Published on Jan 20, 2011
Earlier this week Obama issued a call to renew America’s regulatory system and not a moment too soon. A string of events over the past couple of years have underscored just how strained and ineffectual the current systems of regulation have become.
The FDA’s own Science Board concluded in 2007, for example, that the agency did not have the capacity to ensure a safe food supply, with domestic businesses under its purview having risen to 65,500 from 51,000 in 2001. The Byzantine nature of global food production and distribution only heightens the agency’s capacity problems. The same science board report noted that the FDA currently inspects just 1 percent or 2 percent of imported food shipments—not much of a deterrent to the world’s less scrupulous food producers.
Though worrying in itself, food safety is merely the tip of iceberg. The failure of the SEC to detect the Madoff scandal or sound the alarm on ludicrous lending practices and over-leveraged financial institutions is perhaps the most glaring example. But regulators were also incapable of preventing tainted milk products and toxic toys produced in China from finding their way on to retail shelves in the US and other countries. And the problems hardly end there. Issues as diverse as climate change, water scarcity, emerging technologies, and infectious diseases demand innovative approaches and each issue comes with an impending sense of urgency.
Some of the issues that challenge today’s regulators include the sclerotic pace of rulemaking, growing economic complexity, increasing international interdependency, the corrosive influence of “junk science” and industry lobbying, and a broadly insufficient capacity for effective oversight.
Many of today’s troubles are self-inflicted. After dismantling or circumscribing centralized regulatory agencies in the 1980s and 1990s, many governments now find themselves ill equipped to deal with today’s challenges and their regulatory agencies in need of deep reform.
In most sectors of the economy, the deregulatory movement that started in the 1980s was a cue for regulated industries to start designing and enforcing their own regulations. Decentralized rulemaking was intended to help make regulation more responsive to the needs of industries that were evolving quickly and becoming increasingly global in scope. Governments were to be the “regulators of last resort”—stepping in only after self-regulation was deemed to have failed. But in practice most instances of pure self-regulation have deficiencies and governments (for the most part) have proven unable or unwilling to take swift action when market failures became evident.
Without transparency, oversight and accountability, self-regulation is clearly inadequate. At the same time, the speed, interdependency and complexity of today’s world makes a return to centralized rulemaking and enforcement increasingly implausible.
As Robert Cooter, Professor of Law and Economics, Berkeley University put it, “Centralized law, like socialism, is not even plausible for a technologically advanced society. The forces that reversed the trend toward socialism and destroyed central planning are also undermining legal centrism. An advanced economy involves the production of too many commodities for anyone to manage or regulate. As the economy develops, the information and incentive constraints tighten upon public policy. These facts suggest that as economies become more complex, efficiency demands more decentralized lawmaking, not less”
While these forces don’t rule out effective government intervention, they are undermining the traditional approach to regulation whereby a small group of trustworthy and disinterested expert regulators intervene in the economy to further public objectives. Instead, I’m convinced that effective regulation is more likely to stem from efforts that increase transparency and broaden responsibility for designing and enforcing the rules that govern economic activity.
To its credit, the Obama administration seems to accept these realities and it appears to be taking steps to address the challenges. “Creating a 21st-century regulatory system,” wrote Obama in the WSJ, “is about more than which rules to add and which rules to subtract. As the executive order I am signing makes clear, we are seeking more affordable, less intrusive means to achieve the same ends—giving careful consideration to benefits and costs. This means writing rules with more input from experts, businesses and ordinary citizens. It means using disclosure as a tool to inform consumers of their choices, rather than restricting those choices. And it means making sure the government does more of its work online, just like companies are doing.”
Skeptics often doubt the capacity of citizens and advocacy groups to help regulatory bodies develop more effective systems of monitoring and enforcement. But a growing number of regulatory agencies are already convinced, as evidenced by the US Environmental Protection Agency’s efforts to open up rulemaking, the SEC’s recent announcement that it is developing new systems for collecting anonymous tips in the investment community, and the new Consumer Financial Protection Bureau’s intention to collect tips from millions of consumers about deceptive new financial practices, from misleading mortgages and improper “gotcha’’ fees on credit cards to outright fraud.
Transparency is not a substitute for better regulation by national governments and international institutions, but more disclosure and increased civic participation could be a formidable complement to traditional command and control systems. In fact, transparency is just one component of a dynamic regulatory system.
Both regulatory authorities and the regulated industries should be less concerned with the need to secure definitive legislation and instead press for the creation of framework agreements within which some kind of learning and continuous improvement is possible. These frameworks could include baseline standards, targets and timelines for improvement, and transparent systems for monitoring and evaluating compliance. In many cases, individuals (whether in the role of citizen, consumer, employee, or investor), civil society organizations, and business enterprises are likely to have as much, if not more, influence over the outcomes as government bureaucrats and policy-makers.
The promise of increased stakeholder participation is that more transparent and participatory forms of regulation will help deliver concrete social outcomes without imposing disproportionate costs on either industry or taxpayers. Systems of regulation will become for fluid and timely, responding both to the evolving needs of societies and the capacity for improvement in industry. Citizens will be more informed to make smart choices and more empowered to protect their family, friends, and communities from harm.
Of course, there are risks too. Governments could cede control of the policy agenda to unelected interest groups or fail to adequately scrutinize the effectiveness of these alternative regulatory frameworks, leaving them vulnerable to gaming or insufficient enforcement.
But the greatest risk is that insufficient innovation in regulatory strategies will undermine the legitimacy and effectiveness of policy and undermine economic performance. Worse, systemic regulatory and market failures (comparable in impact to the financial crisis) could unleash detrimental changes in social, economic and political order that will further erode global stability. Harnessing expertise and resources from emerging networks in the private sector and civil society will be an essential part of developing effective and forward-looking policy responses.
Check out part two of this post where I outline the 5 keys to regulatory innovation.