The Political Economy of Electricity Market Liberalization: A Cross-country Approach.

AuthorErdogdu, Erkan

    Since the 1980s, the structure of electricity industry has shifted from a vertically integrated (and usually state-owned) monopoly towards unbundled (and usually privately owned) regulated utilities. This shift has also been strongly encouraged by the World Bank, IMF and other international financial institutions (Williams & Ghanadan, 2006a). The power sector reform began in Chile in 1982 for the first time and then spread through various countries in the world especially after the 1990s. Therefore, the last three decades have witnessed widespread power market reforms in both developed and developing countries that cost billions of dollars. Today, reforms are on-going in many countries and the reform process in power sector is regarded as not only possible and necessary, but also inevitable.

    In all reforming countries (whether developed or developing), reforms take place in a political economic environment and are directly affected by the developments taking place in it. In most cases, political structure of a country largely determines the extent of the reforms in that country. In the United Kingdom, for example, privatization of state owned electricity utility reflected the ideology of the Thatcher government and its interest in reducing the costs of domestic coal subsidies, among other things. Similar ideological and political explanations can be found from Norway to New Zealand (Hogan, 2002). There is no doubt that without political support the reforms cannot go further in any country. This paper attempts to discover the impact of political economic variables on the liberalization process in electricity markets.

    We try to answer the following research questions: (i) what is the impact of industrial electricity consumers (as an interest group) on the reform progress in power sector? (ii) does foreign influence resulting from the dependence on foreign financial support have an influence on the electricity market liberalization process? (iii) do the ideology of ruling party and professional/educational background of the chief executive (prime minister or president) constitute important determinants of the reform progress? If yes, what is the direction of the influences originated from these variables?

    The paper proceeds as follows. The next section presents a literature review regarding the applied empirical studies focusing on the political economy of liberalization processes. Section 3 develops the hypotheses tested in the study. Section 4 summarizes the methodological framework. Section 5 describes data. Following two sections present empirical analysis and discuss the results. The last section concludes.


    Presenting an extensive literature review on the political economy of economic reform is both outside the scope of this paper and not possible given the limitations on the length of the study. Although there is some preliminary academic work that empirically investigates the impact of some variables on electricity market reform outcome (e.g. Nagayama (2007, 2009); Zhang, Parker, and Kirkpatrick (2008)); to the best of our knowledge, this study constitutes one of the first empirical applied investigations that specifically focus on the possible implications of political economic environment for electricity market reform process. So, there is a gap in the empirical literature with regard to the analysis of the possible repercussions of the political economic variables for the power market reforms. This is quite surprising given the economic importance of the sector for both individual countries and the world economy in general, as well as the significant number of reform programs that have already initiated in many power sectors.

    In this section, we will mention only applied studies on the relationship between economic reform processes and political economic variables. The studies presenting an anecdotal discussion of the political economy of the various reform programs without any applied analysis are outside the scope of this section. Within this framework, we will concentrate on three groups of studies: (1) those providing applied evidence from power industry; (2) those on the political economy of reform process in telecommunications industry; (3) studies presenting the results of applied work from non-infrastructure industries.

    The first group of studies (those focusing on the political economy of electricity market reforms) include only two papers by Chang and Berdiev (2011a) and Cubbin and Stern (2006). Chang and Berdiev (2011a) examine the effect of government ideology, political factors and globalization on energy regulation in electricity and gas industries using the bias-corrected least square dummy variable model in a panel of 23 OECD countries over the period 1975-2007. They find that left-wing governments promote regulation in gas and electricity sectors; and less politically fragmented institutions contribute to deregulation of gas and electricity industries. Their results also suggest that long tenures of incumbent government have limited impact on regulation in electricity sector, while it is associated with an increase in regulation of gas sector. Further, they conclude that higher political constraints and more globalization lead to deregulation in electricity and gas sectors; and economic and social integration are the forces that promote deregulation in the gas industry, whereas political integration advances deregulation in the electricity industry. Cubbin and Stern (2006) assess whether a regulatory law and higher quality regulatory governance are associated with superior outcomes in the electricity industry. Their analysis, for 28 developing economies over 1980-2001, draws on theoretical and empirical work on the impact of telecommunications regulators in developing economies. Their study show that, controlling for privatization and competition and allowing for country-specific fixed effects, both regulatory law and higher quality regulatory governance are positively and significantly associated with higher per capita generation capacity.

    The studies providing applied evidence from telecommunications industry are Duso and Seldeslachts (2010), Gasmi, Noumba Um, and Recuero Virto (2009), Gasmi and Recuero Virto (2010) and Li and Xu (2002). Duso and Seldeslachts (2010) empirically investigate the cross-sectional and temporal variation in entry liberalization in the mobile telecom industries of OECD countries during the 1990s. Their findings indicate that majoritarian electoral systems are important drivers for change, while independent industry regulators slow down such reforms. They conclude that powerful industry incumbents hold up the liberalization process and governing bodies that favor a small welfare state accelerate it. Taking the view that political accountability is a key factor linking political and regulatory structures and processes, Gasmi et al. (2009) empirically investigate its impact on the performance of regulation in telecommunications using a time-series cross-sectional data set for 29 developing and 23 developed countries during 1985-99. They provide empirical evidence on the impact of the quality of political institutions and their modes of functioning on regulatory performance. Their analysis finds that the impact of political accountability on the performance of regulation is stronger in developing countries.

    The paper by Gasmi and Recuero Virto (2010) has two related objectives. First, it seeks to identify the key determinants of policies that have been at the heart of the reforms of the telecommunications industry in developing countries, namely, liberalization, privatization, and the (re)structuring of regulation. Second, it attempts to estimate the extent to which these policies have translated into actual deployment of telecommunications infrastructure. They conduct this simultaneous investigation by means of an econometric analysis of a 1985-1999 time-series cross-sectional database on 86 developing countries. Their study finds that sectoral as well as institutional and financial factors are important determinants of the actual reforms implemented. They uncover that countries facing increasing institutional risk and financial constraints are more likely to introduce competition in the digital cellular segment and to privatize the fixed-line incumbent, these policies being economically attractive to both investors and governments. Finally, Li and Xu (2002) examine the political economy of privatization and liberalization in the telecommunications sector in recent decades. They find that countries with stronger pro-reform interest groups, namely the financial services sector and the urban consumers, are more likely to reform in more democratic countries. However, their result suggest that less democratic countries are more likely to maintain the public sector monopoly when the government benefits more from such a governance mode, e.g., when the fiscal deficit is higher.

    The final group of studies presents the results of applied investigations from non-infrastructure industries. The examples from this group include Alberto Alesina, Ardagna, and Trebbi (2006), Boschini (2006), Dreher, Lamla, Lein, and Somogyi (2009), Duval (2008), Fredriksson and Wollscheid (2008), Goldberg and Pavcnik (2005), Huang (2009), Ickes and Ofer (2006), Kim and Pirttila (2006), Olper (2007), Volscho (2007) and Wagner, Schneider, and Halla (2009).

    Alberto Alesina et al. (2006) question why countries delay stabilizations of large and increasing budget deficits and inflation and what explains the timing of reforms. They find that stabilizations are more likely to occur during crisis, at the beginning of term of office of a new government, in countries with "strong" governments (i.e. presidential systems and unified governments with a large majority of the party in office), and when the executive faces less constraints. Boschini (2006)...

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