This is the third post in a four-part blog series on Regulating Ontario’s electricity sector. The series is motivated by my participation in a panel discussion on regulation at the upcoming APPrO 2018 Canadian Power Conference. Panellists have been asked to weigh in on what changes are needed to improve the electricity sector’s regulatory framework.
In this series, I explore three related issues that are fundamental to our understanding of effective regulation. My previous post described the meaning of regulation and outlined two rationales for why we regulate. Regulatory policy can arise partly from the “public interest” objectives of policy-makers, and partly as a result of policy-makers responding to their own private interests and to competition for policy influence among various private interests. In this post, I comment on the two remaining issues: When should government delegate authority to an arms-length regulator?; and, How should this authority be prescribed to the regulator?
When should government delegate regulatory decision-making authority?
In his article for Harvard Business Review, Timothy Firnstahl offers this definition of delegation: Delegating means letting others become the experts and hence the best. He makes a valid point about letting go.
Once the why has been decided (i.e., there is a need for government intervention to achieve a particular objective), the natural next question is: Should government retain regulatory responsibility over the objective or delegate the responsibility to an arms-length, unelected regulatory authority?
Subsidiarity is a useful principle on the issue. Subsidiarity proposes decisions be made and tasks carried out at the lowest level in a hierarchy at which they can be competently decided and executed. [1]
How does that relate to delegating regulatory responsibility? Subsidiarity implies governments should retain regulatory responsibility only if individuals, groups of individuals, or organizations (including private-sector companies) cannot fulfill the objectives of the regulation adequately on their own. Subsidiarity generally favours decentralization. It can improve administrative efficiency and accountability in decision-making. Subsidiarity is helpful in illuminating lines between private and public spheres and for establishing regulatory boundaries. Finally, subsidiarity is useful for allocating responsibilities across local, provincial, and federal governments. Subsidiarity implies that local area governments should have a say in generation or transmission siting decisions.
Note that subsidiarity is embedded within the private interest theory of regulation. Under the public interest theory, responsibility over market outcomes is devolved to the private sector and markets. Governments assume responsibility over market outcomes only if there is good evidence the markets will fail to result in efficient outcomes and regulatory intervention could do better.
Most policy analysts argue government should delegate regulatory responsibility of economic efficiency matters of public interest to arms-length, unelected regulatory agencies. This is consistent with subsidiarity. These agencies are permanently staffed with individuals that possess the requisite competencies to assess efficiency issues most effectively. In contrast, public interest issues of equity and wealth redistribution should be left to elected government officials and implemented mainly through the broad-based tax and transfer system. Equity and wealth distribution issues, which fundamentally involve taking from one group of individuals and giving to another, are important matters of social policy. They involve value judgments that should be debated and determined in the political process. Unelected regulatory officials are generally uncomfortable with deciding who is more worthy, and ill-suited to make these decisions. Furthermore, it is more effective and less costly to transfer wealth in society via the broad-based tax and transfer system than by regulating the price or quantity outcomes in a specific sector.
The agencies that manage Ontario’s electricity sector:
How should government prescribe regulatory responsibility to the regulator?
When considering how much government should be involved, bear in mind the advice below from former U.S. president Teddy Roosevelt.
"The best executive is the one who has sense enough to pick good men and women to do what he wants done and self-restraint enough to keep from meddling with them while they do it.”
– Teddy Roosevelt
Related to subsidiarity is the idea of a clear definition and separation of responsibilities, as is between regulatory agencies and government. Separation is profoundly important when deciding how to prescribe regulatory responsibility to a regulator. Among other things, it lessens the potential for conflicts of interest as predicted under the public choice theory, and enhances the independence and transparency of decision-making.
To effectively separate elected government officials and an unelected regulatory agency, legislation should include a clear and focused public interest mandate to the regulatory agency. Problems can arise if the mandate is vague and involves multiple competing and conflicting objectives. This makes the regulatory agency vulnerable to the influence of private interest groups, rent-seekers, and elected public officials or government bureaucrats that can use a regulatory decision to further their own short-term political objectives. Prescribing the public interest mandate in legislation can further insulate regulatory decision-making against political influence as the decisions are subject to the force of law and appealable to the courts. That is, it creates checks and balances in the system; something that many have argued is currently lacking in the Ontario electricity sector. Including ministerial directive powers in the legislation dilutes the independence of the regulator and opens the potential for political influence and conflict of interests in furthering the legislated public interest mandate.
Prescribing a clear economic efficiency mandate to the regulator will lend itself to objective tests and techniques of policy analysis, including the all-important cost-benefit analysis. Cost-benefit analysis simply adds up the benefits and costs of the regulation over time and compares the two. The regulation’s benefits and costs can be clearly defined and generally quantified. They can be adjusted for their time value through generally accepted standards of discounting. Using objective techniques, such as cost-benefit analysis, enhances regulators’ ability to further resist the influence of private interest groups of government officials that emphasize a regulation’s short-run benefits, which in the long run destroy the incentive for investments and wealth creation.[2]
What changes are needed to improve the electricity sector’s regulatory framework?
In my posts to date, I’ve discussed the problems with the current Ontario electricity regulatory framework, and explored three related issues that are fundamental to our understanding of effective regulation: why regulate, when to delegate regulatory responsibility, and how to prescribe the delegated regulatory authority. I now need to apply these concepts (public interest versus public choice theory of regulations, subsidiarity, and separation of responsibilities) to offer my views at the APPrO conference on the appropriate regulatory framework for Ontario’s electricity sector. The conference is November 12-13. I hope to see you there. But don’t worry if you cannot attend. You’ll be able to catch the highlights of the discussion in my next blog. Watch for it on our website.
[1] Adonis Yatchew and I discuss the principal of subsidiarity in the context of the Ontario electricity planning process in Rivard, Brian and Adonis Yatchew. (2016) Integration of Renewables into the Ontario Electricity System, The Energy Journal.
[2] University of Calgary economic professor, Jeff Church makes a strong case for economic efficiency in his CD. Howe Commentary found at https://www.cdhowe.org/public-policy-research/defining-public-interest-regulatory-decisions-case-economic-efficiency.