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. 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 regulatedRPI
minus X price regulationthey 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