The Nobel Prize winning economist Milton Friedman famously said that the business of business is business, and that business’s only social responsibility is to increase profits within the rules of the game. Those rules contribute to the science and art of economic regulation, addressing market failures or, alternatively, making markets work better. Economic regulation is effectively government-sponsored intervention in market decisions; interventions around how you grow the pie and how you divide it up. But how do you ensure everyone gets a fair share? What is economic regulation? How does it work and how does it impact on inequality?
I looked for answers from Simon Corden. Simon is the Chair of the National Regulators Community of Practice, and a Commissioner with the Victorian Essential Services Commission. He was the Economic Policy Adviser in the Department of Premier and Cabinet in Victoria. He also established the Victorian Competition and Efficiency Commission; worked in Treasury and Finance; the Productivity Commission; and was a director with KPMG.
Licencing as a constraint on monopolies
Simon explains that the sort of things that economic regulators typically regulate are areas where there is monopoly power, like water authorities, landline phone lines, electricity networks, airports, and ports. But where there’s a multitude of businesses selling the same thing we’re less likely to see regulation.
So how do regulators intervene with monopolies?
“Typically regulators licence companies to enter the market,” Simon explains. ‘There are a lot of transmission lines being built at the moment to connect renewable energy sources, windmills, wind turbine farms, and solar farms to the electricity network. But we’re not going to have an array of transmission networks, so regulators will just licence one, and then they’ll set the prices and might also set service and reliability standards.’
So licensing controls who enters the market and the price they can charge. But is that price directly to consumers, or to a wholesaler who then sells on to consumers?
Simon says that most of these big monopoly providers aren’t selling directly to consumers, such as airports that sell landing rights or the right to use the terminals to airlines, not to individual consumers.
But in recent years there has been a greater focus on the individual consumer relationships with some of the providers, with some of the economic regulators looking at retail markets. But that’s less about regulating price and more about setting service standards.
What if economic regulators went away?
Simon says in countries which don’t have effective economic regulation the prices go up, service quality can go down, and innovation can go down. ‘I worked several years ago for the OECD on a project in Mexico, and in Mexico big chunks of the economy are monopolized: the telecommunications company, the phone company, even milk. A whole lot of sectors are very concentrated. And prices were higher, innovation was lower, and service quality was lower. And most of the harm was actually affecting lower income people because the sort of products where this monopoly power was evidenced represented a big part of the expenditure of low-income people. So if you don’t have effective economic regulators to influence the market then you can get poor social outcomes.’
Economic regulators make sure there isn’t a big firm taking over lots of smaller firms in the markets to reduce competition. They also try to help vulnerable populations. The Royal Commission into Domestic Violence was tasked with improving how the energy and water sectors dealt with victims of domestic violence who had financial challenges as a result of their abuse. You can’t turn water and energy companies into social welfare agencies, but there is scope to get a sort of win-win through carefully designed policies that promote inclusion without harming economic efficiency.
It used to be thought that there were no free lunches and that economic regulation should be working only at maximising efficiency, and that social policy objectives would be better dealt with outside economic regulation.
But Simon says that in the last ten years there’s an appreciation that there isn’t always a trade-off, that you can in some cases improve social outcomes without hurting economic outcomes. ‘The big theme from the OECD and the IMF is that economic growth and inclusion are complementary. That you can achieve better economic growth through inclusive policies; that there’s not a trade-off of one against the other.’
There’s certainly been a growing literature since the 2000s on how to get inclusion as well as economic growth. But how do regulators make sure the pie is grown in a way that doesn’t adversely affect the community?
Simon believes ensuring a more just and equitable society is a function of education policy, tax policy, social welfare policy. ‘There a whole lot of areas which have got primacy here. The economic regulators are really just dealing at the margin with these issues. But it’s really about doing the best we can to limit the adverse effects on people who are vulnerable.
‘And to date, we’ve tended to focus on people who are financially vulnerable; people who get into payment difficulties. But more recently at the Commission we’re focused on domestic violence. And there is the question about other forms of vulnerability, such as people with disabilities or poor literacy or from culturally and linguistically diverse backgrounds. Are there ways to achieve better outcomes for these people without having a significant impact on efficiency?
Thin vs. thick markets
But Simon is quick to point out that thin markets don’t always lead to a lack of consumer focus or poor quality. The Australian airline industry is a good example, with Qantas consistently ranked among the best airlines in the world despite few national competitors. Conversely, you can have sectors where there are a large number of providers, but they’re not necessarily competing in a way that generates the best outcomes for consumers. ‘We have lots of different credit card companies, but interest rates are still often over 19 per cent’, Simon points out.
So it can be more about the characteristics of the services being offered than whether the market is thick or thin.
‘For example’, Simon says, ‘one of the issues in the airline sector a couple of years ago was what’s called drip pricing, where a particular price is advertised, but when you click on it you learn you need to pay for this, you need to pay for this, you need to pay for that.
‘The Australian Competition and Consumer Commission (ACCC) intervened to make sure that whatever they advertised, the price was a price the product was available for. If an add-on was compulsory, it had to be included in the price. So if the only way that you could purchase the particular product was to pay five per cent extra for credit card and there was no way to avoid that, then that had to be included in the price.’
The rise of behavioural economics
Simon says one of the big changes in the field of economics since he was at university is behavioral economics. ‘I think this has led to a lot more sophisticated understanding of when markets and market interventions don’t work well, don’t conform to the traditional assumptions of economics. When energy companies, for example, present their bills, there might be rules about how they have to present particular aspects of it to promote more equitable outcomes, to promote more inclusion. So behavioral science has been really helpful in trying to understand how markets can be imperfect.
‘One of the interventions that we’re working on at the Essential Services Commission is the best offer message. So at a certain period of time your energy bill has to have a note on it that says whether the current contract you’re on is the best that’s available from that retailer. And so that’s an intervention designed to encourage people to shop around.’
What about grocery items that have to show the price per kilogram or the price per sheet of toilet paper?
Simon says that’s called unit pricing and is a great example of creating not just more information for consumers, but to do it in a form that makes it more suitable for them to understand their choices. ‘There’s a review of that going on at the moment. It’s interesting, a lot of these sort of interventions, you really can’t be certain how they’re going to work until you try them. For instance, star ratings on appliances for energy regulation. I think that’s been remarkably successful.’
When information is not enough
‘What all regulators are trying to do primarily is change the behaviour of individuals and companies. That’s just regulation rather than any particular sector. What has changed is our faith in information. Twenty years ago we thought, just tell people the information and give them a product disclosure statement, or put a label on a product and their behaviour will change. And what I think all regulators know now is a lot of the time people won’t read that material. If they read it, they won’t understand it. If they understand that, they won’t necessarily change their behaviour. There wasn’t the recognition that there were some consumers who are either unable or unwilling to shop around and that you needed to protect them in some way. So our faith in information disclosure, per say, as a way to change behaviour is a much more nuanced challenge than we once thought.’
In conclusion, economic regulation is more than just addressing market failures around monopolies and how markets function, and how products are sold. Regulators also have a role in protecting vulnerable populations.
And whilst I think Milton Friedman is probably not wrong when he talks about the business of business is business, it’s clear that as long as businesses are operating in society, where there is always going to be vulnerable people, government and professional regulators need to do some level of intervention.
If you liked this article and the discussion on innvoation, you might like the podcast and article I did with Andrew Morgan on ‘Can innovation exist without implementation?‘.
|Chair National Regulators Community of Practice
Commissioner, Victorian Essential Services Commission
|“Twenty years ago we thought, just tell people the information and give them a product disclosure statement, or put a label on a product and their behaviour will change. There wasn’t the recognition that there were some consumers who are either unable or unwilling to shop around and that you needed to protect them in some way. So our faith in information disclosure, per say, as a way to change behaviour is a much more nuanced challenge than we once thought.”
|Simon on LinkedIn