23 February 1996 - 25 February 1996

The Role, Limitations and Legitimacy of Regulatory Mechanisms in Market Economies

Chair: Chairman : Professor Giuliano Amato

Ditchley had, in the past year or two, looked at various sorts of public regulation - notably environmental - indirectly apt to have economic effect. Our focus this time however was upon regulation deliberately designed for such effect, in order to modify the working of markets in situations when it was feared that, without constraint, such working would operate in one way or another to society’s disadvantage.

We noted several possible classes of such situations: where monopoly, or a close approach to it, was likely; where there was serious asymmetry of information as between seller and buyer, or where the individual buyer could not easily handle (because of the scale of risk) the effects of uncertainty; where major externalities had to be managed but could not be captured by ordinary market structures; or where the failure of individual enterprises might endanger the health of their entire sector. None of these classes passed without challenge, especially if inherent permanence were claimed, and the sceptics were minded to attribute current structures as much to the activity of pressure groups with political agendas as to economic merits; but a majority of us accepted that in at least most of our countries there was adequate substance among them for the concept of public regulatory mechanisms on some scale to be justified.

We recognised that, even if accepted, the regulator-justifying situations in our list were of widely different character and might point towards widely-different styles of regulation, for example as between that designed to discipline near-monopoly provision of an essential utility and that for sustaining the overall health of a highly-competitive financial sector. The importance was stressed of maximising the use of more “natural” economic instruments - such as commercial insurance against risk, and thorough disclosure of information - before recourse was had to establishing regulatory bodies; and we were minded also to prefer, wherever possible, general structures - such as anti-trust commissions - rather than industry-specific ones, not least because the latter could not easily handle circumstances in which (as for example with electricity and gas, or road and rail) competition arose between as well as within industries.

Our discussion was recurrently marked by awareness that the conditions and climate of regulation differed significantly as between the United States and Europe, with Canada originally more like the latter but migrating towards the former. In the United States, with virtually no history of recourse to public-ownership solutions, public arrangements for utility regulation were highly mature (though the sceptics might have liked some sharper adjective); the content of regulation was moreover both set and supervised in much detail by Congress. Elsewhere utility regulation was often less narrowly prescribed by political authorities and of more recent origin, partnering a move away from nationalisation and designed to ease the transition to private-sector operation. In these latter circumstances, so several participants urged, it was highly desirable to keep the transitional aspect constantly in view, perhaps by way of a defined timetable and of “sunset” provisions; there were temptations otherwise both to move too slowly and to let regulatory structures develop a continuing life of their own.

Whatever the rationale for regulation, clear operational definition of the regulator’s objectives was crucial to satisfactory functioning. Most of us were moreover strongly disposed towards having few and tautly- framed objectives against which performance could be clearly assessed, rather than a multiplicity of a “take- into-account” kind; blurred focus was a recipe for drift - hard enough anyway to resist - toward pressured politicisation and ad hoc arbitrariness. It was unrealistic to suppose, even in the more discretionary European settings, that regulation could be entirely insulated from political or social considerations; but the more those could be made explicit and external to the regulator’s normal working, the better. We paused specifically upon whether, in monopoly-prone sectors, the emergence of competition should be made a regulatory objective; it was vigorously argued that, even where something in this direction was appropriate, the task should be confined to promoting the conditions for competition, rather than directly generating it.

We lacked time for systematic analysis of the context and techniques of regulation, but several points emerged strongly. Public expectation, bearing down upon politicians, often demanded virtually a risk-free world - water supplies never giving out even in very rare climatic conjunctures, banks or savings institutions never failing. There were both high costs and other grave drawbacks in seeking to meet such unqualified demands by regulation, and at the very least these consequences needed to be exposed clearly to public view. The marginal cost of insurance against the extreme contingency was usually very high, both directly and in resource misallocation; and in the financial sector the effects of trying to guarantee “no failure, ever” were corrosive of proper commercial discipline and therefore of long-run sector efficiency and even viability; in one European country, we heard it suggested, the demand for a perfect publicly-backed safety-net had made banks scarcely commercial enterprises at all.

The theme of unintended consequences recurred regularly. Artificial intervention in complex environments was usually in danger of distortion, or of creating fresh dilemmas. For example, the fixing of upper limits on utility pricing could face awkward choices between setting caps at levels which gave existing enterprises over-comfortable profits, and setting them at levels which constituted an over-severe barrier to the new entrants desirable for enhanced competition. In the financial sector, regulators or supervisors might face similarly difficult choices between intervening early (and so perhaps prematurely removing rights and responsibility from a struggling enterprise) and too late (when the assets for a rescue operation might have gone beyond reach).

Good models for measuring the success of regulatory mechanisms were mostly hard to devise; and it was therefore highly desirable to build systematic procedures - both internal and external to the regulator - for regular and sceptical challenge to the need for and real impact of regulation. The case for such procedures was made the stronger by the risks that - whether for institutional reasons or in reaction to headline-catching events - the volume and detail of regulation would tend cumulatively to grow ; it was in most countries much easier to add a rule than to remove one.

The style of regulation - often reflecting, in newer systems, the personal approach of a key individual - could make a great deal of difference to the merits of the mechanism. Most of us were disposed towards regulation in terms of outcomes to be achieved rather than of input or procedure, and towards flexibility to cope with diverse circumstances and changing markets and technology, rather than fixed precision, for all the latter’s merits in terms of apparent certainty and the former’s perils in terms of arbitrariness, bias or mistrust. The greater the flexibility and judgmental discretion, however, the more - at least prima facie - the need for transparency in the regulator’s decisions, to underpin public understanding and accountability. But here, too, complication crept in. There could be genuine problems over commercial confidentiality, especially in the financial sector where sustaining systemic stability and confidence was a key purpose of regulation; and over- rigid demands for disclosure (as in the wider freedom-of-information context?) might simply drive the real conduct of business off the files. In general, nevertheless, we saw a substantial onus upon regulators to explain their actions in accessible terms; and we were especially keen on candour where decisions imported political or social factors, such as cross-subsidy for redistributive purposes.

Accountability in relation to the defined objectives exercised us a good deal. Yet again, there were balances to be struck. At least outside the United States, it was mostly of the deliberate essence of regulatory- system design that decisions should be distanced from day-to-day political impulses; but political accountability could not be wholly dissolved, and in some countries like the United Kingdom Parliaments seemed as yet under-skilled in making a proper contribution to oversight. We found no neat solution to how (or indeed whether) to involve the customer or client in any formal way. Some regulators set up their own consultative structures for the purpose, but such arrangements would not be credible everywhere. We touched on the role of the courts - necessary, we were sure, provided that the temptation to reach beyond monitoring due process into second-guessing substance could be resisted; and we noted the need to avoid giving every dissatisfied individual consumer locus for litigation. In practice, we knew, much of the required accountability was provided, even if erratically, by the media.

How were regulators to keep themselves knowledgeable about the industries they were regulating? Once more, we glimpsed Scylla and Charybdis. Scylla was being so far detached as to be uninformed, and to lose industry’s confidence (essential to doing the job well); Charybdis was industry capture, with the regulator over-eager to empathise with industry - in particular with its existing members, often keen to slow down change and discourage new entry. Some risk of capture, or at least of what might seem to the public over-influence, was inescapable if the regulator was to be knowledgeable and up-to-date; and the very concept of regulation implied the potential creation of fresh interest   and lobbying incentives. The provenance of the regulator and key staff was an important dimension of these issues. There were merits in mixed origins and regular turnover, we saw no complete escape from the problems, real or perceived, of the revolving door.

We knew, as we departed, that we had not found room to do justice to the international aspects of our subject - just how far (not totally, we were sure) was cross-border consistency in regulatory practice needed for fair trade? We heard surprisingly little about extra-territoriality, and less still about the effects of the European Union. At least however we recognised that these aspects existed and mattered; and that the further and more systematic research needed on the concepts and operation of regulation ought to include a good deal more transnational learning.


This report reflects the Director’s personal impressions of the conference. No participant is in any way committed to its content or expression.

Chairman : Professor Giuliano Amato
President, Italian Antitrust Authority


Mr William Bishop
Professor of the Economics of Competition Law, Collège d’Europe, Bruges
Dr Colette Bowe
Chief Executive, Personal Investment Authority
Mr John S Bridgeman, TD DL
Director of Fair Trading
Mr Ian Byatt
Director General of Water Services
Mr Nicholas Durlacher
Chairman, The Securities and Futures Authority
The Rt Hon Tim Eggar MP
Minister of State, Department of Trade and Industry
Ms Rosalind Gilmore CB
A Director, Securities and Investments Board and a Member, Regulatory Board, Lloyd’s of London
Mr Norman Glass
Deputy Director, HM Treasury
Mr David Harrison
Director of Corporate and Institutional Banking, Lloyds TSB Group pic
Mr Charles Henderson CB
Deputy Secretary, Department of Trade and Industry
The Hon Peter Jay
Economics and Business Editor, BBC
Mr Anatole Kaletsky
Economics Editor and Associate Editor, The Times
Mr John Kay
Chairman, London Economics.
Mr James Marshall
Assistant Auditor General, National Audit Office
Mr Roderick Paul
Lately Group Chief Executive, Severn-Trent Water
Mr Brian Quinn
Executive Director, Bank of England
Mr Alan Riddell
Secretary, Committee on Standards in Public Life

Mr Bernard A Courtois
Group Vice-President, Law and Regulatory Matters, Bell Canada
Dean Ronald J Daniels
Dean, Faculty of Law, University of Toronto
Mr Grant L Reuber OC FRSC
Chairman, Canada Deposit Insurance Corporation
Mr Harry Swain
Special Adviser to the Minister of Finance

Monsieur Francois Lagrange
Executive Director, European Investment Fund

HE Dr Paolo Galli
Ambassador of Italy to the Court of St James’s

Mr D Rhett Brandon
Senior Resident Partner, London Office, Simpson Thacher and Bartlett
Mr Joseph F Condon
President, Condon International Group
Mr T Jefferson Cunningham III
Chairman and Chief Executive, Hudson Chartered Bancorp Inc
Mr Donald W Davis
Retired CEO, Stanley Works; Senior Lecturer, MIT Sloan School
Dr Robert W Jerome
Associate Director, International Management Program, University of Maryland
Professor Paul W MacAvoy
Williams Brothers Professor of Management Studies, Yale School of Management
Mr Fred L Smith Jr
President and Founder, Competitive Enterprise Institute, Washington DC
Mr Donald T Vangel
Senior Vice President, Bank Supervision Group, Federal Reserve Bank of New York