Discussion Papers

Christine Müller, Christian Growitsch, Matthias Wissner

Regulation and investment incentives in economic theory. IRIN working paper for working package: Advancing incentive regulation with respect to smart grids

No. 349 / December 2010


In this paper, we survey from a theoretical point of view to what extend cost-based and incentive-based regulatory regimes stimulate investments. For the purpose of this analysis, we furthermore differentiate by different efficiency measures, i.e. allocative efficiency, productive efficiency and dynamic efficiency and analyse to what extend each efficiency measure is stimulated by the regulatory regime. Special attention is paid to incentives for dynamic efficiency.

Overall, we find that conventional cost-based regulation only stimulates allocative efficiency and strongly encourages over-capitalization (Averch-Johnson-Effect). Moreover, we argue that current forms of incentive regulation only lead to productive efficiency, predominantly incentivizing short-term efficiency in terms of operational expenditures (OPEX). Also, additional instruments such as quality regulation and/or additional allowances, e.g. investment budgets as applied in Germany, may incentivize replacement and expansions investments respectively. However, from a theoretical point of view, incentive regulation does not stimulate dynamic efficiency in the sense of explicit regulatory stimuli for asset innovation leading to a dynamically efficient CAPEX allocation.

Thus, we conclude that complex trade-offs result from the guiding idea of an efficiency oriented network operation (productive efficiency) and the incentivation of dynamic efficiency. A scrutiny of the state-of the art of related academic work shows that this problematic is merely characterized and should be further elaborated within IRIN from different perspectives.

Full version only available in German language.

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