Ministers have in recent years come under much pressure to use regulation to tackle a huge range of problems including threats to the environment, poor health and social care, damaging social media and so on. They have found that regulation generally encounters less opposition than alternative ways of changing behaviour - such as taxing activities which are deemed undesirable. And they have found that regulation is more effective if it can be de-politicised, so that regulators take long term decisions free from political interference. This also helps politicians avoid blame for unpopular decisions. And yet many regulatory decisions are essentially political in that they involve choices, including whether to prohibit or deter behaviour that would otherwise be perfectly legal.
One result of these competing tensions, and changing political climates, is that some regulators are much less 'independent' than others.
Regulators are most effective when they have a small number of non-competing objectives, clearly set out in legislation ('black letter law'). They can then achieve those objectives by deploying their economic and/or legal and/or technical expertise. Competition authorities are the obvious example of high independence, together with NICE (see below) and the medicines regulator that achieved such prominence when authorising use of the COVID-19 vaccines.
Multiple objectives are problematic because regulators then have to make (small 'p') political trade-offs for which they have no democratic mandate. Ofgem is the classic example. The regulator is then forced to look to government for guidance, which immediately reduces its independence. Independent rail regulation has also disappeared as the industry collapsed under the combined weight of austerity, the Covid pandemic and the Conservative government's post-Brexit meltdown.
But it is clearly not possible for politicians to assert that they have washed their hands of responsibility for the quality of education and health services, so the regulators of those services tend to operate in a more overtly political environment. Ofsted, for instance, frequently changes its school inspection policy and lurches from 'leave excellent schools alone' to its 2022 announcement that it will 'inspect all schools by 2025 and increase number of 'longer inspections''. These changes are clearly driven by Ministers' expectations. And you do not get to run Ofsted unless you will pay close attention to those expectations. Follow this link for some additional comments about regulating schools and examinations.
Successive Health Ministers have nevertheless managed to keep a reasonable distance from the decisions of NICE (the National Institute for Health and Clinical Excellence) which decides which treatments and medicines should be made available free of charge on the NHS.
(It is, though, worth noting that it is really quite amazing that Ministers can so effectively wash their hands of decisions that are literally 'life and death' for their electorate. I also have some sympathy for Bryce Newsome's argument that there are too many 'independent' health service regulators and it might be a good thing if the Secretary of State for Health and his officials began to take responsibility for, and do something about, the NHS's many failings.)
(See also Annex 1.)
Environmental regulation is another very complex area where simple rules (such as 'the polluter pays') quickly unravel. See Annex 2 for a more detailed discussion of this subject.
Three Concerns
The huge expansion in regulation has caused growing concern about
- the burden of regulation, and
- the accountability of the Regulatory State,
whilst others have asked: -
- Is the independence of regulators from government quite as strong as it is supposed to be? Indeed does regulators' traditional independence makes sense in the modern economic and political world?
The burden of regulation is discussed in the Deregulation section of this website. The following notes explore the other two concerns.
(The Independence of regulators from their sectors is discussed in the Regulatory Capture section of this website. )
The Growing Regulatory State - and Accountability
The growth of regulation is often cited as one of three major changes in the UK constitution in the late 20th Century - the others being our membership of an expanding EU, and devolution. Some politicians express concern that there is no effective oversight of this new and powerful "State within a State", and draw attention to the damage that cumulative regulation might do to traditional freedoms and to economic growth. Those expressing such concerns are in effect pushing back against Ministers' determination to delegate politically difficult decisions to regulators: decisions ranging from control of interest rates to the choice of medicines available through the National Health Service.
It is hard to underestimate the constitutional significance of such delegations, especially in the field of economic regulation. All the utility regulators have wide powers, such as the power to establish price controls etc. for the companies which they regulate. Some, such as the energy regulator Ofgem, can go further and make laws, in the form of Statutory Instruments, albeit subject to the approval of Parliament. The Competition and Markets Authority has even wider powers. It can make a wide range of orders to overcome competition problems. Such orders, which might for instance establish a price control or require businesses to behave in certain ways, can be binding on companies and individuals - and require no parliamentary approval whatsoever.
A House of Lords committee reported on this subject in 2004 (The Regulatory State: Ensuring its Accountability) although this report concentrated mainly (but not exclusively) on the accountability or otherwise of the economic regulators.
Sir Paul Tucker joined the fray in 2018 joining many others who were uncomfortable that Ministers had delegated so many essentially political decisions to unelected regulators. The Times reported his views as follows:
A former deputy governor of the Bank of England has called for the Financial Conduct Authority to be stripped of its independence or reformed in a broad attack on Britain’s regulatory structures. Sir Paul Tucker, deputy governor for financial stability until 2013, also raised concerns about the power of Ofcom, the media regulator, and questioned the “implausible” unanimity on the Bank’s financial policy committee, which oversees commercial lenders.
He was speaking at the Bank to discuss his book, Unelected Power, in which he argues that too much power is in the hands of technocrats without proper political oversight. His arguments come after the election of the establishment outsider Donald Trump to the White House and the backlash against “experts” in the Brexit vote. “The more power that is put in agencies the more alienated people will become,” Sir Paul, 60, said. “Technocracy should retreat to preserve our system of government.” He cited the FCA, the financial market regulator, and Ofcom as examples in Britain, both of which also happen to be led by potential rivals for the post of Bank governor. Andrew Bailey, FCA chief executive, Sharon White, Ofcom chief executive, and Sir Paul are all regarded as possible successors to Mark Carney next year, although none has confirmed their candidacy.
The Institute for Government published an excellent report (Parliament and Regulators) in early 2024. It was well referenced and contains much interesting information and analysis. Its overall conclusion, sadly, was that Parliamentary oversight of regulators was patchy at best. The IfG's interviewees suggested that too often:
- Committees are poorly informed,
- Hearings are poorly planned,
- Committees are overly adversarial, and
- Committees are unengaged.
The problems caused by reactive and poorly informed oversight were summarised by a former parliamentary clerk:
“It’s the difference between the community policeman on his beat vs. a SWAT team. Select committees mistakenly go for the SWAT team approach straight away - come in all guns blazing, launch a few scattergun shots, and people end up dead, only sometimes the right ones. If relationships and dialogue were established and regulators and committees knew and talked to each other it would work much better".
The result is that:
"The [regulator's] aim is no headlines. Organisationally, you send the person in there to be as boring and bland as possible."
Outside Parliament, however, regulators are perhaps over-accountable - in particular to the courts and via the media. There are growing concerns that the tension between accountability and transparency, on the one hand, and regulators' wish to avoid blame, on the other hand, is leading to over-weak and over-bureaucratic regulation. Follow this link for a more detailed discussion of this subject.
There is a lot more about the accountability of civil servants to Ministers and Parliament on my UK Civil Service website. You could start with this page.
How to Assess whether Regulators are Truly Independent
The independence of a regulator from government can be assessed by answering three questions:
1. Is the regulator legally independent? Is it a body which is legally separate from government, with duties, powers and responsibilities clearly set out in statute law?
2. Does the regulator in practice always proceed without seeking permission from, or the approval of, the Government?
3. Can the regulator's most senior staff (Chair, Chief Executive, Board members) be sacked (other than for obvious misbehaviour) before the end of their (longish) periods of appointment?
Quite a few regulators - and especially the economic regulators - pass these tests reasonably well, although every one has a relationship with their 'sponsoring' government department which is responsible for:
- promoting the legislation which specifies and constrains the regulator's duties,
- making the most senior appointments (e.g. to the regulator's Board) and approving other senior appointments (e.g. of the Chief Executive),
- controlling the regulator's budget, often via approving the corporate plan etc., and
- setting or approving the regulator's senior salaries.
Also, there is bound to be reasonably frequent communication between government and regulator, as the regulator explains what it is doing and assists the government in developing or defending its policies. No regulator is an island, to misquote John Donne. Regulators should not aim to live in an ivory tower, and senior staff need to pay attention to their relationship with both government and industry. Equally, the leadership team, and particularly the Board and Chief Executive, need to be strong characters for government Ministers - or more likely their officials - may on occasion express various degrees of surprise or concern about the regulator's policies and/or decisions. This can be characterised as 'putting pressure on' the regulator. In practice, however, decent regulators are perfectly capable of withstanding such pressure, as long as their independence is truly valued, and as long as the pressure is not accompanied by threats - such as to the regulator's reappointment or budget.
All regulators work within budgets and salary policies set by the Government - sometimes by their 'sponsor' department, sometimes by the Treasury. This can cause problems when the government of the day is aiming to cut total government expenditure, but is less of a problem if the regulator is funded by the industry that it is regulating, for instance via licence fees. There was a potentially serious spat in late 2015 when the Prisons Inspector felt that the Ministry of Justice were taking too detailed an interest in the way he spent his money. The MoJ quickly backed down, but it is well worth reading the Inspector's strong assertion of the independence of his decision making.
And it must be recognised that Ministers can - over time - strongly influence the policy and behaviour of a regulator by appointing Chairs and other senior figures who have known sympathies, including being known to be critical of their predecessors' performance. It was almost certainly the case, for instance, that only those sympathetic to 'light-touch' regulation will have been appointed to the Boards of UK financial services regulators in the period running up to the 2008 credit crunch. Similarly, Education Ministers can, if they wish, appoint examination regulators who are devoted to traditional education methods and syllabuses. And it was obviously sensible for the Trade and Industry Secretary to appoint an energetic pro-competition Chair to lead the newly-formed postal regulator when Royal Mail was given its commercial freedom in 2000 - although the speed with which the company was put under competitive pressure undoubtedly caused surprise.
But Ministers have been criticised for letting personal and political preference override good judgement. Early 2014, for instance, saw considerable concern being expressed about Ministers' failure to reappoint apparently well-regarded (and often politically left-leaning) female Chairs of the Charity Commission (Suzy Leather), the Human Fertilisation and Embryology Authority (Lisa Jardine), the Arts Council (Liz Forgan), the Human Tissue Authority (Diana Warwick), English Heritage (Kay Andrews) and Ofsted (Sally Morgan).
It is of course true that the relevant Secretaries of State must be allowed to appoint sympathetic personalities to lead 'their' regulators in these politically important areas - assuming, of course, that the subsequent appointment processes generate short-lists of candidates who have excellent skills and experience. Indeed, Tony Blair's government was accused of mainly appointing friendly figures ('Tony's Cronies') when making similar appointments from 1997 onwards, although I do not know if the accusation can be stood up in the regulatory area. It is certainly the case that, if the electorate do not like the resultant policies, or recoil from Conservative Ministers' apparent problem with senior women, then they can take their revenge in subsequent elections. But Ministers such as Education Secretary Michael Gove would not explain why they were unwilling to reappoint incumbent Chairs, other than by deploying Mr Gove's slightly pathetic 'need to refresh' argument. They perhaps felt that 'never apologise, never explain!' is a good rule when you know that your explanation is bound to be attacked by political opponents.
This perhaps serves to make the point that regulators can only, ultimately, be as independent as minister will allow them to be. It was reported, for instance, that 'gambling minister' John Whittingdale was intensively lobbied by Scott Benton MP when the minister was in 2021 considering which of four candidates to appoint as Chair of the Gambling Commission. Mr Benton argued that three of the four were 'anti-gambling'. It would be better, Mr Benton argued, if the Chair came from a 'non-ideological background'. The fourth candidate - the one most acceptable to the industry - was duly appointed,.
Ministers have also been known to be a little too free with their opinions when commenting on matters which are more properly the responsibility of one of 'their' regulators. Charles Hendry's interference in energy regulation is mentioned here, and Ed Vaizey's interference in communications regulation is mentioned here.
Why Independence is Important
Despite the challenges summarised above, there remains widespread agreement that economic regulators should be pretty well totally divorced from short term political pressure. Like some other public authorities, such as the Office for National Statistics, they cannot be effective unless their analysis, statistics, recommendations and decisions are trustworthy.
The industries and their investors welcome the longer-term planning horizons and better decision-making that are encouraged by keeping politicians well away from setting price controls, merger control etc. They refer to this as 'reduced political risk'. Politicians, for their part, recognise that independent regulation means that important decisions will not be swayed by short term political pressure. Bestowing independence on a regulator thus demonstrates credible commitment to good decision making.
Politicians also welcome being kept well away from the complex investigations which are necessary in these areas - and the likelihood that the decisions are bound to upset either the industry or its customers - and possibly both.
In a quite different area, Ministers are (or should be) delighted not to have to take prisoner parole decisions. It's easy enough to continue to 'lock 'em up' but - assuming they let some of them out - very few Ministers are going to want to defend their decision to release a previously violent prisoner - who had appeared now to be of good character - when they re-offend.
The promise of independent regulation was accordingly a key feature of UK privatisations of previously state-owned industries beginning with the early 1980s privatisation of British Telecom. The newly appointed regulators clearly enjoyed their freedom and - most obviously in the case of Rail Regulator Tom Winsor - reacted very noisily when they felt it was being compromised. Less noisily, the Board of the postal regulator Postcomm offered to acquiesce in having its powers suspended if the Government wished to persist in its plan to delay the introduction of competition, and allow significant price rises, so as to facilitate the sale of Royal Mail to the Dutch mail operator, TPG.
But there is - perhaps inevitably - some evidence that later generations of regulators are (depending on your point of view) either made of less stern stuff or sensibly allowing their regulatory decisions to take account of wider considerations. Examples of this behaviour might include:
- the Bank of England - for failing to raise interest rates in 2010 and 2011 for fear of damaging the prospects of economic recovery, despite their principal remit being the control of inflation - though it is interesting to note that incoming Governor Mark Carney has suggested that it might be more sensible if the Bank were in future allowed to take account of the extent of unemployment, and target nominal GDP rather than inflation.
- the Financial Reporting Council - for allegedly regulating the big four accountancy firms in a quite gentle way, for fear of damaging their health and maybe causing one of them to fail, so reducing competition even further
- Ofgem - for paying too much attention to their (far too many) subsidiary objectives - such as encouraging low emission generation and protecting vulnerable customers - at the expense of their principal objective of encouraging efficiency and low energy prices. Click here to read a more detailed discussion of this subject - also see the note below.
It is interesting to discuss these issues with those economists and others who work for economic regulators. Some at least of them argue that "regulators can't take on the Government", regulators are "independent up to a point", and that regulators "wouldn't have been allowed to" do certain things. These are not phrases that would ever have passed the lips of their predecessors. Indeed, even strong and experienced regulators increasingly take the view that managing (and not resisting) the interplay between politics and regulation is becoming increasingly necessary. The IfG's Michael Coelho put it like this, in 2015: 'The complexities of competition and technological developments that we face today – and will continue to face – pose challenges that are very different from those of the past. Governments cannot and will not abdicate responsibility for the performance of regulated industries; they will want to have some degree of supervision over what they do, insofar as it relates to policy objectives. ... Regulation operates in the context of policy objectives that are publicly specified and privately delivered. Since there is no clear-cut boundary between policy and implementation, there is a clear need for constant dialogue between regulators and politicians. It is critical to ensure that this dialogue takes place in a transparent manner, rather than behind closed doors, with arms perhaps being twisted. That is one of the fundamental challenges for economic regulators: to preserve independence while working within politically charged environments. Regulatory independence is not tainted by discussion or consultation with government; rather it is enhanced, through greater knowledge of the concerns of those elected to represent the public.'
It was good, though, to see this example of a regulator thinking for itself and making a sensible decision which was nevertheless uncomfortable for Ministers:- The Civil Aviation Authority’s Andrew Haines in December 2017: “we are very uncompromising in our view that we should not be planning for a new [post-hard Brexit] independent aviation safety system in the UK. Indeed, we have consciously decided not to do that work as it would be misleading to suggest that’s a viable option.”.
See the regulatory behaviour page of this website for a discussion of the perils of regulatory capture - that is the need for regulators to be independent of their industry or profession. The same page discusses the problems caused by regulators having too many (often conflicting) objectives but not being politically accountable for the choices and they make.
And follow this link to read a discussion about the greater freedom claimed by at least some regulators in the USA.
Independence of Financial Services Regulation?
The most serious recent threat to regulatory independence arose before the 2007 Financial Crisis when financial services regulators in the UK and Ireland came under sustained pressure to apply 'light touch' regulation to banks etc. Chancellor of the Exchequer Gordon Brown famously promised in 2005 that he would ensure that regulation was not just 'light touch' but would also be 'limited touch'. But the most stark intervention came in May 2005 when UK Prime Minister Tony Blair characterised the activities of the financial services regulator, the FSA, as 'hugely inhibiting of efficient business by perfectly respectable companies that have never defrauded anyone'. FSA Chair Callum McCarthy angrily responded in a letter to the Prime Minister, saying that '[this characterisation] is not one that we recognise or can accept. Quite simply, I know if no evidence which supports such a sweeping accusation. ... 'We are not an enforcement-led regulator (in sharp contrast to the US Securities and Exchange Commission) and have worked hard to concentrate our enforcement initiatives on those particularly important cases where there is a general message of wider significance (we now pursue only a third of the number of enforcement cases each year that were pursued three years ago). ... The thrust of our work ... is to make the markets work effectively, and so avoid the need for regulatory intervention ... '.
Future Prime Minister David Cameron made an equally inappropriate intervention in March 2008 - well after the start of the financial crisis - when he proclaimed that 'As a free-marketeer by conviction, it will not surprise you to hear me say that the problem of the past decade' is 'too much regulation'. Meanwhile, over in the Republic of Ireland, Taoiseach (Premier) Bertie Ahern had in July 2007 let rip at those who sought for many years to warn him about the credit bubble: 'Sitting on the sidelines, cribbing and moaning is a lost opportunity. I don't know how people who engage in that don't commit suicide because frankly the only thing that motivates me is being able to actively change something'.
The trouble with the FSA's response to Mr Blair was that it sought to persuade the PM that the regulator was indeed as 'light touch' as he would wish - if not more so. Subsequent events showed that they had badly mis-judged their role. But it is only fair to point out that it would have required an extremely strong-minded regulator to withstand such strong political pressure, backed up by extremely strong herd behaviour in every quarter. Click here for a fuller discussion of herd and related behaviour.
Fast forward to 2015, and renewed ministerial interference in financial services regulation demonstrated that many politicians had completely forgotten, or chose to ignore, the disastrous result of their predecessors encouragement of light touch regulation. Martin Wheatley, the tough Chief Executive of the Financial Conduct Authority was ousted by Chancellor George Osborne in July 2015, apparently angered by Mr Wheatley's attacks on bank misbehaviour, including several large fines. His temporary successor, Tracey McDermott, then abandoned the FCA's Banking Culture Review - quickly denying that this had anything to do with her interest in taking the job permanently. In the event, Bank of England insider Andrew Bailey was given the job in January 2016 following 'a worldwide search' to which he had chosen not to respond - and he couldn't be released from the Bank for several months. Very strange!
It was also reported that the FCA had not even been consulted before the Treasury had weakened the senior managers regime - the rules aimed at improving accountability in banking - by removing its reverse burden of proof.
Health Sector
.See the Annex below for an excellent short Times article commenting on political attacks on a health sector regulator.
Office for Students
Considerable concern was expressed when a friend of both Prime Minister Johnson and Education Secretary Gavin Williamson, 36 year old Lord Wharton, was appointed Chair of the OfS in early 2021. He did not seem to have any relevant experience, unlike other, apparently better qualified candidates.
EHRC
David Isaac, a former Chair of the Equality and Human Rights Commission, complained in January 2021 that the EHRC was being 'undermined by political pressure to support the government's misguided agenda'. He was particularly concerned (according to the Guardian) that the relevant minister, Liz Truss, 'had made no pretence of the EHRC being independent when announcing that newly appointed commissioners would drive HMG's agenda forward'.
Ofcom
The 2021 recruitment process for the new Chair of Ofcom was restarted after the selection panel refused to recommend Prime Minister Johnson's controversial candidate, former Daily mail editor Paul Dacre.
Notes
The Environment Agency is in effect a combination of part of a government department (many of its staff and functions are ex-DEFRA) and environmental regulator. It doesn't do a bad job in wearing those two hats, but sometimes seems uncomfortable doing so.
Ofgem, too, combines a large number of government functions with a more traditional utility regulatory role. It now works very closely with the Energy Department and big energy investment decisions have in effect been nationalised. There is much more detail here.
The NAO were very clear, in a 2018 report, that Ofsted is now little more than an agency of the Department for Education. It is told what to do by the department, and is severely resource constrained.
Much the same applies to Natural England. Its outgoing Chair, in 2018, told a Commons committee that the agency's grant had been cut by 45% over the previous five years and that all its HR, financial, press and communications functions had been moved into Defra.
Annex 1 -NICE
Here is an interesting Times article by James Kirkup touching on the subject of this web page.
The National Institute for Health and Care Excellence marks its 20th anniversary this week. Nice is a world-leading example of how to make difficult choices about allocating scarce resources. It approves the use of medicines and other treatments on the basis of hard-headed calculations, not politics or popularity. Centralising and codifying decisions on medicine helps to avoid “postcode lotteries” and largely keeps politicians out of the process. Reflecting its 1990s origins, Nice is a very centrist institution: created and run by people focused on evidence not emotion, it just does what works. Which is possibly why it’s under attack. In the post-truth age of Trump and Brexit, the Nice approach seems almost anachronistic and in a recent Commons debate MPs of all parties lined up to criticise the institute for not providing drugs for a range of rare conditions afflicting their constituents.
Hard-headed calculation is easily depicted as cold-hearted disregard for “ordinary people”. Nice decides which drugs are worth funding according to how many “quality adjusted life years” (QALYs) each treatment will deliver. Brutally utilitarian, perhaps, but that’s the nature of a finite health budget: a pound spent treating Patient A cannot be spent on Patient B. All that remains is to decide where that pound will do the most good. It’s an uncomfortable reality to explain and sell, especially to people desperate for treatment. Sadly, some politicians aren’t even trying. That Commons debate was led by Labour’s Liz Twist, who came close to suggesting a populist approach to allocating medical resources: “QALYs, and everything else, that means nothing to people on the street,” she said, demanding instead an approach based on “fairness”, whatever that means. She’s not alone in suggesting that popular perception should trump evidence. A Home Office white paper on immigration last year said that ministers wanted fewer migrant workers because of “the public’s view” that foreign labour drove down wages — something the government’s own economic evidence does not demonstrate
There are certainly improvements that could be made to the Nice model: the definition of a QALY can be revisited, and the wider NHS might benefit from buying more drugs on an “outcomes” basis, where suppliers get paid according to results. But funding medicines on the basis of what you think “people on the street” want would be a step backwards. Britain may be sick of experts, but getting rid of them is no way to help the sick.
Annex 2 - Pollution
This is an extract from John Kay's book The Truth About Markets
Many externalities in modern economies arise from pollution – of air, land, and water. Indeed, the term ‘pollution’ is now widely used to cover many types of externality. Noisy lawnmowers are said to emit noise pollution, offensively sited billboards represent visual pollution. Not all externalities are bad, however; my beautiful garden is an asset to you as well as me. Pollution can be handled by rules, by agreement between the parties, or by the creation of artificial markets in externalities. Rules against pollution are familiar enough: no litter, no busking, no horns to be sounded after half past eleven.
Rules against externalities work well when the objective is clear and enforcement straightforward. But this is rarely the case. No air pollution is a desirable goal, but it would mean shutting down all transport, all electricity generation, and most industrial processes. What we want is a little air pollution but not too much. So we come up with formulas like ‘best available technology not entailing excessive cost’, which is a statement of the problem not an answer.
‘The polluter pays’ sounds like a simple and attractive rule, but it quickly unravels. It seems appropriate that people should pay for the pollution they cause, but the attempt to handle environmental problems through legal processes has not worked well. The problem is by now a familiar one: the definition of rights and rules is not obvious, but the results of a social decision. An electricity generator is not negligent in emitting carbons and sulphur dioxide until we formulate a specific rule that says it is.
Attempts to define the rules retrospectively create worse problems. How long and indirect can the chain of consequences be? Were the emissions caused by the electricity-generating company, or by whoever sold the polluting fuel, or financed the power station, or used the electricity – or by all of these? An American attempt to pursue this route – through the ‘Superfund’ – has simple ensure that the funds intended to benefit victims of pollution have ended up in the hands of lawyers, and have increased business uncertainty by holding individuals and companies liable for events long in the past for which they justifiably feels no responsibility.
In any event, pollution is in the eye of the pollute. You may be offended by my dress, my taste in music or by what I read, but it would be preposterous to suggest I should compensate you for these things. Yet we do have rules against indecent exposure and display, against holding noisy parties late into the night, and to restrict the circulation of violent and pornographic material. To make the principle of ‘the polluter pays’ work, we have to define the default positions: exactly what a world without pollution would be like.
These default positions are the product of social norms, and they change over time. It was once acceptable to deposit excrement in the street, and, until recently, quite normal to allow industrial waste to accumulate in the environs of a plant. In a few decades Heidi and Hermann may find electricity pylons across tracts of beautiful countryside equally extraordinary.
Externalities may be dealt with by bargaining between the parties. This works best where the externalities are big but the numbers affected are small, as when I own land near your proposed factory extensions or you are playing your radio too loudly. Such bargaining usually takes place ‘under the shadow of the law’ and the default position matters here also. I will bargain more confidently if I have a right, rather than a desire, to object to your factory extension, or if a notice says ‘no radios to be played’. Markets in externalities are new. They work best for an externality like sulphur or carbon dioxide emissions with many sources. Tradable permits allow those who can reduce emissions relatively cheaply to benefit by selling rights to those for whom the costs are greater. The advantages of the competitive market – incentive compatibility and low information requirements – allow reductions in pollution to be achieved at lower cost.
Market economies solve co-operation problems through a combination of spontaneous order and social institutions. Nothing guarantees that solutions will be reached, or that those that are reached are efficient. But coevolution has usually produced answers.