Category Archives: regulation

Replace Regulatory Agencies with Simple Laws

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I have talked before about principles-based regulation. I think that one advantage of this approach is that we could get rid of the “fourth branch of government” consisting of regulatory agencies. Instead, regulatory issues would be settled in courts, allowing common law to develop. Violations of the law against taking advantage of consumer ignorance would be punished on the basis of clarity of the violation, severity of the violation, and systematic nature of the violation.

For example, consumer protection could be embodied in a law that says “It is a crime to take advantage of the ignorance of the consumer.”

Let us use as an example a consumer who is obtaining a mortgage. It is easy for the consumer to get ripped off. It is almost impossible to write precise regulations that keep a consumer from getting ripped off. Here is how the law would apply.

How clear is the violation? Ask a juror to say, “If someone I cared about were offered this mortgage, would I want them to take it?” If the answer is “definitely yes,” then there is no violation. If the answer is “definitely no,” than there is a clear violation. If the answer is “maybe, depending on circumstances” or “not too unreasonable” then there is at most a slight violation. And yes, lawyers for each side would be trying to explain to jurors what is or what is not unfair or inappropriate about the mortgage.

How severe is the violation? Back in the day, loan officers would steer a borrower to take a mortgage with an interest rate slightly above what the best rate, because the loan officer would pocket some of the “yield-spread premium.” While this would violate the law, it is not a severe violation, in that it does not cost the borrower much. It is not as bad as foisting a pay-option ARM on someone who only understands the initial monthly payment and does not foresee the future jump in monthly payments. Another measure of severity concerns the vulnerability of the consumer. If we are talking about a financially savvy affluent individual, the violation is less severe than if we are talking about the proverbial poor, trusting widow.

How systematic is the violation? Was pocketing the yield-spread premium an exception to a well-articulated corporate policy. Or were you loan officers trained to extract the maximum yield-spread premium?

What I would like to see happen under principles-based consumer protection is that firms decide to set up internal policies and procedures for designing and marketing products in a fair manner. Instead, under rules-based regulation, the firm focuses on following the rules. This can and does generate a mismatch between the intent of the regulation and the outcome of the regulation.

Comments welcome. I would prefer that you not compare principles-based regulation to rules-based regulation that is perfect in theory. Instead, compare it to rules-based regulation.

Principles-Based Regulation for Food and Drugs

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Anahad O’Connor writes,

The Food and Drug Administration frequently recalls dietary supplements that are found to contain banned substances. But a new study suggests that many of these products return to store shelves months later with the same dangerous ingredients.

With principles-based regulation, you look at companies to see if they have processes in place to ensure that they follow the right principles. Do the health-food stores have people in charge of checking the labels of what they put on shelves? Do the companies that manufacture drugs have people in charge of making sure that they do not put known dangerous chemicals into the drugs? Do the companies that import drugs from overseas have processes in place to ensure that they are not tainted? etc.

When you find processes that are flawed, you order fixes. When find an absence of processes, you impose heavy penalties, which might include prison for the executives.

The Season of Giving

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I would recommend giving your progressive friends gift subscriptions to Regulation. The articles in the current issue, as usual, show the gap between intention and outcome.

For me, the issue was too depressing to digest in one sitting. It is hard to single out any one article, but perhaps Peter Lemieux on the U.S. wanting to apply tariffs to Chinese solar panels is the one that describes a government action that even a progressive should easily find reasons to condemn.

Do you believe in respect for international law? The World Trade Organization ruled against the U.S. Do you believe in using “green” energy to fight global warming? Raising the price of solar panels will reduce the use of solar power. etc.

Paul Ryan on Regulatory Process

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He says,

I’d propose a simple rule for all future regulations. If you’re a federal agency, and you want a regulation that would unduly burden low-income families, you’ve got to go to Congress. If they want it, they should have to fight for it—on the record. It’s your government; you deserve a voice and a vote.

My thought is to cross out the phrase “that would unduly burden low-income families.” In other words, all regulations would have to be passed as Congressional legislation. And each regulation would require a separate vote.

Discuss.

Reputation and Regulation

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From a podcast with Russ Roberts and Mike Munger on ride-sharing and apartment-sharing services.

[Mike]It’s actually subversive of the state’s sort of traditional role of licensing and restricting access. And now we have–the whole world is basically Rotten Tomatoes, where you get by on peer to peer information about reviews, not just the reducing of transactions costs. But the quality. [Russ] Your reference to Rotten Tomatoes, I assume, is to the film site. Not to the– [Mike] Yeah, I try that in class sometimes. I ask my class what would happen if there were no FDA (Food and Drug Administration). It would be the Wild West. All sorts of drugs would be out there. You wouldn’t know what to do. And I say, Yes; what if there were no Federal agency in charge of reviewing movies? And they look at me and say, Well, there isn’t one.

But would we want a decentralized system for reviewing drugs? Do I trust a system that is not dominated by experts?

Room for a Regulatory Arbitrageur?

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Matthew Mitchell and Christopher Koopman write,

Startups in the craft brewing industry face formidable barriers to entry in the form of federal, state, and local regulations. These barriers limit competition and innovation, reducing consumer welfare.

If this is correct, then it should open up opportunities for regulatory arbitrage. An existing craft brewery that has licenses and regulatory know-how could market the products of start-up breweries.

An Attempt to Explain Bill Dudley?

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Ryan Tracy of the WSJ discusses a new paper on the revolving door between Wall Street and regulators.

its findings suggest that the revolving door may be driven by an entirely different force. Instead of “regulatory capture,” the paper provides evidence consistent with “regulatory schooling” – the idea that people take regulatory jobs to become experts on complex regulations before cashing in with a private sector job. Instead of having an incentive to go easy on banks, the “regulatory schooling” hypothesis suggests regulators have an incentive to make rules more complex.

The paper comes from the research staff at the New York Fed.

Regulatory Arbitrage Uber Alles

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Mark Thoma points to an essay by Dean Baker accusing airbnb, uber, and other services of cashing in on regulatory evasion as opposed to the Internet or other economic fundamentals. Thoma comments,

Agree about the level playing field, but perhaps it will serve as a catalyst for changing regulations that “were originally designed to serve narrow interests and/or have outlived their usefulness”?

Or a catalyst for encouraging the incumbents to act differently. The original low-cost bus services between NY and DC ultimately spurred the legacy bus companies to set up low-cost subsidiaries in order to compete.

SNEP Solution: Alternatives to the FDA Process

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One of the problem areas is anachronistic regulatory models. The FDA drug approval process is onerous. The FDA acts as if the worst error that it can make is to approve a drug that it later regrets approving. Essentially, it treats every drug as snake oil unless proven otherwise. As scientific progress speeds up, the FDA process turns into a significant bottleneck.

Bartley J. Madden and Gregory Conko propose,

However, after making a preliminary demonstration of safety and efficacy by completing Phase I trials and at least one Phase II trial, drug manufacturers would be given the option to place an experimental product on a parallel Free To Choose track that would enable patients, advised by their doctors, to make an informed choice to use the experimental drug. Drug makers could opt to continue pursuing a standard FDA approval—with all the attendant clinical testing that would require—concurrent with placing a drug on the Free To Choose track. Or, they could put off standard FDA-regulated clinical trials indefinitely, using Free To Choose track experience to guide future development decisions and randomized control trial designs.

Thanks to Alex Tabarrok for pointing me to the article. However, I think that there may be other instances in which the social cost of denying access to a drug is high relative to the risk that the drug will cause harm.

Somebody who is dying or enduring great suffering might have little or nothing to lose from trying an unproven remedy even before Phase I trials are complete.

As medicine becomes more customized, to the genetic makeup of the patient (or, in the case of cancer, the genetic makeup of the tumor), a question arises as to what is the relevant population for a clinical trial.

Cable Internet: What is the Problem?

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Felix Salmon writes,

Americans really love their TV. They love it so much that cable-TV penetration is still substantially higher than broadband penetration. As a result, any new broadband company will not be competing against the standalone cost of broadband from the cable operators: instead, they will be competing against the marginal extra cost of broadband from the cable company, for people who already have — and won’t give up — their cable TV.

If you’re a cable-TV subscriber, the cost of upgrading to a double-play package of cable TV and broadband is actually very low; what’s more, there’s a certain amount of convenience involved in just dealing with one company for both services.

And yet Salmon argues that the lack of competition in offering broadband Internet is a problem. I am not sure why.

It has always seemed to me that what holds back penetration of broadband Internet is that there are a lot of “want-nots” among American consumers. The penetration rate for cable TV is somewhere north of 90 percent, and as Salmon points out, the marginal cost of adding broadband is low. So if more Americans wanted broadband Internet, they could have it.

The other technology that Americans really love is cell phones. My guess is that going forward the marginal value of bandwidth is much higher in wireless than it is in cable. Worrying about cable monopolies reminds me of the days when the government pursued an antitrust case against IBM for its monopoly in mainframe computers. In hindsight, that monopoly does not appear so formidable.

Pointer from Tyler Cowen, who is on my side, but for somewhat different reasons.