Select Committee on Constitution Minutes of Evidence

Examination of Witness(Questions 43-59)




  43. For our second witness we have Mr Peter Vass, who is the Director for the Centre for the study of Regulated Industries at the University of Bath. We are most grateful to you for being with us. From our point of view your background is ideal for our purposes and we are most grateful as well for the paper that you have put in. That does help provide an overall context, which is extremely helpful to us at this stage in our inquiry so we are very grateful for that as well as for you being with us this afternoon. If I could open. You have had the opportunity to hear the questions we have put to Sir Ian and so the sort of things which are of interest to us. If I could start with a general question about the regulated industries themselves, whether they are broadly content, whether they are happy with the existing regulatory regimes or would they prefer regulators to have more or less discretion? Or are things about right?

  (Mr Vass) Thank you very much, my Lord Chairman, for inviting me here. I think first of all the general answer to that question must be yes, that they are broadly happy because if we imagine a situation in which we have no regulation, or substantially less regulation—these companies generally are supplying essential services and also have a large degree of monopoly power—they would then abuse that monopoly power. This would create a crisis. It would create a political crisis and the outcome would probably be worse than the position of living with good regulation that sustains itself in the long run and their activities. If we went in the other direction and said we want more, heavier regulation, I think that would undermine the beneficial bargain that we have now with our system of incentive regulation, whereby all parties can gain from the regulatory system that we have by which the shareholders, through the ability to earn economic profits, through improving the efficiency of the companies, can gain higher returns than they otherwise would have had under a cost plus system, and equally, because of the gains in efficiency and the new information which is supplied to the regulator, the regulator can pass those efficiency gains on to customers by way of lower prices than, once again, they would otherwise have had. I think this is a mutually beneficial bargain and is effective by the general level of regulation in an incentive regulatory system that we have now.

  44. So you would say that all those who are actually involved in the regulatory process are content with the way the system is operating?

   (Mr Vass) As I say, I believe we can answer yes to your first question but of course you might ask then, why does it appear that there is so much criticism of regulation, particularly from the regulated companies? I think the answer to that of course is in my statement that we have an incentive regulatory system. The regulator sets the targets and the companies seek to beat those targets, the mechanism by which they can then outperform the regulator's forecast and earn economic profits, reveal new information about their efficiency, and so on. So of course there is an adversarial relationship in this. It is a surrogate for competition and naturally in the bargaining process, in the build up to the setting of these targets, they want to undermine the regulator. They want to undermine the regulator's confidence. They want to perhaps have a more generous settlement than they might otherwise have got which makes it easier to outperform that settlement. So I think we have to distinguish in our minds the element of "Well, they would say that, wouldn't they?" It is an adversarial system but they, the companies, have protection if the regulator overdoes it, as you have heard from Sir Ian Byatt. They have certain protections in appealing to the Competition Commission and indeed judicial review. I think we have many examples published in the regulators' documents of companies submitting business plans which were perhaps 15 or 20 per cent higher in cost terms than they needed to be when it came to the periodic review settlement but then they indeed still outperformed that lower target level very substantially to the benefit of their shareholders. So I feel that if we recognise that there is an adversarial element but that it is not a bad thing—this is actually part of the regulatory system—then we can understand that degree of criticism. We need, I think, to be open minded enough to say that we should not always say that criticism is in their self-interest. There may be points at which criticism is justified and of course we should then expect the regulators to improve their practice or their procedures or whatever it is that has been pointed out to be incorrect. But we have to unbundle that argument.

  45. I was also thinking from your opening answer of the other end of the scale as well, that if it had been only the regulator's interest, if the industries had been content then we might have cause for concern that they were content with the process. But if I could broaden it as well to the political dimension, the point I was taking up with Sir Ian Byatt was the fact that as a regulator there is that degree of statutory independence and yet at the same time being part of government, having a relationship with ministers and officials. As you heard, he felt that worked (with the exception he outlined) satisfactorily. Would that be a fair generalisation for other regulators on the basis of your study?

   (Mr Vass) Once again, I think that answer has to be correct. I think the way I would like to characterise this, if you ask what the general lesson is across the regulated industries, is that there is a form of regulatory settlement in this, in the sense that regulation, the responsibility of government—and you quite rightly said, I think earlier in questioning Sir Ian Byatt, that the regulator is part of government—addresses market and conduct failures. Government is responsible for regulatory policy and government debates that regulatory policy, it has Parliamentary sanction and settles that in the legislative framework. It then says, "We have certain, in a sense, market failures or conduct failures that we want to address, one of which is abuse of monopoly power, another of which is public goods and external effects such as pollution", and another issue might be socially inequitable outcomes from an unregulated private market. It may say that in the control of abuse of monopoly power these are technocratic functions, that it is best that we have a policy, that the abuse of monopoly power needs to be controlled, but we can pass that activity down to an independent body and we want that independent body to be independent of day to day political decisions to ensure that there is continuity, consistency, technocratic focus on the issues in question, choice of instruments, and once again we know that that independence is very heavily constrained by judicial review, by the duties and other such things. So the independence is necessary, I think, to be able to take a reasonably longer term and consistent view against the winds (if I may call them) of short term political interests, which clearly exists, whereas regulatory policy by government is usually considered in a longer term framework, as would be the legislation. Of course, along with that goes the necessary discretion, that the independent regulator must have a reasonable degree of discretion to judge the facts of the case as and when the information comes forward, otherwise we would find ourselves in the ridiculous situation perhaps of being consistent but consistently wrong. We have good evidence, I think, in the past where regulators have made mistakes. That is quite legitimate. The question is, when we identify our mistakes, how do we go about putting those mistakes right, either by correcting the methodology which we are using, and perhaps compensating those who have been affected by that mistake, depending on the circumstances? I think we have good evidence of where regulators have adjusted the position—in the context of much criticism, I might say—but quite properly have exercised that discretion with a view to being consistent with the objectives of regulation, not consistent necessarily simply with past precedents: "I did it that way in the past, therefore I must by definition do it in this way in the future." To be fair, the Monopolies and Mergers Commission, for example, made a mistake in 1993 in relation to its periodic review of the British Gas transportation system at that time. By the time they got to their 1997 review they had worked out the methodology of their mistake—they were granting windfall gains to shareholders—and they said, quite rightly, "We are going to have to correct for this." I think British Gas was very aggrieved by that and argued that they should have consistency with their 1993 position but of course that is not a tenable position for the exercise of discretion by the regulator because then that consistency would have been inconsistent with the underlying framework of regulation, which is to avoid the abuse of monopoly power. So hopefully that has given you an example of how that discretion and independence fits within a framework of regulatory policy which is the responsibility of government and Parliament.

Chairman: Thank you very much.

Lord Lang of Monkton

  46. Mr Vass, your answers so far have been very lucid and helpful. Could I play Devil's advocate? I have heard it suggested that under the banner of independence some regulators—and I would not want to be too specific—have become rather highhanded and have themselves been open to the accusation that they are abusing monopoly power. Do you think there is any justification at all in this? For example, I was told that one industry was besieged by requests for consultation information from their regulator to the extent that the compliance cost was imposing a burden which they regarded as unreasonable. Have you heard this sort of thing and how do you offset that against the consumer interests?

   (Mr Vass) Yes, I have heard that and I think it is fair to say that clearly there is a possibility that a regulator is risk-averse, therefore collecting more information is better than collecting less information. They only account for the costs on their office, not necessarily the costs that they are imposing on the other office. So there is a general problem in what I might call regulatory empire building or regulatory creep, but I think this is actually quite heavily constrained by the new procedures of government, the new mechanisms of government introduced by the Better Regulation Task Force in 1998, the principles of better regulation, and where we have new mechanisms, the regulatory impact assessments. But regulators, when collecting information or making regulatory decisions, are now really bound to give good reasons for the decision, why that information is needed to be collected, to set this down in documentation which explains the costs, and benefits of that, including the costs, and benefits as they fall on all parties, and whilst they may still have the power to push through this additional load I think we are seeing on the other side a much greater willingness by the companies to challenge unreasonable decisions by the regulators because, I think, we are seeing the courts themselves beginning to move from a position in which they cannot judge the wisdom—well, they do not judge the wisdom of a decision, they only look at it in the context of it being so unreasonable that it is somehow irrational. I think in the last five to ten years with developments like the Human Rights Act, higher public expectations of accountability, the machinery of government improvements which we have seen coming out since 1998 means that probably when we come to the judicial review the cost—benefit test, the documentary evidence behind the collection of that information, will be more severe and judges, I hope, will look at it in the context of the zone of reasonableness rather than simply saying that something is so unreasonable that it is irrational. You would be very hard put to say that collecting some information for the benefit of consumers was an irrational act but it might be if we could actually have a more precise cost—benefit test within a focus of reasonableness. So I think the criticism has been quite legitimate about empire building but I think protections are beginning to grow against that because regulators are held more to account now for what they do.


  47. Just as a follow up to the Better Regulation Task Force principles, you are indicating what may happen but at the moment presumably they are persuasive only in terms of the regulators?

   (Mr Vass) But growingly so. I think they are rather simple, straightforward principles—transparency, accountability, proportionality, etc—but I think, like so many things, they provide a very firm and intuitive framework for accountability and, of course, we cannot escape the fact that the European Union, the European Commission, is also taking these things forward. We have had the white paper on governance from the European Union and last year, 2002, we had the whole better regulation package, which is then going to inform how they go about developing directives, which of course then impact on us. So I think in that context once again I would argue that they are not just persuasive but in a sense becoming a growing reality.

  48. But for the moment, as you have mentioned, because of their nature they are drawn in very broad terms, extraordinarily broad terms, so presumably interpretation rests with the regulators themselves? They interpret whether they are being transparent or accountable?

   (Mr Vass) Yes, but having said that, I think from those principles, out of which comes certainty proportionality, targeting and the cost—benefit test, the very fact that you have to exemplify the costs and the benefits I think just puts quite a severe test on the logic of their arguments.

Chairman: Thank you very much.

Lord MacGregor of Pulham Market

  49. Two questions. The first is a follow up of what you have just been saying. In paragraph 5(i) of your memorandum you refer to the fact that regulators in a sense are judge and jury (unlike inspectorates) and then you go on to say "However" and you refer to the Competition Commission and judicial review as constraints. I know you have been going into the Better Regulation Task Force's principles. Do you think that these are sufficient constraints or are there others that you would wish to see on the unfettered ability to be judge and jury?

   (Mr Vass) I think they are very important constraints and growingly important constraints. I think the regulated companies have often argued against what I think is often called the nuclear option, of not accepting a regulator's decision and going to the Competition Commission because it re-opens the whole thing and there is the expense and use of management time. But the test of that is, is the matter a serious one? If the matter is a serious one then the companies should feel able to go to the Competition Commission and expect a professional hearing from the Competition Commission, not simply, "Well, the regulator was acting in the public interest. We have got to endorse that position in some way." I have explained that I think judicial review is a growingly important force or will be in the future, although we have not had many cases in the past. But I think the National Audit Office has a growingly good record of reviewing the activities of the regulators, both through a direct audit or through the value for money studies. We have seen a developing progression of those value for money studies. We see that clearly the Public Accounts Committee (PAC) takes account of those. I think the individual Select Committees have a good record of holding the regulators to account and I think they are going to have the opportunity of holding them ever more to account now with the new regulatory impact assessments, which will have to go with their regulatory decisions. So I can imagine a situation in which a Select Committee will be looking at a particular issue and they will have not only the evidence of the annual report but the evidence of the regulatory impact assessment, which justified that particular activity and that will provide a very firm avenue into "Well, hang on, we can actually see the logical methodology that you are following in this cost benefit test. It is either flawed or it is not flawed or there is some uncertainty around that number. How do we justify the uncertainty around that number?" So I think all of these elements will come together to be a sufficient constraint on the issue of being judge and jury but in a public context.

  50. Thank you. The second question is really more about the independence of the regulator and in order to make my point I am going to have to rather exaggerate a current situation. It is in relation to the electricity industry and here I suppose I ought to declare an interest in that I am involved in companies which are not by any means mainstream business but they do have heat and power plants. This is the new electricity trading arrangement, for example, where you have a regulated situation—and here I am now making a sort of supposition, I am not necessarily saying this is true but conceivably what could be happening—where the impact of that very rapidly on the electricity industry is what we have seen happening to British Energy (with which I am not involved) and some of the other electricity companies. Is there a case in a situation like that or situations which may be similar to that for government to step in and say, "We do not actually think that the regulator is making the right decision because the impact on certain parts of the economy is so great", or do you think that it is really up to the regulator to make the judgment as to how that should be changed and put right?

   (Mr Vass) I think this does come back to a government responsibility to understand the policy and the underlying regulatory policies in their legislation. I think we see a gradual move to privatisation, the introduction of legislation, and that regulation could be by way of exclusive rights to certain providers, say the electricity transmission system or the electricity distribution system, and then a form of regulation by way of price control rather than profit control. But government, I think, has always been minded to say that the best defence of the consumer's interest is the introduction of competition and we have certainly seen this in regulatory policy in the energy sector. We have seen a progressive movement in the primary duties of the energy regulator to promote competition to secure competition. Competition is the first choice if appropriate. I think that the introduction of the NETA was in the context of Professor Littlechild when he was the Director-General of electricity regulation at OFFER, the potential or suggested abuse of market power by the two large generators holding electricity generation prices higher than they should otherwise be, and that we needed a new electricity trading system to do that. Clearly the regulator was aware of that. Callum McCarthy took that forward and we had the new electricity trading arrangements and had to work with the companies to achieve that process. Of course there is a consequence to that; we have excess capacity in electricity generation. Everybody knows, government ministers know this probably themselves and certainly their advisers know that if we have a competitive market and we have excess capacity then that excess capacity is going to be eroded and prices are going to fall to variable operating costs until some of them go bankrupt or until there is consolidation and that excess capacity is eliminated. This may be the situation that has happened with British Energy. I do not think government can argue that this is a sort of case of unforeseen outcomes; it is a very foreseen outcome of a competitive market. The question then is whether or not in the context of regulation we have to accept that competition policy may mean that some companies go bankrupt. That does not necessarily mean that we have a nuclear crisis or indeed that we have any nuclear danger, it just may mean that the assets are transferred to another owner given the level of prices. So perhaps another owner could buy British Energy. If the issue is that nobody would buy British Energy, even for a penny, because we have got all the decommissioning liabilities, maybe the Government has to buy British Energy or, as we have seen, maybe the Government has to assume the decommissioning liabilities so that somebody will be willing to pay a positive price. I am not suggesting which of those is right. What I have just tried to suggest here is that the outcomes we have seen recently of the introduction of the NETA were very possible and foreseeable outcomes of a policy which the Government assumed and decided it wanted to introduce competition. It is not, I think, the right stance now to say that somehow the wrong instrument was introduced by the regulator. I think there has to be more collective responsibility for that. We may want to have a re-think and say that in fact no, we do not now want that type of competition policy, we want to give certain exclusive rights to certain types of generators, but I think government then has to take responsibility for saying that is the regulatory policy and framework we want because that is not something you can leave to the independent regulator. The independent regulator has to work within a known policy expressed through the legislation and the duties. I hope that answers your question reasonably without assuming a particular policy outcome, if you like.

Lord MacGregor of Pulham Market: I did not want to assume one either but I was just trying to give an example of where a thing like this could occur. Thank you very much.

Lord Holme of Cheltenham

  51. If I may follow the point about policy. In 11(ii) of your paper you sort of unbundle it and you say that the Government does policy and the regulator does the technocratic functions. That is the split you take. I just wonder parenthetically whether that is always true. If you look at the OFCOM bill about to go through Parliament it is quite clear that large areas of policy are being left to the discretion of the new regulator, or to put it the other way round, that the policy parameters set by the Government are so loose and broad that it is possible for the new regulator himself to interpret what the policy will be. So I just have a doubt about that but it is not really the question I wanted to ask you. The question I want to ask you is, since our particular interest is in Parliament, within your paper the role assigned to Parliament is to duly endorse the proposals of the Government so the policy is discussed, if you like, one time by Parliament but of course the world changes and the role of regulator itself grows in strength and confidence, it decrees precedence and case law, it may be subject to what I think the Americans call regulatory capture. There are all sorts of ways in which the regulator develops and changes over the years. I wonder whether it is enough to say, "Well, we had a discussion in year X about policy in Parliament"; the regulator was established on the basis of that policy and yet not revisited at some point as a matter of public policy debate, but the powers of the regulator as they grow and develop can be looked at three years, five years, ten years later in the light of a judgment of how the public policy requirements are changing. Does not Parliament have a role in that or is it simply a matter for ministers? I think one of the things we are searching for is, are there constructive roles Parliament can play other than initially establishing the regulator in the first place and then through the Public Accounts Committee, seeing we are getting value for money, and so on? Is there any other iterative role that Parliament can usefully play vis-a"-vis a regulator?

   (Mr Vass) I think the answer to that must be yes and let me explain that. But just turning to your very first point about OFCOM, in a sense I agree with you and your concerns. I think we have OFTEL, which was an economic regulator, about using instruments to control the abuse of monopoly power by BT. OFCOM is obviously wider than that. We are merging now content regulation with economic regulation. Will they just be two separate offices in some way or do they have synergies? But of course it all leads into this wider area of public service broadcasting and I think it was quite disturbing to hear both David Edmonds and Lord Currie at recent conferences talking about, "Well, of course OFCOM is going to have to do a lot of thinking about what we mean by public service broadcasting", and so on. I think I agree with you that that thinking should have been done in advance by the Culture Committee, or whatever, so that the Government felt able to define quite precisely what it meant by public service broadcasting and then a regulator can decide how that is best delivered either by some form of all players being involved in some way or by giving exclusive rights to a particular organisation. Once again, I am not suggesting which is the right one but I think there is a prior state where Government thinks through that. On the second point, I think—and Sir Ian referred to this—that of course the statutory position in relation to his responsibilities has changed over time and we have a forthcoming water bill and presumably Water Act and that we have seen a number of instances where important lessons have been learned from the practice of regulation and Government and Parliament has had a chance to re-think and re-codify the position. What I would say is that this should not happen too often in the sense that if we are talking about a policy framework which is set within a general range of powers and duties with a degree of independence and a degree of discretion then that should be able to absorb reasonable changes over the medium term. So it is not something we are expecting every year or every other year, but as time passes, as we have seen with the Utilities Act 2000, we saw quite an important change in the sense that from the first time since privatisation, where the primary duties were set out at the time of privatisation to be to ensure continuity of supply—and they dealt with this by saying "Your primary duty is to ensure that all reasonable demands are met"—and the other duty was to ensure that the businesses could finance themselves. Why would those two be the primary duties at privatisation? Well, of course you have got a nationalised industry, you have got to maintain public confidence that when it goes private it is still going to be supplied in the same way that it was as a nationalised industry, so all reasonable demands being met, but you have got to have city confidence to buy this and one of the things is an avoidance of undue regulation pushing prices below the cost of supply. Any business would expect that so a reasonable rate of return is allowed. But of course, underlying that, the really substantive primary duty of the regulators is customer protection. So, in substance, the primary duty of regulators, and what they did in practice—whether they did the job well or not is a separate question—was customer protection, and if you went to the OFTEL annual report I remember Don Cruickshank always started off the OFTEL annual report with the same line each year: "Everything OFTEL does is for the benefit of the customer." The Utilities Act was an opportunity for Parliament to say, "We want to make this customer protection the primary duty and at the same time to decide that perhaps we want to move away from the model of the individual director-general to a model by which we have a board and other such things." I have a few comments on that but perhaps that will be another question. So we see the Utilities Act. Clearly if we look at the rail sector we had the opportunity to have a privatisation in 1997, to establish an office of the economic regulator on the sort of generic model of the other sectors, an office of the rail regulator, but we have seen quite a progressive development since that time with the introduction of the SRA, of course Railtrack going into administration, now a company limited by guarantee, Network Rail, but effectively the SRA having the controlling vote on Network Rail's activity and a very developed system of guidance from the Department of Transport, instructions for the SRA, guidance to the office of the rail regulator, and these things gradually being codified. So I think that the flexibility within the framework comes to a point where it needs to be re-examined. I think we have evidence that it is re-examined and Parliament plays a proper role there in determining what the framework of regulatory policy should be.

Lord Holme of Cheltenham: Thank you. My Lord Chairman, I should in the context of that question declare a historic interest as the former broadcasting regulator.

Chairman: Thank you very much.

Lord Jauncey of Tullichettle

  52. Mr Vass, I just wonder whether you are not a little optimistic about the role of judicial review in the future because putting aside questions of bite the courts have always been extremely loathe to interfere with executive decisions simply on the basis that they might have done something different. As I understand it, what you were suggesting was that the situation might come when the courts would in fact interfere more or less on those grounds and I just wonder whether perhaps that is not expecting rather a lot given the effect it would have on so many other matters as well?

   (Mr Vass) Yes, I think optimism is an accusation which is probably correct, but let me justify that optimism in the sense that I feel there are tremendous advantages to all parties of our current regulatory "settlement" (and "settlement" is in inverted commas here, a term of art) and if this is undermined by a feeling that natural justice is not available against arbitrary discretion and regulation for those affected by this, and that somehow the courts cannot address this, then I fear for the stability of that system and because I feel that there is a mutually beneficial outcome of this form of regulation—the unbundled stated, the regulatory state, whatever you want to call it—that in a sense the courts will evolve to meet this. Whilst I am not a lawyer, so I do not want to profess any particular expertise in this area, I think we can draw attention to certain sorts of evidence that this is a possibility and, from what I have read, other academic and practising lawyers have argued also that there are movements in this area to address this particular problem. How it evolves exactly we shall have to see. So, yes, I own up to optimism but for a purpose.

Lord Jauncey of Tullichettle: Thank you.

Baroness Gould of Potternewton

  53. I wonder if we might move, Mr Vass, to the question of the public. In response to question 8 in your written memorandum about how the regulators are accountable to the public and the question of the associated consumer bodies you make the reply that they are "growingly supported by `memorandums of agreement', although there may be friction due to duplication of objectives, if not roles." Then you say that part of the problem is that they both have "a primary duty of consumer protection." Can you see how in fact the public can be actually protected against any conflict between the regulator and the consumer body? Who ultimately actually should be the body which is responsible to the public? That is the first part of my question. The second part relates to, do you actually think that the public understand what regulators do, what they are there for, whether they think they are there to their advantage or not?

   (Mr Vass) To answer the first question, I think, as we have explained earlier, the Government takes responsibility for what needs to be regulated, in general terms what market failures or conduct, to protect the public and consumers. It then says, "Well, the way I will do this is to appoint an independent regulator, give that regulator powers and duties, which I have suggested were always a primary duty of customer protection but now is being more accurately reflected in legislation and as the various Acts go through. So I think my answer has to be that the fundamental protection is provided by the economic regulator in the area of avoiding the abuse of monopoly power. In carrying out that function of consumer protection that regulator naturally has to hear the voice of the consumer and it had always been the case when we had the office of electricity regulation, we had the electricity consumer committees which had a certain statutory independence within that, they had to be funded and established on a regional basis, but they were part of the OFFER structure and they advised the director-general on consumer issues. Exactly the same situation pertained in water, where we had the OFWAT National Consumer Council and we had the regional committee structure. My feeling is that that worked well but unfortunately during the pre-election period 1997, when we had the public dissatisfaction with excess profits being earned by the utility companies, the high levels of pay to the directors of some of these companies, a lot of public dissatisfaction, there became a feeling that there was inadequate economic regulation, that somehow the regulators might be in the pocket of the companies. I think we could go through a long argument as to whether that was or was not the case, but that led, I think, to a desire to have independent consumer representation, independent of the clear duty of the independent regulator to hear the consumer's voice. I think, following the election—the review of utility regulation, etcetera—this remained a policy requirement but at the same time of course the Government started to introduce the idea of making it absolutely clear that the economic regulator had a primary duty of consumer protection. The two ran along together and so we get to a situation of, say in energy, where we have EnergyWatch with Ann Robinson and we have Callum McCarthy at OFGEM. I have always been suspicious of bureaucratic arrangements where we need memoranda of understanding. That usually tells me that in a sense a compromise has been brought together in some way and perhaps there is a slimmer, better functioning structure than this, but perhaps we have to live with what the legislation has created. My feeling then would be that whilst EnergyWatch carries out certain activities of dealing with complaints, etcetera, which could properly have been dealt with by an economic regulator, and would have been helpful in terms of informing them about the various concerns of consumers, we either have something which is perhaps at best bureaucratic and expensive, given that they are both appointed by the DTI minister, and at worse adversarial in a way which could undermine public confidence in regulation. So we have the example of when OFGEM had decided there was sufficient competition in the retail gas market to move price controls in that area, Ann Robinson stood up on the same day and said, "Oh, no, there's not sufficient competition and we should be retaining price controls." That may be healthy debate to some extent but not at that point in time. So I think it raises questions about whether or not this concept of independent consumer representation outwith the primary duty of the economic regulator will prosper in the long run or whether, as was said earlier, this may have to be revisited in due course to rationalise the structure.

  54. Could I go to the second part of my question about whether in fact you think the public understand what regulators are there for. Do they feel there is a value in having a regulator there in terms of consumer protection?

   (Mr Vass) I think they talk on the basis of their personal experience. If they see prices coming down, the quality of service being maintained, then fine. Obviously when we had the problems of the drought in Yorkshire people did not say to themselves, "Look, this is an outcome of a 1 in 100 year event. It would have been silly for us to have sufficient capacity to supply water under all circumstances, that would have been very expensive and put up consumer bills in the long run." What they simply probably said was, "There's inadequate regulation here and the company is getting away with murder. Why don't they fund this out of the profits?" My perception really is that there is a disconnection between the understanding of the individual member of the public or the consumer and the representative arrangements by bodies and volunteers and others, who are often very well informed of the issues but act really as representatives, and it is probably at that level that the knowledge is but it does not percolate down much below.

Baroness Gould of Potternewton: I am sure that is right.

Lord Elton

  55. It is an interesting point about the input from the consumer. I wonder if you would like to say a little more about the extent to which ministers can influence the conduct of regulators both in theory and in practice?

   (Mr Vass) If we take the argument of the separation of responsibilities for policy and for technocratic implementation of a known policy then I think it is incumbent upon regulators to remain focussed, outside the cut and thrust of the general political debate about issues of whether things should be done or changed in the future but exercise in a responsible and consistent way their activities to address the potential abuse of monopoly power, or whatever it is. But at the same time clearly they have to listen to what is being said. Take, for example, the change, really with the new Government in 1997, to a situation in which I think the Government wish the economic regulators to be more socially aware, to have social action plans and other such things. This comes from a context in which economic regulators have always argued that they were not agents of social justice. I think Sir Brian Carsberg, the telecoms regulator, said that once in the 1980s in his annual report; not that he disagreed with social justice but it was someone else's job, the minister's or income support, or whatever it is. If you took, for example, OFGEM, I think they have proceeded to develop an action plan. The one developed by Professor Littlechild at OFFER was not considered to be as suitable but even so the social action plan itself has been constrained. It has not moved the economic regulators away from their central task. At best it has probably tried to just simply say to companies, "Look, what is good business practice? It is good business practice to try to keep every customer on board. You do not want customers building up huge levels of debt and finding that they cannot then pay and they have used your product, and so on. So if you actually can engage with the customer, have various forms of payment plan, then this might just be simply good business practice." So a lot of the regulators, I think, have dealt with some of the issues of the social awareness which the new Government clearly wanted to introduce into economic regulation without transgressing the general role of being an economic regulator and not fostering large cross-subsidies within the companies, cross-subsidies being really the responsibility of Government to decide that that is required. I hope that is one way of answering your question, that they listen but they listen within the context until, I think, there is a sufficient change necessary to change the regulatory framework, which would come back to Government.

Lord Elton: Thank you.

Earl of Mar and Kellie

  56. To continue, I think, on the same theme and in particular with the issue of electricity prices, it seems to me that the most desirable forms of electricity, various forms of renewable and possibly nuclear generation, seem to be more expensive. Is it in fact going to be possible for the regulator to actually help resolve this situation or is that in fact beyond the regulator's powers?

   (Mr Vass) I think this comes back to the question of the separation of roles, that we have various failures which are to be addressed—abuse of monopoly power, public goods and external effects. Why are we interested in renewable energy? We are interested in renewable energy, even though it may be more costly, because it avoids an external effect of burning fossil fuels. So, yes, this needs to be addressed and this was a debate which was carried out by Clare Spottiswood when she was the energy regulator. The question which had to be asked was, was it her responsibility to adjust for the external effects of burning fossil fuels or was it Government's responsibility to decide and say, "Look, if there is a social cost to burning coal then we need to send that signal to consumers by perhaps putting on a carbon tax, or whatever it is, on that particular form of generation." She would have argued, "That is not my responsibility, that is Government's responsibility." I think probably, when it comes to the issue of deciding on renewables, if we had a Government policy which used appropriate instruments—and I might commend a recent document from HM Treasury on environmental taxes and the willingness to use environmental taxes as a policy instrument; it was published about two weeks ago and I can find the name of it[1]then that in itself would provide an incentive to new technology which might bring down the cost of renewables. But having said that, could I just make one further observation. As always, there are difficulties with this in the sense that we have a transmission system in electricity which was designed around certain large power stations being built in certain places in the country. It may be very desirable then to say, "Look, we could use wind power in a particular location. We will look at the costs of generating it at that location but the economic regulator quite properly has to take account of the fact that if we start generating there we may have to reinforce the transmission system at great cost at other parts of the country, because electricity of course does not go where we want it to go, it goes where it has to go." So I think the answer is, it is about unbundling which problem we are addressing and who should actually take the first step to address that with the right instrument.

  57. Therefore really the answer to how do we move to favouring particular forms of generation is that that is beyond the regulator?

   (Mr Vass) That is a question for the energy White Paper just about to appear.

  58. Yes. There is one other thing I would like to ask about and that is everybody knows there is what I consider to be a major failure of regulation in terms of the implementation of the fridges and freezers directive which is currently requiring, for example, the local authority where I live, in Clackmannanshire, where there are 2,000 fridges in store, to pay for the storage and then it will have to pay for them to be taken up to Perth or Glasgow for them to be chopped up. That strikes me as a complete failure of regulation in the sense that a regulation has been made but at the present moment it is not implementable.

   (Mr Vass) Right, and without due regard to the consequences.

  59. It is an EU regulation which requires us to do that but there does not seem to be any regulatory solution to this crisis, which is that we implemented a regulation when there were no factories capable of doing the work.

   (Mr Vass) Yes, but whether that is a transitional question or not—can I say I am not an expert in the fridges and freezers directive.

1   Tax and the Environment:using economic instruments, HM Treasury, November 2002 Back

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