NEW PERSPECTIVES ON REGULATION edited by David Moss & John Cisternino NEW PERSPECTIVES ON REGULATION NEW PERSPECTIVES ON REGULATION This work is distributed under a Creative Commons Attribution–Noncommercial– No Derivative Works 3.0 license. Readers are free to share, copy, distribute, and transmit the work under the following conditions: All excerpts must be attributed to: Moss, David, and John Cisternino, eds. New Perspectives on Regulation. Cambridge, MA; The Tobin Project, 2009. The authors and individual chapter titles for all excerpts must also be credited. This work may not be used for commercial purposes, nor may it be altered, transformed, or built upon without the express written consent of the Tobin Project, Inc. For any reuse or distribution, the license terms of this work must always be made clear to others: the license terms are available at http://creativecommons.org/licenses/by-nc-nd/3.0/us/. Copyright © 2009 The Tobin Project, Inc. All rights reserved. For information address The Tobin Project, One Mifflin Place, Cambridge, MA 02138. First Edition 10 9 8 7 6 5 4 3 2 1 Printed in the United States of America This book is set in Adobe Caslon Pro. Text design by Kristen Argenio/Ideal Design Co. ISBN 978-0-9824788-0-6 (paperback) Library of Congress Cataloging-in-Publication Data on file. Visit www.tobinproject.org Contents 5 preface Mitchell Weiss 7 introduction David Moss and John Cisternino 11 chapter 1 Regulation and Failure Joseph Stiglitz 25 chapter 2 The Case for Behaviorally Informed Regulation Michael S. Barr, Sendhil Mullainathan, Eldar Shafir 63 chapter 3 From Greenspan’s Despair to Obama’s Hope: The Scientific Basis of Cooperation as Principles of Regulation Yochai Benkler 87 chapter 4 Government as Risk Manager Tom Baker and David Moss 111 chapter 5 Toward a Culture of Persistent Regulatory Experimentation and Evaluation Michael Greenstone 127 chapter 6 The Promise and Pitfalls of Co-Regulation: How Governments Can Draw on Private Governance for Public Purpose Edward J. Balleisen and Marc Eisner 151 chapter 7 The Principles of Embedded Liberalism: Social Legitimacy and Global Capitalism Rawi Abdelal and John G. Ruggie 163 acknowledgments preface New Perspectives on Regulation New research in the social sciences has yielded insights with important (but, as yet, largely unrecognized) implications for the government’s role in the economy. This new research holds the promise of enabling creative solutions to pressing problems. As the financial crisis unfolds and the global recession continues, the need to share these ideas beyond academia to inform policymaking and public debate has grown ever more urgent. To this end, in the fall of 2008 the Tobin Project approached leading scholars in the social sciences with an unusual request: we asked them to think about the topic of economic regulation and share key insights from their fields in a manner that would be accessible to both policymakers and the public. Because we were concerned that a conventional literature survey might obscure as much as it revealed, we asked instead that the writers provide a broad sketch of the most promising research in their fields pertaining to regulation; that they identify guiding principles for policymakers wherever possible; that they animate these principles with concrete policy proposals; and, in general, that they keep academic language and footnotes to a minimum. As if this weren’t a tall enough order, we asked these scholars for one more thing: because the need for informed debate on our nation’s problems is so great and the prospect of important new government action imminent, we asked that they prepare this new kind of essay on a compressed timeline measured in weeks rather than the many months or even years that traditional academic writing usually requires. Fortunately, a group of leading scholars took up this challenge. This book is the product of their efforts, for which we are enormously grateful. In seven chapters, they condense lessons of a broad and varied swath of research and share insights for how we might address the financial crisis, ensure more enduring prosperity, and improve our regulatory institutions. New Perspectives on Regulation is aimed primarily at citizens and public ser- vants, including our leaders in Washington, who are grappling with a crisis that conventional approaches didn’t predict and don’t yet seem able to solve. But the breadth and accessibility of the work should also make it an excellent starting Preface 5 point for both students and scholars desiring a survey of the state of the art in the social sciences, particularly as it relates to public policy. As an experiment in reconnecting academia to our broader democracy, New Perspectives on Regulation is one piece of the mission that the Tobin Project’s affiliated scholars have undertaken: to invigorate public policy debate by rededi- cating their academic work to the pursuit of solutions to society’s great problems. Mitchell Weiss Executive Director The Tobin Project 6 Weiss new perspectives on regulation Introduction David Moss and John Cisternino Regulation is suddenly back in fashion. After more than thirty years of dereg- ulation being all the rage, the financial crisis of 2007 to 2009 has dramatically changed attitudes about the proper role of government. The market fundamen- talism that drove far-reaching deregulation now looks more like a passing fad than the classic staple of political economy it was advertised to be. At the same time, current thinking about regulation may not be as fresh as its promoters imagine, based to a large extent on ideas that were in vogue back in the 1960s. Market failure theory was then in its heyday. Every college student taking Econ 101 learned that although rational individuals typically maxi mized the welfare of the whole society simply by pursuing their own self- interest, Adam Smith’s invisible hand occasionally (and sometimes spectacularly) broke down. A factory, for example, might spew too much smoke into the air if its owners did not have to bear the costs of the resulting pollution. Concern about “negative externalities” of this sort became a powerful justification and driver of environmental regulation. And this was just one piece of a larger whole, since market failure theory was used to justify a wide range of government interventions, from antitrust law to social insurance. Market failure theory encompasses a powerful set of ideas, and it will inevi- tably remain a pillar of any modern approach to regulation. But it should not be the only—nor perhaps even the principal—intellectual foundation for a new era of regulatory engagement. Since the 1960s, influential new research on govern- ment failure has helped to drive the movement for deregulation and privatization. Yet even as the study of government failure was flourishing, some very different ideas were sprouting in the social sciences with profound implications for our understanding of human behavior and the role of government. Some of these ideas, particularly from the field of behavioral economics, have begun to nudge their way into discussions of regulatory purpose, design, and implementation. Yet even here, the process is far from complete; and many other exciting new lines of research—on everything from social cooperation to co-regulation— have hardly been incorporated at all. Now that many lawmakers and their constituents have apparently concluded that the earlier focus on government failure went too far, it is imperative that Introduction 7 they be able to draw on the very latest academic work in thinking anew about the role of government. This, at root, is the purpose of this book: to make the newest and most important research accessible to a broad audience, expanding our conception of both the possibilities and the potential pitfalls of economic regulation at a time of great turmoil in the global economy. The seven chapters that follow offer seven different perspectives on the subject: • Market failure perspective. Joseph Stiglitz gets things started in chapter 1 with a new look at market failure, which he suggests may be far more extensive—and more damaging—than generally believed. • Behavioral perspective. In chapter 2, Eldar Shafir, Sendhil Mullainathan, and Michael Barr move beyond market failure, showing how a better under standing of the limits of individual rationality can inform better reg u- lation—to protect consumers (against “teaser rates” in subprime mortgages, for example) and to ensure that markets reward producers who make us better off rather than exploit our limitations. • Cooperative perspective. In chapter 3, Yochai Benkler suggests that self-interest is only a relatively small part of what drives human behavior, and he explores how successful experiments in social cooperation (in the collective production of Wikipedia, for example) can serve as a guide for the structuring and regulation of economic activity. • Risk management perspective. Tom Baker and David Moss highlight the government’s critical role as a risk manager in chapter 4; they reveal this as one of government’s most important and successful functions (in poli- cies ranging from Social Security to the FDIC) and, importantly, lay out the basic dos and don’ts of public risk management. • Experimental perspective. Michael Greenstone argues in chapter 5 that we can dramatically strengthen regulation of all kinds by building experimentation into the process of policymaking, developing a culture of testing (modeled after medical drug and device testing) that privileges empirical evidence over theory in the making of regulatory policy. • Co-regulation perspective. In chapter 6, Ed Balleisen and Marc Eisner take up the fascinating (and highly controversial) subject of co-regulation, drawing on a growing international literature to show how best to harness private industry in regulating itself and, at the same time, providing a clear set of criteria for when government-monitored self-regulation is most likely to succeed or fail.