EDITORIAL

By George Vegh, McCarthy Tetrault, LLP

 

July, 2010

 

The Legislatures of British Columbia and Alberta recently passed legislation that transfers decision making authority from energy regulators to governments.  In British Columbia, approval authority for both electricity planning and transmission facilities was transferred from the British Columbia Utilities Commission, to the Government. In Alberta, transmission siting authority was similarly moved from the Alberta Utilities Commission to the Government of Alberta.

 

The transfer of decision making authority from regulators to governments is not confined to provincial energy regulators.  The Government of Canada has also overruled decisions of the Atomic Energy Control Board (respecting medical Isotopes facilities) and the Canadian Radio and Telecommunications Commission (respecting foreign ownership).  Indeed, there have been calls in the United States for greater Congressional oversight of the Federal Reserve Bank, which is typically considered the institution which sets the high water mark of independent regulatory authority.[1]

 

The transfer of powers from regulators to governments is therefore a growing phenomenon that seems to have appeal across jurisdictions and political parties.  So, when we are considering the increasing role of the Ontario provincial government in energy regulation, it is helpful to ask more broadly, why did legislatures once give independent decision making authority to government agencies and why are they now transferring that authority back to governments?[2]

 

In addressing this, I will not pursue the somewhat cynical response that governments think only in terms of short term political advantage.  This response, which I also think is inaccurate, also has a more fundamental problem.  It cannot provide any explanation for why political advantage leads to empowering regulators and one time and disempowering them at others.  It is more useful to proceed on the premise that, when the legislatures created or empowered independent agencies they did so in the public interest, and now that they are overriding those agencies, they are also acting in the public interest.  I will also assume that legislatures generally reflect the desire of the people they serve, so that it was generally considered good governance to create independent agencies, and now those considerations are no longer as important.  So why did governments once believe independent regulation to be in the public interest, but now apparently no longer believe this?

 

A good way to approach the issue is to ask why independent regulators are created in the first place.  Although there is very little empirical evidence to demonstrate why governments create independent regulators, asking the question this way allows for an interesting thought experiment.  The question has been posed by Fabrizio Gilardi, who notes that, “standard principal-agent theory is ill-equipped to deal with” the delegation of decision making authority from government to independent regulators:[3]

 

“The central claim of principal-agent models is that delegation is beneficial but also dangerous, because the agent can use its informational advantages for its own benefit, rather than for that of the principal.  In the case of IRAs [i.e., independent regulatory agencies], however, governments make agencies purposely independent rather than, as predicted by principal-agent theory, designing as accurate control mechanisms as possible, although controls do exist.”

 

In other words, why did governments create agencies for the very purpose of acting independently and, more recently, decide to by-pass those agencies? 

 

In the late twentieth century, the creation and strengthening of regulatory agencies was considered an inherent element of good governance throughout the free world.  According to a study prepared by the Organisation for Economic Co-Operation and Development in 2002, “One of the most widespread institutions of modern regulatory governance is the so-called independent regulator.”[4] 

 

This governance innovation was accompanied by the privatization and creation of markets in previously non-competitive areas such as telecommunications, electricity and natural gas.  The relationship between market creation and regulatory independence should not be under-estimated.  The independent regulator was an integral element of removing direct governmental action, decisions by regulators based on the principled application of rules replaced decisions of governments based on political considerations:[5]

 

“…[T]he term regulatory state ‘suggests [that] modern states are placing more emphasis on the use of authority, rules and standard-setting, partially displacing an earlier emphasis on public ownership, public subsidies, and directly provided services.  The expanding part of modern government, the argument goes, is regulation.’”

 

Thus, transferring authority from Ministries to independent agencies was part of a larger project of reducing the size of governmental operations and relying on market forces to both identify and implement policy goals.  Tied to this transfer is putting decision making authority to independent regulators.  The goal of this transfer was to “depoliticize” decisions in these industries so that decision making could be objective, transparent and informed by technical expertise.  This decision making model would provide a more stable investment environment to private capital.

 

While pro-competitive industry restructure was sometimes called “deregulation”, the reality was that this restructuring was accompanied by extensive regulation.  Independent regulation, as opposed to government decision making, became the signature governance method of public oversight in the regulatory state.  It is a check and balance, aimed at constraining government decision making.

 

Why has this changed?  There are several reasons why we may be moving to a post-regulatory state, but I think the most important is that our expectations from government are different today than they were in the 1980s and 1990s when the regulatory state flourished.

 

The government is no longer expected to only set price signals that result in efficient investment decision making.  They are engaging in larger, more ambitious projects again.  On the electricity side, the infrastructure requirements of “greening” the electricity grid are both physically large and culturally transformative.  As societies, we expect energy to meet social and environmental goals, not just economic efficiency. 

 

In part, the belief in government is based on a more fundamental critique of relying on economic efficiency as the only or even dominant goal of public policy.  This recognition is perhaps most profoundly reflected in the recent report of the Stiglitz Commission.  The Stiglitz Commission is a panel of leading international economists appointed by the Government of France to address the limitations of a country’s gross domestic product (or GDP) “as an indicator of economic performance and social progress.”[6] (at p. 1).  The driver of this commission was a belief that economic efficiency, while an important social factor, is too limited to be a driver of economic policy.  As the Stiglitz Commission reported, “it has long been clear that GDP is an inadequate metric to gauge well-being over time particularly in its economic, environmental, and social dimensions, some aspects of which are often referred to as sustainability.”[7] 

 

The insight of the Stiglitz Commission is important because it demonstrates that even the most ardent Chicago School economists recognize that terms such as “economic efficiency”, and “wealth maximization” are not neutral descriptions of unambiguously positive outcomes.  They are measures that have embedded within them contestable political and social assumptions about what values are important to society.  Measures such as GDP (and most other conventional measures of economic efficiency) measure wealth maximization, not how wealth is distributed or how its creation may deplete the environment.  The decision to put a premium on wealth maximization is a political decision that contains assumptions on how to measure and trade off among a range of values.  Carrying this out is a complex and difficult task for a democratic society.  There is no single “rational” way to do this.  There are many potential approaches to identifying the goals that good policy should further.  Democratic societies appear to have rejected a smaller role for government.  A corollary of that is that independent regulators have less sway then they used to.

 

In other words, the predominance of economic regulation as a policy instrument was a product of a more fundamental neo-liberal ideological commitment to markets and economic efficiency as the primary goal of regulation.  The receding role of faith in markets – and the corresponding growth of the belief in governments to pursue collective social and environmental goals -- is intimately tied to the importance and independence given to economic regulators.

 

Accommodating a larger role for non-economic factors is a challenge for the regulatory state.

 

Regulators have been traditionally charged with the goal of ensuring economic efficiency.  The theory is that market failure in the energy sector requires a regulator to develop models and processes to determine the price, level of investment and quality of service that a market would lead to, if only it worked.  In other words, the regulator’s role is to be a proxy for market outcomes.  When the goal for the sector is to produce outcomes that are different than market outcomes, the case for independent regulation is difficult to make.

 

In the context of the role of energy in the green economy, what this means more precisely is that the goal of energy regulation is not just to mimic the type of investment that a private market would make in energy, but to have the level of energy investment reflect the contribution of the energy sector to achieving broader policy goals.  So, for example, the energy sector is expected to make more than a purely economic contribution to the reduction of carbon.  By shutting down coal plants and by encouraging renewable power, the energy sector makes an environmental contribution representing more than it would under a market system:  it is expected to punch above its weight. 

 

The same is true from a socio-economic perspective.  Energy regulation is expected to play a role in industrial policy.  The greening of the economy generally, and domestic content requirements for Feed-in-Tariff projects specifically, is about creating jobs in the sectors of renewable power generation and clean technology.  The level of employment in these areas is not left to pure economic forces of supply and demand.

 

Regulators, by definition, do not engage in the “big picture”.  Their training, expertise and processes were established to make fairly narrow technical decisions based on limited grounds of cost effectiveness.  They have difficulty accommodating broader policy considerations that take into account social and environmental factors.  Even if they could, it is not clear why regulators are better positioned than governments to make the broader trade offs necessary in considering these factors.  In other words, regulators can assess whether the next mile of pipe is cost effective.  They cannot identify the next frontier where society should dedicate its resources.  If we are looking for new frontiers, they will be identified by governments, not independent regulators.

 

Although it is common to decry political “interference” with the decisions of independent regulators, the problem is more complex than that.  If, as a society, we believe that the government should again be engaging in ambitious projects, then, it is necessary to loosen the strictures of the regulatory state which, by definition, are aimed to constrain government decision making.

 

Regulators are therefore put in a very difficult bind.  They can continue to apply a one dimensional screen (economic efficiency) to a multi-dimensional problem (economic, environmental and social), or they can try to develop a more multi-dimensional screen.  If they do the former, they threaten to undermine the implementation of government policy; if they do the latter, they are acting outside of their technical expertise and invite political oversight.  There is no obvious solution to this conundrum.

 

Even apart from the difficult role that this places on regulators, there are some other fundamental concerns that should be taken into account as we ponder the shape of the post-regulatory state. 

 

First, the reasons for restructuring in the late twentieth century were not confined to an ideological rejection of big government.  It was a practical response to limited government resources.  The state needed private sector capital to invest in big projects.  This has not changed, and given the financial straits of government, is not likely to change in the foreseeable future.  So, for example, when Ontario greens its energy infrastructure, it expects private sector developers to share the investment risk.  This investment requires some confidence that there will be transparent rules in place and that the government will follow the rules.  Predictability and good governance remains an important value:  there may be a larger role for political decision making, but, as long as governments rely on private investment, it is necessary that some discipline be imposed on their decisions.

 

Second, there is a definite mismatch between the election cycle and the timelines for large infrastructure projects.  One of the advantages of the regulatory state is that decision makers can take the long view.  It is not realistic to expect that political decision makers will have such a long term horizon.  This misalignment will be difficult to manage.

 

The roadmap for the post regulatory state is therefore unclear.  While we may have more faith in government’s ability to solve problems than we did in the 1980s and 1990s, there are financial and policy reasons why some checks and balances are still important.  The restrictions on governments may be loosened, but they cannot, and should not be completely unbounded.

 

 

* Note that the term "Post-Regulatory State" is Copyright © George Vegh, 2010.  All rights reserved.