Regulatory capture: cost vs incentive-based regulation

Abstract

Regulation is considered as the key issue in reforms of public service sectors. But, it has been pointed out that regulatory capture could undermine the stated aims of reforms. This paper compares the two main types of economic regulation: regulations based on costs, and based on incentives. While literature usually considers incentive-based regulation to be more prone to capture because of the higher stakes involved, we qualify this view based on findings of the economics of corruption, which opens the black box of processes through which capture occurs. Ultimately, both present specific risks of capture as well as common problems, which are not the least due to similarity of both types in day-to-day regulatory praxis. The paper, thus, detects the weak points by drawing a ‘risk-map’ to provide a foundation on which countermeasures can be designed.