Memorandum submitted by Europe Economics
HOUSE OF COMMONS REGULATORY REFORM COMMITTEE
Submission By Robert Young, Europe Economics
Synopsis: this submission argues that the formation
of larger regulators by merger of earlier smaller regulators has
resulted in a shift of attention away from the limited number
of basic tasks that economic regulators were created to carry
out and towards an expansion of regulatory scope and ambition.
The result has not obviously benefited consumers and it is not
certain that it has resulted in greater regulatory efficiency.
It is perhaps time for Government to pare back the scope of regulation
but to ensure that it is rigorously and independently applied.
BACKGROUND
1. Europe Economics is a private sector
consultancy that specialises in the application of economics and
econometrics to business problems, primarily in the fields of
competition, regulation and public policy analysis and formulation.
The firm's clients include companies large and small, trade and
professional bodies, regulators and competition authorities, and
law firms. About half our business, measured by number of assignments,
comes from outside the UK: our largest non-UK clients are the
European Commission and Irish economic regulators.
2. My credentials for making a submission
to the Committee are as follows. I spent some 20 years in private
sector industry, completed a two-year secondment to the 10 Downing
Street Policy Unit in the 1980s, and was then appointed and re-appointed
a member of what was then the Monopolies & Mergers Commission
(MMC), serving there from 1986 to 1992. In 1993 I began
consulting in competition and regulation issues for Coopers &
Lybrand, and joined Europe Economics five years ago. A good deal
of my work in the past 20 years has been for regulatory bodies
or for companies appearing before them. I have been involved in
31 inquiries by the MMC or its successor body, the Competition
Commission, and in 17 inquiries involving UK economic regulators.
3. Competition and regulation involve overlapping
skill sets: although the institutional arrangements differ, consulting
experience acquired in one is almost always of value in the other.
In some cases, competition and regulation may be closely intertwined.
Sometimes an authority needs to establish whether an unregulated
service ought to be regulated, or whether a regulated service
ought to be removed from regulation and left to competition. It
is no accident that some UK economic regulators have now been
given competition authority powers, to be exercised in parallel
with those of the Office of Fair Trading.
FEWER BIGGER
REGULATORS
4. The single issue I should like to bring
to the Committee's attention is whether the Government's apparently
remorseless creation of fewer bigger regulators from a greater
number of smaller, more specialised regulators has been a good
thing for regulatory efficacy, or, more importantly, for consumers
and UK society. My personal view is that it has not, and I suggest
that the Committee may wish to explore for itself whether, in
practice, bigger regulation has proved to be better.
5. The principal regulatory "mega-formations"
that have taken place under the present Government are the Financial
Services Authority (FSA); the Office of Communications (Ofcom);
and the Gas and Electricity Markets Authority (GEMA), which conducts
its day-to-day activities through the Office of the Gas and Electricity
Markets, Ofgem. The consumer coverage of these organisations is
immense: between them, the services regulated by the FSA, Ofcom
and Ofgem reach into virtually every household in the UK.
THE OPERATING
COSTS OF
REGULATION
6. It has been said that the operational
costs of the new mega-regulators are greater than the pre-merger
totals of their predecessor bodies, although it is now hard to
establish like-for-like comparisons. That said, some regulators
have ballooned more than others:
— As at March 2008 the FSA employed
2,535 people, compared with 1,762 as at March 1999,
by which time it had taken over substantially all the functions
of the predecessor bodies. The headcount increase amounts to 44%.
— Ofcom, formed at the end of 2003, had
727 employees as at March 2004, rising to 812 in March
2008, an increase of 12%. However, this comparison conceals a
substantial dispersion of almost 600 Radiocommunications
Agency employees, and it is not clear that any of the implied
productivity gain should be credited to Ofcom. The two principal
sectors regulated by Ofcom—telephony and commercial broadcasting—accounted
for some 420 staff (at Oftel and the Independent Television
Commission) just before the creation of Ofcom.
— GEMA and Ofgem replaced only two previous
bodies, the Office of Gas Supply (Ofgas) and the Office of the
Electricity Regulator (OFFER). Ofgem records that it reduced its
headcount to 303 in its first year of operation from the
figure of 380 employed by its predecessor organisations.
Nevertheless, in the five years 2004 to 2008, the staff costs
of GEMA and Ofgem rose by 18%, from £16.3 million to
£19.2 million (the published accounts do not reveal
numbers of staff).
7. The running costs of regulators are of
course a burden on the regulated industries that finance them,
and thus ultimately on consumers, and it is for the Committee
to reach a conclusion on whether the increasing cost burden is
either necessary or fair in relation to the regulation carried
out.
THE APPARENTLY
REMORSELESS EXPANSION
OF REGULATION
8. However, my concern is less with cost
increases—which, however objectionable, are still a small
fraction of industry revenues—than with the expansion of
regulatory scope. I am certainly not the first commentator to
raise this matter, and I am sure I will not be the last, but I
do join with others who might hold similar views in urging the
Committee to include regulatory reach and ambition in its investigation.
9. When economic regulators first came to
prominence in the 1980s and 1990s it was expected that as the
monopoly supply industries they regulated gave way to competition
the need for economic regulation would wither away. This has simply
not happened: no economic regulator has vanished except to form
part of a bigger regulator. It is not too fanciful to say that
economic regulation has become an industry in its own right, and
that what has been referred to as "regulatory creep"
is becoming accepted as a normal tendency.
10. There is copious evidence to suggest
that regulators—and their sponsoring Ministers—now
see the expansion of regulation into sector co-management as some
sort of guiding principle. I quote from three sources to illustrate
the point.
11. The first is a speech given by the then
Deputy Chairman of Ofcom, Richard Hooper, to an Australian audience
in November 2005. Here are some extracts from what he said:
"The conclusion of the Telecoms Strategic
Review earlier this year has led to greater investment confidence
in BT, the incumbent and in both types of BT competitors—infrastructure
competitors like Cable & Wireless, and service competitors
like Carphone Warehouse—a win, win, win situation I believe…
"We hope to have encouraged not just investment
but also "innovation"…
"Ofcom engages with its stakeholders not
via remote control but with the emphasis on face to face meetings,
presentations and seminars, not just in London but also around
the devolved nations and regions…
"The new building reminds visitors more
of a professional services firm than a government department…
"There is an entrepreneurial air to Ofcom's
approach to regulation which might surprise people and might on
occasion be more reminiscent of the private sector than the public
sector. There is an element of deal-making in Ofcom's approach
to some big regulatory issues, getting people around a table and
hammering out an acceptable solution and way forward. Whilst there
is and has to be great attention to process, process should not
suck the regulator away from finding lateral, creative, innovative
interventions…"
12. Ofcom's predecessor in the telecoms
sector, Oftel, was set up to carry out such basic function as
price-capping BT's retail prices and its wholesale interconnection
charges. As regards the viability of BT, Oftel was required merely
to ensure that the company could finance its regulated functions.
One might ask: why is it now the business of Ofcom to encourage
investment in BT or in any other competitor for that matter? Is
it for Ofcom to take a position on innovation, and what exactly
do the quotation marks round the word innovation imply? Is it
appropriate for Ofcom to engage in deal-making with regulated,
or even unregulated, entities? Mr. Hooper's remarks make Ofcom
sound like an old-style sponsoring Ministry—the very thing
that independent regulators were established to get away from.
13. My second source is evidence put to
a House of Lords committee which in 2007 produced a report
on Regulation.[205]
The evidence I refer to comes from economist observers of the
UK regulatory landscape, Messrs. Keith Boyfield and Tim Ambler.[206]
Relevant extracts are as follows:
"…regulatory agencies have grown dramatically
since 1997 both in size and the roles they are now assigned.
This trend can be attributed to the current government's relative
scepticism about, or limited understanding of, market mechanisms,
and perhaps regulatory agencies' utility as additional branches
of government. The extent to which government should intervene
in detail in markets is a matter of political opinion. What is
not in doubt is that these agencies enable the party in power
so to do…
"The Labour government's consumerist agenda
has proved hard to define in legal language. We would argue that
it [is] open to doubt whether any government should devolve governmental
responsibilities to unelected quangos in this way. Significantly,
Ministers have provided the utilities with hardly any guidance
on how to fund their social and environmental objectives. For
instance, how far should prices rise in order to cross-subsidise
those who can less afford fuel? And how high should prices go
in order to address with [sic] specific environmental problems?
Little attempt has been made to establish priorities and trade-offs.
The theoretical independence of regulatory agencies is no excuse
for not specifying what they are supposed to achieve."
14. My third source is again the 2007 House
of Lords report on Regulation of which Chapter 7 reads as
follows.
"7.38. A lot of the evidence we received
highlighted the way in which regulators' roles kept on expanding,
taking them further away from eventual demise. This is supported
by the data we received on regulators' costs and staff numbers.
Although a few regulators within our remit have reduced their
individual headcount over the past three financial years, the
number of staff employed by regulators collectively in the financial
year 2006-07 was almost 6,246, a 9.14% increase over the
comparable figure for the financial year 2004-05…
"7.39. Several witnesses commented upon
the tendency for the regulators to keep looking for new things
to do (Q 334, Q 485, p 296, p 459). Clive Davenport from the Federation
of Small Businesses said, "when most of the regulators were
formed the world was a totally different place and I feel that
they have become self-perpetuating bodies, and there is a problem
with that because they end up searching for something else to
look at" (Q 334)…
"7.40. More often than not, however,
we heard the view that the accretion of duties by regulators was
caused by others—Government, Parliament and the EU—rather
than regulators themselves. The Chairman of Ofcom made the following
point about regulatory expansion: "the primary cause of that,
I suspect, lies … in Parliament, because it is
Parliament and Government that tend to expand the roles of regulators"
(Q 41)."
15. It may very well be true that Government
and the EU are responsible for some—possibly even a large
part—of the increasing activity of regulators. But the Committee
may wish to question regulators on whether they take steps to
contain or diminish the scope of regulation.
16. It has sometimes been said—rightly
in my view—that the overarching objective of regulation
is to command public confidence. Has this happened? I think not.
It is hard to see that the new mega-regulators have undertaken
thorough and fearless investigations leading to clinching successes.
The current state of the banking sector speaks for itself, as
does the intractably oligopolistic structure of gas and electricity
supply. The impression one gets of the mega-regulators is that
they have forgotten what their predecessors were created to do—to
defend the consumer interest against supply-side abuse—and
now see their role rather as brokering relationships with suppliers
and furthering sectoral strategic goals.
A POSSIBLE SOLUTION
17. Worryingly, the Government has shown
the same tendency towards agglomeration in reorganising consumer
watchdogs, the independent bodies created to attend to matters
of detail which (curiously) regulators are not expected to manage.
Thus, last October, Postwatch, energywatch and the National Consumer
Councils were merged, not without protest, into Consumer Focus.
It remains to be seen whether Consumer Focus is more or less effective
for consumers, and more or less costly to run, than the bodies
that were merged into it—but recent history suggests that
we should not be optimistic.
18. What, then, might be done? My suggestion
would be to go back to basics—to pare back the scope of
regulation and the duties of regulators to the essential things
that only statutory regulation can do, but then to ensure that
regulation is done yesterday and well. Such a reversal of current
trends needs to jettison any fluffy partnering relationships in
favour of a fierce regulatory independence. The regulatory tool-kit,
one might argue, should contain no more than a hammer and nails—the
hammer for banging companies into line, and the nails for holding
them in place. I acknowledge that regulators cannot by themselves
reinvent the regulatory world: Government has an ineluctable part
to play in cutting back regulation to its essentials, and then
in ensuring that these essentials are carried out effectively
and efficiently, but such moves would benefit from a parallel
commitment by regulators.
19. If we need to look for an example of
how to do it, then in round terms it seems to me that Ofwat, the
regulator of water services, remains a good model, perhaps because
it has moved least far from its original form. One might argue
that, unlike communications and broadcasting, the water and sewerage
sector is technologically slow-moving, but that is to miss the
point. Ofwat's strength and the source of its effectiveness is
that it has continued to concentrate its efforts on those things—and
only those things—that a genuinely independent regulator
needs to do.
February 2009
Letter from Europe Economics
Europe Economics is a consultancy that specialises
in the application of economics and econometrics to economic regulation
in many sectors of the economy, including finance, the utilities,
telecommunications and broadcasting, pharmaceuticals, and sectors
affected by competition policy investigations. Further information
is on our website www.europe-economics.com
One of our Principals, Bob Young, has already
sent you a note on the optimum size of regulatory agencies, and
I attach a copy of a substantial pamphlet just published by another
of my colleagues, Andrew Lilico, addressing the strategic reasons
for the failures of regulation in the financial sector.
This letter comments on two apparent mistakes
in the application of economic regulation, which could have been
prevented without requiring more resources or any major reorganisation
of regulatory authorities. In pointing out these issues we do
not imply criticism of the people concerned; our purpose is with
the benefit of hindsight to help to identify analytic mistakes
that, being addressed, would improve future regulation both of
the financial and of the other regulated sectors of the economy.
The first is the general question of systemic
risk. It should have been obvious to those involved in financial
sector regulation that the new instruments and the processes by
which claims were being valued involved risks to the system as
a whole; and they should have had no difficulty in analysing policy
options that would have contained or prevented those risks.
Similar issues are present in other regulatory
sectors. For example, in energy, is there a systemic risk of inadequate
capacity? Or in pharmaceuticals, is there a systemic risk of facilitating
the introduction of counterfeits through encouraging parallel
trade and expecting pharmacists to act as traders? The question
for your Committee's review, I suggest, is how well are systemic
risk issues understood and addressed by regulatory authorities
and Government Departments. There is no need for international
collaboration in addressing this; within whatever scope each regulator
operates at present, our question is how well are systemic risks
being analysed and addressed?
The second general issue is conflicts of interest.
Obviously, this issue features in most regulatory debates, but
our impression is that it is seldom explored in great depth. The
crisis in financial regulation might have been much less serious
if at an earlier stage the firms auditing the banks and other
businesses involved in financial markets had questioned the values
being placed on what are now called "toxic" assets;
or if the rating agencies had been more effective. Similar comments
may be made about parts of the labour market (bonus targets etc)
and about the large scope of some of the banking institutions.
It would have been possible for the OFT (for example) to investigate
some of these markets in depth, seeking to understand what conflicts
of interest there are, and what risks these imply. This would
still be an extremely relevant investigation.
Dermot Glynn
Chairman
March 2009
205 http://www.parliament.the-stationery-office.co.uk/pa/ld200607/ldselect/ldrgltrs/189/18902.htm Back
206
http://www.publications.parliament.uk/pa/ld200607/ldselect/ldrgltrs/189/7060505.htm£n3 Back
|
