The much-publicized report by the Department of the Interior’s Inspector General on conduct by employees of the Minerals Management Service (MMS) provides a lurid example of a fundamental problem underlying US economic regulation: regulatory capture. As highlighted by many examples over the years, US regulatory agencies are particularly susceptible to “capture” by the very industries they are meant to be regulation. Those very familiar with specific areas of regulation will be aware of a pervasive and multi-level industry influence over the ways in which those industries are regulated,
In other words, the industry, through its direct and indirect influence on the regulators, is able to shape the standards the regulators apply and the way in which these standards are enforced. The techniques range widely, from outright bribery (as in the MMS case) to engaging sympathetic congressmen to lean on regulators (themselves dependent on financial support from the industry) to hiring the best regulators with offers of huge salaries (these former regulators then being able to “decode” the industry interaction with the regulators or use their residual influence at the regulatory agency to secure favorable terms for their new employers). Regulated industries also tend to exert considerable influence over the ongoing staffing of agencies. It is commonplace for agency staff, particularly at the higher levels, to be drawn directly from the industry itself, before they return to the industry to make even more money. This creates a classic “revolving door” situation that can only make the problem more insidious.
I cannot think of a single area of economic regulation that has been or is currently free of some form of regulatory capture.
Not all industry influence is inappropriate: after all, industries exist to make money and, if lawful, their prosperity benefits us all. They should be able to influence the development and application of sensible and appropriate regulations. And industries are entitled to proper regulatory expertise and intelligent, well-versed regulators. But backdoor influence that leads to the kind of capture to which I am referring undermines the whole point of regulation. To use the old metaphor, it leads to the fox guarding the henhouse.
So why is the problem so prevalent in America?
First, we should note that the problem is not exclusive to America by any means. It has grown dramatically in recent years, for example, in Europe–perhaps partly under the cultural influence of American economic participation in the European Union, but also as an inevitable result of the matters at stake. Secondly, the proponents of what is called public choice theory, led by economist George Stiglitz, would argue that the problem is inherent in regulation itself, because regulation is more often than not the product of industry choices and not some kind of general public interest. Realtors, lawyers and hairdressers, for example, might want licensing because it protects them from competition, not because it maintains public standards. In other words, under public choice theory industry is protected, not constrained by regulation. But I do not subscribe entirely to public choice theory because there is a lot of evidence that supports the view that much, if not all, regulation is initially set up to promote public interests, such as safety, competitive markets, and so on. I would of course include realtors, lawyers and barbers in this category. And I do believe that many–perhaps most–people are or can be inspired to “do the right thing” for everyone and not just themselves.
In my view there are many reasons why we have regulatory capture. Fixing the problem is also very complicated, particularly in the American culture. We simply don’t take regulation seriously enough as a society. Indeed, because it seems counter to the “free market” philosophy we all share, becoming a regulator is sometimes portrayed as a sign of failure. “Real men” would be out there actually making the economy work.
To be sure, there are many public-minded Americans–perhaps even proportionately more than in most other countries–but public service is seldom a chosen career path, at least for very long. And for good reason. We don’t teach its virtues and we don’t reward public service adequately. Where are the professors of regulation in the US? We don’t give knighthoods to regulators. They don’t get paid much in other countries, such as the United Kingdom, either but at least they are considered important. But what do we do? We pull them up in front of Congress and beat up on them, so they go get highly paid jobs in the private sector.
We have to figure out ways to modernize regulation from the ground up. This will involve better understanding of the regulatory function through teaching at our higher institutions of learning. It will involve the courage to restructure agencies when changed economic conditions so demand (a courage that has failed Congress in the current financial reforms). It will involve developing incentives (not always financial) for the “best and brightest” and highly skilled young people to go into agencies to help develop the firepower required for effective regulation of powerful industries–and earn those industries’ respect. Modernization would also develop better firewalls between regulators and the regulated. And we need to figure out how to extend a proper social respect for the profession of regulation. Such respect has existed in America from time to time–for the SEC for example, and until recently for the Fed, which were once considered to be elite agencies where graduates clamored to find positions.
Each of these tasks is much easier to state than meet. Some branches of government, such as the military JAG Corps and Naval SFTI Program (TOPGUN) have managed to establish programs of elites who are as highly skilled and motivated as one could find anywhere in the world, yet are compensated on much lower salaries than might be earned in the private sector. In a column last year a former colleague and I toyed with the idea of similar elite corps within the financial agencies, and more recently another commentator has drawn on the example of the Foreign Service for similar suggestions. For years a few, sparsely read and perhaps too ideologically-driven publications have striven sincerely to promote serious thinking about regulation. More recently, however, important and constructive new books, centers and projects are starting to appear and these publications, their adoption in universities and the study promoted by such projects will help to provide a more sophisticated and stable base upon which we can build a regulatory system that meets the challenges of our modern economy.
Until we as a society come to respect the vital role of regulation and start taking it seriously, we will continue to have a situation in which the regulatory systems we create end up serving the industries they are meant to supervise rather then the public they should be protecting.