ENSURING HIGH QUALITY REGULATION

��

Changing Theoretical Basis for Regulation

��

1. Market Failure (oligopolies and externalities) should be corrected by government regulation of outcomes.
2. Government Failure recognized in rent seeking, regulatory fair capture, selfish agencies for public choice.
3. Deregulation Movement: abandons attempts to regulate fair outcomes, instead seeks to expand reach and accuracy of market forces by regulation to ensure a fair competitive process.

Oligopolies addressed by contestable markets open to free entry, banning collusion.

Externalities addressed by tradable licenses.

Accuracy of market prices addressed by enforcing disclosure and transparency, banning dissemination of false information, e.g., exaggerated product claims, ramping of asset prices.

��

Ensuring High Quality Regulation

��

Information Collection and Processing

Regulators should have statutory access to information, Supported by enforceable penalties for distortion and delay.

Firms should be able and willing to provide information in accurate, accessible form.

Information systems should be set up and maintained to record and collate information within a consistent framework which facilitates cross-checking

Economic expertise should be available to process and interpret information.

For example, regulation of the capital adequacy of banks requires an accounting profession with:

1. certification and disqualification procedures

2. accounting standards, backed by laws and regulations.

��

Regulatory Personnel

Appointment and retention of high quality, objective personnel requires:

Source of well educated, well-motivated recruits.

Professional career structure: good salaries, job security, avenues for exit into careers which are sufficiently separated from the regulated industry to avoid distortion of regulatory decisions.

Internal procedures against corruption and bureaucratic inefficiency which jeopardize public support

Convincing ideological framework to sustain regulator morale and commitment in the face of threats and bribes.

��

Political and Business Environment

Support of regulatory goals by national and local political leaders, so that regulations are enforced, not subverted by power holders.

Acquiescence by business community, so that enforcement procedures need be invoked only in exceptional cases.

Incentive-compatible organizational structures within the regulated firms, so that the good intentions of business leaders are translated into compliance by their firms. For example, to safeguard a bank's capital adequacy:

Lending officers should be supervised and penalized for loan decisions which turn out to be poor.

Managers of derivatives desks should be subject to internal limits on the positions which they can take.

��

What if High Quality Regulation Cannot be Ensured?

The conditions for high quality regulation of the competitive process require sophisticated institutional development, both within firms and in the surrounding society.

Prescriptions for developing economies from "experts" from advanced economies often fail to take account of the inadequate institutional infrastructure �� see the collapse of Russia.

A Country which lacks the institutional capacity to regulate the competitive process effectively, should consider regulating outcomes instead if high quality regulation here is easier to ensure.

Thailand lacked the institutional capital adequacy of its banks effectively. In the short-term, it might have done better to regulate directly the total output of real estate via licensing. It could still have used insights from the deregulation movement, e.g., by auctioning the licenses which could be tradable.

Malaysia lacks the scale to limit the manipulation of the international price of the ringgit by oligopolistic speculators. In the short term, direct regulation of the price of the ringgit, supported by quantitative restrictions, could still be beneficial.

Again, some insights from the deregulation movement can be useful, e.g., for people desiring foreign exchange for purposes outside those approved by the government, there could be regular auctions of tradable foreign exchange receipts in this "white market".

The auctioning and white market trading of licenses would:

1. limit black market activity and manipulation, such as over-invoicing of imports and under-invoicing of exports;
2. capture for the public the gains which would otherwise go to black marketers;
3. ensure efficient allocation of the foreign exchange available outside official quotas;
4. provide ongoing information on the extent of distortions created by price regulation, facilitating any eventual return to process regulation.