencies_ has widely been seen as the most obvious recommendation to end political interference with regulatory processes. Independent agencies around the world were copied on the models adopted by the United Kingdom under the Thatcher administration. Regulators were to be recruited based on their skills, not their political connections. They would be protected from the temptation to favor some operators by barriers to the revolving door: limits to how quickly they could be recruited by the industry once their regulatory tenure had ended. They would be paid high salaries to reduce temptations to accept bribes. The agencies would be granted their own sources of funding to ensure they would not have to rely on budgetary transfers, thereby avoiding the risk of blackmail by governments or parliaments. Clearly, the intention was to let the regulatory agencies be instrumental in reducing or even eliminating private agenda distortions in infrastructure governance. The strategy was strongly supported by economic research based on the research on multiple principals and multiple agents, as summarized in Laffont and Tirole (1993) and Bolton and Dewatripont (2005).

Experience has shown the limits of this recommendation. Few, if any country, have managed to achieve a level of independence consistent with what theory argues is needed to minimize the risks of political capture. Evidence shows that politics still matter in regulation - it shows that politics have managed to steer regulatory decisions through loopholes in regulatory mandates and obligations assigned to regulatory agencies.<sup>65</sup> The main sources of weak sector performance are limited capacity, limited ability to commit, limited resources, and limited credibility, as summarized in Estache and Wren-Lewis (2009). In sum, regulation does not seem to have been taken seriously by many governments. It is being paid lip service through the creation of a regulatory institution for which formal regulatory power is dominated by real political power.

# **5.2. Recommendations and new approaches: Some comments on innovative approaches**

Failures in reaching expected sector performance in infrastructure have made policy advisers more humble in their reform ambitions and more careful when they make recommendations for new

> 65 See Thatcher (2005) and Coen and Thatcher (2008) for discussion and evidence from Europe.

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