Written evidence to the Industry and Regulators Select Committee

1. This submission covers questions 1-4 and 8-10 in the Committee’s call for evidence. It relates mainly to the economic regulators i.e. bodies such as Ofcom and Ofgem which guide or control the behaviour of companies in certain sectors, either by regulating the prices they can charge (in the case of monopolies) or by seeking to ensure that markets are working effectively (in areas where a degree of competition exists). It also covers the Competition and Markets Authority (CMA), the UK’s principal competition and consumer authority. Most of these bodies were set up with a particularly high degree of independence from ministers, for reasons which are covered below.
2. The submission is based on my experience working across the regulatory and political arenas. From 2019 to 2023 I served at the CMA as Senior Director for Strategy, Communications and Advocacy and a member of the Executive Committee. Under the last Labour Government I was a Special Adviser to Prime Minister Gordon Brown and, prior to that, I was Head of Government Affairs at Ofgem. I am currently a Partner at the corporate advisory firm Brunswick.
3. Further detail on some of the issues explored in this submission, the arguments for independent regulation and the risks to its effective operation can be found in the paper at this link: https://medium.com/@stuartjhudson/power-without-accountability-16da50f6e328.

Question 1: Are UK regulators being given a clear job to do?

4. The job given to economic regulators has become more complex since they were first created in the 1980s and 1990s. Most of them were first established in order to prevent a newly privatised utility from exploiting market power and charging excessive prices. This meant the regulator had to assess what would be a reasonable rate of return for the company but it was hoped that this role would be a temporary one, only until new entrants gained a strong enough position in the market for competition to obviate the need for regulation. As an early government report stated, ‘Profit regulation is merely a “stop-gap” until sufficient competition develops.’1 This was reflected in the statutory duties that were given to the new regulators, with a focus on the protection of consumers and the promotion of competition.

1 Littlechild, 1983 p1

5. However, it gradually became clear that this was too optimistic. First, the market power of some privatised companies endured and so price regulation in parts of their business could not quickly be removed. Second, over time, energy and telecoms networks required significant investment to improve them, so regulators had to think about the trade-off between keeping prices low for the consumers of today and allowing prices to rise to enable investment to benefit the consumers of tomorrow. Third, other public policy considerations emerged. In energy, rising prices led to concerns that further protections were needed for poorer consumers; and mounting evidence about the causes and effects of climate change led to pressure to decarbonise the energy system. As a consequence, the statutory duties of Ofgem were expanded beyond the promotion of competition to encompass broader social and environmental objectives.
6. The proliferation of statutory duties on regulators has led the economist and Nobel laureate Jean Tirole to warn of the risk that ‘a fuzzy mission may create a lack of accountability’, ‘turf wars and policy coordination failures emerge’ and that ‘no-one is really accountable.’2 I think Professor Tirole’s warning is right but the answer is unlikely to involve simplifying the duties of regulators or shielding them from the trade-offs. For example, we are unlikely to want the energy regulator to stop thinking about one or more of consumer prices or climate change or the financial robustness of the companies. The trade-offs cannot be ignored, and the priorities cannot always be easily ranked, so it is better to acknowledge that they exist and to decide what is the appropriate form of governance for a regulator that is charged with managing them.
7. Is the right balance being struck between the responsibilities of regulators and those of the Government, particularly where there are political or distributional trade-offs that need to be resolved?

7. In a democratic society the idea that politicians should be responsive to voter concerns is a feature, not a bug. Even when complex technical issues are involved – for example on public health questions during the coronavirus pandemic – the Government might have expert advisers but ministers ultimately take the decisions and are held accountable for them. For Parliament to place certain decisions beyond ministerial control is therefore unusual and two reasons tend to lie behind it: political time horizons and political lobbying.
8. One of the most prominent examples of political time horizons leading to sub-optimal outcomes can be seen in the case of monetary policy. In the long run, we know that most of us will be better off in conditions of macroeconomic stability with low and stable inflation – and this is of course a significant policy issue globally at the moment. Achieving low inflation can require increases in interest rates when the economy is overheating, but such rate rises tend to be unpopular in the short term because they raise the cost of borrowing for businesses and homeowners. The theory goes that not only will an independent central bank be more prepared to take unpopular decisions for the long term good, but market participants will also build this into their inflation expectations in the first place, so interest rates need to rise by less in order to have the desired effect.
9. Closely related to this is the ‘time inconsistency’ problem. Let us say that ministers want to attract funds to improve the country’s infrastructure. They promise a return to investors but those investors worry – particularly if they are from overseas – that once they have parted with their cash the host government, or perhaps its successor, might put in place new policies that reduce their returns. The delegation of regulation to a body that is beyond political control can reduce this risk, thus attracting more investment and reducing the risk premium that investors require – meaning it also costs less to taxpayers or consumers. At a time when governments want to attract investment and consumers worry about the rising cost of living, this is a powerful argument for independent regulation.
10. Separately, there is a risk that political decisions could be influenced by small but powerful vested interests. If two politically well-connected companies wish to merge, they could mount a well-funded lobbying campaign to persuade ministers to let their deal through. Consumers might end up paying higher prices as a result of the merger, but individually they lack the time, incentive and technical knowledge to put that case effectively to ministers. In a politically dominated merger control regime, this deal could get cleared, while one involving a politically unpopular acquirer might get blocked even if the deal would pose no harm consumers. By contrast, if merger control is delegated to a body insulated from lobbying, decisions can be taken objectively on the evidence and in the interests of consumers.
11. It is sometimes argued that even where the above factors are present, decisions should not be delegated if they have significant social or distributional consequences. However, as with the previous question, I am not sure how realistic this is. For example, low interest rates in the decade after the financial crisis had a profound distributional impact, as an asset price boom benefited older homeowners while younger renters lost out, but throughout this time decision-making on interest rates was in the hands of the independent Bank of England. To have given that power back to ministers would have allowed them to be held accountable for the distributional impacts but it would also have meant losing the benefits mentioned in paragraph 8.
12. Instead, when such distributional issues are raised by the work of an independent decision-maker, the Government should first of all consider whether it is at all possible to separate those issues from other aspects of the regulator’s work. For example, in energy regulation, price controls of the monopoly network businesses could remain independent in order to address the time inconsistency problem in paragraph 9, whereas it makes sense to enable a greater role for ministers in the retail market where the effects of high wholesale prices were felt hard by consumers, especially those on low incomes.
13. In cases where the distributional issues cannot be separated out, for example in setting interest rates, the question then becomes how to ensure appropriate democratic accountability for the decision-maker, and this is considered below.

3. Are regulators appropriately independent of government? Is the right balance being struck between strategic and political input from government and preserving the operational independence of the regulators?
4. Does the Government provide too much or too little guidance to regulators in making decisions, particularly in deciding between different objectives and priorities?

14. From the earliest days of UK sectoral regulation, there was an acceptance in Whitehall that regulators’ independence would have to be tempered to minimise the risk of conflict between ministerial policy and the regulator. This view was strongly shared by some of the incumbents being privatised, with British Telecom for example warning that the creation of Oftel could ‘stifle investment’, a familiar concern recently.3 The Secretary of State was therefore allowed to give general directions to which the regulator should have particular regard and the regulator would have to report annually to the Secretary of State.
15. Over time, the practice developed of the Government publishing a non-binding ‘strategic steer’, generally once in the lifetime of a parliament, setting out its overall expectation for how a particular regulator should go about its work. However, I do not think this has proved to be a satisfactory way to obtain input from the Government. The whole point of strategic steers is that they are deliberately produced in ‘slower time’ rather than in the heat of a politically pressing issue, but this reduces their immediate political salience and can mean that senior ministers get less directly engaged in them, so the process tends not in fact to elicit strategic ministerial input. The steers might end up being crafted mainly by officials and can, in some cases, specify the various priorities and trade-offs but without giving guidance on how they should be ranked.
16. Even insofar as departmental Secretaries of State do get directly involved in developing a strategic steer, it can be hard for them to anticipate the issues that a regulator will have to deal with and give guidance on how it should make trade-offs between competing priorities. For example, in energy, the war in Ukraine led to an unprecedented degree of concern about household bills which at least temporarily put other policy objectives to one side; and the financial sustainability of suppliers might have seemed a low priority issue until they started going bust.
17. Rather than expect ministers to issue a strategic steer once every few years and then stay largely silent on a regulator’s work, it would be better to have a clearer delineation between those decisions that regulators should take independently and those where it is appropriate for elected politicians to express a view. For example, individual price control decisions by sector regulators and merger decisions by the CMA seem to fall squarely into the categories mentioned above where independence is warranted. But when a regulator is making decisions that have significant distributional impacts or where the CMA is deciding whether to conduct a market study into an issue of major consumer concern, it seems sensible that elected politicians should contribute.
18. The question is, then, how such ministerial involvement should happen. The most formal and transparent way is through specific statutory provisions. For example, the Enterprise Act allows the Secretary of State to intervene directly and publicly in merger cases on certain specified public interest grounds: media plurality, financial stability and a public health emergency. (National security was previously one of these specified public interests grounds but that provision has now been replaced by the National Security and Investment Act 2021.) Another option is for Ministers to indicate publicly their desire for a regulator to investigate an issue of concern, as happened with the CMA in respect of the PCR testing market and the housebuilding market. Where I think ministers would be crossing a line, however, is if having called for an investigation by a regulator they then seek to influence its independent findings; or if they seek to exercise influence privately.
19. This is particularly important because there are always certain things that can give rise to a perception that the regulator is not, in reality, independent. Bill Kovacic has referred to what he calls the ‘universal pressure points for political control or influence’.4 These include the government’s ability to appoint the leaders of agencies; to increase or reduce their funding; to make legislative changes to the agency’s powers or duties; to monitor the agency’s performance or engage third parties to do so; and to set the form of judicial review to which the agency is subject. As Oliver Shah pointed out in the Sunday Times recently, when speculation about political interference gets going, it will not necessarily go away because ministers and regulators assert that it is not happening.5 Ministers and regulators must both therefore be careful to avoid doing or saying things that inadvertently undermine perceptions of independence.

8. Who should hold the regulators accountable for their performance against their objectives? What is the appropriate role of Parliament in performing this scrutiny role?
9. How should the Government and the regulators themselves facilitate appropriate scrutiny and accountability of regulators? Are regulators sufficiently transparent about their own performance?
10. What mechanisms and metrics could be used to hold regulators accountable on a regular and ongoing basis and to judge whether a regulator is performing well?

20. The flipside of the regulators’ independence is that they are not subject to the same forms of accountability as ministers. The chairman or chief executive of a regulator cannot be dismissed in a reshuffle and does not need to worry about winning elections or explaining themselves at question time in the House of Commons. Instead, as a result of Acts of Parliament, the regulators are given the power to make decisions which have little or no ministerial oversight and – in some cases – limited judicial oversight either. This makes it crucial to identify the appropriate forms of accountability.
21. The first level of accountability is in the hands of the regulators themselves. They should set out clearly and consult on their priorities, as the CMA has done in its new strategy which explains its medium-term priorities for the next three years and its areas of focus for the coming 12-month period.6 Having done this, their leaders should be prepared to speak publicly on a regular basis to the media and their stakeholders to explain their thinking and actions and to account for their decisions.
22. The metrics by which an organisation is judged can relate to inputs, outputs or outcomes. For example, in the NHS, inputs might include the number of nurses in post; outputs the number operations performed; and outcomes the changes in mortality rates. In the regulatory world, it can be easiest to measure inputs and outputs but what is measurable is not necessarily meaningful. For example, if the CMA is measured by the number of cases it undertakes, it will be incentivised to focus on smaller and simpler cases rather than necessarily those where it could have the biggest positive impact for consumers; and if it is measured by the size of fines it imposes, it is likely to focus more on high-profile breaches of competition law by individual companies over solving structural problems affecting whole markets. The regulators should therefore embark on a wider public conversation about how their performance should be judged, how their success should be measured and how perverse incentives can be avoided.
23. A key external check on the regulators is of course provided by the courts, but success or failure in court is not necessarily a good way of measuring a regulator’s effectiveness. A timid regulator might rarely lose in court but that might be because it is only taking on easy cases and is not really making much of an impact. A more activist regulator, on the other hand, challenging boundaries in the interests of consumers might lose more often but have a bigger positive impact overall.
24. There is also a limit to what the courts can do. They are of course expert in deciding whether a regulator has acted lawfully but they are less well placed to decide whether it has made correct policy choices. Furthermore, appeals in the courts can require very deep pockets and take a very long time. In the longest example in my experience, the Office of Fair Trading opened an investigation into possible anticompetitive agreements relating to the sale of the drug paroxetine back in August 2011 and, after a lengthy investigation and multiple appeals, the final judgment from the Competition Appeal Tribunal upholding the CMA’s infringement decision came in May 2021.
25. All this reinforces the important role for Parliament in providing effective and dedicated scrutiny of the work of the regulators. In the House of Commons, this scrutiny is conducted mainly by departmental select committees whose remits are wide and whose attention is naturally drawn to issues that are already in the public eye or where there is an opportunity to influence government legislation, rather than looking at the longer term governance of the regulators. The House of Lords has been able to provide more focused attention, for example through this Committee. A permanent select committee on regulators, drawn jointly from the House of Commons and the House of Lords, would be well-placed to entrench this kind of scrutiny of longer-term and cross-cutting issues (and its cross-cutting focus would also help insulate it from lobbying by specific industries). To further strengthen scrutiny, pre-appointment hearings should also be extended to include the nominees for chief executives of regulators as well as their chairmen, given the extent to which chief executives are able to influence the direction that an agency takes.

REFERENCES

Kovacic, W., 2014. ‘Competition Agencies, Independence, and the Political Process.’ In: Josef Drexl, Wolfgang Kerber and Rupprecht Podszun (eds), Competition Policy and the Economic Approach, Cheltenham, UK: Edward Elgar

Littlechild, S., 1983. Regulation of British Telecommunications’ Profitability: Report to the Secretary of State, London: Department of Industry

Parker, D., 2009. The Official History of Privatisation: Volume I – The Formative Years 1970-1987, London: Routledge

Tirole, J., 2022. Socially Responsible Agencies, Working Paper

5 November 2023

Source: https://committees.parliament.uk/writtenevidence/126384/pdf/