The Institutional Foundations of Regulatory Commitment: A Comparative Analysis of

Telecommunications Regulation
Author(s): Brian Levy and Pablo T. Spiller
Source: Journal of Law, Economics, & Organization, Vol. 10, No. 2 (Oct., 1994), pp. 201-246
Published by: Oxford University Press
Stable URL: http://www.jstor.org/stable/764966
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 JLEO.V10N2 201

The InstitutionalFoundationsof Regulatory

Commitment:A ComparativeAnalysis
of TelecommunicationsRegulation
Brian Levy
The World Bank

Pablo T. Spiller
University of California, Berkeley

In this article we use transaction cost economics to analyze the determinants

of performance of privatized utilities in different political and social circum-
stances. Case studies are drawn from telecommunications regulation in Ar-
gentina, Chile, Jamaica, the Philippines and the United Kingdom. We explore
how political institutions interact with regulatory processes and economic
conditions in determining the potential for administrative expropriation or ma-
nipulation, and hence affect the sector's economic performance. We find that
performance can be satisfactory with a wide range of regulatory procedures,
as long as arbitrary administrative action can be restrained. We find also that
regulatory credibility can be developed in unpropitious environments, that
without such commitment long-term investment will not take place, that
achieving such commitment may require inflexible regulatory regimes, that in
some cases public ownership of utilities is the default mode of organization,
and furthermore, that it may be the only feasible alternative.

1. Introduction
This article provides a comparativeassessmentof the impactof core political
and social institutionson telecommunicationsregulatorystructuresand utility
performanceoutcomes in five countries:Argentina,Chile, Jamaica,the Phil-
ippines, and the United Kingdom.' Although in recent years institutional

BrianLevyis SeniorEconomistat The WorldBank.PabloT. Spilleris VisitingProfessorof

BusinessandPublicPolicy,HaasSchoolof Business,Universityof California,Berkeley.This
articleis partof the WorldBankproject"Institutions, Regulation,andEconomicEfficiency,"
undertaken with partialsupportfromthe WorldBankResearchCommittee.Wewouldlike to
thankLee Alston, Hadi Esfahani,AhmedGalal, Alice Hill, MattMcCubbins,RogerNoll,
DouglassNorth,MaryShirley,IngoVogelsang,BarryWeingast,BjornWellenius,OliverWil-
liamson,andtwoanonymous refereesforhelpfulcommentsandsuggestions,andJanetMowery
for editorialwork.The opinionsexpressedhereareentirelythoseof the authors,anddo not
represent the viewsof theWorldBank,its ExecutiveDirectors,or thecountriestheyrepresent.
1. The countrystudieson whichwe baseouranalysisarepartof the WorldBankproject
"Institutions, RegulationandEconomicEfficiency," fundedin partby a grantfromthe World
BankResearchCommittee. Becauseof thenatureof thegrant,we didnotincludetheU.S. as one
of ourcases.Althoughwe makereferences to theU.S. inouranalysis,applyingourframework to
the evolutionof telecommunications regulationandperformance in the U.S. is left for future
research.
? 1994by OxfordUniversityPress.All rightsreserved.8756-6222194/$5.00
202 The Journalof Lav. Economics.& Organization,
V10 N2

analyses have made majorgains in accountingfor the conduct of regulatory

and other economic policies in the United States and elsewhere, the empirical
assessment of some key hypotheseshas been constrainedby the fact that over
long periods of time the U.S.'s core political institutions(institutionsidenti-
fied as key explanatorsof policy outcomes)have changedonly slowly.2 Cross-
country comparativeanalyses are one way to release this constraint.
Utilities privatizationand regulatoryreformare increasinglybilled as ways
to improve service quality and to lower prices. Here we argue that such
expectationsmay not always be attainable.In particular,looking at the prob-
lem of utilities regulation throughthe lens of transactioncost economics-
with its microanalyticalperspective, its emphasison discriminatingalignment
and remediableness, and its view of regulationas a contractingproblem-
provides an understandingof the determinantsof performanceof privatized
utilities in different political and social circumstances. Our objective is to
highlight how political institutions interact with regulatory processes and
economic conditions in exacerbatingor amelioratingthe potentialfor admin-
istrativeexpropriationor manipulation,and hence determiningthe economic
performanceof the sector.
We arguethatthe credibilityandeffectiveness of a regulatoryframework-
and hence its ability to facilitate privateinvestment-varies with a country's
political and social institutions. Further,we argue that performancecan be
satisfactory with a wide range of regulatoryprocedures, as long as three
complementary mechanisms restrainingarbitraryadministrativeaction are
all in place: (a) substantive restraints on the discretion of the regulator,
(b) formal or informal constraintson changing the regulatorysystem, and
(c) institutions that enforce the above formal-substantive or procedural-
constraints.Ourevidence suggests thatregulatorycommitmentcan indeed be
developed in what appearto be problematicenvironments,that without such
commitment long-term investment will not take place, that achieving such
commitmentmay requireinflexibleregulatoryregimes thatgo againstprevail-
ing academic views, that in some cases public ownership of utilities is the
default mode of organization,and furthermore,that such ownershipmay be
the only feasible alternative.
Political and social institutionsnot only affect the ability to restrainadmin-
istrative action, but they also have an independentimpact on the type of
regulation that can be implemented, and hence on the appropriatebalance
between commitmentand flexibility. For example, relatively efficient regula-
tory rules (e.g., price caps, incentive schemes, use of competition) usually
require granting substantial discretion to the regulators. Thus, unless the
country's institutions allow for the separationof arbitrarinessfrom useful
regulatorydiscretion, systems that grant too much administrativediscretion

2. Several studies, however, have exploited the electoral changes and theirrepercussionson
the composition of the U.S. Congress and the executive in undertakingthose tests. See, for
example, Weingastand Moran (1983) and Spiller and Gely (1992).
 TheInstitutional
Foundations
of Regulatory
Commitment
203

may not generate the high levels of investment and welfare expected from
private-sectorparticipation.Conversely, some countries have regulatoryre-
gimes that drasticallylimit the scope of regulatoryflexibility.Although such
regulatoryregimes may look inefficient, they may in fact fit the institutional
endowments of the countriesin question, and may provide substantialincen-
tives for investment.
Our analysis may be especially relevantfor the design of regulatorypolicy
in developing, newly industrializing, and previously socialist countries,
where lack of economic developmentmay be relatedto a generalizedlack of
administrativerestraints.3But the results are also relevant in understanding
the historical evolution of utilities regulation and ownership in developed
countries. Indeed, as the analysis of the U.K. case highlights, restraining
regulatorydiscretionseems to be behind the developmentof regulatoryinsti-
tutions in developed countries as well.4
A word of caution is in order, though. Our effort at comparativeanalysis
has some importantlimitations. The need for detailed analyses of the politi-
cal, social, and regulatoryinstitutions of each country naturallylimits the
number of cases we are able to analyze.5 Consequently, we do not offer
formal statisticaltests of our centralpropositions(such tests would requirea
methodology not feasible at this stage of our research)but insteadprovide an
analytical frameworkand casual but systematicallycollected and researched
evidence. While we believe that our results provide strong supportto some
core propositionsaligned with the new institutionalism,the spiritof the paper
is exploratory-as much an exercise in hypothesisformulationas in hypothe-
sis testing.

2. The Analytical Framework

2.1 The Problemof Utilities
Three special featurescharacterizeutilities and provide the startingpoint for
our analysis. First, most (but not all) utility services are characterizedby
importanteconomies of scale and scope. Second, most utilities' assets are
highly specific and non-redeployable(althoughthe extent of sunk investments
varies with the applicationand with technology). Third, utility services typ-
ically have a broad range of domestic users, usually overlappingthe voting
population of the country. Viewed throughthe lens of the new institutional
economics, these characteristicscreatecontractingproblemsthatundercutthe
ability of ordinarymarketmechanismsto deliver first-bestperformance.6

3. For an extremely interesting analysis of the role of central government discretion in

determiningincentives for private-sectorinvestment, see Weingast(1993).
4. While the McNollgast approachdoes not say it in those words, this is indeed their main
message concerning, for example, administrativeprocedures in the United States. See, for
example, McCubbins, Noll, and Weingast(1987).
5. Multiple, distinct regulatoryepisodes within individual countries do, however, provide
additional"degrees of freedom."
6. See, among others, North (1990), Williamson (1988), Goldberg (1976), and Barzel
(1989).
204 The Journalof Law,Economics,& Organization,
V10 N2

Economies of scale and scope and highly specific assets imply that the
numberof providersof basic utility services is going to be relatively small.
Because a large proportionof the utilities' assets are sunk, a utility will be
willing to operateeven if it cannot recover its sunk investmentsas long as it
covers its operating costs.7 Widespreaddomestic consumptionimplies that
the pricing of utilities is always going to be political.8Furthermore,the whiff
of monopoly (particularlywhen ownershipis concentratedin foreign hands)
increases the gains from political action.
The combination of significant investments in durable, specific assets
with the high level of politicization of utilities has the following result: util-
ities are highly vulnerableto administrativeexpropriationof their vast quasi-
rents. Administrativeexpropriationmay take several forms. Although the
easiest form of administrativeexpropriationis the setting of prices below
long-run average costs, it may also take the form of specific requirements
concerning investment, equipment purchases, or labor contract conditions
that extract the company's quasi-rents. Where the threat of administrative
expropriationis great, privateinvestorswill limit theirexposure.9Thus, coun-
tries where administrativediscretionis the norm may find that public owner-
ship of utilities arises because the hazardsof direct privateinvestmentare so
great.10
Politics and technology stronglyinteractin shapingthe potentialfor admin-
istrativeexpropriation.Sectors with very small sunk investmentsor with rapid
asset depreciationwill not be prime candidatesfor administrativeexpropria-
tion.1 Similarly, administrativeexpropriationmay not be expected in the
short run in countries or jurisdictions experiencingrapid growth in the de-
mand for utilities services, as the costs of investmentdelays may limit the
political gains from opportunisticbehavior. In the longer run, however, the
fight for control over the institutionsof government, and the corresponding

7. Observe that financing requirementsfor sunk investments are not part of the operating
costs. Inability to repay debt requiredto pay sunk investments will only bring the utility to
bankruptcy,but it still will not be worth liquidating.Asset liquidationwill take place only when
operating revenues fall short of operatingcosts, where operatingcosts include a returnon the
nonspecific investmentsof the enterprise.
8. This does not mean thatthe pricingof othersectors, not characterizedby large economies
of scale and sunk investments, is not going to be political as well (e.g., bread prices in poor
countries). What we mean is that the politicization of utilities' pricing, together with its asset
characteristics,bring about unique problems.
9. Investors may limit their exposure by selecting technologies that-although they imply
lower qualityand higheroperatingcosts-may requirelower levels of specific investments(e.g.,
cellular ratherthan fixed-link telephony).
10. Observe, though, that public enterprisesare also subject to the forms of administrative
expropriationwe are consideringhere. In this case, though, systematicunderfundingwill be the
norm.
11. For example, setting the prices of bananasbelow their long-runaveragecost will have at
most a one-yeareffect on bananaprices. On the otherhand, settingprices of waterservices below
long-run average costs may imply a reductionin prices over quite a long period of time.
 The Institutional Foundations of Regulatory Commitment 205

divisionof the spoils, will continuouslyexposethe utilitiesto potentialad-

ministrativeor outrightexpropriation,even in rapidlygrowingeconomies.

2.2 Resolutionof the RegulatoryProblem:A Frameworkfor EmpiricalAnalysis

This section lays out a generalframeworkfor empirical,country-specific
analysisof the extentto whichthe regulatoryproblemsoutlinedabovehave
beenresolved,explainswhy theresolutiontooktheformit did,anddiscusses
the relationbetweenregulatoryoutcomesand the performance of private
utilities.Subsequentsectionsfill in the details.

2.2.1 RegulatoryDesign: Governance and Incentives. In trying to under-

standdifferentcountries'abilitiesto committo particular
regulatoryprocesses
andinstitutions,we findit usefulto look at regulationas a designproblem.
Regulatorydesign has two components:regulatorygovernance and regula-
toryincentives.Wedefinethe governancestructure of a regulatorysystemas
the mechanismsthatsocietiesuse to constrainregulatorydiscretionand to
resolveconflictsthatarisein relationto these constraints.'2 The regulatory
incentivestructurecomprisesthe rulesgoverningutilitypricing,cross- or
directsubsidies,entry,interconnection, etc. In contrastto regulatorygover-
nance,the structureof regulatoryincentiveshasbeenthe centralpreoccupa-
tionof virtuallyall theoretical
workon regulation.A mainresultof thisstudy,
though,is thatsuchemphasisis inadequate. Althoughwe findthatregulatory
incentivesindeed affect performance,their impact(positiveor negative)
comesto theforefrontonlyif regulatory governance hassuccessfullybeenput
intoplace.13
Bothregulatory governanceandincentivesarechoicevariablesin thehands
of policy-makers. Thechoices,however,areconstrained ones. Choicesas to
regulatorygovernanceareconstrained by thespecificinstitutionalendowment
of the nation,whichbothdeterminesthe formandtheseverityof the regula-
toryproblemsandshapesthe rangeof optionsavailablefor resolvingthem.
Choicesas to regulatoryincentivesarealsoconstrained by a nation'sspecific
institutional
endowment.Moreover,a nation'schoiceof the governancefea-
turesof the regulatorysystemwill havean independent effecton the typeof
regulatoryincentivesthatareviable.

2.2.2 Institutional
Endowmentand RegulatoryGovernance. Following North
(1990) and others, we define the institutionalendowmentof a nationas
comprisingfiveelements.First,therearea country'slegislativeandexecutive

12. Williamson would call such constraintson regulatorydecision-making"contractualgover-

nance institutions"(see Williamson, 1985:35).
13. Commenting on the interactionamong technology (institutions),governance, and price
(regulatorydetail), Williamson (1985:36) says: "[i]nasmuchas price and governanceare linked,
partiesto a contractshould not expect to have theircake (low price) and eat it too (no safeguard)."
In other words, there is no "free institutionallunch."
206 TheJouralof Law,Economics,
&Organization,
V10N2

institutions.
Thesearetheformalmechanisms (a)forappointing legislatorsand
decision-makers and for makinglaws and regulations,apartfromjudicial
decision-making; (b) for implementingtheselaws;and(c) thatdeterminethe
relationsbetweenthe legislatureandthe executive.Secondarethe country's
judicialinstitutions.
Thesecompriseits formalmechanisms (a) forappointing
judges and determiningthe internalstructureof the judiciaryand (b) for
impartiallyresolvingdisputesamongprivateparties,orbetweenprivateparties
andthestate.Thirdarecustomsandotherinformalbutbroadlyacceptednorms
thataregenerallyunderstood to constrainthe actionof individualsor institu-
tions.Fourthis thecharacter of thecontending socialinterestswithina society
andthebalancebetweenthem,includingtheroleof ideology.Finally,thereare
theadministrative of thenation.Eachof theseelementsis subjectto
capabilities
change,andthe determinants of eachcanalsobe thesubjectof study.In this
analysis, though, we treateach of these elementsas exogenous-as the institu-
tional endowmentof a particularnation. Here we highlightthe first two, and
comment on the remainingthree whenever appropriate.
The form of a country'slegislative and executive institutionsinfluencesthe
nature of its regulatory problems. The crucial issue is to what extent the
structureand organizationof these institutionsimpose constraintsupon gov-
ernmentalaction. The range of formal institutionalmechanismsfor restrain-
ing governmentalauthorityincludes the following: explicit separationof pow-
ers between legislative, executive, and judicial organs of government;14a
written constitution that limits the legislative power of the executive and is
enforced by the courts; two legislative houses elected under differentvoting
rules;15an electoral system calibrated to produce either a proliferationof
minorityparties or a set of partieswhose ability to impose discipline on their
legislators is weak;16and a federal structureof power, with strong decentral-
ization even to the local level.17 Utility regulationis likely to be far more
credible-and the regulatoryproblemless severe-in countrieswith political

14. For analysis of the role of separationof powers in diminishing the discretion of the
executive, see Gely and Spiller (1990) and McCubbins, Noll, and Weingast(1987, 1989) and
references therein.
15. Nonsimultaneouselections for the differentbranchesof governmenttend to create natural
political divisions and thus electoral checks and balances (see Jacobson, 1990). For an in-depth
analysis of the determinantsof the relative powers of the executive, see Shugart and Carey
(1992).
16. Electoral rules also have importanteffects on the "effective numberof parties"that will
tend to result from elections and, thus, on the extent of governmentalcontrolover the legislative
process. For example, it is widely perceived that proportionalrepresentationtends to generatea
large numberof parties, while first-past-the-postwith relatively small districtelections tends to
create bipolar party configurations. This result has been called Duverger's Law in political
science (see Duverger, 1954). More generally,see Taageperaand Shugart(1993). For analysesof
how the structureof political partiesdependson the natureof electoralrules (with applicationsto
the U.K.), see Cain, Ferejohn, and Fiorina (1987) and Cox (1987).
17. On the role of federalism in reducing the potential for administrativediscretion, see
Weingast(1993) and references therein.
 The Institutional
Foundationsof RegulatoryCommitment 207

systems that constrain executive and legislative discretion. Note, however,

thatcredibilityis often achievedat the expense of flexibility.The same mecha-
nisms that make it difficult to impose arbitrarychanges in the rules may also
make it difficultto enact sensible rules in the firstplace, or to efficientlyadapt
the rules in the face of changingcircumstances.Thus, in countrieswith these
types of political institutions, the introductionof reforms may have to await
the occurrenceof a drastic shock to the political system.
Legislative and executive institutionsmay also limit a country'sregulatory
governanceoptions. In some parliamentarysystems, for example, the execu-
tive has substantialcontrol over both the legislative agenda and legislative
outcomes.18 In such countries, if legislative and executive powers alternate
between political partieswith substantiallydifferentinterests,specific legisla-
tion need not constitute a viable safeguardagainst administrativediscretion,
as changes in the law could follow directly from a change in government.19
Similarly,if the executive has stronglegislative powers, administrativeproce-
dures and administrativelaw by themselves will not be able to constrainthe
executive, who will tend to predominateover the judiciary in the interpreta-
tion of laws. In this case, administrativeproceduresrequiresome base other
than administrativelaw.
A strong and independentjudiciary could serve as the basis for limiting
administrativediscretionin several ways. For example, the priordevelopment
of a body of administrativelaw opens the governanceoption of constraining
discretionthroughadministrativeprocedures.20Also, a traditionof efficiently
upholding contractsand propertyrights opens the governanceoption of con-

18. WVhileparliamentary systemsgrantsuch powersin principle,whetherthey do so in

practicedependsuponthenatureof electoralrulesandthepoliticalpartysystem.Parliamentary
systems whose electoralrules bring aboutfragmentedlegislatureswould not providethe
executive-usuallyheadedby a minoritypartywitha coalitionbuilton a very narrowset of
specificcommoninterests-withmuchscopeforlegislativeinitiative.By contrast,electoralrules
thatcreatestrongtwo-partyparliamentary systems-as well as someotherkindsof nonparlia-
mentarypoliticalinstitutions-wouldgrantthe executivelargelegislativepowers.Foran in-
depthdiscussionof thedifference betweenparliamentary andpresidential systems,andtheroleof
electoralrulesin determining therelativepowerof theexecutive,see ShugartandCarey(1992).
19. In the U.K., regulatoryframeworks havetraditionally evolvedthrougha seriesof actsof
Parliament. Forexample,majorgasregulation legislationwaspassedin 1847,1859,1870,1871,
1873,and 1875.Similarly,waterregulation legislationwaspassedin 1847, 1863, 1870, 1873,
1875,and 1887.Systematicregulation of electricitycompaniesstartedin 1882,onlyfouryears
aftertheinauguration of thefirstpublicdemonstration of lightingby a publicauthority.
The 1882
act was followedby majorlegislationin 1888, 1899, 1919, and 1922, culminating with the
Electricity(Supply)Actof 1926,whichcreatedtheCentralElectricity Board.Fordiscussionsof
theevolutionof utilityregulationin theU.K., see Dimock(1933),Hormell(1928),Keen(1925),
Self andWatson(1952),andSpillerandVogelsang(1993b).
20. Thistraditionallyhasbeenthewayadministrative discretionis restrained
in theU.S., as
regulatory statuteshavetendedto be quitevague.Foran analysisof thechoiceof specificityof
statutes,see Schwartz,Spiller,andUrbiztondo(1993).Observe,however,thatadministrative
law may not developin a systemwherethe executivehas strongcontrolover the legislative
process.
 V10 N2
208 The Journalof Law.Economics,&Organization.

strainingdiscretion throughthe use of formalregulatorycontracts(licenses).

This option is particularlyvaluable for countries where the executive has a
strong hold over the legislative process. Further,a traditionof judicial inde-
pendence and efficiency opens the governanceoption of using administrative
tribunalsto resolve conflicts between the governmentand the utilitywithin the
contours of the existing regulatorysystem. Finally, it provides assurances
against governmental deviation from specific legislative or constitutional
commitmentsthat underpinthe regulatorysystem. While there are no simple
ways of measuringjudicial strength,two featuresseem to us to be key deter-
minants: the extent of perceived judicial corruptionand whether the courts
have a history of deciding against the government. A corruptjudiciary that
attemptsto be independentmay easily find its corruptionpublicly disclosed,
with a clampdown following.21 Similarly, a judiciary that seldom decides
againstthe government,even on contractdisputes, cannotbe interpretedto be
strong.22

2.2.3 InstitutionalEndowmentsand RegulatoryIncentives. If the regulatory

incentive structure is to promote welfare, it should facilitate investment,
allocatively efficient pricing, and the introductionof new services and tech-
nologies. Yet regulatoryincentives cannotbe implementedin an institutional
vacuum. The country'sinstitutionalendowment, the characterof distributive
politics, and the nature of its regulatorygovernance structureall affect the
potential for the successful design of regulatoryincentives.
Consider first the constraintsthat the nation's institutionalendowmentim-
poses on the design of regulatoryincentives. Administrativecapabilities-the
ability of the nation'sprofessionals(e.g., academics, lawyers, bureaucrats)to
handle complex regulatoryconcepts and processes in a relatively efficacious
manner,without triggeringexcessive disputes and litigation-are of particu-
lar relevance. These capabilitieswill determinethe potentialfor the successful
implementationof complex regulatorydesigns. Thus, regulatorysystems that
call for complex implementationwill be inadequatein nations with weak
administrativecapabilities.
As for the impact of distributivepolitics, it can constrain the extent of
allocative efficiency that can be achieved by regulatoryincentives. A major

21. While a corruptjudiciary may tend to side against the governmenton contractdisputes
(after all, governmentlawyers will have very little incentive to bribejudges, while such incen-
tives clearly exist for privatelawyers), on key issues a corruptjudiciarybecomes an easy hostage
to the government. Unexpectedpress disclosuresmay triggerwidespreadscandals, loss of legit-
imacy, and even calls for judicial reformand sanctions. Considerthe following conclusion of a
WorldBank reporton Bolivia: "In additionto being slow, courts are also perceivedto be corrupt.
In a 1991 survey of 226 litigants, 48 percent claimed to have made illegal payments to court
personnel. Confidencein the courts is also weakenedby thejudiciary'sperceivedlack of indepen-
dence. Judges' independenceis compromisedby a historyof executive supremacy,the country's
traditionof political patronage,and the proceduresfor the selection, promotionand discipline of
judges" (WorldBank, 1992:43).
22. This is a necessary but not a sufficientcondition for strength.
 The Institutional
Foundationsof RegulatoryCommitment 209

feature of telecommunicationsdistributivepolitics is the demand for cross-

subsidization from businesses to residential users, which has translatedin
many countries into very high prices for long-distanceor internationalcalls.
Unless eliminated, such cross-subsidizationlimits the potentialfor exploiting
the advantagesof competition.
Finally, and perhaps more important, the institutionalrealities of some
countries may be such that resolutionof the governanceproblemsconstrains
the range of regulatory incentive options to third (or even fourth) best. In
some countries, the only way to constrainadministrativearbitrarinessmay be
to almost totally withdraw administrativediscretion. The resulting gover-
nance considerationswould constrainthe rangeof workableregulatoryincen-
tive designs to those that provide only limited flexibility. In telecommunica-
tions, where technological change is rapid, the cost of this reduction in
regulatoryflexibility is high-but so too is the cost of failing to adequately
restraindiscretion.
Yet, even given these constraints, the individual country studies suggest
that in most cases thereexists a broadrangeof discretionfor policy-makersas
to the design of regulatorygovernanceand incentivestructures.Indeed, utility
performanceappears to be best in countries that have achieved a good fit
between their exogenous institutions and their regulatory governance and
incentive designs, and worst in those instances where regulatorydesign pro-
ceeded without attentionto the exogenous institutionalrealities. Furthermore,
the qualityof design of regulatoryincentivesemerges in the countrystudies as
an independentinfluence on performance.23

2.3 A Decision Tree

The decision tree in Figure 1 summarizesthe above discussion and sets the
stage for analysis of the five countriesin a way thathighlightsthe impactof a
country's exogenous institutionalendowmenton its regulatorydesign.24The
heavier lines in the figure are branchesrepresentedby observations in our
sample. Because our frameworkhas implicationsfor other institutionalenvi-
ronments, we present the decision tree in its general formulation.We make
four sets of distinctions.
The first distinction is between those countriesthat have domestic institu-
tions capable of credibly refrainingfrom arbitraryadministrativeaction and
those that do not. Our frameworksuggests that the existence of an indepen-
dent judiciary with a reputationfor impartiality,and whose decisions are
enforced, is a necessaryconditionfor makingthese crediblecommitments.As
discussed furtherbelow, among the countriesstudied, Chile, Jamaica,and the

23. Indeed, it is possible (although we have no examples where this is the case) that an
especially poorly designed regulatoryincentive structurecould in itself underminethe credibility
of a regulatorysystem, even if the regulatorygoverance foundationsappearfirm.
24. The discussion that follows can be interpretedas eitherpositive or normative.It is positive
in that it predictswhich combinationsof backgroundinstitutionsand regulatorysystems will lead
to good performanceand which will not. It is normativein that it suggests whatkind of regulatory
design will be credible given the backgroundinstitutionsof the country in question.
210 The Journalof Law,Economics,& Organization,
V10 N2

noGlFt
ADECSKONTRE

LUNFE

YES

JUDIARY?

OovsNERSr
$ERWAONAL
GUARANTES

Figure1. A decisiontreemodelof a country's

institutional
endowments.

United Kingdom had in place a well-functioningjudiciary, while Argentina

and the Philippines did not. Countrieslacking a well-functioningjudiciary
will face difficulties in the short term in developing a regulatory system
capable of sustainingefficient levels of privateparticipationand investment,
and thereis little reasonfor them to devote substantialscarceresourcesto such
an effort. Instead, alternativemechanismsof securingcommitment(like inter-
national guarantees)will be necessary.
Among countries capable of using regulation to secure commitment, the
second distinctionis between those countrieswhose electoral, legislative, and
executive institutions are structuredin a way that enables them to achieve
credible regulatorycommitmentsvia legislation and those countriesthat can
best achieve crediblecommitmentsby embeddingtheirregulatorysystems in
the operatinglicenses of privatecompanies. As we discuss below, legislation
may provide regulatorycredibility in political systems that do not generate
unified governments, like presidential systems with multichamberlegisla-
tures, fragmentedparties, and nonsimultaneouselections. For legislation to
provideregulatorycredibility,however, it should make specific the process by
which regulatorydecisions are to be taken. Otherwise, regulatorydiscretion
will be unchecked. Legislation, however, does not provide credibility to
regulatory policy in, for example, two-party parliamentarysystems where
parties alternatein government. In this case, regulatorycredibility can be
obtainedby basing the regulatoryprocess in contractlaw, ratherthanadminis-
 The Institutional Foundations of Regulatory Commitment 211

trativelaw.25As will be seen, Chile falls into the formercategory(as does the
United States), and Jamaicaand the United Kingdom into the latter.
The third distinction, not depicted in Figure 1, is between countries that
requirespecific, substantiverules to achieve credibilityand countriesthat can
use flexible regulatoryprocesses and still restrainarbitraryaction. In general,
the potential for flexibility in design will be highest in two sets of countries.
The first set comprises those whose exogenous institutionalendowments in-
clude informalnormsor bodies of administrativelaw thatrestrainthe arbitrary
use of governmentalpower even if explicit legal restraintsare absent. The
second set comprises those where an institutionalizedprocess of argumenta-
tion and consensus formation sets de facto limits on the extent to which a
private utility can be subjected to administrativeexpropriation.Among the
countriesstudied, althoughneitherJamaicanor the U.K. can providecredibil-
ity throughlegislation, Jamaicafalls into the category of countriesrequiring
specific, substantive rules to achieve regulatorycredibility, while the U.K.
can achieve such credibility with a more flexible regulatoryprocess. Chile,
while able to use legislation as its regulatoryinstrument,also has the ability to
achieve credibility with a more flexible regulatoryframework.
Among countries that require very specific, substantiverules to achieve
credibility,the fourthand final distinctionin Figure 1 is between those coun-
tries that have strong administrativecapabilitiesand those that do not. Coun-
tries with strong administrativecapabilities can put in place a regulatory
system based on specific, substantiverules thatcan both attractinvestmentby
restrainingarbitraryaction and promote efficiency and flexibility. Countries
with weak capabilities may have to settle for less efficient rules for their
regulatorysystem to work. Among the countriesstudied, Chile falls into the
former category, and Jamaicathe latter.
Viewed from a differentperspective, the decision tree identifiesthree com-
plementarysets of mechanismsto restrainarbitraryaction. First are substan-
tive restraintson regulatory discretion, which can take the form of either
process regulation or specific, substantiverules (i.e., distinctions 3 and 4).
Second are restraintson changing the regulatorysystem, of eitherthe legisla-
tive or licensing variety (i.e., distinction 2). Finally, there are institutions,
notably a judiciary,for enforcing both the substantiverestraintsand restraints
on system changes (i.e., distinction 1). A centralhypothesisto be exploredin
the comparativecountryanalysis is thatfor privateperformanceto be satisfac-
tory all three mechanismsmust be in place and they must be properlyaligned
with the specific characterof a country's backgroundinstitutions.

25. When electoral laws are designed to returnthe same party to power in every election,
complex partydecision-makingmay provideregulatorycredibility,even in the absence of de jure
contractual arrangementsor very precise legislation. This seems to have been the Japanese
example, until the 1993 elections. See Baron (1992) for an excellent discussion of how decision-
making in Japan'sLiberal Democratic Party (LDP) was structuredso as to provide for a large
numberof veto points.
 212 The Journalof Law.Economics.& Organization,
V10 N2

3. The Institutional Background of the Country Cases

This section describes the exogenous variables-the institutionalbackground
of each of the five countries.26Section 4 then providesthe link between these
and our endogenousvariables-regulatoryregimesand regulatoryperformance.
Table 1 provides a snapshot of the main institutionalcharacteristicsof
Argentina, Chile, Jamaica, the Philippines, and the United Kingdom, and
relatesthem to the potentialfor opportunisticgovernmentbehavior.In explor-
atory researchof the kind describedhere, there is an ever-presentrisk of ex
post rationalizationin interpretingthe role of exogenous variables.To obviate
this risk, we have tried as much as possible to anchorour depictions of the
exogenous institutionsof the five countries in prior scholarly writings. Fur-
ther, we alert the readerwhereverwe push our interpretationof the behavior
of a country's institutions beyond previous interpretations.We divide the
countries into three groups: traditionalparliamentarysystems (Jamaica and
the U.K.), the archetypalpresidentialsystems (Chile), and rent-seekingpresi-
dential systems (Argentinaand the Philippines). Each group has distinct im-
plications for what type of regulatoryregimes are workable.

3.1 TraditionalParliamentarySystems: Jamaica and the United Kingdom

Jamaicaand the U.K. provide the observationsfor the Figure 1 branchthat
answers yes to the "unifiedgovernment"question. The political systems of
Jamaicaand the U.K. are parliamentary,characterizedby a strongjudiciary
and electoral rules that tend to generate two strong parties.27As a conse-
quence, the majorityparty invariablyhas an absolute majorityin Parliament
and controls both the governmentand the legislature.28The two countries'
judicial institutionsare also similar.29Britainhas led the world in the develop-
ment of a judiciary with an exceptional reputationfor probity. Jamaica's
judiciary is also well regarded, and has ruled against the government on

26. The detailed case studies on which this article is based follow a research framework
developed in Spiller and Levy (1991). That frameworkemphasizes, as this article does, the
contractingproblemsendemic to utilities regulation,and requiresthe gatheringof detailedinfor-
mation about the regulatorystructure(includinginformationon regulatoryproceedingsand court
cases) over time. It also requires the collection of a common set of informationconcerning
investments, prices, and outputs.
27. JamaicainheritedBritish political institutionsupon obtainingits independencefrom that
country in 1962. In Jamaica, the percentageof the vote and the numberof seats obtained by
candidatesindependentof the two main parties(the PNP and the JLP) fell, respectively,from 35
percentand 5 (out of 35 seats) in 1944 to I percentand 0 since the 1959 election (see Stone, 1981,
1986). See also Cox (1987) and Cain, Ferejohn, and Fiorina (1987) for an analysis of party
politics in the U.K.
28. It is not surprisingthat both countrieshave had drasticpolicy shifts as partiesalternatein
power.
29. While Jamaica'sjudicial institutionsparallel those of the U.K., there are two important
differences. First, as a former colony, Jamaica'sjudicial system has retainedthe right of final
appeal of its decisions to the Privy Council in the U.K., providingan unusuallystrong source of
credibility.Second, unlike the U.K., Jamaicahas combinedthe institutionof a sovereign parlia-
ment with a written constitution.
 The Institutional Foundations of Regulatory Commitment 213

numerousoccasions.30 Note, though, the implications for the judiciary of a

political system based upon a sovereign two-partyparliamentwith no written
constitution:undersuch a system, the parliamentis free to act as it pleases, so
long as it follows generallyacceptedprocedures(on which more later),but the
courts have no formalrestrainingauthority.31To a large extent because of this
feature of parliamentarypolitics, in neither country has the judiciary devel-
oped a strong administrativelaw doctrine, althoughboth have a long contract-
law tradition, and have upheld contracts against the government.32In both
countries, then, administrativedecisions are essentially undertakenin the
dark.33Agencies do not necessarilyjustify theirdecisions (althoughthe U.K.
Office of TelecommunicationsRegulationdoes),34nor necessarilyhold public
hearings.35'36Judicial review of agency decisions is not customaryin either
country.37Furthermore,in the U.K., regulatoryreview is not a strongweapon
for the regulatedfirms and intervenors,38because regulatorscan make deci-
sions that effectively preventjudicial review.39
Thus, the formal institutionsof governmentin the U.K. and Jamaicaallow
for substantial governmental discretion. This governmentaldiscretion can

30. For example, duringthe firstadministrationof PrimeMinisterMichael Manley,the courts

blocked Manley's attemptto expropriatelandholdingsby requiringthe governmentto pay fair
compensation.
31. The fact that the U.K. does not have a writtenconstitution,though, has not precludedthe
development of a large body of constitutionallaw.
32. See Salzberg (1991) for a discussion of the secondary role of the U.K. judiciary in
statutory interpretation.See Spiller and Sampson (1993) for a discussion of the judiciary in
Jamaica,and Spiller and Vogelsang(1993b) for a discussion of the role of thejudiciary in license
enforcementuntil the nationalizationof the electricity sector after WorldWarII.
33. For a discussion of the development of regulatoryagencies and their proceduresin the
U.K. since the beginning of the privatizationprocess, see Veljanovski(1991).
34. For, example, "the Cable Authorityis not bound to give reasons for its decisions and it
may well decide not to spell out its selection criteriain any detail in an effort to retainthe greatest
flexibility" (Baldwin and McCrudden, 1987:292).
35. The JamaicanPublic Utilities Commission (JPUC) during the period 1966-75, did hold
public hearings and was, in principle, subject to U.S.-style conditions for judicial review.
36. See Baldwin and McCrudden(1987) for a discussion of procedures in various U.K.
regulatory agencies, including the Office of Fair Trading and the Monopolies and Mergers
Commission.
37. Judicial review in the U.K., however, is becoming more frequent,in particularat the local
governmentlevel, as conflict between local and centralgovernmenthas increased. Baldwin and
McCrudden(1987:57), quoting Sir Michael Kerry,the former TreasurySolicitor, observe that
judicial review of administrativeagencies has "increasedfrom a handfula year in the 60s to 50-
100 in the early 70s, to a rateof about400 a year in the firstsix monthsof [1982]." Furthermore,
Kerry reported that most of these cases "come under two main heads, applications to quash
planning decisions . . . and immigrationcases." (see Kerry, 1983:168; and Young, 1985).
38. However, in the U.K. judicial review may be effective in resolving disputes among
branchesof government. See Baldwin and McCrudden(1987:59) for a discussion of this issue.
39. In the U.K. judicial review can be initiated on proceduralgrounds or if the regulator's
decision has been unreasonable.A claim of unreasonableness,however, rarelywins, because the
regulatoris not requiredto provide a thoroughexplanationof the basis for making a particular
decision (e.g., the granting of a cable license). See Baldwin and McCrudden(1987:292-93).
 Featuresof Argentina,Chile, Jamaica, Philippinesand United Kingdom
Table 1. Institutional

Legislativeand
Country ExecutiveInstitutions Judicial Institutions Social Conflict

Argentina Separationof powers Weak and politically Basic urban-rural R

with fragmented manipulable. conflict.
partystructure.
Chile Separationof powers Strongand Regional balance. R
with fragmented professional;
partystructure. defended private
Orderlyaltemation propertyduring
of powerexcept socialist period.
duringGen.
Pinochet'sregime.
Jamaica Parliamentarysystem Strong and pro- Small middle class R
withtwo strong fessional; upheld holds political
parties. utilitycontracts balance. No major
against government regional differences.
priorto 1966 and Violenturbanpoor.
 defended private
propertyduringthe
first Manley
administration.
Philippines Separationof powers Weakand corrupt. Regional competition R
with weak parties among members of
and strong elite.
presidency. Until
1960s, partial
United States
supervision. Military
regime during
Marcos.
United Kingdom Sovereign parliament Verystrong and Large middle class, S
with strong two-party professional; holding political
system. upholds contracts balance.
against the
government.Weak
administrativelaw.
 216 The Journalof Law.Economics,&Organization,
V10 N2

translateinto importantpolicy shifts, with the judiciaryplaying a minor role

in restrainingadministrativediscretion. Informalrules of legislative decision-
making, however, restrain both governments' ability to undertakepolicy
shifts without consulting interest groups. For example, over the years the
U.K. has developed decision-makingprocesses that tend to limit the endemic
secrecy of parliamentarysystem governmentsby allowing interest-groupcon-
sultations.Althoughboth these countrieshave the potentialto undertakelarge
policy shifts, some amount of consensus in policy-makingis required.The
need for consensus-makingproceduresarises as much from the need to legiti-
mize governmentaldecision-makingas from the need to avoid cracks in the
governing party with the consequent loss of legislature support. Ways to
develop consensus and conduct interest-groupconsultationsvary from coun-
try to country;they include the role and use of ad hoc commissions and white
and green papers,40the use of collective ministerialresponsibility,41as well as
the use of party organizationsto settle disagreementsprior to parliamentary
action. Within-partyconsensus-buildingmeasuresare useful for single-party
governments not just because they grant stability and credibility to their
actions, but also because they provide legitimacy to the party leadership.
Legitimacy is importantin safeguardingagainstother factions' attacksand in
maintainingbackbenchers'support.42

40. For example, majorpolicy changes startwith an ad hoc commission that is chargedwith
analyzing the policy change the governmentis interestedin undertaking.The outcome of the ad
hoc commission is a consultative"greenpaper,"which while not representingthe government's
exact intentionsis neverthelesscirculatedfor public comment. (Telecommunicationsreform, for
example, started in 1981 with the Beesley report, which recommendedunrestrictedresale of
leased lines, British Telecommunication'sprice flexibility on leased lines, and networkentry.)
Following this comment period, the government may decide to drop or to continue (with or
without modification)the policy initiative. If the governmentdecides to go aheadwith the policy
change, it will eventually publish a "white paper," which forms the basis for the cabinet's
legislative initiative. This process, which is also followed in Jamaica,has the virtueof providing
interest groups with warning signs about impendingpolicy changes. Interestgroups then can
lobby partymembersand legislators in an attemptto influencethe policy change in theirdesired
direction. See Miller (1985:197-211) for a discussion of how the decision-makingprocess in the
U.K. providesopportunitiesfor interestedpartiesto participatein the legislativeprocess. See also
Spiller and Vogelsang(1993a). The role of this decision-makingprocess is not too dissimilarfrom
the advance warningfeaturesof the U.S. AdministrativeProcedureAct. For a discussion of the
U.S. AdministrativeProcedureAct, see McCubbins,Noll, and WVeingast (1987) and Spiller and
Urbiztondo(1993).
41. On the role of ministerialresponsibilityin limiting the potential for breaks in the party's
controlover government,see Cox (1993). Cox's mainpoint is thatthe effect of requiringjoint and
several ministerialresponsibility"is to increasethe powerof the executive body by decreasingthe
chance that executive decisions will be challenged in any broaderarena. Indeed, the convention
of collective responsibilityin the United Kingdom has been so effective in preventinginternal
Cabinet disagreements from spilling out into the Commons that many have questioned the
independentimportanceof the legislature"Cox (1993:47).
42. To some extent, because Japan'sLDP until recently had continuouscontrol over govern-
ment in a contestable legislative environment, it developed a formal process of government
decision-makingprior to submittinglegislation to the Diet. This process involves the formal use
of the LDP's Policy Affairs ResearchCommittee(PARC) and industryadvisorycommittees, as
 Foundationsof RegulatoryCommitment 217
The Institutional

In the U.K., furthermore,at the level of policy implementation,the West-

minster model of governmentdefines the prerogativesand responsibilitiesof
politiciansand bureaucrats,43with mutuallyrecognizedboundariesof authori-
ty, even where theirpower is not explicitly constrained.Jamaicaand the U.K.
differ, however, in the extent of professionalismof the bureaucracy.While the
U.K.'s bureaucracyis professionaland largely apolitical, the politicizationof
the bureaucracyduring the first administrationof Jamaica'sPrime Minister
Manley seems to have had an irreversibleeffect in reducingthe qualifications
and role of its bureaucracy.44
Thus both the U.K. and Jamaicahave electoral systems that provide for
great legislative flexibility,andjudiciariesthatdo not stronglyrestrainadmin-
istrativeactions. As a consequence, neithercan base its governancestructure
on legislative acts. They need furtherconstraints.As we will see, both found
them in contractlaw.

3.2 The ArchetypalPresidentialSystem: Chile

Chile, with its archetypalpresidentialsystem,45is the countryin our sample
that provides the observationsfor the Figure I branchthat answers no to the
"unifiedgovernment"question. Between 1973 and 1989, Chile went through
a period of militaryrule underGeneralAugusto Pinochet. This period, how-
ever, stands out as a 15-year exception to more than 100 years of rule by
civilian government. For the rest of this 100-year period, the country was
governed by a constitution that embodied the principles of separation of
powers, orderly transferof authority,and regularelections between compet-
ing parties. For an extended period, voters were divided among multiple
parties, with none strongenough to legislate, except by coalition. Legislators'
independencefrom centralpartyapparatusled to the developmentof a legisla-
ture with a strong sense of local representation.46A series of constitutional

well as informal consultations with Zoku (tribe) Diet members and LDP factions. For an ex-
tremely insightfuldescriptionof governmentaldecision-makingin Japan,see Baron(1992:chap.
13). Lupia and McCubbins (1993) stress that a major role of PARC's review is to provide
backbencherswith informationabout Cabinet intentions. Because the Japaneseelectoral system
develops a strongerpersonal vote in Japanthan in the U.K., Japanesefactions are more intrin-
sically independentfrom the party leadershipthan in the U.K. As a consequence, more formal
consensus-building processes are required to keep interfactionconflict from spilling into the
legislature.
43. For an interesting transaction-costdiscussion of the raise of the Westminstermodel of
bureaucracy,see Palmer (1992).
44. During his first administration,Prime MinisterManley broke with political traditionand
replacedmany PermanentSecretaries.Since then, PermanentSecretarieshave lost some of their
influence and prestige, reducing the position's attractivenessto highly qualified middle-class
individuals (see Stone, 1986). For a discussion of the U.K.'s bureaucracy,and a comparisonto
that in the U.S., see, for example, Fesler (1983).
45. Shugartand Carey (1992:173-74) use Chile's political system until 1970 to characterize
the "archetypalpresidentialsystem."
46. At the same time, concurrentelections providedfor the developmentof bipolarcoalitions
thatoffered voterschoices over nationalpolicies withoutthe need to develop strongcentralparties
(Shugartand Carey, 1992:174).
 V10 N2
218 The Journalof Law.Economics,&Organization.

reformsbetween 1958 and 1973 shiftedthe balanceof authorityin favorof the

presidency and elevated national (ratherthan regional) politics and parties to
center stage. These reformsgrantedmore executive powers at the same time
thatthey developed strongerchecks andbalances.47The reformsincreasedthe
potential for conflict between the legislative and the executive branches,
which became evident during the regime of President Salvador Allende.
Thus, while not entirely resistantto extreme pressure, Chile's long-standing
set of legislative and executive institutionsand the natureof its checks and
balances can be seen as potentially providing some credible safeguards
against arbitrarychanges in the regulatoryregime governing utilities. This
period of extended stability, broken only by the military takeover in 1973,
developed in Chile a strong respect for institutions.48
Chile's strong, professional, and independentjudiciary provides a partic-
ularly effective check on the government,on issues of both constitutionaland
statutoryinterpretation.For example, Allende's 1970-73 governmentrepeat-
edly clashed with the courts over issues of expropriationand compensation,
with the courts refusing to back down. Its large pool of highly qualified
professionals,has served Chile well in providinggovernmentsfrom the differ-
ent parties access to qualifiedpolitical appointees.
Chile's diffuse political power, then, provides opportunitiesfor designing
regulatorygovernancestructuresalong several alternativelines. Because spe-
cific legislation is more difficult to change in Chile than, say, in the U.K.
specific legislation may play a more importantrole in the regulatorygover-
nance structureof Chile than in the U.K. On the other hand, Chile's strong
judiciaryprovides also for implementingregulatorygovernancebased purely
on proceduresor contractlaw.49

3.3 Rent-Seeking PresidentialSystems: Argentinaand the Philippines

Argentinaand the Philippinesprovidethe observationsfor the Figure 1 branch
that answers no to the "independentjudiciary"question. These two countries
share some common political features. First, both have modeled their formal
political institutions upon those of the United States, creating a complex

47. Shugartand Carey (1992:183) call the system before the constitutionalchanges of 1958
and 1970 the "inefficientsecret," because the regionalizationof politics and the relatively weak
powers of the president provided for a very dynamic legislature. Concerning the post-1970
Chilean system, Shugartand Carey (1992:200) describe it as the strongest among presidential
systems. It featuresa strong germanenesslimitationon amendmentsand permitsonly the presi-
dent to offer a budget bill. Thus, the presidentfully controlsthe budgetprocess, althoughthat is
not the case on nonbudgetaryissues.
48. One may ask whetherthis respectfor institutionspersistedeven duringthe militaryregime
of General Pinochet. Even then signs of respect for long-standinginstitutionswere evident. For
example, during the military regime the constitutionwas amended by a popular referendum.
Similarly,the militaryregime's decision to returnthe countryto a democraticsystem followed an
electoral loss.
49. See, McCubbins, Noll, and Weingast(1987) for a discussion of the role of proceduresin
providing commitment.
 The Institutional
Foundationsof RegulatoryCommitment 219

system of checks and balances.50Indeed, both countries have experienced

quite extendedperiods of constitutionalrule duringwhich executive authority
was largely restrained.Yet structureis not determinative:the history of both
countrieshas been punctuatedby periods of extra-constitutionalrule in which
governmentalauthoritywas concentratedin the president(see Hill and Ab-
dala, 1993; and Esfahani 1993).51Second, in both countries,the endemic lack
of respect for constitutionalorder has translatedinto a corruptbureaucracy
and judiciary, and into turs to the militaryas the panaceafor interest-group
conflicts.52,53

50. Forexample,bothcountrieshaveseparation of powersbetweenlegislature, executive,and

judiciary;a writtenconstitutionlimitinglegislativeandexecutivepowerandenforcedby the
courts;two legislativehouses,withweakpoliticalparties;anda federalstructure of power,with
strongdecentralizationevento thelocallevel.Althoughelectoralrulesaresuchthattheeffective
numberof partiescontestingelectionsin thePhilippines is 2, in Argentina
it is higherthan2 and
increasing,reaching3.4 in 1989(Shugart andCarey,1992:220-21).Toa largeextent,thiscanbe
explainedby theimportance of nonconcurrentelectionsin Argentina.Thefactthattheeffective
numberof partiesin thePhilippinesis twodoesnotmeanthatthesearestrongparties.Indeed,in
thePhilippines,as in theU.S., partiesdo notcontrolnominations, nordo theyuse list ranksto
controltheorderof electionsorpoolthevotes.Thus,as in theU.S., Filipinolegislatorsarequite
independent of theircentralparties.
51. Argentina's 1853 constitutional separation of powers remained in place for almost a
century, until it was amended in 1949 by President Juan Per6n in a way that substantially
expanded the powers of the president. The military overthrewPer6n in 1956 and restored the
earlier constitution. However, two subsequentmilitarygovernmentscame to power in 1966 and
in 1976. In the past, during Argentina'speriods of civilian rule, governmentseither have been
fragmented,making it difficult to enact sustainedeconomic reforms, or have pursuedzero-sum
policies which rewardedthe supportersof those in power. The presentadministrationof President
Menem is an importantexception to this patternof civilian rule. Not only did his PeronistParty
win control of both houses of Congress(as well as the executive) in the 1990 elections, but when
Menem took power, Congress (with the active supportof Menem'sopponents)ceded him special
powers to deal with the economic crisis (see Hill and Abdala, 1993).
52. The theory to explain why some polities develop rules of the game that defer the arbitra-
tion of interest-groupconflicts to the judiciaryand the legislatureratherthanto the armyis yet to
be developed. Calvert's (1992) view of constitutionsas conventions is a step forward, in that
coordinationgames have multipleequilibria,with one equilibriumbeing characterizedby lack of
coordination. We do not attemptto provide an answer to this question here.
53. In Argentina, the disdain for constitutionallegality appearseven in the transferof power
following democratic elections. The transferof power from the Radical Party to the current
PeronistPartygovernmentwas advancedto several monthsbefore the legal date. The transferof
power was arrangedthroughan agreementbetween the PeronistPartyand the Radical Partythat
required the incumbent Congress (not yet dominated by the Peronists) to pass an Economic
EmergencyLaw grantingthe futurepresident(CarlosMenem) the power to implementby decree
a series of economic measures (see Hill and Abdala, 1993). Also, membersof the judiciary are
appointedby the country'spresident(and confirmedby the Senate)and serve for life, giving them
substantialformal independence.In practice,however, changes in government(whetherconstitu-
tional or nonconstitutional)have in the past been accompaniedby turnoveramongmembersof the
judiciary. Indeed, in 1990 the new government of President Menem, with the agreement of
Congress, altered the SupremeCourtby increasingthe numberof justices from five to nine and
naming all new justices. By 1993 PresidentMenem was able to appointsix of the nine Supreme
Courtjustices. The Menem Court has recently been plagued by corruptionscandals (see The
Miami Herald, October 12, 1993).
 220 The Journal of Lawv,Economics. & Organization. V10 N2

Although the governments of both the Philippines and Argentina have

traditionallyfollowed "beggar-thy-neighbor" policies toward political oppo-
nents, the governing Filipino elites have followed, even during the Marcos
regime, a "nonexpropriation" norm, wherebyassets of political opponentsare
not expropriatedoutright (Esfahani, 1993). Instead, since control over the
governmentrotatesamong elite groups, business owners not aligned with the
elite in power tend to be subjectto administrativeexpropriation(see Esfahani,
1993).
To summarize, both Argentina's and the Philippines' institutionalframe-
works seem to be sufficiently weak, and the scope for executive dominance
sufficiently strong, that our frameworksuggests that regulatorygovernance
has to go beyond the choices of legislation, procedures,or contractlaw.54 We
discuss these issues in Section 4.2.

4. Exogenous Endowments and Regulatory Commitment Mechanisms

This section describes and interpretsthe regulatoryexperience of the five
countries in question. The discussion of regulationis organizedaroundthe
three mechanismsto restrainarbitraryadministrativeaction that were identi-
fied earlier:(a) substantiverestraintson the discretionof the regulatorthatare
written into the design of a regulatorysystem, (b) restraintson changing the
regulatory system, and (c) institutions for enforcing both the substantive
restraintsand restraintson system changes. Each subsectionsets the stage for
discussing regulationby briefly describing the evolution of telecommunica-
tions ownership in the relevantcountries.
As the analysis reveals, across the five countries and different periods,
regulatory systems worked and attractedprivate investment at reasonable
rates of returnonly when all three mechanismswere in place. Moreover,the
evidence suggests that the exogenous institutionalendowmentsof individual

In the Philippines, on the other hand, while its writtenconstitutionincorporatesan independent

judiciary and prior to the proclamationof martial law in 1972 the judiciary was reasonably
independent, the Philippines press has long been filled with tales of judicial scandal. Under
martial law, its independence was furtherconstrained and President Marcos effectively was
empoweredto remove any judge. Since 1986, the judiciaryhas regainedsome independenceand
influence, althoughcorruptionscandalscontinue. For example, in 1992 the Philippines'Supreme
Courtblocked the entry of a competing internationalcommunicationscarrier(EasternTelecom).
A few months later the author of the decision (Justice Hugo Gutierrez) resigned, following
allegations that the opinion had been written by a PLDT lawyer (Panaligan, 1993-cited in
Esfahani, 1993).
54. Viewed over the longer term, though, the multiplicityof partiesin both countriessuggests
that if the currentdemocraticepisodes representa clear break with unconstitutionaltransfersof
power, future authority may be weaker than at present. U.S.-style legislative and executive
institutions were reasonably effective in constrainingarbitrarygovernmentalauthority in the
Philippines in the first quarter-centuryafter it obtained independencefrom the United States in
1946-although the Philippines'constitutiontilted the balanceof power more sharplytowardthe
executive than does the United States model (see Abueva, 1988). PresidentMarcos'sdeclaration
of martiallaw in 1972 (despite some modest reformsafter 1978), furtherconcentratedpower in
the executive. Since his overthrow in 1986 the country has revertedto a somewhat modified
version of its pre-martial-lawpolitical institutions.
 Foundationsof RegulatoryCommitment 221
The Institutional

countries have influencedboth whetherthey were able to put in place work-

able governance designs for their regulatorysystem and, if so, the specific
forms of such designs. Tables 2 through4 summarizethe informationpre-
sented below.

4.1 TraditionalParliamentarySystems: Jamaica and the United Kingdom

Table2 summarizesthe chronologyof telecommunicationsownership,regula-
tion, and performancein Jamaicaand the U.K.55 Three featuresof the chro-
nology are especially noteworthy and are examined in some depth below.
First, both the U.K. and Jamaicahave had sustainedperiodsof high levels of
private investment in telecommunications:in Jamaicabefore 1962 and after
1987, in the U.K. since corporatizationand privatization(1982 and 1984,
respectively). Second, duringthe periods of high investment,regulationtook
differentforms in the two countries. In Jamaica,rate-of-returnregulationhas
been the standardregulatory method, although with importantdifferences
between the pre-1962 and post-1987 periods;in the U.K., on the other hand,
price-cap regulation was introduced for the first time in the regulation of
BritishTelecommunication(BT). Finally,althoughbothJamaicaand the U.K.
had periods in which private ownership was associated with strong invest-
ment, Jamaica experienced a long decade (from the early 1960s to the
mid-1970s) during which private investmentlagged.
In this section we attemptto explain these three featuresin the light of the
frameworkdeveloped earlier.The thrustof this section is the following: First,
despite seeming differences in their regulatoryframeworks,the strong com-
monalitiesin the two countries'regulatorygovernancestructureshave roots in
the similarities of their exogenous institutionalendowments;second, the dif-
ferences in the substantiverestraintsdeveloped in both countriescan be traced
to importantdifferences in their respective exogenous endowments;third, in
all three high-investmentperiods the regulatorysystems were appropriately
aligned with exogenous endowments in a way that createdworkablemecha-
nisms to restrainarbitraryaction; finally,Jamaica'sdisastrous 1966-75 expe-
rience was the consequence of a misalignmentbetween its exogenous institu-
tions and the chosen regulatorygovernance structure.

4.1.1 The High-InvestmentPeriods. As Table 2 describes, Jamaicahas had

two high-investmentperiods:the firstcontinueduntil the government'sdeci-
sion (in 1962) to switch from license-based, rate-of-returnregulation to a
U.S.-style, Public Utility Commission-based regulatory framework. The
second period startedwith the creation and privatizationof Telecommunica-
tions of Jamaica (TOJ) in 1987. The U.K.'s high-investmentperiod began
with BT's corporatizationand subsequentprivatizationin 1984. As we dis-
cuss below, these events provide the observationsfor the Figure I branchthat
answers yes to the "de jure contractualarrangement"question.
Although the regulatoryincentive schemes in the three periods are quite

55. This section is based on Spiller and Sampson (1993) and Spiller and Vogelsang (1993a).
Table2. RegulatoryHistoryand CommitmentMechanisms:Jamaica and the United Kingdom

Private Substantiv
Country/Period Ownership RegulatoryHistory Performance Restraints

Jamaica-1966 Privatelyowned Rate of return(7- Sustained network Monopoly righ

with separate 9%)on assets expansion up to plus precise
domestic and stipulatedin the 1962. Steady, rate of retur
international license. Ad hoc moderate rate of long period;
companies.a rate boards re- return. writtenin the
sponsible for license.
rate reviews.
Decisions chal-
lengeable in
courts.
Jamaica In 1962 govern- New license is- Initialnetworkex- "Fair"rate of
1966-75 ment announced sued in 1966 pansion, then return.
intentionto specifies JTCto slowdown.Low
change regula- be regulatedby profitability.
tion system at li- JPUC. License
cense renewal specifies rate of
time. Sale of returnto be fair
JTCto CTC and reasonable,
(Continental although Tele-
TelephoneCom- phone Act spe-
pany) in 1966. cifies 8% return.
In 1971 govern- JPUC interprets
menttakes ma- legislative man-
joritystake in date to be not
new internation- binding. JPUC
al operations institutesrate in-
company,and in creases based
 1975 takes over on investment
JTC. performance.
Sustained regu-
latoryconflict.
Jamaica Creationof Tele- License stipulates Majorinvestment Monopoly righ
1987- communications rate of return in domestic net- plus precise
of Jamaica (17.5-20%) on work. Reduction rate of return
(TOJ),a joint shareholders're- in real prices long period;
venturebetween valued assets. and sustained writteninto
the government Speedy arbitra- high profitability. license.
of Jamaica and tion. Govern-
Cable and Wire- ment cannot
less, to combine challenge in-
JTCand JAM- vestments. Gov-
INTEL.Privati- ernmentto
zation starts in monitorquality,
1988. and may require
quality improve-
ments.
United King- Publiclyowned License specifies Takeoffof invest- Main regulator
dom 1984- from 1912 until price cap, and a ment in 1982, sues, includ
privatizationin complex mecha- with large gains RPI-X,with a
1984. nism to resolve in national specific X, w
regulatorycon- welfare. ten into licen
flicts

company:Cable and Wireless(WestIndies);domestic company:JamaicaTelephoneCompany(JTC);majorityshareho

alnternational
Table3. RegulatoryHistoryand CommitmentMechanisms:Chile

Substantive
Period Ownership RegulatoryHistory Performance Restraints

1930-58 Controlledby ITT Regulatorylaw Initially,relative Vague. Based on

(International open-ended, no rapid expansion, legislation.
Telephoneand independent reg- then slowdown.
Telegraph). ulatory.Govern-
ment had rightto
intervenein the
company'sopera-
tions. Disputes to
be resolved by
SupremeCourt.
1958-73 Partialtakeoverof Regulatorysub- Networkexpansion Strengthenedby
CTC (Compaiia agreements in accelerates prior 1958 subagree-
de TelIfonosde 1958 and 1967 to intervention ments.
Chile) by govern- eliminated and nationaliza-
ment in 1967, vagueness con- tion.
governmentinter- cerning rate of
ventionin 1971, relturn(set now
and total take- at 10% instead of
over in 1974. EN- up to 10%)and
TELcreated to imposed new in-
 provide long- vestment obliga-
distance services tions.
in 1964.
1987- Privatizationin Detailed bench- Unprecedentedly Veryexplicit,pre-
1988. mark regulation high rates of net- cise price regul
for noncompeti- workexpansion tion based on
tive marketseg- and trafficgrowth rate of returnof
ments. Price subsequent to efficientfirm,
regulationbased privatization. plus explicit pro
on performance cess for definin
of theoretically noncompetitive
efficient firm,re- activities subjec
calibrated every to price regula-
5 years with inter- tion. Both stipu-
im indexation. lated by law.
Law stipulates
process to be fol-
lowed to compute
and rate of return
to efficient firm.
Explicit arbitra-
tion procedures
for recalibration.
Regulatorydeci-
sions can be ap-
pealed to
Supreme Court.
Table4. RegulatoryHistoryand CommitmentMechanisms:Argentinaand the Philippines

Substantiv
Country Ownership RegulatoryHistory Performance Restraint

Argentina Maintelephone License-based regula- Highly profitable Explicit price-

companies na- tory frameworkspe- to initialinves- adjustmentf
tionalizedin cified initial2 years tors. Investment mula.
1946, to forma based on rate of re- levels match or
nationalcompa- turn,followedby 5 exceed license
ny (ENTEL). Di- years withprice cap renewal require-
vided into two withx = 0. Exclusive ments. Very
regionalcompa- license to be ex- high prices (in
nies and pri- tended to 10 years US$), and quali-
vatizedin 1990. only if minimumin- ty problems re-
vestmenttargets are main. Too soon
met. Infact, price to determine full
freeze instituted4 impact on wel-
monthsafterprivat- fare.
ization. Companies
 negotiated indexa-
tion based on U.S.
consumer price in-
dex. Regulatory
agency created un-
der the Ministryof
Economy.Appeals
only to the Minister.
Regulatoryframe-
workcurrentlyunder
review.
Philippines Privatesince in- Long-standingregula- Alternationbe- None.
ception, with tion by commission tween stagna-
ownershipshift- with vague mandate, tion and periods
ing fromGTEto lack of politicalin- of moderate in-
private Filipino dependence, and vestment, fol-
parties in 1967. modest power. lowing political
cycle. Very high
unmet demand.
Profitabilityun-
known.
 228 TheJournal
of Law,Economics. V10N2
&Organization,

dissimilar (Jamaica having in both periods a rate-of-returnregulation with

specific profitabilitytargets and strong limitations on regulatorydiscretion,
while the U.K. has no formalprofitabilitytargetsin its price-capregime), the
regulatory governance structuresare quite similar. The licenses served as
contractsbetween the regulatedcompaniesand their respectivegovernments,
since attemptsby the governmentsto deviate from the license specifications
could be, and were, challenged in court. For the judiciary to serve as a
credible arbitrator,however, the licenses must be specific enough thatjudicial
outcomes are predictable.Licenses, then, can serve as an effective restraintto
administrativeaction. Indeed, in the three episodes, licenses have been very
specific about price-setting procedures. Both Jamaicanlicenses require that
prices provide the companywith a specific rate of return(7-9 percenton real
operating assets in the pre-1966 period, and 17.5-20 percent on revalued
shareholders'net worthsince 1987). The 1987 license also limits the abilityof
the regulatoryto disqualify investments or to delay price increases through
administrativesilence. Furthermore,the 1987 license provides for speedy
arbitrationto resolve price-settingconflicts. Both Jamaicanlicenses specifi-
cally grantedthe company the ability to challenge governmentdecisions in
court. BT's 1984 license (and all its amendments)is equally specific aboutits
price-settingprocedures.Price-settingpowers are grantedto BT, with only ex
post supervisionby the regulatorto see that regulatedprices follow the price-
cap structure specified in the license. In both countries, attempts by the
regulatorto alter the main featuresof the regulatoryregime requiresa license
modification. In Jamaica,license modificationsrequirethe agreementof the
company.In the U.K., license modificationsinvolve a well-specifiedprocess,
which to be undertakenagainst BT's will, requires the agreement of the
Monopolies and MergersCommission(MMC) and the Secretaryof Tradeand
Industry(the Board of Trade). Furthermore,an attemptby the regulatorto
circumventsuch a process can be challenged in court.
Thus, in both Jamaica and the U.K. the use of very specific licenses
provided the companies with substantialassurancesabout the expected prof-
itability of their investments.56Furthermore,because these licenses were
specified for long periods of time, were not easily modified, and were en-
forceable in the courts, the companies were assuredof substantialregulatory
stability.57

56. Although BT's license was very specific on price setting, it was quite vague on quality
regulation. Thus, Oftel, the telecommunicationsregulator,has spent most of its efforts, and
administrativediscretion, in implementingquality-controlmeasures(see Spiller and Vogelsang,
1993a). Given BT's disastrous internalquality-controlsystems at privatizationtime, it is not
altogether clear that such efforts by Oftel were not in the interests of BT's shareholdersand
customers.
57. Jamaica'slicenses traditionallyhave been grantedfor 25 years. While BT's license was
grantedfor a similar period, its currentprice-capfeatureexpires after 5 years. Thus, unless BT's
license is modified before the sunset provision of its price-capregulation,BT's pricingbecomes
 The Institutional
Foundationsof RegulatoryCommitment 229

The emphasis on contractratherthan administrativelaw in providingregu-

latorycredibilityin both Jamaicaand the U.K. is consistentwith the natureof
their political institutions.Their systems of parliamentarysovereignty imply
thatthe mere existence of a law governingregulation,even if it is very precise
and specific, providesvery little assurancethatthe currentregulationswill not
be subsequentlymodified. On the other hand, the courts in both Jamaicaand
the U.K. have a strong history of upholdingcontractsamong privateparties.
Jamaicancourts were called to resolve contract(regulatory)disputesbetween
the government and the regulated company before 1962, while the U.K.
courts dealt with electric power license interpretationissues prior to World
War II. While U.K. courts have yet to hear and decide a case against a
regulatorof the privatizedutilities, it seems that the threatof legal action has
restrainedthe UnitedKingdom'sregulators.58.59 No disputesover the termsof
the 1988 Jamaicanlicenses have yet been broughtto court.
To summarize, in the threeperiods with substantialprivateinvestment,the
three regulatoryregimes specified importantsubstantiverestrictionson the
discretion of the regulator;furthermore,there were serious impedimentsto
changing the regulatoryregimes;and finally,in all threeepisodes therewas an
institutionthat could credibly be called upon to enforce both the substantive
restrictionson the regulatorand the stability of the regulatoryregime.

4.1.1 Differences in RegulatoryGovernance. Although both the U.K. and

Jamaica have based their respective regulatorygovernance structureson li-
censes, BT's license has a measureof flexibility that TOJ's license does not
have. BT's license can be amendedagainst its will; TOJ's cannot. Amending
BT's license against its will, however, is no minortask. It requiresagreement
among the Director General of Telecommunications,the Monopolies and
Mergers Commission, and the Secretaryof Tradeand Industry.These three
authorities can be expected to differ with one another in their regulatory
views; indeed, two of them (the Director General and the Monopolies and
MergersCommission) enjoy more than a modicumof independencefrom the
governmentof the day. As Spiller and Vogelsang(1993a) show, the traditional

unregulated.This sunset provision gives BT a strong bargainingposition, since undertakinga

license modificationagainst its will may take as much as a full year (see Spiller and Vogelsang,
1993a).
58. Spiller and Vogelsang (1993a) report that following the failure at the Monopolies and
Mergers Commission of the DirectorGeneral'sproposal for license reformconcerningthe mar-
keting of 900-type calls, the Director General was advised not to proceed with his proposal
because he would be successfully challenged in courts.
59. Recently, however, Mercuryfiled a suit against BT and Oftel and it won its preliminary
court hearing. Mercuryclaimed that "Oftelhad not offer it with reasonableterms for the carriage
of its trafficby BT, througha consistentmisinterpretationof BT's governmentlicence. Mercury's
victory . . . means that there will be a full hearingof its applicationfor a legal interpretationof
that part of the licence which deal with interconnection"(Financial Times, 1 March 1994, our
italics).
230 The Joural of Law.Economics,& Organization,
V10 N2

independence of the MMC and the inability of the Secretaryof Trade and
Industryto dictate decisions to the DirectorGeneralof Telecommunications60
imply that the multiplicityof veto points make a license amendmentagainst
BT difficult, though not impossible.
Jamaica's licenses have never had that measure of flexibility. Since the
beginningof utilityregulation,Jamaica'slicenses have requiredthe agreement
of the company for any amendment.61That requirementhas given the regu-
lated company substantialbargainingpower. As a consequence, even dramat-
ic technological or political changes may fail to bring about changes in the
regulatory environment.62While such rigidity could be criticized from a
purely normativeperspective,Jamaica'sinstitutionalendowmentprovidesthe
clue for the need to introduceinstitutionalrigidities in the regulatorygover-
nance. In the U.K., regulatoryflexibility was built on a foundationof a long
traditionof informalchecks and balances and the use of independent,expert
commissions. By contrast, Jamaicahas never had a system of administrative
checks and balances. The JamaicanPublic Utilities Commission created in
1966 was the first, and only, experimentwith independentcommissions, and
as the next section shows, the result was quite disastrous. Furthermore,the
repercussionsof the politicizationof the bureaucracyduringthe first adminis-
trationof Prime Minister Manley in the early 1970s eliminatedthe potential
for using delegation of regulatoryresponsibilitiesas a source of commitment
(Spiller and Sampson, 1993).63Our frameworksuggests, then, that attempt-

60. Constitutionalinterpretationtraditionallyhas seen independentregulatoryagencies in the

U.K. as separate entities from their respective Secretary of State. The (CAA) revocation of
Laker's Skytrain license to fly to the U.S. in 1976 following the issuance of the Secretaryof
State's guidance for the CAA was successfully challenged in the Court of Appeal (see Laker
Airvays v Departmentof Trade [1977] QB 643, cited in Baldwin and McCrudden, 1987:167).
The Courtstatedthat the Departmentof Trade'sguidance"couldsupplementthe CAA's statutory
objectives; it could not replace them. .... In issuing peremptoryinstructionsto the CAA it
constituted direction ratherthan guidance.... Parliamentcould not have set up an elaborate
licensing code, subject to limited powers of direction, only to allow the Crownto renderlicences
useless by use of the prerogativepower." See Baldwin and McCrudden(1987:167). This, how-
ever, did not preclude Ministerialinfluence. Indeed, because the statuteprovidedfor appeal of
CAA's decisions to the Secretaryof State, since Laker 18 appealsto the Secretaryof State have
been successful, in whole or in part, while priorto Lakerno appealto the Secretaryof State was
successful (Baldwin and McCrudden,1987:168). WhatLakershows is thatthe Secretaryof State
may use the powers given by statute and consistent with the constitutionalview of the role of
independentagencies.
61. As mentioned,Jamaica'slicenses traditionallyhave been grantedfor 25 years. At expira-
tion, the drawingof a new license agreementwould also requirethe acquiescenceof the company.
62. For example, the U.S. experience with flexible competitiveboundariesas a way to adapt
the regulatoryregime to new technologies (see Knieps and Spiller, 1983) cannotbe implemented
in Jamaica without compensating the company for the reduction in its profitability.Thus, for
example, if new entrantswere to be allowed, interconnectionrateswould have to compensatethe
company for its profit loss. This is not altogether different from the position taken by New
Zealand's High Court in its recent Clear Communicationsdecision concerningthe interconnec-
tion of new entrantsto New Zealand Telecom's network (see Mueller, 1993).
63. As mentioned above, the politicization of the bureaucracyduring the mid-1970s dimin-
ished the attractivenessof the position in the eyes of the Jamaicanmiddleclass. Severalcommen-
 The Institutional Foundations of Regulatory Commitment 231

ing to design in Jamaicaa regulatorygovernance system with as much flex-

ibility as that in the U.K. will most probably undermine the credibility
of Jamaica's regulatory process, and hence negatively impact the sector's
performance.

4.1.2 Differencesin RegulatoryIncentives. Jamaicaand the U.K. differ not

only in their regulatorygovernance structuresbut also in the natureof their
regulatory incentive structures. Jamaica pursued a straightforwardrate-of-
returnregulatorysystem,64 while the U.K. introducedprice-capregulation.
Because the normative inefficiencies of rate-of-returnregulation had been
discussed at length in the economic literatureby the early 1980s and because
price caps were already widely discussed as superiorto rate of returnby the
late 1980s,65 it is proper to question whether Jamaica'sregulatorysystem
introducedin the late 1980s was the result of a mistake, capture, or of the
constraintsimposed by the institutionalbackgroundof the country.
Although we cannot reconstructthe mental processes by which Jamaica's
government privatized TOJ and compare it to that undertakenby the U.K.
government, it is clear that in both instances substantialemphasis was given
to how to design the regulatory system to be applied to the privatized
company-in the case of the U.K., through the commissioning of several
white papers,66and in the case of Jamaica,throughnumerouscabinet meet-
ings.67 While captureand mistakes are difficult to discardas reasons for any
regulatory decision,68 our framework sees the institutionalbackgroundin
Jamaica as limiting the potential implementationof a flexible price-cap re-
gime.69 In the U.K., the regulator'srevision of the price-cap rules is con-

tators have mentioned to us that since the 1980s secretarieshave tended to depend less on the
advice of their permanentsecretariesand more on non-civil-service advisors.
64. The modem Jamaicanrate-of-returnsystem, though, differsin importantdimensionsfrom
that common in the U.S. or Chile prior to the 1970s, and even from Jamaica'sown pre-1966
system, in that the regulatoris given very little latitudeto challenge capital investmentsand the
rate of returnis based on stockholders'revaluedassets ratherthanon fixed or operatingassets (as
was the case pre-1966).
65. For analyses of price-cap regulation, see, for example, the RANDJournal of Economics
symposium on price caps (Vol. 20, No. 3, 1989).
66. For a discussion of the legislative process up to the passage of the TelecommunicationsAct
of 1984, see Newman (1986:8-I 1). See also Spiller and Vogelsang (1993a).
67. Conversationwith RichardDowner of Coopers& Lybrand,Jamaica,and consultantto the
Jamaicangovernment.
68. Spiller and Sampson (1993) provideevidence againstthe capturehypothesisby computing
the value of TOJ under its license scheme and comparing it to the price paid by the private
investors. They find that the price of TOJ was very close to theircomputationof TOJ value as of
privatizationdate. In theircomputationthey assumeda 4 percentdividendpolicy and thatthe rate
of returnon equity would be the lower bound specified in the license. As the discount rate, they
use the real returnof Jamaicanbonds.
69. However, it is possible to say thatthe regulatorysystem in Jamaicahas a de facto price-cap
feature, because a freeze has been imposed on the price of local calls since privatizationwhile
internationalcalls have been used to provide the necessary rate of return.A five-year freeze was
informallyagreedupon at privatizationtime. Since then, TOJhas maintainedthe nominalfreeze.
232 TheJouralof Lavw V10N2
&Organization,
Economics,

strained by a very specific process that is built around the integrity and
credible independence from government of the various layers of authority
required to approve license amendments and around a range of informal
norms in the U.K., which ensures that the process cannot easily be manipu-
lated. Such a process, however, could not easily be transferredto Jamaica.
Jamaicalacks the multiple layers of independentauthoritynecessary to build
in credible U.K.-style restraints.70Since price caps are by naturetransitory,71
it is reasonableto expect the X factor to be increasedopportunisticallyat the
next price-cap renewal. As a consequence, the regulatedcompany will limit
its exposure, unless the initialprice-capregime would provideit with substan-
tial up-frontrents.72In other words, U.K.-style RPI-X (price cap) regulation
is not readily transferable.

4.1.3 RegulatoryMisalignment:Jamaica 1966-1975. In 1962 the Jamaican

governmentdecided to move, at license renewaltime, from a license-basedto
a PUC-style regulatorystructure.In 1966 the governmentissued new licenses
to the domestic company based on the JamaicanPublic Utilities Act of 1966,
which mandated"fair"rates of return. It also established a permanentand
independentregulatorycommission, the JamaicanPublic Utilities Commis-
sion (JPUC), to oversee regulation of domestic telephone and electricity
services. The JPUC had substantialadministrativediscretion and promoted
participationin the regulatoryprocess by a wide rangeof interestgroups. This
episode provides the observationsfor the Figure 1 branchthat answers no to
the "de jure contractualarrangement"question.
From its inception, the relationshipbetween the JPUC and the domestic
company (JamaicaTelephoneCompany,or JTC) were acrimonious,and the
conflict increased over time. Price increases fell substantiallybehind infla-
tion, and the JPUC introduceda policy of promising price increases condi-
tionedon qualityimprovementsand investmentlevels. The domesticoperations
company stopped all investmentprogramsin 1962 following the government
decision to change the regulatory regime. Except for a short period fol-
lowing the U.S.-based ContinentalTelephone Company's takeover of do-
mestic telephone operationsin 1966, there was no network expansion until
the 1980s.
The primaryreason for the acrimonyand the deterioratingperformanceof
JTC was the absence of substantiverestraintsin the regulatorysystem. The
JPUC was created to replicate the operationsand freedoms of a U.S.-style
PUC. The JPUC invited participationfrom interest groups, undertookhear-

70. Indeed, since the eliminationof the JamaicanPublic Utility Commission(see below) there
has not been even a single regulatory agency with substantial visibility and reputationfor
independence.
71. A fixed price cap in perpetuity will bring widely unstable profitabilityoutcomes, and
hence is not credible.
72. We claim this to be the case in Argentina(see below).
 The Institutional Foundations of Regulatory Commitment 233

ings, and made determinationswithoutstrongconstraints.The enablinglegis-

lation only requiredit to set "fairand reasonable"rates. Although the JPUC
Act of 1966 grantedthe Jamaicancourtsthe right to review JPUC'sdecisions,
during the 1966-75 period the judiciary did not provide any importantre-
straintto the JPUC. Indeed, given the vagueness of the license, the "unrea-
sonableness"criterionrequiredto overturna governmentaldecision became a
very stringent standard to overcome.73 The JPUC was, for all purposes,
unchecked, except for the direct intervention of the government.74Thus,
duringthis period, the judiciary could not be called to provide the regulatory
credibility inherentin the pre-1966 and post-1987 regulatoryregimes.

4.2 The ArchetypalPiesidential System: Chile

Table 3 provides a summarychronology of telecommunicationsownership,
regulation, and performancein Chile.75 As in Jamaica, Chile's regulatory
history can be separatedinto high- and low-investmentperiods. During the
high-investmentperiods, regulationtook very differentforms-rate of return
in 1958-71, and benchmarkregulation from 1987 on. The low-investment
periods were (a) from the end of WorldWarII until the late 1905s and (b) from
the Allende government,throughthe interventionin 1971 and nationalization
in 1974, until the regulatoryreformsof the mid-1980s. Here we focus only on
the period under private ownership (up to 1971 and from 1987 on). In this
section we attemptto explain and interpretthese patternsin the light of the
frameworkdeveloped earlier. The thrustof this section is as follows: first,
during the periods of high investment, the regulatoryschemes were better
aligned with Chile's exogenous endowmentsthan duringthe low-investment
period; second, that such alignments restrainedarbitraryaction in the three
dimensions noted above.

4.2.1 The Low-InvestmentPeriod. The Compafifa de Tel6fonos de Chile

(CTC) was operating in Chile as early as 1880. In 1930 it entered into a
contract with the government (later written as Law No. 4791/30), which

73. Following a JPUC decision to increaserates, both the JTC and a groupof users filed cases
in Jamaica'sSupreme Court. The formerbecause the rate increase was too low, while the latter
because it was too high. The SupremeCourtdeclinedto heareithercase. In 1974, the government
amendedthe JPUC Act to specify a minimumrate of return(relatedto the yield of the Jamaican
goverment's foreign debt) for the companies regulatedunder the Act. The JPUC nevertheless
interpretedthat amendmentas not specifying a "total entitlement"but rathera maximum (see
Spiller and Sampson, 1993).
74. For example, in a 1973 rate case the JPUC rejected the company's request for a price
increase. The governmentthen imposed a tax on telecommunicationsand providedthe company
with a subsidy equal to that tax. The JPUC claimed that such action by the government was
illegal, but there was no legal challenge to the government's action. In considerationof the
subsidy scheme, the governmentreceived a 10 percent share in the JTC (Spiller and Sampson,
1993).
75. This section is based mostly on Galal (1993).
 234 The Joural of Law.,Economics,& Organization,
V10 N2

remainedin effect until the governmentinterventionin 1971. The 1930 con-

tract provided CTC with a 50-year concession, indexed its tariffs to "peso-
gold," stipulateda returnon assets up to 10 percent,76protectedthe company
against terminationof the concession,77 and requiredfrom the company a
particularinvestmentprogramover the next few years. The contractprovided
the governmentwith the ability to take over the company's operationsunder
vaguely defined terms (Galal, 1993). While the 1930 law seems to have
provided an impetus to telecommunicationsinvestments, investmentsstarted
to lag and conflict with the governmentover tariffsand costs developed. The
subagreementsentered into in 1958 and 1967 resolved those conflicts. The
1958 subagreementassuredCTC of a 10 percentrate of return(ratherthanup
to 10 percent as in the 1930 law), and CTC agreed to start an eight-year
developmentplan. The 1967 subagreementmaintainedthe rate of returnand
redefinedcosts, and CTC agreedto an expansionplan up to 1971, committing
to increase lines from 1971 on at a rate of 6-7 percentper annum.
Although many other reasons may lie behind the low investment levels
priorto the subagreementof 1958,78the vagueness of Chile's telecommunica-
tions law did not provide strongsafeguardsagainstopportunisticbehaviorby
the government,particularlyas the post-warperiod was one of rapidpolitical
change. The telecommunicationsstatutespecified a maximum,but not neces-
sarily binding, rate of returnof 10 percent.The vagueness of the law had two
main implications:first, regulatorshad substantialdiscretionin its interpreta-
tion; second, because of its vagueness, governmentcould modify the law
throughregulatorydecrees, as it did in 1958 and 1967.79Thus, not only did
the regulatoryregime provide wide latitudeto the regulatorbut therewere no
importantlimitationsto changing the regulatorysystem itself. The subagree-
ments of 1958 and 1967 did not change the regulatoryincentive structure,but
ratherimprovedupon regulatorygovernance.The change in performancethat
followed can be related directly to such an improvement.This period, then,
provides an observationfor the Figure 1 branchthat answers no to the "spe-
cific process written in law or contract"question. This period resembles
Jamaica'sJPUC period. In both instances, regulatorygovernancestructures

76. Any return in excess of 10 percent would be divided equally between CTC and the
government.
77. At terminationof the concession the government could either take over the company,
paying the value of its assets expressed in "pesos-gold," or could renew the concession for
another30 years.
78. In particular,we refer here to potentialmacroeconomicconsiderationsarisingfrom World
War II and its aftermath.
79. In Latin America's presidentialsystems, laws may be interpretedby the administration
through the issuing of regulatory decrees (decretos reguladores) that have the power of law.
Indeed, some legislative acts have no power until such regulatory decrees are issued. As a
consequence, changes in a regulatorydecree may require specific new legislation, unless the
regulatorydecree itself leaves open the need for its own modification(see Shugart and Carey,
1992).
 TheInstitutional
Foundations
of Regulatory 235
Commitment

were not alignedwith the countries'institutionalendowmentsand neither

restrainedregulators'discretionnor limitedthe potentialfor changingthe
regulatorysystems.In bothcases, networkexpansionwas limited.

4.2.2 The High-InvestmentPeriods. While the regulatoryschemes of 1958-

71 and 1987 to the presentare quitedifferent(see Table3), bothattemptto
limitregulatorydiscretion.In bothcases, limitsto regulatorydiscretionare
attainedthroughspecificlegislation.As noted,thesubagreements of 1958and
1967 eliminatedthe vaguenessof the previouslaw by assuringCTCa 10
percentrate of return(while at the same time imposingnew investment
obligations).The post-1987regulatoryregimeis of a differentnature.After
experimenting witha varietyof regulatory schemesas a preludeto privatiza-
tion, Chile's militarygovernmentintroduceda new regulatorylaw thatre-
mains in force to this day. The new law providesprecisedetailsfor the
implementation of rate-of-return regulationof the noncompetitive market
segments.Furthermore, the law specifiestheprocessto be usedin determin-
ing which services are noncompetitive, and hence subject to regulation. The
processinvolvesa determination by the AntitrustResolutiveCommission,
following a referencefrom the telecommunications regulator(the Sub-
Secretaryfor Telecommunications).
Priceregulationfor the noncompetitive servicesis designedto providea
rateof returnto a theoretically efficientfirm.Thespecificityof
best-practice,
the telecommunications law is suchthatit specifieshow to computethe cost
of capitalof theputativelyefficientfirm8Oandhowto compute,giventhecost
of capital,the maximumprices(basedon a long-runmarginalcost modelfor
each of the individualservicesat the pointof departure) for the regulated
services. Note, though,that Chile permitsentryeven into these regulated
marketsegments.81This benchmarkis recalibrated every five years (with
indexationin the interimperiods)by the regulatorin consultationwith the
privatecompanies.Thelaw alsospecifiesanexplicitarbitration processin the
eventof disagreements-withthe courtsas finalarbiter.82
Becausethe law is so specific,regulatory changesrequirenew legislation,
as the law's specificityprovidesverylittlelatitudefor alternative interpreta-
tions. New legislationwouldhaveto overcomeinstitutional obstacles,like
bicameralismand a divided legislaturewith a minoritypresident.The

80. Thelawrequirestheuseof thecapitalassetpricingmodelin computing theallowedprice

levels. Furthermore,the law alsostipulatesthepreciseaveraging procedureto be usedin recal-
culatingthecosts of the putativelyefficientfirm.
81. Chileimposesbenchmark regulation onlyin thosemarketsegmentsthataredeemednotto
be contestableandhasanexplicitprocedure of publichearingsfordetermining whethercontest-
abilityexistsin individualsegments(see Galal,1993).
82. Severalaspectsof theregulatory regimeremainedto be interpreted by theantitrustcom-
missionsandthecourts-for example,interconnection agreements andtherightof Entel(a long-
distancecompanycreatedin thelate1960sandprivatized alsoin thelate1980s)andCTCto enter
intoeachother'sline of business(see Galal,1993).
 236 The Journalof Law.Economics,& Organization,
V10 N2

post-1987 period, however, provides a particularsource of flexibility that did

not exist in the 1958-74 period. Because regulationis to be undertakenonly
in noncompetitive segments, the boundaries of price competition are not
fixed in the legislation but ratherare allowed to be changed by decisions of
the antitrustcommission. It was possible to pass such specific legislation in
the first place, because at the time Chile's governmentwas unified underthe
military,partiallyresolving the legislative obstacles to the creationof a com-
plex regulatorysystem. However, this does not mean that only throughmili-
tary regimes can such specific legislation be achieved. In fact, other demo-
craticallyelected governmentshave introducedsimilarlyspecific legislationin
other regulatoryareas.83
Thus, during the post-1987 period, and to some extent following the sub-
agreementsin 1958 and 1967, governancestructureswere designed to limit
regulatorydiscretion. These governance structureswere particularlyaligned
with Chile's institutionalenvironment.Specific regulatorylaws in Chile pro-
vide regulatorycredibilitybecause specific legislative changes are not easy to
implement. Finally, deviationsfrom both specific regulatoryinstructionsand
attempts to change the system by governmentalactions can be easily chal-
lenged in the courts. The Chilean judiciary has a record of hearing-and
resolving impartially-regulatory disputes. Indeed, since privatizationit has
become involved in a series of disputessurroundingthe regulationof telecom-
munications concerning, in particular, the determination of competitive
boundaries(see Galal, 1993).
The two periods, however, providevery differentlimitationson regulatory
discretion. While regulatorydiscretionduringthe 1958-71 period was more
limited than duringthe periodpriorto the subagreementsof 1958 and 1967, it
was still much higher thanduringthe post-1987 period. Since 1987, short-run
regulatorydiscretionin pricinghas been almost completely eliminated,as the
1987 law specifies not only the proceduresto be followed, but also the way
informationis to be processed. These episodes, then, provideobservationsfor
the Figure 1 branchthat answersyes to the "specificprocess writtenin law or
contract"question.
We should note, however, that such legislative specificity would not have
provided the same type of commitmentin Jamaicaor the U.K., where laws
can be amendedmuch more easily than in a presidentialsystem like Chile's.
While specificity of the sort designed in Chile could be stipulatedin a license
(a la U.K. or Jamaica), such a high degree of specificity and complexity
requires that those active in enforcing the license-that is, company execu-
tives, bureaucrats,and the courts84-be able to effectively navigateits com-
plexity. While the U.K. bureaucracyhas traditionallyattractedhighly quali-

83. For example, in late 1992 Argentinaintroduceda similar regulatoryregime for the elec-
tricity sector (see Spiller, 1993).
84. We could even include the media, as license renewalshave always been very public affairs
in both Jamaicaand the U.K.
 The Institutional
Foundationsof RegulatoryCommitment 237

fledprofessionals,it is questionable whethertheJamaicabureaucracy hasthe

and
necessarydepth experience. As a consequence,it is reasonableto specu-
late that the introduction of Chilean-styleregulatoryincentivesin Jamaica
could have triggeredcontinuouslitigation,forcingthe Jamaicancourtsto
makehighlytechnicalinterpretations, withanunstableoutcomebeinghighly
probable. In termsof Figure 1, the U.K. andChileprovideobservations for
the branchthat answersyes to the "strongbureaucracy" question,while
Jamaicaprovidesobservations forthebranchthatanswersno to thatquestion.
To summarize,the evidencepresentedhere is consistentwith our main
hypothesisthatperformance is relatedfirstandforemostto theextentto which
regulatorygovernancestructuresare alignedwith the institutionalendow-
ments of the country.While the incentivestructuresof Chile'spost-1987
periodare particularly strong,theywouldnot be crediblein the absenceof
appropriate regulatorygovernance.

4.3 Rent-Seeking PresidentialSystems: Argentinaand the Philippines

Table4 providesa summarychronologyof telecommunications ownership,
regulation,andperformance in Argentinaandthe Philippines.85Threefea-
turesareparticularly noteworthy andwill be examinedin somedetailbelow:
first,in neithercountryhas a workableregulatory governancestructure been
in
successfullyput place; second, telecommunications in
development the
Philippines has been characterizedby a "politicalinvestmentcycle";third,
investmentlevels havebeenreasonablein Argentinasinceprivatization, but
wereaccompanied by veryhighratesof return.In thissectionwe attemptto
explainandinterpretthesepatternsin the lightof the framework developed
above.Themainthrustof thissectionis as follows:thegapsin theexogenous
institutionalendowmentof the two countriesaccountfor theirchronicfailure
to establish workable regulatory governance structures;as a consequence,
investmentdecisionshavebeenmadewithveryshorthorizons,withnegative
implicationsfor long-termperformance.
4.3.1 RegulatoryGovernanceProblems. In 1990 Argentina'smain state-
ownedtelecommunications company,ENTel,was splitandwas latersold to
two separateprivateconsortia-one headedby Telef6nicaof Spain, the
secondheadedby FranceCableandRadioandStetof Italy.86 Therulesunder
whichthe privatecompanieswereto operatehaverepeatedlybeenchanged,
with pricinga vivid example:one set of pricingruleswas announcedwhen
privateinvestorswere invitedto bid for ENTel;these ruleswere changed
duringnegotiationswiththe bidders,werechangedtwicemorein 1991when
the initialagreementscame into conflictwith broadermacroeconomic poli-
cies, andwererenegotiated yet againin late 1992. Underlyingthe fluidstate
of the regulatorysystemaroundthe timeof theprivatization,theinitialprice

85. This section is based mostly on Hill and Abdala (1993) and Esfahani(1993).
86. These companies became known as Telef6nica and Telecom, respectively.
238 The Journalof Lavw,
Economics.& Organization,
V10 N2

level for the basic telecommunicationpulse87was negotiatedafter the compa-

nies submitted their bids and after the bids were adjudicatedbut before the
companies signed their license agreementsin 1991.88 The two winning con-
sortia negotiatedhard to set the initial price level before taking control over,
and paying for, the two operatingcompanies, suggesting that they were not
confident that the proposed regulatory scheme would actually be imple-
mented. Indeed, although the regulatorysystems specified in the operating
licenses granted at privatizationincorporatedsubstantiverestraintsof some
type or another,what actuallywas implemented(i.e., a price freeze, followed
by indexationto the U.S. consumerprice index) bore no resemblanceto what
was specified in the original licenses.89 We have found no evidence that the
affected companies tried to force implementationof their license specifica-
tions throughappealsto the courts. However, this is not surprising,given the
politicization and corruptionof the Argentinianjudiciary.
The Philippines also has not had a system that imposed any substantive
restraintson regulatorydiscretion. Formally,the telecommunicationssector
has been under the control of a regulatorycommission since colonial times:
before 1972, the Public Service Commission (PSC) was responsible for all
utilities;subsequently,responsibilitiespassed to a specializedtelecommunica-
tions regulatoryagency. However, at no time have either the boundariesof
authorityof the regulatoryagency or the substanceof its regulatorymandate
ever been clearly delineated. Other than the splitting of the PSC into its
componentparts, therehave been no systematiceffortsat telecommunications
regulatoryreform, at least since the Philippinesobtainedits independencein
1946. Given the fragmentationof the Philippines'legislature, and the poten-
tial for judicial corruption,the system limits the ability of the regulatorto
promotecompetitionwithoutlegislative support.While the traditionallyfrag-
mentedlegislaturesof Argentinaand the Philippinescould providea basis for
stable regulatoryregimes, in fact both polities' lack of informal restraints,
weak judiciaries, and disregardfor the rule of law have meantthatthe oppor-
tunities for enacting restraintson changing the regulatorysystem are very
limited.90Furthermore,the existence of corruptjudiciaries in both countries

87. All call prices are based on the price of a "pulse,"with more expensive calls (e.g., long
distance) incurringmore pulses per minute.
88. A similar disdain for rules is reflected in that the exclusive licenses included the service
areas of the main private regional telephone company, CAT, a subsidiary of Siemens. As a
consequence, the licenses took away CAT's legal standing, forcing it to be sold to the new
licensees (see Hill and Abdala, 1993).
89. For example, the original licenses specified a two-yearperiodduringwhich pricingwas to
be set on a rate-of-returnbasis (the rate of returnset at 16 percent, although it was unclear
whetherthis was a maximumor a minimum,with legislatorsand the presidentof ENTeldisagree-
ing on that point), followed by a price-capperiod with X set to zero.
90. Given that the currentregulatoryregime has few substantiverestraints,and that there are
no restraintsto changing the regulatorysystem, it is only a theoreticalexercise to think aboutthe
enforcementof restraintsin the cases of Argentinaand the Philippines.We will not considerthese
issues here, except to note that while the judiciary in the Philippines has played some role in
 The Institutional
Foundationsof RegulatoryCommitment 239

seems to constitute a basic institutionalflaw, as they cannot be trusted to

restrainthe regulatorsnor to restrainchanges in the regulatorysystems.

4.3.2 Investingin the Face of Adversity. It is reasonableto ask how invest-

ment takes place at all in countrieswith such weak governancestructures.The
answer resides in the extractionof short-termrents. Measuringprofitability
rates in the Philippinesis an impossible task given the extent of corruptionin
procurement(Esfahani, 1993), but "short-termism" can be seen in the rhythm
of telecommunicationsinvestmentin the Philippines-which is attunedto the
ebb and flow of political actors "friendly"to the telecommunicationsutility
rather than to the business cycle. In particular,Esfahani (1993) shows a
repeated three-pronged investment pattern: first, investment in telecom-
municationstakes off immediatelyfollowing the inaugurationof governments
alignedwith the groupcontrollingthe main telecommunications utility(PLDT);
second, investmenttails off in the later years of the regime; and third, invest-
ment stagnates in periods when relations with the group in power are more
distant. As a consequence, sector performancehas been poor, especially in
the provision of local service. Between 1950 and 1991, the numberof tele-
phones in service expandedat the modestaveragerateof 4 percentper annum,
with bursts of moderate growth in fixed assets punctuatedby periods of
stagnation. As of 1991, recordedunmet demandfor telephones amountedto
almost 65 percent of the numberin service.
In Argentina, short-termismis apparentin the extremely high profitability
of the licensees. For example, for the 11 months ending on September30,
1991, the rate of returnto Telecom's operatorwas 26.9 percent, while that of
Telef6nica's was 203 percent. The returnsto both consortia were also quite
remarkable: 58 percent and 72 percent, respectively (Hill and Abdala,
1993:Table 8). While 1991 investments were not higher than anticipated,
during 1992 both companies increased their number of lines by twice the
number required by their licenses to maintain their 10-year exclusivity
period.91

5. Final Comments and Open Questions

The evidence presentedin the previous section can be interpretedas follows.
First, privateutilities were aggressive investorswheneverthe threerestraining
mechanisms identified in Tables 2-4 were in place (in Chile, 1958-70 and
post-1987; in Jamaica,pre-1962 and post-1987; in the U.K., post-1984). By
contrast,out of the remainingfour cases wherethe threemechanismswere not

limiting regulatory discretion, this restrainingrole seems to have been tainted by corruption
allegations (see Esfahani, 1993).
91. To a large extent, given the political impossibility of repatriatingall the cash flow gener-
ated by these companies, the fact that they quadrupledtheir additionsto main lines in 1992 may
simply reflect the use of available cash flow. By reinvesting their retained earnings now, the
companies relax the constraintsthat license investmentrequirementsmay impose in futureyears,
when cash flow reductionsmay requirethe companies to obtain fresh funds.
240 The Joural of Law,Economics.& Organization,
V10 N2

in place, only Argentinahas experiencedany significantprivateinvestmentby

telecommunicationsutilities (althoughonly two years have elapsed since pri-
vatization). And that experience has been accompaniedby unusually high
rates of return.
Second, there were substantialvariationsin the specific forms of the three
mechanisms.These variationsappearto derive from the natureof each coun-
try's exogenous institutions.Chile incorporatedsubstantiverestraintsinto its
regulatoryincentive structuresby specifying precisely how regulatedprices
are to be determined.Jamaicaand the U.K. limited administrativediscretion
by granting the regulated company freedom to set prices subject to some
overall price constraints(rateof return,in the case of Jamaica,price cap in the
case of the U.K.) and by limiting the ability of the regulatorto interferewith
such decisions. Restraintson changing the regulatorysystem were also in
place in those threecountriesduringthe periodswhen the regulatoryincentive
structureslimited administrativediscretion. The characterof these restraints,
however, varied across the threecountries, with the variationsconsistentwith
the countries' exogenous institutionalendowments: the U.K. and Jamaica
used licenses, while Chile used specific regulatorylegislation.
Third, all three countrieswhose regulatorysystems have successfully con-
strained the discretionarypower of regulators have independent and well
regardedjudiciaries. And in all threecountries,these judiciarieshave a record
of hearingregulatorydisputes and resolving them impartially.Thus, while in
seven of the nine regulatoryepisodes discussedhere, countrieswere endowed
with exogenous institutions capable of restrainingarbitraryadministrative
action, in only five of these seven episodes did governmentsuse these exog-
enous endowmentsto put in place regulatorysystems that restrainedarbitrary
administrativeaction, and, in turn, were successful in attractingprivate in-
vestment. The remaining two episodes-Jamaica between 1962 and 1975,
and Chile before the subagreementsof 1958 and 1967-appear to be cases of
missed opportunities.In both episodes there was a basic flaw in the design of
regulatory governance-a failure to build substantive regulatoryrestraints
into the system itself. Chile's 1930 law imposed a ceiling (but no floor, until
amended in 1958) on rate of return, and gave the governmentthe right to
intervenein the company's operationsunder vaguely defined circumstances.
Jamaica'sregulatorysystem between 1966 and 1975 was modeledon the U.S.
system and promotedparticipationin an open-endedregulatoryprocess by a
wide range of interest groups-but without the proceduralandjudicial safe-
guards that traditionallyhave protectedutilities in the U.S. Consequently,in
both episodes private utilities eventually failed to invest, and the resulting
conflicts with governmentculminatedin nationalization.
The two remainingcases, Philippinesand Argentina,are more of a mixed
bag. In the Philippines the exogenous domestic institutionshistoricallyhave
provided an inadequatefoundationupon which to erect a regulatorysystem
capable of restrainingadministrativediscretion. Private ownershipseems to
be based on rents extractedthroughthe political process. For all their histori-
cal weaknesses, Argentina'spolitical institutionsmay provide some basis for
 The Institutional Foundations of Regulatory Commitment 241

makingcrediblecommitments,as long as thejudiciaryachieves a modicumof

independentcredibility and enforcementcapability.If democracybecomes a
permanentfeature of Argentina, then power is likely to be more fragmented
than it is at present, both between the executive and the legislatureand within
the legislatureitself. Thus, regulatoryreformsthatlimit administrativediscre-
tion, either through licenses with very specific and limiting provisions or
through very specific legislation, may prove difficult to change and may
therebyprovide investors with safeguardsfor futureinvestments.The Philip-
pines' stable political institutions, however, seem to frustrateeven such a
mildly positive assessment (Esfahani, 1993).
Our analysis suggests that the foundationof a successful regulatorypolicy
consists of the developmentof a regulatorygovernancestructurethat is ade-
quate, given the nature of the country's institutions, to constrain arbitrary
administrativeaction and that induces private investment to take place. An
exclusive focus on regulatorygovernance, however, is inadequate,as it offers
only limited guidance as to what should be the specific contentof substantive
regulatoryrules. Thus, a unified approachto regulatorypolicy must incorpo-
rate regulatoryincentives (that is, rules concerningpricing, entry, and inter-
connection) into the analysis as well as consider the impact of the specific
content of regulatoryrules on the efficiency with which privateutilities per-
form. Exclusive emphasis on the latter, however, may result in a totally
inadequateregulatorystructure.
At this point it may be useful to speculateon what alternativesare available
to countries that lack the crucial exogenous formal and informalinstitutions
discussed here. Our discussion suggests that in those countriesprivateinvest-
ment will requirethe developmentof alternativesafeguards.One exampleof a
safeguardingmechanismis a privatizationprogramthatdistributesshareown-
ership (and thus a stake in the performanceof the privatizedcompany)among
a broad part of the population. Building a broad base of shareholderswas
importantin the privatizationof telecommunicationsin the U.K., and played
a modest role in the Chilean, Argentinean,and Jamaicantelecommunications
privatizations(but was an importantcomponentof otherChileanutilityprivat-
izations; see Spiller, 1993). Attempts at widespread ownership require the
prior developmentof a stock market, with relatively well developed security
regulations, which may be lacking in some countries. Similarly, widespread
ownershipmay requirethe developmentof privateinstitutionalinvestors(e.g.
pension funds, insurancecompanies)thatprovidea low-cost conduitfor wide-
spreadand diversifiedstock ownership.The U.K., Chile, and to some extent
Jamaicahave developed these types of institutions,thus facilitatingthe further
development of investment safeguards.92A second option is to privatize
enterprisessequentially (and to have sequential sales of shares in individual
enterprises). Since the success of the later steps of a sequenced program

92. For example, even when the U.K. Labour Party denounced BT's privatizationin the
mid-1980s, its platform called for renationalizationwithout "speculative gains," rather than
outrightnationalization.
242 TheJournal V10N2
&Organization.
of Law,Economics,

depends upon whether the privatizinggovernmentabides by the agreements

made in the earlier steps, the costs to governmentof reneging on its early
agreements can be high. Among the cases studied, Argentinaprovides the
clearest example of this approach. Its privatizationof telecommunications
was the first dramaticstep in a sweeping programto privatizepublic enter-
prises. The potential impact on the remainderof the programafforded the
private buyers of the telecommunicationsutility some confidence that the
Argentineangovernmentwould refrainfromex post administrativeexpropria-
tion (Hill and Abdala, 1993). Unless the requiredinstitutionsdevelop as the
privatizationprocess progresses, investors will be increasingly reluctantto
invest, because of fears that the end of the privatizationperiod may unravel
the goverment's self-restraint.
As for internationalsubstitutesfor missing nationalfoundations, Jamaica
and the Philippines in the 1950s come closest of all the countriesstudied to
using this mechanism. Jamaica'sjudicial system continues to recognize the
Privy Council in London as the final arbiterof Jamaicancourt decisions, a
feature that may partiallyaccount for its continuedcredibility.Even though
the Philippineswas formally grantedindependencefrom the United States in
1946, for the subsequent 15 years the continuityof pre-independenceinstitu-
tions, the strong leverage of the United States, and specific agreementsthat
protected U.S. investors provided a predictableand safe environmentthat
facilitated investment by both Filipino and U.S. investors.
The potentialexists to go much furtherin using internationalinstitutionsas
substitutesfor weaknesses in domestic commitmentcapability.One innova-
tion that has begun to receive attentionis for an internationalinstitutionlike
the World Bank to provide private investors (and lenders) with guarantees
against noncommercialrisk, including the risk of administrativeexpropria-
tion. These guaranteesare provided at the request of the host countryof the
investment. In the event of privateinvestorscalling in the guarantee,the host
country becomes liable to repay the internationalinstitutionthe value of the
guarantee.A failure to repay would provokea costly ruptureof the country's
relationshipwith an importantinternationalinstitution.Throughsuch guaran-
tees, the country's good standing in the internationalcommunity and its
continuing commitment to regulatory restraint are held hostage to each
other-providing some commitment against administrativeexpropriation.93
In sum, the success of a regulatorysystem dependson how well it fits with
a country'sprevailinginstitutions.If a countrylacks the requisiteinstitutions
or erects a regulatorysystem that is incompatiblewith its institutionalendow-
ment, efforts at privatizationmay end in disappointment,recrimination,and
the resurgenceof demandsfor renationalization.

93. Note that a programalong these lines is different from existing programsof insurance
against noncommercialrisk-which shift the costs of administrativeexpropriationto the insurer,
and thus do little to enhance the incentive of the host countryto abide by its commitments.
 The Institutional Foundations of Regulatory Commitment 243

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