Productivity growth and incentive regulation in Austria's gas distribution

The projected rate of productivity growth is the critical determinant of the price cap in incentive regulation. However, the regulatory authorities generally lack sophisticated industry TFP studies to set an optimal cap. We thus estimate productivity growth in the Austrian gas distribution sector in a translog cost function framework. A key feature is our unique panel database on costs and outputs of regulated utilities for the period 2002–2013, covering six years prior and during incentive regulation as introduced in 2008. We find a modest TFP growth rate in the early sample years, followed by a decline to zero or even slightly negative rates in recent years. We also find a significant potential for returns to scale, which is left unexploited, indicating that utilities could significantly save on costs by merging. As essential investments have already been undertaken in the past, opportunities for technological progress seem to be limited in recent years.