Select Committee on Constitution Minutes of Evidence

Supplementary memorandum by Sir Christopher Foster

  1.  I submit this memorandum in amplification of my answers to Questions 204-211 asked me by members of the Committee on 26 March, 2003.

  2.  In Britain there are two main lines of accountability a public body may have: through ministers to Parliament (though there are a few bodies whose accountability is direct to Parliament) and to the courts through judicial review.

  3.  However, in their sections covering economic regulation, the privatisation statutes aimed at a third line of accountability for utility regulators where these were established. The statutes gave them duties. These duties varied both in wording and in substance. Some such variations were readily explicable in terms of the different characteristics of the industries or the form of their privatisation. Others less so and seem better explained by their being drafted under instructions of different departments of state. [2]Though were differences in how these duties were expressed, among them there were in general requirements that they act so as to avoid excess profits in the industry; ensure nevertheless that those regulated are able to avoid financial loss; and promote competition. Even where the promotion of competition was not explicit, utility regulators were able to interpret their duties to embrace it.

  4.  In their activity with the greatest potential for affecting the financial well-being of those they regulated—RPI minus X price regulation—they were to be accountable to the Monopolies and Mergers Commission, subsequently replaced by the Competition Commission, except in one case where the Civil Aviation Authority was to perform a similar role. This accountability took the form that those regulated could ask that these decisions be reviewed and altered by the MMC (or CAA).

  5.  There was a precedent for such a form of accountability in the relation between the Office of Fair Trading and the MMC, though there were differences in how it was operated, again in part due to differences in circumstances. In particular in utility regulation the Minister was deliberately excluded from the review process. There was good reason for this. Being investigated by OFT or being brought before the MMC or now the Competition Commission is a rare event for a company and with care and good legal advice may be avoided. Taking action, which may run that risk, is a deliberate management decision which makes it a calculated risk. By contrast an RPI minus X review is a periodic event which a regulated company cannot escape and which may have a dramatic effect on its future profitability. It therefore seemed vital that in this respect these regulatory decisions should be:

    (a)  Free from the possibility of political interference, except inasmuch as ministers might issue guidance which regulators should only follow insofar as they believed it did not conflict with their economic duties;

    (b)  Required to follow court-like procedures subject to judicial review. These the regulators developed and to the best of my knowledge continue to adopt;

    (c)  Capable of being reviewed by an appropriate body also free from political interference and using court-like procedures. Unlike the United States this right of review or appeal was not to be to the courts themselves because British judges in general were not thought to have developed the appropriate expertise. (I recall from memory the astonishingly high proportion of American judges who have economics or business degrees).

  6.  I believe those protections wise, if, as was intended, these regulated industries are to be run as quasi-markets with as much competition as possible and with regulators acting so as to make those markets simulate ordinary competitive markets as closely as possible. Otherwise there will be too much uncertainty over profits for firms to be able to act competitively. Hence the vital needs of requiring independence from ministers and accountability by review of appeal to a court-like, appropriately expert body.

  7.  Appeals: Indeed there is a case for arguing that all economic decisions by such regulators should similarly be capable of being appealed against. Otherwise as now, regulatory independence goes too far. Where there is no right of appeal or review, they are accountable to no one. However, to curtail regulatory process and avoid vexatious appeals, there is a case for following the example of judicial review by requiring complainants to apply for it giving their reasons so that the court may refuse it if they believe the case trivial, vexatious or already covered by a decision in a previous case.

  8.  Codification: Because of variations in the words used in the statutes, several not readily explicable, there is in my judgement a case for reviewing them all as a basis for comprehensive regulation which will codify the powers and duties of utility regulation.

  9.  So-called social or political regulation raises different issues. Several privatisation statutes or associated regulations laid social duties on regulated industries. Or they were expected to continue previous unprofitable practices. Payphones and various provisions limiting price variation even when justified by cost differences, are examples. So is BA running unprofitable services to Shetland, Orkney and the Western Isles. On a grander scale so are train companies running unremunerative services for which they are compensated under franchise agreements.

  10.  These present no problem for economic regulation provided the obligations are contractual, preferably explicitly so as under franchise agreements. If regulated firms are to be fairly remunerated for these unremunerative activities, their (marginal) cost need to be known or at least estimated approximately. Then regulators and appeal bodies can allow for them in making their economic decisions, whether or not their costs are borne by Government as with railways, or by general consumers as with most others. What would be destructive of profit certainty and commercial confidence would be if Government, the regulator or anyone else were able to vary the extent of these social obligations and therefore their cost without compensation.

  11.  Where government imposes these obligations, it is appropriate that the firms which discharge them are accountable through ministers to Parliament for them, as for other decisions made by ministers. Regulators may have several roles here, including ensuring regulated firms have enough financial resources to perform them. Insofar as they do they are properly accountable through ministers to Parliament, as they are not for their economic duties.

  12.  In my oral answers I explored a number of second best possibilities where the distinction between the economic and social roles of utility regulators are not as distinct as I believe they can and should be. They had the characteristic of using procedures which made the trade-off between changes in social obligation and the marginal cost of such changes as well-evidenced and transparent as possible. However, as I argued, it is far harder using such procedures to achieve the explicitness in calculating the trade-off between firms' profits, the cost attributable to the social measures and the social benefits arising from them. This is bound to increase the uncertainty with which regulated firms run their business requiring them to secure higher returns if they are to cover those risks. Otherwise as on the railways the government de facto agrees to bail them out. Thereafter in reality they are no longer private firms.

  13.  What I argue is to be avoided at all costs is a situation where a utility regulator has both economic and social duties in a form which require him or her to make their own trade-off between those duties as a matter of their own private calculation, whether the regulator is one person or a board:

    (a)  It has always been the British practice that such balancing of political or social considerations and economic ones should be done by Ministers accountable to parliament (or democratically elected local authorities);

    (b)  It has the potential for creating appreciable, even unlimited, profit uncertainty and decline in commercial confidence so destroying the competitiveness of these regulated markets.

  14.  Hence my conclusion that economic and social regulation are best separated with social obligations expressed with the certainty given them by their being in contractual form so that economic regulation can be conducted so as to allow regulated markets to operate fairly under conditions which simulate competitive markets as closely as possible.

Sir Christopher Foster

7 April 2003

2   I have discussed an there issues further in C.D. Foster, Privatisation, Publication Ownership and the Control of Monopoly, Blackwell, 1992. Back

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