resulting in little benefit to consumers even though production costs have been reduced. Regulation attempts to redistribute the gains between consumers and the producer.

Unbundling the sector, both vertically and horizontally, allows the possibility of introducing competition in the market, both between generators and between distributors. This would provide a further push to improve efficiency, since lower costs can be used to increase market share as prices are lowered relative to rivals. By this process, consumers can benefit from the change in market structure. Larger consumer gains are expected to accrue from the presence of several competitors with no dominant firms. Where there is still market power on the supply side, regulation can again be used to improve the welfare of consumers.

This simple account of the underlying arguments for sector reform including the four key components allows qualitative evaluation of the impact of each policy component singly and in combination with other policies.

- (a) _Unbundling on its own (U)_ . Unbundling the SOE vertically and horizontally into separate SOEs would create smaller but state-owned companies. The potential costs and benefits from such a move have been analyzed by Pollitt (2008b) and Vagliasindi (2012). Both authors warn that there are costs as well as benefits to unbundling, and that by itself this policy cannot be counted on to improve performance of the system overall. Some authors have emphasized that there are different degrees of unbundling with different consequences for performance (Vagliasindi and Besant-Jones, 2013),<sup>2</sup> and there are arguments suggesting that unbundling improves performance through improved transparency, accountability, and management focus.

- (b) _Private sector participation (PSP) on its own (P)_ . Without unbundling, privatization could entail the creation of a private monopoly electricity company. In many developing countries the performance of the SOE is so poor that it would be hard to attract bids for the entire utility. Although there are efficient, fully integrated, private sector electricity companies, there is limited experience with this model in developing countries.<sup>3</sup> Privatization would be expected to increase efficiency as the firm seeks to reduce costs and increase profits (as well as to increase tariffs when these have previously been held below the profit maximizing value). In the absence of regulation, tariffs could be set too high and consumers would lose out.

The introduction of Independent Power Producers (IPPs), selling power to the vertically integrated SOE through power purchase agreements (PPA), introduces a limited form of private sector participation without unbundling the existing SOE. In this case the SOE remains unchanged and purchases power from this new form of supply. Without direct pressure on the management of the SOE the incentive to improve performance will be low. Most statistical studies do not separate the different forms of unbundling and treat the introduction of IPPs as being the same as the vertical or horizontal separation of the existing SOE.

> 2 The categories of unbundling drawn from Besant-Jones (2006) are: vertically integrated monopolist, single buyer, IPPS, third party access, power market.

> 3 In Pakistan KESC was a state-owned vertically integrated company, operating in parallel to the rest of the system. It was privatized in 2005 as an integrated entity.

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