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.