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Rethinking regulation with the help of systems thinking

This speech was delivered in Sydney on 17 November, 2022 by Energy Consumers Australia Chair Louise Sylvan to the Independent Pricing and Regulatory Tribunal, NSW,  30 Year Anniversary Conference: Rethinking regulation in a changing world

Louise Sylvan
Louise Sylvan

Session 2: How effectively can consumers, communities and disruptors counterbalance the market power of natural monopolies in the digital age?

As usual with new tools, digital technologies will be wonderful and they will be awful.

On the evidence to date, these technologies clearly have enabled much enhanced competition in a variety of areas of the market – in some markets creating fundamental disruption (eg. taxis, short-term accommodation, book selling, banking, etc).

These technologies also clearly allow a monopolistic rise for the platform companies and for any intermediary that can control the relationships – and the data which is generated – between buyers and sellers. So, a terrific “thumbs up” and a terrific “thumbs down” for the new tech – which should hardly surprise us.

A couple of matters underlie the question for our session about whether digital tech will enable countervailing power against natural monopolies – the answer is that it depends of course; and the real question for me is whether our understanding of market systems and consumers in those systems is adequate enough to ensure the good outcomes that we would want to achieve for our societies from such a digital transformation of any sector.

Sandra Gamble has asked us to be provocative, to challenge people and to challenge received wisdoms. So I’m going to try to oblige!

My two main messages are:

First, that regulatory systems that make heroic assumptions about consumers are not very good regulatory systems and not very good for consumers. Culprit #1 today for me is the energy market – where dysfunction for consumers for many years has simply been exacerbated by extreme global events. Worse, a lack of real knowledge about consumers tends to result in outcomes that hit hardest in our society those that are already the most vulnerable. We actually had some interesting commentary from the head of the AER on the vulnerability issues in the energy market a few weeks ago.

My second point is not simply one about markets or the way economists (and lawyers in the space) have been trained to think. There is a broader issue – one well beyond economic models – which is that we seem to be struggling in many areas of our work to think and act in a systems way. And it is systems that we are mainly dealing with – not just as regulators. This can be illustrated by examples well outside of economic areas of regulation.

So to Understanding Consumers

When I first came back, about eight years ago, into the energy space to chair Energy Consumers Australia, the fourth market body set up by energy ministers, I recall vividly my first COAG meeting. Almost every official, particularly the energy regulators, said: “Thank God you’re here! We’ve created this beautiful energy market and consumers just won’t play – they are not changing energy retailers and not shopping around – and we even have comparison sites for them – what is wrong with these consumers?”

And can I say, that is not an overstatement; that is basically a verbatim quote of many of the conversations. I am hoping today, after a long period of intervening and work and research by Energy Consumers Australia, and some serious reflection by regulatory folk, that officials would recognise that kind of comment for the arrogant elitism that it represents; and I have to say, I can’t recall being asked a question like this in the last three or so years.

In case we didn’t realise, energy is a very complex market in which to buy products (and made deliberately complex by the providers I think) – and again I’ll note Clare Savage’s honest recounting of trying to pick a plan for her family member, and not being sure (despite this being her business) that she’d picked the right plan; and then because of the circumstances, and despite trying, the family member just failed to be able to make the change in provider.

This is a market – deregulated by governments on the advice of their economic officials – with a serious lack of understanding about consumers and how they operate. And, it shows. It shows in the distrust of the market and the market participants, the worried feelings even of highly numerate active consumers as to whether they are still being ripped off, the constant change of offerings that are opaque and difficult to work out, the lack of information about usage to enable informed decisions (that data is actually not available to a consumer – you have to buy additional kit for your home if you want to understand usage adequately).

And of course, we knew as we proceeded with the deregulation of the retail side of this market, that less able, less literate, less well off people would struggle even more than others.

Electrons that used to come into your home without giving you a headache; all of a sudden turned into a complex financial product. All on the promise of lower prices which sort of eventuated for a little while and would have possibly been better without the gold plating in the network systems. Now as regulators, we can choose to learn from this, or we can choose not to. The key learning is that efficiency is not actually the equivalent of consumer outcome; it can only even marginally be argued as equivalent if you discount much else about what is happening to consumers and in particular what is happening to vulnerable consumers.

The sleight of hand here is to say that ‘those outcomes are not our problem as regulators” – so we put a box around it, tie it up with ribbon and say “within our defined box, all is well” – until of course it starts to fall apart, as it is. Not only do we fail to design well and with knowledge of people’s behaviour in markets, we do the same in other areas as well.

You might recall, for example, some of the initial anti-aircraft gun designs. I’m embellishing the story a bit, but the engineers designed these terrific guns and the soldiers could hardly hit a damn plane – of course, the engineers argued: “we’ve designed these beautiful guns, and the soldiers can’t hit anything – what is wrong with these soldiers?” (I’m sure you recognise that question.) The engineers thought soldiers obviously needed more training, more educating and so on. However, with war approaching again, that rather helps to focus the mind. The military brought the problem to MIT, who looked at the design and concluded that it was not a matter of training, but that the operation of the guns were insufficiently intuitive; under stress, people could not succeed because the counter-intuitive design didn’t use the behavioural information about how someone would go about trying to hit a fast-moving target above them.

The guns needed to be designed for humans in an intuitive way for how a human would behave in these circumstances. So, the modifications – a combination of the engineering and the human behaviour – succeeded. Markets also need to be designed with the humans in mind – the real humans and not the shorthand ‘economic ideal’ ones. Otherwise, we get failure. Which brings me to systems.

Systems Thinking

The more I study how we think about systems, the more I am struck by how poorly we still do this type of thinking, just in general. And I am also struck how badly governments do it – in the main because of the complexity of the issues they deal with but also because of the way they approach the problem definitions and the way they have real trouble actually working with the people they are going to be affecting.

In my view, the great hallmark of systems thinking is that it examines the interconnectedness of an issue or problem. It is thus much richer, much more complex, and doesn’t allow for the laziness of saying ‘this is our box – and the rest can be ignored.’ So systems thinking unsurpassedly focusses on actual outcomes. If customers are not buying a product, a systems approach does not allow you to say ‘what is wrong with these customers’ – you start looking for the reality of what is not working well – and preferably, you would have done some of that work during your product and systems design.

Unsurprisingly, a lot of systems thinking arises in medicine, but even there, great errors can be made by trying to break down problems in order to make them bite-sized – in fact, this is a hallmark of our way to doing science. One of the larger mistakes of our time in my view occurred when the research on fats was being done.

Basically, and oversimplifying the story, the work was done in the usual linear fashion that science is conducted – and then applied to a complex biological system, the human body. And the understanding was wrong. Fat per se was never the problem; and the result of this misunderstanding – because industry moved to take fat out of products and substituted carbohydrates (often highly-available carbohydrates such as sugars) – is a quite substantial contribution to our modern intractable problem of overweight and obesity.

To make the point even stronger, we take studies of one thing – let’s use bacon which is now in the category of a class 1 carcinogen – and feed it to mice or rats in large quantities – and it causes cancer. I ask the irreverent question, what about ‘bacon and tomato’?

Any systems scientist is very amused by that question, but also knows exactly what I’m asking – which is, what is the result when a piece of bacon – usually eaten with something else like in a bacon and tomato sandwich or with an egg – in combination with other foods is tested for how it affects a biological system whether that system is a human or a mouse? We actually don’t do the science that way – for a range of quite good reasons. But this is a rather interesting challenge for many disciplines. It would, in fact, probably be quite diffcult to get a ‘bacon and tomato’ question funded at the moment.

There are innumerable examples in the medical world of non-system thinking – a prime example is when we look at the results of taking a drug and say there are ‘side effects’. What there are, are effects on the human system – some are desirable, some not. Also damaging were industrial processes where we put a box around the production process – and excluded the rest of the system outcomes ie. the pollution of that the process created. So, non-system thinking ignores the whole and its interconnectedness, often to our detriment.

Looking at the obesity problem, which is a world-wide problem, we now have a system product – overweight and obesity – and it is very substantially contributed to by ultra-processed foods (it’s not the sole factor, obviously, but an important one). However, if you listen carefully to the ultra-processed food industry lobbyists, it’s nothing to do with them: we have apparently had a global loss of will-power of the last 50 years – that is pretty extraordinary!

And the message from this industry lobby is: “what is wrong with these consumers allowing themselves to get fat and obese.” I’m sure you’ll again recognise the question – and it infers that there is nothing to look at over here in the food supply system. In fact, the whole food environment has dramatically changed around humans – we have actually had a major systems change – and people’s normal survival behaviour has turned out to be a disadvantage in this new environment. Although there was no
‘designer’ as such for this global food supply system, we have a design which is no longer intuitive for people to operate in.

People will recognise that ESG reporting is an attempt to put companies back into the systems they operate within – Ann Sherry at the AICD yearly director update on Nov 15 2022 remarked that we’re making lots of progress on the E and the G, but that the social is proving quite difficult. Our conversations about social license are conversations about the social system and how energy regulators and companies have responsibilities and relationships in that system. The addition of the word “emissions” to the National Energy Objective probably requires a systems approach to regulation – so the challenge is going to be immediate.

The major systems transformation – energy decentralisation

In my closing comment, I want to bring together the points about understanding consumers and thinking about systems in which consumers and markets operate.

We have one of the most astonishing transformations taking place – and I don’t mean the decarbonisation of our energy system (which is amazing and challenging in itself). But the decarbonisation of energy could just mean that the big generation which comes down big wires to littler wires to plugins remains unchanged as a system – it’s just that the generation is altered to non-CO2 producing fuel. No system change is needed even though it is a big and challenging technical and behavioural task.

But the transformation I am referring to arises from the technological advances that enable households, small businesses, large businesses to produce their own energy and use it or store it locally. That difference is fundamental. This is not simply a comment about rooftops – because too many people do not have rooftops: people in tall apartment buildings with not much roof, people who are renting, and so on. But everyone will ultimately have electric vehicles with batteries in them, and I hope smart appliances, smart hot water – all of these products that can either store energy or use it at certain times or not use it at certain times. Just in relation to rooftops, however, – which are the cutting edge of decentralisation at the moment – already, photovoltaics taken together constitute one of the largest generators in the country. Australia is absolutely at the leading edge of this transformation globally. So what we do matters more than usual.

Now there are two ways of looking at this extraordinary development. We can say “We’ve designed this wonderful system – just look at this beautiful grid – and these pesky people are causing all sorts of instability problems for us: I need to control this.” That’s one framing choice. The other choice is: we have a complete system transformation happening, and we need to think about all of these myriad energy producers as partners in our system – how is this going to work to deliver not only a secure and affordable system, but one where people can actually control their outcomes while also benefiting their communities and societies?

That’s a different framing choice. The road we choose – the story we tell about this – will truly matter for the future. You’ll remember that amusing story about the Irishman being asked how to get to Dublin – and he replied “well I wouldn’t start from here”; that’s more or less what we need to say about how we conceive this decentralisation revolution: it is not simply some kind of problem of integrating all of this pesky production into “our beautiful grid.”

System planners need to start with where production is and increasingly that is distributed and in the control of consumers – so they need to be front and centre. The key recognition is that this isn’t the same type of system. There has never been a market like the one that is emerging in energy with a massive set of interconnected producers and consumers – and the lines blurred around who is what. A system structure that was conceived when Edison was a boy might just not quite be the right energy system either for the 21st century and certainly not for decentralised energy world.

So to conclude, if the digital and other technological transformations simply result in the same energy system but more streamlined, with bigger data sets, de-carbonised but essentially the same thing – characterised by its lack of understanding about consumers, its lack of human-centred design, and lack of systems thinking informing it – then that will be a great opportunity squandered. To return to the question that is posed in this session, the biggest disruptor of a natural monopoly is system transformation enabled by technology. The task of economic regulation in this circumstance is, I think, to enable that disruption to occur.

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