Annual Forum Papers

Regulatory Reform: Lessons from the UK

  • Year: 2001
  • Organisation: University of Oxford, department of Economics
  • Author(s): Simon Cowan

In the 1980s the UK (and Chile) began the processes of privatizing and restructuring stateowned enterprises, liberalizing the markets in which they operated and regulating their conduct. Since then many countries at all levels of development have implemented their own programmes of regulatory reform. Almost two decades after the process started it is time to take stock and to reflect on the general lessons to be learned from the UK experience. In the rest of the introduction I outline briefly the major events and themes. For detailed surveys of UK regulatory reforms see Armstrong et al. (1994), Helm and Jenkinson (1998) and Newbery (1999). Cowan (2001) covers the theoretical principles of regulation and relates them to UK experience. There were many reasons for privatization and the accompanying regulatory reform. State-owned enterprises had performed poorly in terms of both productive and allocative efficiency because of imperfect monitoring, unclear objectives and lack of competitive pressure. Privatization and, particularly, competition would weaken the power of trade unions in the enterprises. The government was unwilling to finance the major investment programmes required by the enterprises. Shifts in demand and in technology reduced the scope of natural monopoly conditions. The government was keen to obtain an immediate inflow of cash from asset sales. Equity sales offered the opportunity to extend share-ownership.

The main landmarks in the process were the privatization of telecommunications (1984), natural gas (1986), airports (1987), water and waste-water (1989), electricity supply (1990/91) and rail (1994/95). Sector-specific regulators, with a large degree of independence from the government, were established around the time of privatization to regulate dominant firms' conduct, especially their pricing. The main innovation as far as conduct regulation was concerned was the use of price caps, backed up by yardstick competition in the regionally organized industries (water and electricity). Setting price caps, however, has not proved as straightforward as was imagined by early proponents, and it turned out that regulators have to make substantial use of the tools used when applying rateof- return regulation. A difficult aspect of price control has proved to be the determination of access or interconnection prices, which are the prices that a vertically integrated firm charges rival suppliers for the use of its network services.

Issues of industry structure were initially left to one side, and British Telecom (BT) and British Gas were privatized as vertically integrated dominant incumbents. This contrasts with policy in the USA at the time, which separated AT&T vertically into a long-distance company and the regional Bell operating companies. In the UK a single firm, Mercury, was licensed to compete with BT in the long-distance market with the guarantee that there would be a duopoly for seven years. Since the end of the duopoly policy in 1991 entry into all telecommunications markets has been fully liberalized, though a decade later it is still the case that BT has a dominant market position. British Gas was left untouched as a monopsonistic buyer of gas, as the only gas transporter and with a de facto monopoly in the supply of gas. Although entry into gas supply for large customers was liberalized in a legal sense there was no competitive entry for almost ten years after it had become feasible. Thereafter the regulatory authorities chiselled away at BG's structure and conduct, until BG split itself vertically in 1997 into separate transportation and supply companies. Full competition in supply has existed since 1998.

The regional water and wastewater companies were privatized as vertically integrated entities, and only recently have there been moves to introduce some product market competition in water. The electricity industry, though, was subject to large-scale restructuring. Transmission was separated from generation and the generating company was split horizontally into three competing businesses. A power pool was established to allow spot market trading of electricity. Distribution and retail supply remained regionally organized, with a rolling programme of allowing entry into retail supply. The retail supply markets were fully liberalized in 1998. Ownership structures have changed significantly over time, with many of the regional companies being owned by foreign utilities, and some vertical reintegration has been allowed. Distribution and supply businesses have built new generation capacity and generators have been allowed to buy supply businesses once market power was deemed not to be an issue in generation.

The railway industry was subjected to the largest restructuring of all at the time of privatization. The monolithic state-owned British Rail was transformed into more than eighty companies. Provision of track, stations and signalling was separated from train operation, which was itself split into separate routes and regions and franchised. Train ownership was separated from train operating companies, and track maintenance was likewise divorced from track ownership. In the next section I consider the regulation of conduct, including price controls, quality and investment monitoring and the use of spot markets for intermediate products. Section 3 covers structural regulation and entry conditions. Section 4 considers the role of regulatory institutions. Section 5 concludes.