Regulation is one of the most important powers of the state. It plays an integral role in shaping the social, political and economic life of citizens and is intended to bring about socially-desired or desirable outcomes. Regulatory policy is responsible for a considerable part of social welfare and economic development, provided that regulatory policy is undertaken sensibly and implemented well. Regulatory policy analysis makes use of regulatory economics and public policy tools that look at the theories, models and empirical issues in the regulatory world. It also includes the application of economic analysis by policy makers in their assessment of regulatory objectives, possible regulatory policy scenarios, their scope, their impacts and any possible unintended consequences. Regulatory policy is formally applied through the legislative instrument and enforced by the police and the armed forces of the country. However, social norms, markets and systemic factors also affect regulatory outcomes and therefore need to be accounted for in any regulatory analysis carried out or regulatory policy advice dispensed.
Good regulatory policy should ensure that a regulatory framework is efficient in terms of the regulations being relevant, suitable, and in the best interest of society with the latter usually being defined either in teleological or deontological terms. Through this, good regulatory policy should promote and be consistent with the principles of good governance, the rule of law, economic growth, innovation, investment, business competitiveness, and the overall wellbeing of society. The evolution of a country’s regulatory policy will largely depend on its socio-economic objectives. These objectives will vary over time and may necessitate regulatory reviews, regulatory reform, or an entirely new set of regulation.
Recent historic trends in regulatory policy show a period of deregulation in the 1970s and 1980s and a period of regulatory reform through the liberalisation of economic sectors in the 1980s and 1990s. Regulatory policy now seems to be changing direction again in response to the global financial crisis. Regulatory policies are mostly used to manage international or supranational regulations or a country’s regulatory framework on a sectoral, local, regional, or national level. Through regulatory policy and its implementation, regulatory agencies try to find optimal solutions to their specific requirements. These practices, to some degree or another, usually include transparency and objectivity in regulatory decisions, non-discrimination, the quantification and minimisation of regulatory compliance costs, and the creation of independent advisory bodies. The deployment of tools such as Regulatory Impact Analyses (RIA) and Regulatory Cost Models (including the Standard Cost Model), empower regulators to bring about effective regulatory management with the final goal of increasing social welfare.
Over the last fifteen years, many countries have made an effort to create a regulatory policy framework to stimulate economic growth and development, while ensuring that no members of society fall below pre-specified economic wellbeing thresholds. Regulatory policies are primarily directed by politicians (the legislature), formulated by cabinet, technocrats and civil servants (the executive) and enforced by courts (the judiciary) and the police force. Government Ministries and/or Departments usually also have an advisory role in relation to which issues require attention and to what policies to propose to address these same issues. In several cases, from time to time, all branches of government require specialised technical expertise to help them in formulating the right policies conducive to their objectives.
Equinox Advisory has on several occasions provided its services as an external advisor on issues related to regulatory policy. Through statistical sampling and thorough analysis of the collected data, as well as the use of secondary data, Equinox Advisory can advise policy makers in determining the policies that will be most effective in terms of meeting their objective and overall compliance in a given situation and jurisdiction.
Regulatory Impact Analyses (RIAs) are used to measure both the positive and negative impacts of a proposed regulation or an implemented one. Through RIAs, governments, regulatory bodies and regulated entities can assess the effectiveness of a regulation in relation to the current state of affairs and the socio-economic sector it is targeted at. This evidence-based approach to policy-making and appraisal is a valuable tool for ensuring that unintended regulatory consequences are kept to a minimum and that good regulatory practices are being adhered to. This usually also increases the transparency of the decision-making process and paves the way to well-informed political debates.
Through the analysis of the potential benefits, consequences, and alternatives to a regulatory framework or specific legislation, RIAs give rise to better and more informed policy-making processes. RIAs can be used to ensure policy coherence, that is, the mutual effort by government departments to achieve a common set of objectives through public policy. This has the potential of limiting the interdepartmental burdens and frictions of policy making by creating synergies between departments, by ensuring the streamlining and alignment of policy objectives thereby resulting in a lower incidence of unintended policy consequences and through the undertaking of public consultations in the process.
Behavioural economics is the study of decision-making under different sets of circumstances. Microeconomics is generally about making optimal decisions when faced with several constraints. Behavioural economics researchers have developed several techniques to help understand how and why decisions are made, and how they may be influenced. With a clear understanding of this, governments and regulators can design regulatory policies and implementing instruments that are designed to bring about desired outcomes while taking into account feedback loops that might emerge as a result of the regulatory policy.
Behavioural economics is being increasingly applied to the policy design area to ensure that incentive compatible, welfare maximising outcomes can result. The understanding of how individuals and businesses behave in the face of incentives and constraints meted out by regulation can be a form of evidence-based public regulatory policy. As a matter of fact, even the OECD has endorsed the behavioural economics approach of formulating regulatory policy, while citing over sixty instances where behavioural policy has informed good regulatory policy decisions.
Prices are, under normal circumstances, determined autonomously by the market. The production value chain arrives at a price that the consumer of the goods or service have to pay to obtain and consumers decide whether to buy the good or service at that price or not, and the production value chain adjusts over time in line with market signals from consumers and by testing different price points through special offers and discounts. At times, prices might also be negotiable within certain bounds. Prices established by this mechanism are usually considered to be welfare-maximising under conditions of no significant market failures. However, under market failure conditions, regulatory interventions might be required to ensure that an industry’s pricing policy leads to welfare-maximising outcomes. This is usually when price regulation comes in.
Price regulation comes in many different forms. Wholesale (upstream) prices or retail (downstream) prices might be regulated in many different ways and for many different reasons in accordance with the market failure identified. For upstream price regulation, bottom-up, top-down and hybrid cost modelling are rather popular as the basis on which to establish regulated prices. Several principles need to be applied within these cost models and they determine what costs are to be taken into account and on the basis of which apportionment mechanism. Long-Run Incremental Cost (LRIC), Long-Run Average Incremental Cost (LRAIC), Fully-Distributed Cost (FDC), Total Element Long-Run Incremental Cost (TELRIC) and Total Service Long-Run Incremental Cost (TSLRIC) are the apportionment methods that are most widely in use today, though they are by no means the only apportionment bases. Most of these methods require regulatory accounts to be able to work well.
For downstream price regulation, the most common mechanisms implemented are cost-plus pricing, retail-minus pricing and WACC-based pricing. Again, this list is not exhaustive.
As a general rule, regulators should, where feasible, encourage competition, minimise information asymmetry costs, minimise transactions costs, provide operators with incentives to improve their performance, provide for price structures that improve economic efficiency, and establish regulatory processes that provide for stable law-based regulation that is non-discriminatory, transparent, predictable, legitimate, and credible.
Equinox Advisory has over eight years of experience in advising regulators and public bodies with regulatory policy formulation, structural reforms and regulatory optimisation. Equinox has helped its clients in the regulatory policy area in fields such as telecommunications, energy, waste, health, transport, water and commerce and trade. The team at Equinox Advisory can leverage its success in these areas to help clients by:
- Advising governments and regulatory agencies on their regulatory policies and structures;
- Advising governments on regulatory reform, as well as on sectoral privatisation to establish a clear operator/regulator distinction free of conflicts of interest;
- Helping design encompassing regulation that minimises instances of incompatible regulatory siloes and unintended regulatory consequences;
- Carrying out behavioural economics studies to determine feedback loops and close off loopholes in proposed regulations;
- Conducting Regulatory Impact Analyses and Standard Cost Model studies to evaluate, either ex ante or ex post, the impact and effectiveness of a regulation or legislation;
- Conducting Cost-Benefit-Analyses or Cost-Effectiveness-Analyses to determine the effects of a regulatory policy;
- Carrying out tariff design and pricing policy formulation to achieve regulatory objectives (e.g. maximise revenues or the overall social benefit of a new regulation); and
- The provision of training in regulatory affairs, including regulatory economics.