Regulation, deconstructed and reconstructed

This entry consolidates points from earlier blogs on regulation.

I

It’s fairly easy to deconstruct a dominant discourse about government regulation in some quarters and identify its discrepancies. Reading the Financial Times in the run-up to and during the aftermath of the 2008 financial crisis, I learned that:

Post-crisis banking re-regulation adds significant costs to the economy and thus reduces growth, while the pre-crisis light-touch regulation undermined the very financial infrastructure necessary for economic growth.

What were indicators of positive economic growth under light-touch regulation—rapid uptake in home mortgages—were later indicators of regulatory failure. Mortgages were a relatively safe asset for banks to own, until they were the source of unimaginable losses.

Overregulation is nowhere better illustrated than in comparing the more recent nearly 2000 pages of the Dodd-Frank legislation to the less than 20 pages of the Depression’s Glass-Steagall Act—but under no circumstances are our regulators to repeat the 1930s! Anyway, those who lobby for simplifying regulation end up making it more complex.

It’s a bad thing for regulation to try to squeeze too much risk and complexity out of banking, especially when fresh risk reduction—less leverage, greater capital reserves—is itself too risky. Regulation discourages risk taking and only with risk taking do we have innovation, except when too much innovation and risk taking are encouraged as in the deregulated finance sector up to the 2008 crisis.

Regulators must always have the best information, even when those regulated—the banks and investment firms—haven’t a clue as to their current real-time positions. Regulators will never have the capacity to know the real-time positions of actual firms, except in those cases where firms, like Lehman, insisted regulators did have the real-time information.

Global business and supply chains are great, except when the firms are too big to fail or regulate. Country defaults are horrible, except where they wore as in Argentina or Mexico.

Global markets are a permanent fact of life, but we must never suppose that the drive to regulate them for the better is just as permanent. Markets are best at price discovery, except where market efficiencies are realized because of lack of transparent discovery, as in unregulated dark pools.

II

In short, I learned from the Financial Times that government regulation is in crisis because of the shambolic expectations about government regulation. (A friend suggests I should have been reading the Guardian.)

However, look closer at the discrepancies.

Note how the Financial Times discourse disaggregates into specific example and general proposition. At the micro-level, indicators, defaults and legislation are to be contrasted case by case; at the macro-level, “Do X” entails somebody else’s “Do not X” (as if semiotically a proposition is defined against the backdrop of what it is not, including counter-propositions).

The X/not-X pairings are reminiscent of the problem adduced long ago by Herbert Simon in his The Proverbs of Administration: “they almost always occur in mutually contradictory pairs. ‘Look before you leap!’—but ‘He who hesitates is lost.’” “For almost every principle one can find an equally plausible and acceptable contradictory principle. Although the two principles of the pair will lead to exactly opposite organizational recommendations, there is nothing in the theory to indicate which is the proper one to apply” (my italics).

Why? Not surprisingly, Simon comes back to fact that administration and organization—and here we add, government regulation—are so complex as to ensure no one categorical proposition or single exemplar dominates important cases at all the important times. The entire point of complexity is there is no one theory for deciding.

What to do? How can we more usefully describe government regulation and its various scenarios and specifics, without dead-ending in contradictions?

Here too the methodological imperative is: First, differentiate! “Government regulation” is too abstract a category for the preceding questions. In what follows, I focus specifically on one subcategory, that of regulation of critical infrastructures by their regulators of record.

III

Shifting to infrastructure regulation helps identify and describe a meso-level between macro-design principles for such regulation and the micro-cases of actual regulation. This is to say the subcategory, “infrastructural regulation,” is only partly described by macro-propositions and micro-examples.

This meso-level is the space of decisionmaking competence bounded by better systemwide practices that emerge across a variety of site-specific examples and by the what-if scenarios that adapt macro-principles to local conditions that vary case by case. The knowledge embodied in systemwide better practices and in locally-specific design applications adds to the knowledge represented by macro-principles on their own and by micro-cases tacitly understood.

These different knowledge bases differentiate infrastructure regulation further and in so doing we begin to reconstruct what regulation—at least infrastructure regulation—is all about. For our purposes there, this reconstruction has three features that recast infrastructure regulation significantly:

  • To the extent that infrastructure regulation is equated with what their regulators of record do, we will have a very fragmented understanding of how regulation functions for critical infrastructures. Infrastructure regulation is not just what the regulators do; it is also what the infrastructures do in ways that their regulator of record could never do on its own. This includes infrastructure control rooms correcting for regulatory deficiencies and gaps in real time by the application of these better systemwide practices and what-if contingency scenarios, none of which need have been formalized or made official.
  • In related fashion, there is not just the risk of regulatory non-compliance by the infrastructure, there is also the infrastructure’s risk of compliance with incomplete or otherwise defective regulations promulgated by the regulator of record. Note that the criticality of time from discovery to correction of defect reinforces a process of dispersed regulatory functions: A shorter time to discovery has the advantage of discovering errors that would have propagated into much larger ones if left uncorrected.
  • The upshot for the regulator of record?

• If, notwithstanding the recognition that regulation is understandably dispersed, government still insists that the regulator’s task is one of regulating the whole cycle of the infrastructure throughout its operational stages of normal, disrupted, failed, and recovered onwards, then it is better to say that at best the regulator of record is in permanent setback management. At worst, its own activities require the coping behavior we associate with emergency management during crises, i.e., its setbacks are primarily negative.

• This is to say that the regulator in terms of its own cycle of reliable operations never recovers fully; or if you’re on the optimistic side, recovery is its new normal for the regulator of record. We know from research, however, that the probability of failing to be reliable is even higher in recovery. To assign more and more duties and responsibilities to the regulator of record under the insistence that it regulates the whole cycle of the infrastructure is to walk hand-in-hand with ignorance on one side and magic on the other.

IV

So much for downsides. How in contrast is the insistence on a dispersed nature of infrastructure regulation useful for rethinking the wider issue of “infrastructure regulation”?

Textbooks are fond of repeating that government has allocative, distributive, regulatory and stabilizing functions. But society’s critical infrastructures have their own allocative, distributive regulatory, and stabilizing functions. Of course, government can be seen as prioritizing a number of social values (healthcare, education,. . .) and relying on critical infrastructures to realize them. Yet these infrastructures–many of them privately owned or managed–prioritize the societal values of systemwide reliability and safety, in particular, of their respective critical services.

The challenge is to better understand the institutional niche of critical infrastructures, that is, how infrastructures themselves function in allocating, distributing, regulating and stabilizing that reliability and safety apart from, if not independently of, the respective government regulators of record. That this knowledge will always be for regulators partial and punctured by gaps and ignorance should go without saying.

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out /  Change )

Google photo

You are commenting using your Google account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s