Regulatory failure (2): A public interest perspective

In the previous blog post, I have explained that it is challenging to synthesize the international academic literature on regulatory failure.

I should probably have said: it is challenging if the aim is to arrive at a clear and undisputed definition of what a regulatory failure is and what its causes are. But unfortunately, there is no agreed definition, and there typically are no simple explanations of the causes of regulatory failure.

Beyond a (too) simplistic understanding of regulatory failure and its causes

One of the main reasons this is challenging to define and explain regulatory failure is that it is often as much an analytical as a rhetorical issue.[1] How people experience regulatory failures is influenced by how they think about (the need for) regulation. What is experienced and presented as a (major) regulatory failure by some may not be experienced by others.

Because experiences of regulatory failure differ and because the (political and personal) framings of regulatory failure differ, it is challenging to compare different documented regulatory failures to draw central lessons across them. But suppose we begin to acknowledge that there are different ways of looking at regulatory failures. In that case, we may become better at understanding them—and hopefully, we become better a preventing them.

To help us broaden our understanding of regulatory failure, I will present the findings from the literature by following different broad theories of regulation. This will allow a better grasp of the broad variety of regulatory mishaps and negligences, and their causes.

In this blog post, I will summarize how regulatory failures are framed through the lens of the public interest theory. In the blog posts that follow, I will do the same for the private interest theory of regulation, public choice theory, and institutional theories.

A very brief summary of public interest theory of regulation

Public interest perspectives on regulation hold that regulation is developed and implemented to pursue goals that serve and protect the public at large. This includes addressing market failures and ensuring just and equal welfare provision.

This conceptualization immediately points out the challenges of pursuing regulation from a public interest point of view. There is no objective answer to what is a market failure and what is equal welfare provision. Answers to these questions will always carry normative (and political) weight and can (and will) be challenged by others.

In addition, those who justify regulation from a public interest point of view may face criticism when the (economic) benefits proposed regulation are not immediately apparent, are challenging to measure, and take a long time to materialize.[2]

Regulatory failure from this point of view

For those who pursue regulation from a public interest point of view, regulatory failure means those situations where regulation that intended to overcome market failures or to protect the public at large fail to achieve those same goals.[3] It also includes situations where the (monetary and other) costs of regulation do not outweigh its benefits.[4]

Kinds of failure and their causes from this point of view

Overlooking the literature that engages with regulatory failure from a public interest point of view, three broad themes stand out: failure in the design of regulation, failure in the implementation of regulation, and failure due to the economic costs (and lack of benefits) of regulation.

Failure in the design of regulation

For various reasons, regulators may fail to design clear, consistent, and fit-for-purpose regulation (whether it is a regulatory instrument or even a full regulatory system). This could result from information challenges such as a lack of information about the problem to be regulated, information asymmetries between regulators and regulatees, or ambiguity in the original legislation.[5] A regulatory ‘error of commission’ may occur when regulators introduce the wrong regulation based on flawed information. A regulatory ‘error of omission’ may occur when they do not introduce regulation because they lack information.[6]

Regulators may also have a poor understanding of cause-effect relationships in regulation and introduce regulatory solutions, for example, because they have worked in another context. There then is a risk of a mismatch between regulatory interventions, the problems they address, and the context in which they operate. A typical example is the critique of both one-size-fits-all solutions because they are too blunt to deal with complex situations and detailed and case-specific regulation because it comes across as over-protection and over-regulation.[7]

Failure in the implementation of regulation

Regulatory failure is likely to occur when the agency in charge lacks the infrastructure, the power, or both to enforce regulation.[8] Likewise, regulatory failure may result from the wrong sort of implementation. For example, a too coercive stance in implementation may run the risk of animosity on the side of regulatees and a diminished willingness to comply, yet a too cooperative stance may result in regulatees learning how to roll with the punches and get away with non-compliance.[9]

Regulators may also not respond timely enough, let minor violations slip too often, or let regulatees get away with increasingly more significant violations. Such ‘failures’ could make it difficult to ultimately take action—and it could set a precedent for other regulatees to reference when the regulator does not cut them any slack. The Madoff investment scandal is an example of a regulatory culture of not standing up against prominent corporate violators even when wrongdoing was known to the regulators.[10]

Another recurring example of regulatory failure due to implementation is ‘creative compliance’ (which could also be a design failure—the boundaries often overlap). Usually, these are understood as situations where regulatees comply with the letter but not with the spirit of the law,[11] but sometimes it goes a step further. Here the Volkswagen’ Dieselgate’ scandal is illustrative: a ‘defeat device’ was installed to reduce vehicle emissions only when cars were tested in a lab setting to show compliance and regulators’ failed’ to also assess vehicle emissions outside of the lab-setting.

Failure due to (economic) inefficiency

A final ‘kind’ of failure that is often observed from a public interest point of view is too costly regulation or situations where the costs of regulation do not outweigh the benefits. It is often complicated for a regulator to provide good insights into (all) the (economic) benefits of regulation. Still, it is relatively easy for those subject to regulation to point out its costs. Likewise, regulators may be experienced to ‘fail’ in spreading the costs (or benefits) equally or equitably over those subject to or benefit from it.

Along the same lines, regulators may fail to consider the indirect costs of regulation (or its absence), such as transaction costs or the costs of unintended consequences of regulation.[12] As Fiona Haines concludes in an overview of the literature in 1999, from an efficiency point of view, “[regulatory] failure might result from perceptions of too much regulation … too little … or the wrong sort of regulation”.[13]

To conclude

By no means is this an exhaustive overview of all the kinds of regulatory failure that can be identified when looking at regulation from a public interest point of view. Yet, this overview gives a flavour of the sort of failures that regulators, policymakers, and the public at large have pointed out when arguing that regulation (may it be specific interventions, their implementation, or regulatory systems as a whole) has failed to deliver outcomes that serve the public interest. Already in 1989, the renowned regulatory scholar Robert Horwitz argued that “public interest theory remains the yardstick by which [regulatory failure] is measured”. This seems to hold still for how regulatory failures are discussed in policy debates and in the (popular) media. The academic literature has, however, become a little more nuanced since. In the blog posts that follow, I will explore the kinds of regulatory failures and their causes from the viewpoints of public choice theory, private interest theory, and institutional theories.

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[1] Baldwin, R, Cave, M, and Lodge, M. Understanding Regulation: Theory, Strategy and Practice – Second Edition. Oxford: Oxford University Press, 2012. Particularly Chapter 5.

[2] Joskow, P. “Market Imperfections Versus Regulatory Imperfections.” CESifo DICE Report 8, no. 3 (2010): 3-7.

[3] Carman, J, and Harris, R. “Public Regulation of Marketing Activity, Part III: A Typology of Regulatory Failures and Implications for Marketing and Public Policy.” Journal of Macromarketing 6, no. 1 (1986): 51-64.

[4] Wolf, C. “A Theory of Non‐Market Failure: Framework for Implementation Analysis.” Journal of Law and Economics 21, no. 1 (1979): 43-70.

[5] Wilson, G. “Social Regulation and Explanations of Regulatory Failure.” Policy Studies 32, no. 2 (1984): 203-25.

[6] O’Doherty, R, Bailey, I, and Collins, A. “Regulatory Failure Via Market Evolution: The Case of Uk Packaging Recycling.” Environment and Planning C 21, no. 4 (2003): 579-95.

[7] Baldwin, R, Cave, M, and Lodge, M. Understanding Regulation: Theory, Strategy and Practice – Second Edition. Oxford: Oxford University Press, 2012.

[8] Baker, R. “Institutional Innovation, Development and Environmental Management: An ‘Administrative Trap’ Revisited – Part I.” Public Administration and Development 9, no. 1 (1989): 29-47.

[9] May, P. “Compliance Motivations: Perspectives of Farmers, Homebuilders and Marine Facilities.” Law & Policy 27, no. 2 (2005): 317-47.

[10] Kavame Eroglu, Z, and Powell, K. “Role and Effectiveness of Asic Compared with the Sec: Shedding Light on Regulation and Enforcement in the United States and Australia.” Journal of Banking and Finance Law and Practice 31, no. 1 (2020): 1-22.

[11] May, P, and Burby, R. “Making Sense out of Regulatory Enforcement.” Law & Policy 20, no. 2 (1998): 157-82.

[12] Carman, J, and Harris, R. “Public Regulation of Marketing Activity, Part Iii: A Typology of Regulatory Failures and Implications for Marketing and Public Policy.” Journal of Macromarketing 6, no. 1 (1986): 51-64.

[13] Haines, F. “Regulatory Failures and Regulatory Solutions: A Characteristic Analysis of the Aftermath of Disaster.” Law & Social Inquiry 34, no. 1 (1999): 23-50.