In many countries, the low quality of electricity supply slows down economic growth. Without a continuous and reliable supply of electricity, firms face difficulties in improving their productivity and competitiveness. All key sectors of the economy – agriculture, industry, and services – benefit from electricity as an input.
In recent work published in the Journal of Policy Analysis and Management (gated; ungated pre-print), Joonseok Yang and I investigate the value of a specific power sector reform for encouraging private investment in power generation. We focus on the problem of electricity generation, asking a simple question: how can governments encourage private investors to increase generation capacity?
The results from the study suggest that allowing independent power production (IPP) is enough to produce a large increase in private investment in electricity generation. Both domestic and international investments increase, and the private increase easily compensates for any reduction in public investment in generation capacity.
These results are good news and important for policy because IPP reform is among the easiest available to governments. It does not require fundamental, politically controversial changes to the governance of the power sector. The government simply allows independent producers to generate and sell power to state-owned electric utilities based on purchase agreements.
The results are also somewhat surprising, given that governments’ inability to commit credibly to policies is a thread running through the literature on investment. But when we investigated cases of IPP reform, we found that governments had a good track record of honoring their commitments under purchase agreements.
As governments aspire to fuel their economies and reach universal electricity access, power sector reforms are bound to play a central role. While IPP reform does not solve difficult problems in the distribution sector, such as electricity theft or agricultural electricity subsidies, this policy does allow governments to rapidly expand their electricity generation capacity. In countries that face capacity constraints in the power sector, our evidence should encourage governments to pass policies that encourage independent power production.