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Lord Ezra: My Lords, I referred not only to the length of time but also to the significant changes that have taken place in certain of the sectors, particularly gas and electricity.
Baroness O'Cathain: My Lords, that is, of course, a valid point. I thank the noble Lord for mentioning it. However, I believe my point still stands; namely, relatively few years have passed in terms of the privatised utilities having to develop a completely new ethos and culture and learn new skills, and we shall create difficulties if we tamper with them once more.
The recommendations in the report concerning the workings of the regulators' own operations not impinging on the operations of the utilities is another matter. I was heartened to note--a couple of other noble Lords have mentioned this--that on page 47 of the report the commission agrees with the suggestion made by some witnesses to the commission that it would be helpful for the regulators to be able to call on a board of independent individuals, but not those representing sectional interests. That is a terribly important point.
It should be stated that regulation has been a terrific success. The regulators ought to be congratulated on all that they have achieved. I was pleased to hear the noble Lord, Lord Dubs, make favourable comments about the regulators because they have achieved a great deal. Their contribution to the success of the privatised utilities is acknowledged by the said utilities--and what better commendation could there be?
In my home area there has been a reduction of 22 per cent. in annual electricity bills in real terms since 1991 and there has been much better customer service. These improvements have been brought about by the combination of competition and action taken by the regulators. This combination, regarded by the electricity company as a double edged sword--that is, it cuts both ways--operates wholly in favour of the
customer. The regulator has played a serious role. For example, the simple introduction of league tables has resulted in much better service and the electricity company--Seeboard in this case--is rightly proud of its number one position nationwide, but conscious that it has to work even harder to maintain that.Another simple but most effective action by the regulator has been the hugely improved standards of customer service. There is a list of "offences", mistakes or inadequacies--call them what you will--which the regulator has drawn up and which incur fines. One such is that if the utility makes an appointment to read a meter and fails to arrive at the time promised it incurs a fine of £20. In 1996, of the 411,000 appointments made, only one failed to meet the promised time and incurred a fine of £20. If we recall the days when we had to stay in to wait for the meter reader and all the rest of it, the present position is a sea-change.
The relationship between the regulator and the private utilities is excellent. In the regional electricity company that I have named there is regular communication and a deep understanding of the problems and concerns expressed by both parties. It could well be described as a partnership based on the sole objective of ensuring that the service provided is the best possible.
It is imperative that that success is built upon and not tampered with or harmed in any way. It is only by striving for a stable environment in which the utilities operate that it can be guaranteed that the ultimate customer--you and I--will continue to benefit. What no one needs is uncertainty. Uncertainty and change there will always be but some uncertainty is created by political dogma, and that is the uncertainty the utilities can well do without. I make no bones about referring to the current uncertainty created by statements that the party opposite would bring in a windfall tax on the privatised utilities if it got into power. That is greatly exercising the utilities at the moment. Not only would it be a retrospective and possibly illegal tax; it would also weaken the financial base of the utilities and in turn would lead to higher prices for customers. I know that the party opposite is usually most concerned about unemployment, but such a step could ultimately lead to job losses.
But leaving aside all of that, will the party opposite consider how it can justify such a volte face? When the proposals to privatise the utilities were produced by this Government, the Opposition fought them tooth and nail and in doing so they talked down the price. The utilities were sold cheaply. The businesses have capitalised upon that, with magnificent results for customers, and now noble Lords opposite want to milk that. We should be extremely grateful for the success of both the utilities and the regulators and subscribe to the maxim "If it ain't broke, don't fix it".
Viscount Hanworth: My Lords, I too with to thank the noble Lords, Lord Currie and Lord Haskel, for their respective roles in promoting this important debate. And may I also offer my congratulations to the noble Earl, Lord Inchcape, on his maiden speech?
Since my noble friends have dealt in detail with many of the technical points which arise I feel free to be more discursive. More than 40 years ago, the American economist John Kenneth Galbraith, wrote a small book, American Capitalism. The thesis of the book was there was a remarkable disparity between the ideology of American business enterprise--its self-image, if you will--and the realities of American industrial organisation.
Since much of the book was to be devoted to an analysis of economic mythology, Galbraith thought it appropriate to begin his account with some words which can be found at the start of the tract of John Maynard Keynes, The General Theory of Employment Interest and Money.
Keynes, in his introduction, observed:
That is not an attractive passage. It is a distasteful display of arrogance on the part of a professional economist. However, as Galbraith explained in his book, Keynes's dictum provided an accurate summary of the state of mind of the American business establishment in the 1950s. What is also clear is that it summarises the outlook and the mentality of the political party which has been in power in Britain over the last 18 years.
The economic theories which have held such sway arose at the end of the 18th century and are commonly associated with the name of Adam Smith. As many will readily recall, Smith asserted that if it were allowed to operate without hindrance and intervention and if individual self-interest were given free rein, then the economy would be guided, as if by a hidden hand, to a state in which the wealth of the nation would be maximised and in which competing interests would be reconciled in a manner which would be to the benefit of all concerned.
Among the major hindrances to the free operation of the economy, Smith identified the power of monopolists. Prominent amongst the monopolies which he observed were those which had been sponsored by the state, many of them in association with the military provisioning of the wars with France. He attacked state monopolies with particular venom. Neoclassical economic theory, which is Smith's intellectual legacy, was invoked by the Thatcher administration in its pursuit of the denationalisation of Britain's public utilities. These were to be taken out of the hands of the state and subjected to a regime of competition which would restore their health and eliminate their supposed economic inefficiencies. Some weak guidance was to be applied by independent economic regulators whose role was to monitor the performance of the denationalised industries and to ensure that they had been purged of their erstwhile tendencies; but it was envisaged that, ideally, this role would be largely superfluous.
That was the ostensible purpose of privatisation. But little has been done to ensure that privatised industries should be subject to competition. Many are the subjects
of natural monopolies, and it is impossible to populate them with the competitive enterprises of neoclassical economic mythology.Such provisions as have been made to induce competition are bizarre in the extreme. The competition in rail franchising has been a mad scramble for windfall profits. The competition in the gas industry promises to be competition among rival sales forces to bamboozle the public with a confusing array of discounts, rebates and loss-leaders, all designed to market an identical project piped through the self-same gas lines. In the case of water and sewerage, there really is no possibility of any meaningful form of competition.
We should have no doubt that the real purpose of privatisation has been to make it almost impossible for industries to fulfil the social agendas which were envisaged when they were nationalised.
I may say that some of us--perhaps there are many--on this side of the House are proud of the history of the nationalised industries in this country. Nationalisation was applied to a set of industries which were in a state of chaos and dilapidation. In some cases, notably mining, the industries had been notorious over many years for abusing their workforce. I think that it is true to say that the nation at large had a high regard for the nationalised industries in their heyday.
Moreover, it is becoming clear, in the light of recent academic research, that far from being examples of economic efficiency, some of the industries in question had records of investment and innovation which were markedly superior to those of similar industries, in the United States and elsewhere, which were the subject of so-called free enterprise.
According to the thesis of Professor Galbraith, it was quite inappropriate to describe the conditions under which the analogous American utilities were operating as free enterprise. The industries of transport, electricity supply, telecommunications, and so on, were each subject to an active regime of federal regulation which did not hesitate to set the prices and other essential parameters within which they should operate.
It seems surprising, at first, that, under such circumstances, so little complaint was heard from the industries regarding the heavy interference of the state. However, the fact of the matter was that the federal regulatory commissions had been so deeply penetrated by the industries themselves that it was often difficult to determine whether they were working in the interest of the state and of the consumer or merely of the industries. This is a hazard which, in this country, we must resolve to avoid.
In particular we ought to heed the example of the electrical supply industry in the United States. That industry has been subject to a form of regulation which has allowed it to withdraw its services from low-income inner city areas with the result that some urban ghettos are now completely bereft of electricity. That is an extraordinary circumstance which should not be tolerated in any advanced industrial country in the 20th century.
In this country, there are already some disturbing analogies with the American experience. Some of the erstwhile public utilities are currently pursuing pricing policies which are bound to compel poorer people to forego what have long been regarded as the basic amenities of life; namely, water, gas and electricity. Moreover, it seems that there is little that industrial regulators, with their present, inadequate, powers, are capable of doing to avert this circumstance.
Another experience of American federal regulation has been the sporadic episodes of state intervention, ostensibly designed to foster competition, which have utterly disorganised the industries in question. The two best known examples concern the telecommunications and the aviation industries which have both been subject to federal cartel busting.
Among the more felicitous consequences of those interventions is that Britain's own air passenger and telecommunications industries have been able to exploit the opportunities which have arisen to become major players in global markets at a time when their strongest competitors have been disabled. We ought to heed that warning as well.
The point of these stories is to assert that economic regulation has to be attuned to the circumstances of the industries concerned. It cannot afford to be the product of a preconceived ideology which is intended to be applied across the board and which is liable to be applied sporadically.
In this country, we have already seen some of the deleterious effects of applying the free-market ideology to nationalised industries. It is simply not enough to place the task of regulating a major industry such as gas, water or electricity in the hands of a solitary professor of economics suffering an unaccustomed degree of public exposure or in the hands of some worthy doyen of consumerism. In the words of Galbraith, there is a need for a strong countervailing force which can stand in opposition to the considerable economic powers of the industry.
In the case of the telecommunications industry, for example, we need to guard our national interests and ensure that the path of technological innovation is a smooth one. In the case of the domestic utilities of gas, water and electricity, we need to bind the industry to a social contract. In other words, the state itself, following socialist precepts, must enter the demand side of the market to ensure that the interests of the consumer are not sacrificed to the uninformed forces of the market or to the greed of a new class of corporate moguls.
Lord Peston: My Lords, it is an excellent report; and it has been an excellent debate. I add my congratulations to the noble Earl on his maiden speech. I think I heard him say that it was 40 years before his father made his maiden speech, and two years have elapsed before he now makes his maiden speech. I believe that there is more to human life than speaking in your Lordships' House and I see no reason to apologise for taking time on these matters. On the other hand, I found his speech interesting and robust. I hope that he will be encouraged to speak again before another two years elapse.
The report is of great value. The chairman, John Flemming, is one of the most distinguished economists in the country. He got together a group of members of extraordinarily high standing. One can always think of other interests that one would like to have on such a commission and--dare I say it?--I think that probably there are too many economists in areas where other issues need raising. Nonetheless, the members are all to be congratulated.
It is a most appropriate time for such a debate. We are at the end of an era of economic policy making. We shall soon have a new Parliament and a new Government whose task will be to lay down the foundations for economic efficiency and prosperity for the new millennium. I do not wish to exaggerate, but I think it is obvious to all of us that the performance of the privatised utilities will be a significant factor contributing to that, as will the behaviour of the regulators. My noble friend Lord Paul was right to emphasise how important that is for the future efficiency of industry in general. The noble Baroness, Lady O'Cathain, was right to emphasise more generally the customer interest in this matter. But one should not forget that the customer interest includes the interest of industry. The noble Baroness rightly emphasised the importance of practice. However, to refer back to her joke, the trouble with practice is that it is excruciatingly boring. What is really interesting is theory. That is why some of us at least concentrate on matters of that kind.
A paradox to which I must refer at the outset concerns the intellectual origins of regulation in this country. It used to be associated with the so-called revisionist wing of the Labour Party. The late and lamented Anthony Crosland took the view a long time ago that nationalisation was really an irrelevance and that where monopoly was inevitable the public interest could be better served by regulated private ownership. It is intriguing that such a philosophy, rejected by his own party at the time, was adopted and adapted by this Government. I say "adapted" because I do not believe that Crosland would have favoured selling off the public's assets at prices so disadvantageous to the long term interest of the taxpayer. I believe that he might have advocated retaining an equity interest in all the relevant concerns. But those are technical matters.
Having made that point, let me make another point in the Government's favour. Most economists, including myself, had taken it for granted that we are dealing with the so-called natural monopolies. I think that the noble Lord, Lord Ezra, used that expression, as have others. Indeed the Government seemed to start from that position. The privatisation of gas was an example; and the way electricity was privatised into what was essentially a duopoly was another. Interestingly, since then, thinking has moved forward. As the noble Lord, Lord Ezra, said, the regulators are supposed to encourage competition. The Government have at least started to do some of the things that they can do to promote competition. Most of what has happened so far is experimental. I agree with my noble friend Lord Hanworth that some of the experiments seem a little silly. Nevertheless, trying to be objective, if we are to have the utilities within the private sector, but
regulated, it may well be that we can think more imaginatively of possible competitive solutions or analogies. It is certainly a subject worth thinking about. The whole point is that regulation was, and continues to be, experimental.I was involved from these Benches when some of these issues were debated. Those who devised the original legislation, and those of us who argued about it, did not fully appreciate what was in the process of being developed, rightly or wrongly. I have no difficulty in confessing that I did not anticipate for one moment many of the important and interesting problems that have emerged. That is one of the reasons why the Hansard Society report is of such value. It is also why I think all of us--not least, the Government, but outsiders as well--need to take a long, hard look at the regulators and the process of regulation. Here again, I am afraid I disagree slightly with the noble Baroness, Lady O'Cathain. I do not think it is too soon to examine this matter. If we are to learn from what is going on, we have to examine the process of regulation more or less continuously through time just to see whether we can do better. That is effectively the point made by the noble Lord, Lord Ezra.
To revert back to the remarks of my noble friend Lord Hanworth, as I understand it, the regulator is meant to create an operating environment that is analogous to the working of the competitive market. It is all a bit peculiar, because three of the four Acts of Parliament to which we are referring--leaving aside the water Act, which is the most peculiar Act of Parliament altogether--use the expression, "meeting all reasonable demands". As I have said before in this House, the concept of "reasonable demand" does not exist in economics. I have not the faintest idea what it is supposed to mean. I have asked more than one Minister sitting on the Benches opposite to give an account of it. I must tell the noble and learned Lord that I do not insist that he does so today. The point is that the competitive market certainly does not operate on any concept of "meeting reasonable demand". It operates on the concept of "meeting demand". That is different altogether. That is therefore one of the problems for the regulator; he is supposed to see that "reasonable demand" is met, when some of us believe it to be a meaningless concept.
More generally, producing an analogy to the competitive market is easier said than done. We have to recognise that competition in the real world is a highly dynamic process. It is far from the static model so beloved of economics textbooks and academic articles, and--dare I say so?--professors of economics.
The important point to bear in mind--this is a great problem for the regulator; I am certain it is one that noble Lords on the other side of the House appreciate--is that in a competitive environment it is still possible for a firm to earn very large profits. Therefore the appearance of large profits is not necessarily an indication of lack of competition. That is particularly the case if new competition can appear. The sophisticated view of competition is that such profits are meant to bring in new competition and then they are driven away. How is that to be simulated by a regulator? I have very
little idea as to how that could be so. In some cases, as my noble friends pointed out--for example, local water supply--it is impossible. Hard as I may think, I cannot think of a way in which to achieve "free entry" into a local water supply. But others more intelligent than I may be able to do so.The second point about an analogy with the free market--a point made in the report--is that profits are justified as a reward for taking risks. But one of those risks is the risk of bankruptcy. One matter that is not fully appreciated is that the regulator must regulate in such a way that bankruptcy still remains possible. I know it is difficult, but that is so. If the regulator allows the use of market power to avoid the risk of bankruptcy, shareholders in the privatised utilities are, ipso facto, being over-rewarded.
One of the main objections to monopoly generally is that the owners of the monopoly firm are rewarded by more than is necessary to bring forward the output in question. That is what the regulator is supposed to prevent. The evidence is that, typically, he does not, but the point can be argued.
In my view it is a genuine error to say that monopoly profits are acceptable if they are ploughed back into investment. It is simply not a valid argument. Monopoly profits are not acceptable, end of story. If investment is desirable, it must be financed in the normal ways. What worries me slightly about the regulators is that they seem to have fallen for that argument.
My noble friend Lord Hanworth referred to the "arrogance" of a professional economist. Speaking as an arrogant professional economist, as he well knows, perhaps I may make one point about the windfall tax. It is a well-known proposition in first-year economics that proportionate tax on the profits of a monopoly has no effect on allocation of resources, price or anything else. Therefore it is simply impossible that the windfall tax that my honourable, right honourable and noble friends wish to introduce could have the adverse allocative effects that are sometimes suggested. The alternative is that economics is wrong--which I, of course, find impossible to believe or even consider. It is very important to bear in mind that there is nothing simple in this world.
I wish to refer briefly to one other matter which I believe should be debated in this House at some time. Several noble Lords referred to transparency and how the regulators can be appointed. The report refers to this whole area of raising constitutional matters. It states:
The report is entirely right in that regard. It is not obvious to me that those of us who are either economists or business people are the right people to be discussing that issue. But some of our colleagues in this House might well take the opportunity to have a debate of their own examining the constitutional side. It is not a trivial matter to vest such great powers in people of this sort without considering what that means for the political process.
In conclusion, I congratulate all those who took part in the debate.
Lord Fraser of Carmyllie: My Lords, I listened with interest to the debate introduced by the noble Lord, Lord Haskel, in place of the noble Lord, Lord Currie, on the report of the Commission on the Regulation of Privatised Utilities. I followed with keen interest the contributions made, ranging from a robust and expert knowledge of the way regulation has developed recently to a fascinating and, if I may say so, deeply unfashionable defence of the former nationalised industries--unfashionable particularly on the Benches opposite.
The debate has been very worth while. I join those noble Lords who complimented my noble friend Lord Inchcape on his maiden speech. I noted with interest all that he had to say in his short and forceful speech. I enjoyed in particular his timely reminder of how things were before many of the utilities were privatised. I recall most vividly that, when I was Member of Parliament for Arbroath--from whence my noble friend's famous family stems--the largest single file I had was for those who wished to be connected to the telephone system. If they had the impudence to ask of their Member of Parliament how they might move up the six-months queue, they received short shrift, as I did. Nowadays there will not be a single Member of Parliament in another place who has any file whatsoever dealing with those wishing to have a telephone installed.
I was gratified and interested to see that the report unambiguously acknowledges that the present arrangements work a great deal better than the old ones. I feel, like my noble friend Lady O'Cathain, that it would sound as though I had not read beyond the introduction if I take as my particular quotation a passage to be found at the bottom of page 1 and continuing at the top of page 2, but it is such an excellent executive summary that I make no serious apology for so doing. The report states:
I am grateful for that very useful conclusion.
The commission was an independent body established in 1995 with a remit,
Its report, published last month, examined the procedural or "constitutional" aspects of the regulatory regimes for telecommunications, gas, electricity and water. It made some 24 detailed recommendations aimed at increasing,
of the regulatory regime. I join others who have contributed to the debate in welcoming that examination and accept that this is a timely moment to undertake it, not least because it coincides with a number of other inquiries currently being undertaken into the regulatory regime.
The present arrangements work a great deal better than the old ones. Indeed, following the speech of the noble Lord, Lord Haskel, it would seem that it is now a settled orthodoxy that these arrangements should be kept in place.
I join the noble Lords, Lord Ezra and Lord Dubs, and my noble friend Lady O'Cathain in recognising that regulation is not an end in itself. There will of course always be those who believe that some form of regulation is needed to protect vulnerable customers. There may be some argument about that. There will certainly always be a need for regulation in areas where natural monopoly is likely to remain; otherwise regulation is a proxy or a surrogate for the competitive forces which operate in a free market.
In our view, the key to future benefits does not lie in trying to find perfect regulation, a will-o'-the wisp that we do not consider could ever be wholly achieved and that could never be more than an imperfect proxy for the competitive forces which it seeks to replicate.
I entirely agree with the noble Viscount, Lord Hanworth, that there are dangers in having a preconceived ideology of regulators. Matters have evolved and will continue to do so. It has been extremely useful that the commission has considered ways in which the system might be amended.
I make no apology for emphasising that we wish to see the introduction of more competition. Indeed there has been more. Over 190 new telecoms licences have been issued since 1991. Large and medium sized gas and electricity users can already choose their supplier. Last April we began to open up the domestic gas market. It has now been extended to Dorset and the former county of Avon and next month it will be extended to 1 million consumers in Sussex and Kent. Full competition will be introduced into the domestic electricity market in 1998 and by the end of 1998 all gas and electricity consumers will have a choice of supplier. We are examining further proposals for extending competition in water and sewerage services, initially for the larger users.
The Government's immediate policy objective is to press ahead with the development of competitive markets to ensure continuing improvement in prices and services to customers and to reduce to a minimum the amount of regulation and substitute the workings of the market itself.
I was disappointed that the noble Lords, Lord Paul and Lord Haskel, considered that insufficient competition had been introduced into the electricity market. I do not pretend that it has yet reached a final stage. However, at the end of 1996 there were of the order of 17 new-entrant generator companies in England and Wales with a capacity of something like MW 12,000. I also accept that the electricity pool is not yet in a perfect form. A number of changes are being considered in terms of involving consumers. While it has perhaps not yet been taken forward as vigorously as I should like, I am interested that intensive energy users and others are clearly suggesting that some sort of demand-side bidding would be a desirable addition to the techniques whereby the pool might work.
Competition has evolved but I recognise that the regulatory system is not perfect. We welcome practical suggestions for improvement. While I do not disagree with much of what my noble friend Lady O'Cathain said about the evolution of regulation, a further argument needs to be addressed. Even though we have received a number of good ideas for its improvement, it is clearly desirable to secure a stable regulatory environment. That is important because the investment decisions taken in this area are long term. Those who are proposing to invest should have the confidence to enter these markets and remain involved in them, thereby contributing to the further development of competition. The desire to tinker is one that I suppose many Ministers have. I am resisting it, though I want to see some change in an evolutionary way, because of that important consideration.
The Government have acknowledged that in due course there may be a case for bringing together the electricity and gas regulatory structures. It would be appropriate to look at this in about a year's time--not because that is the other side of a general election but because by that time the thrust towards full competition should have been secured in terms of both gas and electricity. We have said already that in the medium term the broadcasting and telecommunications regulatory regimes should be brought together to reflect convergence. The review in a year's time will be an opportunity to look at other aspects of the regulatory regime also, building on the strength of the existing system but maintaining its fundamentals. We should not, in the Government's view, embark lightly on any changes.
In his opening remarks the noble Lord, Lord Haskel, referred to the competition Bill. Let me assure him that we remain committed to reform. The curtailed nature of this final Session of the present Parliament meant that it was not possible to introduce a Bill in this Session. In relation to one of the recommendations made in the report we propose a prohibition on anti-competitive agreements based on Article 85 and are considering the feasibility of a prohibition of abuse of market power based on Article 86 for the economy as a whole in the context of the competition Bill. The Government have not ruled out a prohibition approach modelled on Article 86 and are promoting further debate on this issue, for example by talking to business and other interests.
Some noble Lords made reference to the formula that might be applied and whether RPI minus x might be appropriate. I was interested to hear that and even more interested to learn that in the course of a conference on competition policy last week the Opposition spokesman, Dr. Kim Howells, explained that the Opposition had concluded that the main beneficiaries of price regulation based on profit-sharing would be lawyers and accountants and that there was after all much to be said for RPI minus x. I am told that there are something like 50,000 lawyers in the United States engaged in regulatory matters. I see certain advantages in that which others may not see. But the RPI minus x formula is very much more preferable.
Let me take a moment to address in more detail the concerns of my noble friend Lord Crickhowell, particularly given his expert appreciation of the duties
in relation to environmental matters. There is the recommendation by the commission that the industry directors general should not have duties for quality regulation, notably environmental duties. I understand that my noble friend strongly disputes that. The recommendation deals with the need to balance differing objectives when regulating an industry. The consumers' interest in value for money and the best possible service for the least payment cannot always be apparent. Other objectives may be just as important--for example, health and safety and environmental improvement. In some cases those other objectives are so important that there are indeed other public regulators charged with achieving them. In the case of water, the health objective is safeguarded by the Drinking Water Inspectorate and environmental protection is regulated by the Environment Agency.
The Government agree with the recommendation that in such cases it should not be for the industry director general to duplicate the work of quality regulators. In the Government's view there is already a clear separation of functions: the quality regulators set standards and police their implementation; the industry regulators consider their cost implications. We do not want to see any confusion. But I noticed with interest what my noble friend had to say about the value of having some tension in the relationship between the two.
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