UCL Centre for Law & Economics

The Role of Market Organization in Public Governance - Ioannis Lianos, Director

Economic theory perceives the market as a discret method of organization of transactions and as the most efficient mechanism providing information on the utility of goods and services for the consumers. Firms generally take this information into account by adjusting accordingly the level of their production or in taking their decisions to stay at or exit from a specific market. The market is the governance mechanism that provides information on consumer preferences at the lowest cost. However, this does not explain why private entrepreneurs will sometimes enter into simple market transactions with those providing inputs or rather join them to create a single legal entity, a firm, which will operate on a hierarchical model. The seminal contribution of Ronald Coase and new institutional economics provide a powerful explanation for the decision to opt for the market instead of a hierarchical governance mechanism. The comparison of the cost of making a specific transation within a market and that within a hierarchy may provide a guiding principle explaining the choice of the entrepreneur.

Although the previous setting applies to situations of private governance, an equivalent approach could be relevant in the context of public governance. The research project will examine two related issues:

  • First, how reliance on markets transform the way we perceive the need for public governance and more broadly State intervention. Administrative or regulatory action respond to citizens' needs. Citizen do not always express their preferences as consumers do on a market but through the process of public deliberation and free elections. Furthermore, State activities traditionally concern public goods, where there os no real market, which could provide information on the exact "value" of the regulatory provision of regulation or public services to an optimal level. A possible solution to this information deficiency could be the establishment of artificial markets or quasi-markets. This mechanism has been employed for specific activities (such as the healthcare sector in the UK) but may be costly and subject to failure.. This systematic comparison of the cost of administrative or regulatory "transactions" with their benefits (cost benefit analysis, impact assessment) may provide another posibility that could be of general application.

  • Second, what is the adequate form of State intervention? This question relates to the choice of the right regulatory technique. There is an important literature on the different regulatory strategies available that can be used to influence industrial, economic or social activity. Alternative strategies require different levels of State intervention, going from regulation by ownership to the creation and protection of property rights and disclosure regulation.

The starting point of the research project is that, during the last three decades, there has been a considerable evolution of public governance techniques. During the 1970s and, more intensively, during the 1980s, an incresing number of scholars criticized command and control regulation and identified a certain number of problems, such as the risk of capture of the regulatory process by private interests, the alleged propensity of command and control regulation to produce unnecessarily complex and inflexible rules, an expensive and uncertain enforcement regime. Furthermore, the development of a sophisticated separate system for regulation by contract led to a thicket of rules and legal formalism that did not sufficiently take into acount the incentives of the parties.

As a consequence fo this growing criticism, new techniques of public governance emerged. A common characteristic of these schemes is that, contrary to command and control regulation, they constitute market-based models of State influence. The focus is on economic incentives and new regulatory techniques rely on the market, as the best organisational setting providing information on the economic incentives of the regulated firms.Furthermore, contrary to command and control schemes, incentive regulation is typically understood to be a form of State intervention that provides the regulated firm with the types of earnings/incentives found in a competitive market and allows the firm, to some degree, to respond to those incentives, thus leading to the completion of the objectives set in the most cost effective way. The emergence of public private partnerships as an intermediate form of intervention, between state ownership and contracting out, also illustrates the need to combine the superior incentive scheme of the private sector with the necessity to deliver high quality public services. The belief that the marketplace and private governance may contribute to the completion of the objectives set by the State constitute the leifmotiv of these new forms of State action.

Largely framed in accordance with traditional techniques of public governance, the administrative and regulatory law framework is steadily transformed in order to take into account this new reality. The recent financial and economic crisis may, however, bring this evolution to a halt.

The research project will focus on this transformation and will examine in depth the following aspects: An important comparative analysis will be undertaken on the operation of cost-benefit analysis and impact assessment and the broad implications of their systematic use prior to any type of State action. The project will also focus on two forms of state action that have recently emerged: Public-private partnerships have transformed the conception of government by contract and present an interesting ground of study with regards to the consideration of incentives and the management of risks between public and private partners. The emergence of incentive regulation in utilities and its implications in regulatory design and the application of competition law will also constitute an important aspect of our work.