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Monday, April 29, 2019

Exploring issues about regulation: regulatory capture and bias

In my first article in this series (Regulation - the staff of life) I referred to regulation being a necessary and pervasive part of life. I highlighted some of the challenging dimensions of being a regulator. I said I would provide some practical insights into common regulatory issues.
This article talks about something that can undermine a regulators’ focus on delivering public value – regulatory capture and bias. In this context, I am using the term public value to refer to what the actual purpose of a regulator’s activity is – that is usually to protect those who might other wise suffer harm, loss or damage as a result of the actions of a regulated party.
The classic definition of regulatory capture comes from a theory associated with George Stigler, a Nobel Laureate economist. Basically, regulatory capture occurs when regulators act in ways that benefit the people they are regulating, not the people who are supposed to benefit from regulation. 
Big picture examples of this are easy to find (like everything else, on the internet[1]!). For example, it is suggested that in the early 2000s the US Securities and Exchange Commission (SEC) acted in the interests of Wall Street banks and hedge funds, instead of in the interests of the Bank’s and hedge fund’s customers. This allegedly included deciding not to investigate Bernie Madoff who ran a massive ponzi scheme[2] - because of the strong links between the people that ran the SEC and the industry they were tasked with regulating. Essentially, the SEC was said to be ‘captured’ by the industry it was supposed to be regulating so it wasn’t doing its job properly.  
Regulatory capture is a form of bias exhibited by a regulator. The kinds of examples referred to above involve a significant level of bias that may be thought of as being hard wired into the regulatory organisation. There are a range of other things that can also drive bias and underpin regulatory behaviour that favours those being regulated over the delivery of public value - if these issues are not understood and addressed clearly by the regulator. Here are a few of the things that can drive bias, or at least perceptions of bias:
  • viewing the parties being regulated as customers. Extreme examples of this manifest themselves in regulators losing sight of who the real beneficiary of regulation is, and can significantly soften and make ineffective the ways that a regulator responds to breaches of the law and standards by regulated parties. A way for a regulator to address this is to consider specifically the kind of relationship required by the regulator with a regulated party, describe it clearly and inculcate an appropriate approach in the culture of the regulator. In Maritime NZ we have essentially ‘banned’ the use of the word customer to describe those we regulate. The act of doing this has driven a lot of conversation about what relationship we should have – which is one that is driven by our values of integrity, commitment and respect - always remembering that we are here to serve wider purposes around safe, secure and clean seas and waterways. You can read more about this issue in an article from Policy Quarterly: Are regulated parties customers?
  • working closely with regulated parties. It is very clear that good regulatory outcomes can be achieved through working constructively with regulated parties. Many regulators do this through advisory groups, joint projects and workshops where regulatory problems are addressed and solutions identified. Such arrangements can also be fertile ground for bias, so its very important to give careful consideration to the scope and extent of relationships with regulated parties. The regulator must always maintain its independence. Tripartite relationships are always likely to be more effective - involving regulators, industry and worker or consumer groups – mitigating the possibility of regulatory capture by any one party.
  • receiving gifts from regulated parties. This is a basic conflict of interest issue. It needs little explanation as to why it can be a problem. A key way of addressing this is to have a policy of not accepting gifts – although this can cause problems where its culturally offensive to refuse or would be embarrassing for the gift giver, expecially with gifts of little value. More usual is to have policies around disclosure and seeking approval for the way the gift is used in the agency, to ensure any potential conflicts are managed effectively. The latest word on this is covered in the State Service Commission's conflicts of interest guidance. Jeroen van der Heijden, chair of regulatory practice at the school of government at Victoria University, commented on an example of risks associated with receiving gifts in this media article “Exclusive sports events risky for regulators: expert
  • employing staff from the regulated industry. Without doubt, industry regulators need to employ people with experience in the industry they are regulating. The challenge this poses is that those people might identify more strongly with the industry and its culture than with the regulator and its culture and purpose. There is no silver bullet for dealing with this – it is a combination of careful recruitment, sound induction and good training around the regulators’ purpose, methods and ways of working. One core element of training that Maritime NZ has embraced is the Government Regulatory Practice initiative’s Core Regulatory Knowledge qualification. This is part of G-Reg'soffering as it works to develop regulatory practice as a professional activity.

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