When competition will not do

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The recent difficulties faced by Railtrack and other utilities raises fundamental questions about how to achieve low prices and high safety standards. It may be necessary to look for new kinds of public-private partnerships and new ways of combining competition and regulation to achieve the best outcomes. This article provides a framework for thinking about these issues.

Competition is usually better than regulation in safeguarding the interests of consumers. That is a general lesson of two centuries of market economics and a specific lesson of Britain’s experience of privatising state industries.

But what of activities where competition is impossible? Some of these – such as water supply and the rail network – have been privatised . Others – like policing and criminal justice – cannot be. All of these are natural monopolies which means that an administrative process, rather than a market, is needed to secure efficiency and protect customers.

The idea behind privatisation was that the public sector – government, parliament and a regulator – could lay down the framework of what was required and a profit maximising company could then be instructed to deliver what had been agreed. This structure requires in effect that we separate the questions of what is delivered from how it is delivered – the traditional division between policy and implementation. It is because this distinction has not been effectively made, and is very difficult to make effectively, that privatisation of water and the rail network has not been successful and privatisation of the police and the courts is impossible.

Delivering any complicated service to the public involves balancing conflicting objectives. We want a railway that is safe, fast, punctual and cheap. But we need to make choices. More of one of these things often involves less of the others. It is easy to say after tragedies like Ladbroke Grove or Hatfield that safety must always come first, but we don’t really mean it. We could have an almost completely safe railway at the price of much slower trains and much higher fares, but few people would wish to travel on such a railway. There is a danger that, after Ladbroke Grove and Hatfield, this is the railway we will get.

The need to makes these choices and tradeoffs is not confined to public services. Airlines, for example, face the same conflicts. But in competitive conditions, a combination of market forces and judicious regulation gets us to roughly the right answer. The market defines the tradeoff between price and customer service. If you want to fly to Brussels, you can pay a high fare and get free wine from British Airways. Or, if you don’t mind travelling to Charleroi in an older aircraft, you can go with Ryanair for a pocketful of loose change. The outcome is determined by the strength of consumer demand for these different services.

The balance between price and safety is less easy to manage. The safety record of an airline is not as easily observed as whether or not it lands at a convenient airport. And there is a public interest in keeping unsafe planes out of the sky even if economy-minded passengers were willing to fly in them. So we have a regulator who imposes minimum safety standards. And competition and concern for reputation ensures that most airlines do better than that. The Civil Aviation Authority takes on the job of balancing the public’s demand for cheap and speedy air travel with the need for safety in the air. It is not an enviable job but the authority has the objectivity and – through its relationships with many airlines and with other regulators – the information to do it.

So in competitive industries, the market, with a bit of help from regulators, does the job of balancing the multiple needs of customers and the rest of the public for service quality, affordable prices and social objectives. But who does that balancing job in a monopoly? The theoretical answer, in the case of privatised utilities, was that the regulator would exercise this function. It was up to the political process, through its regulator, to define the framework with which the company operated and the company’s duty was to make as much money as possible within that framework. Issues of public interest are for government. The operators act as commercial enterprises.

But this system cannot work. In industries such as railways and water, the job of balancing competing public and private interests cannot be done by laying out a simple set of rules. That balance needs to be interpreted in thousands of individual decisions that need to be made every day by operational managers and individual employees. So if these choices are to be determined by the regulator, he or she needs to be involved in the detailed management of the business. If the balance of public and competing private interests are to be determined by the industry itself, we have handed over to a private company social obligations which are inconsistent with the company’s basic responsibilities to its shareholders.

This unresolved tension has led the regulated industries to complain that the powers of the regulator are intrusive and arbitrary, and has led the regulators to conclude that they have insufficient authority to do their job. Both complaints have some truth. The line between regulation and commercial operation was simply drawn in the wrong place. There are two alternatives. Either the function of balancing competing interests should to be given to the regulator – which means that the strategic direction of the industry has to be undertaken within the public sector; or this obligation is transferred to the operating business – in which case this obligation cannot be exercised by private companies with a primary responsibility to shareholders.

Both these solutions are on the agenda today. Railtrack is no longer viable in its present organisational form, therefore the best and most likely outcome is an expanded role for a public agency responsible for system design and operation. In Wales, Glas Cymru is helping to pioneer the development of new organisational forms in the water industry. Perhaps this marks the beginning of a mature discussion of private and public partnerships in these large areas of the economy where competitive markets are impossible and political control has failed. Then again, perhaps it marks the continuation of a characteristically British muddle.

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