Follow Simon Caulkin on Twitter



Article Archive
2019
May
April
March
February
January
2018
November
October
September
August
July
June
May
April
March
February
January
2017
December
November
October
September
August
July
June
May
April
March
February
January
2016
December
November
October
September
August
July
June
May
April
March
February
January
2015
December
November
October
September
August
July
June
May
April
March
February
January
2014
December
November
October
September
August
July
June
May
April
March
February
January
2013
December
November
October
September
August
July
June
May
April
March
February
January
2012
December
November
October
September
August
July
June
May
April
March
February
January
2011
December
November
October
September
August
July
June
May
April
March
February
January
2010
December
October
September
2009
November
October
June
May
April
March
February
January
2008
December
November
October
September
August
July
June
May
April
March
February
January
2007
December
November
October
September
August
July
June
May
April
March
February
January
2006
December
November
October
September
August
July
June
May
April
March
February
January
2005
December
November
October
September
August
July
June
May
April
March
February
January
2004
December
November
October
September
August
July
June
May
April
March
February
January
2003
December
November
1998
January
1997
January
1996
February
1994
May


Why regulation is not the answer

Fri, 8th Mar 2013

 When something goes wrong the knee-jerk reaction is to demand tighter rules to stop it happening again. Whether it is children at risk, NHS hospitals, banks, MPs’ expenses or bankers’ pay, as night follows day the enquiry set up to investigate the scandal/tragedy/accident at one point recommends stricter rules and regulation to corral behaviour into ever narrower channels of compliance.

The regulatory reflex is understandable. Dating in its present form to the wave of privatisations in the 1980s, regulation seems to offer a pain-free means of taking the edge off market excess on one hand and monopoly public-sector indifference on the other. In that sense, regulation is an attempt to find a middle way between the two extremes.

It is true that a framework of ground rules is essential for both a functioning market and functioning public services. As Michael Porter showed in an important HBR essay in 1995, positive regulation that frames broad objectives but crucially leaves method open to experiment can be a powerful incentive for innovation. But good regulation is rare. As is becoming increasingly clear the other kind – prescriptive rules that specify method and detail what is and isn’t permissible – is deeply problematic. And there is now so much of it about that the problems it has thrown up are as bad as, or in some cases worse than, the ills it was expected to cure

Leave aside for a moment the ever-present issues of information asymmetry and potential regulatory capture. The bottom line is that the regulatory reflex drives a dynamic which makes it ever more intrusive, ineffective and costly.

Regulation is a substitute for trust. We apply it to the private sector because we don’t trust companies not to extract rents from customers, suppliers and society to transfer to shareholders (and executives). We use it in the public sector when we don’t trust managers and civil servants not to put the producer interest first.

Mid Staffs and horseburgers show that the cynicism is understandable. But here’s the thing. Regulation does nothing to solve the underlying problem. Rather, it makes it worse, systematically manufacturing and amplifying the mistrust so that it becomes self-defeating.

Like targets and inspection, regulation focuses attention on what’s being regulated, to the exclusion of what isn’t. It thereby sets up an arms race between regulator and regulated that, as Said Business School’s Colin Mayer points out in his provocative new book, Firm Commitment, turns compliance and risk departments into their mirror-image – compliance-avoidance and risk-augmentation units. 

Given the aforementioned information asymmetries and the impossibility of foreseeing all available avoidance ploys in advance, it’s not surprising that regulators are usually one if not two steps behind. By the time new regulation comes into force the horse has long departed to another unlocked stable. Sarbanes-Oxley, passed in the wake of the Enron and WorldCom scandals, was perfectly impotent to prevent the dotcom rip-offs and even less the 2008 financial crisis. In the same way the 2010 Dodd-Frank Act is fit for the purpose of preventing the 2008 crash but not the next crisis that is even now gathering in the wings.

The enquiry into Mid Staffs is a good example of the regulatory ratchet in action. As Nicholas Timmins noted in the FT, ‘Too much of the Francis report... works on the assumption that the answer to failed regulation... is yet more regulation.’ Doctors and nurses are already regulated. The beneficiaries of additional rule-making will be the parasite parallel industries that always spring up to exploit them, in this case ambulance-chasing lawyers. And the threat of criminal sanctions will not only make life even more difficult for whistle-blowers (who will understandably hesitate to put colleagues behind bars) but may well also deter potential board members from coming forward to do what is already a thankless job.

Much though one sympathises with MEPs who want to curb bankers’ bonuses and Swiss voters who have backed tough restraints on all high pay, it’s the same with pay. The case against regulation is not that overpaid chief executives don’t deserve to be cut down to size – they do – but that by deflecting attention from the real issue regulation will make matters worse. Focusing managers’ and HR departments’ attention on pay rather than the job will do nothing to benefit customers, and with their inbuilt information advantage they will surely drive a a phalanx of Rolls Royces through the rules. 

In the meantime the real debate – not about the size of bonuses but about the flawed and deeply unscientific payment-by-results mentality that creates the perceived need for executive incentives in the first place – will not take place. In the same way, the crisis of the meat-processing industry of which uninvited horsemeat is the symptom is not poor regulation but the non-existent trust and excessively transactional relationships in the UK supply chain, something that is outside the ability of regulation to fix.

It’s often forgotten that all regulation carries costs both direct (the cost of employing regulators, inspectors and data-processors) and indirect (the cost and opportunity costs of gathering information and of doing the things that regulation demands even when they're useless) and those costs rise dramatically the more the bureaucratic friction intensifies. As LSE’s Michael Power notes in his book The Audit Society, the societies that have attempted to insitutionalise checking in the shape of regulation, inspection and audit on a grand scale ‘have slowly crumbled because of the weight of their information demands, the senseless allocation of scarce resources to surveillance activities and the sheer human exhaustion of existing under such conditions, both for those who check and those who are checked’. That’s seems like a pretty good description of what’s happening to the NHS right now. 

Is there an alternative to that depressing prospect? Yes, there is. It consists of managing properly, that is, using measures related to purpose to gather evidence of what works and then use it to improve, in the way scientists do. More on that next time.




<< Back to Index

User comments

Henning Sieverts :: 9th Mar 13
Isn't the issue smart regulation vs dumb regulation? It is simply stupid to try to get doctors and nurses to do better work by imposing detailed rules, targets, and penalties. But it's not so stupid for a regulator to require that public companies file proper financial and other reports every year. It's dumb to require teachers to follow detailed curricula and to report in detail that they have done so. But it's not dumb to expect a private water company to keep its water clean, to plug leaks, and so on, if it wants to keep its franchise and to have its rates approved. Linking tax breaks to certain corporate behaviours can work. Requiring hospitals to keep accurate clinical records and to generate performance data from them is something that clinicians can and do support. Of course, even smart regulation can fail if the business environment tolerates and even encourages gaming, false reporting, and the like. At best, regulation works when there is a compact of trust between the regulators and th
Henning Sieverts :: 9th Mar 13
...the regulated. In the corporate world, it is well-established but too often not put into practice that an organisation does well when its workforce is empowered to solve problems and create positive results, and badly when top-down rule-making is the main practice. A certain S Calkin is an eloquent champion of this. The nature of regulation is analagous: it can work in the public interest when the requirements are sensible and in the long-term interests of both the public and the regulated industry.
Paul reading :: 9th Mar 13
Unfortunately the policy is driven by the advisors and senior civil servants who are part of the revolving door process, and most of our elected representatives are so lacking in real management experience they swallow the nostrums of this elite. The result is that government does not listen to outside advice from the likes of Simon but actions whatever their departmental support prescribes, and passes on those "experts"'well practiced "responses" supporting the policy. The problem goes higher than the NHS and is embedded within our disfunctional government systems. That's why the Italians voted for a comedian in despair.
Name:
Comment:
Check:8+4=