Collusive contracting with private power plants in Bangladesh has resulted in high power prices that cost the taxpayer around U$1 billion in subsidies. The main driver of collusive contracting is the unwillingness of politically unconnected firms to engage in a high-risk environment. The government has adopted a targeted risk absorption strategy to attract investment that negotiates markups with interested firms. This article argues that this strategy cannot discover the minimum markup that would induce investment. Moreover, because only politically connected investors are likely to bid and negotiate, this approach encourages investors to set high mark-ups. An alternative strategy is competitive risk mitigation that provides contestable subsidies from development finance institutions (DFIs), such as preferential finance and partial risk guarantees. Contestable subsidies work by reducing risks of unconnected investors, encouraging their participation to make collusion more difficult, and constraining mark-ups. To test the hypothesis, a dataset on plant-level DFI support and prices was collected from 58 private power plants in Bangladesh from 2004 to 2017. The empirical analysis finds that financing instruments with contestable subsidies from DFIs are associated with a 26% reduction in plant-level prices controlling for plant capacity, size, and fuel type.
Authors: Khan, Mushtaq; Watkins, Mitchell; Zahan, Iffat
Type: Journal Article
Year: 2022
