Understanding Regulation

Facts, Analysis and Comment

Non-Price Outcomes

No-one ever buys a product or service just because it is inexpensive. At the very least, we expect that it will be delivered to us within a reasonable time, and will not harm us. In regulators' jargon, we endeavour to maximise PQRS - an appropriate combination of the price that we are charged (P), the quality of the goods etc. being sold (Q), the range of products and services made available (R), and the associated service that is offered to customers (S). In an unregulated market, we choose the combination of P, Q, R and S that best suits us at a particular time. We sometimes choose to shop in a large supermarket, and we sometimes pop into our local store. We sometimes shop in Harrods Food Hall, and sometimes in Lidl. We sometimes have an expensive meal in a posh restaurant, and sometimes we pop into McDonalds.

This fundamental fact poses real problems for those involved in utility reguation. Put positively, if market failure requires the imposition of regulation, then someone has to decide what quality, range and level of services should be provided, and at what cost. Put negatively, it is no use forcing prices down if the regulated company is allowed to provide a poor service to its customers. This is an important issue for e.g. the energy regulator which requires licensees to pay compensation for missed appointments, the postal regulator which requires Royal Mail to meet certain prompt delivery targets, and the airports regulator which does not have effective ways of forcing airport operators to provide a decent and reliable service to passengers - see further below. It also turned out to be a vital issue in the regulation of the health service in the UK, where the Francis report on the dreadful events at the Stafford hospital noted that '... no effective consideration was given to the potential effects of cost savings and staff cuts on patient safety and quality. The Healthcare Commission had little by way of financial expertise available to it, and Monitor [the economic regulator], likewise, little clinical resource. The impact of one on the other does not seem to have been fully appreciated.' Mr Francis therefore recommended that 'There should be a single regulator dealing both with corporate governance, financial competence, viability and compliance with patient safety and quality standards for all trusts'.

More generally, however, the trade-offs between non-price outcomes are better decided by elected politicians than by unelected regulators. It is also much better for politicians to resolve the tensions between the needs of present and future consumers - such as whether current consumers should pay more for their gas and electricity so as to facilitate investment in green/renewable technologies which will benefit future generations. There is in practice an effective division of responsibility in the case of postal regulation, where Parliament has mandated a 100% universal postal service, however remote the customer, and a reasonably effective division in the case of water regulation, where politicians in London and Brussels mandate water quality, and Ofwat then determines the maximum prices that may be charged by water companies in order to provide water of that quality. (Only 'reasonably effective' because I do not believe that politicians are aware of the cost consequences of their determination to mandate ever-increasing water purity.) But energy regulation is currently a complete mess because of politicians' failure to take decisions on a number of social and environmental issues, preferring to leave these to an increasingly overwhelmed regulator.

Another useful rule is that ...

It is better to specify rules and behaviour than to specify outcomes

The network nature of utility industries means that there are in principle two quite distinct types of utility/network regulation.

• Rules regulation establishes the process through which the various companies interact with one another and their customers. This is hugely important as, without such rules, it would not be possible for, say, an electricity generator to sell his output to a distribution company, for customers to be able to switch to cheaper suppliers and so on.
• Output regulation determines outcomes in the form of prices charged to customers, service standards etc.

In an ideal world, effective rules regulation does away with the need for output regulation as it facilitates effective competition. This was the logic which drove the electricity regulator to abandon retail price controls in 2002.

 

Martin Stanley