Beyond efficiency: What should be the role of economic regulators?
11 August 2023
Members of the SR Economics team recently attended the annual ACCC Regulatory Conference held in Brisbane. The theme of this year’s conference was “whether economic efficiency is enough, as the compass or true north for public policy and regulatory frameworks applying to systems and markets”.¹ As always, the conference was well attended by regulatory practitioners from across Australia and internationally.
The first plenary session of the conference was titled Beyond Efficiency in which the speakers were invited to explore whether economic efficiency should continue to be the sole objective pursued by economic frameworks and economic regulators in Australia; or alternatively, whether the remit of regulators should be expanded to include objectives, such as improved affordability, enhanced environmental outcomes or greater social equity. The chair of the session submitted that this topic is of increasing significance given that across all regulated industries, there are growing challenges arising from innovation and uncertainty and therefore it is timely to pause and test how regulatory frameworks are adapting under these circumstances.
This note provides a short summary of the arguments made both for and against the proposition and makes some additional observations.
Two of the three speakers argued in favour of expanding the objectives of Australia’s regulatory frameworks so that economic regulators are guided by an efficiency-plus set of objectives. Reasons proffered by these speakers included:
That the challenges arising from innovation and uncertainty across all industries mean that economic regulators (such as the ACCC and the Australian Energy Regulator (AER) should consider more issues than just economic efficiency.
That a focus solely on economic efficiency means that economic regulators focus on how consumers should behave as opposed to how they actually behave when making decisions. That is to say that the current economic frameworks applying to essential services are deficient because they assume that consumers are rational.²
That in markets such as energy, which must make an unprecedented transition to renewables, the thinking of regulators must go beyond the traditional notions of efficiency and that greater focus must be given to coordination risks and energy governance.
That every pricing decision made by an economic regulator for an essential service has equity implications for consumers. Hence, regulators should focus on maximising economic efficiency plus equity.
Technological innovation is making markets and purchasing decisions more complex and challenging for consumers and that consumers often suffer from having too much information, much of which is complex, conflicting and of low quality.
One of the speakers argued the merits of regulatory frameworks to require economic regulators to focus solely on maximising economic efficiency³ noting that the concept of economic efficiency is not just about minimising the cost of production, but rather to maximise overall social welfare. Overall social welfare is a broad concept that includes maximising economic well-being, satisfaction and prosperity.
This speaker also noted that regulatory intervention is only justified when there is clear evidence of market failure and that in the case of Australia’s natural monopoly industries (such as energy, water, transport and telecommunications) the market failure identified was that prices and output levels were being set at levels which diminished total social welfare. Accordingly, regulatory frameworks for these industries have been established to promote economic welfare so as to promote the long-term interests of consumers taking account of incentives to invest.
Additional arguments made in favour of economic efficiency being the sole objective of Australia’s economic regulators and economic frameworks applying to natural monopoly industries included:
Regulatory agencies should not perform the role of elected Government officials in seeking to redistribute society’s resources from one group to another. The pursuit of equity and social justice objectives are most appropriately pursued by elected officials that are accountable to their constituents.
Making regulators accountable for equity, social justice and environmental protection issues risks duplication of accountabilities with elected Government officials and other branches of government with the potential for conflicting regulations and policies, and for scope-creep by regulators.
There is overwhelming evidence that the most effective organisations (both public and private) are those that pursue a single objective, rather than multiple (often competing and poorly articulated) objectives.
Reflecting on the arguments made at the ACCC conference on this important topic (and reviewing some of the literature referred to by the speakers) it is our view that there is simply not a compelling case to expand the remit of Australia’s economic regulators to pursue objectives other than economic efficiency. This is for several reasons.
Technological innovation and uncertainty are nothing new; they are an ever-present feature of all markets, and it is not clear why heightened levels of innovation and uncertainty at this time justify economic regulators having an expanded role in relation to issues such as equity, social justice and environmental protection. Indeed, technological innovation presents opportunities for market actors (firms and consumers) to address these issues and potentially avoid the inevitable costs that come with government or regulatory intervention.
Those in favour of expanding the remit of economic regulators appear to give little acknowledgement to the fact that economic regulatory frameworks operate in addition to other policy instruments that serve to address issues, such as equity, social justice, and environmental protection; while non-economic regulators operate to address other issues, such as supply chain co-ordination risks, consumer safeguards and industry governance risks. For example, in the face of escalating electricity prices, which are partly a function of regulatory decisions by the AER, the Commonwealth Government announced as part of the 2023/24 Budget a range of measures aimed at ensuring equitable outcomes for Australian households and businesses, such as the Household Energy Upgrade Fund and changes to the Nationwide House Energy Rating Scheme. Similarly, the Australian Communications and Media Authority (ACMA) is responsible for administering a range of consumer safeguard initiatives to ensure that consumers are well-informed and that all Australian households and businesses can access a broadband connection. Furthermore, economic theory suggests that the most efficient mechanism to fund social equity initiatives is via a broad-based tax and transfer scheme.
While it is acknowledged that economic regulators are knowledgeable about the industries they regulate, there is no evidence to suggest that they are better placed than other regulators or policymakers to address issues of social equity, social justice, environmental protection, supply chain co-ordination or consumer safeguards that may be relevant to those industries. In this context, it is noted that Australia’s economic regulators are important contributors to the wider policy-making process at both the State and Commonwealth levels of government.
Proponents in favour of expanding the remit of economic regulators often point out the deficiencies inherent in existing regulatory frameworks. However, they do not explain why giving economic regulators an expanded role will overcome these deficiencies. Also, to the extent that all regulatory frameworks are imperfect, and impose costs on society, it would not be unreasonable for one to ask why the role of economic regulators should not be scaled back as opposed to expanded.
As noted by one of the speakers at the conference, some objectives (such as maximising social equity and economic efficiency) conflict with one another and where this is the case it may be impossible to achieve one objective without sacrificing the other. Proponents in favour of expanding the role of economic regulators remain silent on how this conflict would be dealt with and why economic regulators are better placed to deal with these conflicts than elected officials or other branches of government.
In summary, the case for economic regulators, such as the ACCC and the AER, to focus solely on maximising economic efficiency³ in regulated industries remains valid. Regulatory practitioners should caution and argue against scope creep by economic regulators into areas such as social equity, social justice, and environmental protection. This does not mean that economic regulators should not acknowledge and consider these issues where relevant to maximising economic efficiency, but rather economic regulators should not seek to promote these other issues at the cost of maximising economic efficiency.
¹ ACCC/AER Regulatory Conference agenda – 2023; 2023 ACCC/AER Regulatory Conference 2023
² The first speaker referenced this paper when making this point. Ben-David. R., 2000, The case for re-creating the energy market, see 2006-The-case-for-re-creating-the-energy-market.pdf (monash.edu)
³ Kumareswaran. D., 2023, Should economic regulators pursue other objectives such as equity and social justice, in addition to efficiency? See Economic Regulation: Beyond Efficiency? - Frontier Economics (frontier- economics.com.au)