What is regulation?

I noticed this policy paper on regulation sometime in August 2006 (when it was released on planning commission website). On first glance, it did not look very good and hence ignored it.

However, a friend of mine asked me for this paper sometime back and I just went through the paper once again and found it to be really good. It discusses concepts and approach to regulation in a very simple and elegant manner.

(Addendum: People can write their comments/ suggestions/ criticisms on this paper till 31 Aug., 2007. Details are here. This is a welcome move and is a big development in public policy. Most of these documents are nowadays available to general public for comments.)

First what is regulation? The paper defines it really well:

Regulation may be broadly understood as an effort by the state ‘to address social risk, market failure or equity concerns through rule-based direction of social and individual action.’

Note: every word is important in the definition.

Economic regulation is seen to be that part of regulation which seeks to achieve the effective functioning of competitive markets and where such markets are absent, to mimic competitive market outcomes to the extent possible. It also identifies and addresses subsidies and cross-subsidies in the pricing of infrastructure services.

However, governments have a broader role for regulation:

States generally use economic regulation in a broader context to achieve a range of non-market objectives which include ensuring universal and equitable access, consumer protection and maintaining safety and health standards.

The paper applies the basic regulation concepts to infrastructure sectors. Before discussing the basics it lists the status of regulation in each of the infrastructure sectors in India.

What is special are the observations on the nature of regulation in each of the sectors. In most, there is no regulatory authority. Wherever there is, there is no accountability and is mostly run by respective ministries.

So what are the core principles of regulation design?

1. Seperation of Power: means the constitutional powers and functions are divided among the three branches of government: legislature, executive and the judiciary.

The paper says, rightly so, whenever we try and combine the two or all three functions in any institution, the institutions fails. The paper says:

In the case of regulatory institutions, this problem is aggravated as a single institution makes rules of law, administers them, and finally adjudicates disputes which may arise. This multi-dimensional character of regulation raises complex problems of compliance with the separation of powers principle. The separation of judicial power from executive and delegated legislative power has been litigated repeatedly in the case of the securities markets regulator, the telecom regulator and most recently the competition authority.

Needless to say, but with India this seperation is the basic cause why nothing happens.

Inter-institutional bargaining is essential to secure liberty in a plural democracy where different interest groups have varied levels of access and control over the diverse institutional apparatus of the state. So if the liberty of citizens is at stake then the separation of powers must be ingrained in regulatory institution design. Moreover, this is a constitutional imperative.

2. Democratic Accountability: How to ensure both- independence of regulator and make it accountable as well. Three ways,

  • make regulatory bodies answerable to legislative (i.e. ministry),

  • make former answerable to public (this is possible by adopting processes and systems whereby interested citizens or groups of citizens may seek and acquire information, make representations and be accorded full process and participation rights),

  •  appoint competent regulators having full integrity

3. Federal Principle: As the subjects of economic regulation are often divided between Union and State competencies, the regulatory structure should reflect this distribution.

The paper sumamrises very precisely the nature of regulation in US, UK, Australia and Sri Lanka.

Then it presents a case of what should be done to build a proper regulatory structure for infrastructure. It categorises various infrastructure sectors nicely:

Each of the infrastructure sectors can be broadly divided into carriage and content segments. Content normally refers to electricity, gas, data or voice. On the other hand, carriage refers to transmission lines, networks, exchanges, airports, ports, highways and other fixed assets.

While carriage is typically regarded as a natural monopoly, the content is eminently amenable to competition. In order to enable competition in the content segment, the carriage should be subjected to non-discriminatory open access under close regulatory oversight including determination of tariffs. Where technology or market structure enables adequate competition in carriage, its regulation could remain light handed. These aspects would have to be clearly addressed in the overarching approach to regulation.

And then it applies the principles of regulation design(discussed above) to build an institutional structure for regulation in infrastructure sector. .

An excellent initiative I must say, to explain basics of regulation. What it lacks is a reference list. I do not understand why our policy makers do not provide references to the various topics addressed in the papers. It helps a lot as firstly it builds credibility and secondly, provides the readers a nice list of papers to read. It could have also done some empirical analysis on the subject.

Anyways, a must read paper.

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