Aretae thinks that my take on regulation is wrong. Here’s his argument:
- Ideal regulatory systems can be modeled as games.
- Regulators *try* to solve problem by creating regulations.
- The regulated participants *try* to circumvent regulations by following the letter of the law, avoiding the intent.
- In any system where there is enough money involved, there is no contest…the regulated participants necessarily win.
- Letter-of-the-law regulation is therefore *guaranteed* to fail in high $ industries like finance.
- This is a big problem, insofar as we can agree that an unregulated finance industry is undesireable.
As he seems to know, the biggest problem with this line of reasoning is point #2. There’s no reason to believe that regulators try to solve problems by creating regulations. Kling knows this, see here, for an example of regulators openly supporting (and endorsing!) their own rules being arbitraged. Giving regulators scope to make rules more flexible exacerbates this problem.
Point #4, therefore, also makes no sense. The contest isn’t necessarily between regulated vs regulator. Regulator and regulatee are often on the same side, as Kling has pointed out.
Point #5 is problematic, since “letter-of-the-law” regulation doesn’t exist in the modern government. Again, when legislative and executive and judicial powers are combined in the same entity, it’s meaningless to speak of letter of the law regulation. One entity is judge, jury and executioner (and law-maker and policeman) – and they’re essentially unaccountable to anything. If your theory of regulation misses these points, it doesn’t get off the ground.
My take is that arguing about “forms” of regulation misses the point. The regulatory structure is so far removed from what most people assume that their suggestions just don’t make sense. You need to work with the existing structure (i.e. make regulators accountable for specific failures) or blow up the structure. Everything else misses the point.
It’s also worth pointing out that PBR isn’t a new idea. It was all the rage in the UK before the crisis. If you want to know how that worked out, ask Northern Rock.