Building markets that work

20 July 2015

In late 2014, Reform published the excellent Markets for good, proposing a new way of contracting for human public services (ranging from support for addiction recovery to skills training) ‘using clear rules and strong incentives to harness the power of genuinely free and fair markets’. The paper argued in favour of a licensing regime—if an entity (public, private or third sector provider) has the skills to deliver these services, they should be allowed to enter the market, operating across traditional organisational boundaries (be they geographical or technical). Payment for delivering these services would be based on the achievement of outcomes set by government and customer satisfaction, and excellent provision would be encouraged through earning higher profits.

I specialise in the economic regulation of infrastructure companies, and Markets for good is advocating regulated competition in the provision of human public services. Bringing a model that works well across from the provision of one type of essential services (e.g. water, energy) to another (e.g. social work and prisoner rehabilitation) has the potential to shake up service provision, encouraging disruptive innovation.

What have we learned from over 30 years of economic regulation that could be applied to the ideas advocated in Markets for good?

Markets for good, Figure 1: Vicious cycle

Markets for good, Figure 1: Vicious cycle

 

 

 

 

 

 

 

 

  • Professional, independent regulation is vital: Moving away from local commissioning of specific services towards regulated markets with heterogeneous prices and outputs will require extensive expertise and a pro-market approach by the regulator(s). This is not out of the question, but neither the transition challenges (for example, Monitor, the sector regulator for health services, has experienced a steep learning curve since its establishment in 2004), nor the temptation that leads to ‘bureaucratic interference’ (see Figure) should be underestimated.
  • Outcomes in this environment present difficulties: Regulating for ‘effectiveness’ is much harder than regulating for ‘efficiency’. In judging performance, regulators prefer to focus on what they can measure, rather than more ephemeral ‘outcomes’, although economic regulators are moving towards doing just that (as exemplified by the regulators of energy and water, Ofgem and Ofwat, at recent price reviews). However, in the competitive licensing environment espoused by the authors of Markets for good, outcomes are uncontrolled (which civil servants often struggle with). At the same time, the nature of services being provided—in which outcomes are often changed by the user (unlike in energy or water)—adds a host of factors outside the control of providers. Importantly, some desired outcomes (e.g. minimum standards across local authorities) would have to be specified to ensure that they are indeed provided.
  • Get the profit environment right: A general challenge in UK society at present is the notion that profits are payment for privilege, rather than reward for risk-taking. As such, I would recommend that independent regulators monitor profits being made by human public service providers under this model, but that they step in only if European state aid or competition rules are being breached (essentially, when profits are persistently above a risk-adjusted benchmark). Otherwise, why would you take the risk of deploying a new type of service if payment for your innovation is simply capped by the next tabloid headline? The regulator(s) will also have to work hard to ensure that sufficient profits are available given that the market being suggested features relatively low entry barriers.
  • Avoid accusations of cronyism: Traditional procurement of public services offers an effective defence against provision by the friends of those in power. A licensing model can also deliver similar protection, assuming that, as part of its ongoing monitoring of market participants, the regulator can ensure that the licensee passes a series of checks, including that the service is being provided to high standards, innovation is ensured and profits are not persistently high.

For me, Markets for good is an extension of a great British export—economic regulation—and it can learn a lot, and get better, by taking on some of the lessons from the regulation profession.

Andrew Meaney, Partner, Oxera

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