“Objectives Based Regulation:” buzzword du jour?

by Bruce Carruthers on April 2, 2008

Buried within the U.S. Treasury Department’s just-released blueprint for a new financial regulatory structure is a “proposal”:http://www.treas.gov/press/releases/reports/Blueprint.pdf for a new approach to regulation. The report calls the regulatory status quo an “institutionally based functional system,” and as a long-term goal seeks to replace this with “objectives-based regulation.” In fact, OBR is celebrated in the document as the optimal regulatory structure. Strong words indeed. I’ll resist the temptation to dismiss this as recycling “management-by-objectives” for the public sector. Instead, it is useful to regard OBR as one of a new set of approaches to economic regulation, all of which stem from criticism of “old-fashioned” command-and-control regulation. These new approaches include “principles-based” regulation and “performance-based” regulation.

Whatever their faddish qualities, the problem they respond to is real. When regulation is done by promulgating detailed rules (that explain what the regulated shall and shall not do, and how), and then enforcing compliance with those rules, two problems arise. First, the regulated activity or industry typically evolves faster than the governing rules, and so the latter become increasingly irrelevant. In fact, escaping the grasp of static regulations becomes a big incentive to innovate. Regulators trying to keep up will usually add more rules, spelled out in excruciatingly greater detail, until the ungainly corpus of rules looks like, like, well, … the IRS code. Second, compliance increasingly becomes formal compliance with the strict letter of the law, even when such compliance violates the spirit of the law. It encourages a “check list” mentality that focuses solely on the literal meaning of the rules. OBR, and the other alternatives, try to avoid such difficulties by recasting regulation so that it focuses on a desired outcome or objective, and then grants a measure of flexibility to the regulator to steer towards that goal in whatever way seems best. Flexible regulations make sense if the behavior, market or industry that is to be regulated is dynamic, innovative, or highly variable.

Is OBR truly optimal? Who knows? Evidently the Australians have some experience with it, and the British know something about its close cousin “principles-based” regulation. But OBR certainly isn’t a failsafe measure, for the flexibility that makes OBR adaptable can also be used to render it ineffective or even toothless. The discretion that it necessarily entails means that both the regulators and the regulations matter. Thus, people who fear regulatory capture get even more worried about the possibility that the captured regulators possess lots of authority that they can legally exercise under the rubric of broad rules.



Donald A. Coffin 04.02.08 at 9:11 pm

“…until the ungainly corpus of rules looks like, like, well, … the IRS code…”

Or, perhaps, like the NCAA recruiting handbook.


Peter L 04.03.08 at 1:46 am

Hi Bruce – I was thinking about this new approach that you could draw a straight line from RC Merton’s financial innovation work and the new line out of the Treasury. That is, that the ‘institutional’ approach (regulate the institutions, banks or insurance) is less useful than the ‘functional’ approach (regulate the activity regardless of the institutional wrapper within which it takes place). A total opposite meaning to sociology’s institutional/functional distinction, I’d say.

If this is close, shouldn’t we be seeing performativity folks enter in at some point to show how theory->practice->confirming the theory? Or is that just glib?


Flapple 04.03.08 at 5:09 am

Who knows? My experience in Australia is that the support for performance-based regulation tends to divide large and small businesses. Large businesses with their compliance departments prefer performance based regulation, while smaller business prefer just to be told “what to do”.

I would think that the real stand out in performance based regulation is the EU. This is kind of a humourous outcome, I hear it often said that the US is a “free-market” economy, and yet their regulatory system is a extensive old-school command and control system (with the exemption maybe of guns and the labour market). the california consumer agency licences 230 professions!!

In contrast the EU is much more up to date in modren performance based regulation (for example the EU General safety Directive vs the US Product Safety Commission).

I am not quite sure why the US is so far behind in regulatory reform. the debate on performance based regulation is from 15 years ago. Is it becasue in a Parliamentary democracy the more unified government has the ability to drive regulatory reform than the balkanised US system?


HH 04.03.08 at 1:54 pm

The overwhelming evidence of bad faith in the Bush Administration makes all their initiatives suspect. One simply never knows what is a cover story for mischief and what is well-intentioned incompetence.

The best approach is pobably to ignore everything they propose until the rubbish is hauled out of the executive branch after the next election. A parliamentary form of government in the US would have spared America and the world several years of ruinous graft and incompetence. Blair is gone; Bush will remain with us for many more debilitating months.


Joseph 04.03.08 at 4:47 pm

The blueprint seems like a recipe for unintended consequences the likes of which we have not seen before and shall not be able to roll back nearly as easily as they were created in the first place. I’m tempted to make some sort of ontological quip about existence being more advantageous than nonexistence where policy is concerned, but maybe the point is obvious.

There was a short story published several years ago called “Wouldn’t Giving It a Name Just Make It Worse?” I was reminded of this when I saw the term “Objectives-Based Regulation”. There are a number of problems with this label, not the least of which is that it implies a paucity of objectives in any regulation that came before the blueprint, including those in play today. I think the ideas behind OBR are probably pretty sound, but as public policy goes, it’s probably better not to burden a good idea with a faddish name.


Bruce Wilder 04.03.08 at 5:40 pm

I don’t know why people seem to think that the U.S. has a “command-and-control” regulatory system. That’s not the typical paradigm for U.S. regulation.

The usual paradigm, which has been successfully pushed, at least since Nixon if not Eisenhower, is meta-regulation, a form of self-regulation. The FAA does not inspect planes; the FAA inspects the airline system that inspects planes.

The chief vulnerability of any system of meta-regulation is that, in its abstract nature, it loses all touch with reality. And, the regulated players will work the system to prevent the flow of feedback, which would allow command-and-control to emerge from time to time. The FAA will be told the number of incidents (the numerator), but not the related denominator.

Command-and-control schemes for political regulation are problematic because innovation in business consists largely of developing new command-and-control schemes for managing business processes, while politics depends on being able to institutionalize paralysis and hand off responsibility to technocrats — the technocrats rely on the underlying political paralysis as their institutional foundation. The EU has taken technocracy to new heights, because the EU has the deepest foundation of institutionalized political paralysis conceived since Rome.


Markup 04.03.08 at 6:23 pm

Of course the “innovation” at the heart of the matter here can only be generously called a “scheme,” or really even an innovation beyond the application of new technologies to the age old shell game. The problem is no ‘perfect storm’ of unimaginable [random] events. Obviously [hopefully] we are not experiencing the desired outcome, but there was a malodor noticeable by myself and others [incl a number in the admin] over half a decade ago. Seems the technocracy suffered from some of that good ol’ institutionalized political paralysis, perhaps only briefly until the revolving door opened up the right way.


Andrew 04.03.08 at 7:08 pm

If you want to make it illegal for someone to rob a bank, this is how you do not go about it:

Pass a law stating that it is unlawful to break in through the front door to steal the money. When someone breaks in through the back door instead, a law is passed stating that it is unlawful to break in through the back door, at which point people begin to break in through the windows. Etcetera ad nauseum.

The point of the law is to prevent anyone from stealing from the damn bank. Instead of stating that plainly, we devolve into a game of whack ‘a mole.

This seems to be exactly what has happened with our financial sector, however. Granted, my analogy is somewhat inverted when applied here, because it is more practical to state explicitly what one can do, and all else is verboten. You may do x,y, and z. If you have an ‘innovation’, it must be subjected to a b/c analysis by an oversight agency . If it is determined to be another way to mislead and defraud people, it will not be approved as a business practice.


Bruce Carruthers 04.03.08 at 8:57 pm

One thing to keep in mind: the politics of OBR are not straightforward. Although the Treasury plan has been in the works for a time, and although it looks to many commentators like more deregulation packaged to look like something else, in fact some conservatives have expressed concern about this kind of approach. An AEI paper published in June 2007 worries that “principles based regulation” will leave too much power in the hands of the regulators. Detailed rule regulation has the advantage, in the eyes of conservatives, that it ties the hands of the regulators as much as it does the regulated. And in fact the latter are free to innovate and circumvent the regulations in a way that regulators cannot.

Hi Peter — I’m not sure exactly what your intuition is connecting performativity with regulation, but it sounds interesting. Please spell out some more.


John Quiggin 04.04.08 at 12:33 am

My experience as an Australian regulator is that even with a desire for flexible, performance-based approaches, it’s hard to avoid getting involved in a fair bit of detail, if you want the objectives to be achieved.

Still, it’s generally accepted here that regulation is supposed to facilitate the achievement of desirable outcomes, not ensure compliance with a fixed set of rules.


dork matter 04.04.08 at 6:56 pm

Writing here as a former reporter on U.S. federal tax policy and regulation. Pet peeve: there is no such thing as an “IRS Code.” It’s a minor tangent from the gist of your post, but highlights one way in which those who set U.S. law often try to then hold responsibility for the law at arm’s length.

U.S. tax law is found in U.S. Code Title 26. Regulations implementing the code are in the accompanying section of the Code of Federal Regulations. I’ve heard an endless parade of politicians and commenters decry the “IRS code,” when in fact every word of U.S. tax law was passed by a Congress and signed by a president.

It’s more legitimate to criticize the way in which Treasury regulations implement a section of the U.S. Code, if one can make a case that the interpretation is not reasonable under the law. Pretending that a provision of the U.S. Code is an IRS creation, in contrast, is an old dodge.


Bruce Carruthers 04.04.08 at 8:07 pm

Re Pet Peeves and “IRS Code”: point well taken. Tax law plays a special role in American political rhetoric as the thing we all love to hate. And as you indicate, many of the politicians who decry tax law were in fact complicit in its passage. Evidently, they are shocked, shocked to find that the code contains so many detailed provisions, and that it is hard to comprehend in toto.


E lizabeth Brown 04.06.08 at 5:59 pm

Regulatory capture is less likely to occur when a regulator supervises a wide range of actors rather than a very narrow segment of a market. Financial services are increasingly fungible with one another. The providers of financial services do not all share the same interests and thus, an agency that regulated the entire sector, rather than just thrifts or just insurance companies, would be less likely to be captured and write regulations that benefit that subset of market actors.

Part of the problem with moving to a consolidated regime is that too many market actors have captured the existing regulators and they don’t want to lose that control. Insurance is a good example. The requirement that an insurance company that wants to operate in all 50 states must seek a license in all 50 states and get all of its products licensed in all 50 states is a HUGE barrier to entry and reduces competition in the insurance markets. Consumers end up footing the bill for this.

I have discussed the agency capture issue in more detail in my article on creating a US FSA, which discusses the pros and cons of a consolidated regulatory regime, and is available at SSRN: http://ssrn.com/abstract=757010

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