The SMF’s new Senior Fellow, Stuart Hudson, explains how Keir Starmer’s government can deliver regulatory reform in practice
The government has promised an overhaul of Britain’s regulatory system in order to drive investment, innovation and growth. As a first step it has published an action plan to reduce costs and administrative burdens – and beyond that it has set out a vision for “real, system-wide” regulatory reform over the course of the parliament.
But as the government seeks to put flesh on the bones of this vision, the challenge is as much psychology and philosophy as policy. Particularly for the centre-left, it can be easy to dismiss deregulation as a fundamentally right-wing project. Depending on our generation we might associate it with Margaret Thatcher pledging to “set the people free” or with Liz Truss and Kwasi Kwarteng and their talk of “Britannia unchained”.
The corollary is that regulation, or re-regulation, can seem a fundamentally progressive policy tool. After all, it involves the active use of the state (with which progressives tend to sympathise) to address failures in the market (about which progressives tend to be concerned).
However, I think this is the wrong way of looking at the issue; and at a time when the government’s overriding mission is driving economic growth, it risks undermining that mission and harming those on low incomes most.
Our starting point should be to remember that regulation is only one of the tools available to a government to deliver progressive goals – and it is by no means the most important one.
Government can use macroeconomic policy to alleviate an economic downturn. It can use labour market and welfare policies to help people into work. It can deliver public services such as health and education that the market would not otherwise provide. It is currently using its trade policy to try to address the latest threats to jobs and growth. And it can redistribute income and wealth to address unfair and unequal market outcomes.
These are quite a lot of things that a progressive government can do before it gets to regulating businesses. And as Sam Freedman’s Failed State shows – as does a cursory glance at polling data – the British state has hardly mastered them all so brilliantly over the years that it can now turn its expertise to telling businesses what to do.
But regulation has certain attractions that some of these other tools do not. When a company engages in behaviour that the public or policymakers consider undesirable, proposing a new rule to ban it can be intuitively attractive and politically popular. It also has the merit of imposing little if any upfront cost to the Exchequer so there need be no difficult conversations with the Treasury.
The problem is that there are quite a few things that tend to get in the way of regulations working as intended.
For a start, there are challenges in designing a new regulation. They tend to be created in the midst of media pressure and political lobbying, so even if there is a case for a new rule in theory, what ends up coming out of the regulatory sausage machine may be quite different.
Second, once a rule has been created companies face the direct administrative costs of complying with it.
Third, there are the unintended consequences e.g. the companies might decide to reduce investment in the UK because of the higher costs or even exit the market completely; and the new rules might constitute a barrier to other companies entering the market, meaning competition is reduced.
Fourth, the new rules might not eliminate the problem fully, or its knock-on effects might create pressure for the regulation to be tweaked (usually making it more complex), meaning the cycle continues.
Fifth, this creates a need for more bureaucrats (possibly in a new regulator) to do the monitoring, tweaking and enforcing. This certainly does cost money to the Exchequer.
Sixth, the affected companies will then spend money trying to influence the regulator, and in doing so they stand a good chance of capturing it so that it ends up serving the interests of incumbents rather than consumers.
Finally, there is the cumulative effect of regulations which individually might be sensible but which collectively undermine economic dynamism. Might there be a straw that breaks the camel’s back?
These are not just theoretical concerns. We have seen in practice that over time regulation tends to get more complex and to cost more money to the economy, while the productivity of the bureaucracy appears to decline. The cumulative effect of this happening across a range of sectors is to increase the cost of doing business in the UK and to divert the attention of talented people from productive economic activity to rent-seeking.
And all too often, the regulation does not even serve the progressive ends for which it is intended. Take energy. Regulation of the gas and electricity sector has become more complex and intrusive over the past twenty years, but in that time prices in Britain have gone from the lowest in Europe to the highest. Meanwhile, consumer trust in regulated sectors appears to be no higher than in unregulated ones. It is not simply that regulation is having too onerous an impact on businesses and investors; it is failing to deliver on its own terms, for consumers.
This is why I think the time has come to consider radical regulatory reform, as far-reaching as privatisation in the 1980s. Although there is rightly much media and political focus at the moment on the apparent failure of privatisation in water, this is in fact more of a failure of regulation than of privatisation itself, as Professor Dieter Helm has compellingly argued. When we look across the privatised industries as a whole, there can be few of us who would rather go back to the days when a monopoly British Gas was responsible for everything from extracting gas from the North Sea to selling appliances in its showrooms; when we had to apply to a monopoly British Telecom for a new phone and go on a waiting list for weeks or months; or when the state was owning businesses from trucking to car manufacturing and even sugar.
In a few years’ time, might we look back in similar bemusement at the role we used to give to the state in regulating a whole range of product markets?
This is not just about bat tunnels and other such examples of obviously wasteful and unnecessary regulation. Even apparently common-sense regulation can turn out to have unintended consequences. Take car safety. The economist Sam Peltzman found that when car safety regulation was introduced in the United States, cars were already becoming safer and fatalities were falling because customers generally wanted safe cars and manufacturers recognised this so they were competing and innovating on safety, not just on price. But after regulation was introduced this progress stalled. Although driver fatalities fell, pedestrian fatalities actually increased as drivers appeared to take more risks following the government’s safety stamp of approval for their cars.
If we accept the argument that regulation can go, and has gone, too far, two points are often raised in response. First, is it really possible to turn round the super tanker, given the political and bureaucratic pressures that seem to drive regulation forward? There is evidence that it can be done. The OECD found that product markets for airlines, telecoms and energy firms across its member countries were about half as regulated in the mid-2000s as they were in the 1970s.
The second concern follows on from that. Didn’t the financial crisis show that the previous deregulatory wave went too far? In the banking and shadow banking sectors that was certainly the case. Institutions took on risks that they either did not understand or did not feel incentivised to manage. But banks are special institutions that create a unique kind of risk. They engage in maturity transformation, accepting deposits that can be withdrawn with little or no notice, while making loans which will not be repaid for many years. This creates the risk of a ‘run’ if depositors panic and seek to withdraw their money simultaneously, and if the bank then goes bust it has a negative impact on the wider economy. The fact that such runs occurred in 2007-2009 – whether in the main banking or shadow banking systems – does not necessarily tell us much about markets or regulation in other sectors of the economy.
How, then, should we strike the right regulatory balance? And what should a practical regulatory reform agenda look like today? I propose five elements to consider.
The first relates to regulation of monopoly networks. At present there are multiple economic regulators – e.g. Ofwat, Ofgem, Ofcom and the CAA – each responsible for imposing price controls on those companies in their sector that have significant market power. Each of these regulators has to hire people with similar expertise to conduct similar work, for example in assessing the companies’ cost of capital. It would be more efficient to have a single regulator responsible for conducting price controls across all the monopolies. Furthermore, appeals against decisions of this unified regulator should be to the same judicial body and under the same standard of review, rather than the panoply of different appeal and redetermination processes that currently exist. As well as saving taxpayers’ money, this would make it easier for the staff involved in regulation to share expertise and best practice and it would be far simpler for investors to understand.
Second, now that parliament has strengthened consumer protection law through the Digital Markets, Competition and Consumers Act, a review should be conducted of how far it really remains necessary for each sector regulator to impose its own additional sets of rules and licences on those companies in its sector that are competing in a market (as opposed to the monopolies in the above paragraph). This review could also extend to the various product market regulations that exist in sectors without their own regulator to enforce them. To the extent that these regulations and regulators are fundamentally about ensuring consumers are treated fairly, could they be abolished or reduced and instead rely on the enforcement of the newly strengthened competition and consumer law across the economy by the CMA? Some of the savings could even be allocated to the CMA to enable to it do more of this work. As well as saving money, this would also have the benefit that a cross-economy enforcer is less prone to capture by incumbents than a sector regulator, and is less likely to add to the overall burden of regulation by creating new rules in a given sector over time.
Third, as this would mean far fewer staff being employed by regulators, those who remain could be taken out of the structure of the civil service and paid more. (At present, some regulators – e.g. Ofgem and Ofwat – are part of the civil service and subject to its pay scales while others – e.g. Ofcom and the FCA – are outside it and have much greater freedom.) This would make it easier for the regulators to attract and retain high-quality professional staff, reducing the temptation of the lucrative revolving door into the private sector and thereby reducing disruptive high levels of turnover.
Fourth, the oversight of regulators and regulation within government and parliament should be reformed. At present, each regulator has its own ‘sponsor’ department e.g. DBT for Ofgem and the CMA, Defra for Ofwat, DfT for the CAA. This means there is no central repository of expertise in government on regulation and no straightforward way to consider cross-cutting issues or to ensure that the lessons from failures by one sector regulator are learned by others. There should be a single unit responsible for regulatory policy and for the sponsorship of the regulators, sitting in the Treasury or the Cabinet Office. Similarly, parliamentary scrutiny of the regulators is currently split between the various departmental select committees, and it would be better to have a single select committee for regulators or alternatively for more scrutiny to be conducted by the Public Accounts Committee.
Fifth, when elected politicians are presented with demands for a new regulation (a ‘tough new rule’), either from their constituents or from vested interests, it is unrealistic to expect them simply to resist these by referring to economic theory. Politicians need better support to evaluate the pros and cons. This is not about the kind of quantitative cost-benefit analysis that is conducted by a government department, often the very department that may be a pushing a new regulation. Instead, the independent CMA or the new Regulatory Innovation Office could be given a specific role to advise publicly on new regulatory proposals. They would be asked to address some straightforward questions: Is there clear evidence of a market failure? What might the (intended and unintended) consequences of the proposed regulation be? Are there alternative proposals that should be considered? And the CMA/RIO would be asked to answer these questions in an objective and non-technical way to help public and parliamentary debate. When a new regulation is proposed, a sympathetic politician need not therefore call for it to be passed straight away but rather for an immediate report from the CMA/RIO and for parliamentary time to be allocated to debate it. This would allow for a much more informed and effective public and political discussion.
Some of the above proposals are relatively straightforward whereas others would require significant parliamentary time and institutional upheaval. This is where my final point comes, in on timing. We are currently early in the lifetime of a parliament, the government has a large majority, the opposition is divided and the global economic turbulence is creating an openness to change. If the government wants to undertake a radical programme of regulatory reform, there will never be a better moment to do it than now.
Stuart Hudson is a Senior Fellow at the SMF and a Partner at the corporate advisory firm Brunswick. He was formerly Senior Director of Strategy at the Competition and Markets Authority and Special Advisor to Prime Minister Gordon Brown
This article was originally published by the Social Market Foundation
