Better regulation - Managing Political Risk

Speech by Chris Huhne delivered to Centre for the Study of Regulated Industries on Tue 14th Nov 2006

When I was working in the City on country risk, I was invited to participate in one of Shell's famous scenario planning sessions. There were lots of sage oil men, one of whom asked me whether I thought Norway or Nigeria was the riskier environment for them to operate in. I naturally said Nigeria, which had a bond rating so low as to be sub-terranean whereas Norway has an impeccable record of debt service. It was the wrong answer. My interlocutor said everyone in the oil business knew that Norway was far riskier because they kept changing their tax and regulatory regime. It was certainly a lesson for me.

First, let me say that I do not regard better regulation as always and everywhere less regulation. The political process needs to regulate to achieve objectives like financial stability and the reduction of carbon emissions. Hiring a contract killer may boost the income measure of gdp but I presume that not many of us would think that deregulating contract killing would be a sensible prescription for economic welfare. Perhaps more to the point, I remember when the Major government decided to deregulate the utilities from the queuing system for digging holes in the road. The resulting chaos forced a quick retreat. In theory, business people don't like regulation. But if it reduces the time they spend in traffic jams, it is all to the good.

There will be a political debate of course about the objectives of regulation and that is right and proper. The traditional sources of regulation are unlikely to diminish: market failures due to lack of information or just high information costs, plus the need to regulate natural monopolies and other sectors where there is a lack of competition. My guess is that we are entering a period when regulation will become more intrusive to meet what Sir Nick Stern in his review of the economics of climate change has rightly called the greatest market failure of all time.

We have to decarbonise the world economy and we have very little time to do it. That is going to require extraordinary intervention in market decisions on a scale we have probably not witnessed since war time: an emissions trading scheme that prices carbon for big users of energy, green taxes that shape market decisions in atomised sectors like transport, requirements for particular types of electricity generation through the renewables obligation, regulation in the built environment and in product standards at EU and national level to name but a few.

Given this, it seems to me that there is an equally important debate about how we ensure that regulation is efficient, namely that it is done at least cost not just to the public purse but to those who have to comply with it. I suspect that this is all about accountability and checks and balances, good old-fashioned Liberal themes. The issue is not more state power or less state power - the issue that Labour and the Tories love to argue about - but about how to ensure that state power is used wisely, economically and proportionately to the risks. How do we set up a framework that delivers better regulation?

I think there are several parts to the answer. The first is the Dutch model introduced by our sister party, the VVD, under its leader and finance minister Gerrit Zalm. It uses an independent agency to assess the design and costs of a regulation when it is being proposed, which in itself provides a discipline on the proposing department to ensure that its statutory instruments are fit for purpose. Mr Zalm stresses that the system of review is not designed to make a bonfire of regulation, as the Dutch clearly recognise the need for it. But it is designed - and has developed a reputation for - cutting the burden of red tape and more economically achieving the objectives of regulation.

The Dutch government has estimated that the total cost of red tape on business is about 3.6 per cent of gdp, and the objective is to cut red tape by a quarter by 2007 compared with 2002. By 2003, an estimated €900 million had been cut from compliance costs. According to the Central Planning Office (cpb) this operation structurally yields an extra annual contribution to the Gross National Product of 1.5%.

ACTAL is the agency tasked with ensuring unnecessary regulation does not slip through the net. It is an organisation deliberately placed outside the realm of political decision-making, focussing solely on advising the government departments and Parliament on the reduction of administrative burdens on businesses and citizens. The agency has the ability to commission its own research and has the freedom to decide how it will achieve its aims.

Whilst its decisions are not binding on the Dutch cabinet, all new proposals must go through this body. The agency has the ability to recommend improvements, or reject legislation entirely. ACTAL is given a hard edge as it requires ministries to quantify the administrative burden in new legislation and report on alternative policies that may result in a reduced burden on businesses and citizens. The agency is widely regarded as a success and is on course to achieve its 25 per cent target for cuts in costs.

The potential for doing the same in Britain is enormous, and not just in the normal by-ways of formal regulation. Tax law is a substantial element of business costs, and it is soaring. Indeed, one measure is the sheer weight of the tax legislation as recorded by Butterworths guide: it is up in sheet kilograms by 50 per cent since 1997. It would make a lot of sense to simplify the tax system with a standing tax commission modelled on the law commission. It would also make sense to change the way the budget and finance bill process works to split politically sensitive decisions on tax rates from the more technical process of tax legislation. This procedure would be to prevent fiascos such as last December's reversal of policy on Self-Invested Pensions Plans, where an obviously damaging policy was introduced in the 2005 Finance Bill without proper consultation and had to be withdrawn a few months later.

Let me end with one other thought on checks and balances, which is that there should systematically be review or sunset clauses in regulatory legislation. I am very proud that I was the Liberal group's economic spokesman in the European Parliament when we introduced the first sunset clauses into EU law limiting the Commission's secondary legislative powers to four years. That may not be the appropriate time limit, but there should be some point at which regulation has to be formally reassessed to see whether it continues to fit modern circumstances. That would tie up with the proposal for an ACTAL to make a real difference in my view to the quality of regulation.

The key, though, is to improve the processes by which regulation is promulgated. To consult. To minimise costs. To have open debate. To ensure that there are independent bodies that stand outside the political process whose views are given due technical weight by virtue of their authority. With proper checks and balances, we can have a far better and more economical system of regulation with far less attendant political risk.