Casualties of prescription

IT IS an article of faith among most businessmen and politicians that the British economy is flexible and market-dominated, unlike the economies of mainland Europe, which remain subject to heavy-handed central control.

But we fool ourselves. The harsh fact is that whether big business in Britain prospers or fails is often as much a factor of regulatory whim as it is of market forces.

An examination of the companies in the FTSE 100 index, excluding foreign stocks, shows that more than half the valuation of the Footsie is vested in companies where UK State regulation and intervention is a factor in their financial performance. Try the sum for yourself.

Consider all those companies under the control of an economic regulator whose rules dramatically affect profitability. These include rail, water, gas, electricity, telephones and mobiles.

Next, think of those companies where the bulk of UK pricing is set by the State as a major customer or because it licences the activity. That brings in defence, pharmaceuticals, much broadcasting and airlines. Then add all those under the Financial Services Authority, given its powers to set capital requirements, to say nothing of the Government's flirtation with product price-capping.

Carphone Warehouse, the retailer, and insurer Standard Life each in their different ways demonstrated this impact the other day. Both now find their business significantly shaped by the impact of regulatory policy - a policy that is not necessarily either benign or in the customer's best interest. And because UK regulation encourages standardisation, it significantly changes the risk.

One used to worry that companies making big investments were betting the whole business whereas now some of these big bets, driven by the regulatory environment, affect the whole economy.

Contrast this with the United States. There, in an industry such as mobiles, the government sells the licences but lets the industry decide how to proceed. There is inevitably a diversity of approach, with the result that a range of business models emerge, some of which work and others that don't, so winners and losers gradually emerge.

In Britain, and increasingly in Europe, the regulator not only sells the licence, but also lays down in great detail how it will be exploited. The conditions are so restrictive that there is little scope for diversity.

The companies concerned adapt their strategies to exploit the given regulatory environment as best they can, but the reality is that much of their freedom of action has been curtailed in advance and they end up all doing basically the same thing. This increases the business risk hugely, because so many of them are in the same space.

Nor does the consumer necessarily benefit.

In mobiles, the licences for 3G so disabled the industry that Europe lost its global lead. The process and the cost slowed down the evolution of the industry and created a window which Asian and American competitors have been able to exploit.

The savings industry challenge is similar. The Government lays out the playing field and business deals with that reality. It produces what it thinks can be made to work, but not necessarily what is best for the customer.

The clampdown on Standard Life carries this a stage further because it is clearly designed to remove any risk of future financial failure, even if that means lower returns for customers.

In normal commercial life there is a trade-off between security and growth, and it would be a commercial decision where to strike the balance.

In this case, however, the regulator has decided that safety is paramount, so the growth that customers may actually prefer - some of them anyway - goes by the board. The primary objective is for no one to get hurt and for everyone to be able to cover their backs.

Not that the regulators can be blamed. They want to avoid another debacle, and the political imperative is for them to play safe. Unfortunately, it is not really individual companies that suffer because in time they adjust and make profits in the environment they are given. The real casualties are the economy as a whole and the people in it - the customers who face the restricted choices that come from a curtailed market for products.

Business people complain constantly about regulatory cost, but focus on compliance and ignore the real issue.

Our penchant for prescriptive regulation is gradually moving the economy a considerable distance away from the influence of market forces and exposing it to levels of regulatory risk and inefficiency of which few people seem to be aware.

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