Risk and Regulation
Every day we witness regulators denying people their freedom of action: The FDA prevents patients from taking potentially beneficial drugs; the SEC restricts the types of securities investors can buy; the FAA sets such detailed “guidelines” that airplane designers and owners find it difficult to innovate and operate profitably. Beyond these are the innumerable regulatory obstacles which individuals and firms must constantly surmount.
As economic activity dwindles, and tea party activism rises, some Americans are now beginning to question the most flagrant of these rules and regulations. But that alone won’t suffice. If we’re to truly effect fundamental and long-lasting change, we must identify, examine and challenge the basic premises responsible for the regulatory state.
One vital concept here is that of risk. Regulators act on the implicit premise that our primary focus should be on avoiding risk. According to them, all we have to do to be successful is avoid tainted food, drugs with side effects, companies that could swindle us, imperfect aircraft, etc. Moreover, in their view, doing so is easy. Simply ban and forbid any risky product or idea from the marketplace.
What they fail to appreciate is that avoiding a negative is not the same as achieving a positive. Avoiding tainted food doesn’t ward off hunger any more than avoiding a side-effect will cure the primary disease. Instead, what life requires are positive values, from material goods like food, shelter and medicine; to emotional ones like a lover or a spouse; to spiritual ones like a lifelong purpose and career.
As much as regulators may pretend otherwise, these values aren’t just there for the taking, they’re created by positive human actions which aren’t—and can’t be—automatically successful. That is, the risk of failure or of something going wrong is inherent in the very nature of value-creation. Investing in a company carries the risk that its new products won’t appeal to potential customers, that competitors will undercut its prices, or that its CEO will turn out to be a deadbeat. A suitor seeking a romantic relationship can get involved with someone unstable, untrustworthy, or who’s simply a waste of valuable time. Yet those are the risks that must be borne to find wealth and love respectively.
Risks must therefore be evaluated—and often accepted—in the context of our individual value pursuits. It’s this personal weighing of risk and reward that theright to our freedom of action is meant to protect.
Yet regulators don’t just reverse the hierarchy of values and risk. They also forget that because values are intensely personal, so too must be any criteria of “acceptable” risk. Bureaucrats aren’t privy to our individual goals and desires—hence they’re in no position to determine what risks we should be willing to bear, much less to impose a “one size fits all” standard on everyone.
For example, if the Wright brothers have a burning passion to fly, there can be no justification for an FAA to stop them, in effect telling them “it’s for your own good”. Who can know how important the invention of flight was to those inventors and thus what risks were “acceptable”? (It’s worth considering other historical episodes in this light, for instance would any regulator today dare sign off on Darwin’s dangerous voyage to the Galapagos, and if so, after how much red tape?)
Want to hear about regulators out of control? My Northern California county is using the new General Plan to expand all agricultural land into ‘open space’ and conservation easement properties. Never mind that not only stipulating and regulating the size of your new home, where your building is to be located, the type of farming to be conducted on the property, but if there is to be a new homesite, the REST of the parcel (some of ours are large parcels) is to be put into permanent conservation easement. This is clearly a taking of our Constitutional right to private property, but the arrogance of our supervisors and all of the environmental agencies involved is quite frankly, frightening. The agencies recently boasted in a meeting of the hundreds of thousands of dollars that they will soon be receiving to manage and/or acquire new agricultural lands to control. Easements and purchase by non-profits either remove or diminish property taxes. Our property has just been reassed for 12% more than last year, because the tax assessor announced to us that our grazing land was really not taxed at the proper level. Upon our protest, the answer was, “YOu’ve been getting a good deal for a long time”… Stipulated in the General Plan also is that there will no longer be maintenance of county roads by the county, and there will be a new district formed to charge the rural area for fire protection… no doubt doing away with our volunteer fire department, and ignoring the fact that Cal Fire has a base in our valley. So, we are soon to be paying even more taxes to receive no services. Our rural areas are just going to be in a freeze frame so that the surrounding urban areas can come out and enjoy the scenery. Our private property land use options are over. The ‘regulators’ are certainly out of control here.
This is exactly the way it is in many European countries. Farm land cannot be sold for any other purpose…. unless some politician/bureaucrat gives permission to do it. Rerating of what can be done happens something like every ten years. And even if the property is sold, there are incredibly strict guidelines as to what can be done with the farm house, the barn, the shed. And don’t even think of compromising the “view” neighbors have enjoyed of the pastures with anything a politician/bureaucrat might think is ugly or not “green” enough. Not my definition of private property…
Amit does a nice job explaining why problems with agencies like the FDA are part of a broader problem of regulation *as such*.
In essence, all such agencies attempt to usurp the function of the individual’s mind and instead substitute the state’s judgment — whether it be for what medications we can take, what foods we can eat, or what kinds of consumer products we can purchase. The “nanny state” is saying, “Don’t worry — we’ll do your thinking for you!”.
This is a sure path to tyranny.
And also a pathway to corruption.
I posted a link to your piece here:
http://www.actuarialoutpost.com/actuarial_discussion_forum/showthread.php?t=201074
My comment (repeated at my link):
Part of the problem is you are ignoring externalities.
Let me ignore financial regulation for a bit, because that’s bit murky. Let’s consider flight regulation.
If it’s just the Wright Brothers with a craft that can go only a few hundred feet, only a couple feet off the ground, and they’re testing it in an empty area with the permission of the landowners — fine, no externalities. If they do something dangerous and kill themselves, they, the people who decided to take the risk are the people who bear the brunt of the failure or success of that risk-taking.
But what if you’re flying a larger plane that goes farther? You could crash into someone else’s house — a someone else who had no part in the decision-making of the risk-taker. So it is reasonable to have regulation where the risk-takers may be endangering others.
It gets more intangible in other regulations that are out there — definitely for financial regulations — but there is a legitimate governmental interest in regulations. It can have positive externalities in protecting innocent bystanders. The problem is to figure out where that regulatory power should end, since, as noted by the author of this piece, the regulation can prevent any useful activity and impose negative externalities of their own.
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You’re right.
Our legal system derives from the English legal system, a “common law” system that goes back to the Middle Ages. Such systems rely upon “judge made” law, as compared to most European legal systems, which rely strictly upon statutes and regulations issued by the government. Thus, in our system, when someone suffers some harm, and there isn’t any government-issued statute or regulation to cover that factual situation, the judge and jury can decide whether or not the injury is compensable, and by whom, and how much. Those are known as tort cases. The decisions in such cases have precedential value, so that the decision in a present case comports with similar decisions in earlier cases, which lets the citizens have a pretty good idea what the law will be in a similar situation in the future. A system like that puts a lot of power in the hands of regular old citizens. It’s a pretty good system if you like freedom, and if you think people should be responsible for their actions.
When deciding a tort case, once the facts are all presented, the jury has to determine whether the plaintiff’s injury is a consequence of someone else’s having acted negligently. The standard that the jury uses to decide negligence is “what a reasonable man would have done in the same situation.”
There wasn’t any FAA around to t regulate the Wright Brothers. If they had smashed their airplane into somebody’s house in Kitty Hawk and caused injury, and if a jury decide that Orville and Wilbur had acted negligently, they’d make them pay the damages. If Orville and Wilbur had not acted negligently, they wouldn’t have to pay. Of course, pilots don’t really want to die, so if airplanes kept falling out of the sky, even if juries weren’t awarding millions, airplane makers would start to make them safer. That would raise the standard of negligence, and anyone who didn’t meet it would be held responsible and pay damages to the owners of smashed houses.
An excellent point.
“Necessity is the plea for every infringement of human freedom. It is the argument of tyrants; it is the creed of slaves.”
William Pitt, Speech in the House of Commons (November 18, 1783).
Living in society, especially an advanced technological society, necessarily caries some man-made risks. The appropriate goal is not to find a magical acceptable level of risk for everyone, but to appropriately define what individual rights one has in that context and how best to protect them. That implies a very different approach from the one you suggest.
Also, removing the regulatory State and the mindset that supports it does not entail an advocacy of anarchism.
I disagree. The so-called problems of “externalities” can be handled through tort and criminal law. There is no need for the micromanaging prior restraint on action that comes from government regulation.
Also: An airline facing the loss of millions if an aircraft crashes and a pilot facing the loss of his life have a much stronger incentive to take care of the plane than does a “disinterested” FAA regulator.
Um, Airplanes still crash into people’s houses (not to mention large office buildings) with the FAA regulating to its heart’s content! And oil platforms explode, despite the DOE, drugs cause unwanted side-effects, even with the FDA, and, believe it or not car accidents happen even though we have a DOT! This “regulation” thing you advocate doesn’t seem to be accomplishing the goal you set out for it.
Could it possibly be that:
a) prior-restraint regulation actually makes people more complacent and less self-responsible, thus making accidents/abuse more likely?
b) regulatory agencies are filled with self-interested actors that are easily capturable by the industries they regulate?
c) the regulatory web is by its nature so complex and ultimately unenforceable that it defeats its own purpose?
d) specific regulation, which is the only possible kind you can have without grinding the economy to a complete stop, is unable to keep up with technological change?
Others have mentioned the solutions to these problems – at least the only solutions that are possible in the non-Platonic realm: tort/common law, and a culture that holds people responsible for their actions. Regulation works against both of these institutions, and thus makes things worse.
Quite right! Regulators are not infallible (think SEC, NY Fed, the egg inspectors, just to name a few.) The government’s knee jerk reaction is to lay on another layer of regulators! Madness. We, as citizens, need to understand that regulators are not infallible, and we must be vigilant in asking questions of our representatives. (Ha! This is not infallible either…) But the point is, we all need to share some part of vigilance required in our society. AND, in our personal lives, we should NEVER abandon common sense. (Hmm, it must be OK to take three cold medicines at the same time otherwise it would say “Do not take three cold medicines at the same time because it is dangerous.” OR “The speed limit here is 60 mph and so it must be OK to drive 60 mph here even though the road is in bad shape and there is a dense fog.”)
Thanks to Cap’ Rusty and Dana H. for their eloquent and succinct comments. I agree with both (though I couldn’t have expressed the ideas nearly as well).
I’d also add a more general observation that proponents of regulation (perhaps due to the pernicious influence of anarchists) often conflate regulation with law itself. Yet that’s obviously a mistake: were we to rid ourselves of regulation, we’d still have — and need — a whole body of law including against crime, negligence, fraud, libel, infringement, etc. This is vital to our society because it’s the formal means by which we bring force under objective control. Indeed, in an advancing society we’d even need new laws (and a mechanism to formulate them), for example to define the extent and use of property which arises from new discoveries. (See Ayn Rand’s article: The Property Status of Airwaves in Capitalism: The Unknown Ideal.) What would go, however, are any laws that are preventative in nature (say curfews, martial law, restrictions on the medicines, etc.) as well as laws taking away your freedom of action in the name of helping you (the basis for the whole nanny state).
Superb analysis. You get to the heart of why regulation is unjust and destructive. The regulator forcefully imposes his judgment on us, and prevents us from bringing our evaluation of our own context to bear on what we choose to do or buy. Also, you chose great examples to illustrate your point. I hope this article reaches a wide audience.
Quis custodiet ipsos custodes?
Regulators must regulate as sharks must swim. The problem is to determine how to limit their natural and incorrigible inclination to add, multiply and proliferate the rules, mandates and prohibitions. Congress has neither the capability nor the inclination.
The US Offshore industry (through the American Petroleum Institute) has for a long time issued guidelines for building and maintaining oil and gas production facilities. Now the guidelines are are being merged with the ISO code (International Organization for Standardization). This represents a shift from guidance to a code (read mandates). The US oil industry use of guidelines allowed a high level of innovation to be achieved; the industry is one of the most innovative industries in the world. Shifting to the European method of relying on ISO codes will suppress that innovation and weaken our economy.
Amit’s superb essay makes the case for personal responsibility and making one’s own choices with respect to risk. The thousands of regulations on the book do far more harm than good and violate the rights of both producers and consumers to base their risk evaluations on their own values.
Among many good points, the author does a fine job of making the link between the spiritual and practical dimensions of the rights to freedom and voluntary trade.
This article exemplifies why true Capitalism suffers the same fate as true Communism. While Communism assumes everyone is perfectly altruistic, Capitalism assumes everyone is perfectly knowledgeable.
From your 1.5 line bio you trade stocks for a living. Presumably you do fairly well, which implies you spend the time to research your trades. Now imagine you had to spend that same amount of time for every single transaction. Which store sells ground beef, and which adulterates theirs with horse? Who covers up the smell of decay with chemicals? What gas stations adulterate their gasoline or rig their pumps? What companies spew unacceptable amounts of pollution into the air I breathe? The water I drink? And so on.
Since there are only 24 hours in a day and you’ve got to sleep sometime people will make snap decisions, something I’m sure you’ve profited from in the stock market. Furthermore all the time spent coming up with and answering questions is time not spent on economic activity to make us all wealthier.
Regulation can be abused, and there is such a thing as too much of it. But the answer isn’t to get rid of regulation altogether. Regulation has been a part of trade since the minting of coins and the establishment of standardized measures.
Quite the contrary, it only assumes that people are rational beings capable of making their own choices. And if you don’t trust your own judgment, you can hire someone you trust. They just don’t get to impose their ideas on the rest of us.
And don’t think you will get away with equivocating standards (i.e. mutually agreed uppon standards) with regulation (rules imposed by the government about things that do not violate any individual rights). The first is desireable and abridges no one’s freedom. The second is tyranny.
Once again, the underlying assumption of basic capitalism is that all actors have perfect information. Without perfect information you won’t reach market equilibrium, you will instead reach an equilibrium based on the unequal distribution of information. We already have problems with distortions caused by incomplete information (Enron et al., mortgage-backed securities) this proposal would bring those problems into daily life.
We take for granted that what we buy in the store is safe, pure, and what’s on the label. We take it for granted because it is illegal to adulterate or mislabel products. It wasn’t always the case, as a quick perusal of The Jungle will attest.
Your “solution” of hiring an agent to make judgments simply moves the problem up one level. It takes almost as much time to determine if a potential agent is honest and had judgment matching yours as it would to make the decisions yourself.
Furthermore I suggest you look into the history of standards. Here’s a hint, why is a foot as long as it is?
You seem stuck on ideology: capitalism, communism. While standards are within the realm of economic tools, regulation belongs to governments. You seem to overlook that, and therefore, fail to make a distinction. Standards develop naturally and by consensus (now, you can compare foot to metre). Regulation is imposed through authority. It is not natural but artificial. Pace energy-saving bulbs – they are good for you not because you want them but because you must have them by law, i.e. your hand is forced. They also contain mercury, which is poisonous to humans. Do you have a choice between having an incandescent bulb with no risk of mercury contamination (and other benefits) but using more electricity (your privilege, your wallet), and the product imposed on you through legislation? Generally speaking, no. Your freedom of choice is all but gone. This may be despite your preference for incandescent bulbs due to the superior information you hold on the issues involved. The ability to hold such information is personal, and you may have earned it by devoting more time to searching various information sources, making enquiries, etc. Yet you cannot exercise your judgement, due to an enforced lack of choice. You could have, under normal circumstances, taken advantage of your knowledge but cannot now. While others only know that a bulb is a bulb is a bulb and produces light at a flick of the switch, you know better. Yet you are unable to make use of that knowledge: regulation has already had a crippling effect on your personal freedom.
Your assumption of capitalism´s basic assumption is badly flawed, no doubt due to ideology again: If it is Das Kapital you are leaning on, just drop that stick. As stock traders will eminently know, perfect information is the sum total of information held by every single participant in the market at a particular point in time. Market provides for the process of discovery, just as with Enron. Mortgage-backed securities? Talk about distortion if the Clinton administration tells the banks to provide a mortgage to everyone! There was a Will, and there was a way. Your notion of what capitalism operates with is very imperfect, but that reflects life.
I am very curious as to what economic school provides you with your definition of capital, capitalism and its requirement of perfect knowlege.
Just guessing: The Soros Academy of Global Economic Enlightenment?
“Now imagine you had to spend that same amount of time for every single transaction. Which store sells ground beef, and which adulterates theirs with horse? Who covers up the smell of decay with chemicals? What gas stations adulterate their gasoline or rig their pumps? What companies spew unacceptable amounts of pollution into the air I breathe? The water I drink?”
If this was the problem you suggest it is, man would never have survived to the 20th century, when the regulatory state as we know it came into being. Do you really believe that it is only government regulators who stand between you and death?
I disagree on several counts. First it’s not necessary for everyone to know everything in order for a market to work. Those with the most knowledge — when they’re free to use it — set prices and standards at the margins. That’s why my grandmother can walk into any brand name retailer and buy a computer which will work and will be reasonably priced. It’s not her knowledge — nor that of some computer czar — that’s key, but the knowledge and actions of all the other market participants: cutting-edge buyers, product reviewers, competitors, etc.
Second, regulation isn’t the reason we get safer or better products. Instead there’s only one real way to mitigate risk and improve products: by discovering and then using new knowledge. And the primary requirement for gaining and using such knowledge? The freedom to think and act. Since the types of regulation under discussion remove freedoms, they actively hamper the very activities necessary for us to avoid and mitigate risks.
As I wrote in a previous article (linked to above):
“So to benefit man, one must defend his freedom to think; not usurp it.
But if ceding our minds to the government isn’t the way to protect ourselves against ignorance, what is? The free market. For here, knowledge is efficiently shared, and authorities and standards naturally emerge. Yet everyone retains the freedom to follow their own ideas if they so choose. Looking once more to the computer industry, we see that there are computer magazines (PC Mag, Macworld), computer rating and standards groups (CNET, IEEE), and countless online message boards and forums where experts, aficionados, and neophytes alike congregate and share information. Knowledge is valued, but it’s not forced on anyone. This makes disagreement, dissension, and often breakthrough innovations possible.”
Mr. Gauch,
You bring up a good point, but come to the wrong conclusion. Who primarily needs the freedom to think, to figure out what constitutes high-quality, safe products? It’s not the consumers or average person, it’s the producers, i.e., the scientists, the engineers, the businessmen, that need intellectual freedom (and no regulations) so badly to make sure things work.
For human beings to survive, to live properly as happy human beings, to be safe from natural environmental dangers, we need to take more personal responsibility, be self-interested, and do need much much more freedom in our personal lives. But it’s the people making things, whether it be oil rigs and pumps, nuclear weapons, waterways, food, etc., whom dictates cripple. Passing a law that says “you must make safe water” or “this oil pump must work” and giving a council the power to order dictates will not make that water or oil pump safe, or produce on a large enough scale for proper human existence. Only an engineer and scientist who want to live, who enjoy their work and using their minds, and are free to act on their independent judgment can make things safe on a regular basis. They can make mistakes, but only working under freedom can they potentially make things work safely and produce enough.
That same engineer, being made a regulator and having the power to order whatever dictates he pleases (or any type of regulation restricted by any standard you can think of) will not be able to do his job, as great industrial projects require a huge amount of selfish cooperation amongst freely acting highly intellectually active people who enjoy life and want to see things work properly.
The government can only protect people from blatant, objective criminal threats such as banning drunk driving (inherently and directly leads to hurting other individuals) or murder. Police and courts can only do so much before they cause major harm. They will only be used very very sparingly used in a functioning society.
The production that has existed under statism in this country is not nearly enough in terms of safety or quantity, not even close. The level and safety of production for the last century has been abysmal by objective standards and will eventually collapse, whether through unsafe things being made (like bridges collapsing) or economic depression. We’re on a slow drift to collapse now, and even until that collapse happens, being controlled so much in such an important realm of life–production–is spiritually, emotionally, psychologically, and intellectually stifling and dull.
Want to make sure architects design safe (and well-spaced) buildings? Want to make sure pilots don’t crash? Only selfish architects who want to see safe buildings that make good use of space, materials, etc., being made and selfish pilots who don’t want to crash, want to help economic and spiritual progress (by helping good people act on their ideas by going places and meeting people far away), and enjoy flying can do so.
For 8 years I operated nuclear power plants for the US Navy. Trust me when I say I know how soul-crushing regulation can be. On the other hand I know from personal experience that some people cannot be trusted to act in a safe and appropriate manner using only their innate talents. Some of these people can be idiot-savants, able to regurgitate perfect answers on a test or oral examination, yet completely lacking any ability to apply that knowledge to the safe operation of the actual plant. Forcing them to adhere to the letter of the regulations allows the dumb and malicious to operate in a safe manner.
As I’ve said before there can be too much regulation. The solution isn’t no regulation at all. We need enough regulation so that, when I order a 1000 gpm water pump I can trust I’m not going to get a casing full on pinball machine parts.
If you order a 1000 gpm water pump and get a casing full on pinball machine parts , then you shouldnt pay for it . no regulation and no laws required .
If you pre-paid your order for a 1000 gpm water pump and get a casing full on pinball machine parts then laws against fraud would allow you to recoup your loss, again no regulation required.
If you try to order a 1000 gpm water pump and cant because all pumps must be specified in litres that is regulation .
We all know ‘some level’ of regulation may be needed. Protections are needed to safeguard the people from those who would prey on us.
Now, before everyone blows their tops!!!!
Our problem, as “I” see it, is our regulators have taken the one inch square of regulatory approval congress gave them, and in typical liberal fashion, they developed 10,000 square miles of regulations. Its just like the health care bill. We all know we need improvements to how the system works. But, liberals took that & developed a bill that is deliberately designed to destroy the free market system of health insurance delivery, while also turning over actual health care, to federal bureaucrats. And yes, it sure does look like one of those ‘quality assurance panels’ has the job of establishing the date of death for some who will be refused treatments simply because some liberal ideological extremist has a position w/in that bureaucracy & “they think” once you reach a certain age, you no longer have productive value. It appears ‘return on investment’ has become the rule of thumb in “our” health care.
America’s ‘regulators’ have taken their jobs & expanded their authority, far beyond what the original legislation intended & definitely far beyond what the people ever wanted those regulators to have authority to do. With almost NO congressional oversight, regulators have constantly expanded the scope of their mandates & now, almost no one can figure out what some of them were ever supposed to do in the first place. Congress needs to re-examine the authority each piece of their legislation authorizes on a regular basis. And they need to curb many of the mandates regulators have imposed, or properly authorize those regulations w/ appropriate restrictions according to the will of the people.
Perhaps each new regulation should require congress to debate & approve. That may keep congress busy enough they will stop interfering so much in our lives!
But no matter what, we must limit the number of federal agencies and we must limit the ability of the feds to expand their control of our lives. After all, doesn’t each state have a tax dept, a commerce dept, an education dept, a transportation dept., etc., etc., etc. While the feds may coordinate the whole mess, they need not dictate what each state does or does not do, or ‘what’ each state may or may not do. Every federal department or cabinet level agency, has expanded far beyond its original commission &/or what everyone ever thought it would. What the feds do not realize is, they simply are not worth the money or the effort!
regulations are not “protections” however.
It’s quite discouraging that many Repulicans equate freedom with chaos. This piece does a great job of refuting that notion, and of showing just how human liberty is. Liberty is merely freedom from coercion, and it’s liberty, not freedom, that we want.
Amit: This is the only regulation needed; “Love thy neighbor as thyself”. The state cannot regulate that, try as they do, they will always will fall short and continue the oppression of men. The state is meant to replace God for the godless and the state will continue to write rules and regulations until the paper they are written on is piled so high it reaches the moon and men must remain motionless in order not to break the written rules and even then the state will fall short of Gods ability. So for freedoms sake let the goverments of men become small and let all men return to their Creator for true justice. Just five words would be required to rule all men if they would do so.
Good article.
Regulators don’t add value to an economy. They can only restrict those of us that do. It is time to dismantle the regulatory state.
This is a great observation by Mr. Ghate. He correctly identifies the underlying premise of the regulatory state: The idea that the values needed for life come automatically and it is the regulators who tell us what products we aren’t allowed to use that are do the real work. But, this is absolutely false, and I think the regulators are going to find out the hard way that they can’t pass laws to force an economy to function.
As a boy I remember the freedom to ride my bicycle without laws for a regulation mandated safety helmet. You can thank the insurance lobby for many of these government imposed regulatory restrictions. On the other hand, seat belts for autos, brake lights, turn signals, air bags, safer tires, and gas tank designs were a good thing in the end.
Let me be clear, the auto cost soared, auto insurance is state mandated, and it soared to cover your risk, and often the risk of the un-insured, yet the roads, and cars are safer. Collision damage soared to cover the higher auto cost for replacement. In every instance regulation gets liable issues into the court system sooner or later. It seems to me that each level of regulation in any area, spawns a new case level for the crowded courts. The cost of regulation’s seem to behave like money, and compound interest rates… they just keep growing and costing us more as individuals in a regulated society.