Regulation -- like chasing the wind with a net

With the economic troubles that began in 2007, and especially now with a national political campaign underway, there is an intense focus on wrongdoing. Every newspaper, it seems, now has an editor in charge of exposing wrongdoing.

There is a visible desire to punish wrongdoers. A desire to stop wrongdoing.

Quite naturally people say: Let's prohibit it; regulate the behavior of bankers and oil drillers and others; make bad behavior illegal. That'll stop the bad guys.

Then the political debate takes over. We argue about who should be regulated and who shouldn't -- assuming that regulation is in the public interest because, of course, bad behavior should be stopped.

In the process, we skip over the question of whether regulation can be effective. Maybe it can. Maybe not. Perhaps it depends. Let's see.

Years ago, for a nickel at a book sale in a barn, I picked up a lesson about that: a copy of Chester Barnard's "The Functions of the Executive," signed by the author, an executive at Jersey Bell Telephone. The book became a classic in business management and political science.

Authority, Barnard said, resides in the person to whom an order is given.

We see small violations like people running red lights, or big ones like the Southern states' massive "noncompliance" after the Brown decision in 1954 ordered them to integrate their schools.

Regulation is hard. First, somebody has to write the rules. Then, when people don't obey the rules, someone has to see and report the violation.

(How could those people in Texas have made off with $375 million in fraudulent Medicare and Medicaid billings without someone noticing?) Then comes the job of trying to stop what's happening.

Years ago I saw an amusing example of regulatory limits in action when I went to a Washington, D.C., hotel bar to meet some visiting Minnesota legislators -- one of them an influential senator known for his affection for scotch.

At the time, at least, Washington prohibited drinking while standing at a bar. You were required to drink seated. The senator preferred to stand.

He shifted his rear another fraction of an inch onto the stool; foot still on the floor. This went on. The waitress eventually looked, sighed and conceded defeat.

It is hard to see everything and to enforce everything. So in practice most enforcement is on-complaint, after some violation becomes visible.

But the price of waiting until something bad happens can be high: Think about the Deep Horizon oil well blowing out in the Gulf of Mexico.

The cards are stacked against regulation working as intended, Walter McClure explained in 1981.

McClure, founder of the nonprofit Center for Policy Studies in Minnesota, long a strategist for changing the medical/hospital system, says simply: People and organizations tend to behave the way they are structured and rewarded to behave.

McClure pointed to the incentives that bear on regulators:

The interests of consumers (the people a regulator is supposed to protect) are diffuse and hard to mobilize. The interests of producers (the people a regulator is supposed to control) are focused and easy to mobilize.

Small groups have disproportionate influence.

The enforcement process is lengthy.

Regulation costs money.

So the temptation is to put off action. The benefits are speculative; the bad thing might not happen. True, innovation can suffer if existing producers are protected. But the costs of that can be passed on, largely invisible to consumers.

So, McClure wrote, "The rewards to the regulatory agency for permitting perverse behavior are high and the risks are low, whereas the rewards for opposing the perverse behavior are low and the risks are high."

Realistically, too, regulation sometimes is calculated to protect private interests -- existing producers.

When I covered North Dakota's legislature for the Minneapolis Tribune, the companies drilling water wells had a bill to "fence out" the oil company employees who were using their shot-rigs in off hours to drill water wells for farmers.

There's a bill to restrict such "occupational licensing" in our Legislature this year.

One former commissioner of education remembers having to remind his department: We are not entitled to tell everybody what to do just because we work for the state.

In most real cases, the interests are mixed in ways that can make effective regulation difficult -- and difficult to evaluate.

Consider the latest developments in the effort St. Paul began in Randy Kelly's time as mayor to get tougher with the owners of substandard housing about rats and about plumbing and heating that doesn't work.

The landlords went into federal court, arguing that the city's crackdown had a "disparate" -- real though unintended -- impact on people of color and low income. Such impacts are prohibited by the Fair Housing Act, part of the 1960s civil-rights legislation.

The trial court held for the city. On appeal, the landlords won. The city appealed to the U.S. Supreme Court. Argument had been set for Feb. 29 this year. But pressure from civil-rights organizations persuaded St. Paul to pull its appeal.

Yet, in a way, the heart of the problem lies outside the case. It lies in the zoning and building regulations that make it almost impossible to build inexpensive housing new. In this country, as a practical matter, affordable housing is created mainly by running down and subdividing existing housing.

If regulation is inherently so difficult, so often ineffective, how is it possible to keep bad behavior from happening?

McClure argued -- as did the late John Brandl, at the Humphrey School, in the Legislature and in his columns for this newspaper -- for designing systems to induce individuals and organizations to do the right thing in their own interest and on their own initiative.

There really is market failure. But the answer is not necessarily regulation, McClure argued, because there is also regulatory failure, and regulatory failure is worse, because it is so much harder to correct.

The trick is to "build social markets that work," as Howard Davies titled the little book he wrote on leaving the Audit Commission in Britain in 1992. This is what Minnesota will be trying to do in designing the exchange, the social market, in which citizens will buy health insurance.

We agreed: That curve is too tight. And so it proved.

The Minnesota Department of Transportation later installed 19 yellow signs telling drivers: Do this and not that. Still, drivers crash into walls and guardrails. Regulation cannot overcome bad design.

What's true for little projects is true in the design of big systems, in what McClure calls "large-system architecture."

If education were designed to combine authority and accountability in the school and with the teachers, there would be less need for regulations trying to ensure teacher effectiveness.

If school were designed to motivate students (would anyone assert that it is?) there would be less need for regulations trying to drive achievement.

Look at the signs at the exit that say "Use Other Door" rather than "Use This Door." Think about the traffic arrows that tell us "Don't Turn That Way" rather than "Turn This Way."

Why?

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