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									Sawyer: The UK Economy 16e

        Chapter 9

Privatization and Regulation
• Privatization is the transfer of ownership from the public
  sector to the private sector. Privatization in practice
  involves rather more than a change of ownership (though
  some of the changes are closely related to the change of
• The objectives of privatization have been variously
  summarised and usually taken to include the reduction of
  government involvement in industry; improvement of
  efficiency in both the privatised companies and the
  remaining public sector; reduction of the governments’
  borrowing; weakening the power of trade unions in public
  sector wage bargaining; widening share ownership; the
  encouragement of employee share ownership and the
  gaining of political advantages.
• The privatisation programme shifted all of the
  major utilities with the exception of the postal
  service from the public to the private sector,
  as well as selling a wide range of companies
  such as Britoil, Jaguar Car, National Freight.
• Employment in public corporations fell from
  1,867 thousand in 1981 to 599 thousand in
  1991 and further to 379 thousand in 2002
  (Economic Trends, September 2003).
         Theory of Regulation
• The general analysis of regulation by government
  (and its agencies) in a market economy arises from
  the ‘market failure’ approach.
• The privatized utilities were, at least initially, in a
  monopoly position, and hence the perceived need for
  regulation of their prices and other activities.
• The ‘agency capture’ argument is that there will be a
  degree of capture of the regulatory agency by the
  regulated utility (its owners and managers), and that
  the regulatory agency will come to reflect the
  interests of the producers (public utility) rather than
  the consumers.
          Modes of Regulation
• The rationale for the regulation of ‘natural
  monopolies’ arises from their monopoly power, and
  hence focuses on control of their prices and/or
• The ‘direct’ route would be to impose controls on the
  level or rate of profits, often used in the United States
  under the heading of rate of return regulation (ROR).
  In effect, public utilities are there constrained to a
  maximum rate of return on assets.
• This mode of regulation was seen to have some
  undesirable effects, particularly in terms of effects on
  costs and efficiency. The basis of the argument was
  that a constraint on the rate of return provided the
  managers of public utilities with the wrong incentives.
          Modes of Regulation
• The approach to utility regulation in Britain has been
  described as drawing on three principles: ‘the
  rejection of rate-of-return regulation; the rejection of
  direct government control; and the rejection of the
  assumption of monopoly as a permanent feature’
  (Helm, 1995).
• The first principle led to a general mode of regulation
  (the precise application of which varies between
  industries as will be seen below) generally described
  as ‘RPI - x’ where RPI refers to the general rate of
  inflation and x is a figure fixed by the relevant
  regulatory authority.
         Modes of Regulation
• The second principle led to the appointment of
  regulators who, subject to general specified duties,
  operate independently of government.
• The third principle has been reflected in the
  liberalisation of the gas and electricity markets
  whereby the previous monopoly positions of British
  Gas and the regional electricity companies have
  been replaced by competition in the supply of gas
  and electricity.
          Modes of Regulation
• There may be a ratchet effect in operation whereby
  the achieved productivity growth in one period feeds
  into the target productivity growth for the next period.
  If the regulator underestimates the productivity
  growth potential, then there can be a profit bonanza
  for the public utility concerned.
• The regulation of price leaves the issue of the quality
  of the product to be purchased for the regulated
• Some incentive for the regulated firm to lower quality
  to reduce its costs.
• The regulatory agency is then drawn into issues of
         Modes of Regulation
• The relationship between the regulator and
  the regulated has aspects akin to the
  principal-agent problem, where one person
  (or group of people) – the principal –
  contracts another person (or group of people)
  – the agent – to undertake a range of
  activities on their behalf. The principal-agent
  problem arises since the principal lacks
  complete information on the possibilities
  facing the agent, and cannot fully monitor the
  activities of the agent.
   Regulation of Public Utilities
• The major regulatory agencies are Office of
  Water Services (OFWAT), Office of the Rail
  Regulator (ORR), and initially the Office of
  Electricity Regulation (OFFER) and Office of
  Gas Supply (OFGAS) now placed together as
  Office of Gas and Electricity Markets
  (OFGEM), and the Strategic Rail Authority
  (SRA). Office of Telecommunication (OFTEL)
  was the first to be established and has been
  absorbed in late 2003 into Office of
  Communications (Ofcom).
   Regulation of Public Utilities
• For the water industry (covering
  England and Wales only) the general
  formula for the price cap has been
  described as RPI + K (in contrast with
  the RPI - x rule elsewhere with prices
  generally falling in real terms).
 Regulation of Public Utilities
The roles of the Strategic Rail Authority
(SRA) include the awarding of
franchises to operate particular rail
networks, within which the ‘franchise
agreements…specify minimum service
levels and subsidy (or payments),
define performance standards for
incentive regime and enforcement
purposes, and regulate the price of
certain fares’.
      Regulation of Public Utilities
• The formation of OFGEM, combining the regulation of gas and
  electricity markets under one regulator was in part a response to
  the mergers between utility companies, and particularly between
  gas and electricity companies.
• The gas industry was privatised in 1986 and electricity in 1989.
  Following privatisation, gas and electricity prices were subject
  to regulation of the RPI-X form.
• The regulation of the National Grid Company by OFGEM follows
  the RPI – x formulation with x currently set at 3 per cent though
  with an initial reduction in price within the control period. But the
  allowed revenues as calculated by OFGEM are based on
  average pre-tax cost of capital of between 5.5 per cent and 6.25
  per cent.
Regulation and Consumer Protection
• There are numerous laws governing trading
  activities, setting product standards and
  contractual terms on the sale of goods and
• These laws could be viewed as part of the
  regulatory framework for the operation of
  business. There are also other limitations on
  the activities of firms come from legislation
  relating to consumer protection, much of
  which is enforced by the Office of Fair
  Trading (OFT) and by Trading Standards
Regulation and Consumer Protection
• The OFT has a duty to collect and assess information on
  commercial activities, so that trading practices which may affect
  consumers’ interests may be discovered.
• The OFT has sought to draw up codes of practice in a range of
  industries (covering, for example, direct selling, double glazing,
  motor trade and credit) and can set in motion procedures which
  can lead to the banning of specified trade practices. Under the
  Fair Trading Act 1973, the DGFT can seek assurances on future
  good conduct when traders persistently disregard their
  obligations under the law in a manner detrimental to consumers,
  and if such assurances are not given or given and then broken
  the DGFT can bring proceedings to obtain a court order (breach
  of which may result in action for contempt of court). The DGFT
  has powers to refuse, grant or suspend licence applications in
  particular areas of business and trade.
Regulation and Consumer Protection
• One particular area of regulation and consumer
  protection which is overseen by the Office of Fair
  Trading is credit licensing, under which an individual
  or firm wishing to provide credit requires the
  necessary licence. Thus, the conditions of entry into
  the ‘credit industry’ are controlled. Possibilities of
  confusion of consumers as to the terms on which
  credit is being supplied, the impacts of excessive
  debt, and perceptions that there may be an
  imbalance of information and power between those
  supplying and those requiring credit are amongst the
  reasons behind the licensing of credit provision.

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