Just who are The Regulators?

David Nicholson-Lord evaluates the record of regulation. Plus the Independent's formbook on the watchdogs A new and growing power in the land

Privatisation was not supposed to be like this. The decision by Professor Stephen Littlechild, the electricity regulator, to announce tough new price controls on the eve of the £4bn flotation of the power generating utilities has wiped billions of pounds off shares, embarrassed the Government, infuriated the City and left the regulator himself looking alarmingly exposed. For those with long memories, however, it may have a familiar ring.

Privatisation was conceived as a means of making services more efficient and also of getting politicians off the backs of the nationalised industries. Nearly a decade after the first privatisation, British Telecom, the politicians are out of the way. Instead, we have the regulators, who appear to picking up where the politicians left off.

The regulators, according to critics, have turned into the enemies of privatisation. Ofgas, Offer, Oftel and company are accused by right-wing think tanks such as the Adam Smith Institute of high-handedness and arm- twisting. The privatised utilities say much the same: John Baker, chief executive of National Power, one of the subjects of the current flotation, argues that regulators have been consumed by the "cult of personality" and wants to see them replaced by five-person tribunals. Clearly, there is an element of special pleading in this. Equally clearly, the system is not working as its theorists intended.

The Conservatives' privatisation programme had to contend with notoriously monopolistic terrain. Some free-market Tories thought there should be no price limits at all when British Telecom was privatised. Most people, however, favoured, "light touch" controls - hence the creation of Oftel and the "RPI-X" formula, supposed to safeguard consumers from monopoly pricing while letting BT run its business as it chose.

RPI-X allowed privatised companies price increases based on the inflation rate plus or minus a figure arrived at by the regulator after negotiation. When linked to five-yearly pricing regimes, it gave them a simple target and a stable financial environment - safe from the politically inspired wage setlements and enforced buy-British deals which marred the running of the nationalised industries. By concentrating on pricing, the system was set up to encourage efficiency. It avoided, for example, the "cost- plus" syndrome seen in the US where controls are based on an assessment of the company's costs - which it thus has less incentive to reduce.

Even so, according to George Yarrow, director of the Regulatory Policy Institute at Hertford College, Oxford, there was a "widely held view that price regulation was temporary, to hold the fort until competition arrived." In 1987, Sir Alan Walters, then Margaret Thatcher's economic adviser, said the proportion of privatised utilities' output covered by price caps was "confidently expected to decline in the future".

In fact, the reverse has occurred. Controls were extended across the full range of British Telecom's business and, with each successive privatisation, regulation became ever more detailed. Water, for example, involved several companies and enabled the regulator to compare costs between them. It also involved quality and environmental standards imposed by government - the multi-billion-pound programme to clean up rivers and beaches. Regulation was thus extended from prices to standards of service and investment programmes.

The phenomenon of "regulatory creep" - the tendency of regulation to become more intrusive - is not difficult to explain. First, the powers of the regulators are ill-defined - much therefore depends on personal attitudes. Second, they are more or less a law unto themselves: companies can only appeal to the Monopolies and Mergers Commission. And third, they are operating in an arena which, thanks to price rises, profit bonanzas, executive perks and cuts in services, has become highly politicised. It is thus in the regulator's interest to cover his or her own back - to make sure that the utilities are not pulling a fast one.

Regulation has also come under fire for its inscrutability. Discussions take place behind closed doors - the companies prefer this for commercial reasons - but even if they were out in the open, it is doubtful if many people would understand them.

The row over electricity is a case in point. It has long been acknowledged among industry-watchers that electricity privatisation was too generous to shareholders (a "rip-off", according to Mr Yarrow), that prices have remained unjustifiably high and that last August's settlement by Professor Littlechild would generate even more profits for the industry. But it was not until Northern Electricity proposed handing out £500m in sweeteners to shareholders to fight off a hostile takeover bid from Trafalgar House that the man and woman in the street - and those at Westminster - gained an inkling of the size of the companies' cash reserves.

Views of what constitutes interference by regulators vary greatly. From the consumer's - as opposed to the City's - point of view, Professor Littlechild's decision this week was welcome. According to the National Consumer Council, some of the biggest gains for consumers have come in precisely in those industries where regulation has been "strongest" (ie most "intrusive") - gas, for instance, where prices have fallen by a third in real terms since the mid-1980s. Yet gas, unsurprisingly, has been the scene of some of the fiercest conflicts between industry and regulator, culminating in the desperate decision by British Gas two years ago to refer itself to the MMC - a move not unlike a turkey voting for Christmas.

Professor Littlechild's decision to review the price caps agreed last August, however, is "political", just as the decisions made 20 years ago by ministers in charge of nationalised industries were political. According to Mr Yarrow, Britain's system of regulation is in a "total mess", in large measure because the process has been "repoliticised". But, as he points out, regulation involves decisions "about the distribution of resources in the economy. In that sense it is inherently political and open to political agendas." The gain, compared with the bad old days of nationalisation, is arguably that such decisions are no longer party political.

Industry, however, may not appreciate such fine distinctions. Hence the calls for a "regulator of regulators", greater accountability and "transparency", a new select committee for regulated industries, more control by the MMC or the National Audit Office. The irony, of course, is that the more accountable and transparent regulation becomes, the more political it will be. Regulation always was an uneasy half-way house between monopoly and the free market. One day, when a fully liberated and deregulated market exists for electricity, water, gas and telecommunications, it may become unnecessary. Until then, we have to make the best of it we can.

d

Stephen Littlechild, OFFER

Age: 51

Title: Director General of Electricity Supply

Salary: £90,000 to £100,000 (estimate)

Staff: 220

Style: Quiet and thoughtful, but insular and not a team player.

Background: Academic. Professor of Commerce and Head of the Department of Industrial Economics and Business Studies at Birmingham Univesrity (1975-89).

Scale of problem - from 10 (hard) to 1 (easy): 10.

Successes: He has scared the generators, National Power and PowerGen, and the regional electricity companies.

Failures: Was not tough enough initially. His subsequent changes of mind have caused uncertainty in the market.

Verdict: An undistinguished performance in a very

difficult job.

Effort: 4 out of 10.

Don Cruickshank, OFTEL

Age: 52

Title: Director General of Telecommunications

Salary: £90,000

Staff: 170

Style: Dour, shirt-sleeves Scot with a fine eye for detail, inquisitorial, sharp and businesslike.

Background: Accountant by training. Worked in finance and marketing before joining McKinsey management consultants. Managing director of the Financial Times information and entertainment division (1980-84) and then the Virgin Group (1984-89). Chief executive of the National Health Service in Scotland until he joined Oftel in 1993. Succeeded Bryan Carsberg (generally regarded as the best of all regulators with an overall 9 out of 10) who did a lot to open up competition.

Scale of problem - from 10 (hard) to 1 (easy): 7.

Successes: Feet firmly on the ground; readily grasps the issues; genuinely believes that the interests of consumers are paramount.

Failures: Has got bogged down in detailed battles with BT. His attempts to make the workings of the regulatory process more transparent have not been enough to satisfy some of BT's rivals.

Verdict: Competent but uncharismatic.

Effort: 6 out of 10.

Ian Byatt, OFWAT

Age: 63 tomorrow

Title: Director General of the Office of Water Services

Salary: £70,000 (estimate)

Staff: 160, including 10 small regional offices.

Style: A quiet charmer; intellectual, astute and highly political with a liberal management style.

Background: Trained as an economist. Deputy chief economic adviser at the Treasury (1978-89). Appointed to Ofwat in 1989 and reappointed in 1994 until June 1996.

Scale of problem - from 10 (hard) to 1 (easy): 5

A natural monopoly in which there is no real competition and the freedom for manoeuvre is limited by environmental requirements and EU regulations.

Successes: A good analyst. He took seriously the soaring bills in the water sector and publicly questioned the massive capital expenditure programmes in the industry that are largely to blame for rising bills.

Failures: Nothing spectacular.

Verdict: A balanced and fair regulator. His review last year of water and sewage charges among 31 companies was challenged by only two companies who opted to have the matter referred to the Monopolies and Mergers Commission. Has done a good job but then there was not much of a job to do.

Effort: 8 out of 10.

Clare Spottiswoode, OFGAS

Age: 41

Title: Director General of Gas Supply

Salary: £70,000 (estimate)

Staff: 65

Style: Outgoing, approachable, can be naive - she sent thank-you flowers to a senior civil servant after she was appointed to Ofgas.

Background: A Treasury economist (1977-80). She left to start a family - she now has four children - and set up her own businesses, the first selling gifts, the second a computer software firm of which she was chief exec until 1990. Joined Ofgas in November 1993 on a five-year contract.

Scale of problem - from 10 (hard) to 1 (easy): 9.

Successes: Extremely open in her approach; tougher than expected and decisive; more analytical than her predecessor, James McKinnon (1986- 93), who had a blunderbuss approach rated 6 out of 10.

Failures: She has angered environmentalists by refusing to sanction large energy-saving schemes funded through gas bills.

Verdict: Jury still out but the signs look promising.

Effort: 7 out of 10.

Compiled by Paul Vallely and Mary Braid from the off-the-record views of industry insiders