Price-Capping Regulation as a Protectionist Strategy in Developing Countries

In developing countries undergoing liberalising economic reforms, there are typically local incumbents facing the loss of protection. Strategic lobbying by such firms for a price-capping regulatory regime is, under certain conditions, one way in which they can deter entry by competitors who are likely to be foreign firms. We show that a regulatory price can be set such that the net profit of the entrant is lower than the entry cost thus deterring entry. We then show that it is possible for the profit of the incumbent to be greater under regulation which deters entry than under unregulated duopoly. Counter-intuitively, we further discover that lobbying for regulation is to be expected where the incumbent firm is relatively cost-efficient. We also consider the case of multiple incumbents threatened by entry. We observe a co-ordination problem and consider the possibility of co-operation in lobbying. We then show that such cooperation, if possible, is always preferable to non-co-operation. We also extend our analysis to incorporate the possibility of lobbying by the entrant and show the importance of the cost of lobbying and the probability of successful lobbying by the incumbent. JEL Classification: L11, L41, L51