Opinion

The Great Debate

The slow death of the regulatory state

June 4, 2010

At a time when public spending and deficits are ballooning on both sides of the Atlantic, taxes are rising and governments are enacting far-reaching reforms to financial regulation, healthcare and carbon emissions, it might seem strange to talk about the withering away of the state as an economic and industry regulator.

The past year has seen thousand-page bills on healthcare and banking reform and the greatest-ever increase in government spending outside wartime, prompting small-government conservatives to complain bitterly about over-reaching by the Obama administration and the resulting threat to individual freedom, enterprise and wealth creation.

Advocates for U.S. banks complain heightened capital requirements and compulsory clearing of derivatives will hamper their ability to extend credit and raise costs for customers. In the United Kingdom, retailers have fought a high-profile campaign against higher payroll taxes. Everywhere businesses groan about the burden of complying with an inexorably growing list of government regulations.

Free-market advocates at “The Economist” magazine have stressed the need to begin rolling back the state after a period of unprecedented peacetime expansion.

Adam Ridley, former director-general of the London Investment Banking Association, has an impassioned column in today’s “Financial Times” warning that “regulatory policymaking in Europe has become much harder to influence” because “the ideological and emotional context is no longer sympathetic”.

“Financiers have become public bogeymen, and the philosophy of liberalised global markets has become, in the eyes of many, the discredited Anglo-Saxon model. In Europe especially, the City’s traditional confidence is often seen as hubris”.

WEAKNESS NOT STRENGTH
But a closer look at the events of the last decade suggests it is not the over-mightiness of the state but its increasing weakness that lies at the root of a long list of catastrophic failures — from the mess in the U.S. mortgage market and banking industry, to the tragic mining accident at the Upper Big Branch mine in West Virginia and now the disastrous slick emanating from BP’s oil well in the Gulf of Mexico.

In each case, on paper, regulators (the Federal Reserve, Mine Safety Administration, and Minerals Management Service) wielded immense power to enforce rules on health and safety and risk-taking. But in practice they subcontracted enforcement and even the rule-writing to the firms they were supposed to be overseeing.

In Washington, the power of K Street lobbyists to influence, even write, whole sections of important bills has become notorious, under both Democratic and Republican administrations.

It is fuelling an outraged anti-incumbent populism that denounces both Washington and Wall Street alike, from both the political left (where insurgents have forced Arkansas Senator Blanche Lincoln into a run-off) and the right (where the “Tea Party” movement already toppled Senator Bob Bennett in Utah and is moving after other Republicans).

Much the same drift towards government by interest groups has been evident in the United Kingdom, where rules on financial supervision and markets published by the Treasury and the FSA often seem to have been largely written by industry groups.

Regulatory capture –where regulators come to share the interests and viewpoint of the industry they are supposed to be overseeing, rather than acting in the broader “public interest” — is nothing new. President Dwight Eisenhower warned about the power of the military-industrial complex in 1961.

But the scale of the capture across so many agencies, reaching into the heart of the regulatory state, under governments of all colours, is unprecedented in modern times.

It represents the largest “privatisation” of government since the Old Corruption of the 18th century (where government offices and laws were seen as an opportunity for private profit rather than a matter of “res publica” or the public interest).


CONFIDENCE AND CAPACITY

Industry groups whose interests will be most directly affected have strong reasons and a right to try to shape those decisions. They can also bring expertise and specialist understanding to discussions with regulators. But that expertise and understanding is never impartial and disinterested.

The proper role for regulators is to listen to representations and concerns from all the affected parties to a decision, assimilate them and then reach their own, independent and carefully thought through position. It is much like a judge in a law case. In fact much regulatory activity is described as “quasi-judicial”.

But in the past two decades regulators seem to have lost both the intellectual capacity and more importantly the self-confidence to perform this role. Rather than seeking input from companies and lobbying groups before forming their own independent position, they have increasingly contracted out the writing and enforcement to industry and professional advocates (lawyers, accountants, tax specialists and lobbyists).

Rather than the state as an overbearing Leviathan, a more accurate characterisation of modern regulatory agencies and legislatures is a hollowed out husk, thoroughly penetrated by the tentacles of private interest.

RETREAT FROM REGULATION
Several factors have contributed to the hollowing out of the regulatory state. But perhaps the most important has been the ascendance of an intellectual philosophy since the 1970s that markets and the private sector are inherently superior (more efficient, more responsive, more effective) to the public sector and regulators.

In the United States, this has been reinforced by a slow revolution in the courts that has sought to pare back regulators’ discretion. Everywhere from antitrust policy to health and safety regulations, the pro-business majority on the Supreme Court, and more importantly in the circuit and district courts, has sought to narrow the authority of regulators.

It is all part of regular historical swing of the pendulum between laissez-faire reliance on markets and private property rights and dirigiste intervention in the economy to redress imbalances and inefficiencies. In this case, the evisceration of the regulatory state represents the slow repudiation of the perceived excesses of the New Deal.
Part of the problem is also complexity. The skills and knowledge of regulators have not kept pace with the increasing sophistication and complexity of the industries they oversee.

THE FAILURE OF SELF-INTEREST
Proponents of this conservative “counter-revolution” insist self-interest and self-regulation can usually do a better job than state regulators. Investment banks talk about putting the client at the heart of everything they do, and being long-term greedy, to explain how they manage conflicts of interest. But it is not clear that such self-regulation can work in practice.

The foremost apostle of self-interested self-regulation, former Fed Chairman Alan Greenspan, admitted to the House Committee on Oversight and Government Reform in October 2008 “Those of us who have looked to the self-interest of lending institutions to protect shareholders’ equity, myself included, are in a state of shocked disbelief”.

Asked by Democratic Committee Chairman Henry Waxman: “Do you feel that your ideology pushed you to make a decision that you wish you had not made”, Greenspan replied: “Yes, I’ve found a flaw. I don’t know how significant or permanent it is. But I’ve been very distressed by the fact.”

Faith in self-interested self-regulation seems to have been at the root of the “dysfunctional” relationship between the regulators and industry over offshore drilling controls. It permitted no-income no-asset (ninja) home loans as well as the securitisation of vast quantities of poor quality credits and their sale to apparently witless investors.

I don’t want to suggest the state should account for an even larger share of economic activity, or try to regulate risk out of the system. Nor suggest there is not plenty of regulation around (thousands of pages of rules, guidance and interpretations continue to flood forth). But not very much of it is intelligent and effective, and for the most part that reflects the weakness of regulators, in terms of intellectual capacity and confidence, not their overbearing strength.

Comments
20 comments so far | RSS Comments RSS

Wow. Spot on!

Posted by tmc | Report as abusive
 

The slow death of the regulatory state
We live in interesting times.
Unless our administration starts administrating and enforcing the rules and regulations that they have written and not the corporations have written, are we doomed to continue down this slippery slope of rule by corporation and vested interest.

Posted by The1eyedman | Report as abusive
 

In other words, the inmates have taken over the asylum.

Posted by Art_In_Seattle | Report as abusive
 

I wouldn’t call it an “intellectual philosophy” that markets and the private sector are inherently superior to the public sector. As may be readily seen from reruns of recent history repeatedly repeating itself, that old hat about private sectors being superior to ANYthing turns out to be one lulu of a rotten, hollow falsehood.

Unfortunately and for too long, the private sector managed to get regulators to let it write its own rules which in consequence turn out to be as defective and contradictory as necessary to make even those few public enforcers that aren’t on the take look publicly stupid.

External regulation is the only kind that works, which would explain why it’s the sort of regulation America simply doesn’t have, nor is likely to as long as the corporations get to call all the shots. Nothing good can come of this.

Posted by HBC | Report as abusive
 

“… the greatest-ever increase in government spending outside wartime.”

So… the incursions in Iraq and Afghanistan were/are just an exercise in pretending the U.S. is not at war. Perhaps you should examine the cost of these exercises, not only in monetary terms but in the costs to human lives.

Posted by Warburton | Report as abusive
 

History goes in circles… the next bit is the weeping, wailing and gnashing of teeth if I’ve read my history correctly.

Posted by Tiu | Report as abusive
 

Excellent. Government shouldn’t be regulating business. Now we need to fix the flip side of the coin. Government also shouldn’t be protecting business. When a business screws up, it needs to be allowed to fail and/or be sued out of existence.

Here’s to a truly free market!

Posted by mikeinohio | Report as abusive
 

Philip Bobbitt
TERROR AND CONSENT

If you read this book you will understand where we have been going.. ,this has become the defacto hand book of modern government…it is trully terrifying

Posted by Mzungo | Report as abusive
 

There are plenty of laws, but no one seems to mind ignoring them because the enforcement does not exist. Besides the financial sector, I can think of several other areas that lack oversight, regulation, auditing and/or enforcement, and are a risk to our safety and national security:

- Food additives
- Food imports
- Illegal immigration
- Chinese manufactured products

We are now in an era of laziness, disregard, and leave-it-for-the-other-guy syndrome.

Posted by finneganG | Report as abusive
 

The regulatory culture needs a lot deeper discussion. Remember that the legislature creates laws, the executive signs them, but unelected employees actually write the regulations. Then you have enforcement police. The government employees who write the regulations may have their own philosophies on what should be done and don’t interpret the intent of the legislature correctly. Or, if we follow some of the advice that seems to be offered here, they may have little practical experience in the industry they are supposedly regulating. Then there are the enforcers. (Where I grew up in the US strict building codes were just an excuse to have crooked building inspectors demand more payoffs.) Maybe leaving regulation entirely up to the industries affected is not effective, but some more creative thinking has to go into what should be done.

Posted by AmericaninCan1 | Report as abusive
 

so i think agent house should tax low price rent than high bill. agent tax real house sell or sale make mistake alot math. people feel lost job and lay off.. america not fault. u know emoic too high tax bill trillion can’t slove back own bill trillion. please keep people too child stay not leave house or leave build.

Posted by marcosg39 | Report as abusive
 

I am amazed at how people think they can regulate integrity and are shocked when somebody breaks a law. If you really could, people wouldn’t be going around with guns robbing 7/11′s.

But…we’ll elect some more people who feel they have a mandate to go pass some more laws so they can justify their “power” and go home thinking they did a good job today. And tomorrow, somebody will figure out a way around it.

Until you make the penalty not worth committing the crime, people will break the law. Won’t stop it, but will certainly cut the crime rate.

Posted by CalinCA | Report as abusive
 

It appears on quick glance that the author has no faith in the basic theory of the free market. Leave people alone, let the free market do it’s work, and we shouldn’t need government regulation. One State in the USA with NO taxes and NO regulation would likely become the most prosperous location in the world within 10-years.

Posted by DrNewdell | Report as abusive
 

Thank you for a reasoned discussion of regulation. In recent years, such subjects have been buried in political sound bites.

You have hit on several of the issues that cloud regulation. Yes, we are buried in regulations that are not enforced while still lacking some rather common-sense rules. It’s no wonder that modestly intelligent people have a sense of derision toward regulators and regulations. Most of us have contributed to the failure of such regulations to moderate our interactions.

It should be obvious that self-interest is inadequate to curtail common, excessive greed. We have revered greed far too long.

Posted by ptiffany | Report as abusive
 

Well written!

I think of regulations like a chain, each one being a link, the ones that are huge examples of sloppy thinking are the ones that naturally get all the attention.

I do see the “chain” getting infinitly longer by the day though. I see an “end game” for that modus operandi in which regulators will all be in a “state of shocked disbelief”.

IMO: The industrial revolution has been like a tornado in a trailer park with the human race. We have collectively gotten to big for our breeches, we can either slow down voluntarily, or non-voluntarily, but we will.

Posted by Illinois | Report as abusive
 

This is Reuters commentary at it’s best, I hadn’t thought about some of this stuff. However I have often heard it said “we don’t need more laws, just enforce the ones we have”.

Posted by 2pesos | Report as abusive
 

Regulations have to be knocked down to simple effective rules people can actually follow. Regulations written by lawyers are inherently self-interested to require more lawyers to interpret.

Posted by VancouverBC | Report as abusive
 

Free enterprise is a myth. In the U.S., we don’t have open, fair, and competitive markets. We have unfair regulations that ensure the market dominance of monopolistic oligopolies. Deregulation simply unleashed “the animal spirits of capitalism” to run rough-shod all over consumers and to exploit the masses. How else can we explain pay-day lenders in all our inner cities charging 400% annual interest rates, credit cards with up to 29% APRs, exhorbinant bank fees, unsustainable subprime mortgages, and predatory lending practices?

Posted by Todd2 | Report as abusive
 

Apologies to John Kemp for my comment earlier today. I should have read his article more carefully as it is very well written an indeed pertinent,

Posted by Warburton | Report as abusive
 

Yes, you are correct. No one should believe for a second that industry self-regulation could be a cure. Weak, compromised regulators were the problem in the cases you cite. I say make the regulators responsible. Rip their hearts out (metaphorically speaking) if they fail at their assigned task of regulation. Line those in industry who were in any way involved in these failure and rip their hearts out too. We seem to have learned as a society that drunk drivers are a hazard to society. These folks are too. A little round of prison time to all involved! Make it easier to prosecute by law or persecute by regulating board. The public is still hopping mad that Wall Street, coal mine owners, and now oil men get away with what they do and spend no time in jail or receive any punitive action. Don’t make the company responsible, make it an individual responsibility. When someone fears for their job, their life, and their livelihood – when they fear incarceration – that’s when folks straighten up and give up industry’s version of drunk driving.

Posted by Tom_MacKnight | Report as abusive
 

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