The Public Interest: Regulation and Trust   

A recent conference topic was “How important is trust in business?”  With respect to the regulation of public utilities the question becomes “How important is trust for a regulatory agency?”

A hundred years of regulation in the USA has proven that public “trust” is crucial for the ongoing operation of a regulatory agency.  In fact, the continued existence of public utility regulation and the regulatory agency is wholly dependent on the ongoing consumer trust.  That trust must be based on a majority of the public holding the opinion that the regulator has in the past, is now and will in the future, be acting in the “public interest.” Recent calls for “nationalization” of England’s privatized water companies is an example of a loss of such trust in regulation by citizens.

The “public interest” standard in the US means that, whether implicitly or explicitly, every individual regulator, responsible for the ultimate setting of the rates of monopoly electric, gas and other utilities, must address the issue of how the “public interest’ is best served by the orders issued.

This is particularly true when private corporations are franchised and entrusted to provide essential “public services” as “public utilities.”  This public utility industry ownership structure is common in the US, parts of Europe and occasionally found in Africa and Asia.

For any regulatory agency to be successful, especially a new one, it must gain and keep public trust.  This trust is gained in the public performance of the regulators’ duties. Regulatory agencies have three general functions:

1. to adopt rules for the implementation of laws established by the legislatures or parliaments,
2. to administer these rules daily, and
3. to make quasi-judicial determinations concerning licensing, financing and setting tariffs.

In practice the question of public opinion and “trust” in the regulators is most tested when the only actions reported on and observed by the citizens of the state are the requests for periodic rate increases. In handling such as request the regulator is performing in the quasi-judicial rate role. How the regulator handles the high visibility “rate case” becomes the litmus test for regulatory trust. Ultimately the question becomes one of “Does the public believe the regulator acted in the public interest.”

The “public interest” standard, as practiced in US-style regulation and adopted by many countries in the past twenty years with respect to rate setting and other determinations, dictates that the benefits to the consumer (both immediate and future) , in terms of service reliability, supply adequacy or favorable economic benefits, of a rate increase be of greater value than the impact of the immediate increase in rates on the customers.  In other words, the public must trust that a rate increase today will bring increased benefits (value) in the future and that the increased price is worth these future benefits.

Model regulatory principles include the necessity that the regulator’s order, enabling the rate increase, provide a full and compelling statement of why the rate change is necessary.  The order must be comprehensive in presenting the facts, the law and the rationale supporting the decision of the regulator to raise (or in some case lower) previously approved rates for service.

In my experience, while a rate increase is not always warmly welcome by consumers it can be grudgingly accepted when accompanied by publicly acknowledged benefits.  Not everyone agrees. As I have written back in 1991 (when rate increases were common in the USA) there was then a perception by some that, “regulation is the systematic and periodic governmental exercise of allocating pain to all even remotely interested parties.”

However, that same regulation should ensure that:

• service is adequate (enough installed capacity to meet peak power needs),
• service is reliable (few interruptions of service) and
• that rates for service are reasonable.

I would add one more criterion and that is that utility service be delivered in compliance with existing environmental, safety and other applicable laws. These then are the ongoing “benefits” of utility service which define the “public interest.”

As long as the citizens’ trust that the regulator has complied with the “public interest” requirement the continued existence of regulation, as performed by independent regulatory agencies, is insured. In other words, the consumers will, again grudgingly perhaps, accept regulatory decisions, even increased rates, when they trust that the regulators are doing their jobs in looking out for the public interest. There is a further benefit to a regulatory agency when it has the public trust and that is that regulators, who are trusted, have fewer requirements to make public day to day operations, travel and schedules and the other details of the regulatory process and ratemaking.

The moment that trust becomes an issue for a regulatory agency trust is lost.

A few years ago, the California Public Utilities Commission (CPUC) had to consider a pilot program that would change the nature of communication between the regulators and the state's utilities. An independent investigation determined that a pilot program would help the commission move away from the backroom dealings that have cost the regulator so much “public” trust in recent years.

With the loss of trust will come, as there have been in the past in the USA, calls for reform of regulation. That “reform” can include a variety of legislative actions.  State legislatures in the US in the past under public pressure have legislated restrictions on certain regulatory practices, abolished the existing regulatory agency and created a new one, changed the name of the agency, changed the number of regulators, and changed the method of selecting regulators from appointment to direct election.

In some states, where utilities have been operated by private corporations under state regulation, the loss of “trust” in regulation has called into question the entire structure of the industry.  The concept of private ownership under state regulation (sometimes called the “regulatory compact”) has been challenged as not being in the “public interest.” In some other cases there have been periodic calls for the acquisition of the utility by local government under “eminent domain” laws, the equivalent of “nationalization” (government ownership) of the public utilities.

As Peter K. Manning has noted “when trust becomes a visible issue and requires restoration or enhancing, it has ceased to exist in available form.”   In the USA we have over a hundred years of experience with independent regulatory agencies making decision in the “public interest” that affect the health, safety and economic wellbeing of every American.  Called “scientific regulation” and also referred to as “The Wisconsin Idea” of around 1912 the concept was that “in dealing with complex economic subjects the legislature lays down general principles” then relies on “appointive commissioners (with) the responsibility for administration of these principles” and on “trained experts” where the “commission is given the authority to determine in a scientific way whether certain issues are or are not reasonable.”

That system of “scientific regulation” could only have been sustained for over a century by keeping the “trust” of American consumers. That trust can be lost. This loss of trust occurred in a few states in the USA in the early 1980’s when double digit inflation increases, double digit rise in interest rates, coupled with an oil price shock and new environmental requirements resulted, in many communities in regulator’s approvals of unprecedented annual rate increases. The rate impact was exacerbated by the fact that it followed almost two decades of no rate changes or even rate decreases.

Some state regulatory commissions survived, during this period, with minor changes in laws affecting their regulatory practices. In those states regulators quickly realized that the public needed more information about the law, the regulatory process and the availability of the regulators to take public testimony and directly hear public concerns. In some states regulatory agencies were impacted with new rules restricting the use of certain regulatory practices (automatic fuel cost adjustments) or requiring periodic rate reviews etc. A few state agencies even had their names changed from “public service commission” to utility “regulatory commission” as a symbolic act of correction by the legislatures.

In most cases however, regulators carefully exercised their authority and fully explained to the public the necessity for rate changes as being in the “public interest”.  Overall US regulators were able to maintain the consumers’ “trust” in the independent regulators’ ability to meet the public interest” standard without requirements for additional legislative or judicial supervision or reform. They will continue to do so in the future too.