Russia's invasion of the Ukraine has upended what we have come to regard as the 'normal' relationship between politics and regulation. It involves a response that only governments can make - not regulators. The inexorable rise of what is termed 'the regulatory state' seems to have come to a halt. This blog looks at the new policy environment and at how far we can expect the relationship between politicians and regulators eventually to swing back towards regulation as the preferred tool.
The new agenda.
The supply shock associated with Russia's invasion of the Ukraine is not the only shock influencing government/regulatory relationships. It comes on top of the COVID pandemic and the not-so-distant international financial crisis of 2008/9. In addition, in recent years the market has been undergoing a structural change as the concept of the firm undergoes a fundamental change in response to a recognition of the externalities of corporate behaviour. What is known as the ESG agenda was already requiring a review of the terms of reference of regulators before the supply shock.
The impact of the supply shock is first and foremost to place security of supply at the top of the policy agenda. In addition to encouraging investment in renewables, this involves governments deciding how far to delay the phasing out of coal and nuclear power generation, and how far to issue fresh licences for oil and gas developments. It also requires governments to make a renewed effort to raise insulation standards in housing and to consider more direct measures to curtail demand from households and businesses. At the same time governments have to address the cost of living crisis that makes it unlikely that consumers will spontaneously wish to pay out for better insulation and that will curb the demand for new EVs. Security concerns are not limited to the energy sector but also affect other critical infrastructure, including communications and finance.
The regulatory world continues to play an active role in the response. Central banks remain key to the task of combating inflation and financial sector regulators have new stress tests to perform, new evaluations to make of the risks of 'stranded' assets, and new assessments of environmental claims to make in looking at ESG evaluations in changed market conditions. Nevertheless, the balance of tasks seems to have swung decisively towards policy actions that only governments can take.
To assess how far the underlying relationship between governments and regulators may have changed for the long term it is useful to take three different perspectives - a policy perspective, an institutional perspective and a normative perspective.
At first sight the policy perspective suggests a clear swing towards actions that only governments can take. Moreover, the effects look to be long-lasting. Russia's place in global supply chains will not be quickly or easily restored, even with a change of regime. Nor will the effects of cost of living increases
on the need for more targeted income support policies fade away quickly.
There are however two qualifications to make about this picture. The first is the authority of regulatory bodies in making policy that flows from their superior knowledge of their field. In one well-known visualisation they are seen in terms of representing ‘truth that speaks to power’ (the politicians). From this perspective the regulatory bodies are likely to regain their role as agenda setters because they often know best what needs to be done in their field. Their epistemic advantage has not changed. Moreover, the need of regulators for independence from government to protect knowledge and expertise-based policy making from inconsistent short term political pressures and interference will possibly be even greater as governments predictably flounder in their responses. In the UK the new government has lost authority and the Bank of England gained.
Secondly, the policy making perspective brings into focus the forces within politics that restrain governmental and legislative action. Here, much of the attention turns to what are called veto players - those actors within the institutional arrangements who can block policy change. They may exist within the parliamentary assembly where a sufficient coalition to agree on change may not exist, or between chambers in a bicameral system where different parties control the two chambers. In a crisis situation coalitions may be easier to assemble and bi-cameral rivalries may also be replaced by bi-partisanship. However, over the longer term, the tensions within parties ,or between coalition partners, and the rivalries between chambers, are likely to reassert themselves.
Thus, in this policy-oriented depiction of the dynamics of the relationship, regulatory bodies are likely to re-emerge possibly strengthened in a policy making role as the immediate crisis fades away.
Probably the most common way to approach the question of the relationship between regulatory bodies and the elected bodies of politics is from an institutional perspective.. From this perspective a standard division of functions is to see the government as the principal in the relationship and the regulatory body as its agent. This perspective puts the focus on the discretionary power of governments to choose how far to tax and spend, how far to subsidise and where to target subsidies, where to ration and redirect demand. In addition, legislation is needed to update the terms of reference in the agency world. For carrying out the new agenda, the institutional perspective clearly seems to put governments back in the driving seat.
There are two limitations to this perspective. First, public services increasingly involve chains of intermediaries for their delivery, with their own institutional and regulatory logic, and the government is several stages removed from the end product. Once through the immediate crisis, regulators are likely to regain their authority in overseeing the policy delivery process. Secondly, blame deflection behaviour is well recognised as an entrenched reflex on the part of governments and governments may once again find it convenient to pass the buck back to regulators as soon as the crisis has passed.
A normative perspective accentuates the role of politics in setting normative standards acceptable to the public. The new standards must be endorsed through political processes and involve the normal give-and-take of political debate and a pivotal role for the political parties that represent different views in the legislative branch. It is further expected that regulators will also look to governments to decide what is acceptable when questions arise in relation to new ethically sensitive questions such as the targeting of income support.
However, the primacy of government in setting normative standards is not black and white. Regulatory bodies do not just perform technocratic functions but, in normal times, take important decisions relating to the environment, income distribution, access to services, and the allocation of credit, including the governance of the businesses they regulate. They routinely weigh risks against benefits and one class of risks against another.
A key issue concerns the standards for judging what is publicly acceptable. In the case of politics, two different standards are sometimes distinguished. In many cases governments command a legislative majority and can use that majority to set and to update normative standards. In cases of societies where there are deep normative divisions, the need to achieve a consensus among as many political parties as possible may be seen as the more appropriate standard by which to judge what is acceptable or not. Where responsibility ends up may depend on which standard is adopted. A majoritarian standard places the initiative with the political branch; a consensus standard will be difficult to meet and will put many normative judgements back with regulatory bodies.
These different ways of visualising the dynamics of the relationship between governments and regulators suggest that, as the crisis fades, the regulatory world will reassert itself. The epistemic advantage of the regulatory world is unchanged and so is the advantage in overseeing delivery chains and processes. The role of regulators in continuing to oversee how markets respond to a changed concept of the firm will remain essential. However, what is missing from this picture is the need for the terms of reference of many regulators to be updated in order to reflect the new circumstances. That role of government has become even more urgent.