Understanding Regulation

Facts, Analysis and Comment

Utility and Network Regulation

The regulation of the telecoms, energy and other network industries has huge economic, social and political importance. This part of this website explains the key issues and controversies. A separate section of this website comments on the regulation of specific markets, such as energy, airports and communications.

The overriding purpose of utility regulation is described below, together with the important question: Is competition is always better than regulation?

This leads naturally into a discussion of the relationship between the government and utility/network regulators. This may be found here. There is also a separate web page, in the key issues section of this website, which discusses of regulators' accountability and independence.

Then there is the challenge of finding effective ways in which to involve customers and other consumers in developing regulatory policies. This discussion may be found here.

Finally, follow these links for introductions to price controls and access pricing.

Purpose:- Competition or Regulation?

It is very important to remember that utility regulation is a poor second best to, or substitute for, a properly functioning competitive market. Although regulators are often seen as a useful agent for those who want to change the behaviour of utility industries in various ways, the principal purpose of utility regulation is to limit the economic harm that would occur if these naturally monopolistic industries were not regulated. Such harm would likely include inadequate investment and reduced innovation as well as higher prices, poor service and so on. Economic regulators accordingly aim to align the interests of the three key stakeholder groups: the providers of capital, the companies themselves, and their customers. It is wrong to think of the these three groups being adversaries.

It is of course possible to ask regulators to assume wider responsibilities, such as helping vulnerable groups or improving the environment, but this generally requires regulators to make trade-offs between their economic and societal objectives, and these decisions are in principle better left to politicians.

It follows that legislators should not impose regulation without first considering (a) whether the market will not provide an optimal outcome and, if not, (b) why not? Only then is it possible to consider the best way to address the market failure through instruments which might include targeted exemptions from taxation, or targeted taxation. In the energy field, for instance, would it not be better to reduce the income taxation of those with low incomes, rather than introduce social energy tariffs, which in effect tax other energy users in a stealthy way? After all, we don't mandate social tariffs for other key products, such as food or clothing.

It also follows that legislators should set tasks and duties for regulators - not outcomes - and should in particular require regulators to encourage competition. (Good legislative formulae include phrases such as "... the Commission shall exercise its functions in the manner which it considers is best calculated to further the interests of users ...", "... wherever appropriate by promoting effective competition ...".) Legislators should thus encourage competition (or, in its absence, consultation with customers) which will lead to outcomes which are free to vary over time, from place to place, and depending on the nature of the company and customer.

To the extent that effective competition cannot (yet?) be achieved, and to the extent that such decisions are not taken by politicians, the regulator has to allocate risk between investors, customers and society more generally. The general aim should be to allocate risk to those best able to manage and/or bear it. Capital markets may, for instance, not be able to bear the risk of financing large and long-pay-back investments in highly regulated industries. Regulators may then need to require current customers to investments, such as in clean water, or a new runway, which will mainly benefit future generations.

(The UK Regulators Network published a useful guide, in 2014, for investors in UK regulated infrastructure sectors. They noted that their regulated sectors – aviation, energy, telecoms, rail and water – needed to invest over £100bn in the next five years alone, and wanted to describe what they saw positive environment for that investment.)

In seeking to achieve particular outcomes, regulators can seek to influence companies' behaviour through persuasion and publicity, maybe merging into provocation. But it is often necessary to impose price controls and associated conditions. In this case, it is better to encourage market mimicking behaviour through incentive regulation. Direct interventions - telling companies what to do - are best avoided.

Last, but not least, regulators must always remember that unpredictability = risk = less investment or higher cost of borrowing or higher returns to shareholders (i.e. higher profits). Put another way, utilities crave predictable regulation, and unexpected interventions will usually lead to underinvestment by firms.

 

Martin Stanley