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 sectoral 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 twenty 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 nearly five years ago.
A good deal of my work in the past twenty 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. Within Europe Economics I am
a Principal, a term that denotes the firm's highest consulting grade.
3. For me personally
as well as for Europe Economics, 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. There are suspicions 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 per cent.
· Ofcom,
formed at the end of 2003, had 727 employees as at March 2004, rising to 812 in
March 2008, an increase of 12 per cent.
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
per cent, 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 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 in their
action plans and budgeting. 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.
15. My second source is evidence put to a House
of Lords committee which in 2007 produced a report on Regulation.[1]
The evidence I refer to comes from economist observers of the UK regulatory
landscape, Messrs. Keith Boyfield and Tim Ambler.[2] 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."
13. My third source
is the 2007 House of Lords report on Regulation referred to above, 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 per cent 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)."
14. 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.
17. 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 and furthering strategic goals.
A possible solution
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, and to ensure that
regulation is done 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. 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.
20. 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.
Robert Young
Europe Economics
27 February 2009
19 March 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
[1] http://www.parliament.the-stationery-office.co.uk/pa/ld200607/ldselect/ldrgltrs/189/18902.htm
[2] http://www.publications.parliament.uk/pa/ld200607/ldselect/ldrgltrs/189/7060505.htm#n3
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