It is my great pleasure today to welcome Professor Stephen Littlechild to our MOOC. I'm afraid I'm losing my voice, and this is the last interview after over two years of recording the MOOC. So I wasn't about to not do this. And anyway, this is not about me, it's about having Professor Littlechild here. I'm just going to ask the questions. Professor Littlechild has been a professor at the University of Birmingham and Cambridge University here in the UK. And his ideas have revolutionized the way we think about regulating private utilities not only in the UK but throughout the world. And not only has he provided the intellectual framework for a new way of regulating private utilities. He's also worked in government to implement many of these ideas from 1989 to 1998. Professor Littlechild served as a Director General of the Office of Electricity Regulation in the UK. In other words he was the regulator, so he's seen both sides of this problem. Both from the conceptual academic point of view and from the practical of political perspective. He's consulted with governments around the world and written extensively in academic journals about regulatory issues. And he's generously agreed to come to Manchester and share his thoughts on the regulation of utilities. Thank you so much, Steven, for coming today, it's really great to see you. We just met, just downstairs, it's the first time we've met in person but we actually have a link, right? A connection that I wanted to tell the students about. We have the same dissertation advisor at the University of Texas, Abraham Charnes. So in academic terms we're actually brothers, in academic bloodlines. And our students on the MOOC U are actually grandstudents of Professor Abraham Charnes at the University of Texas. And I thought Steven maybe we could start the interview, and you could reflect a bit on Heid and what you learnt from him and how it influenced your career. >> Sure. Abe Charnes was a very distinguished mathematician as you know. He made important contributions to the development of linear programming. He extended that to mathematical programming, to stochastic programming, game theory. He even as we are discussing a moment ago, he had an input, in fact he developed this notion of data envelopment analysis which is being used in water regulation. Perhaps, we'll touch on that later. I first got to know Charnes because I was at Stanford University in the OR department, and I thought it was pretty theoretical and I wanted something applied. So I asked my supervisor, who was Ken Arrow the economist, I said who should I go and talk to this summer who's interested in Applied OR. He said Abe Charnes is your man. So I went there for the summer and he said, stay for a month and work with us. What I discovered was two things, he wasn't only interested in applied problems, which I was, he also worked with his students. He spent lots of his time with his students, he wrote lots of his papers with his students. Maybe two or three times a week we'd all go to lunch with him, we really got to know him. And I felt that kind of input encouraged me to work further in this area. You going to ask another question? >> [LAUGH] >> [LAUGH] >> Yeah we were both really lucky to have him as a dissertation advisor, he's an extraordinary man. I think he would get a real kick out of seeing us here today speaking with all of the students around the world. He was a great teacher. >> Yes, and I think one thing that was particularly important about him. He put a lot of emphasis on, A, originality. So he wasn't interested in just regurgitating what the theory was, he wanted to do something new and original. Secondly, he was very interested in applied problems and in understanding what was distinctive about particular businesses or governments. So he would say, well, what are their objectives and not just something simple like profit maximization but are there more important short term goals? What are the constraints on them? What do they care about? If you can model that and then analyze it, you can come up with a better understanding and new insights and new recommendations for policy that you wouldn't otherwise have done. And I think that emphasis on getting to the heart of the problem [CROSSTALK] >> Yeah practicality of- >> Yes >> What reality really looks like. >> Yes >> It wasn't just driven by theory. >> Yeah, absolutely. >> Let me ask you the first question about sort of policy innovation. I've interviewed people for the MOOC, sort of talked to them about where do the ideas come from? And so how did it happen that you came up with price cap regulation? Can you give us a little bit of the background, the history of this? >> It's an interesting story I think. It started because the British government decided to privatize British Telecom in 1982. And this was the first nationalized industry that had been privatized. So the Department of Industry said, well, we must look to other countries with private telephone systems, that's the United States. They have regulation, they have rate of return regulation, that's what we must have too. Now Alan Walters who was a professor, who was at that time advising Margaret Thatcher number 10 said, but I've been to the United States. I've seen rate of return regulation, it's awful. He said, it doesn't give any incentive to the companies to be more efficient. It's bureaucratic, it's run by lawyers, it's very costly, we need something different. So the Department of Industry said, well, if that's the problem, we'll have a rate of return, let's say 5%, but we'll let the company earn up to 10% and that will be the maximum rate of return, after which it has to hand money back. And so Alan Walter said, but that's 100% taxation, that's socialism. And any minister who was thought to be advocating socialism in Margaret Thatcher's government thought they better find another way through. So they said, well, Professor Walters, what do you suggest? And I think within a few hours or a few days at most, he had to come up with another form of regulation. And he said, the main problem with monopoly is that it restricts output in order to increase price, in order to increase profits. What we must do therefore is to encourage British Telecom to increase its output, we should give it a target to sell more telephones. At the time, telephones were in short supply in Britain. And then if they exceed that target, we should reduce the tax on them. So the department said, well we've never seen anything like this before. They couldn't agree and so it was agreed that they'd find an independent economist who would look at these two options and choose between them. Then as I understand it, there were two or three candidates for this, I was one of them, I was told. Now I had several advantages I thought. I knew Allan Walters because he taught me at the University of Birmingham and then I've been a colleague of his free year at the University of Birmingham. Incidentally, he had been to Northwestern for a year, that's where he learned about American regulation. And he'd been a colleague of Abe Charnes and a friend of Abe Charnes. >> And I knew him at the World Bank actually. I didn't know this connection but he was there, yeah. So that was the first thing. Second, when I did my thesis under Abe Charnes I did it on telephone pricing. That was the main element. In fact, I was looking at a copy of it just this morning. It was in December, 1968 I wrote my first draft of this paper. So I knew something about telephones, I knew about regulation in the US because I looked at it in the US context. And fourthly and finally but not least important I think, from the time I was at school, I've been very keen on. Free markets and on privatization. And I had been looking at that as a policy in the UK. So I kind of ticked all the boxes. So I was asked to adjudicate between these two systems. I soon found that I agreed with the argument that rate of return regulation wasn't very sensible, but I found problems with Allan Walters' proposal. For example, he was suggesting that British Telecom should be allowed to get reduced tax if it exceeded its target, but it didn't pay any tax at the time, so this scheme would have meant introducing a tax in order to remove it. So I wasn't persuaded by that and I thought, well, if I'm not persuaded by either of these two, I've gotta think of something different. So I spent quite a lot of time talking to the company, British Telecom, about what their concerns were, talking to the department, talking to Allan, talking to others like Michael Beesley. >> That's just what Abe Charnes would've recommended you do, right? >> Yes, I think so. >> To go talk to the company. >> And it was fascinating, because I had a deadline of a couple of weeks or so, to produce something. One of the things that the company told me about was that a couple of years earlier that they and a sore to raise money as a government owned entity on the private capital market. This was normally frowned upon it, was told that it would cause inefficiency and they said no. We will keep our prices down as the result of this by 2% below the rate of inflation. And I thought we'll that's an interesting idea and put it filed away in my mind. Then increasingly I begun to think, could this be the basis of some form of price control which would be better than rate of return control. I didn't like price control, I didn't want to go down in history as the man who invented the price control. But it seemed to me, if it was temporary and we could encourage competition so that we could be needed after five years, say, then it wouldn't be as problematic as it otherwise it might have been. >> So there's this holding the fort kind of notion. >> So this was the notion. What we need is something to reassure costumers that things aren't going to get worse, in fact they're going to get better. And if you can assure them that the prices will go down in real terms by say 2 or 3%, every year, that should be a useful assurance. Secondly, you can say to the companies, look you're not going to to have a regulated jump on you and suddenly freeze your prices. You are allowed to increase your prices at the predetermined amount. RPI was the retail price index, that was important because rate of inflation, essentially. The rate of inflation, until just a year or two earlier, had got up to 27% in one year. So the companies desperately needed some kind of, both companies and investors, some kind of reassurance that they could pass through that cost, which was outside their control. So this was a reassurance to both parties. And it turned out to be acceptable to our malters, to the department, ministers, merchant banks. Yes, we can sell this, it's not American regulation but, it does reassure customers and companies and that I think is how it got adopted. >> That is fascinating. It is almost like there was an imperative to develop something, right? The innovation happened under considerable pressure. >> Yes. We're talking about two or three weeks here, in which this had to be produced. >> [LAUGH] Yeah. >> Over Christmas, as I recall, when I was having to give the end of my lectures to my students. And, the bill to privatize British Telecom was on its way through Parliament. I mean, so that's just a matter of two to three months before something like this had to put in. A solution had to be found and found pretty damn quick. >> If you haven't found the solution, do you think you would have force to go back to return to regulations. I mean would that have been the fall back? As a matter of fact, I put in a preliminary report, I think it was two weeks before the deadline. And at that time, I hadn't thought of RPI minus x or applying it in this way. And it said I don't like any of these, but it maybe that rate of return regulation which is what we going to have to do. And so, I had two weeks to think of something better. [LAUGH] >> [LAUGH] That's a great story. You've just kind of alluded to this, but I wanted to ask sort of what the response was in the broader political system to this price cap regulation. I mean, you were a young academic, this was untested, this idea. Did you have pushback on this? It sounds like it arrived just in time. And the way you described it, there wasn't a lot of controversy about it. >> No, I think as I said the deadline was very urgent, something needed to be done. It had to be something that satisfied Allan Walters because he was the Prime Minister's adviser. He says in his diary that I happened to see a few weeks ago, that is now public, Steve Littlechild came to see me, I think I've lost this one. >> [LAUGH] >> [LAUGH] So Allan, I think, accepted that his thing wasn't going to run, and as long as it wasn't right of return regulation and he could see the merits in it. >> Yeah. >> We haven't touched on those yet, but your students, no doubt, know. The point about a price cap is that, if a company reduces its cost below that price cap, it can keep the difference. And that is an incentive, to be more efficient and to innovate. And he fully understood that and was 100% behind that. And I think everybody else saw the merit of a scheme that was tailored to the specific situation of the privatization of the national industries. Because the key consideration above anything else was to make these industries more efficient. And that is what this scheme tried to do. >> It's a great story, and I'm struck I wonder how many people really understood it, did they think it through? I'm just wondering if they needed it and it's provide a certain legitimacy to the privatization effort and you know they trusted you, they trusted Allan Walters. But I guess I'm asking sort of, how well do you think the concept was really understood in those early days? >> I think it was understood by the key people, the economists in the department, by Allan Walters obviously. Michael Beesley was another colleague that I talked to on this. And basically wasn't just off the top of my head, this was building an ideas of economics and incentives. But the pretty fundamental to the economics literature and the economics profession maybe more favored in Chicago than some other places. But this, I think, was based on sound economics. And that is why people didn't question it, as well as needing something like this to see them through this crucial process. And one of the ministers involved said later in his autobiography, we got stuck on privatization until Professor Littlechild showed us a method of showing how that would be beneficial for monopolies, as well as potentially competitive industries. So I think you did provide that legitimacy that it could be applied for a whole range of industries. >> I mean, you said the kernel of the idea actually came from industry. I mean, in your discussions, what was the reaction among the other players in the industry when they first heard of your idea? Did you get a response on- >> Well, British Telecom was crucial, but could hardly object to a scheme that itself had suggested just a couple of years earlier. >> Yeah. >> So that got them on board as well. The question then boiled down to how do we save x. Now, I wasn't involved in that. But I now know from reading the official history that [LAUGH] this process went on for months and months and was pretty difficult. I didn't realize it would be that difficult, but they were on board as well. They could see something practical and tangible, something that they would know for the next five years, or three years, whatever. Not something they would have to haggle about afterwards, not something uncertain. >> Steven, you're talking about the history. Were there any real life examples of price cap regulation? I guess the other question is why didn't you sort of rely more on sort of economic theory here? I mean, there is a lot of economic theory about incentives. And you didn't really say much about that in your response to or the challenge that Allan Walters had given you. >> Yes, well, of course there's a lot of literature on price controls and it's generally pretty bad. But [LAUGH] I was very conscious of that. So I didn't need to highlight that. But I was also conscious that I was an academic being asked to give an opinion on practical policies concerning privatization, government, politics, the running of a business. And people would say, this is an academic, what does he know about it? So I didn't want to emphasize the academic foundations of this. What I wanted to do was look for real examples. And one, for example, was the Monopolies and Mergers Commission, a few years earlier, had put a price cap, and it was sort of an RPI minus x price cap, or cost minus x price cap, on the London Rubber Company, which produced contraceptive sheaths. So here was a real live example of the UK competition authority actually using this kind of price cap in the private market. And that, I thought, was an illustration that a privatized company could also live with that kind of control, at least for a few years. >> That's great. I have a few questions about the early years of the price gap regulation. I've got your 1983 report here, and it's been called the most cited publication that's never been read. We've provided it to our students in the MOOC. We've also provided your 1986 report on the economic regulation of water utilities, the water companies. And also your Oxford Review of Economic Policy, summary of the regulation of water companies. But why do you think it was not widely read at the time? It's true, you think that's true. >> It sold out the day [LAUGH] it came out, was the first reason. >> [LAUGH] It was going to have a limited run, right, yeah. >> So yeah, very limited run and it had to reprint. But it is quite complex, it's quite long. And I think you can express the main idea in a few paragraphs, if you like. And once the people concerned with the privatization knew about it and accepted it, I think others, basically, understood what it was all about and accepted it. So they didn't need to go back to the original. >> To the original, yeah. I wanted to ask you about the initial stock price for the water companies. A lot of our students in the MOOC have asked us about this. There's a lot of literature that says that the water companies were given away too cheap. And do you have an opinion on this? I mean, how do you think about the initial flotation of the water companies? >> Well, of course, my job, as I saw it, was to recommend a form of regulation. And I was going beyond my original remit in saying, I've got a better idea than either of these two. What I didn't have a remit to do was to decide what x was, or should be, or even to indicate the kind of factors that would be taken into account in any detail. So I was no longer involved in the process, although I did a little bit of a revision to my report before it was published. And I spoke to people in the department and they said, well, if we're going this route and we're trying to create more competition, here's a few more ideas for you. So I put those in the report. But I didn't get involved in the setting of the x. It's true that a lot of people felt that the company was sold too cheap. But they felt that to all the companies, all the privatized companies. Certainly, the stock prices went up after they were sold, all of them. But this was, to some extent, intended. The government wanted this to be seen as a successful program. It wanted those people to invest, to make a profit. It wanted to attract new investors that had not been in the stock market before, smaller investors. And it succeeded there. But over time, I think people felt a, that these profits were perhaps higher than they should have been. And secondly, in some cases, they felt prices were going up, which they didn't like. And they said to the regulators, well, look, it's your job to deal with this. And we, as regulators, felt that if the government ministers had set these price caps a little tighter, there wouldn't have been this problem. So we weren't concerned so much with the share price and the sales proceeds. We were concerned about the tightness, or otherwise, of the price controls. And we felt that, well, it's our job to deal with this, but we can't do that for five years because this control says regulators will stand up for five years. So it was a slightly difficult period for the first four or five years. I think that regulators, after they tightened the price controls, revised them, addressed this problem. But you could tell that there was a lingering concern. And what happened, eventually, was that when the Labour government came in, the first thing they did was to put on a new profits tax on the utility companies. And whereas we would not have advocated this as regulators, I think, nonetheless, we felt that it dealt with that problem and it made customers and taxpayers feel better. And it felt that our job was that little bit easier afterwards. >> We're going to come back to this question about the lessons for the developing countries. But one of the messages that I take away listening to you now is that You really needed a lot of political support for this. Both the price cap and the privatization. Because there are going to be bumps along the way as you get started. Do you think that's accurate? Was there any sort of pressure to back away from price cap regulation? Or the privatization when people were complaining about giving the. >> As I said, there were pressures on the regulators to revise these controls a bit earlier. Certainly that was on me. And I said, look this whole system has been set up to benefit customers over a period of time. And if we chop that short earlier than it was planned. Or earlier than we reassured the companies. They won't be able to reduce their costs as much. And we won't have as much to pass on to customers in the future. So we had to hold the line there. And I think we did. Although, when I come onto this later, I think it led to different type of price controls being examined. For example, should you have a control that isn't a simple cap? Where the company gets everything below that cap? Of it's costs reduced below the cap. Or should you have some sort of sharing mechanism? Which wouldn't be as strong an incentive on the company to reduce costs. But would have an appearance and a reality of a greater fairness, you see. >> Right. >> And that, I think, is something that is well-worth considering. And I've began to think more favorably about that over time. We can perhaps come on to that later. >> Yeah, yeah, yeah, good. I want to come back to this question in the early years of the price cap regulation. And in your 86th report, you mentioned six different tools. Policy tools that the regulator could use and I'll just read them here. The price cap, the service requirements. The dividend in Bargo, location of a license. Information disclosure, and the legal liability for nuisance or for using a tort law. As you look back over 30 years of regulation, which of these are most important? And how did it Play out, these were being implemented? >> I think there's absolutely no doubt that constraints on prices, in one way or another. And changes in the quality of service obligations on companies have been far and away the most important technique. The reason for that I think, is a that people care about these things. And be that regulators can do something about them. If you take some of the other items on the list, like the law of nuisance. If you want to change that, you've got to get an act of parliament. And they are difficult enough to do anyway. And regulators don't have the power to do that. So it's really not something that regulators can deal with. There were other examples. Dividend embargos. Well, you don't want to. If you've got a regime that says you can, provided you meet this price control, you can keep the results. You don't want to start saying yes. But you can't give them to your shareholders. So that seems inconsistent. >> Right. >> Other examples- >> Well information disclosure was on the list. >> I don't remember that being a significant issue. I think more information about most things came out as a result of regulation. Not everything. So that didn't seem to me to be used as a technique for controlling or directing the companies. There was a fifth, sixth one there that you mentioned. >> Let me see. I had price cap service requirements. Well, you talked about service requirements, dividend bargos. The license. >> License. >> Yeah. >> Now, in principle, you could take away a license and give it to someone else. I mentioned that in my report. But in practice, A, you are taking away a company's life if you like. That is a major thing to do. And secondly, you got to find someone else to run this company. And who you are going to get to do that. These are not trivial things. They can be done as easily. And as the flexibility and kind of irreversible things. So, that I think went rather beyond what a regulator could do. I think the government, in one or two cases, has done that, when there'd been very serious problems. But that's not the kind of thing a regulator can do. >> Yeah. >> So we focused on what people cared about and what we could do something about. >> So, my next set of questions is about the implementation of the price cap. The regulation, I've got three questions. You are good for uniform acts in the RPI minus X formula group. Good reason to keep the pressure on the companies to continually cut cost. But as I understand it, in fact, that is not what happened in the implementation. That different companies got different X values. What were the implications of that for regulating the water company? Why did it happen? Why did it turn out that way? >> This was an idea that occurred to me when I was writing that report. I was looking for a way of putting some sort of pressure on efficiency when you didn't have competition. And it seems to me that being able to compare one company with another company would be a way to do this. Now I think in fact the spirit of that was in fact, adopted by companies. I mean, I found when I sit to companies as regulator, you can do better than this. They would say, what do you know? You don't run this company. So then I have to say, but it's not me. But this other company here, they can do better than you. Then that was quite interesting exchanges. Because what we found is that the companies with the lower costs would say to us. Look, we're much more efficient than these other people over here. You don't need to worry about us. You need to go after them. So then I'd go to the companies with the high costs. And I said, look, these other companies have told me that they're much more efficient than you. Because they've got lower costs, you see. And I need to bear down on your prices. And they said. No, no. It's not like that. We've got different conditions. We have more rain here. We have higher winds here. We've got more mountains. There's less sun. We've got population all over the place. It's much more expensive to run a business here. We're just as efficient as them, it's just that we have different conditions. So I went back to the first set of guys and I said, look. They say they're just as efficient as you. And they have different conditions. Take no notice of them, they're incompetent, they said. So that lead on, of course, to ways in which you can use this kind of differences in efficiency. I think that regulators found that the differences was so great that they couldn't easily hold to one single X for all the companies. The differences began to emerge. I mean, they existed before privatization, began to emerge after privatization. The differences in conditions, as well as differences in efficiency. One of the things I did was to say well, let's run a regression line. Some of you guys are above it, some below it. You say that that's because of different conditions. I reckon half of that difference is due to different conditions. And half is your efficiency or inefficiency. It was a simple sort of judgement like that. So we were able to use comparisons between the companies to set this price controls. Without necessarily setting the same x. What I did in the case of the electricity distribution companies is to say, we need to adjust for this situation, but I want to keep a uniform x. So I'll have a change in what we call a p-naught change. The price at which you start the next five years, we're going to make a once-and-for-all adjustment there. That adjustment was as small as, I think, 5% for some companies, as much as 12% for others. And then a year later, I actually jacked that up by another 10%. So really big differences in immediate changes in price. >> We'll come back to this question about the initial price, but that's interesting. So you handled and sorted differences among companies not in the x, but in the adjustment to the initial price. >> That's what I did in the mid 90s. Now I think my successors, and probably in water too, they said, well, maybe we should be looking at changes in x as well as changes in initial prices. So I think they've been willing to consider different xs, which I didn't have to do. >> Our students often ask us, when we present this material on price cap regulation, if there's a risk of the water companies getting together and trying to collude on the price adjustment, the x. And do you think that this has been something to worry about in the UK water regulation, or? What's your opinion on that? >> Well, it's a point to consider. My own impression is that these companies are so diverse, and, if you like, the laws against collusion are pretty severe. They really wanted to run their own thing. I didn't ever get the sense that there was collusion. I thought there was certainly lots of issues on which they would make the same argument. They all argued, for example, that they should have a higher cost of capital, and their operating expenses were going to go up, they needed to invest more. So they had the same interest, in many respects, but they would easily argue against each other with respect to who is more efficient, for example. So I didn't feel that was a problem. >> I have another question that I wanted to ask you, that's puzzled me, about the implementation of the price cap regulation. And it's really about this issue of tariffary balancing versus tariff design, and how customers respond to increased prices. So in the RPI minus X, the initial price is a weighted average of prices to different customers. So the companies actually have to forecast how customers are going to respond to different price changes. My question is, what if they get it wrong? They actually tried their best to forecast how customers would respond to different prices, but they missed it. So they didn't succeed in keeping their weighted average under the price cap. Did this ever happen, or do you see this as an issue? >> No, I don't think it was a real problem. We'll come back later to rebalancing. As far as possible, I tried to formulate this price cap based on previous observed parameters. Like, for example, not a forecast of next year's retail price index, but an observed value for last year's. I can't remember precisely, but I think I would have been inclined to look at the actual volumes of consumption of water, or telephone calls, or whatever, in setting that control. So you would look at last year's consumption, and set present prices in such a way that at observed values of inflation and quantities you would meet that control. Having said that, I don't think that was entirely possible. And it certainly was, not occasionally, but almost always the case that companies either made less or more than their price cap allowed. So what we provided for was that there was a correction factor that would apply to next year's prices. Now, we said, if a company inadvertently charged prices that brought in more revenue, average price, than it should have done, they had to pay back that back next year. So they said, well, that means if we make less than we're entitled to, we should be able to put that on next year. And I couldn't really object to that. So this correction factor was applied every year, and it could sometimes be quite considerable. It could be two or three percentage points. Furthermore, one or two companies said, we can see things are going to get more difficult in the future. We're not going to take our whole allowance each year, we're building two or three percentage points below it. And after I reset the control and cut prices by 12%, this company said, good news, we don't need to reduce our prices, because we've got this back lock, or this error, you see. >> [LAUGH] When you say doing the correction, let me just make sure I understand, you're talking about the correction in the weighted average price, right? >> Yes. >> You still are leaving it to the firms to set the price to different customer classes. >> Yes, well, that was the basic principle, that they could set their own prices for all these prices, as long as the weighted average met this limit. And typically what they would do, and I guess it's the same in all of them, maybe a couple of months before they published these prices. They'd show them to us and we'd just look through, and they seemed okay. So that was the way we did it at the time. Error correction wasn't a serious. It was a nuisance, because you couldn't easily predict what the prices were going to be. As regulator, I didn’t know what these prices were going to be the next year. So whereas I've been telling customers, and regulators, and governments, you'll know that your prices go down by x percent in real terms. Well, sometimes it was x, sometimes it was x plus one, sometimes it was x minus on, you never actually knew. And that was, I discovered, one of the slight limitations of this approach. >> We're going to come back to applying the price-cap regulatory model to developing countries. But one of the issues that we may find in developing countries is that, in the water business, the UK didn't have a lot of metered connections when we started. And that's still a problem in developing countries. But I would think the correction would be a bigger issue when you have metered consumption, right? You wouldn't expect customers to respond if they have a flat rate on their monthly charge on their water, right? >> You're right. This question about how far customers respond, I don't really remember that being an issue in water, and really not with respect to distribution charges. In fact, electricity generally at the time was thought to be pretty inelastic, the demand inelastic. >> And water's the same way, yeah. >> So it wasn't really a big issue, I think. And even now, as you probably know, metering in water is, what, 25% of households? It's still very low. >> I have one more question on this, and it's really about the regulatory culture. And one of the things I take away from your 1986 report is your sort of emphasis on Light touch. And really having the company spend their time on what they do best, not get the regulator involve in certain micro managing the business. When you were in the regulator in the electricity sector, was this a hard culture to create to have the regulator kind of step back and not micro manage. I mean it seems like a it kind of a tendency regulators to want to micromanage. I mean, how do you create a culture with a light touch? >> There wasn't a culture there before in this respect. I felt very strongly about that culture. I didn't want to micromanage. I wanted the minimum of regulation. I would have preferred if we didn't have any regulation at all, that was where I was coming from. So, for me that wasn't an issue. And that was the culture we had in our organization. But you could sense the strong pressure's coming to intervene, political pressures and from consumer groups. Now they had legitimate concerns about quality of service for example, which you had to investigate. But if anything went wrong, they would say to the regulator, this is your job to sort this out. Why aren't you getting in there. So overtime I think, the culture changed to where the regulator felt more responsible for more of the details. I think with the setting of price controls too, you had to instead of saying, well, these are your costs, just keep them under control, you said, well, hang on, how much are you going to be investing over the next five years, because that's going to influence how we set the price cap. And then you said, well, wait a minute, do we think you're to be investing that much? You had to begin to take a more detail and intervention as view I think. So I think it's got to the stage now where it's the norm that regulators take a more hands-on view. People are now joining regulatory bodies, with the thought that they're going to be able to exert influence and do something about these companies. And some regulators, including the water regulator I think, are beginning to think, hang on has this gone too far? Should we now be trying to step back a bit. Because what's happening now is that the companies have been saying, well this isn't really our business plan. You rejected our business plan. You said we must do this and that and we mustn't do this, that and the other. It's really your business plan, not ours, and regulators don't want to be in that position. So I think it's going backwards and forwards, and at the moment, the feeling is, can we step back a bit? But hang on, can we leave everything or doing what do we need keep our fingers on? >> I want to comeback to this issue of the re-balancing and ask you about how that x was initially set in the water issue? How did that actually happen the first time it was done? >> I think the critical time was when it was first set in British telecoms. The situation was that I had said, we've got competition coming down the road for long distance calls. We can see this new entrant mercury offering long-distance calls. We haven't got competition for local calls. What we need is a price cap applied to local calls. And that was the idea for the RPI minus X on local calls. So the minister, having agreed this approach, went to BT and said okay, what can you propose for X? And they said well, we think something like RPI plus 3%. He said, what you mean, 3%? It's got to come down. And they said, no, no, no, no, no. We're making a loss on local calls. We're making profits on long-distance calls. So if it was only on local calls, we'd have to put prices up. And he said, well, I can't sell this to consumers and investors. What if we extend the cap to include some long distance calls. That's all right, we can do an RPI minus ten if you did that. So, the RPI minus was obtained because the cap was extended. And this meant that the British Telecom was allowed to re-balance. And then the question became, well, are some people going to be worse office as a result of that re-balancing. And eventually they started putting the local prices up and the long-distance prices down, meeting the price cap but those people who only made local calls felt they were wears off. This wasn't what they've been promised, so the regulator brought in a sub cap just on the local calls. So you can see that this concern about re-balancing was there from the very beginning. What you got is a situation where nationalized industries for the last 20, 30 years haven't really been interested in the individual costs and prices of particular products. They were just concerned to make a return overall. But in the competitive market, competitors are going to come in if you're overpricing. And they're not going to come in if you're under-pricing. So regulators had to be very concerned to get this re-balancing whereas the company, and the companies were but some of the politicians weren't so key. That I think is why there's a continued concern about has been about re-balancing. And probably why this has gone less far in water than it has elsewhere. I think there has been a concern that if you expose these costs, some people are going to be paying rather high up prices than you'd like them to be. Perhaps in rural areas or perhaps certain kinds of customers. So, there's been a hesitation in water to expose all this re-balancing. >> Well, one last question about re-balancing and tariff design. You talked about Alan Walters. Originally, he was a big proponent of marginal cost pricing, right? And then he, instances, did this issue ever come up in the price cap regulation, I mean about the tariff design trying to get customers to face marginal cost? >> It was certainly important part of my thinking. So let me tell you about that. When I was a student in the mid 60s, marginal cost pricing was a new and exciting and controversial idea. Lots of the economist supported it but others like Ronald Coast of the LSC had opposed it, but the French electricity company had pioneered marginal cost of pricing and lots of economist, as you say like Alan Walters, very keen on it. So, when I wrote the first version of the paper on telecom pricing, I see this morning that I said, let's set prices equal to marginal cost. And the one sixth of the level for long distance costs but they were looking to recover the balance of the overheads from government. And as I began to look at this, I realize that ain't going to fly. So firstly, I became skeptical about that. Secondly, when I got back to UK after getting my degree with a chance, I sit to the Treasury, I should say in 1967, the Treasury issued a white paper giving guidance to the nationalized industries on how to set their prices and it said as far as possible, you should set price equal to marginal cost. This became official government policy in 1967. So when I got back in 1970, I went to the Treasury and I said This is your policy, I have a mechanism for doing it. So I have mathematical programming techniques that'll give you the numbers. I said, a very interesting, that's good, we're interested. So I went along to meetings between the treasury and the industries. And they began by saying, well, over the last year you don't seem to have introduced marginal cost pricing yet. What progress are you making with that? And the industry would say, we quite agree that, in principle, this is the right way to go. But for our industry, it happens that it's not the right thing to do. And the treasury after a bit of debate would say, can you tell us that next year you'll spend more time trying to apply Marginal Cost Pricing? And they say, yes, yes, we shall. Every industry said that and they said that every year. Nobody actually did it. So Marginal Cost Pricing was that something people talked about but they didn't actually do. The next thing we found was that these nationalized industries, the problem with them was not that their prices didn't reflect the structure of costs. It was that they were inefficient and they were not innovating and this was much more important. And I was, while I was still working probably with the treasury, was arguing for moving away from marginal cost pricing because that didn't tackle the real problem and no one took any notice of it. Instead to saying, get your costs down and let us set you the financial target. Let us introduce competition as far as we can and eventually over time, introduce private ownership. So the reason marginal cost pricing wasn't high in my thinking at that time was because that wasn't the priority. Efficiency, productive efficiency was the priority not allocated efficiency. >> Interesting story. I have a set of questions about how the regulatory model has evolved over the last almost 30 years in the UK. I mean as you look back over almost three decades now, what surprises you most about where we are today with the regulatory structure, and where you started in the 80s? >> I don't know that I'm massively surprised by where we are. I'm quite pleased in a sense that the broad framework of regulation and of incentive regulation, of some variant of our has stayed the course and proved popular, and indeed used around the world. So that has been very satisfying, it indicates that it's been found useful. I guess what I hadn't quite anticipated is the degree of effort that would be involved in resetting these X values. I had an initial taste of that when I was regulatory in electricity and I had to reset the distribution network prices. Let me talk about year. We said, this what the price is at now. We said the companies, to customers, what do you think? These are the cost, how should we base this control? And thinking of a mechanism to reset the X and arguing, discussing with the companies, deciding and implementing that took about a year. Seemed to me a long time but it seemed to me time well spent a year after which the companies would have five years to get on with it without me interfering with them. What happened overtime is that this one-year period extend it to two and then to three years. And in fact, together with saying to customers and companies beforehand. How do you think we should go about it in the light of how we went about it last time and what has changed? And then at the end saying well, how was it for you? What do think lessons, what lessons should we learn? It's five years. It's a full time job now setting a price control, five year a full time job to set the next one. Now that seemed to me disproportionate. And I begun to look for ways in which you could cut that down. That I think is possibly one of the most disappointing aspects of how things have turned out. >> In your 86 report you also talked about the possibility of restructuring the industry. And that hasn't really happened much, has it? I mean, in other words, that if you got the price cap regulation working right, there would be incentives to restructure the companies. Why do you think that hasn't happened? >> There's an interesting contrast there between electricity and water. In electricity we set out to re-structure the industry from the very beginning. Seeking to distinguish between the monopoly paths, the distribution and transmission networks and the competitive paths which were generation and retail. And we wanted to encourage the maximum amount of, if you like, changes in structure so that you could have a marketing company. So that people could buy and sell a retail company or a distribution company. So that companies could specialize. Some of them would say, we only know about networks. We'll stick to that. We don't really know about customers and commercial markets. We'll sell our business. And others will specialize in that. That was an aim of policy and it was adopted by government and I encourage that. In fact I went to considerable length to encourage the two largest generators to split themselves up and sell some generating stations. And we had the takeover, not just a threat of takeover, we had takeover by the Americans, by the Germans, by Chinese, all over Spanish, all over. Very international market because there are companies in the US and Canada and Japan and China and Germany and so on that are in the private sector that are interested in moving in. In water, on the other hand, the government saw no prospect of competition and I have to say at the time, I didn't. So they didn't see the need for it. And when you're privatizing, there are a lot of things to do and if there isn't, you don't need to do something, you don't do it. Secondly I think, as I indicated earlier, they might have been a little apprehensive as to what this would have shown up in the way of cost differences. And they weren't particularly keen to reveal that. And thirdly, and I think this may have been at the suggestion of Michael Beasley, my colleague. He was worried that if you had takeovers within this industry, it would consolidate from one with maybe 20 or 30 companies down to one with 2 or 3 companies. They might argue they would be more efficient. But there wouldn't be any comparison left. >> And you couldn't do the benchmarking. >> You wouldn't do the benchmarking. So he got put into the act that the last minute, a provision that no company within the UK could takeover another company without a reference to the Monopolies and Mergers Commission. And he was looking to encourage water companies from other countries to move in, and UK companies in other businesses to move in. Well, what in fact happened is that there aren't many companies in the UK that feel they can do a good job at running a water company, because they don't know much about it. There aren't many privatized Water companies around the world. So we had virtually no takeovers. So you didn't get this market mechanism working. So there was never the pressure, in those early years, to restructure this company and specialize. It just didn't happen and it wasn't encouraged. That I think is changing now. I don't know whether you want to go into this later, but now, I think, both the government and the regulator realize that they may be scope for introducing competition at the retail level, and encouraging competition at the wholesale level. And already just last week, one of the largest companies, Southern Water, said, we don't think we're going to be any good at retail. We're going to sell our retail business off. You've got restructuring suddenly beginning to happen now. >> I was going to come back to that, but let's just talk about it now. Do you see that as a major development in England and Wales water companies, this retail competition? >> I think it's going to be a major development. It's happened in Scotland. They've had retail competition for maybe ten years now. For business customers it's proved extremely popular. What the companies, the new entrants, who have typically been from England and Wales, they've been able to offer slightly lower prices. But they've been able to offer better service. There will say for example, if you want a single bill for the whole of Scotland, we'll give it to you. If you'd like your bill itemized in this way, we'll do it for you. If you'd like advice on saving water, we'll give it to you. So they've offered better service. The incumbent water company in Scotland has had to say, my God, we've got to increase our game, and we're going to offer these services too. So everybody is very pleased about it. That is going to happen in Britain, in England and Wales, in 2017, I think. The companies are gearing up for that, that's going to happen. Whether you'll get a lot of competition at the wholesale level, I think, remains to be seen. The problem is you don't have a wholesale grid, in the same way that you have a transmission grid in electricity. Whether it's going to be possible to have a water source here that can be conveyed to a customer there, or whether these companies are going to buy and sell from each other at the wholesale level, I think is a question as yet unknown. What the regulator is saying, which I think is right, is, let's see what prices this throws up. Let's see what opportunities for trade and specialization it suggests. Then we can make a better judgement. And I think, and this is again something we have in common, too, customer groups are going to have an important role in this process. >> We'll get to that, I do have one last question on this issue on how the regulatory model has evolved. Steven, I wanted to ask you a question about the concerns some people have about the cult of the individual, that regulation can become too personalized. Do you think this is a problem? And what can be done about it? >> Some people felt that it was a problem initially. I should say that the regulators in the UK were all appointed as individuals. They're not boards, they're not commissions. And the first regulator, the telecom regulator, said, I want to bring home to people that I am an individual, I am a person. This is not some bureaucracy with no face. So he wrote all his decisions by saying, I have concluded that, I have been thinking that, I will do this. Everything was I, so we all took the lead from him. So we never said we, we never said, the office. We said, I will do this, I will do that. That I think was fine, wasn't the problem. I think as prices began to get rather high, individuals began to be identified, and people said, are these individuals doing their job properly? And then the time came for changes in the individuals as new people were appointed. And the new appointee wouldn't necessarily follow the same policy as the previous one. I think there was one case where there was some question of energy efficiency, and the previous regulator had been very strongly in favor of it. And the subsequent regulator said, I don't think customers would be willing to pay for this. So then it began to be said, by people that were a bit critical of the regulators, it depends on who the regulator is. This isn't a good system, it's unpredictable. And I think that came along with the new Labour government, who had really disapproved of privatization, but had come to support it. They supported competition. The only thing left to criticize about what the previous government did was regulation. So they said, well, one of the problems, obviously, is individual regulators. So they said, we'd better have a commission instead. I think those of us who were regulators, individual regulators, on the whole felt that this was not a good development. Certainly, you got more views expressed as a board. But we used to get those views from advisers in business, or customer groups, and so on. What it did do, I think, is make the whole thing a little more bureaucratic, it made it slower. It meant that an individual couldn't put their personality on the industry and the regulation as much as before. We, of course, thought that our policies and our personalities were okay, but maybe others didn't. So I don't know, I don't see any sign of it going back at the moment. But I wouldn't say we've reached the final stage. But I would say that the cult of the individual isn't only something that you find amongst regulators. You find that in companies as well. A lot of companies are quite pleased to keep their heads down and run with the pack. And so they're not going to try to stand out. They want to be as efficient, but don't want to stand out more. But you'll always find one or two chairmen, or chief executives, who do want to make their mark, and want to say, we can do better. And this is something that the recent regulatory approaches, I think, have built upon. We maybe come on to this later, but regulators have been saying, it goes back to the point we talked about, about comparative regulation. They'd been saying, if you can reduce your costs fast enough, we will tick your price control. And some companies have said, I don't know, we'll wait and see what the others do. But some companies have said, yeah, we can reduce our costs faster than anybody else. And the regulators are rather welcome there. So you get individuals in business- >> In both, right? >> Yeah. >> Yeah, so let's move on and talk a little bit about your current work in Scotland and with the customer forums. What is your current thinking about the role of customer participation, customer engagement in the regulatory process? >> Well, we always had a role for hearing from customers. And I had some consumer bodies, one in each area, who gave me, I thought, very good advice. But it was always advice that I would say, well, thank you very much, I'll think about that. When I finished regulating, I thought, are there things we could do better? And one of the things I thought was, should we get customers more involved? And I began to look at what happened in the US. And it seemed to me that although US regulation in may ways we were critical of, actually, the customers and the companies there had found ways around this and the regulators too. And they had a system which they call negotiated settlements, whereby, if the company can come to agreement with its main customers, about for example, a change in price or tariffs and put that to the regulator. The regulator might well say, well if you're satisfied, I don't see any need to reopen this, tick. You don't need to go through this long legal process which is time consuming costly and uncertain. And I thought there was a lot to be said for that and we ought to explore it in the UK. So, I encouraged water regulators in England and Whales and in Scotland, and the energy regulators to have a look at that and to be fair something like that had been done at airport regulation in recent years as well. And they did and they saw something in it and what developed is a process of customer engagement in the water sector and in energy. Where the regulator basically said, we would like you, companies to give us a business plan. It has to be a challenging business plan and it has to have the support of your customers. And if it's sufficiently challenging and it's sufficiently supported, in effect they said, we will be minded to tick this and give it a fast track through. Whereas, if it's not very challenging or if it doesn't have the support of your customers, we will give it the usual three year treatment which we all know we don't like but we have to go through. >> So, you're actually very positive about this negotiated settlements in the context to the regulatory model, if I just- >> Yes, indeed. Now, I do know that in the US some people would say, hang on, the regulator doesn't know what's going in, in these negotiations. He doesn't know what the company is giving to the customers to persuade them to agree. Surely, the regulator should be making these decisions. And that's something the regulator needs to consider but as far as I could see, in most cases, the regulator was saying, we want to be satisfied at what's coming out as sensible and if the customers are sensible, are supportive of it, we think that's probably okay. >> There's kind of an interesting link with the low income countries here. And our students in the MOOC, who we've spent a quite a bit of time talking about community participation, how to consult with customers, very poor people in policy design and implementation. Do you have any new thoughts on sort of techniques that have been successful in the UK or Scotland on sort of how you consult best with customers? >> Well, a question that everybody tends to ask is, [COUGH] how do customers know enough about this business to have a sensible negotiation with them? In the US the answer is, these customers tend to be large companies that have a lot of financial interests at stake in their energy bill. They are able and willing to provide experts who know about the business and they can hold their own in a discussion. In the UK, we wanted to get people representing ordinary households. What happened in England and Wales I think, is that basically not much was done in that direction. The regulator later felt that the companies had not told the customers as much as they should have done. They pointed to some companies that had offered to cut their costs quite significantly. And they said to the others, you could have done that but you didn't tell your customers you could have done. You haven't really negotiated in good faith. We are not going to fast track you. So, the regulator then came in later to say, we are going to take up this business of looking at the costs and I'm afraid we haven't been able to rely on the customers to negotiate. That, I think, is potentially a weakness of the approach because it in effect says to the companies and to the customers. Well, you can approach, you can discuss these things and maybe a great business plan when it comes down to it, its regulated who's going to decide then, we may or may not taking notice of what you've done. So the question is, is that going to happen in another year? Are companies and customers going to be willing to engage? So that thing is although the approach is promising, that's one of the limitations of the England and Wales approach in water and in energy. >> One of the things we worried about in developing countries is really how do you get a representative sample or an inclusive sample of the customers and communities, right? There's often a few individuals that speak up or dominate meetings. I mean, do you have any sort of insight into how you get a wide encompassing view of what customers really think, as opposed to some small focus group, where a few people said something? >> I think there's two interesting experiences here, in England and Wales, I think in water and in energy the regulators said to the companies, we invite you to set up customer groups. It's up to you who you choose to be on that group, who you think should represent your customers? That's your choice but bear in mind that if we don't think much of your choice, if we think they're just a bunch of yes men, we are going to be less convinced about your business plan. So, we are going to be more convinced if you can produce a customer group that is broad-based, representative as far as possible, of all the different parts of your customer-based and has really challenged you well. I don't know the details of what happened but the groups were very different. I think on the whole it worked very well. They also had an all groups I think and in some cases shared the groups. People from the customer body, the official British government customer body, who had a degree of expertise here. In Scotland, on the other hand, in the Scottish water sector, the Scottish regulator and the water company and the consumer body jointly agreed to do this and they said, we will select a customer body that we think is sufficiently representative. And the customer body carried out interviews and it picked a set of people that it thought could represent. Broadly speaking, the views of lots of different kind of customers not represented if in the sense of fighting for lower prices necessarily, or for particular narrow groups but understanding, we're interested in understanding what customers were concerned about. >> Can we just continue into your Scottish example? I'm not sure our students will realize that it actually you got a public company, right, in Seattle. >> Yes. >> Do you might want to say it a bit about that but, I guess one question I got is, so, how applicable are the lesson from Scotland back to the private companies in England and Wales? >> Well, let's just indicate how this was done different in Scotland and Scotland the water regulator said We see the same kind of issues. We want to get customer views in this process. I mean, I should say that in the water industry particularly, and in energy too, the amounts of new investment that have been talked about and planned, in order to increase customer service are enormous and are very costly. And so, regulators in both sectors increasingly being saying well hang on, are we really sure that customers want to spend this money to increase quality of service? How we going to decide that? Let's get the customers in. So that was one reason for doing it. And secondly, if you're going to be, have to be looking at price increases, which could well be required, then it's better to have the customers and their representatives on board with you, rather than shouting from the sidelines you should have allowed much lower price increases or price reductions. Better that they understand it. So in both cases, a concern to get the customers involved, to get them talking to the companies. And in so far as the companies and the customer groups could agree, this would reduce the time and the conflict involved in this whole process. Reduce the uncertainty, and indeed, it did and it turned out to be a very rewarding process. It did require a lot of effort, but it was typically done more quickly than a price control review. And everybody, I think felt they were doing, it was worthwhile. So that was the way they approached it in Scotland, in both countries, but they did something more. The company and the regulator and the customer group agreed on a process for doing this and the regulators said you will seek to represent the views of customers and take into account the guidance we give you. And halfway through the process, they thought this is going pretty well, we will ask the customer group and the company to seek to agree on a business plan that can be used as a basis for a price control which never been done in England and Wales. So, they were on course to negotiate and agree something, on the implicit understanding that this would be used for setting the price control. And they were told that they should do this consistent with guidance that the regulator gave, about cost, operating cost, capital expendage of the way prices should go, quality of service. The regulator didn't determine everything, but it determine an area within which if this parties were able to agree the regulator would might be able to approved it. And that happened. So you got to the end of this process and everybody felt, yes, it's worth while with negotiating a good deal and the regulators improved and the government has approved. A much better feeling than in England and Wales where one or two companies got to that state but most of them were rejected and has to go through the old slow route. >> I'm laughing because I'm thinking about what would say here You've identified the core here within which you got to find the solution, right? [LAUGH] >> [LAUGH] Absolutely, yup. >> [LAUGH] One last question about Scotland before we move on. Could you talk a little bit about this new idea of financial tramlines? >> That is something that's novel and only has just been invented in Scotland, and we really don't yet know how it is going to work. The idea was that instead of saying fix this price control and then that is what will apply for the next five or seven years, this was a government own body, I think the government was more concerned that things went on all right along the way. And secondly, the regulator felt that if you could provide some sort of reassurance to the company and to the customer groups, that whatever they agree is not absolutely the end, but if things don't turn out the way they expect, it will be possible to put things right. So if, for example, the customer group agrees a price path, and the company meets that and makes loads of profit, to a greater extent than expected, to an embarrassing extent, perhaps, then the parties will get together. The tramlines would say If your financial ratios go outside this area, either higher or lower, the parties would sit down and discuss ways of adjusting. So the company would be invited to say, well we could perhaps reduce prices, or we could increase our investment, or we could increase quality of service, or we could return more to the government. Or if on the other hand the company was struggling, then it could say, well we may need a price increase or we may need to cut back our investment. Or we may need a little more government borrowing. There would be this way of discussing and finding a way through which the parties told us made it easier to agree in the first place. Because they knew they was as it were another stage if necessary. So that facilitated agreement, but the question in my mind is first, how is it going to work. And secondly, could you you use that if you didn't have a government-owned company but you had privately owned companies. The privately owned companies like RPI minus X because basically they're told this is your price for the next five years, get on with it and we're not going to interfere. The tram lines mean, well we're actually going to be looking at this every year for the next five years, and we may indeed, [LAUGH] Want to suggest something. Could you get a private sector company to agree to that, in the way that a government company did in Scotland? We don't yet know. >> It's interesting know is there's another innovative idea coming out of the regulatory sector, right? I mean, what I'm struck with is this continual generation of new ideas. And where did this one come from? >> I would have say, that came from the chief executive Allan Sudermann of the water industry commission for Scotland and, you were right. I think Scotland has been particularly innovative here, because they've been particularly conscious of some of the limitations of the standard methods in England and Wales. But I would have to say that if you compare England and Wales with the United States or Australia, it's been much more innovative, because basically regulators are told, you can do what you like, as long as you get the agreement of the companies. And regulators haven't hesitated to change regulation, the nature of regulation, the process, the individual licenses, and so on. That has been a standard, ongoing procedure, and companies have not on the whole said, hang on this is regulatory uncertainty because they know, they can object and it can be sent off to the competition commission to adjudicate if they can't agree with the regulator. So on the whole, regulators have been willing to innovate and to discuss with companies how to do this. And in start contrast, I think in Australia, the regulators are not allowed to make changes, there's another regulatory body that decides on the rules that the individual regulators have to follow in setting Price controls. It's very different there. And in the US much more legalistic and a matter of going through the courts, you have to go through due process. Very difficult to change things is my sense. >> Stephen, I want to shift gears here and talk about the lessons from the UK regulatory experience for developing countries. And one of the things we see in developing countries is that prices are very low. Most of the utilities are publicly owned. Not all, but the real challenge is how to get capital into the sector. And that's really hard to get capital into the sector and efficiently manage if you've got very low prices. You wrestle with the problem of the initial price in the UK, maybe you didn't have to change so much, but what advice would you have for people in developing countries about applying the price cap regulation, and the sort of challenge of initial prices? >> Well, you make a very important point about the initial price. If you privatize an industry and the first thing they do is put their prices up, this is not going to be electorally popular, and the prime minister in particular was very concerned to avoid the association of the privatization with price increases. So what the treasury did before any of the privatization was to say, are the prices presently at a level [COUGH] viable for the foreseeable future? And if not, let's try and get them to that level before we privatize. Now, I have to say that was criticized to sort of fattening the goose ready for Christmas before you sold it. But I think that was absolutely necessary. Probably the main industry in which that wasn't possible was water because so much more investment was needed. Not just to be viable at the present level of investment but to improve quality of service. So water was the one industry in which prices rose the most after privatization, and as you know, one that ran into some political difficulties as a result. But the government was very concerned to get prices high enough initially that these industries were viable, financially viable. On the whole the privatized industries were at all near that position. So it wasn't a difficult problem. It was something that could be done in a year or two. I quite understand that in many developing countries the situation is far from that. So it seems to me absolutely crucial if you're going to have a private sector industry that it be self-financing, that it's not dependent on a series of government grants, at least over the longer term. Because where you have government grants involved, then you've got the government pulling the strings and dictating prices and employment policies for political reasons. And that is not consistent, generally, with running an efficient business. Quite how you do that I don't know, you may have some ideas from you own experience. >> Yeah. Well, in developing countries many times you've got very inefficient water utilities, publicly owned. In the UK, you actually used a price cap regulation for privatized companies. You're asking me, a real challenge is this decision on whether to privatize or not, given the sort of initial state of the world. What do you think? If you have a public water utility in a developing country, suppose it's performing well, would you push toward making it private? >> Yes I would, partly because one doesn't know how efficient these companies are. They say they are efficient, they may seem to be efficient but are they as efficient as they could be? We had a really striking example of that with electricity. All the nationalized industries we thought were inefficient and could be improved. But electricity everybody thought was the most efficient, and there wasn't really much scope for improving efficiency. Maybe you could get a power station built a little quicker, or a little cheaper. What we found was that over the ten years that I was regulating, the number of staff in that industry fell to one-third of what it was at the beginning. That was the extent of the inefficiency that nobody recognized. Companies, once they were freed from the implicit duty as a nationalized industry to keep on employing everybody, and they offered good severance terms I might say, this was done without recriminations. But to get move two thirds of your workforce out over ten years, that is incredible. So I would say that the opportunities, the greater efficiencies that can be achieved along with higher quality of service typically rather than lower, they suggest that a private, properly regulated entity is going to be more effective. >> One of the big problems we've got in developing countries is serving poor households. Do we have any lessons from the UK regulatory model about how to reach poor households, and meeting service obligations to the really poor? >> Service obligations, I think, have not distinguished between the rich and the poor, so everybody gets good quality water service, and for other utilities as well. But you're right, there's a problem insofar as some people find it very difficult to pay for their water. Water is not metered in the UK. There is a question, I think, whether if poorer families had water meters, would they be able to use that to reduce or adjust their consumption and save money on their water bill? Or would they simply reduce the amount of usage at some personal cusp to themselves? I don't think we know enough about that, because water metering has not gone very far in the UK yet. But certainly the regulator and government are very concerned, and there are provisions for offering rebates or special terms to poorer customers. But of course these are paid not by government, not by taxpayers, but by other water customers. And one of the things that's emerged from the customer engagement is that the customer representatives are really rather reluctant to go very far in this direction. They do not like the idea that some customer should subsidize others. They think on a whole, for the most part, customers should pay the cost of providing their water service. >> You know it's interesting, I was just looking at some data this week about what we have from Kathmandu. And we have almost the same conclusion on additives. I mean there's a real concern about affordability and fairness. But there's also a concern about making special arrangements. Of course in the UK, I mean in a sense you've got a very unique way of doing is you can't disconnect people. So you've got a lot of debt on the water companies books from people that actually don't pay and that also falls on customers that. That do pay. And in a developing country context, well, that may be hard. I mean, you can't have 50% of your people not meeting, not paying their bills, right. I mean, you can afford to get by with this. But that's a tough business proposition to sort of allow people to not pay their utility bills. >> Absolutely, absolutely. >> Yeah. >> But I think if you continue to let governments pay these kind of expenses, then you don't have as much commercial drive for efficiency and for lowering prices as you might otherwise would. Which I think you were asking earlier about privatizing these entities. I do think there's so much that can be offered and I do think that regulation is by no means as effective if it's a government owned company, if you want to explore that issue. So privatization I would say is a priority provided that it's done properly. >> Yeah. So I want to ask you about future challenges for the regulatory model, and particularly in the water business. We're looking at a world with climate change becoming, already here, water scarcity around the world, very different than the UK situation. And people are looking at very different technologies than the sort of traditional pipe network. And in particular we're thinking about much more recycling, either at the neighborhood level or municipal level or even at the household level. So just imagine hypothetically that you had a technology that would allow the household to sort of disconnect from the pipe network with some small makeup water. Say there are small discharges, really become independent, kind of like the cell phone disconnecting from the landlines. Many people think this is coming. If you were the regulator, how would you deal with a disruptive set of technologies like that? How would you think about keeping a level playing field, or allowing for technological innovation that maybe we haven't seen in the water sector in a long time? >> I think regulators are now asking these questions. But I wouldn't claim and I don't think they would claim that they've got the answers yet. For example, about five years ago, off Jim developed what it called RIIO as an approach to regulation to move on from RPI-X. And instead of assuming certain kind of investments would be made and the demand would be this. It moved to saying we don't actually know what the demand is going to be, but we will reward you if you meet it and we will penalize you if you don't. So it's moving to a situation where when you're setting price controls and regulatory frameworks generally, you don't really know what's going to happen, but you want to incentivize good things and try to discourage bad things. So I think that's the beginning of a recognition that the world isn't as simple as it used to be when we first designed regulation. This kind of thing is being explored much more actively I think in Australia, for example, and New Zealand. Where they're much more conscious of solar technology and of batteries as being game-changing developments. And I think even there they're saying to consultants, it's something that I've been involved in slightly, tell us what you think the future might look like and what kind of regulatory models would be appropriate. Now I don't think we've got the answer. I think myself that we want customers involved, as well as companies. And because we want A, more knowledge of what customers might be doing. B, more buy in from the customer side. And C, less fewer constraints of a regulatory kind that might stop innovation. Whether regulators will be willing to step back and let these things happen. And whether certain customers that might think they're losing out will be willing to let this happen. And whether government ministers will let this happen, I don't yet know. It's more change I think now than any time I can remember. >> I think it's not just customers losing out, it's the possibility that the companies also will lose business, right. I mean that a lot of their capital stock will become obsolete and how will those losses be allocated between shareholders and public? >> You're right, that's happening. And I think what companies are increasingly saying is, we don't want to make our only come from a price per unit sold. We want another income in terms of a monthly charge. >> A fixed charge. >> For being here. >> Yeah. >> And just in case you need it. >> Yeah, exactly, well, that's the risk though about if you in terms of a level playing field. In my example, if a household wants to disconnect from the water system, they just need a little makeup water, they don't have a lot of waste water to distribute. And the company comes back and says, yeah, but that make up water is going to cost you a big fixed charge, right. I mean, where that, in other words, to protect the value of the capital stock that's already there. That's the challenge it seems to me in terms of how you think about a disruptive technology. >> I think so, my inclination would be to let these things happen. But in order to do that, you haven't got to tie the companies down too much. You've got to give them more flexibility, not put many additional obligations on them now. But to let them form the judgements as to whether these are sensible investments or not. >> I want to ask you about this choice between public and private ownership again. And it's particular relevant in developing countries. I mean, in the world I'm in, people are watching very closely things like Paris moving back from a private utility to a publicly owned utility. The reverse of what you're talking about. Do you think there's any chance that the water companies and the water utilities in the UK will go back to public ownership? I mean, what's the likelihood? It's not impossible because if you ask people in surveys, a number will say we should go back to nationalization. Not just water, but electricity, gas, telecoms, perhaps. And there are people in the left wing of the labor party in Britain that would advocate re-nationalization. I forget now whether it's waters on their list but rails certainly is. But it seems to me that the vast majority of people are not looking to move back, because they see that these companies are now more innovative and efficient than they used to be. They, even though they see some prices coming up, I think on the whole the quality of service has got better. They, I think wouldn't like a situation where they couldn't choose now in some industries, the gas, electricity, telecoms, they now have a lot of choice. If you had a nationalized industry, would that offer any choice? Probably not. And so, and then, finally there is the question about how you finance these industries. Water is a particular case, enormous amounts of investment required, billions of pounds every year on a continuing basis. Where's that going to come from? The government doesn't have that kind of money. You'd have to increase taxation if that was going to be necessary. So those kind of pragmatic considerations I think are going to argue against any significant amount of re-nationalization of any of these industries including water. >> I mean, you would also have to compensate the shareholders, right? Well, people would take different views on that. But I think in practice, in a country that respects the rule of law and property rights, the answer is, yes, you would. >> Yeah, we could go on, but I want to wrap up. And just thank you so much for taking the time to come to Manchester. Do you have any last advice for our students around the world here? I mean, suppose one wants to become a regulator, get into the business here. What kind of skills do they need or what would your advice to them be? They're fascinated with the stories you told and the experience in the UK. And they want to work in this area. Well, I think one thing that came home to me as regulator, I certainly realized how many different skills you need. I'd been an economist and an operations researcher, very technically oriented, and I suddenly discovered you needed to know about engineering. And you needed to know about people. And you needed to know how politics worked. So I think that Abe Charles, our mentor, would say, get into this industry, whichever industry you're interested in, or get into a regulatory body and talk to everybody. Find out how it works. And what you will discover is that you need to have all sorts of considerations in your model so you understand how the whole thing works, rather than simply come at it as an operations researcher person or an economist or a marketing person or whatever. It takes a bit of everything. Look at the actual industry and the actual companies. >> I think Abe would have of loved that answer, Steve. Thank you so much for coming. >> Thank you so much >> Great, yeah.
