Regulating prices and profits in utility industries in low-income economies: Rate of return, price cap or sliding-scale regulation?

Purpose - The aim of the paper is to examine alternative methods of regulating prices and/or profits of privatised utilities in low-income countries with a view to identifying their strengths and weaknesses. Design/methodology/approach - The economics of regulation literature has favoured the use of a price cap over rate of return or cost of service regulation because of its greater incentive effects. A third alternative, sliding-scale regulation, has been put forward as a compromise between the price cap and a controlled rate of return, which is said to combine the merits of both methods. This paper considers the operation of a price cap, rate of return regulation and sliding-scale regulation in the context of low-income economies by reviewing the theory in relation to the conditions likely to be found in low-income economies. Findings - It is concluded that the case for the use of a price cap is much reduced in low-income economies. This is because of its information requirements, need for regulatory expertise and, more broadly, the institutional endowment found in many low-income countries. Research limitations/implications - It is recognised that this conclusion is tentative and deserves further research, comparing theory and practice. Practical implications - Countries need to consider carefully which method of regulation will work best in the context of the institutions of the country, rather than simply copy a method from the developed world. Originality/value - This is one of the first papers to challenge the prevailing belief that price cap regulation is superior to rate of return regulation in the context of economic development. © Emerald Group Publishing Limited.