Do Governance Costs Explain the Problem of Private Investment in the Indian Power Generation Sector?

After two decades of attempts to deregulate the Indian power sector and bring in more competition, the question we are asking is: why has private investment not flooded in as expected? We analyze the problem using an economics of governance framework which suggests that various organizational arrangements: markets, hierarchies and hybrids align themselves to minimize transaction costs. We subject our observations to the privately owned gas based power plants in two Indian states - Andhra Pradesh and Gujarat. The Andhra Pradesh Independent Power Producers (IPPs) suffered because the government reneged on its soft commitments to provide gas, leading to a situation of incomplete contracting whereas the IPPs in the state of Gujarat performed better because they had insulated themselves against the risks of such contractual hazards by securing private gas supply contracts. Our analysis shows that the problem of private investment will persist as long as the costs of governance (adaptation to ex-post contractual hazards) are high. Under such a scenario, rather than moving towards a market based system, the sector will move towards organizational arrangements which are closer to vertical integration. To substantiate this, we also give some indicative evidence