The Objectives of Economic Regulation: Feasibility & Public Acceptability, Sept 2019

In honour of Professor Catherine Waddams’ lifetime of research, the Centre for Competition Policy is hosting a special one-day conference looking at how regulatory objectives have changed in the last forty years.

At the origin of the current regulatory structure, economic regulation may be characterised as focusing on a narrow definition of economic efficiency. These objectives have since broadened, largely in response to political imperatives. In some sectors, the number of legislated objectives for regulators has multiplied, without regulators receiving simple and implementable guidance on how to weigh the different objectives against each other.

This conference will discuss the theoretical and practical consequences of such trends, as well as the implications for political and public acceptance of devolving regulatory mandates to independent entities not subject to day-to-day political oversight. See below for an overview of the days discussion:

The Objectives of Economic Regulation – Opening Remarks

For the last 10 to 15 years, the objectives of British regulators have evolved in both magnitude and complexity. CCP’s Director Professor Sean Ennis highlights the importance of holding this conference at this precise moment in time, when fairness and acceptability questions regarding the objectives of regulation are being raised both from academia and the public sphere. By honouring the life work of Professor Catherine Waddams, this conference has brought together a handful of very relevant scholars and professionals of the sector to shed light on the upcoming challenges.

Professor Frances Bowen, Pro-Vice Chancellor for Social Sciences at UEA since September 2018, praises the work of Professor Catherine Waddams. In her more than 40 years’ experience and involvement in regulation, Professor Waddams research has been widely cited and published in reference journals, especially in Energy Markets, and she has been an active participant in the development of the British regulatory agencies. For the last years, Professor Waddams has been a non-executive member of the British Water Services Regulation Authority (Ofwat), and a member of the expert advisor panels of the UK Regulators Network.

Professor Waddams reviews the development of the British regulated industries. Starting with marginal cost pricing in the nationalised industries like gas, followed by the 1980s privatisations, and the subsequent introduction of competition in industries like telecoms and energy, her research has contributed to the sate-of-the art economics on each of the phases. More recently, Professor Waddams has been leading the project on Fairness and Equity in Energy Markets in CCP. The political climate of the upcoming years will define what will be the new direction that the British Economic Regulators will follow.

Session 1: The Development of Regulatory Objectives Over 40 Years

In this first session of the CCP seminar on the Objectives of Economic Regulation, in honour of Professor Catherine Waddams, UEA Law Professor and CCP member Michael Harker, and CCP Senior Research Associate David Deller speak about the objectives of regulation from different perspectives.

Statutory duties and the Decision-making of an Economic Regulator:  a case study of Ofgem

In the first part of this session Michael Harker focused on the importance of the definition of statutory duties for regulators and about shaping the decision-making of an economic regulator, mainly reporting the results of set on interviews conducted with Ofgem regulators.

Harker was mainly concerned with the effects of regulation complexity on energy markets, with special attention to transparency, looking to draw a broad picture of the duties of the regulator, social or economic, and of the main challenges that regulation agencies face. Interviewees by and large reported on what they saw as the excessively complicated role of regulation its lack of transparency.

In fact, these concerns are substantiated by the drastic evolution of the regulators primary and secondary duties since 1986, and especially with the introduction of competition through privatisation under the Utilities act of 2000. In general, Harker highlights how the role of regulators have become increasingly more complex over time, with an expanded set of objectives to be delivered: from consumer fairness and protection to promoting efficiency and enforcing quality standards.

In this sense, the House of Lords Committee on Regulators (2007) concluded that government should be careful not to offload policy duties onto unelected regulators. This Committee established broad principles of regulation for the UK, and set the objectives to increase transparency and simplify the role of regulator, but Harker raises the point that it is incredibly difficult to determine the optimal levels of duties to be assigned to regulators.

Overall, Harker’s key conclusions from the case study in Ofgem are that statutory duties are important to structure decision making within regulators, and that clarity of objectives is invaluable when regulators are dealing with controversial measures that can impact consumers negatively in favour of other objectives.

Economic Regulation in Context: the case of the water sector in Europe. David Deller, CCP.

David Deller discussed three issues regarding the role of regulators in different European countries: The different society’s objectives for the water sector by country, variations in the water sector’s outcomes and organization and the perks of setting up an independent regulation system.

David pointed out that society has a range of objectives for the water sector that need to be balanced, such as operating efficiency, appropriate investment in the long run, affordability, water conservation, security of supply, public health. All of these are affected by economic policy, but some of them are complementary to the economic objectives – such as operating efficiency and affordability – but others conflict with economic objectives, like affordability and water conservation.

Different countries place differing weights on these objectives. Data from the Global Water Intelligence (2018) suggests that Germany, for example, places much importance on long run investments, water conservation and reducing waste, and low weights on the importance of prices. Germany, according to this study, is an example of a system with high costs and high quality, opposite to the Italian system, which places a lot more value on price than on quality and conservation.

Looking into system ownership models, Germany is largely a publicly owned and publicly run system, where even the private systems have a large public participation. In Italy the system is a lot more varied, with a large variety of system sizes, and many possible combination of ownerships.

At this stage Deller looked into the impact of the water nationalization of the Italian water system, which go far beyond a simple transfer of ownership. David claims that the objectives of the system have also changed, now placing even more weight on affordability and less on conservation. But regardless of ownership, ensuring long-run investment is a potential issue. At the heart of network utilities is infrastructure requiring continuing investment to remain effective.

Delegation of regulation to an independent body may be useful in this world because it can ensure commitment to a particular level of investment, this is because:

1)      Under public ownership funding levels could be directly linked to the regulators assessment of investment needs;

2)      Under private ownership regulators are required to guarantee a reasonable level of return on investment for firms to continue in operation

Session 2: International Experience with Goals of Economic Regulation

Dr Liebhaberg  discussed on the new roles of the regulator in the context of digitisation. competence issues. Following the role of data mobility, regulators are now forced to innovate. France provides an example in the telecoms sector by establishing an algorythmic regulator. The role of platforms is also leading regulators to expand their role as consumer protection and privacy protection are an increasing issue.  Competition regulators not only work at the national level but also within a network of national regulators. Finally, the speed of technological changes implies that business models are changing so fast that it creates a trade-off between defining bona fide policies and long lasting policies for the regulator.

Professor Simon Roberts talked about economic regulation in South Africa. Regulation of network industries was passed on to competition authority but the country is seen as a success of competition law establishment. In network industries such as the energy and telecom sectors regulators are independent but they failed to address the structures of the economy. Prices were too low in the electricity industry and independent producers were unwilling to supply. In the telecom sector, the regulator tried to get information for network firms which boards are politically nominated. A central is how to open up the energy sector in a context of climate change. Finally there is an Issue of trust in markets as people believed being robbed and there is a need to rethink of the overall role of the regulator as part of a political settlement and not a substitute for policy agenda.

Dr Russel Pittman discussed on the regulation in the fret railway sector following vertical and horizontal separations of infrastructure and operations. In the US and Mexico, large regions are served by only one or two vertically integrated companies. For rail captive shippers (bulk chemicals, construction materials), vertical separation addressed the problem of market power: a customer could get own wagons if prices were too high from the original provider. Under horizontal separation, access can be allowed by requiring the serving railroad to allow another rail service to use its track. As for tariff setting, Ramsey pricing is an efficient way to regulate prices but it should be complemented by the use of competitive rate benchmarking, commodity specific rate or geographic specific rate of return regulation to address fairness matters. However to attract private capital in emerging countries, giving private companies long term franchises for fret railway has been successful. The experience of Mexico and Brazil in this context have attracted private capital through private consortia.  

Session 3: Economic Objectives of Regulation

Stephen Littlechild, Emeritus Professor at Cambridge University and one of the main economists involved in British historical privatisations and liberalisations, chairs the third panel of the conference on the economics objectives of regulation. He reviews the history of the British nationalised industries since the 1950s until privatisation. During the 1970s many problems were identified in the nationalised industries, that were performing financially very poorly, and several government proposals were aimed, among other things, to introduce competition in order to improve performance. But at that point, privatisation was still a political taboo. It was not until the privatisation of British Telecom in 1982, in which Professor Littlechild played a major role, that Economic Regulation of private enterprise became a major challenge in the UK.

Stephen Littlechild reviews the history of the British nationalised industries since the 1950s until privatisation.

Michael Waterson follows with a discussion on the history of regulated monopolies. He has been Professor of Economics at the University of Warwick since 1991 and has written widely on industrial economics topics including several books and a large number of articles, including papers in American Economic Review, Quarterly Journal of Economics, Economic Journal, Rand Journal, etc. As Milton Friedman put it, every time we encounter a natural monopoly we have to choose between three evils: an unregulated private monopoly, a regulated private monopoly, or government provision. But the nature of natural monopolies has evolved over time. Some parts of traditional network natural monopolies have been able to be liberalised due to technological changes, as telecoms. Similarly, the continuous development of network industries will create new challenges in the future.

Michael Waterson gives a history of the regulation of network utilities and gives his thoughts on it’s future

Consumer engagement and protection in the energy retail market is the next topic, presented by Monica Giullietti, Professor of Microeconomics and Head of the Economics Discipline Group at the School of Business and Economics, Loughborough University. She has also been a member of Department of Energy and Climate Change panel of technical experts for the Electricity Market Reform. Professor Giullietti highlights that liberalisation in the Energy Markets was not as successful as predicted partly because consumers are not that engaged and do not switch providers as traditional models predict. Both her and Professor Waddams have collaborated to identify which consumers might be vulnerable and so protected by regulators, making a huge contribution to the field.

Monica Giulietti discusses consumer engagement and protection

Professor David Newbery is the Director of the Cambridge Energy Policy Research Group and Emeritus Professor of Applied Economics at the University of Cambridge.  He has managed research projects on utility privatisation and regulation, road pricing, transition from state socialism to the market economy in central Europe, electricity restructuring and market design, transmission access pricing and has active research on market integration, transmission planning and finance, climate change policies, and the design of energy policy and energy taxation. He closes the panel by highlighting future regulatory challenges in the electricity market and in network industries in general. The standard regulatory model with periodic reviews, lengthy consultations, etc., results in regulatory stability and so it is good for investor inefficiencies. Unfortunately, it is poor at addressing inefficiencies, short-run challenges.

David Newbery highlights future regulatory challenges in the electricity market and network industries

Session 4: Regulatory Objectives – Past, Present & Future

Martin Lodge is a Professor of Political Science and Public Policy at the Government Department of the London School of Economics, working on executive politics and regulation. He is also managing director of the journal of Public Administration and co-editor of the book series Executive Politics & Governance with Palgrave. Martin discusses The Changing Nature of Economic Regulation, arguing that since the last economic crises, regulators themselves have become part of the political environment. Newspaper mentions of price reviews have skyrocketed over the past 6 to 7 years, evidence that a lot more media attention is now devoted to regulation. According to Martin, this is a strong signal that regulation is now part of the contentious political arena.

At this stage, Martin shifts to the implications of this movement. The politicization of regulations is a concerning issue due to the potential challenges that politicized argumentation and polarization can pose to technical decisions, shifting regulators away from their responsible regulatory state towards what has been called a responsive state.

Tim Tutton, Associate at the Centre for Competition Policy at UEA, is also a member of the Competition Decisions Committee with the Financial Conduct Authority and a non-executive director of Bristol Water plc. Tim talks on the Political Control of State-owned Utilities: Lessons from UK experience with nationalised and privatised utilities, underlining that his talk is not about the desirability or otherwise of nationalising energy networks, but yet about how political control of utilities can work.

Political control of utilities is problematic, regardless of whether private or state-owned, this is because of many reasons, the most important one of them is that utilities are politically salient and day-to-day political intervention tends to compromise utility operations.

So how can political control actually worked in the nationalised era (1940s)? According to Tim, political control followed the blueprint of Herbert Morrison’s book Socialisation and Transport (1933), heavily emphasizing the central role of the boards of the public corporations, while also giving these corporations a high level of autonomy, even though political ministers could be appointed to central roles in the decision making. This was problematic because politicians, contrary to the expectations, held little interest in the overarching strategical framework of utilities and ended up more involved in day-to-day operations that initially intended, curtailing the operational autonomy of these utilities. Other challenges impending were also the lack of incentives to improve efficiency and to achieve adequate financial performance, endemic of the nationalization framework.

But according to Tim, this framework has substantially evolved over time through a series of legal improvements and policy papers. Also privatisation and regulation imposed a new framework for the political control of utilities. Even though in the immediate post-privatization period regulators were largely independent, this independence came under fire especially from the mid 2000’s, mainly due to higher energy prices and climate change policy, which also took its political toll on ministers through higher utility prices.

Tim Tutton presents ‘Political Control of State-owned Utilities: Lessons from UK experience with nationalised and privatised utilities

Session 5: Practical Challenges of Regulators with Multiple Objectives

The final session, chaired by Greg Olsen, introduces topics on the challenges faced by regulators having multiple objectives through interventions from Dr Amelia Fletcher (CCP, University of East Anglia), Dr Maureen Paul (Ofgem), Alex Plant (Anglian Water) and Lucy Eyre (Ofcom).  Greg Olsen is partner and head of the London antitrust practice of Clifford Chance. He specialises in EU and UK competition law and has significant experience advising on cartels and other critical antitrust investigations. He regularly represents major corporations and institutions before the EU and UK competition authorities and has worked across a wide range of industry sectors, including financial services, media and consumer goods & retail.Dr Amelia Fletcher makes suggestions about changes with a competition authority, the CMA. This February the CMA made a variety of proposals for reform in the duty of CMA to enhance consumer benefits, such as consumer enforcement work. However this does not fit in the framework of the CMA’s objectives. This leads to the question of whether there should be one or more consumer enhancement duties. Having only one duty is politically appealing. Secondly, it is easier to explain publicly. Third, there is a clear focus on consumer interest that makes CMA’s guidelines more explicit. The CMA should shift towards more consumer interest with the idea of strengthening CMA’s legal framework to intervene in consumer interest. Thus having a single objective is clearer and cleaner in regards to the public debate.

However, having several consumer protection objectives could be easier to show a likely harm to competition. Second, all sorts of factors can affect consumers (quality of product etc…) and CMA should avoid to take responsibilities for issues arising outside its scope of intervention.  Third, there is the aspect of short term consumer protection and long term competition protection. A more consumer protection duty makes competition protection less likely. Interestingly, Dr Fletcher points out that if the CMA really wants to ensure that competition remains its main duty, it should ensure that CMA promotes consumer interest rather than protecting.

Dr Maureen Paul focused on the importance of balance of objectives on an aggregate basis over time in the context of gas and electricity markets. Among the objectives, promoting effective competition and protect vulnerable consumers are the main ones. Achieving all objectives is tricky and impossible. Hence, managing the trade-offs is key. For example, price cap regulation tackles these two main challenges. Second the implementation of the target charged review addresses the inefficient system that incentivises consumers to make inefficient decisions. Thus, to achieve efficiency, Ofgem has to let go of a group of consumers. Dr Paul stressed that taking a portfolio approach and a measure of decisions over time instead of policy by policy basis was more appropriate, with the idea of considering the distributional impact on consumers. Impact assessment are key to know how effective is the approach adopted. However data availability remains a challenge to better understand the implications of decisions. Finally, cross regulator work remains desirable.

Lucy Eyre highlighted the trade-offs in the objectives of spectrum auctions. Ofcom wants to ensure that spectrum is allocated to the acquirer that values it the most. However, Ofcom also reviews the competitive state of the mobile market in the allocation decision process. For example, it assesses whether the acquirer has a strategic value in acquiring the spectrum. Furthermore, mobile coverage is included in the objectives, with a target of 90% coverage of the land mass. In addition it is important to provide of quality of coverage. Finally, Ofcom should ensure timely availability of spectrum. A number of measures can be adopted to achieve high coverage. For example it is possible to provide different coverage obligations to the spectrum at different prices. The buyer can the select the one that it prefers. An alternative mechanism is to sell different frequencies coverage that are not necessarily substitute. Nonetheless, Lucy Eyre highlighted that the efficient allocation can be distorted if prices are not set appropriately. Recently mobile operators came up with a new proposition as an alternative.

Alex Plant talked about consumer interest objectives from a company perspective. He stressed that a water company ought to be delivering consumer interest services rather than a return maximising behaviour. The firm has taken a further major step by changing articles of association. It consists of delivering more long-term value to consumers, the environment and communities. For instance, the company has adopted the 6 capital decision outcome. Finally Mr Plant highlighted that tricky trade-offs can be made more easily within the board of directors and more engagement between companies and the regulator is desirable.

Comments are closed.