Forty years on the regulatory commons.

Yandle, Bruce

On January 18, with much fanfare that included a Wall Street Journal op-ed (a rare act for a sitting president), President Obama announced Executive Order 13563. The order set in motion yet another presidential effort to exert control over the federal government's regulatory Leviathan, an estate with 280,000 workers and a $60 billion budget that turns out 3,000 new rules annually.

With noteworthy innovations, the order contains some of the same logic for improving regulation found in President Richard Nixon's October 1971 order that established in the Office of Management and Budget a Quality of Life review for major federal regulations. From Nixon forward, there has always been an executive order requiring some kind of White House review of new regulations. And over the years, regulatory review orders have evolved in an apparent effort to free up the economy by reducing regulatory burdens.

With 40 years of accumulated executive order wisdom to draw on and knowledge tapped from turning out some 2.5 million pages of Federal Register rules since 1970, President Obama looked the Leviathan in the eye and called for a review that will "root out regulations that conflict, that are not worth the cost, or that are just plain dumb." His order calls for renewed efforts for agencies to conduct benefit-cost analysis of new rules, asks agencies to identify and eliminate regulations that serve no meaningful purpose, and instructs regulators to conduct retrospective reviews of rules and make beneficial modifications. The president also initiated an expanded web-based process that opens windows for those who wish to see what is going on inside the regulatory process. While emphasizing that strenuous benefit-cost analysis must be applied where possible to justify regulations, the order also allows for softer considerations that include "equity, human dignity, fairness, and distributive impacts."

But in spite of the complex administrative machinery described in the Obama order, human incentives still matter most, and incentives for regulators and the regulated have changed over the past four decades. There is nothing in EO 13563 that recognizes that the U.S. economy in the 21st century is very different from Nixon's 1971 economy.

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Regulatory commons

In a world where everything can be regulated, requiring agencies to act on better benefit-cost analysis is a wonderfully important idea and requiring retrospective reviews of mossy rules is to be celebrated. But as good as they are, those ideas and others in EO 13563 do not take account of our regulation-driven capitalism and the incentives playing throughout it.

Ours is a regulatory capitalism where regulators and the regulated are intertwined in symbiotic cartel-forming ways that often make working the halls of Congress and regulator offices far more profitable for firms and organizations than struggling in labs, stores, and service organizations to earn consumer patronage. EO 13563 gives commands to an army of regulators who operate as if they are external to the economy they seek to fix, while in fact they are a part of it.

The transformation of the U.S. economy into regulatory capitalism began around 1970, which was the start of the modern regulatory era. It was then that regulation became highly centralized at the federal level, that newly formed social regulators such as the Environmental Protection Agency, Occupational Safety and Health Administration, and Consumer Product Safety Commission joined older economic regulators like the Federal Communications Commission, Securities and Exchange Commission, and Federal Trade Commission to form a new legal environment that ultimately transformed the United States from a common-law to a code-law country.

Inspired by statutes directing action, our 60-plus federal regulatory agencies are somewhat like sheep with legislative guiding shepherds grazing on a regulatory commons, a resource space where there are no systematic limits on the number of rules that can be produced, the time required to read and abide by them, or the economic resources consumed in meeting the rules. Fed by growing budgets and expanded duties, the regulators write more rules. While budgets, congressional directives, executive orders, and benevolent forbearance partially constrain the commons, there is always room for one more bite by the sheep, one more regulation.

The regulatory commons parallels its brother, the fiscal commons. Deficits are the inevitable tendency on one; excessive regulation on the other. In fact, across the years 1970 to 2010, regulatory agency budgets were fed by deficit dollars; they grew faster than federal revenue.

What is it like on the regulatory commons? When one puts on a pair of externality-visualizing glasses, one sees endless opportunities to internalize external costs and maybe even render the world Pareto safe. Whether it be dealing with lead paint, mandatory inspection of catfish, energy efficiency for refrigerators and furnaces, minimum standards for drivers licenses, diesel engine emissions, advertising over-the-counter drugs, marketing practices of funeral homes, or ridding the market of noisy Hickory Dickory Dock pounding toys, the world is full of unhappy and dangerous situations that need fixing.

But with externality glasses, it is much easier to see the flaws than to determine if all people taken together are made better off after the regulatory repairs are in place. And who has time to check? As a result, in the post-1970 period, regulations affecting processes--product design, marketing, personnel, purchasing, finance, manufacturing, and waste disposal--began to affect each and every industrial sector. In a chaotic sense, industries such as autos, food, steel, construction, paper, chemicals, banking, insurance, health care, and higher education were transformed to a new kind of public utility, but without the usual regulatory commission to look after them--and be captured.

On rare occasions over the last 40 years, government analysts made a back-breaking, overall-industry assessment to describe and analyze the cumulative effects of all federal regulations imposed on a single industry. But most of the time, no one has kept score. And even more rarely, regulators would conduct retrospective analyses to determine if indeed the regulations that appeared to be so strongly net-beneficial when imposed really turned out that way. As all of us who have been part of the regulatory establishment understand, there is seldom enough agency time to deal with business in the pipeline, let alone enjoy the luxury of self-examination. All of the incentives go the other way. The next Federal Register press run is waiting. In a way, the nature of our work as regulators made it far more important to turn out more regulation than to inquire about outcomes. It was as if no one really cared about outcomes; regulation was the only outcome that mattered. And if there are to be retroactive assessments, does it really make sense to let the regulators pick the ones to assess?

Changing political economy

Years ago, when regulation was young, before we had published those 2.5 million pages of rules, economists spoke knowingly in tones of certainty about market failure and intervention to correct difficulties from such problems as market power, information asymmetries, failed institutions, and unspecified property rights. We spoke as though government and regulation were exogenous to the market process, that on occasions regulators would open a window, examine features of the economy, make some efficiency-enhancing adjustments, and then quickly close the window to leave the economy to operate in a more glorious way. Indeed, we used the word "intervention" and we referred sometimes to Michael Lantz's 1937 FTC statuary metaphor where a powerful flee market horse is being bridled by a benevolent plowman who presumably serves the public interest.

But as regulatory windows opened and closed daily and agencies pumped out more rules, firms and industries became intertwined with government. Government was no longer exogenous to the behavior of firms in the marketplace; government became endogenous. While major regulations may have reduced some perceived market failure, they also cartelized industries and reduced competition. The strong horses and other special interests came seeking the plowman.

As the political economy has changed, so the words we use to describe and explain what we are doing have become obsolete. When banks become tantamount to regulated public utilities with rules at every margin, can we accurately refer to problems in the industry as evidence of market failure? Would we better say government failure? Or regulatory failure?

Our theories of regulation suffer as well. Long ago, we referred to public interest theory to describe what regulators sought to do when they opened and closed the regulatory windows. We then talked about capture--that happens when the window is open too long. Then came special interest theory that recognizes the competitive battles at play when multiple interest groups seek regulation to obtain well-packaged gains. And yes, there is bootleggers-and-Baptists theory that offers to explain how apparently opposing groups may struggle on the regulatory commons to obtain the same set of rules. But we must enrich our behavioral theories. We must focus on the process itself and how the regulatory process has affected the U.S. economy.

Final thoughts

Ours is an intertwined political economy where economic agents--public and private, always connected--interact on the commons. Cutting through the entanglement will be difficult. Each rule worth revising or repealing maintains wealth for members of the regulatory cartel.

While critically important, as EO 13563 makes clear, it is no longer enough to do benefit-cost analysis on a rule-by-rule basis in the belief that regulation is exogenous to the market process. In terms of improving the new rule, the following should be incorporated:

* Agencies should be required to conduct potential cartel analysis for every major industry rule. They should also identify industry winners and losers under proposed rules, account for the gains and losses that may result in a rule-induced regulatory cartel, and estimate deadweight losses imposed on consumers.

* The Antitrust Division of the Department of Justice and the Federal Trade Commission should be required to review major rules in cooperation with the White House's Office of Information and Regulatory Affairs, and should intervene as appropriate in regulatory proceedings that may have inefficient outcomes.

* In conjunction with the required retrospective assessments and industry reviews, Congress should hold annual hearings to review those reports, with an eye toward improving the competitiveness of the U.S. economy and identifying the economic gains obtained through regulatory review by OIRA.

Going beyond executive orders and OIRA review, Congress should exercise its sovereign responsibility on behalf of the people. This requires it to close the circle of accountability so that all regulatory agencies--executive branch and independent--meet the same accountability standard. To accomplish this, Congress must pass legislation that requires the Congressional Budget Office to:

* become a government-wide scorekeeper on regulatory burdens imposed by legislative mandates, and

* assess pending legislation that includes regulatory mandates and recommend cost-effective alternatives.

Congress must then hold annual hearings on the state of regulation in the economy and how regulation is affecting competitiveness in the U.S. economy. On the basis of those hearings, Congress should take action to set constraints on the amount of regulatory cost that can be imposed annually on the U.S. economy.

Two and a half million pages of rules and 40 years later, it is time to enclose the regulatory commons and sharply revise the way we regulate.

READINGS

* "A Theory of Entangled Political Economy, with Application to TARP and NRA," by Adam Smith, Richard E. Wagner, and Bruce Yandle. Public Choice, Vol. 148, Nos. 1-2 (2011).

* "Bootleggers and Baptists: The Education of a Regulatory Economist," by Bruce Yandle. Regulation, Vol. 22 (1983).

* Public Choice and Regulation: A View from Inside the Federal Trade Commission, edited by James C. Miller III, Robert Mackay, and Bruce Yandle. Hoover Institution Press, 1987.

* Regulating Business by Independent Commissions, by Marver H. Bernstein. Princeton University Press, 1985.

* Regulation by Litigation, by Andrew P. Morriss, Bruce Yandle, and Andrew Dorchak. Yale University Press, 2009.

* "Regulatory Process Reform," by Murray Weidenbaum. Regulation, Vol. 20 (1997).

* "The Theory of Economic Regulation," by George J. Stigler. Bell Journal of Economics and Management Science, Vol. 3 (1971).

BY BRUCE YANDLE

Clemson University

BRUCE YANDLE is professor of economics emeritus at Clemson University, distinguished adjunct professor of-economics at the Mercatus Center at George Mason University, and PERC senior fellow.