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“BT Director of Regulatory Affairs Cathryn Ross on the Economics of Regulation” (Two Think Minimum)

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Bob Hahn: Good afternoon. My name is Bob Hahn and I’m delighted to be doing this podcast for the Technology Policy Institute. I’m a Senior Fellow there and the podcast is called Two Think Minimum. We’re broadcasting to you today from beautiful downtown Aspen, and if you haven’t been here, I highly recommend it. It’s got a splendid view of some spectacular mountains. Today it’s my pleasure to interview, kibitz, and possibly chat with a person who’s a good friend of mine and also an eminent regulator in the United Kingdom. I’m going to say a little bit more about Cathryn Ross, but Cathryn, let me just say hi. 

Cathryn Ross:  Hi Bob.

Bob Hahn: Catherine is a very well known applied economist, she spent some time at Oxford with a good friend of mine, professor there by the name of George Yarrow and since then has moved on to greener pastures. Most recently, and I think where we met, Cathryn was head of the water agency in the UK. What’s the formal title for the water agency?

Cathryn Ross: If you see it on a Sunday, it’s called the Water Services Regulation Authority. Most of the week, it’s just called Ofwat

Bob Hahn: Do they have good water at Ofwat? 

Cathryn Ross:  Excellent. 

Bob Hahn: Good. In any event, Catherine has actually moved on from Ofwat and now has a position in the private sector. Can you say one or two words about that?

Cathryn Ross: Sure. I’m looking after regulation for a company called BT, which is British Telecom, so it’s sort of roughly the equivalent of AT&T in the UK. I look after regulatory affairs. Most of that is about regulatory affairs within the UK, so thinking about of what our telecom regulator Ofcom is doing, but actually BT’s present in more than 180 different countries, so I’m also looking at regulation across the globe.

Bob Hahn: That sounds fantastic and can we charge you for that advertisement?

Cathryn Ross: At a reasonable rate! 

Bob Hahn: Okay, great. Before taking the position with the water authority and with BT, Catherine did extensive work in the regulatory arena and worked for the Regulatory Authority there involved in overseeing railroads and we may touch on that today. She’s also done a lot of work in what the Brits call competition, but we call antitrust and we may touch on that as well. Her experience in the UK- in fact, I probably don’t know anyone who’s more experienced and also has a serious economics degree and who’s done so much in the regulatory arena. We feel very, very privileged to be able to chat with you today. And, if you misspeak at all, I understand you’re your jet lag. One of the beautiful features of recording is that we can edit the tapes. Feel free to let it rip on this very exciting subject. I thought we’d start by a just a very simple question. Could you tell me in your view, either with examples or with a definition that might be suitable for your or my class at Oxford, what the heck is economic regulation?

Cathryn Ross: This is a really good question and I suspect we could probably spend about two hours just talking about this. I’m going to kind of boil it down to two schools of thought on this. The first is really a school of thought that concentrates on the economic regulatory toolkit and tends to see it in quite a sort of narrow and purest way. They would characterize economic regulation as already being about the process of setting price controls and quality standards and the process of enforcing licenses. And that is certainly an awful lot of what economic regulators spend their time doing. But there is a different school of thought, and that is taking a much more broader view in a sense, more of a sort of teleological view, and thinking about what economic regulators are there for. I think if you look at it through that lens, you quickly realize that economic regulators play a key role essentially in aligning the interests of private providers of public services with the interests of customers and society. And if you look at it through that lens and obviously they have a much more diverse toolkit because they’re doing all of the things that they can within their power to create that alignment of interest. Personally, that’s the view that I take and I think it’s much more aligned with what the public expects today.

Bob Hahn: That’s great. Let’s pretend you’re talking to my parents at the dinner table and rewind that. Okay. You used lots of big words that I’m not sure everyone in our audience may appreciate, like price controls, quality standards and a word that I’m not even sure I could spell, teleological. Can you give me an example? Let’s say you’re the head of the water regulatory authority there, you’re doing work for the railroad regulatory authority. What’s a day like?

Cathryn Ross: Gosh. They could be anything you like. Principally what we are doing when we’re working in a regulator is we are limiting the ability of companies to exercise monopoly power. So if you think about the kind of things that a company might do, if it has monopoly power, it might put prices up, or it might put prices up and deteriorate the service quality. So typically in a regulator you spend a lot of your time looking at both of those two things. What is a fair price that the monopoly company should be able to charge and what should a reasonable standard of service for that kind of price look like?

Bob Hahn: Okay. You’re trying to prevent price gouging. That makes sense to me. As you know, I lived in England for about seven years and used to ride the train on occasion and I loved it. One of the great things about living England as you can get to 99% of the places you want to go by taking a train or a bus. My wife and I love the fact that you could do this and the trains were supposedly fairly regular, but there were two problems I had. One was there seemed to be frequent breakdowns on some of the trains that I was riding. And the second is the quality of the coaches, I’m not sure what you call them, the rolling stock or whatever, was not always- I’m not talking about first-class, might’ve been 30 years old. What is it that the railroad regulators are doing to fix this problem or why are we paying you or your successors to do this stuff and what’s the problem here?

Cathryn Ross: I have to say Bob, if you spent time in the UK and as you did, you would realize that one of the things the Brits like to complain about most is trains. So you are not alone in complaining about the quality of the train service in the UK. There are basically two different pools of regulation that apply on railways in the UK. One is for regulation that governs what the people who operate the trains, can charge their customers and the kind of core to your service that you experience on the train. That’s really done by government because what government does is it lets a series of contracts by which private companies can sort of bid for those contracts and then they get the right to operate the trains on tracks. And as part of those contracts, the government sets the prices the train operators can charge their passengers. And they’re also pretty interventionist on things like the quality of the rolling stocks, or the quality of the train carriages that you’re sitting in. That’s really all up to government. Then the government basically lets these contracts and the people who bid the most on the contracts get to run the services, which is a little controversial because of course, one of the ways that they get the money to bid high for the contracts is by saying that they will actually raise prices to customers. One of the things that has happened in the UK is that the price traveling on the trains has gone up enormously over the past 20 years, which means that people are wondering what they’re getting for their money. But actually what’s simultaneously been happening is that the government is being reducing the subsidy that’s going into those train operations. Taxpayers would be doing well, but passengers are paying more. The government, I think, is actually coming around to your view, which is the quality of the trains isn’t good enough. So a lot of the contracts that it’s letting at the moment include a stipulation that the train operator that has to bring a new rolling stock. Of course, that is causing another problem, because I think one of the things that you talked about is delays on the system. And of course, every time you introduce new new rolling stock, you have to train the drivers to use the new rolling stock. But you’re trying to keep costs down. Basically what you’re trying to do as a train operator is you’re trying to take your drivers and squeeze more and more out of them including training on the new trains and driving the old trainings. One of the reasons why there’s loads of delays in the UK at the moment is basically there’s not enough slack in the system to do both of those things at once. That is not helping. 

Anyway, that’s trains which is regulated by the government contracts. And then there’s tracks. Track is owned by a monopoly company called Network Rail, which is now actually sitting back on the public balance sheet. And that is regulated by what you might call the traditional economic regulator that sets the charges that Network Rail can charge the train operators for running on the track. And it spends a lot of time trying to get under the skin of what the efficient costs of running a railway would look like. And then of course when trade operators and government wants to pay for improvements to the train track, then the ORR, the Office of Rail and Road, comes along and looks at what the efficient costs of doing that is. And one of the most controversial parts of that is how do people get compensated when those works, those engineering works, on the track overrun? There are a lot of delays, but whenever that happens, there’s a transfer of funds that goes from that rail to the train operators and in theory, should go from the train operators back to the passengers. But of course the passengers don’t claim the compensation. So actually those delay minutes are quite a nice earner for a lot of the train operators in the UK.

Bob Hahn: Got it. I didn’t want to spend the whole time on railroads, but they do fascinate me. And I did get a Lionel set for Christmas one time and it was great. I loved putting the smoke tablets in the engine and watching the engine as it went around the track, but I have a broader question for you. We have a company in the United States called Amtrak that provides service between New York and Washington and other places like Boston and it’s been subsidized for a long time. Imagine it- I don’t want to just stick it, stay on Amtrak- but imagine that you either have the opportunity to whisper in the year of the next president of the United States or the next prime minister of the UK if there is a UK in five years or whatever, what would you tell him or her about a good or not so good way to regulate the rail industry if your objective is to get consumers good value? Should we have regulation at all?

Cathryn Ross: Yeah, I think regulation is a really, really useful element of the railway system because essentially what it does is that enables you to give scrutiny to cost. So railways are complicated things and they’re costly things. There’s a lot of just on the ground engineering and if you really, really don’t pay attention to cost, then those costs can spiral, and an economic regulator can help you to scrutinize those costs. And of course if you keep costs down, then it’s more efficient, and if it’s more efficient than people pay less to use it. If they pay less to use it, they consume more, and everybody’s happier. Paying attention to costs is a big factor, but not driving costs down so low that you don’t get investment. It’s gotta actual genuine cost efficiencies that you focus on. 

Bob Hahn: Sounds like a delicate balance.

Cathryn Ross: It is a delicate balance, but that’s how regulators can help.

Bob Hahn: Let’s talk about a delicate balance or what might be a delicate balance in another area where you are one of the world’s premier authorities, both as a regulator and as a thinker and that’s water, like the stuff we’re drinking on this table here. What challenges did you face as CEO of the Water Regulatory Authority in the UK and what can you tell us about the challenges you faced, how you addressed them, and lessons that can be learned more broadly in the area of water?

Cathryn Ross: Where to start. A lot of the challenges that we faced when I was at the water regulator are actually quite common to regulated sectors across the UK. One of the things that we were trying to do was incentivize a massive program of investment, particularly to improve environmental quality and also to improve resilience of water supplies in the face of things like find the change in population growth. That is great, and it’s really important. But of course you need to manage that with the fact that people need their water bills to be affordable, and in the UK, people pay a separate bill for their water services. So it’s very transparent and that’s great, people can see what they’re paying. But there’s a limit to how much that they’re prepared to pay. Ultimately the question you’re trying to solve is how do you get massive, massive, a hundred billion pounds of investment into a sector while keeping bills affordable.

A lot of that came down to how you use the regulatory toolkit. Because of course, if you’re regulating a monopoly, a service, and you’re regulating a service where you’re pretty sure people are going to demand that service not just today but into the future, then one of the things you could do as a regulator is you can enable the companies that you regulate to smooth costs between generations because you can give a guarantee as a regulator that if the firm incurs those costs today, then you will enable it to recover those costs through regulated revenues in the future. So that was the big balance. Probably the biggest problem that they were trying to solve to regulate water in the UK was around intergenerational equity and how you spread those lumpy costs over a long period of to help everybody get not just the resilient water supplies you need, but also the environmental quality.

Bob Hahn: I heard you say a couple of things and I have a question. You talked both in the context of rail and in the context of water about getting people to invest, I guess, in the infrastructure, the rolling stock or whatever you need to supply water. And then you also talked about this four letter word that you mentioned earlier that economists like to use called cost, and you want to keep the costs down. Is this a generic feature of economic regulation where you’re trying to encourage investment in there, but you’re also trying to make sure that people get reasonable value for their money?

Cathryn Ross: Yeah, I mean, to an extent that is certainly true. Even if your network is a more or less steady state, that network has to be maintained and it has to be renewed to maintain its capacity. But I think one of the things that we’re living through in the UK right now is that we’re 30 years after a lot of our public services were privatized. Some of them are now approaching a period where they need massive game changing investments. For example, in the electricity transmission network, government has come out with a target that the UK will be net zero carbon by 2050. That requires a massive reengineering of the electricity network and that requires massive investment. Same with water, we’re facing climate change and population growth. It needs a massive amount of investment in infrastructure to cope with that. And in telecoms too, we’ve been using the copper network that’s been in place for decades and now we know we need fiber and we know we need 5G. That trade off between needing investments and trying to keep costs down and keep those affordable has always been at the heart of regulation. But I think a lot of economic regulators right now are facing that trade off in a really stark way because of the lumpy massive new investment programs that are needed.

Bob Hahn: As you know, I go over to the UK occasionally, to sample the pubs in London and Oxford and do other things like think a little bit with my friends. But I guess one of my questions for you is that you mentioned the word privatization and the UK went through that many years ago. Could you tell us a little bit about what that process was like? And are you implying, cause I don’t want to put words in your mouth, are you implying that this privatization and regulation that took place may have been a mistake? Or are you simply saying that it’s done okay for the last 20 or 30 years, but we need to rethink certain aspects of it as we move forward over the next few decades?

Cathryn Ross: Gosh, there’s a lot in that. And I think we might want to come back to this question about whether privatization is a good thing or not, because that’s a big debate right now. But in terms of what happened at the time of privatization, I think it’s really important to be clear that there were lots of different things happening at once. One thing that was happening was literally the transfer of ownership of businesses that had been owned and operated by the state into the hands of private shareholders. That was literally just a transfer of ownership. But in most sectors, so I’m talking about electricity and gas, in rail and in telecoms, it wasn’t just about the transfer ownership, it was also a process of market liberalization and the creation of competition. You weren’t just privatizing monopolies, you were privatizing companies that were monopolies but that were being systematically opened up to competition. I think if you’re asking the question about whether privatization with a success or not, and you kind of have to divide into two. One is does the private ownership and the governance and the private sector discipline that you have in those privately owned providers of the public service create benefits? And then there’s a separate question about whether competition is the right market model and what the pros and cons of that are. As you know, in both of those questions being revisited right now.

Bob Hahn: So talk to me a little bit, or maybe you could provide an example about where competition might be the right model. Perhaps something in the energy sector, I don’t know. And where a competition isn’t necessarily gonna work because something looks like a lot like a monopoly no matter what you do.

Cathryn Ross: Yeah, okay. I mean, I’m currently working in a telecoms company and that is routinely held up as being one of the sectors where competition has delivered massive benefits to consumers and I might agree with that. You’ve got a couple of things going on. One is that you have a prices that are held down, but then the other thing is that consumers are getting way more for the same price than they were two, three decades ago. And there’s a massive amount of product innovation and service innovation. All that’s happened because of competition. The kind of competition that has driven that in telecoms to date has been done through resale competition. The network has been pretty much a monopoly. It’s been regulated pretty much as a monopoly, and then what the regulator has been trying to do has been to hold down wholesale prices and make sure that there’s enough value down stream at the retail end to encourage competition and then stand back and let that deliver for consumers. There’s no arguments, I think that that’s been a good thing. Now, you can compare and contrast that with what happened in water. Where unlike most sectors that were privatized in the UK, the water sector in Wales was privatized as a monopoly and with no intention of rolling out competition. And in fact there is very, very limited competition in water. And in fact, couple of years ago, the UK government decided that it would open the business customer retail market in water to competition. So residential customers, domestic customers, they can’t choose that supplier. Now in water the argument always was that the economics was different, right? It’s a natural monopoly quote unquote.

Bob Hahn: What does that mean? Bigger is better and cheaper or what does that mean?

Cathryn Ross: Yeah, in water, the issue is that water is cheap as a substance. It’s heavy, and basically there are long distances between where the water is and where the people are. Actually it doesn’t really work to introduce competition in that environment. It’s always been seen as a natural monopoly. It’s always been seen as big, heavy, low value and not susceptible to competition. But I would argue, and I did argue when I was regulating water in the UK, that you need to distinguish between different parts of the value chain, so the wholesale provision of water. Getting the water out of the ground, treating it, transporting it, and getting it to your tap, that isn’t monopoly. It doesn’t make sense to have duplicated networks. It doesn’t make sense to have two different sets of infrastructure doing that.

But actually at the retail level, when you’re really talking about customer service and you’re talking about billing, anybody could do that. The economics of that aren’t telling you that there can only be one provider because lots of people can do that. I was quite pleased when when the UK government decided to open the business customer market in England competition, so then they could see what benefits that could deliver the customers. That’s only been open for a couple of years. So it’s a bit too soon to tell. But there were certain developments that are happening in the water sector for business customers that would never have happened without competition.

Bob Hahn: So some politicians, notably the head of the Labor Party have called for nationalizing certain industries or certain sectors in the UK. And I’m wondering if there’s any place that you think nationalization, as this politician defines it, might be preferred to smart regulation or if it’s not a good idea across it’s the board.

Cathryn Ross: Yeah, it’s certainly getting a lot of traction publicly, there’s no doubt about that. And if you look at some of the survey data that shows you what the British electric thinks, there is massive support for re-nationalizing water, massive support for re-nationalizing rail, and massive support for also re-nationalizing the Post Office. Those are things that people seem to care very deeply about. I haven’t got too much experience in relationship to the other sectors, but we did do some work on this when I was at Ofwat, when I was at the water regulator, and it was really interesting to see how people thought about water. Just to abstract one minute from the question about price, support, and that kind of stuff, if you sit in a room with a bunch of water customers, let’s say in England, I bet you anything that within the first half an hour, somebody will say well water just falls from the sky. I don’t understand why we pay for it at all. And also within the first half an hour, somebody will say, actually, water is a human right and the government should provide it now. I agree, I think water is a human right. I wouldn’t necessarily equate that with government provision, but it is a human right. People aren’t daft, they do know that it does cost money to take water out to the ground and to treat it and transport it. I wouldn’t take that statement literally, but I think it tells you a lot about how people feel about the relationship with water. If you can couple that with some demonstrable failures of the water industry to deliver what seemed like really basic standards, then actually you’ve got a pretty powerful narrative in favor of- well, there’s a problem here, the industry is delivering and the solution is re-nationalization. Personally I think it’s a lot more complicated than that, and I think the answer smarter regulation, but you can also see why there’s a plausible narrative for a different view.

Bob Hahn: So I know we said we were going to talk about economic regulation, but your statement about water sort of piqued my interest. So I want to ask you a broader question about water. I think there was a recent UN report, I’m not sure, that talked about water scarcity being a very serious problem over the next 25 to 50 years. What should a domestic regulators, the regulators within a country, be doing about this to make sure their countries are doing okay? And do we need any super-national institutions looking at these issues and/or regulating these kinds of commodities?

Cathryn Ross: I do think water scarcity is a huge issue and it’s a huge issue in parts of the globe where maybe it isn’t obviously a huge issue right now. I’m thinking here about the UK. Everybody you talk to about water scarcity in the UK will say, how can you possibly have scarcity? It rains all the time, which is true. It does rain all the time, but it’s also possible that we don’t have enough water when and where we need it. And that is only gonna get worse with climate change and population growth. So if it’s a problem in the UK, then it’s certainly a problem elsewhere across the globe, but much more acute. I think they’re right to highlight it as an issue. I think regulation can play a really important role in solving that problem. I don’t necessarily think a super-national regulator is the answer.

Cathryn Ross: In fact you could argue that the more local regulators isn’t a bad idea because of course water, it’s a very physical thing. You can’t divorce water supply from the geography. The natural units when you’re thinking about water supply, is actually a catchment area, and not even necessarily a country. You need to think very carefully. When you start talking about sort of the value of super-national regulators, I think that we’ll be limited. There is certainly a case, I think for regulators to learn a lot in terms of what works and what doesn’t from across the boat. So for example, I used to workin the UK water regulation. We were really, really interested in what the Australians were doing in the face of the millennium drought in the Murray Darling basin because one of the things that they face there are, I think they had a drought that went on for something like seven, eight years. So literally the whole of the Murray Darling basement, the catchment area, was drying out and they actually had to think really carefully about how they they rationed scarce supplies. And one of the ways they did this, they created a sort of an allocation of water that would go to the public water supply for human consumption, because clearly that has to be a priority. But then they created a system of trading for, like, agricultural use of the water, which was the biggest single sort of non-human use of water in the Murray Darling Basin. And they basically created a system of allocation of rights and then a secondary market where you could trade those rights. And of course, what that did is it revealed those uses of water that were more valuable than others. So if you are a, let’s say a farmer that was producing rice where you could sew a crop one year, and if you didn’t sow it that year, that’s fine, you could sow it next year, maybe you didn’t value water as highly as if you were a farmer who was running it orchard, where if all your trees die, it’s another 10 years before you can really get a decent harvest again. But that worked quite well. So we were interested in UK looking at how that kind of water trading system that could work in the UK. 

Another thing which is massively, massively under developed and you were good enough to help me with in the UK context is the whole approach to demand management and thinking about behavioral responses to scarcity of supply. It’s really interesting that when you’re a regulator, you spend an awful lot of time talking to the companies that you regulate. Often times it is in their interests to come to you with very sort of heavy supply side solutions to things like water scarcity, because of course they get a return on the investment that they make. If you’re talking to a water company about water scarcity, unsurprisingly one of their first answers is we need any reservoir. These things cost millions and they’re not cheap, but might be the right answer. But let’s make sure that before we spend millions on new reservoir, we know what the demand is we’re actually trying to satisfy, which might mean working with customers in a smarter way to make sure that they have information about the water they’re consuming and they have choices about when and where they can consume less. And again, that’s another one of these things where they’ll necessarily take you down the road of a super-national regulator. But it is one of those things where there is massive scope for learning between countries.

Bob Hahn: We’re gonna need to wrap it up shortly. I was intrigued by your example of the Murray Darling Basin and the idea of using markets as a way of getting a price signal about the scarcity of water. How far do you think you can push these market ideas, when you have resources like water or the environment or whatever, as a way of either more effectively or efficiently allocating these resources or getting a price signal about what people are willing to pay for them? Or is this still politically very difficult for legislators and decision makers to embrace?

Cathryn Ross: Politically it is difficult, there’s no doubt about it, because whenever you have a market like that, somebody wins and somebody loses. Although one of the things that was really interesting in the Australian example was actually because you allocated out the water rights and the people have the ability to monetize those rights by treating them, some of the farmers actually did quite well. It was not necessarily the case that if you are in a position where you sold your water rights, you are not a loser because actually you got cash in that might’ve been worth more than your crop would have been in that year anyway. It’s a bit more nuanced than that, but it is controversial, and there is always, I think a little bit of a temptation, for politicians to want to make these kinds of decisions, in terms of rights allocations themselves because, you know, they have democratic legitimacy, it should be their call on who gets this water, that’s why they’d be elected. But to be honest, I think even if you are in a world where the ultimate decision might flow to the politicians, and even if you are in a world where you might need to make some political interventions, the basic information that is revealed about relative values of water in different uses by having some kind of a price mechanism or some kind of trading mechanism is enormously useful. I think it’s a very valuable lesson for the whole world.

Bob Hahn: Cathryn, this has been a very stimulating conversation and it’s always fun talking with you and it’s always fun having a beer with you. We’ve been talking at this TPI podcast on the economics of regulation with Cathryn Ross. And I hope you have a chance to have you back when you visit United States next. Thank you very much.

Cathryn Ross: I’d be delighted. Thank you.