Regulation by duopoly under political constraints

In a variety of economies, the past two decades have witnessed sub-stantial privatisation and regulation of previously state-owned monop-olies. An important question for policy makers in such situations is the design of the regulated industry: should it retain its monopoly sta-tus (as British Gas did) or should it face immediate competition? An important influence on this decision may be the degree of regulatory capture in the privatised industry. Accordingly, we adapt Auriol and Laffont’s [3] model of regulated industry design to allow for this effect. We find that delegation to a benevolent regulator is welfare enhanc-ing. A non-benevolent regulator (i.e. one open to capture) reduces welfare because he requires costly incentive payments and outputs are lower to reduce rents (thereby hurting consumers and firms). Auriol and Laffont’s favouring of duopoly is strengthened in this case, which raises interesting questions about the optimality of regulated industry structures in a number of economies