Is it up to regulators to Spark innovation?

Regulatory frameworks (including those in Australia) implicitly require the sector to consider the value of innovation through the incentives within the frameworks. In contrast, Ofwat (the economic regulator of the UK water sector) has decided to explicitly highlight the role that innovation plays in driving efficiencies throughout the sector. This has not necessarily resulted in significant changes to the framework mechanisms; instead, the concept of innovation and its importance is more explicitly considered. Specifically, Ofwat has commenced its Spark program – an innovation campaign that is intended to inspire the water sector and provide a platform for the sharing of ideas through providing guidance on developing an innovative culture within the sector.

A concern I have is that if regulators start to blur the lines between developing regulatory frameworks for regulated sectors to operate within and intervening in the operations of regulated businesses, they can potentially create conflicts of interest for regulatory decision makers in the future. For example, if a business adopts an approach that was implicitly endorsed by Ofwat through such a campaign, is Ofwat under greater pressure to accept the approach as being prudent and efficient? The alternative to this is regulators developing stronger incentive mechanisms within the regulatory frameworks that further encourage the sector to seek efficiencies through innovation, thereby abstaining from providing guidance to businesses regarding how they should be seeking further efficiencies.

It is true that innovation will play a key role in ensuring future efficiencies are realised by the water sector. Maybe Ofwat considers that it hasn’t been seeing enough innovation from the water sector through utility pricing submissions under the current incentive mechanisms, and so has to intervene and provide additional guidance to the industry.