TCS Daily

What's Your Regulatory Policy?

By Solveig Singleton - June 18, 2008 12:00 AM

Only a decade ago, deregulation was in vogue. Alfred Kahn and his disciples phased out the Civil Aeronautics Board and the Interstate Commerce Commission, which were sources of wasteful and costly regulation of trucking, railroads, and airlines.

Financial markets were deregulated, though to a much lesser degree. Some anti-pollution rules were re-styled in more market-friendly ways, with tradable emissions permits set up by the Clean Air Act. Ira Magaziner, President Clinton's tech czar, agreed with free-marketers that the Internet and computer industry's amazing growth was due in large part to its much-less-regulated status. Antitrust law went through a serious reform, as old, and stupid, doctrines were jettisoned in the name of market dynamism.

Much of the dedication to deregulation was rhetoric rather than reality, and was always tenuous. The FCC was never abolished, despite importuning by some pundits, and Reed Hundt turned the 1996 Telecom Act into a massive regulatory enterprise. Most of the rules administered by federal agencies--EPA, the FDA, the SEC, and so on--remained untouched.

Now, some of the de-regulatory victories are in doubt. Treasury Secretary Paulson recently declared that the loosened regime of financial regulation has failed. The FCC is debating new rules to guarantee Internet neutrality. Economic scholarship has developed an interest in game theory as a justification for more aggressive antitrust action in fast-changing technology and innovation markets, and the DOJ and FTC are determined to prevent restructuring of industries such as hospitals and airlines.

Before embracing new regulatory panaceas, it would be wise to revisit the reasons why we rejected the old ones just a few years ago.

The difficulties with regulatory schemes are well recognized. Economists who have observed agencies in action, such as the EPA or transportation regulation, were troubled to find that there were "countless cases where rules and regulations imposed tremendous costs while delivering little if any benefit." (The quote is from Bruce Yandle's classic article, "Bootleggers and Baptists: The Education of a Regulatory Economist."). That observation was made some years ago; little has changed since. There are plenty of theories as to why. The problem is not the people—they are not perfect, but they are as knowledgeable and public spirited as one could expect. The problems would affect anyone is the same institutional setting: Regulatory "capture" by special interests; the limitations of theoretical economics to grapple with real business problems like pricing; the delay and uncertainly created by regulation; the incentive structures created when regulators are excoriated if anything goes wrong.

Despite these known problems of regulation, it can appeal when markets become messy, as they often do, especially in the short term.

Many problems with financial markets stem from principal/agent problems. Even well-informed principals putting up investment money often lack the initiative to oversee what their agents did with it. The agents collect on their commissions so long as nothing untoward happened, and odds are nothing untoward happens—for a few years. Then, as always happens in the long term, a risk adjudged tolerable in the short term blows up. This is now branded a "market failure."

The networked communications platforms of the Internet present their own conflicts between short run and long run interests. Will investors in content move ahead without assurances that the conduits will not down the road threaten to cut them off if they don't sign away all the value their content creates? Much rhetoric about simply abolishing regulation overnight gets little traction for good reason.

In a sense, both models - market and regulatory -- are flawed. But there is a difference. For every theory contending that markets fail, there is usually an answering argument that they tend to self-correct. Once, economic theory worried that markets would fail to fund "public goods" like lighthouses—until more careful economics revealed markets doing exactly that. More theory pointed to the evils of monopoly. But in reality a monopolist reaping substantial profits is a big target, with every entrepreneur looking for a substitute good or service. Many of the markets' self-correcting mechanisms are simple Darwinism. Poor investors and badly run businesses lose (their own) money until they go under. Technology and other factors that bring change keep even established firms on their toes.

In contrast, self-correction is not a common response to regulatory failures. There is no good explanation for how an agency or a system of rules can be designed to systematically succeed or self-correct. Regulators charged with the expenditure of public monies may waste it, but this is not the same as losing one's own money. Legislators task regulators with broad discretion to overrule markets, without any meaningful way to measure progress towards success, and without any meaningful response in the case of failure.

Left in this discretionary vacuum, it is no wonder there is action without results, and with regard only to those aspects of cost that regulators bear personally—career costs. More alarmingly, Milton Friedman noted that regulatory failures too often result in the expansion of the regulatory program in question, on the theory that it must have been understaffed or underfunded. Yet increases in staff or funding rarely fix the problem. The U.S. Patent and Trademark Office is a case in point, where steep increases in funding have brought few measurable improvements, and more importantly where the measures of improvement are themselves dubious. The bottom line: "Reinventing government" still needs to happen; and if there is a "third way" it is apparently very hard to find.

Are there solutions? Possibly. Yandle's article called for attention to paperwork burdens, to internal agency incentives and rules, and to legislative oversight. Others have suggested that agencies ought to be more politically accountable—headed by a single powerful political appointee with strong ties to the executive branch. There is the old idea of separation of powers within agencies, the idea that rule-making and judicial functions ought to be strictly separated. Privatization and outsourcing have enjoyed a brief vogue.

But none of these ideas seems to hold any interest at present, and no others have been put forward. Perhaps regulation can be improved based on pure pragmatism, on experience? A less formal term for this might be "muddling along." That indeed seems to be the hope of the day. But this seems to leave unresolved some of the most significant legal and institutional problems of our time, issues that have significant bearing on economic growth going forward. Who is regulating the regulators?

Some technologists are alarmed that so few presidential candidates have a technology policy. But it is even more alarming that none of them have a regulatory policy.

Solveig Singleton is Adjunct Scholar with the Convergence Law Institute.

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