Challenges of regulation_2009
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Transcript of Challenges of regulation_2009
Class Exercise: Quiz Time! Quizzes of the Karnataka Quiz Association (of
which I was founder secretary in 1983!), there’s a concept called a Theme or Connection
You get bonus points if you can connect the answers to a bunch of questions by a theme that holds them together
Let’s try one such Theme/Connection round Put down your answers and raise your hands
when you think you have the Theme You’ll have to justify why you think your
answers to individual questions connect with the theme
Don’t announce your answers aloud … PLEASE!
1. Identify the country
2. Who took this picture?* What does it depict?
*Hint: She featured in a film showcasing an Indian icon
3. Identify this man (really, he’s a man, not a God as previously thought)
PS: Bonus points for identifying origin of painting
4. Ripley’s Believe It or Not! This guy is a professor! Who?
5. Who’s the magician, in this doctored image of a TIME cover?
6. Identify this gentleman
And the Theme?
CHALLENGES OF REGULATION
We actually got something right!
When the worldwide bull run/bubble was going on, “We kept wondering if they had figured out something that we were too dense to figure out. It looked like they were smart and we were stupid.” Luis Miranda, ILFS Infrastructure
Instead, India was the smart one, and we were the stupid ones –Joe Nocera, NY Times.
An American Journalist Talks to Indians
How could we have brought so much trouble on ourselves, and the rest of the world, by acting in such an obviously foolhardy manner? Didn’t we understand that you can’t lend money to people who lack the means to pay it back? The questions were asked with a sense of bewilderment — and an occasional hint of scorn. Like most Americans, I didn’t have any good answers. It was a bubble, I would respond with a sheepish shrug, as if that were an adequate explanation. It isn’t, of course. Joe Nocera, New York Times
How India Was Saved “In India, we never had anything close to the subprime
loan,”—Chanda Kochhar, ICICI “All lending to individuals is based on their income.”
“Indian banks are not levered like American banks. Capital ratios are 12 and 13 percent, instead of 7 or 8 percent. All those exotic structures like C.D.O. and securitizations are a very tiny part of our banking system. So a lot of the temptations didn’t exist.” –Chanda Kocchar, ICICI
“When the bubble was going on, we did not change any of our policies. We did not change any of our systems. We did not change our thought process. We never gave more money to a borrower because the value of the house had gone up. –Deepak Parekh, HDFC
Reasons for India’s Escape-1
Part of the reason is cultural. Indians are simply not as comfortable with credit as Americans. “A lot of Indians, when you push them, will say that if you spend more than you earn you will get in trouble,” an Indian consultant told me. “Americans spent more than they earned.”
Reasons for India’s Escape-2
But there was another factor, perhaps the most important of all. India had a bank regulator who was the anti-Greenspan. His name was Dr. Y. V. Reddy, Governor of the Reserve Bank of India.
70% of the Indian banking system nationalized, so a strong regulator is critical, since any banking scandal amounts to a national political scandal as well.
Reddy was the right man in the right job at the right time. “He basically believed that if bankers were given the
opportunity to sin, they would sin,” said one banker For all the bankers’ talk about their higher lending
standards, the truth is that Mr. Reddy made them even more stringent during the bubble.
Bankers Lavishing Praise The underlying risks of having “a majority
of loans not owned by the people who originated them” was not apparent during the bubble. Now that those risks have been made painfully clear, every banker in India realizes that Mr. Reddy did the right thing by limiting securitizations. –Chanda Kochhar, ICICI
“At times like this, you tend to appreciate what he did more than we did at the time,” –Rana Kapoor, Yes Bank.
“He saved us,” –Deepak Parekh, HDFC.
Let’s Hear Yaga Venugopal Reddy
'India has been largely protected because of the decisions we took,' –YV Reddy
'This was because of the regulatory framework that restricted exposure of our banks and financial institutions to risky financial products, specifically, complex derivatives.
'What is happening across the globe is due to regulatory failure. Firstly, some parties such as hedge funds and rating agencies were regulated very, very lightly. Then there was a failure to understand derivative products,' –Y V Reddy.
Regulatory Failure Worldwide
How did it happen? What are the consequences? The case of the Global Financial Crisis
A Crisis that puts us on the Verge of Another Great Depression
Paul Krugman, Nobel Laureate 2008 “this crisis bears some resemblance to
the Great Depression” Well, the current mess in the Global
market is THE WORST since the great depression on 1929.
The US bore the brunt of the Great Depression; this time the effects are spread across the globe
The Key Differences Unlike during the Great Depression, when
governments acted too little or too late, this time around governments around the world are rallying to rescue the financial system
In the Great Depression there was no work and there was widespread poverty. People struggled through the winter with no heating and no food.
Then, a quarter of all Americans were without jobs. Today, unemployment in the US is at 6.1% … bad but not disastrous
And the US of today is still an inventive, resourceful, resilient nation
How Did This All Happen?Root Causes of the Crisis
Mortgage Backed Securities Innovative Financial Instruments
Derivatives Credit Default Insurance
Insufficient Regulation Globalization of Finance
Root Cause: Faulty Assumption & the Housing Bubble
Created by the assumption that housing prices will continue to go up without end
Mortgage brokers get paid for sourcing new mortgages—incentive is to sell more
Thus sold mortgages to people who did not have ability to pay: SUBPRIME loans
Logic: since house prices will go up, even if a loan defaults, you still make a profit
Risk Spreading and Derivatives Markets, Globalized
The last few decades have seen risk being extracted, packaged, and sold globally through innovative financial instruments like Collateralized Debt Obligations—CDOs (It’s when these became illiquid and homeowners
started to default on the underlying securities that the market collapse started)
And the “quants” at investment banks have created all sorts of new derivatives
These help to manage risks & create new markets but are not fully understood by regulators or firms
In particular, Credit Default Swaps, were not regulated carefully
Rating Agencies’ Failure Moody’s, Standard & Poors, and other rating
agencies were supposed to evaluate these mortgages and CDOs and rate their risk levels
Instead, they gave bogus high ratings to trillions in dubious mortgage-related investments and CDOs
“The story of the credit rating agencies is a story of colossal failure,” Rep. Henry Waxman, D-Calif., chair of the House Oversight and Government Reform Committee
Other Systemic Factors Financial Times: The deep squeeze on household and
corporate incomes from the commodity boom of the first half of 2008, which almost no one predicted, weakened the non-financial sector before banks had any chance to repair the damage from the subprime crisis and was a crucial element of the disaster that unfurled this autumn"
Swaminathan S Anklesaria Aiyar’s List of Culprits
Alan Greenspan & Federal Reserve Presided over bubbles in housing, credit, and stock
markets
US Politicians Wanting to provide a home for every American,
they pushed Fannie Mae and Freddie Mac to underwrite 80% of US mortgages, without sufficient regulation
Fannie Mae & Freddie Mac Bought toxic debt wanting short term profit
…
Financial Innovators Derivatives provided cheap, easy credit,
leading to global boom of last 5 years But complex instruments hid risks Credit Default Swaps insured bonds against
default. But grew to $60 trillion. When markets fell and defaults widened, those holding CDSs faced disaster
Regulators Everywhere did not intervene carefully
…
Banks and Mortgage Lenders As they were packaging and selling loan
portfolios, they did not check the creditworthiness of borrowers
Investment Banks Borrowed heavily to play the market
Rating Agencies Allowed BBB mortgages to be seen as AAA
Basel Rule for Banks Relaxed rules; Iceland banks had 10 x GDP
…
US Consumers Spend far more than they earn, leading
to zero or negative savings Asian and OPEC Countries
Undervalue currency to stimulate exports and generate trade surpluses with US
Buying US securities lowered interest rates thereby leading to more borrowing
Everybody Nobody wanted to be the party pooper
Warnings Were Ignored Northern Rock Bank collapse in UK Bear Stearns bailout in US Warnings by “Dr. Doom:” Nouriel Roubini of New York
University Hedge funds short selling was curbed
This could have sent correct signals But there is concern about speculative and market
manipulating short selling Overall, it seems governments have little institutional
memory: remember Long Term Capital Management, the Savings and Loan Crisis, etc.
And real-estated induced crises in Japan, Sweden, etc
Scale of the Underlying Problem
Impacts
Collapse of US Investment Banks Liquidity and Solvency Crunch Collapse of Economies: Iceland Potential Worldwide Depression
Liquidity Crisis Impacts in US Fannie Mae and Freddie Mac placed into
conservatorship, i.e., nationalized Lehman Brothers declared bankruptcy after
failing to find a buyer Bank of America agreed to purchase Merrill
Lynch AIG got an $85 billion rescue package;
Federal Reserve would receive an 80% public stake in the firm.
The biggest bank failure in history occurred when JP Morgan Chase agreed to purchase the banking assets of Washington Mutual
Further Damage Possibilities
Job Losses Leading to Credit Card Debt Default And the Big 3 Automakers Now Want
Help! Chrysler is being sold to FIAT And the US government is buying up a
large share of the iconic General Motors
US Government Actions Initial estimates $700 billion to $1 trillion As of mid-November, it was estimated that the new
loans, purchases, and liabilities of the Federal Reserve, the US Treasury, and FDIC, brought on by the financial crisis, totalled over $5 trillion: $1 trillion in loans by the Fed to broker-dealers through
the emergency discount window $1.8 trillion in loans by the Fed through the Term
Auction Facility $700 billion to be raised by the Treasury for the Troubled
Assets Relief Program $200 billion insurance for the GSEs by the Treasury, a $1.5 trillion insurance for unsecured bank debt by FDIC
So What Are We Witnessing? A transition from a capitalist economy to a
socialist regime? No, the financial sector has always been
regulated intensively Now the difference is that we are trying to
ensure that the failures in the financial sector and its regulation do not cripple the functioning of the larger economy
And so we are rethinking the role of government, in line with the ideas of John Maynard Keynes
A New Keynesianism Keynes: To combat depression,
governments should jump start growth through aggressive public spending
Public spending has a multiplier effect but will also increase fiscal deficits (print notes!)
But this is OK as long as economies recover and grow
Along with cash, we need to maintain Confidence
Hence the bailout of large financial institutions
Then and Now
Class Exercise: Identify this Innovative Company
It began as an energy producer in 1985 following the merger of Internorth & Houston Natural Gas.
It was the first to realise energy and water could be bought, sold, and hedged just like shares and bonds. …
It became a huge "market-maker" in the US, acting as the main broker in energy products, also taking financial gambles far bigger than its actual core business.
As a result, in just 15 years it grew from nowhere to become America's seventh largest company, employing 21,000 staff in more than 40 countries.
Fortune magazine named it "America's Most Innovative Company" for six consecutive years from 1996 to 2001.
And then things began to unravel Its trading operations relied heavily on complicated
transactions, many relating to deals many years in the future.
Many of these gambles on future energy prices were losing money, and to disguise this a network of dubious "partnerships" were created - devices for keeping debts off the balance sheet (& in offshore settings) & thus keeping profits high and shareholders happy.
It is alleged that these partnerships bought losing businesses from the company to boost its balance sheet.
Until the sh*t hit the fan Many executives allegedly made massive profits
by selling shares before the company's problems went public and its stock price collapsed.
It achieved infamy at the end of 2001, when it was revealed that its reported financial condition was sustained mostly by institutionalized, systematic, & creatively planned accounting fraud.
As it collapsed, it left behind $31.8bn of debts, its shares became worthless, and 21,000 workers around the world lost their jobs.
If you haven’t figured it out by now …
Who is this? She spearheaded
this company’s entry into India? And built this.
So How Did All This End Up Happening?
George WillConservative Commentator …
The problems revealed by Enron’s collapse are “rooted in recent changes in US legal, financial and accounting professions,” [and] an “epidemic of aggressiveness in the 1980s, when all three professions began to think of themselves as ‘can do’ people—‘problem solvers’ who ‘think outside the box.’”
The result of this mentality and the increasing use of stock options, was a “hyper-aggressive management cadre continually trying to impress analysts with ambitious targets for growth in stock values. When the targets were met, the analysts raised the bar, and sometimes the ever-higher expectations could not be met without financial and accounting practices that were the equivalent of steroids.”
The primary cause of Enron’s “risky behaviour” was the “growing arrogance of executives who became confident that no-one was looking over their shoulders, watching—and understanding—what they were doing.”
Paul KrugmanEconomics Guru …
“Crony Capitalism: American Style” “The Enron debacle is not just the story of a
company that failed; it is the story of a system that failed. And the system didn’t fail through carelessness or laziness; it was corrupted.”
“The Enron affair has revealed that the institutions governing the capitalist economy, including modern accounting rules, independent auditors, securities and financial market regulation, and the prohibitions against insider trading have been corrupted.”
Impacts of the Enron Collapse In 2002, the Enron scandal caused the
dissolution of Arthur Andersen, which at the time was one of the world's top five accounting firms.
Arthur Andersen was convicted of obstruction of justice because key partners shredded documents related to its audit of Enron
Since the U.S. Securities and Exchange Commission does not allow convicted felons to audit public companies, the firm agreed to surrender its licenses.
In 2005, the Supreme Court overruled the conviction on technical grounds
Enron was hardly the only company rigging the system Many other companies took advantage of regulatory
gaps such as insufficient enforcement of disclosure requirements, excessive reliance on peer review for auditors, and inability to keep brokerage and investment banking activities separate.
Brokerage firms took fees for offering a preferred list of firms. For example, Morgan Stanley had failed to inform investors of the compensation it received for selling certain funds.
Under diffuse shareholding and independent managers, as prevail in the US, the information asymmetries between the principals and their agents become acute and require active regulatory intervention.
Regulatory Reactions to Enron (and Other Corporate Scandals)
As a direct result of Enron and other scandals, the US Congress passed a tough new law, called Sarbanes-Oxley, which imposes stricter rules on auditors & makes corporate directors criminally liable for lying about their accounts.
The Act establishes a new quasi-public agency, the Public Company Accounting Oversight Board, to oversee, regulate, inspect, & discipline accounting firms in their roles as auditors of public companies.
The Act also covers issues such as auditor independence, corporate governance, internal control assessment, and enhanced financial disclosure.
Considered among the most significant changes to US securities laws since the New Deal in the 1930s.
How Did Enron Get Away With All This?
The Political Economy of Lobbying
Enron’s Lobbying Prowess—All Perfectly Legal
Enron had the loyalty of Texas until it collapsed Houston's "kingmaker" Kenneth Lay, CEO of Enron,
secured that loyalty through a potent combination of money, lobbying and a “revolving door” through which employees went in and out of government
Enron spent $10.2m influencing Washington politicians. During 1997-2000, it gave $1m to Texas political action committees and state candidates, and spent $4.8m on 89 Texas lobby contracts
Justices of the Texas Supreme Court (who are elected) received $134,058 from Enron since 1983. In 1996, a conflict arose when the justices reversed a lower
court decision to cut $15m off inventory taxes Enron owed a school district.
The Political & Economic Payoffs Ken Lay’s friend, Gov. George W. Bush's "gifts" to Enron:
Deregulated the state electricity market Went easy on corporate air polluters Supported laws protecting business from lawsuits.
Enron was able to convince people it was the future: "The message Ken Lay peddled is, 'We are going to be the
most important company in the world. We are going to change every market'." It was a message the Texas government was eager to hear and promote for the betterment of the state.
Enron paid Wendy Gramm, wife of Texas senator Phil Gramm, $50,000 a year to be on its board. Enron hired her in 1993, within weeks of her leaving the top job at the Commodity Futures Trading Commission, where she started the deregulation of energy futures markets.
Perspectives on Regulation
What is Regulation?
‘A government imposed limitation on the behavior of individuals or organizations.’
Regulation can be defined as government intervention in markets to influence those decisions of private agents that would otherwise not fully consider public interest.
Justifications for Government Intervention and Regulation Correction of Market Failures
Correcting Externalities like Environmental Pollution Regulating Actions of Natural Monopolies
Utility Pricing Merit Goods and Setting Standards
Health care related areas, public morals Redistribution and Equity
Minimum wage or rent controls
Techniques of RegulationControl of price – Aimed at preventing predatory pricing and over
charging. Control of quantity – Universal service obligation, maximum
production limits.Control of entry – e.g. in long distance telecoms and NYC taxicabs Control of quality – e.g. of emissions, customer service levels, safety
etc.
Instruments of Regulation: Environmental Policy CaseCommand and Control
Bans Standards Technology Choices
Economic Incentives Taxes (Fees) Subsidies Liability Tradeable Permits
Information Provision Check www.scorecard.org
Theories of Regulation
Public Interest Theory of Regulation:Pigou Regulation needed to correct for market failures,
including lack of competition (monopoly) Assumptions:
Government are benign and capable of taking care of these market failures effectively
This justification for Regulation is seen as promoting growth of government.
Counterarguments: Private players will behave well—Reputations matter Cartels usually collapse Markets subject to potential entry by competitors
Regulatory Capture & Rent Seeking
George Stigler: The Economics of Regulation
Stigler’s Economics of Regulation Regulation is actively sought by the regulated party Rational political class provides it Concentrated interests provide votes and resources to
political sector to attain goals Preferred over direct transfer of resources to industry as
subsidies encourage new entrants Diffuse nature of loss ensures no significant opposition Methods: tariffs, quotas, occupational licensing Capture: information for regulator comes from regulated Justifications: public interest [oil security (Oil Import Quota),
helping airlines grow (Air Mail Subsidy), quality health care (American Medical Association)]
Example: The Oil Import Quota
Public Interest Justification: In the interest of national security, it is important for
the USA to have a strong domestic oil industry Therefore the import of foreign oil should be
restricted through quotas Thus dependency on outside entities minimized
Economic Impact: Higher cost, domestic oil producers get assured
captive share of the market No wonder the regulated seek regulation!
Civil Aeronautics Board & Regulation of Airlines, USA
The Civil Aeronautics Board was set up to help the fledgling airline industry take off
It allocated routes and regulated pricing Captured by regulated entities Throughout its tenure, no new airlines were set up It was disbanded in the 1970s, during Jimmy
Carter’s presidency Main airlines in regulated era—TWA, Braniff,
Eastern, etc., collapsed once competition came in Since deregulation, there has been a shakeup in
the US airline industry and re-consolidation Prices are low on busy routes & high elsewhere
Regulation is Political: Rent Seeking Every interest in society will try and create a
monopoly position for itself, using the government to ensure this (or at least entry/trade barriers). This way, that interest will capture (monopoly) rents for itself at the expense of the consumer.
Rent seeking techniques: tariffs, quotas, & government contracts; favorable regulatory action
Rent seeking leads to inefficient expenditures (bribes, bureaucratic angling for key posts, suboptimal investments, wasteful competition between economic interests for government favor)
In a sense, regulatory arena is another marketplace where interest groups compete for spoils
Wilson’s Critique of Economic Analysis of Regulation
Economic arguments interesting but too simple World is full of regulatory activity that affects
concentrated economic interests harshly (e.g., EPA regs & auto industry, FDA regs and drug approval)
“Captured” regulatory bodies like CAB got eliminated
Look back at origin of regulation, typically in public interest & large coalition support (Civil rights, environmental protection, drug safety, etc)
Lots of opponents out there in society to counterbalance concentrated economic interests
The Enforcement Theory of Regulation
Andrei Shleifer: Understanding Regulation
Regulation: Between Disorder & Dictatorship
Design Regulatory Frameworks Based on Prevention of Abuse
All strategies for social control of business are imperfect Optimal institutional design involves a choice among
these imperfect alternatives. The enforcement theory specifically recognises a basic
trade-off between two social costs of each institution: Disorder—the ability of private agents to harm others Dictatorship—the ability of the government and its officials
to impose such costs on private agents. As we move from private orderings to private litigation
to regulation to public ownership, the powers of the government rise, and those of private agents fall.
Social losses from disorder decline as those from dictatorship increase
This tradeoff is called the Institutional Possibility Frontier
Regulatory Enforcement and India: The Case of Bt Cotton
Bt Cotton Bt Cotton is produced by inserting a synthetic version
of a gene from the naturally occurring soil bacterium Bacillus thuringiensis, into cotton.
The primary reason this is done is to induce the plant to produce its own Bt toxin to destroy the bollworm, a major cotton pest.
The gene causes the production of Bt toxin in all parts of the cotton plant throughout its entire life span.
When the bollworm ingests any part of the plant, the Bt cotton toxin pierces its small intestine and kills the insect.
Source: http://www.greenpeace.org/india/campaigns/say-no-to-genetic-engineering/ge-crops-in-india-the-story
Why use genetically engineered cotton when pesticides exist? When cotton farming was introduced as a lucrative
alternative to food crops in the 1980s, farmers invested in expensive varieties of seeds and pesticides. When crops failed, small farmers found themselves severely indebted.
Indebtedness triggered a spate of suicides. Crop failure was caused basically by the resistance
the American bollworm insect developed to all kinds of pesticides and pesticide cocktails.
Farmers found themselves on a “pesticide treadmill' where higher pesticide use led to greater resistance which in turn led to even higher pesticide use, …
Manufacturers of Bt cotton argued that the genetically engineered plants would be resistant to pests at low costs
Risks of Bt Cotton Economic risks:
Crop failure possible even with the use of this technology Ecological risks:
Increased Pest Resistivity:As the insects feeding on the Bt crops are exposed to the toxin regularly, they can develop quicker resistance. If this happens, both the genes in transgenic plants and Bt sprays will be rendered ineffective.
Gene flow to wild relatives=>Super Weeds:As Bt crops are grown close to their wild relatives, it is possible that the Bt gene can spread to them through pollen transfer. The new genes in the wild plants may produce enough toxins to ward off insects that normally feed on them. Some of the wild plants could grow hardier and act as weeds. This technology can also contaminate other species, as transgenic plants displace other plants.
Political risks: NGOs active in opposing Bt cotton; taking direct action
NGO Opposition to Bt Cotton & GM Crops
So when Monsanto applied for permission to sell Bt cotton seeds, government decided to regulate
Regulatory Response relied on hierarchy Expertise driven—led by scientific establishment Multiple ministries involved—Biotechnology,
Environment; some less so (eg, Agriculture) Top down—driven by Delhi; states less involved,
even though they have to implement Field level science not well integrated—agricultural
university scientists not fully involved Non-formal voices kept out—NGOs, Farmers
Rational vs Hybrid Regulation:Scoones (2005)
Professed Ideal Rational, science-based process, whereby guidelines
developed centrally by experts are enshrined in law and implemented by bureaucrats with assent of politicians
Actual Reality Regulations emerge through a political process of
negotiation among a wide range of actors in multiple sites … an uneven compromise based on technical, social, political and sometimes moral considerations
Thus There is a process of ‘co-construction’ of regulatory
policy, operating in a hybrid world that straddles science, business, and government interests
Regulatory Process for Monsanto-MAHYCO
Elaborate scientific tests of Bt Cotton seeds Monsanto-MAHYCO goes through long
testing period before field trials Testing process highly contentious on
ground with NGO protests, e.g., destroying test beds
Various protection measures insisted upon—refuges of non-Bt cotton
Process may have been significantly long and arduous because applying party was Monsanto
Process subject to significant NGO scrutiny, particularly using courts
The Regulatory Assumptions versus The Ground Reality
Regulators grant approval based on safety measures, e.g., refuges Small farmers unable to provide environmental
refuges of non-Bt cotton Regulators assume that state and district
administrations can police Bt cotton use State and district administrations not up to task Seed market fragmented, unorganized, non-formal
Regulators assume scientists inspect correctly Scientific teams feel process inadequate
Attention entirely focused on Monsanto
Meanwhile, back on the farm … Farmers in Gujarat found to be planting
seeds with Bt Seeds obtained from Navbharat, which
claims its their own hybrid Legal action against Navbharat initiated by
government and MAHYCO Central government orders destruction of
Bt cotton crop Gujarat state government balks—says it is
unable to compensate growers for cotton destruction
Uneasy regulatory stalemate prevails
So, the Bt is Out of The Bag Bt cotton seeds are now
widely available underground/camouflaged
Hybridization with local cotton variants rampant
Regulation of seed sellers practically impossible
Growing practices do not emphasize safety
Overall, a failure of the regulatory process
The Regulators
Behavior and Politics of Regulatory Players
Behavior of agency: depends on appointee type Careerists: work to cover their flanks, risk averse, but also
pass strong rules to survive Politicians: may take activist role, especially in preparation
for future political office Professionals: peer group outside agency, in profession,
eg, law, medicine, => activism Perceptions key:
If any group seen as unfairly benefiting at nation’s expense, there will be a countervailing force to eliminate this. Lots of interest groups exist to counter and fight
Political process accessible; e.g., thru media, judiciary (Bad implementation because of nature of challenge?)
Regulatory Actions and Paradoxical Outcomes
Paradoxes of Regulation A Regulatory Paradox is a Counterproductive Regulation:
eg, A Clean Air Act that actually makes air dirtier Overregulation produces underregulation:
Implementability difficult/unjust so bureaucrats/judges won’t implement regulation/law;
eg, 3 strikes & you’re out law => more out of court settlements
Stringent regulation of new risks can increase overall risk levels: Older, riskier cars & drugs stay; new versions kept out
Best Available Technology retards technological development Industry has no incentive to show feasible improvements
… Redistributive regulation harms those at bottom of
socioeconomic ladder Minimum wage laws freeze out marginal job seekers; Rent control laws dry up rental property provision
Disclosure requirements make people less informed overload, people process information differently
(heuristics & biases); inability to counteradvertise against tobacco
Independent agencies are not independent Can get captured or influenced by regulated entities
Magnitude of counterproductive reaction is key: Sometimes some amount of inefficiency is OK
Former US Sen. Mike Gravel on Legalizing Drugs
http://www.youtube.com/watch?v=38ma-nUmySo&feature=related
India’s Regulatory Environment
Liberalization: Government as Facilitator
India liberalized its economy in 1991 Since then many sectors have been thrown
open to private participation The government has worked to create
appropriate regulatory frameworks Opening of some sectors to participation by
international players has meant that Indian regulatory institutions and frameworks have to meet international best practices
The Challenge of Capital Market Regulation in India
Capital markets provide effective intermediation of savings, allocation of investment, price discovery, pricing and hedging of risk; but they are subject to information imperfections, excess volatility, and market manipulation.
The regulator has to be something like a policeman, but a smart one, who preserves market integrity through clear and self-enforcing rules of the game while encouraging the game itself.
SEBI and the Financial Sector Securities and Exchange Board of India,
tasked with: Regulating securities and stock markets Establishing monitoring, surveillance and
implementation of world class rules Regaining investor confidence after major scams
(Harshad Mehta, Ketan Parekh) Creating a deeper market that protected the
small investor Successfully pushed systemic reforms, drove the
movement toward paperless transactions, T=2 settlements, etc.
Still considered weak in terms of enforcement of penalties against violators
Telecom Sector
Challenge: How to provide a level playing field in the
presence of a dominant publicly-owned player with bureaucratic support?
Department of Telecommunications and Telecom Regulatory Authority of India
DoT Allocates territorial licenses for mobile telephony
Criticized for numerous changes in policy Criticized for allowing backdoor entry to
Reliance into mobile telephony Highly politicized?
TRAI Sets rates Enforces Universal Service Obligation
Weak in terms of enforcement power Packed with retired bureaucrats rather than
other sector experts
Courts as Regulators: The PIL
Courts step in when Bureaucracy Fails Bureaucracy (& legislature) fail to regulate or
enforce pollution laws effectively Normally, since pollution costs are diffused
over society, collective action problems would have prevented public opposition
But courts have allowed individuals to file Public Interest Litigations (PILs) on behalf of an affected public: judicial innovation!
Has led to courts having more impact on pollution control than legislature or executive
E.g., forced Delhi government to act on CNG
Role of Judicial Process
Courts have admitted cases under Article 21 (Right to Life) (MC Mehta’s PILs)
Courts have: Invoked “polluter pays” principle Given a clear market signal that polluting
activities of industry will not be tolerated
Limitations
PIL-based litigation seems to depend on individual judges and their propensity to be activists
Judicial intervention is too often too late and many cases are dismissed as the damaging actions have already occurred and can’t be overturned easily.