But economists have played an important role in providing intellectual justification for the changes that have been made. First, economists have urged that price controls be confined to situations in which a market may be dominated by one or perhaps two firms. Otherwise, if markets are reasonably competitive, there is no place for price regulation. Consistent with these propositions, the federal government in the late s and early s began dismantling price regulation of various transportation services, where there are multiple firms and thus choices for consumers see airline deregulation and surface freight transportation deregulation.
Still, there are pockets of economic activity— insurance is one notable example—where some kind of price regulation remains, even though the underlying markets are fundamentally competitive. Similarly, economists have encouraged policymakers to reduce entry controls so that any firm or individual can enter any market, except in situations where they judge that low quality should not be tolerated.
For example, bank regulators no longer closely scrutinize the need for new banks before handing out charters and instead limit their scrutiny only to whether banks have adequate initial capital and whether their owners are reputable. Licensing systems still remain, however, for doctors, lawyers, accountants, nuclear power plants, and the like because some policymakers believe that the potential damage from low-quality providers can be substantial or irreparable see consumer protection for another viewpoint.
Second, economists have urged regulators to design more efficient social regulations so that a given goal—such as clean air—can be achieved at least cost. In practical terms, this means not telling firms exactly what technologies to use i.
In addition, economists have urged regulators to allow firms to trade their compliance status with other firms. For example, a firm that, because of a cheaper technology, can reduce the emissions of a noxious chemical to a level below the standard would be able to sell the rights to emit that shortfall to another firm whose cost of complying is higher.
This reduces the total cost for a given reduction of overall emissions. In fact, regulators have taken this advice to heart. The federal agencies governing the safety of automobiles, industrial workplaces, and the environment all have moved in the direction of regulating by performance rather than by design. The U. Environmental Protection Agency EPA , in particular, has implemented emissions-trading programs for sulfur dioxide and other pollutants.
Because even a well-functioning economy will have market failures, however, there will always be a case for some regulation. In some of these cases, it is useful to think of regulation as an alternative to direct government expenditures or tax incentives. For example, to ensure cleaner air or water, the government itself could pay for or subsidize technologies to prevent emissions in the first place and then pay to clean up any residual mess that firms and individuals may leave behind.
In large part because governments are unwilling to increase taxes to follow such policies, and in part because of pressure from environmental NGOs, governments tend to embrace regulation instead. For example, the EPA has introduced and enforced a series of standards for various kinds of pollutants. Often government regulates intrusively. The EPA, for example, has compelled firms to install the best available pollution removal control technology rather than allowing firms to meet prevailing standards by changing their input mixes to prevent pollution from arising in the first place.
Eastern U. OMB now does this every year and has improved its methodology over time. It would be a mistake, however, to conclude from these aggregate figures that the benefits of all individual regulations exceed their costs.
In fact, independent analysts have documented the reverse for many regulations. In this ideal pure market world, rules restricting buyers or sellers can only distort the optimal distribution of goods and services. However, this abstract academic lesson tells us little about the real world, because pure market conditions almost never exist in actual commerce.
Real-world markets differ from theoretical models in markets in several ways — and good regulations can help those imperfect markets work better:. Throughout American history, governments have subsidized businesses and established conditions for markets to function. But periodically, as Americans experienced unacceptable harms from market practices, they have insisted that public authorities override protests from profit-seekers and step in to secure the public interest. Examples of such public-interest regulations include laws to outlaw child labor, building code regulations to ensure stable construction and prevent catastrophic fires, food and pharmaceutical regulations, environmental protections, and laws to prevent irresponsible mortgage lending.
Those who claim that all such regulations are unwarranted are implying that governments should only maximize private profits, not protect the environment and ensure public health and security. This makes little sense.
Claims that regulation is bad for business are wrong — because the interests of more companies are well served by regulations in the public interest. To sell their products, businesses depend on public confidence that products will not harm people. Businesses also benefit when all of them have to meet the same standards, so some firms cannot undercut others.
Even when some businesses are in fact disadvantaged by proposed regulations—such as coal-fired power plants required to limit pollution—others will benefit, such as firms promoting wind and solar power. Not all regulations are effective or achieve their purposes.
Some are too restrictive, while others are weak or improperly implemented. But that does not mean that all regulation is harmful. Although society benefits from well-functioning markets, critics are wrong to claim that all government regulations are bad for business.
Retrospective review must rely heavily on the street-level body of knowledge and information already resident within the executive agencies, and with the associated leadership resources in OIRA.
However, we also are concerned that the instincts of self-justification within those agencies—the reflex to defend the judgments taken by those same executive offices in the past—could prevent objective retrospective review. One way to circumvent any tendencies of agencies to be closed-mindedly defensive about their own regulations in any review process would be either to expand the resources of OIRA so that it could have a separate shop that focuses of retrospective review. Alternatively, a new and independent office could take on that responsibility.
What would not work is requiring existing staff at OIRA or the agencies, already required to assure the quality of new regulations, also to take on the responsibility for retrospective review. Both functions would suffer, beyond any self-protective instinct in the retrospective review function. The office charged with retrospective review could select existing regulations for the earliest review, guided by priorities set by the Congress.
The Congress must play a stronger role in regulation. There is always the potential for a costly Catch dilemma for the executive, should a less-than-fully-informed Congress mandate the creation of a new regulation that must pass a cost-benefit test, while imposing conditions such that the creation of such a regulation is impossible.
The Congress does need more expertise to ensure that the legal foundations that it builds for future regulations are sound. So, better creation and ex-post review of regulation will cost money. It is important that the nation not swallow whole the fallacy that more resources for regulators mean more regulation.
It must be made to mean better regulation. It can mean better data to facilitate stronger and more-frequent review, and therefore the cleaning-out or improvement of obsolete or deficient regulations that otherwise would evade scrutiny.
All that is needed is the leadership and the understanding to make that happen. It is imperative for a dynamic, prosperous economy. We largely agree with the recent conclusions of the Council on Foreign Relations: proposals for regulatory reform should continue to emphasize better ongoing evaluation and oversight of regulatory policy that might be directed, guided, and even conducted outside the executive-branch regulatory agencies themselves.
A deeper discussion of regulatory governance is included in Appendix 3. Who in the executive branch and who in the legislative branch would best be given the responsibility for unbiased evaluations of regulations, and how can we best keep cronyism and special interests away from regulatory analyses and decision-making? At the same time, policymakers will need to devote adequate resources to whichever entities are charged with conducting these impartial analyses, to make sure that such evaluations can be done in a comprehensive, systematic, effective, and yet timely and cost-efficient manner.
We find some of the ideas in the literature highly promising, others less so. At the headline level, we have already noted that approval of any regulation is at least an implicit assertion that its benefits exceed its costs. We believe that to the greatest possible degree, comparison of costs and benefits should be explicit.
We recognize that cost-benefit analysis can be extraordinarily challenging and believe that sound cost-benefit analysis in a world of uncertainty should make all of its assumptions explicit and should provide alternative upper- and lower-bound estimates of its key components. We also believe that our proposed retrospective review should allow reconsideration on the basis of those sensitivity analyses.
We believe that such cost-benefit analysis is the gold standard of the regulatory process. We fear that some alternative decision rules, however well meaning, might yield inferior outcomes. For example, an aggregate regulatory budget or regulatory cost cap could yield perverse results. A new regulation with benefits exceeding costs could be rejected by an aggregate regulatory cost cap or budget.
But at the same time, old regulations whose costs exceeded their benefits would be protected against a cost cap or budget solely because of their incumbency. We fear that a well-meaning mandatory sunset requirement would soak up considerable resources to reimpose justified and uncontroversial regulations—resources that would better be devoted to the difficult and more important issues.
If we were assured that those basics were unattainable, we would consider falling back on the second-best alternatives. But we see no reason to declare pre-emptive surrender on the most-sound options available to our regulatory system. There are other recommendations that we find highly appealing. We believe that even statutorily independent regulatory agencies should be subject to the same process and review requirements as the line executive regulatory agencies. We also align ourselves with the governance principles in the OECD report.
This CED review of U. The problem of biased, inefficient, and outdated regulations could be better avoided if policymakers would pursue an overarching strategy of favoring principles-based over rules-based regulation which would be more immune to special interest hijacking and manipulation.
Measurement challenges and resource constraints continue to prevent adequate levels and quality of both ex-ante and ex-post retrospective evaluation of regulations to ensure that policies are beneficial and optimal. The United States is doing better at ex-ante justification but could and should strive to do more monitoring and evaluation of regulations after they are put in place. Some other countries have surpassed the United States in regulatory management in this regard.
The independent body in charge of reevaluation of regulations could be charged with criteria to order the existing stock of regulations for review. But we believe this to be a permanent function of looking for regulations that have fallen behind the changing times—not a once-for-all housecleaning.
Toward the goal of more regular scrutiny of regulations, a reinvigoration of the congressional reauthorization process is needed. Legislators need more resources so that they can develop realistic standards for new regulations, and can pay better attention to the function and performance of regulations after they are put in place, too.
More and better data on the effects of regulatory policies are needed. This has been recommended for decades, but we really should be doing better now that the costs of collecting, maintaining, and analyzing data in real time have come down and will continue to decline rapidly. At the same time, funding for the statistical agencies should be preserved and enhanced to take advantage of the increasing productivity of investments in data. More sharing and disclosure of information with stakeholders and the public—more transparency—is needed.
Regulatory policy making should involve other parts and levels of government and the public, not just the federal executive agencies. Increased stakeholder participation will shed light on and help avoid inefficient regulations that benefit special interests over the public interest. These recommendations continue the spirit of our recommendations. Unlike our recommendations in , however, we now put less emphasis on Congress doing the heavy lifting.
We also conclude that no matter who is in charge of developing and maintaining regulations, the regulations will be more supportive of the economy and the public interest—as well as more sustainable over time—if based on broadly defined, commonly agreed-upon economic principles rather than narrowly defined technical rules.
If we are to improve the regulatory policymaking process and the ultimate quality and effectiveness of the regulations themselves, we will need to determine which entities are best able to consider, construct, administer, and review regulations in ways that help businesses, the economy, and our society.
See a more detailed discussion of issues of stakeholder involvement in Appendix 4. Reorienting our approach to regulation in this way will help to achieve our goal of regulations that are better justified and regularly monitored, reevaluated, and scrutinized to be economically smarter, not just administratively simpler. Following are some valuable contributions from the recent literature. Frantz and Instefjord 72 present an academic, theoretical paper on rules- versus principles-based financial regulation.
We study the relative strengths and weaknesses of principles based and rules based systems of regulation. In the principles based systems there is clarity about the regulatory objectives but the process of reverse-engineer[ing] these objectives into meaningful compliance at the firm level is ambiguous, whereas in the rules based systems there is clarity about the compliance process but the process of forward-engineer this into regulatory objectives is also ambiguous.
The ambiguity leads to social costs, the level of which is influenced by regulatory competition. Regulatory competition leads to a race to the bottom effect which is more harmful under the principles based systems. Regulators applying principles based systems make dramatic changes in the way they regulate faced with regulatory competition, whereas regulators applying rules based systems make less dramatic changes, making principles based regulation less robust than rules based regulation.
Firms prefer a rules based system where the cost of ambiguity is borne by society rather than the firms, however, when faced with regulatory competition they are better off in principles based systems if the direct costs to firms is sufficiently small. We discuss these effects in the light of recent observations.
When we think of regulation, we think of specific rules that spell out the boundaries between what is approved and what is forbidden. I call this bright-line regulation BLR. What I want to propose is an alternative approach, called principles-based regulation PBR. With PBR, legislation would lay out broad but well-defined principles that businesses are expected to follow. Administrative agencies would audit businesses to identify strengths and weaknesses in their systems for applying those principles, and they would punish weaknesses by imposing fines.
Finally, the Department of Justice would prosecute corporate leaders who flagrantly violate principles or who are negligent in ensuring compliance with those principles. The banks will always be savvier than the consumers and nimbler than the regulators, so bright-line regulation is bound to fail. As with any regulatory approach, principles-based regulation must be well executed in order to work.
A key element is that the principles should have clear meaning. They are just glittering generalities that offer no concrete guidance to a firm.
Businesses often use internal mission statements and lists of principles as a tool to align employees with the goals of top management. However, in many instances, the statements are so general that they have no implications for any particular way of conducting business. The truly meaningful statements of corporate philosophy are those that provide strong signals of what type of business directions the firm will and will not take. Similarly, for PBR to work, the principles have to clarify rather than obfuscate.
Legislative commentary should include specific examples of conduct that falls outside of the principles, in order to provide further guidance Principles-based regulation is not a cure-all. There are many regulatory problems that are better addressed with bright-line regulation. For example, the algorithm for calculating the Annual Percentage Rate of interest should be standardized and clearly specified by regulators. And any regulatory system will have gaps and flaws.
After all, those who design and implement regulations are as human as the people who run the businesses that they regulate. But in an increasingly complex and fast-paced market environment, there are likely to be many regulatory issues where principles-based regulation will prove to be more robust.
Burgemeestre et al. There is an ongoing debate in law and accounting about the relative merits of principle-based versus rule-based regulatory systems.
In this paper we characterize what kind of reasoning underlies the two styles of regulation. We adapt an original account of Verheij et al. The model is validated by a comparison between EU and US customs regulations intended to enhance safety and security in international trade. Black et al. It is proposing a significant shift towards reliance on broadly stated Principles rather than more detailed rules. The implications of a more Principles-based approach for regulators, those regulated by the FSA and those whose interests the regulatory regime is designed to protect are the subject of ongoing dialogue The potential benefits claimed of using Principles are that they provide flexibility, are more likely to produce behavior which fulfils the regulatory objectives, and are easier to comply with.
Detailed rules, it is often claimed, provide certainty, a clear standard of behavior and are easier to apply consistently and without retrospectivity. They explain:. Because most global companies concentrate on making their systems operate as efficiently and functional as possible, they can lack the agility and appropriate mindset to navigate and manage reputational risk and its underlying drivers with alacrity. Compounding the challenge can be corporate dependence on rules-based compliance systems to manage risk.
These are situations in which agents are motivated by incentives that reflect legal, regulatory and political constraints rather than and frequently at the expense of moral and ethical imperatives. Professor Caroline Kaeb at the University Connecticut Business School concludes that rules-based compliance systems possess far greater hidden costs that prevent maximum compliance at a level of economic efficiency.
In addition, rules-based systems often pose design challenges. Their rules are over- or under-inclusive. Therefore, they are unsustainable since global risk has become fragmented and increasingly qualitative, simultaneously Many regulatory policy experts across the political spectrum call for better review of regulations after they are put in place to get rid of stale, outdated, and inefficient regulations.
The findings from ex-post, retrospective reviews could also serve to validate ex-ante assessments. Multiple presidents from both parties and with increasing emphasis over time have pushed for greater retrospective review of regulations via executive orders. He mentions a detailed reappraisal a quintessential retrospective review of the cost and effectiveness of the rule mandating center high-mounted stop lamps on cars and light trucks, and the original prospective study that had randomly assigned vehicles to have the special stop lamps under consideration.
Orrin Hatch, Republican from Utah would establish a Retrospective Regulatory Review Commission to review and make recommendations to repeal rules or sets of rules that have been in effect more than 15 years.
Congress would approve the full package of recommendations via joint resolution. These proposals are explicitly supported by former OIRA Administrator Susan Dudley and implicitly achieve policy goals laid out by many other regulatory policy experts. Their conception is that:. The [Regulatory Improvement] [C]ommission would consist of eight members appointed by the President and Congress who, after a formal regulatory review, would submit a list of regulatory changes to Congress for an up or down vote.
Congressional approval would be required for the changes to take effect, but Congress would only be able to vote on the package as a whole without making any adjustments. This is illustrated in Figure 6. The GAO report identified the major strategies and barriers that affect agency implementation of retrospective analyses:. Strategies: i establish a centrally coordinated review process to develop review plans; ii leverage existing regulatory activities to identify needed changes; iii use existing feedback mechanisms to identify and evaluate regulatory reforms; and iv facilitate tracking of reviews and interagency discussion and collaboration on best practices.
Agencies need to be forced to or more strongly encouraged to analyze data at regular intervals and in an impartial manner;. The regulatory system needs to better provide and align resources and incentives to undertake and enforce retrospective review. Who is responsible for designing and implementing regulations, and can that person or entity be trusted to pursue and enforce economically beneficial regulatory policy?
Role clarity: An effective regulator must have clear objectives, with clear and linked functions and the mechanisms to coordinate with other relevant bodies to achieve the desired regulatory outcomes;. Preventing undue influence and maintaining trust: It is important that regulatory decisions and functions are conducted with the upmost integrity to ensure that there is confidence in the regulatory regime. This is even more important for ensuring the rule of law, encouraging investment and having an enabling environment for inclusive growth built on trust;.
Decision making and governing body structure for independent regulators: Regulators require governance arrangements that ensure their effective functioning, preserve its regulatory integrity and deliver the regulatory objectives of its mandate;.
Accountability and transparency: Businesses and citizens expect the delivery of regulatory outcomes from government and regulatory agencies, and the proper use of public authority and resources to achieve them.
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