generates growth not only in this hemisphere but elsewhere in the developing world. Empirical
cross - country studies showed that the quality of institutions had more impact on the per capita
growth rates than economic policies per se. It seemed that good economic policies are a result of
good institutions and hence one ought to concentrate efforts on establishing strong, transparent,
and reliable institutions first, rather than designing policies that may just be the result of current
conventional wisdom. (Easterly and Levine 2002, Rodrik, Subramanian, and Trebbi 2002). In
Latin America, the improvement of institutions was part of so-called ”second generation reforms“
(Naim 1994), and as these public institutions were transferred to the private sector, attention was
drawn to the regulatory frameworks that emerged as these newly privatized institutions began to
operate.
If the importance of institutions is recognized as vital in generating economic growth, it is also
recognized that the institutional environment in many countries is far from optimal - perhaps
more so in poorer countries than in richer ones. When a weak institutional environment exists, a
different set of economic policies may be advisable than those that would be recommended in
healthier settings. For instance, tax policy in low income countries does not seem very effective
in achieving redistributional goals. When some economic policies are ineffective, than several
first-best solutions may be irrealistic. In the context of regulation of public utilities, the lack of
first-best solutions may justify the existence of different types of subsidization schemes,
including cross-subsidization, in order to achieve certain goals. As is well known, the welfare
maximizing tariffs of a natural monopoly are the so-called Ramsey prices, where the fixed costs
are distributed to consumers according to their inverse price elasticity, which may imply some
cross subsidization (Krakowski 1988). However, cross subsidization which is not due to Ramsey
pricing should not occur because it would lower welfare. When some subsidies for certain
consumers are considered desirable by society - for example telephone for the elderly - then
direct subsidization should be applied. If a weak institutional environment does not support this
kind of first best solution, or if it implies high costs, then maybe a second best solution - like
cross subsidization - should be considered.
This kind of reasoning draws attention to welfare considerations of utility privatization and
regulation. When the only objective of privatization and regulation is the most efficient provision
of a service, than possible negative welfare effects might be remedied by transfers via direct
subsidization. When direct subsidization is not feasible, then a wider set of solutions should be
contemplated, including subsidization of the poor by other segments of society. Possible
subsidization schemes range from general price subsidies to lifeline tariffs, merit-based price
discounts, cash transfers, and noncollection. A description, including merits and lack thereof, of
these types of subsidization schemes is provided in the appendix to this document.