Ministers have in recent years found that regulation is generally more politically attractive than the alternatives (such as tax and spend). They have also found that regulation is generally more effective if it can be de-politicised, so that regulators take long term decisions free from political interference. But the popularity of regulation amongst politicians has caused growing concern about
- the burden of regulation, and
- the growth of the Regulatory State,
whilst others have asked:
- Is the independence of regulators quite as strong as it is supposed to be, or indeed does regulators' traditional independence makes sense in the modern economic and political world?
The burden of regulation is discussed in the 'Getting the Balance Right' section of this website, accessible via the homepage. This note explores the other two concerns.
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.
More generally, 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.
The Independence of Regulators
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.
Some regulators are less 'independent' than others. 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. A small but telling piece of evidence of their lack of independence was the Government forcing both Ofsted and Ofqual (the education and examinations regulators) to transfer their websites in 2014 to the single gov.uk mega site, despite objections from their Boards. There was no question of the economic regulators following suit. But the Care Quality Commission, a major health regulator, still has its own site.
And successive Health Ministers have sensibly 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).
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.
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.
There nevertheless remains widespread agreement that economic regulators should be pretty well totally divorced from short term political pressure. 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, 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. 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 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.'
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.
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.
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.