3  Methods of regulating

3.1  Institutions and instruments in regulation

The two key concepts in regulatory design are institutions and instruments. Regulatory institutions include formal governmental bodies at trans-national, national and local level and behavioural constraints such as constitutional principles and the regulatory quality regime (eg, regulatory impact statements). Regulatory instruments are the tools available for institutions to apply, and include treaties, primary (statute), secondary (regulations) and tertiary (notices and guidelines) legislation, national instruments for directing local government such as national policy statements or national environmental standards, and regulatory takings.

Upstream regulatory design examines how institutions and instruments create incentives for regulators to design an optimal regulatory structure. Downstream regulatory design considers how a regulatory structure creates incentives for individuals or firms to act in a manner that achieves a socially efficient outcome. Although the incentives involved in upstream and downstream design are similar, the tools available to influence them are quite distinct. The downstream issues are significantly more diverse (covering both economic, including competition law, and social regulation), than the upstream issues which are reasonably common across all sectors (including such broad concepts as subsidiarity and regulatory quality). Both provide opportunities for feedback, as a better upstream process should improve downstream outcomes, and downstream experience should provide useful information on designing upstream structures.

The institutional structure is something that can be designed so as to improve the regulatory outcomes.[6] The key purpose of regulatory quality regimes, is therefore in relation to upstream regulatory design; ie, to modify the institutional structure within which regulation is developed and applied to improve the quality of the decisions made at both stages.

3.2  Performance based or prescriptive regulation

All regulation falls somewhere along a spectrum in terms of how much detail is specified and what is left to interpretation (eg, by users or the Courts) or dependent upon external factors (eg, an occupational licensing regime, market forces, another regulator). Prescriptive regulation and performance-based regulation fall within this spectrum.

Prescriptive regulation, in principle at least, defines how activities are to be undertaken (eg, what techniques or materials to use, what qualifications must be held, where the function may be performed). This approach clearly emphasises a known degree of risk mitigation over innovation or cost management.

Performance-based, or outcome, regulation puts more emphasis on specifying a performance standard for the desired outcome and does not deliberately constrain how compliance is to be achieved. A parallel in environmental regulation is with a requirement to use specific emission control technologies versus the use of market-based instruments to control pollution (Guerin, 2003). This approach is more consistent with innovation and efficiency than prescriptive regulation.

In both cases there is an inevitable dependence on external factors to make the regulation effective. Neither approach will succeed unless the necessary supporting structures are in place, such as quality assurance, and effective monitoring and enforcement.

Performance-based regulation acknowledges this explicitly, which allows for those external factors to be identified and assessed more easily. Prescription, on the other hand, may simply appear to be safe through being a “tried and true” approach which incorporates experience and known techniques and institutions. It may, however, deliver a more certain outcome, although at the possible expense of efficiency and foregone benefits from innovation.

3.3  The components of a regulatory environment

This section considers how to create an environment that fosters high quality regulatory design, on the assumption that this is the approach most likely to deliver the outcomes that society wants. It does not attempt to define what will constitute high quality regulation or to isolate what the desirable regulatory outcomes might be. A focus on design, capability, incentives and follow-up is required to achieve full integration of best practice and an environment for consistently delivering high quality regulation. These components are addressed below.

Well-designed regulation has a depth of techniques and principles that (1) allows regulators to judge whether a particular proposal meets the appropriate quality standard and (2) covers all significant regulatory activity. Good design therefore requires a commitment to a quality standard that can be readily applied by both those performing the original work and those required to review the results. Those standards typically cover basic principles such as benefits exceeding costs, transparency, fairness, consultation, feasibility of compliance, and whether the regulation is administered at the appropriate level of government. Whatever the nature of the standard however, the way it is framed and the nature of the guidance material available to those applying it will be crucial to whether it is met in practice. Standards that are too open to interpretation, have too many loopholes or are not well communicated will fail.

A crucial issue is how to create an environment in which institutions and individuals involved in regulatory processes are mandated and encouraged to apply quality tests to regulation in practice. The central element is the incentives that are placed on ministers and officials to carry out these processes. It is, however, very difficult to alter those incentives because it is difficult to design outcomes objectively and ascertain responsibility effectively.

The tools most likely to be effective in this situation are therefore indirect. The first involves transparency in the design and implementation of regulation to maximise the probability and reputational effect of identifying problems. If decisions, and their consequences, are opaque then there is unlikely to be any real pressure for good performance. Transparency may not be sufficient to ensure quality, but it is probably necessary.

Another, but even more difficult to apply, tool is consistent and strong commitment from the highest political and administrative levels, to the desired outcome, sending a signal of expectations to both individuals and institutions regarding the type of behaviour that will be rewarded. This must then be coupled to effective performance management systems which are themselves much more easily prescribed than achieved in the public sector, but are also desirable for reasons other than regulatory quality.

The same point applies to capability, which in this context means that regulators have the resources to perform their required tasks and that those responsible for designing a regime and implementing it are aware of its likely impact and of the quality requirements it must meet. Good incentives are worthless without the ability to respond adequately. This involves significant issues of public sector funding and organisation. Government has a crucial role in training and education. This can both involve informing people of the requirements of the regulatory quality regime, and helping them use the tools available to meet those requirements.

An effective regulatory quality regime must be practical in terms of both compliance (see discussion above on design and capability) and follow-up. Follow-up involves creating the necessary institutions to monitor the performance of regulators against the quality regime and respond to success or failure. That response can take a number of forms which must reflect political and administrative realities; eg, a veto on progressing low quality regulation may be impractical in urgent situations or may clash with constitutional constraints. Other options include publicity around organisation performance, inclusion of quality comments in documentation within the regulation making process, and formal process reviews. Follow-up does not extend to actual evaluation of policy outcomes, since it is focused on the regulatory process itself, but would include assessing specific policy processes on whether or not appropriate evaluation procedures were built in.