Regulatory Governance: Issues & Trends

Regulatory Capitalism, Meta-Regulation and Accountability for Regulation

Note prepared for Warwick Law School/Law Commission Symposium on Law Reform and Regulation

Colin Scott

Dean of Law and Professor of EU Regulation and Governance, University College Dublin

1.     Introduction

The financial crises which have enveloped much of the industrialised world since 2008 are only the latest incidents to cause policy makers and academics to question the effectiveness and desirability of dominant models of regulatory governance. Whilst there is widespread disenchantment there is little consensus on either the causes of problems with regulation nor on the possible solutions. It is more or less inevitable that in a crisis vulnerable governments should assert the needs for more stringent regulation and, at least implicitly, attribute responsibility for failures to weaknesses in control. This is not the only way to think about the problem. A precisely converse position would be that market actors placed too much dependence on regulation to guide their behaviour (‘unless it is prohibited I can do it’), taking insufficient responsibility for knowing what they should do upon themselves. There is, of course, a degree of oversight of regulatory policy and strategy. Better regulation policies have tended to focus chiefly on traditional forms of rule making and have not been so strong on encourage the search for effective alternatives to classical regulation.  Law reform policies are not yet well equipped to address general regulatory issues (Brown and Scott 2011).  In this brief note I discuss a variety of conceptions of regulation which underpin the discussions about the appropriate role of government and regulation in steering behaviour with some consideration of the implications for accountability of regulatory regimes.

2.     Conceptualising  Regulatory Governance

Perceptions of weaknesses and strength in regulatory governance will depend in part on what we call regulation. Much ink has been spilt in developing contrasting definitions of regulation (Black 2002). These range between the narrowest concept of a statutory instrument to analyses of processes of control involving rules and/or the state through to the broadest perspective taking in all forms of social control (Baldwin, Scott and Hood 1998). My own view is that different concepts of regulation may be appropriate for different purposes and, that for the purposes of law reform, it may be helpful at least to start from Selznick’s often cited and relatively narrow conception of regulation

‘as sustained and focused control exercised by a public agency over activities that are valued by a community’ (Selznick 1985: 363).

How is control achieved? Regulation scholars increasingly think of the ambitions for control associated with regulation as comprising three elements – some norm reflecting the goals, objectives, rules or standards around which a regime is organised, some mechanism for detecting deviations from the norm and some mechanism for correcting deviations (Figure 1).

Selznick’s concept of regulation, drawn from long-standing American experience with independent regulatory agencies at state and federal  levels, can be mapped on to a range of key issues as to who does what to who and how (Table 1). The classic regulatory model, involving agencies monitoring and enforcing by reference to legal rules is shown, alongside models of delegated and pure self-regulation.

Model	Set Norms	Instrument	Monitors	Enforces	Legal Basis	Enforcees	Example
Classic	Legislature/ Ministers	Primary/ Secondary Legislation	Departments/ Agencies/LAs	Agencies/Local Authorities	Criminal/ Administrative Law	Businesses	Unfair Commercial Practices – OFT/Local Authorities
Delegated Self Regulation	Prof/Body/ SRO	Statutory Codes	Prof Body/SRO	Prof Body/SRO	Administrative Law	Businesses	Broadcast Advertising - ASA
Self-Regulation	Prof Body/SRO	Codes (Contract)	SRO	SRO	Contract	Businesses	ABTA Code of Conduct

Table 1 Regulatory Models and Roles

3.   Weaknesses in Regulatory Governance

If we take Selznick’s definition of regulation as a starting point it is possible to outline a range of widely identified weaknesses with regulatory governance. These weaknesses are partly to do with the capacity of regulatory agencies to exercise controls over others because of limited authority and information, partly about risks regulatory power will be used to pursue private interests of regulators and regulatees, and are lastly focused on concerns about limits to democratic participation in and accountability for regulatory activity.

a.     Capacity

Regulatory capacity is concerned with having the resources necessary to exercise control. Following the classic NATO analysis associated with Christopher Hood these resources can be identified as nodality, authority, treasure and organisation (table 2).

Table 2 Regulatory Resources . Source adapted from  Hood 1984; Hood and Margetts 2007.

The concept of nodality focuses on the importance of both the collection and dissemination of information for steering behaviour. Economists have long recognised that regulators may suffer from information asymmetries where regulatees know a great deal more about such matters as costs than do the regulators.  The significance of soft mechanisms of steering which deploy information probably remains under-stated both in policy and scholarly literatures. Weaknesses in knowledge of regulators may extend beyond information per se  to generate an epistemic or cognitive dependence on regulatees in understanding what is thinkable and doable within a particular regulated sector (Hardwig 1985; Power 2003). Turning to authority, the Canadian administrative lawyer, John Willis, coined the phrase ‘governments in miniature’ to capture the authority capacity of North American regulatory agencies to make, monitor and enforce legal rules within a single agency (Willis 1958). Within most Westminster systems of government regulatory agencies typically lack the authority both to make rules and to apply formal sanctions directly and, indeed, Canada experienced a retreat from the US model in the second half of the twentieth century (Doern and Schultz 1998). Accordingly most regulatory agencies are dependent on legislatures (for which read governments) for new or adapted legal rules, and on the agreement of courts for the formal enforcement of rules. The exceptions to these significant capacity limits, for example the power of the Financial Services Authority to make detailed rules, or the Office of Fair Trading to levy fines in respect of breaches of competition law rules, constitute exceptions to the more normal constraints and, like the counterpart powers of American independent agencies are hedged around by significant and potentially onerous procedural requirements. The point here is that while regulators may take on a purposive approach to their tasks, considerations by legislatures and courts as to how they should respond to regulator seeking rules or sanctions are likely to be tempered  by very different considerations (Scott 2001) . The resource position of regulatory agencies in terms of finances and organisational capacity varies by sector and across time. Clearly few regulators have unlimited resources. Many regulators develop enforcement strategies which emphasis negotiation of compliance with businesses in part because this conserves resources, enabling them to spread enforcement efforts over a wider range of businesses.

b.    Interests

There has been long-standing anxiety that the concentration of regulatory power in agencies may encourage businesses to seek to steer the use of regulatory power for their private purposes. Theories of regulatory capture are well established and involve ideas either that regulatory regimes are established with a view to protecting narrow private interests (Kolko 1965; Stigler 1971)  or that the close relationship between regulatees ad agencies makes it likely that regulators will come to understand and sympathise with the problems of regulatees, and reduce the stringency of regulation (Bernstein 1951; Grabosky and Braithwaite 1986). The latter scenario is supported by evidence that senior officials from regulatory agencies, in some jurisdictions, tend to secure employment with firms they used to regulate, arguably rewarding them for applying rules with reduced stringency (Makkai and Braithwaite 1992). The phenomenon of the ‘revolving door’ is termed amakaduri, or ‘descent from heaven’ in Japan (Colignon and Usui 2003).

c.     Democracy

A third set of concerns with classic models of regulation is that they operate at one remove from democratic governance. Indeed, theories of credible commitment associated with the establishment of regulatory agencies argue that a central objective of establishing regulatory agencies is to reduce the extent to which regulatory decision making may be subject to political intervention (Thatcher 2002). This has had particular importance in network industries where the capacity to secure long term investment in energy and communications infrastructure is premised on a belief among the firms and investors that the regulatory regime will be relatively stable and not subjected to political opportunism. A distinct argument in favour of putting regulatory decision making at one remove from politics is that this enables agencies to build up and deploy expertise which is not typically available in general civil service departments (Everson and Majone 2001). On these analyses the lack of democratic engagement with agencies is a virtue. However some question the extent to which regulatory decision making can really be neutral or apolitical, for example highlighting the distributive consequences of decisions concerning such matters as pricing of services or the broad impact of environmental decision making (Prosser 1997). A distinct democratic concern from the question who makes and applies regulatory rules, applying both to public and private regulators,  lies with their accountability to public bodies for their actions. Accountability for regulatory decision making is a perennial concern (House of Lords Select Committee on the Constitution 2004).

4.     Regulatory Capitalism and Meta-Regulation

From the perspective of critiques of the classic agency conception of regulation, concerned with capacity, interests and democracy, alternative ways of conceiving regulation have much to commend them. Regulatory capitalism recognises the diffusion of capacity and a high degree of interdependence which is in turn suggestive of a move beyond control to models of regulation based more in learning (Scott 2010). The literature on regulatory capitalism acknowledges the growth in regulatory forms of governance (more rules, more arms-length agencies and so on) but suggests that the growth in private regulatory capacity is at least as important (Braithwaite 2008; Levi-Faur 2005) . Public and private capacity relevant to regulation are seen as parallel and interdependent phenomena. To the extent that such an analysis proves correct it clearly has implications across the range of issues briefly addressed in this note.

a.     Capacity

Within the perspective of regulatory capitalism any assumption that regulatory capacity lies only with government and its agencies is abandoned. The state is de-centred (Black 2001). The challenge for regulatory capacity lies in an understanding that a wide range of organisations have substantial autonomy vis-a-vis one another. Rules can be made and enforced using bilateral or associational contracts. The big supermarket chains might be seen as important for the regulation of food safety and quality as the Food Standards Agency or local authority regulatory officials. Monitoring can be carried out by purchasers, self-regulatory bodies or third parties. Third party monitoring might be purchased under contracts (Blair, Williams and Lin 2007) or mandated under legislation, as with money-laundering reporting requirements on banks and professionals, or immigration control duties imposed on airlines (Gilboy 1997). Governmental and private actors may each been seen as having regulatory objectives within their sectors with no priority given to the governmental definition of the public interest. On this analysis the challenge is to identify who has the capacity to set objectives and rules, to monitor for their compliance and to correct deviations from those norms. In some instances we may conclude that some conception of public interest can only properly be pursued through the involvement of government agencies at every stage, in other instances the configuration of interests and actors in a sector may lead to the conclusion that no public involvement is required for the generation of effective norms and mechanisms of implementation and/or that public engagement may be counterproductive (Scott, Cafaggi and Senden 2011).

b.    Interests

It is widely assumed, following Adam Smith, that the establishment of private governance capacity is always directed towards pursuing the private interests of those involved. However, there are many examples of private regimes which have long been accepted as operating in the public interest. Perhaps the most numerous are those involved in the setting of technical standards by national and international standardization organisations and the numerous more specialised organisations concerned with such matters as electrical standards (Brunsson and Jacobsson 2000) . The rationale for such standardization bodies is that their activities facilitate doing business by ensuring the acceptability of components & products across sectors and jurisdictions. There is a degree of alignment between the public interest in having efficient markets and the private interest in being able to participate in those markets. The line between legitimate standardization and a cartel may often be a fine one (Maher 2011). Whereas standardization regimes frequently involve a common interest, many regimes involve conflicting interests , for example concerning environmental standards. In this instance we might think that divergence of interests provides an argument for public regulation and in many cases that will be true. However, to the extent that the existence of parties with conflicting interests may have capacity to represent and argue over positions then the establishment of sites of discussion and negotiation may provide an alternative which harnesses the knowledge, interests and capacities of those involved. The scheme of Environmental Improvement Plans in Australia, which involve local stakeholders in agreeing and monitoring the plans put forward by companies provide an example (Holley and Gunningham 2006).

c.     Democracy

The idea that regulatory regimes may constitute sites of political contestation, rather than technical decision making, has particular purchase in the context of transnational private regulatory regimes (Bartley 2007), where private and public governance may be in competition and the stakes in terms of worker rights, environmental standards and so on may be high. In many non-state regimes there is at least some evidence of an evolution in decision making towards practices and norms that bear resemblance to administrative law doctrines which provide for participation and fairness for those affected by a regime. Even in highly technical regimes of standardization it is striking the extent to which good governance principles have come into play as part of processes by which lead organisations seek to manage their legitimacy (Black 2008; Schepel 2005). If the decentring of the state is to be as effective as it is inevitable then it is arguable that more work needs to be done both to stimulate organisations with regulatory capacity towards one or more forms of democratic decision making and to understand the variety of forms which such decision making might take. The distinct questions of accountability for regulation find some answer in the model of regulatory capitalism which recognises that diffuse capacity within regulatory regimes leads to a form of interdependence between regulators, regulatees and others with relevant capacity (Scott 2000). This interdependence is exploited in the model of meta-regulation discussed in the next section of this note.

5.     Meta-Regulation & Accountability

No doubt there are many spheres of regulatory life where the state retains a central role. This note discusses claims that in many regimes non-state capacity is also significant for effective and legitimate regulation and in others the state has less significance. Such an analysis suggest that governments and state agencies might be more effective were they more modest about what they could achieve directly. Such regulatory modesty involves an inquiry into the variety of ways in which behaviour might be steered. Where regulatory capacity substantially lies with others the concept of meta-regulation offers a valuable way for thinking about the potential for indirect control and for stimulating learning in target organisations (Parker 2002). The analysis  has been extended beyond what we might think of as self-regulation to apply also to the self governance of companies (Parker 2007; Scott 2008). For reasons of space I do not address corporate governance issues in this note.

 In this context meta-regulation refers to the regulation of self-regulation (Parker 2002). The potential of meta-regulation and related forms of regulatory experimentation lies in the ways it encourages groups with regulatory capacity, such as firms, trade associations and professional bodies, to learn about and implement regimes of self-governance, whilst being held accountable for those self-regulatory activities (Gilad 2010). Examples have emerged in the UK in the oversight of both medical and legal professions. The Council for the Regulation of Health Care Professionals (to give the Council for Healthcare Regulatory Excellence its statutory name) was established in 2003 to oversee a wide range of statutory regulatory bodies each of which has a significant self-regulatory element. Key powers include the capacity to monitor and investigate performance and to recommend changes, and refer outcomes of disciplinary cases to the courts where outcomes are judged to be unduly lenient  (National Health Service Reform and Health Care Professions Act 2002, ss 26-29).In similar fashion the Legal Services Board is a statutory overseer of the self-regulatory capacity (some of which is underpinned by legislation) for the legal profession in England and Wales. The Legal Services Act 2007 required the professions to separate their regulatory and representative roles and provides for meta-regulatory oversight of the former by the Legal Services Board.  

Whilst the oversight of self-regulation in the medical and legal professions  show examples of explicit, statutory meta-regulation, other examples may be implicit. It is widely recognised, for example, that the Advertising Standards Authority, established in 1961 to provide sufficient self-regulation of the advertising industry to bolster its reputation in the face of criticism of its techniques, has been subjected to advice and warnings from government on a number of occasions which required enhancements both to the substantive and procedural elements of the regime. Such enhancements where bargained for in the shadow of legislation (Baggott and Harrison 1986). It is significant that advertising self-regulation is also bolstered by participation in a European network, coordinated by the European Advertising Standards Alliance, which has given it significant credibility within the EU (European Commission 2006).   Self-regulatory bodies for the press sector have periodically been encouraged to raise their game with discussion by government ministers of ‘the last chance saloon’ and similar threats. In Ireland and Press Council and Press Ombudsman were established by the industry in 2008 under coercion from a government threatening legislation. Further sophistication was added to this implicit steering through provision in the Defamation Act 2009 (s.44) that the minister could give statutory recognition to a press council provided that it complied with minimum requirements for a scheme of self-regulation set out in Schedule 2 of the Act.  Statutory recognition confers various benefits on the scheme and its members, including qualified privilege for its reports.

The technique of giving statutory recognition to self-regulatory codes which comply with minimum standards is, of course, not new. It was, for example, one of the unexpected successes of the (now superceded) Fair Trading Act 1973, as it encouraged a wide variety of trade associations to develop and enhance their self-regulatory regimes in order to secure recognition from the Office of Fair Trading . The Unfair Commercial Practices Directive includes amongst its misleading actions ‘non-compliance by a trader with commitments contained in codes of conduct by which the trader has undertaken to be bound’ where the trader has undertaken to be bound by a code and its commitments are not simply aspirational (2005/29/EC, art 6(2)(b)). Such actions are criminalised both in Ireland and the UK (Consumer Protection Act 2007 (Ireland), ss45, 47, Consumer Protection from Unfair Trading Regulations  2008, SI no 1277/2008, regs 5,9.). This oversight does not set any minimum requirements for self-regulatory codes, but rather holds businesses to their commitments to follow them.

6.     Conclusions

Any attempt to work out appropriate regulatory responses to policy problems is likely to be shaped both by conceptual understanding of regulation, and the understanding the makeup of the targeted sector. The approach set out in this brief note suggests it is worth taking time to puzzle over issues such as the distribution of regulatory capacity and then to find ways to harness and oversee that capacity, whether it is held by government, associations, firms or NGOs. Such an approach has potential to engender stronger engagement between the variety of stakeholders within any regime and, arguably, a better understanding of the regime through which to achieve a degree of accountability. The approach has potential to address not only issues of capacity, but also the scope for alignment between public and private interests and regulatory regimes, and issues of democratic participation and accountability.

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LAW-AND-ECONOMICS: LESSONS FOR THE REGULATION OF TAXIS AND PRIVATE HIRE VEHICLES

Anthony Ogus

Emeritus Professor, University of Manchester

Paper to be presented at the Symposium on Law Reform and Regulation, University of Warwick, 14 September 2011

1. What is “law-and-economics”?

Law-and-economics involves the application of economic theory and methodology to legal principles and institutions, in order to predict the behavioural response of individuals and firms to different legal forms – the positive dimension - and to evaluate the capacity of different legal forms to generate economically preferable (generally referred to as “allocatively efficient") outcomes – the normative dimension. The focus of most of the early law-and-economics literature was on private law. Nevertheless the University of Chicago, where the origin of law-and-economics is to be located, was also a prime mover in the critical evaluation of public law, in particular regulation. Economists there had remained hostile to Keynesian arguments for state intervention. They sought to show that regulatory structures were not conducive to efficient outcomes. The private interest theory of regulation which emerged seeks to explain how politicians and bureaucrats may be motivated to meet the demands of interest groups for regulation of a particular form. The basic idea is that regulation is a commodity made available in the political “market-place” and “supplied” by politicians and bureaucrats by reference to the demand of those who will benefit from its promulgation.

            Such an approach proved to be valuable for lawyers who, perhaps naively, had tended to assume that government was predominantly well-intentioned in its approach to regulation, attempting to generate outcomes consistent with the public interest. In their view, if regulation failed, in general this was because it was insufficiently stringent or inadequately enforced. Private interest analysis was an alternative and tool for understanding regulatory failure. But there was a danger of oversimplifying the debate in the light of such analysis. The policy solution could not always be a crude abolition of interventionist measures since in many areas there existed a significant degree of market failure. The question then became one of investigating whether the measures could be adapted to meet the failures at lower cost - in short, whether a more sophisticated analysis could lead to more efficient solutions.

            To meet this challenge, mainstream law-and-economics, which hitherto had applied standard price theory, transaction-cost analysis and organisation theory primarily to private law institutions and principles, developed a new branch of public interest analysis, sometimes referred to as “progressive law and economics” The new approach involved a three-stage inquiry into the market for particular products or services: first, there was a need to identify and explain instances of market failure; secondly, alternative methods of correcting the failure had to be investigated; thirdly, the predicted response of actors to the different methods had to be assessed, with particular attention to the minimisation of administrative costs, notably information and enforcement costs. Such analysis can lead to the selection of optimal regulatory forms, that is regulatory principles and institutions which can meet the goals of regulation at lowest cost; it is the focus of this paper.

2. Justifying Regulation

Regulation deals with a huge variety of industrial and non-industrial activities and involves a multitude of different legal forms. The choice of an appropriate regulatory instrument must, in the first instance, depend on the justification for the intervention. Once the justification/s has/have been identified, the policy-maker must then consider the advantages and disadvantages, primarily in terms of costs, of different legal instruments.  In the light of those considerations, the task is to select the instrument which can meet the regulatory objective resulting from the justification(s) at lowest cost.

            Logically regulation should only exist where the unregulated market will fail to reach the desired outcomes. Let us begin with the classic instances of market-failure. The first category comprises monopolies or other significant impediments to a competitive market and regulation deemed to necessary to correct this kind of failure is generally referred to as “economic regulation”. The other categories which give rise to “social regulation” centre on (1) inadequate or asymmetrical information affecting the relationship between suppliers and consumers or (2) externalities (spillover effects) whereby activities affect third parties in ways not reflected in the prices set by producers. To these can be added (3) co-ordination problems where, though desired outcomes can in principle be achieved by private transactions, the costs of co-ordination are so high that it is cheaper for the law to prescribe appropriate conduct.

            If these are the key instances of market failure, phenomena which hinder wealth-maximisation within a society, we should be aware that governments may wish to regulate for other, non-economic, reasons. These can be very varied but two stand out as being particularly important. First, the unregulated market may lead to outcomes which do not accord with what is perceived by government to be a just or fair distribution of resources. They may wish, then, for regulation to intervene on grounds of distributional justice. Secondly, governments may believe that, in particular markets or instances. individuals are assumed not to be good judges of, or are not trusted to act in accordance with, what is in their own best interest. Such regulation may be referred to as paternalist. Note that whereas the classic instances of market failure can, in principle and on the assumption of adequate data, be assessed objectively, the non-economic justifications for regulation are crucially linked to ideological and political values.

3. Selecting Regulatory Forms: Traditional Instruments

a) Efficiency and costs

There are many regulatory instruments and no consensus on how they should be classified. To illustrate the law-and-economics approach, we can take a brief look at some of the main forms used for social regulation and see how their appropriateness can be judged by reference to the goal of allocative efficiency. More specifically, the aim is to minimise three sets of costs. In relation to a particular market for goods or services, these are: the costs arising from the unregulated market; the costs to industry of complying with the regulation; and what may be called “tertiary costs”, mainly the administrative costs arising from the regulatory intervention. Minimising the first two of these sets involves balancing the benefits arising from the intervention, in terms of reduction of social losses, against the primary cost, that to industry in preventing or abating the harm, as required. That gives us the notion of optimal harm reduction.

            For regulatory policy-making purposes, and from a law-and-economics perspective, minimising the third set of costs is the most challenging and perhaps the most interesting task. What are to be included in tertiary or administrative costs? Clearly account should be taken of the cost of formulating and implementing a particular instrument, and that includes also the acquisition of information necessary to do this effectively. Then there is the expenditure incurred in monitoring behaviour to ensure compliance and, if necessary, engaging in formal enforcement procedures. There are also some less obvious, but no less important, consequences which may be relevant to the selection process. First, different instruments have different incentives for technological development, for example for industry to evolve new and cheaper techniques for risk-abatement. Second, as private interest theory has been so quick to reveal, some instruments impede competition and thereby create significant welfare losses. Finally, instruments vary in the extent to which they can be well targeted on particular phenomena and regulatory goals, thereby potentially creating what may be described as error costs.           And so to a survey of the traditional forms of social regulation.

b) Licensing

The most interventionist approach involves a system of prior approval. This prescribes that firms, before lawfully engaging in an activity or supplying a product or service, must first obtain a licence or permit from an authorising agency; and for such approval they have to satisfy the agency that certain conditions of quality meet the regulatory goal. The administrative costs of scrutinising all applications is very high and to these must be added the opportunity costs arising from any delay before the licence is granted. Moreover, significant welfare losses arise if the system is used, within the industry, for the anti-competitive purpose of creating barriers to entry. The benefits from prior scrutiny must therefore be very large to justify, on public interest grounds, these substantial costs. Such benefits may include the weeding out ex ante of notoriously unfit suppliers and, as we shall see, when discussing the licensing of taxi services, the ability to enforce regulatory compliance by the severe penalties of suspension or abrogation of licences.

c) Standards

            The mandatory standards technique allows the activity to take place without any ex ante control but the supplier who fails to meet certain standards of quality will be subject to penal or administrative sanctions. Standards can be subdivided into: performance (or output) standards requiring certain conditions of quality to be met at the point of supply, but leaving the supplier free to choose how to meet those conditions; and specification (or input) standards compelling the supplier to employ certain production methods or materials; or prohibiting the use of certain production methods of materials. The most important economic variables in choosing between these types of standards are the costs of being informed on the technological means of achieving the regulatory goals, and the administrative costs of formulating appropriate standards and monitoring compliance. In principle, firms should be given choice as to how to meet the goals, since that encourages innovation in risk abatement. Hence there is a presumption in favour of less interventionist measures. However, the benefits of such measures might be outweighed by the costs of administering them and/or the costs to firms of acquiring information on the appropriate technology.

d) Information disclosure

            Rather than impose standards on suppliers, forcing them to adopt optimal loss abatement, legislation may simply require that they disclose to purchasers and others information regarding harms or risks which may arise from the activity or product. If regulation forces suppliers to reveal adequate information as to quality/safety, on the basis of which consumers can exercise choice, market transactions will ensure that preferences are met; and there will be no welfare losses from consumers being deprived of choice, as can occur under a standards regime. Moreover, mandatory disclosure will reduce costs where the consumer is the least cost-abater, notably by responding to published warnings. The administrative costs of formulating and enforcing disclosure rules are also relatively low, given in particular that policy-makers do not themselves have to determine optimal levels of loss abatement.

            On the other hand the potential application of this technique is limited since not all those affected by the product or activity will receive the information and be able thereby to adapt their behaviour. Moreover, even within the narrower group of purchasers who can use the information there may be problems. It may be impossible to summarise the necessary information in a form which the great majority will read and understand. The “bounded rationality” of individuals may constitute a further obstacle: there is evidence that individuals tend to overestimate risks associated with low-probability events and underestimate those arising from higher-probability events. Given the often significant costs to purchasers of assimilating information and making decisions, it may be cheaper to force suppliers to adjust the product or service to what purchasers would presumptively have chosen if those intellectual processes had been completed. This solution may be particularly apposite where the costs arising from consumer error are high, for example where death or serious personal injury may result.

4. Selecting Regulatory Forms: Newer Instruments

In the last two decades, there has been much discussion, and some exploration of alternatives to traditional social regulation. Economic analysis has played a significant role in the debate. Technological advance has perhaps led to the most important criticism of traditional regulatory forms which attach directly to the activity of firms. If such activity-based intervention is to be successful, the agency must be able to understand and evaluate latest developments. One consequence of a heavily prescriptive regime is that the regulatees have little or no incentive to develop or discover cheaper means of meeting the regulatory goal. Another is that, given the diversity of activities and techniques which must be controlled, traditional “rule-books” become very detailed and bulky; and hence give rise to heavy administrative costs.

Economic reasoning suggests that regulation is likely to be improved if decisions relating to activities and products can be taken closer to their production than is usually possible with command-and-control regulation and if regulatory mechanisms can be harnessed to market-based incentive structures. Here we examine two regulatory forms designed to meet these goals: fiscal instruments and co-regulation.

a) Fiscal instruments

         The idea of correcting or internalising negative externalities by the imposition of financial charges or taxes on the responsible individual or firm has gained much currency in the recent debate. Advocates of regulatory taxes claim for them the principal advantages that they reduce information and administrative costs because, to secure an optimal level of abatement, the regulator need have no knowledge of a firm’s compliance costs. Also taxes create incentives for technological innovation, since the firm is free to explore different ways of minimising the financial charges.

On the other hand, the idealised tax systems envisaged in the economic models give rise to a number of difficulties. First, to set the optimal tax, regulators must have adequate information on the total social costs generated by the activity. While they may proceed by estimates, adapting tax rates on an iterative basis as the effect of the instrument becomes known, this generates uncertainty and thus increases planning costs. Second, the collection of financial payments involves substantial administrative costs. Third, while the regulatory objective will be met if the activity of the firm is price-elastic and thus behaviour changes in response to the charge, inelasticity will hinder this outcome, because the firm’s preference will be for paying the charge. Since governments benefit from greater revenue, officials may prefer the latter, thus distorting the regulatory objective.

b) Co-regulation

         For the purposes of traditional regulation a public agency formulates the rules and enforces them against industry. Under a system of self-regulation, the state delegates part or all of the rule-formulating and enforcement functions to agencies representing the regulated industry. In terms of private interest theory, this might seem to imply “capture” in its most complete form, but there are, nevertheless, some powerful public interest arguments for self-regulation. In particular: self-regulating agencies normally have greater technical expertise than public agencies - the costs of formulating and interpreting standards tend therefore to be lower; interaction between self-regulating agencies and the firms should involve mutual trust - thus there should also be a lowering of monitoring and enforcement costs; and self-regulating systems should involve less formalism, thus involving savings in administrative costs.

         The challenge is then to devise institutional arrangements which retain the advantages of low-cost rule formulation and enforcement but involve some degree of public accountability, to constrain private interest influence. In some areas “co-regulation” has emerged: self-regulatory agencies, or firms themselves, issue, and sometimes enforce, rules but with a degree of oversight from, or participation by, public agencies.

5. The Regulation of Taxis and Private Hire Vehicles

“The taxi trade should be a model of textbook economics. There are lots of sellers (drivers), lots of buyers (passengers) and low barriers to entry (the price of care). It isn’t. Throughout the world the trade is distorted - by government rules, monopoly, political lobbies, mafias, racial exclusiveness and every other sin in the free marketeer’s book.” (The Economist, 22 December 1990)

a) Justifications for regulation

Taxicab regulation provides an excellent example of the law-and-economics approach to regulation. There are significant variations between regimes in different jurisdictions and allegations that many of them are ill-targeted and/or excessively restrictive on the supply of services (OFT, 2003). The relevant market failures justifying regulation are, however, not difficult to identify.

            The main problem is that of information. Customers hailing a vehicle in the street almost certainly have insufficient information about the quality and reliability of service being offered, and – in the absence of regulated fare tariffs – the same will be true of prices. Note that these failures are less likely in relation to services which are the subject of pre-booking, since then the customer has the opportunity to acquire some of the relevant information and, indeed, to compare what is being offered by different suppliers. Thus we would expect different regulatory regimes as between taxis and private hire vehicles which cannot be hailed in the streets.

Externalities are also likely to be present. The poor quality of services supplied can affect third parties, that is individuals other than those hiring and paying for the service. Also taxi services can significantly add to problems of congestion and give rise to other adverse environmental effects. Of course, these arguments apply to all road users, but regulation designed to deal with other problems may take account of such external costs. Note too that potentially there may be external benefits, as well as external costs, since taxi services may contribute to, or be a partial substitute for, public transport, and hence play a part in the local infrastructure. Reference is also sometimes made to the fact that taxi services are insufficiently competitive. However, this is invariably a consequence of regulation rather than of market conditions. Let us now examine the regulatory forms typically used to correct the acknowledged market failures.

b) Licensing

Regulatory systems invariably require that both taxicab vehicles and their drivers are licensed. It follows that many of the standards involved in vehicle and driver quality controls – see below - have to be verified and satisfied prior to any lawful supply of the service. The administrative costs of such an ex ante scrutiny system, combined with those of monitoring ex post, are very high. As regulation theorists have been telling us for some time, there is also the risk that standards imposed under such a system are used to limit the number of suppliers, even though these standards are ostensibly designed only to control quality (Ogus and Zhang, 2005).

What then are the justifications for the use of this method of quality regulation? There is, of course, the familiar assertion, considered above, that ex ante measures serve to prevent harm whereas ex post measures can only hope to deter it; and notoriously unsuitable vehicles and drivers can be weeded out at an early stage. But the most powerful argument for the licensing technique is probably that based on enforcement considerations (Gallick and Sisk,1987). The capital invested and acquired in licence plates by licence-holders operates as a bond which the latter will forfeit to the authority should they, or the vehicle, fail to comply with the quality standards imposed. Reliance on the ex post infliction of financial penalties in an unlicensed regime may generate insufficient incentives for compliance, especially where the probability of apprehension is relatively small and the resources available to pay the penalties are limited.

c) Quantity controls

Limiting the number of taxicabs permitted to ply for trade is the most direct form of entry control. It has been a feature of most regimes and still operates in many jurisdictions. Given the adverse effects generally attributed to quantitative controls, limiting the availability and variety of services, and enabling supra-competitive profits to be earned, strong public interest arguments are necessary to justify them. “Excessive competition”, by itself, has little meaning and if the concern is rather with possible deteriorations in the quality of the service, these can be addressed by means other than quantitative controls (OFT, 2003). The same applies to important externalities such as road congestion and pollution.

            Where regulation has imposed quantitative limits, it has often conferred considerable discretion on the authority responsible for issuing licences. And such power is obviously open to abuse, encouraging corruption or at least capture by rent-seeking individuals.

            There are some quantitative measures which seem to proceed on the assumption that the supply of taxis in a free market will not match demand, although it is difficult to find support from economists for the proposition. In any event, why should regulators be able to assess supply and demand better than those exercising the particular trade? Take, for example, peak demand periods. Regulating the quantity of supply to meet this problem is almost impossible, while in an unregulated market vehicles which have other functions during off-peak periods can enter to meet the demand, the result being reduced costs and prices (Australian Trade Commission, 1999).

d) Price controls

Where road space is very limited and congestion is a major problem, price controls can be used to regulate the demand for taxis relative to that for other forms of transport (Yang et al, 2000). Indirectly this amounts to a pricing of road use, justifiable by reference to externalities. But there are several more traditional economic arguments justifying price controls (Frankena and Pautler, 1986). First, demand for the services is inelastic since a customer hailing a cruising cab will not be able, at low cost, to compare the price offered with that of an alternative supplier; and the same applies at a taxi stand insofar as there is in operation there a “first-in; first-out” allocation scheme. In addition, the costs of bargaining a fare may be unduly high, or such as to enable the supplier to exploit the customer.

Of course, these arguments do not apply where cabs are hired by telephone or otherwise in advance, hence the separate regime for private hire vehicles. Further, it may be possible to dismantle allocation practices at stands enabling customers to exercise freedom of choice in that context (Seibert, 2006). Deregulation of price controls may then be possible, provide that customers have sufficient information as to prevailing tariffs before entering a particular vehicle, and this can be achieved by a “price-posting” regime.

For vehicles hired by hailing in the street, price controls are generally desirable although, to encourage some degree of competition, these can be in the form of price-caps, rather than a mandatory tariff (OFT, 2003).

e) Quality controls

Customers hiring a taxi will normally be insufficiently informed on the safety and quality of particular vehicles and their drivers. To some extent, the problem may be alleviated where firms supplying in the market are able to develop a reputation for the quality of their service. But since it is only consumers able to identify and select cabs operated by the firm who will be able to rely on this reputation, the argument does not apply to large areas of the market. It is therefore widely accepted that safety and quality regulation is necessary. The more difficult questions are how extensive the regulation should be and what forms it should take.

Take first obligations on drivers. Uncontroversially they must have the relevant driving skills, competence in the relevant language and specialist knowledge of the area where they seek custom. But some regimes go clearly beyond what can be justified by information asymmetry, for example the driver’s dress. Also if the conditions to be fulfilled by the licence-holder are vague, such as a record of “good conduct”, there is always the risk that they can be used to restrict entry on arbitrary grounds.

Quality conditions applying to the taxicab are subject to similar considerations. The consumer information problem can certainly justify regulations concerning the installation and maintenance of meters as well as the means of identifying the cab and its driver. So obviously when they govern the safety of the vehicle. However, over-rigid specification standards can give rise to unnecessary costs which must then be passed on to the consumer (OFT, 2003); and what are we to make of regulations which, as in London and some other British cities, require that taxis conform to a certain design and appearance? No doubt they may be more easily identified and many customers may be reassured to be conveyed in the traditional format, but if cheaper designs meet their needs just as well, why should the customers pay for the increased cost?

REFERENCES

Australian Trade Commission.1999, “Regulation of the Taxi Industry”, Commission Research Paper.

Frankena, M.W. and Pautler, P.A. 1986, “Taxicab Regulation: An Economic Analysis”, Research in Law and Economics, 9: 129-165.

Gallick, E.G. and Sisk, D.E. 1987, “A Reconsideration of Taxi Regulation”, Journal of Law, Economics and Organization, 3: 117-128.

Office of Fair Trading. 2003. “The Regulation of Licensed Taxi and PHV Services in the UK”, OFT 676.

Ogus, A and Zhang, Q. 2005. “Licensing East and West”, International Review of Law and Economics, 25: 124-142.

Seibert, C. 2006. “Taxi Deregulation and Transactions Costs”, Economic Affairs, 26: 71-73.

Yang, H., Lau, Y.W., Wong, S.C. and Lo, H.K. 2000, “A Macroscopic Taxi Model for Passenger Demand, Taxi Utilization and Level of Services”, Transportation, 27: 317-340.