Regulating Public Utilities in Europe: Mapping the Problem

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EUI WORKING PAPERS

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European University Institute © The Author(s). European University Institute. version produced by the EUI Library in 2020. Available Open Access on Cadmus, European University Institute Research Repository.

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EUI Working Paper RSC No. 98/42

Eberlein: Regulating Public Utilities in Europe: ' V M apping the Problem

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The Robert Schuman Centre was set up by the High Council of the EUI in 1993 to carry out disciplinary and interdisciplinary research in the areas of European integration and public policy in Europe. While developing its own research projects, the Centre works in close relation with the four departments of the Institute and supports the specialized working groups organized by the researchers. © The Author(s). European University Institute. version produced by the EUI Library in 2020. Available Open Access on Cadmus, European University Institute Research Repository.

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E U R O PE A N U N IVERSITY IN ST IT U T E , FL O R E N C E ROBERT SCHUMAN CENTRE

Regulating Public Utilities in Europe:

Mapping the Problem

BURKARD EBERLEIN

RSC Jean Monnet Fellow (1997-98)

EUI Working Paper RSC No. 98/42 B A D IA FIESO L A N A , SA N D O M EN IC O (FI) © The Author(s). European University Institute. version produced by the EUI Library in 2020. Available Open Access on Cadmus, European University Institute Research Repository.

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No part o f this paper may be reproduced in any form without permission of the author.

European University Institute Badia Fiesolana I - 50016 San Domenico (FI)

Italy © The Author(s). European University Institute. version produced by the EUI Library in 2020. Available Open Access on Cadmus, European University Institute Research Repository.

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TABLE OF CONTENTS

0. Introduction

1. Concepts and Theories of Regulation 1.1. American-style regulation

1.2. The rise of the regulatory state in Europe

2. The Aftermath of Liberalization: The Challenge of Re-Regulation 3. The New Regulation Game: The Pluralisation Hypothesis 4. British Utility Regulation: Whose Utility?

5. Lessons from British Experience and the German and French Case 6. Explaining the Regulatory Process and Outcomes

7. In Lieu of Conclusions: Proposals for Comparative Research on Utility Regulation References © The Author(s). European University Institute. version produced by the EUI Library in 2020. Available Open Access on Cadmus, European University Institute Research Repository.

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INTRODUCTION

This paper addresses a topic of growing salience for public policy-making in Europe: the (re-)regulation of utility and infrastructure industries in the new context of market liberalization. Prominent examples are not only telecommunications but also electricity and gas, water, or railways. In short: we are dealing with network industries or sectors, which, in Europe, have traditionally been publicly owned and/or exclusively licensed as a monopoly by the state.

Beginning in the early 1980s, a wave of privatization, liberalization, and (supposedly) deregulation has swept across European economies.1 In general, commercial public enterprises were the first candidates for privatization. Meanwhile, the ongoing process of liberalization and (partial) privatization, after a quite successful start in telecommunications, has reached other public utilities such as electricity and gas. And although the U.K. has played a pioneering role, other countries too, not least under the pressure of European competition requirements, now start to - or soon will - be faced with the challenge of utility (re-)regulation in a post-liberalization setting.

Utility regulation is a field where most non-technical academic research and policy analysis has traditionally been provided by economists and lawyers. This raises the double question a) which kind of contribution can political science make to an interdisciplinary debate on utility regulation? and b) which kind of relevant issues does the field of utility regulation raise for political science?

My claim is that this field offers important insights into the changing role of the state in the economy. In the new, post-liberalization setting of European economies, the regulatory scene will be an important battleground for

political conflicts about the proper nature and scope of public intervention and about the very notion of ‘public interest’. Political science can make an

important contribution to the crucial question of how, and on which social and political grounds, governments can, do and should continue to intervene into an essentially market-driven allocation process. How can competitive markets be

1 It is important to distinguish between privatization, liberalization and deregulation. Privatization denotes a "change in the legal form o f public corporations from public to private law status and/or the selling o f shares o f publicly owned corporations", whereas liberalization implies the relaxation or abolition o f market entry restrictions, that is de-monopolisation. Deregulation is about the "relaxation or abrogation o f existing laws, statutes or rules” by means o f which the state tries to influence private sector behaviour (Grande 1994, 141). For an account o f the privatization movement in Europe see Wright (1994), Vickers/Wright (1989), for a global perspective see Suleiman/Waterbury (1990).

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reconciled with public interest concerns? The political boundaries of marketization in the sensitive area of public utilities are at stake.

My concern is to provide a tour d ’horizon, to map the nature of the problem, to raise some questions and to define a research agenda, but it is not to provide answers. Therefore, the paper should be read more like a research proposal. Nevertheless, I also seek to advance some tentative hypotheses on some features and aspects of re-regulation in Europe.

The particular focus will be on the interest politics dimension of regulatory settings and processes, which is a classical concern of the regulation literature. Regulatory institutional patterns can be conceptualized as political opportunity structures for interest representation. Under a given regulatory regime, specific patterns of interest representation and intermediation, underpinned by distributional coalitions of interest, will emerge and consolidate in some form of institutional equilibrium.

My goal is to study the current transition from one form of economic intervention, i.e. public ownership and/or publicly licensed monoply, to a new form, i.e. to the public regulation of de-monopolised and/or private service delivery. The main question is: how will this transition affect and transform entrenched sectoral and national patterns of interest representation and distribution and associated political constructions of the ‘public interest’. How will political opportunity structures be reshaped? Which new actors come in, how do old actors react to these transformations? In short: the task is to unravel the

logic of the regulatory process and its distributional implications. This will

involve important empirical research on largely unchartered territory, that is the first and descriptive challenge (for future research). The second, explanatory challenge is to identify those factors which shape the character and outcome of the regulatory process.

Based on well-established American and more recent British experience in utility regulation, as well as on some preliminary evidence from the emerging German and French regulatory scene in telecommunications, I seek to draw some

general lessons for utility regulation across European countries. The main if

simple lesson is that the specific ‘regulatory bargain’ struck at the moment

of liberalization and/or privatization is the single most important determinant of the regulatory process.

The paper proceeds as follows. First, I will tackle the tricky concept of regulation and carefully discuss and evaluate different theories of regulation and their U.S.-American background, drawing some lessons for the current European

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debate. Second, based on my own approach to regulation developed in this context, I will discuss the regulatory problems which arise in the aftermath of the liberalization process in Europe, with particular emphasis on the specific dilemma posed by utility services. I will introduce an analytical distinction between first- order and second-order regulation which will help to capture the basic regulatory dilemma. A third section will briefly explore the range of regulatory scenarios following liberalization and present the ‘pluralisation’ hypothesis. Fourth, I will take a look at the regulatory scene in Britain, the pacesetter country in Europe. In particular, I will focus a) on the institutional dimension of the regulatory process, i.e. who is to regulate and under which organizational design, and b) on substantive issues, i.e. the scope, content and distributional implications of regulation. In a fifth section, I will draw lessons from British experience and, based on some preliminary evidence from emerging German and French telecoms regulation, I will advance three hypotheses on the logic the regulatory process across European countries. In section six, I will try to identify the factors which shape the regulatory process. Finally, instead of a conclusion, I will outline a framework for doing comparative empirical research on the questions raised in this paper.

1. CONCEPTS AND THEORIES OF REGULATION

There are innumerable different understandings of the term regulation (for a conceptual overview s. Mitnick 1980). The only common ground is that the notion of regulation suggests the restriction of (private) choice by the imposition of (public) rules. Beyond this most vague statement there is very little agreement. A closer look at the literature reveals, roughly speaking, a bifurcation between a broader, more European understanding and a more focused U.S.-American approach to regulation.

For many European scholars, the term regulation, in terms of rule-making, is synonymous with the entire range of governmental activities.2 These are, both normatively and analytically, not viewed in separation from a pre-existing and unfettered market process. Rather, the emphasis is on interaction and interdependence. In a major school of French political economy, for example, the

théorie de la régulation, regulation is the complete set of institutional rules

governing capitalist modes of production (Boyer 1987). From a different, pluralist and neo-institutionalist background, Dyson (1992, 3) advances an equally broad, but more useful concept of regulation, speaking of its four-fold character: as a

2 While acknowledging the classical distinction between regulatory, distributive and redistributive policies, many observers stress the fact that there are regulatory elements, meaning rule-making, in every policy field.

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cultural phenomenon (meaning views about the role of the state in economy and society), as a formal, institution-based mechanism (expert regulators), as a political and coalition based process, and as a learning process. Hancher/Moran (1989) use the concept of ‘regulatory space’ fundamentally shaped by the interaction of big organizations, public and private, in the context of the wider process of intervention and control in advanced capitalist economies.

Within this perspective of a broader understanding of regulation, much of current political science writing focuses on the notion of ‘regulatory reform’ (Thatcher 1994, Vogel 1996). The starting point is to say: with the benefit of hindsight, we now know that the wave of privatization and liberalization did not lead to a simple retreat of the state as an economic actor (MiillerAVright 1994). 'lather, governments have engaged in the task of re-regulating economic activities. The popular expression ‘deregulation’ turned out to be a very deceptive concept indeed. In the ‘hard case’ of financial markets, for instance, there was substantial tightening of state regulation (Liitz 1997). Therefore, what has happened is much better captured by the notion of regulatory reform, which, as Steven Vogel (1996) put it, might very well combine "freer markets" with "more rules".

This literature emphasizes that, in spite of strong technological, market and/or European integration pressures for convergence towards government disengagement, a) governments continue to exercise important control over market processes b) that there are important national and sectoral variations of regulatory patterns and c) that, in general, these institutional patterns are very sticky. Thus Vogel (1996, 256) argues that "those countries with a tradition of government intervention in industrial affairs and tighter sectoral networks structured regulatory reform to maintain critical government capacities and protect valued institutional arrangements". Whereas in the US he sees overall disengagement as a result of regulatory reform, in France and Germany he observes reinforcement of government control instead. On the sectoral level, different rates of technical change, growth, market exposure and of political-legal ‘drive for reform’ are identified as important determinants of the pace and direction of liberalization processes, for example when comparing telecoms to electricity liberalization (Schmidt 1998). And finally, in the context of the debate about the impact of Europeanization on domestic structures, different authors discuss the relative weight of Europe as a causal factor accounting for liberalization processes (Schneider 1997, Thatcher 1997).

The emerging picture is in line with institutionalist thinking in terms of path-dependency and institutional stickiness. In most of this literature, economic regulation is not treated as a specific and new form of state intervention in

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Europe. Instead, the focus remains on the general policy-making process, which introduces a bias towards variation and gives little room to detect common patterns across countries and sectors.

This is not to say that I disagree with the general thrust and findings of institutionalist approaches. My point is that, within this broad focus, the proper logic of the post-liberalization regulatory process might not be sufficiently highlighted. I believe it is worthwhile to take regulation seriously in its own right, i.e. as an important, new mode of state intervention in Europe with its proper characteristics and dynamics. Therefore, while paying close attention to institutional differences, the American regulatory experience and literature can be very useful. While starting from the interest-based, distributional logic of regulation, I will, however, argue that it is crucial to go beyond simple economic capture theories and narrow market failure and efficiency-oriented concepts of economic regulation (which tend to dominate the American debate), and to incorporate the fundamental political-process character of regulation, which includes close attention to instutitional factors. It is in this middle-ground perspective that political science can make an important contribution to a new political economy of regulation.

1.1. American-style regulation

In the U.S.-American context, regulation is a more narrowly defined but also better-developed concept. The study of regulation has been elevated to the status of a sub-discipline in economics and political science. Regulation in the American sense (s. Kahn 1971, Breyer 1982, Noll 1989) is about the public control of private-sector economic activities by regulatory agencies on public interest grounds: "Regulation is the public administrative policing of a private activity with respect to a rule prescribed in the public interest" (Mitnick 1980, 7). Here, we find a clear divide between the market and the state. The unregulated marketplace is the norm, and there is the strong belief that the market is the superior form of economic allocation and normally best serves the public interest, and should thus only be interfered with in clearly defined cases of market failure. Therefore, industries and utitilities which in the European case were nationalized, usually remained under private ownership subject to public regulation.

Regulation is seen as a distinct form of government control over private business activity, usually involving a government agency with the responsibility of writing rules constraining certain kinds of (private) economic decisions, using quasi-judical administrative processes to develop these rules. These processes involve expertise-based fact-finding, rule-making, and adjudication (Noll 1985, 9- 10). The spirit of American-style regulation is quite well captured by Selznick

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(1985, 363-4). He defines regulation as "sustained and focused control exercised by a public agency over activities that are valued by a community." Market activities are valued, i.e. they deserve encouragment and protection, but also need control. This is the basic regulatory dilemma. "Sustained and focused control" refers to the fact that regulation requires more than the passing of a law or other general framework, namely the constant "monitoring of relevant activities, continuing asssessment of public values at stake, and rule-making sensitive to changing needs and circumstances" (Selznick 1985, 364).

The U.S. organizational solution for this regulatory challenge is statutory regulation by specialized, single-purpose or single-industry regulatory agencies or boards and commissions. The basic principle is that the delicate task of public interest assessment and decision-making is given to experts who enjoy some independence from direct or party-political control. Examples are the Federal Trade Commission or the Federal Communications Commission. This, however, does not mean that regulatory agencies and commissions operate in complete independence. To begin with, some, like the Environmental Protection Agency, are not independent agencies but part of the federal departmental hierarchy. More important, all federal regulatory commissions and agencies are subject to Congressional statute and funding, presidential appointments, and judicial review (Shapiro 1997). Nevertheless, regulatory agencies have been attacked on the grounds that they constitute a non-representative ‘fourth branch of government’, lacking democratic accountability.

The U.S. are widely regarded, as far as state intervention in market processes is concerned, as the prototype of a regulatory state.3 The history of modem American regulation of business dates back to the last quarter of the 19th century, when the rise of big private corporations and trust formation triggered a strong regulatory response, carried by a deep-seated mistrust of big business. "The land of the Trust was also the land of antitrust" (Keller 1981, 65). The commitment to social individualism, fair economic competition and the value of small business helped those interests with particular grievances caused by the power of trusts (like the farmers and merchants who were victims of rate discrimination by the big railroad companies) to make their voices heard. But since mistrust of big government was just as big as mistrust of big business, public ownership was not an option. The social battle over capitalism was not fought out over the question of ownership but over questions of regulation.

3 Breyer (1990) gives a short and useful introduction to the basic features o f US-American regulation. © The Author(s). European University Institute. version produced by the EUI Library in 2020. Available Open Access on Cadmus, European University Institute Research Repository.

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The Sherman (Antitrust) Act of 1890 and the 1887 creation of the Interstate Commerce Commission, to regulate railroads, marked the birth of the modem American regulatory state. This type of economic regulation focused on the control of market entry and of prices. After railroads, regulation progressively extended to trucks, telephone services, airlines, electricity, radio, television and natural gas. While the federal government regulated the interstate aspects, state commissions regulated the intrastate portions of the same businesses. There was also some safety regulation in transportation, food, and drug industries, and in banks and securities. It was only in the 1960s that regulation vastly expanded in scope and depth, with safety of consumer products and of the workplace, health, and environmental protection as new regulatory objectives. It was this kind of so- called ‘new’ or ‘social’ regulation which led to an important expansion of regulatory activities and agencies, and gave rise to later criticism about over regulation and the movement to deregulate. And only then some important characteristics of American-style, i.e. process-oriented and legalistic, regulation were fully developed: the passage of detailed and highly specific statutes; the confrontational style of regulation, with regulatory officials more willing to prosecute but also more constrained in their discretion; the active role played by the courts; the considerable opportunities for participaton by non-industry constituencies and for public scrutiny (Vogel 1986, 241).

Most theories of regulation were developed in this American environment, which means that we need to be sensitive to institutional differences when applying them in the European context. Nevertheless, they provide essential conceptual lenses for the current regulatory debate in Europe. The dominant economic understanding of regulation provides a good starting-point.4

The normative economic theory of regulation views the unregulated marketplace as the norm, and competition as the most efficient allocation mechanism. Regulation, i.e. the public intervention in market processes, can only be justified on the grounds of market failure. There are basically three types of market failures: externalities, i.e. important third party effects of production and consumption, and asymmetric information, e.g. consumers do not have sufficient information about the safety or quality of the product. These first two items relate to new or social regulation. Old-style economic regulation is normally justified on the grounds of ‘natural monopoly’, i.e. due to important economies of scale and scope, provision by a single firm is more efficient than by several firms. Competition would be wasteful duplication. Natural monopoly is traditionally viewed as the central quality of the industries we are concerned with: public utilities with major networks which imply substantial fixed costs, such as in

1 For an introduction see Noll 1989 and 1991.

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electricity or railways. Unless competition in terms of at least ‘contestable market’ can be brought in, regulation is needed to curb excess profits and monopoly power. Thus, regulation of price or return, and of market entry, as well as the imposition of non-discriminatory service obligations are the main instruments in the field of utility regulation. In sum, the public-interest rationale for regulation in the economic perspective is about allocative efficiency and consumer welfare.

In contradiction to the ‘public-interest thesis’, the positive economic theory of regulation found that regulation did not serve the public but distinct private interests. Already in 1955, a political science contribution, Bernstein’s (1955) "Regulating Business by Independent Commission" found that, over time, regulatory agencies were captured by the very economic interests they were supposed to regulate. The new positive economic theory of regulation originated in the 1971 article by Chigago economist George Stigler who took as his starting point the distribution of costs and benefits of regulation. He advanced the thesis that "as a rule, regulation is acquired by the industry and is designed and operated primarily for its benefit" (Stigler 1971, 3). Regulation is a good demanded by industry for its own protection. Peltzman (1976) later generalized and extended the notion of regulation as a market where government officials sell regulation and firms buy it. In sum, regulatory agencies were captured or dominated by the industries they supposedly supervised in some public interest.

These contributions centered around the capture-thesis were fruitful insofar as they directed attention to the political and interest-based processes underlying regulation. However, the economic theory of regulation failed to explain much of the social regulation of the 1970s, which could hardly be shown to be in the interest of business (Wilson 1984). Moreover, since it operated with a black-box concept of political institutions, it was unable to account for the success of deregulatory agendas, which were pushed by the agencies themselves, as in the case of airline deregulation at the end of the 1970s (Derthick/Quirk 1985). Obviously, a more complex analytical framework was needed to account for different patterns and outcomes of regulatory policy-making.

Political scientist Wilson (1980) sought to provide just this. He refined the classical distinction made by Lowi between three types of policy-making which would produce three types of politics (i.e. political processes). Regulatory (as opposed to distributive and redistributive) policy was said to produce a pattern of politics dominated by interest groups. This was in line with the capture theory. However, as Wilson showed, the kind of politics to emerge will vary with the distribution of burdens and benefits. The classical distributional pattern which capture theorists had in mind, namely the benefits are concentrated, the costs are

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widely distributed, is indeed prone to capture. The small industry group concerned by agency regulation has a very strong incentive to organize and lobby the agency, while the broad public, with rather small costs per person, has not. Wilson called this constellation ‘client politics’. But this is only one of four analytical constellations. If benefits are widely distributed, and costs are borne by a narrow group - as in much of the new social regulation - political entrepreneurs or leaders of public interest groups can successfully step in, overcome collective action problems and mobilize consumer interests.

The exclusive focus of capture theories on the superior power of producer interests, does, however, hardly give a fair account of the politics of current American regulatory policy-making. We must not forget that capture theories were developed in connection with old-style economic regulation of the Progressive and New Deal era, and that capture theory does not a good job in explaining the rise in social regulation against business interests. But more important still, the general political environment has changed quite dramatically, and this also concerns economic regulation, and Thus our utility case. First, most observers concur that interest group politics has changed: "the present-day situation is one of much greater variety and diversity of politically effective groups than was the case when capture doctrine was developed" (Reagan 1987, 64 ).5 The important rise of consumer, environmental and other public interest groups and their succees in influencing regulatory policy-making contradicts the assumption, that producer interests will always dominate regulatory policies. This also holds for economic regulation. In State Public Utilities Commissions, for example, former industry dominance has been substantially reduced by the rise of consumer advocacy groups and statutory provision in a number of states for a governmental consumer advocate (Reagan 1987, 64). Second and relatedly, some important developments in the regulatory process underpinned a more pluralist type of policy-process: a greater variety of access channels open for citizen and public participation, consumer-oriented policy entrepreneurs active in Congress, more precise statutory objectives, and strong judicial oversight.

Also other, less industry-focused variants of capture theory did not fare very well in empirical testing. This concerns the ‘revolving-door hypothesis’, which holds that, because regulators often come from the industry they are to regulate or will move to that industry later on, they will favour industry interests. Quirk (1981) questioned the assumption that employment incentives of regulators

5 Petracca (1992, 28) relates these changes to some general developments o f American politics: "new resources for the mobilization and maintenance o f groups, governmental stimuli to group mobilization and activity, changes in the structure o f Congress, the development o f new communication technologies, the continued decline o f political parties, and the demobilization o f the American electorate".

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will induce a pro-industry orientation: future private employers might be much more impressed by a vigorous regulatory style. Gormley (1979), in his study of the FCC, found that party differences explained voting patterns in the commission better than prior background of regulators. Weingast and Moran (1982) showed that agencies respected the policy preferences of overseeing congressional committees, while Moe (1982) stressed the weight of presidential policy preferences. His 1985 study of the NLRB (Moe 1985) shows the variety of actors and factors impacting upon regulatory policy-making: agency staff, presidents, congressional committees, courts plus the general economic and political context. Derthick/Quirk (1985), aiming to explain why pro-competitive economic deregulation happened in the U.S. at the beginning of the 1980s, point to the power of ideas. Elite opinion converged in support of reform and leading officeholder took initiatives. And the very economists who had criticized capture were successful in removing pro-business regulation from within agencies, such as the prominent regulation economist and last chairman of the Civil Aeronautics Board, Alfred Kahn (1971), in the case of airline deregulation.

In sum, a system of countervailing powers or pressures seems to have emerged. But conflicting pressures on regulatory agencies may also enhance its own room for manoeuvre and its independence: the professional values of regulators become an important determinant of policy-making and even a new source of capture by professional norms (Reagan 1987, 65).

What can we leam from this short overview of the American regulatory process? First, neither the normative public-interest rationale of market failure nor the positive capture theory of producer dominance are a good guide to current reality of the regulatory process. Regulation is not only about the efficient working of the market place, but it is also an important political arena for distributional conflicts and the pursuit of social and political goals advanced by different actors, including the regulatory officials themselves. The so-called ‘public interest’ can not be deduced from expert economic reasoning. Its definition will depend very much on the outcome of these conflicts. Second, while economic regulation is very much about the distribution of costs and benefits and often opposes producer and consumer interests, a great variety of interests and actors might exercise influence upon regulatory processes and outcomes. Obviously, this pluralist picture reflects the specific characteristics of the American political system, which offers multiple points of acces for diverse interests, notably the Courts and the working of Congress. Therefore, we need to pay close attention to the specific institutional configurations in a given national context, and how they might open or close channels for interest representation, distributional coalitions, and political control in general.

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1.2. The rise of the regulatory state in Europe

In his pioneering work on the rise of the regulatory state in Europe, Majone tried to bridge the gap between the American understanding and tradition of regulation and current developments in European political economy and public policy (for an overview s. Majone 1996). With the decline of public ownership as the traditional European mode of economic regulation, he sees a paradigm shift from the positive or interventionist state to the regulatory state (Majone 1997). He identifies a change of the role of the state "from a producer of goods and services to that of a regulator whose main function is to ensure that economic actors play by the agreed rules of the game" (Majone 1991, 84). He advances a concept of regulation which, quite paradoxically, is both broad in the European and narrow in the economic understanding of the concept.

Regulation is defined as one of three main types of public intervention in the economy, the other two being income redistribution and macroeconomic stabilisation. Following the decline of the Keynesian interventionist state, which relied heavily on taxation and spending and was engaged in macro-economic management, a new regulatory state is said to emerge whose main instrument is rule-making. The main arena of conflict will change from budgetary allocations to the review and control of rule making, and new key actors, notably regulators, experts and judges will enter the scene. The dual role of the state as an external or market regulator and internal regulator6, make for a new mode of governance under the heading the regulatory state. Allowing for national differences in terms of speed and scope of change, Majone nevertheless claims to detect a clear trend towards a new ‘Regulatory State’ across different European countries and, most clearly, on the European level.

It is not my concern to discuss thoroughly if it is useful to subsume the current upheavals in European political economies under the single heading of the ‘Regulatory State’ as a new mode of governance. I think that his argument holds much better on the European level, as a theory of European integration, than on the national level.7 While Majone’s work provides an excellent starting point to tackle the growing salience of regulation in liberalized European economies, there are shortcomings in the picture he draws of the regulatory process. This brings us

6 Majone (1997) refers to internal administrative reform processes which normally take the label ‘New Public Management’.

7 The argument is that for reasons o f budgetary restrictions and systematic barriers to positive integration on the European level, Europe progresses very much by regulatory policy-making. The traditional welfare state functions, by contrast, will remain on the national level. This, however, calls into doubt the hypothesis that, on the national level, too, the Keynesian positive state will be replaced by the regulatory state.

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back to his narrow, economic definition of regulation. For him, regulation is limited to the correction of market failures, and regulation is being sharply divorced from questions of redistribution.

As a matter of fact, as he states himself, "the adoption of microeconomic efficiency as the main normative criterion (...) implies (...) that regulatory instruments should not be used to achieve redistributional or other social policy goals (Majone 1993, 28). This is because: "(...) in a democracy redistributive policies and institutions can only be legitimated through direct political accountability" (Majone 1994, 23), which means that these issues should not be left in the hands of independent, politically unaccountable regulators. Efficiency issues, however, defined as "positive sum-games where everybody can gain", can be delegated to expert regulatory agencies, since "efficiency oriented policies and institutions are basically legitimated by the results they achieve". While Majone (1994, 24) recognizes that "regulatory policies, like all public policies, have redistributive consequences", he holds that "for the regulator such consequences represent policy constraints rather than policy objectives".

For normative purposes, this may be a useful approach to escape from the legitimacy problem of non-majoritarian decision-making. My argument is that, in practice, it will be very difficult to separate efficiency and redistribution or equity concerns, and to bind regulators and the regulatory process to an exclusive concern with micro-economic efficiency. This argument, of course, applies much more to old-style economic regulation in politically sensitive infrastructure industries with important distributional consequences along producer-consumer lines. In this respect, utility regulation is admittedly an extreme case, which Majone might want to exclude from the range of policy fields amenable to his efficiency logic. It does not come as a surprise that Majone draws most of his empirical examples from the field of European social regulation, and is less concerned with classical economic regulation at the national level.

As we have seen in the American case, the political process of economic regulation does not evacuate issues of equity and redistribution. In reality, there are distributional effects, and these include loosers who are not compensated out of joined efficiency gains. Caporaso (1996, 43), in his review of Majone’s Regulatory State as a form of state for the EU, makes a similar point about Majone’s "failure to ask the cui bono question. (...), the failure to highlight this issue perhaps stems from the efficiency orientation". He also points to the problem that "the principle that guides politicians is almost certainly not Pareto efficiency but the provision of a politically optimal distribution of rents across groups seeking to influence government policy. If the economic theory of regulation is read with a liberal dose of capture theory, Olsonian interest-group

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theory, and Schattschneider’s emphasis on the partial (and highly biased) nature of interest-group politics (1960), it is easier to see why large, concentrated, well- organized and well-financed groups will usually win out in carving the pie" (Caporaso 1996, 43). While more recent American regulatory experience does not quite support his conclusions of necessary producer dominance (see above), he is right in pointing to the fundamentally political logic of regulation, which makes it hard if not impossible to protect expert regulators from the distributional battle.

The lack of an exclusive focus on market efficiency is more than obvious in the traditional European form of regulation by public ownership or publicly licensed monopoly. As a matter of fact, governments used public ownership or exclusive licensing for a variety of social and political goals that often took precedence over the concern with market failure and allocative efficiency: national security, economic development, technical innovation, redistribution between income groups or regions or employment policies. Therefore, neo-liberal critics would argue that it was the very neglect of the efficiency question of economic regulation and the poor economic performance of nationalized industries, which helped to push the agenda of liberalization and/or privatization.

If the liberalization process is about restricting governments to the role of a market regulator or referee exclusively concerned with efficiency issues, then the following questions arise: Do governments simply give up on other social and political goals and equity concerns pursued in the context of public ownership? And if not, which are the functional equivalents they use in the post-liberalization context to pursue these goals? Which instruments of indirect government intervention are developed? Put in another way: if market competition becomes the new overriding norm, the public interest rationale, which in the European case, was like a ‘messy bundle’ of economic, social and political goals, has to be unbundled, and then re-composed, i.e. redefined. These problems are particularly pressing in the sensitive field of public utilities. Following the erosion of direct, public service provision, governments need to find functionally equivalent instruments, build up alternative capacities of indirect intervention, to safeguard the ‘public interest’. To these issues of transition to a new mode of market regulation we will turn now.

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2. THE AFTERMATH OF LIBERALIZATION: THE CHALLENGE OF RE-REGULATION

Privatization and liberalization did not herald the retreat of the state as a powerful actor in the economy. Instead, governments have started to re-regulate liberalized industries and sectors. While intervention continues, it changes in nature.

I think it is most useful to think of regulation as external market control exercised by public rule-making on a continous, case-by-case basis. This definition includes the (case-oriented) application of competition (or anti trust) law, though regulation will go beyond the simple provision of a general legal framework. Regulatory control is not necessarily exercised by an

independent regulatory agency. Competition authorities or traditional ministries might also be the main public actors.8

Why do governments re-regulate markets they agreed to liberalize in the first place? As regards the justification or rationale for regulation, I suggest to introduce a distinction between first-order and second order re-regulation.

First-order regulation refers to the classical domain of economic regulation but

is also somewhat broader: regulation is not only needed to maintain competitive markets, but also to constitute them in the first place. In short: we are talking about the market-making and pro-competitive function of regulation. This understanding goes well beyond neo-classical economics, because it is not assumed that markets somehow naturally pre-exist prior to political intervention.9

While this is a general principle, the problem is particularly challenging in utilities. Utilities are network-based industries with important economies of scale and scope. They are at least partially, i.e. as far as fixed networks, grids or pipes are concerned, natural monopolies.10 Therefore, the privatization of a public utility service might simply replace a public with a private monopoly. For the same reason, liberalization, i.e. abolition of market entry restrictions, will not in

In the U.S. tradition o f economic regulation there is a distinction between general anti-trust law (enforced by the Department o f Justice) and sector-specific regulatory control exercised by single-purpose regulatory agencies. In the European case, the utility sector has usually been exempted from general competition law, with no ‘independent agency-type’ o f oversight. It will be interesting to see which division o f taks and which kind o f interplay between competition law and regulatory control will emerge in the European countries after liberalization. (Susanne Schmidt alerted me to the close linkages between competition law and market control by regulation.)

9 More basically, for markets to arise and function, there is a need for systemic markets rules like property rights or legal rules for the establishments o f economic entities.

10 For an introduction to the economics o f natural monopoly regulation see Berg/Tschirhart (1988). © The Author(s). European University Institute. version produced by the EUI Library in 2020. Available Open Access on Cadmus, European University Institute Research Repository.

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itself invite or create competition, since new entry implies enormous sunk investments in specific and non-redeployable assets. Under theses conditions, monopoly markets will hardly be contestable, since the potential threat of entry is low.

In this context, regulation is needed to substitue for or mimic the effects of competition, by bringing monopoly prices or profits down to a competitive level, by generally constraining the monopolist's anti-competitve behaviour on the basis of a public license stating obligations or restrictions, and more specifically, by introducing pro-competitive rules which allow competitors access to network facilities. If access to a single network becomes the bottleneck of competition, then regulation will very much revolve around this issue of how to provide fair access to the ‘essential facility’, i.e. the network." Other instruments to deal with natural monopol characteristics are to break up the public monopoly, prior to privatization, in regional monopolies in order to allow so-called ‘yardstick competition’, or to organize a bid for franchise or monopoly licence limited in time (‘competition for the field’).

These regulatory tasks require, to take up Selznick’s (1985) words, the "sustained and focused control" by a public agency able to closely monitor and react, on a case by case basis, to market developments. This also implies that, until natural monopoly characteristics can be overcome thanks to technical changes, regulation will be a permanent task.'2

If regulation was only about substituting for competition (and discounting for the fact that regulation might in practice be a very poor substitute, and is ridden with failures, just as the markets), we might actually live in the world of market efficiency-oriented regulation. However, in practice first-order, efficiency- oriented regulation is supplemented by second-order or social and political

regulation, which, quite often, is about the correction of undesirable market outcomes, instead of the correction of market failures. Again, this is

particularly relevant in the case of utilities. "Utility services typically have a broad range of domestic users, often as broad as the entire voting population of the country" which (...) "implies that utility pricing is always going to have a political component, while the whiff of monopoly (particularly when ownership is 11 12

11 There are several solutions to the latter problem: imposing access obligations on the monopolist and network owner, separate accounting for network operation and services, or separating network ownership and network operation. For an illustration o f bottleneck and essential facility in telecommunications see Vogelsang/Mitchell (1997, 55-58).

12 The initial idea o f British economists that regulation was to be a temporary remedy, "to hold the fort until competiton arrives" (Stephen Littlechild, quoted in Foster 1992, 186), proved to be overoptimistic. © The Author(s). European University Institute. version produced by the EUI Library in 2020. Available Open Access on Cadmus, European University Institute Research Repository.

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concentrated in foreign hands) raises the stakes for political action" (Levy/Spiller 1996, 3). On top of this, utilities like electricity or water have a fundamental infrastructural and strategic importance. In case of an energy crisis security of supply might turn into a matter of national security.

Governments will have to make sure that certain user interests that are not catered for by market forces or private decision-making are taken into account, for example to guarantee at least some minimum service at an accessible price to every citizen. This is the notion of service public or Daseinsvorsorge, often focusing on issues like universal service. But other political concerns can come in, too. For example in energy, one form of market correction could be to make sure that a certain (environmentally sound) mix of energy sources is respected by private suppliers. Of course, there are no objective limits to what might be considered public service or other-regarding obligations, and the decision will be a politically contested one. Therefore, also under private ownership, governments will continue to impose some social or political obligations on utilities, though the bundle might be less messy or much less ‘social’ than before. At least, social or political aims will have to be stated more clearly and be better legitimated, against the background of the new overriding market norm.

The conditions of large investments in specific assets and strong politicization make for a particularly delicate regulatory dilemma. On the one hand, given the need or temptation for governments to intervene, the risk for private investors is very high, unless they operate in a sector with rapid asset depreciation and/or high growth rates and short-term profits.13 To successfully invite new entry, governments have to offer a reliable regulatory system with stability over time. This means to build in mechanisms which restrict arbitrary administrative action and regulatory discretion. On the other hand, governments are reluctant to see their hands tied and give up the chance to revise earlier assessments and make adjustments to new developments. As a matter of political necessity they will need some sort of reserve power.

As a result, we find a constellation of ‘imcomplete contracting’ between the government or the regulator and the regulated industry. To be sure, social and political obligations can be written into the license, so as to provide the private investor with some measure of predictability. But the rules and obligations, especially if they combine market-failure corrections and market corrections, i.e. first and second-order regulation, are always open to interpretations and, do not provide solutions for problems which will only arise later on in the process.

13 In telecommunications, for example, the risk seems much less important than in other utilities. © The Author(s). European University Institute. version produced by the EUI Library in 2020. Available Open Access on Cadmus, European University Institute Research Repository.

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Regulation will be both permanent and, to some extent, discretionary. And in Europe in particular, regulation will have to strike a new balance between first- order and second-order regulation.

This is how institutional economics conceptualizes the regulatory dilemma. The main concern lies with restraining government discretion and intervention and protecting private property rights. From a political science perspective one could argue that, first, ‘incomplete contracting’, in terms of changing government preferences and policies towards market processes, is an inherent feature of democratic political life.14 Second, the provision of infrastructural services like electricity supply or water and sewage could equally be addressed as a specific subset of the public-good problem. The fixed networks (railtracks, grids or pipes) have public-good value. Moreover, even though markets can and will, in principle, provide some (excludable and rival-consumption type of) utility services, the specific type of service desired, for instance a nation-wide service to all citizens at a standard price and quality (citizen-based, political non excludability), will not be produced by market forces.

This last argument shades into the discussion about merit goods and associated distributional concerns. "The case for State intervention in the provision of merit goods rest ultimately on distribution. (...) This has been based on the notion that an individual should have access to basic minimum social or merit goods to provide a minimum standard of living. The consumption of these goods provides the basic capabilities to enjoy a decent standard of living. This is a positive right or freedom" (Dilnot/Helm 1989, 56). Like food, health or education, energy supply could be considered to fall into this category. In this context of public or merit goods, the question is how to pursue welfare goals like interregional equity in service provision. The concern shifts from investors’ property rights to the welfare-enhancing functions of public intervention, and, more widely, from allocative efficiency to citizen rights. The basic argument is that public utilities provide essential services to citizens (and, furthermore, constitute an indispensable component of a country’s infrastructure). Therefore, there should be limits to the ‘commodification’ of utility services, which, regardless of questions of ownership, will, by necessity, carry some public service responsibility (Ernst 1994). This is reflected in the legal American concept of businesses "affected with a public interest", first enunciated in the famous 1877 Supreme Court case Munn v. Illinois.

14 The underlying problem o f constraining successors in political office by way o f institutional design is discussed by Terry Moe (1990).

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Keeping these different perspectives in mind, it is possible to break down the basic dilemma of economic regulation into some more specific problems with which European regulators have started to, or will have to wrestle in the future (see Grande 1997 and Majone 1994, 60, who draws up a list of "failures of economic regulation").

1) The first one concerns the relationship of monitoring and control between the

regulator and the regulated industry. Especially in utilities, where the regulator is often faced with a monopolist, there is a serious problem of information asymmetry. For effective regulation the regulator crucially depends on information controlled by the monopolist. More generally, the goal of regulation, compliance, requires some measure of cooperation between regulators and the regulated industry. The necessity of cooperation might lead the regulator to compromise on some of the public interest obligations. This is one important source of agency capture by the regulated industry.

2) The second pitfall is a direct consequence of the fusion of first and second order regulation, the uneasy mixture of competition and public service goals. Typically, statutes lay down vague or contradictory goals for the regulator (for the British case see Graham/Prosser 1991, 193). This may result either in more discretion for the regulatory agency (since it will be up to the regulator to strike a balance between the conflicting goals), or it might also paralyze the agency because its decisions will be constantly challenged, as they are open to litigiation on the grounds of failing to meet one particular objective.

3) The third issue concerns the distribution of regulatory power between

different governmental bodies and, hence, the question of coordination of regulation. Will the regulatory agency supposed to perform the assessment of conflicting goals and values have the necessary powers to do its job properly, or will regulation be ineffective because, for example, important powers are held directly by the government or rival agencies? Regulatory effectiveness might suffer from poor coordination between different agencies, both in the same industry field or across different sectors. If different regulatory goals are given to different agencies to handle, the regulation process might suffer, especially if the line of conflict coincides with the conflict between first and second-order regulation. Finally, a single-industry regulator might be more prone to capture than an agency with cross-sectoral monitoring power.

4) Fourth, and finally, the question arises: who guards the guardiens (Shapiro

1988), or who will regulate or control the regulators? Again, we confront the basic regulatory dilemma. On the one hand, regulators need some political independence to perform their task, on the other hand, independent regulatory

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decisions lack political accountability. Here, the risk is not capture by industry, but capture by agency, i.e. if there are no sufficieny checks on regulators, regulatory decisions will reflect the professional or personal values of regulatory officials, more than the statutory duties they are supposed to implement.15

In sum, public regulation is ridden with some severe dilemmas or pittfalls. This is not to say that the previous form of economic management, public ownership or monoply, was without government failure. However, under the previous arrangement the conflict between competing goals, especially between efficiency goals and distributional or social goals could, at least in principle, be resolved by way of national ministerial hierarchy. The government of the day, subject to some constitutional and other constraints, could decide how to strike the balance between a variety of regulatory goals and define the ‘public interest’, while, some would add, the taxpayer picked up the bill.

With the transition to a liberalized and European market one would expect the old public-ownership definition of ‘public interest’, the particular mix of economic efficiency-orientation on the one hand and social and political market- correction on the other, to be seriously challenged in favour of more market efficiency, and, institutionally, of more centralized, European regulation. The process of disentanglement and recomposition of regulatory goals unleashes open political conflicts because it uproots distributional bargains and coalitions struck under public ownership. The distribution of cost and benefits is at stake. The battle over a new definition of public interest, over a new bargain between competing goals, opposes old stakeholders and new entrants, the winners and loosers under the traditional setting. But also new actors formerly not involved appear on the scene. Together, they enter into debate and conflict on the proper scope of government intervention. New boundaries between state and market, private and public interests, in short: a new institutional equilibrium is at stake.

3. THE NEW REGULATION GAME: THE PLURALISATION HYPOTHESIS

What does the regulatory scene in Europe look like? How do governments deal with the basic regulatory dilemma, and in which way are the political conflicts about a new bargain between first and second-order regulation being fought out? In which way are roles and powers re-allocated, costs and benefits redistributed, which new mix between first- and second-order regulation emerges?

15 O f course, this is what central banks are all about, and some are quite happy to see that the logic o f professional norms will replace the political battle.

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A closer look at the new regulatory scene should take as its starting point the traditional constellation, in the light of our analytical focus on the recomposition of public interest definitions and distributional coalitions. To simplify for analytical purposes, the distributional bargain under public ownership or monopoly could be characterized as a producer-dominated coalition of politicians, public managers, trade unions, centered around the monopolist and privileged suppliers. For Majone (1997, 149) this capture by politicians and trade unions comes close to a "corporatist policy style". The excluded actors were the consumers, potential (foreign) competitors and alternative suppliers. What these terms try to express is the closed and cartelized nature of decision-making. From these structures of decision-making did not follow, however, that benefits were not more widely distributed, for example to satisfy particular regional or group constituencies. Thus, the public-interest logic of service provision implied substantial cross-subsidization to keep prices artificially low for some consumer groups.

In how far and in which direction has this deal been uprooted and transformed by the transition to liberalization and (re-)regulation? There are

different hypothetical scenarios: a) continuity of European-style producer

capture, b) classical industry capture, by the monopolist or a new cartel of industry interests, c) ‘Central-Bankers’ solution’, meaning regulation by experts, ending up in transnational professional communities of sectorally specialized regulators, d) American-style politicized pluralism, i.e. a constellation of counter vailing forces e) self-regulation, i.e. associational or bi- and multi-lateral agreements between producers or producers and consumers, as well as variants of "producer self-constraint" in the shadow of government regulation.

The most obvious and simple expectation would be some kind of pluralisation: European competition requirements, market forces and/or regulatory pressures (national regulatory monitoring and international regulatory competition) will combine to reduce monopoly profits and and increase consumer benefits at the expense of producer groups. This seems to be Majone’s (1997) expectation concerning the redistributional consequences of ‘post-keynesian’ regulation.16

16 Apparently, Majone (1997) subscribes to the pluralisation hypothesis. However, he does not offer a very precise definition o f what pluralist might denote. Basically, for him this seems to imply tow things. First, two new groups will gain in importance: courts and judicial review in general, and experts and regulators. Second, corporate interest groups, which were at the heart o f Europen-style neo-corporatist arrangements, will decline in importance at the benefit of non-economic, single-issue groups. What he has in mind, is an Americanization o f European countries, and, extending the Schmitter/Streeck argument from the EU to the national level, that national corporatisms, in the transition to the regulatory state, will be eroded and replaced