1 The privatisation of formerly state-owned industries has been one of the most striking political and economic developments worldwide over the last decade and more. It typifies the way in which the state has been redefining its role : in many areas of economic activity governments are withdrawing from direct participation to a more detached role. These include areas which in many countries were previously seen as core state activities, such as the provision of a wide range of essential services - telecommunications, gas, electricity, water, transport. Governments now increasingly see themselves as purchasers or facilitators rather than providers of such services.
2 Privatisation was impelled by the failure of industries when in state-ownership - characterised by a lack of competitive pressure, low investment, low productivity and political interference. There was the belief that these businesses would do better in a competitive environment, securing their survival, turning them from loss-making to profit-making, and tax paying. In Argentina and the UK privatisation has been widespread. In the UK, for example, state-owned industries accounted for over 10 per cent of gross domestic product in 1979. By the turn of the century that had fallen to 2 per cent.
3 But privatisation does not mark the end of the state's involvement in these industries. The continued supply of these energy utilities, railways, airways etc is crucial to the economy, and to every voter. Moreover in state-ownership they were monopolies and in most cases, because of the speed of privatisation and the desire to increase their appeal to the market place, the businesses were privatised as monopolies or dominant players. If the state did not take care, these privatised monopolies would over charge their customers and fail to provide a satisfactory level of service. On the other hand the state did not want to be seen to be intervening too directly in the supervision of these businesses. An interesting response to this dilemma was the introduction of the industry specific economic regulator, operating at arms' length from Ministers and empowered by law to exercise influence and control over the suppliers of privatised services to consumers.
4 In this presentation I am going to outline the introduction of industry specific economic regulators in the UK, and give you some examples of their impact on suppliers and customers. I shall also outline the role of the UK National Audit Office in examining the effectiveness of economic regulation and publicly reporting to the UK Parliament on how the system is operating. Finally I shall draw out some of the lessons identified by an international Working Group of national audit offices meeting this week in Buenos Aires under the auspices of the President of the Auditoria General de la Nacion.
5 So, first, the UK system. A key issue for economic regulation is how to incentivise privatised monopolies to improve the quality of service to the customer, at a reasonable price which will not deter new suppliers from entering the market, while enabling existing suppliers to finance their operations. The solution devised in the UK was to control the prices charged to consumers through a device known as the RPI-X formula. The Retail Prices Index (RPI) is commonly used to measure inflation - the costs of goods and services are weighted in the index to approximate to a typical family's spending pattern. Under this formula, the increase in prices which a supplier can charge over a period of say five years is limited to the increase in the retail prices index less a proportion to drive up supplier efficiency (the X factor). If necessary, the X factor can be set to allow increases in prices above the RPI, for example where the supplier needs to be assisted to invest to improve the underlying assets of the business; this was the case for instance when the water industry was privatised in the UK after many years of under-investment in reservoirs and pipes while the industry was in state ownership. The idea behind the formula is that the business will have a clear price control for a set period, and if it manages to improve its efficiency beyond what is required by the price control it can retain the benefit for its shareholders until the next price review. This contrasts with the longer established regulation of companies' rates of return which is a key feature of regulation in a number of countries such as the USA.
6 Another key aspect of the regulator's role is to secure the supply of essential services so that access is provided for all customers, including those who are the most vulnerable. So the regulator is empowered to prescribe, for example in the licence conditions, what standard of service suppliers must meet and to monitor whether suppliers are meeting those standards. These arrangements are underpinned by an array of consumer representative bodies who can make representations both to the regulator and to the suppliers. The regulators are commonly also required to have regard to the longer term financial viability of the companies they regulate. This has acted as a counter-weight to the pressure to drive down the prices paid by customers.
7 To enable these functions to be discharged in an informed way, the regulator is also empowered to obtain data from suppliers across the whole range of their activities; clearly for example the regulator needs reliable information about suppliers' cost structures and financing costs if the RPI-X formula is to be set at a level to achieve the level of service the regulator is seeking.
8 The UK Government’s view has been that, where it can be developed, competition is preferable to price regulation as a means of protecting consumer interests. All the regulators have been empowered and encouraged to promote competition through the breaking of monopolies, associated of course with the encouragement of new suppliers to enter the market, and enabling customers to choose their supplier. As a result, regulators have been able to change market structures, to separate parts of the business where competition could be introduced from those where monopoly was unavoidable. For instance, to facilitate the development of a competitive market for the supply of gas, the regulator required British Gas, the privatised gas utility, to establish in a separate company its business of distributing gas around the country which is a ‘natural monopoly’. The regulator was concerned that without this separation, the distribution business would enable British Gas to discriminate against rival firms in the supply of gas.
9 Finally the structure chosen for these economic regulators was intended to reduce as far as possible the risk of their being over-awed by the major businesses they were influencing (risk of regulatory capture). They were made industry specific so as to help them focus on the nature of that particular business rather than having to get to grips with a wide range of industries as general competition regulators have to do. They were given flexibility over their recruitment and the terms of service they could offer their staff, subject to overall control by the Treasury (Ministry of Finance) as regards their budget. Suppliers could appeal against decisions of the regulator to the general competition regulatory body, but in that case the economic regulator could counter-appeal on that and wider issues.
10 I now turn to the role of the UK National Audit Office in monitoring and reporting on the effectiveness of the regulators. Our principal responsibility is to report to Parliament on how Government departments have spend the taxpayer's money and whether the programmes and policies they have established for the benefit of the citizen - including economic regulation - are proving effective, achieving their objectives. As part of that process we aim to identify ways in which these programmes can be made more effective, and to persuade the responsible public bodies to introduce these changes in order to secure benefits for the citizen as customer as well as taxpayer. As a spur to our efforts, we set ourselves the target of saving £8 for every £1 it costs to run the Office.
11 As you may imagine Parliamentary interest in how this regulatory system is working is intense: the businesses have an annual turnover well in excess of $80 billion affecting over 50 million consumers. There was general dissatisfaction at the quality of the service provided by these businesses when in state ownership and lively debate as to whether the citizen would get a better deal when they moved to private ownership and if not whether regulation would improve that.
12 Once the regulatory regime had been up and running for a few years we embarked on a series of studies and reports to Parliament on how it was turning out, and what its impact had been. One of our first major reports was in 1996, in which we examined and compared the operations of the first four major regulators, those regulating the telecommunications, gas, water and electricity supply industries. We looked at the operation of the RPI-X regime and the latest price fixing exercises. We found that as a result of a number of pressures, including the RPI-X formula, there had been substantial reductions in prices in real terms since privatisation in three out of four utilities.
13 Since privatisation, electricity prices have fallen by nearly 20%, gas prices by 40%, and telephone prices have more than halved (all in real terms). By contrast, water and sewerage bills have nearly doubled in real terms for all customers, representing the cost of meeting higher environmental standards and enabling suppliers to invest in the improvement of services.
14 We have made a series of reports to Parliament on the arrangements for consultation and appeals followed by regulators and for handling customer complaints. These reports have encouraged more consultation by regulators of customers and more co-operation between regulators. We have examined how regulators seek to protect the interest of vulnerable groups such as the elderly. In some respects the record is encouraging. For example, in 1990, 55,000 electricity customers were cut off by their suppliers. By 1997 that had fallen to 471. On the other hand domestic customers who pay by payment meter (4 million households for electricity) and who are disproportionately drawn from poorer income groups, have not benefited as much as other consumers from price reductions.
15 The regulators have been strikingly successful in the introduction of competition to the telecommunications, gas and electricity markets. All customers, domestic as well as business, of these three utilities can now choose their supplier. In our 1999 report on the introduction of competition into the domestic gas market we showed that 25 new companies were selling gas. Nearly 6 million of the 20 million domestic customers have now exercised their choice and switched from British Gas, the former monopoly supplier. In the process customers who changed to a new supplier were making an average annual saving of $135 in real terms. In the aggregate these savings can be substantial. We calculate that the total reduction in customers' bills since the introduction of domestic gas competition has been about nearly £1½ billion a year. On the other hand a number of domestic consumers have encountered hard sell techniques by competing suppliers. Nevertheless more customers could benefit by
changing supplier. So in co-operation with the regulator we produced a leaflet for domestic customers setting out the scale of savings that they could make. So far 10,000 of these leaflets have been taken up.16 In the water industry, the regulator is now negotiating tougher price controls with suppliers, assisted by analysis and recommendations in a series of reports from the NAO and Parliament. If his proposals are now accepted, we shall have contributed to savings for customers approaching £3 billion. In the meantime, savings to the customer as a result of our reports have already contributed to meeting our overall value for money target of saving £8 for every £1 we spend; total savings over the last three years have reached £1.3 billion.
17 Since the election of the Labour Government over three years ago consumer protection has moved up the agenda. There has been pressure for further tightening of the RPI-X price controls including closer probing of the rates of return needed by companies to secure new investment and more transparency is being sought in regulatory decision making. With the opening up of the energy markets to competition, the electricity and gas regulators are now combined in one person and the Government have introduced legislation to replace this single regulator with a full time executive board. A similar change in the structure of the telecommunications regulator has been put on hold pending a review of the scope for bringing together broadcasting and telecommunications regulation in one place to reflect the convergence in technology as a result of broadband digital telecommunications and the internet. And the Government has established a regulatory body for the Post Office even though this remains in Government ownership, to bring to the industry the benefits of regulation which they have recognised in the privatised utilities.
18 We have examined consumer protection and quality of service in other regulated industries. For example, we recently reported to Parliament on the regulation of investment in maintenance and renewal by the privatised railway industry. The regulator agreed with our conclusion that the regulation regime did not specify sufficiently clearly what performance is expected of the railway infrastructure company, or provide sufficient independently validated information to enable the company’s maintenance and renewal of the network to be effectively monitored. Parliament was particularly critical of the fact that the company had received incentive payments while failing to meet its targets related to the reliability and punctuality of the service. The regulator is changing the conditions under which the company operates, and requiring reductions in the delays caused by failings in the network.
19 So to what extent are these experiences shared across the world? In some countries, many state-owned industries have been privatised. Others have embarked on the process, but have not yet completed it. And a number of countries have yet to take the plunge. Noting that privatisation by sale is not the end of the privatisation story, and that economic regulation of both privately and publicly owned businesses is a growing area of importance for government and citizens, in 1998 the International Organisation of Supreme Audit Institutions (SAIs) invited its Working Group on the Audit of Privatisation to develop guidance on the audit of economic regulation. The Group began by surveying state audit offices on the extent of economic regulation and its audit in their countries. The SAIs of 67 countries replied and in 1999 the Group produced a report based on those replies. The survey showed that while in the majority of countries economic regulation is still mostly exercised directly by government, in a growing minority of cases it is carried out by specially constituted bodies operating at arms' length to government, some responsible for regulating specific industries and some operating across the economy.
20 The survey also revealed many instances of the positive impacts of both economic regulators and the SAIs on improving the provision of regulated services. It is clear that citizens are increasingly looking to SAIs to carry out authoritative examinations of the work of economic regulators and the performance of the industry they regulate and that the reports of SAIs are leading to increased efficiencies in the supply of regulated services, to the benefit of both consumers and suppliers. You can read the report on the Working Group's website (
www.nao.gov.uk/intosai/wgap/home.htm).21 In the light of the survey the 30 members of the Working Group are drafting a set of guidelines highlighting a series of key questions that SAIs are likely to need to address when examining the efficiency and effectiveness with which economic regulators set about their tasks. You can also read the draft on the Group's website.
22 The guidelines are grouped in five sections, illustrated by examples from the survey.
Section 1: Auditor Skills
If we are to carry out well thought through performance audits, leading to worthwhile recommendations and to spread good practice, we need to have access to a wide variety of relevant skills and a thorough knowledge of the regulated industry. We can learn much from each other's experiences, facilitated by such measures as the exchange of staff and parallel or joint audits.
Section 2: The Business of Regulation
We need to have a clear understanding of the context of economic regulation as well as its objectives, functions and powers. It is important to evaluate how robustly the regulatory body maintains its impartiality and integrity, and competence, whether it obtains sufficient information about suppliers' operations and how effective are its consultation arrangements.
Section 3: The Supply of Service
One of the regulator's key objectives is to secure the supply of essential services, so that access is secured for consumers, not least those who are most vulnerable. So we need to examine what standards of service have been laid down and how the regulator monitors whether suppliers are meeting those standards. Complaints procedures should be put in place and effectively applied. And regulation goes wider than economics. Health and safety and environmental considerations are vital too; SAIs are well placed to examine and report on whether these objectives are being addressed.
Section 4: The Price of Service
Another key objective of the regulator is to ensure that the price charged is commensurate with the quality of service on offer, and that where regulation has social objectives these are reflected in the pricing regime, including any public subsidy element. This section examines issues relating to price and other controls, and factors that need to be taken into account in considering suppliers' financing costs, including investment programmes, and measures to improve supplier efficiency, having regard to other considerations, including securing supply and environmental objectives.
Section 5: Developing Competition
This final section examines key issues relating to the role of economic regulators in developing competition, including the improvements in quality of service and pricing that can result, and the steps needed to maintain competition, including combating anti-competitive practices.
Conclusion
23 It is not for auditors to say whether or not there should be regulation and if so what form it should take - that would be getting into policy or political issues. But we can usefully examine how effectively particular regulatory arrangements are working in practice. And these guidelines are designed to help regulation achieve its objectives. So we are commending them to all parties - governments, regulators, suppliers and customers, as well as auditors.
Temporary Imposition or Growth Industry?
24 So the thrust of these guidelines is to set out some of the key questions that need to be addressed if economic regulation is to provide a spur to supplier efficiency and to consumer protection.. But many commentators would regard economic regulation as, at best, a poor substitute for competition. So, as competition grows, will regulation diminish?
25 Not so far. Even in industries where competition has markedly increased since privatisation, regulation continues. in part that reflects a concern to protect the consumer from lack of awareness of an increasingly complex marketplace; hence the long standing regulation of the highly competitive financial services industry. All the indications are that regulation is likely to be with us for the foreseeable future. And national audit agencies can play a valuable role, in a rapidly changing environment, in highlighting both good regulatory practice which is adding value at a reasonable cost and areas where reappraisal may be needed.