Regulatory capture: a regulator’s perspective

Lots of people like to talk about regulatory capture. Almost no one has any idea what it really is. Here are some random thoughts on it.

Wikipedia states that, "regulatory capture occurs when a state regulatory agency created to act in the public interest instead advances the commercial or special interests that dominate the industry or sector it is charged with regulating."

I think this relatively concise definition will work for our purposes, but first we need a little background.

Temporary government vs. permanent government

Many people think that appointments like this one are evidence of regulatory capture. I think this view is wrong. Mr Daley is part of the temporary government. The real essence of regulatory capture is the capture of the permanent government. (I don’t mean to suggest that the revolving door between the temporary government and big business is not a problem, but I think it’s a problem distinct from regulatory capture).

By the time any major regulation is enacted, Mr Daley will be long gone. The financial reform bill, for example, requires at least 243 rulemakings. These rulemakings will be carried out by bureaucrats who were government employees prior to hiring of anyone in the Obama administration and who will be around long after the Obama administration is gone.

To begin then, we can clarify that regulatory capture is the capture of these permanent bureaucrats by industry.

The permanent government

The permanent government is composed of well-educated people who have little practical experience in the industries they regulate. We are asked to regulate incredibly arcane sections of complex industries and we are entirely unaccountable for the resulting regulations. For example, the financial reform bill asks regulators to put limits on proprietary trading. This is a business that no one really understands beyond, perhaps a few specialized traders. How is someone with a college degree who has lived in Washington since he graduated supposed to implement this regulation?

The only way to understand the true phenomenon of regulatory capture is to put yourself in the position of a member of the permanent government. Your a well-educated person who is being asked to put significant limits on a multi-billion dollar industry. If you don’t crack down enough, the financial system might be brought down by the failure of a large bank. If you crack down too much, decreased profitability could weaken the banking system, jobs could leave the US, GDP could decline, New York state could fail, etc.

What is such a person to do?

The regulatory process

The regulatory process requires significant interaction between regulators and interested parties. In normal times, the only interested parties are industry representatives and a handful of crazy people who think regulators are industry shills. You may find this troubling, but a system of instituting regulations without any consultation is also a bit troubling.

In sum

Let’s re-visit the Wikipedia definition, which states that, "regulatory capture occurs when a state regulatory agency created to act in the public interest instead advances the commercial or special interests that dominate the industry or sector it is charged with regulating."

Let’s see where we stand: 1) the "regulatory agency" is really a permanent bureaucracy composed of relatively inexperienced (and totally unaccountable) regulators; 2) the "public interest is totally unknowable and unclear and impossible to include in the process; 3) regulators are tasked with writing highly-complex regulations that they cannot possibly hope to understand; annd 4) there are potentially dire consequences if regulations over-step.

In other words, what I’m trying to say is that "regulatory capture" is guaranteed when government gets big. If you expect to regulate arcane aspects of business, regulatory capture will necessarily follow. If you like big government, you must learn to love regulatory capture.

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