Regulations, schegulations

The debate on the whole regulation thing has gone its predictable course, i.e. we libertarians have asked “Are you in favour of free-markets or are you in favour of regulations?” and we’ve got the answer “Being pro-markets does not mean being against regulations” to which we’ve replied “What about the license-quota-permit raj? Do you think the free market could have flourished under those regulations” to which again we’ve got the answer “So are you saying that there is no need for laws at all? If someone does wrong, shouldn’t we punish them?” to which we’ve screamed back “Where have we said that there shouldn’t be laws? We are against regulations. Completely different thing.”

I think the fault is on both sides. We FMSs have never made it clear what we mean by the laws we support and the regulations we oppose, and the NHBs constantly claim that “some regulations are needed” without specifying which ones are.

I had in fact thought of remedying this problem some time back. I will still do it in more detail, as a post on the Indian Economy blog. But in the meantime, let me propose a way to distinguish between “good” regulations and “bad” regulations. We libertarians tend to call those good regulations “laws” but let me drop that terminology for clarity. Also, I must caution you that this is not the only distinction. These “good” and “bad” regulations form the extremes – good ones are unambiguously good for the market, bad ones are unambiguously bad for the market, but there are others in between which are not so clear.

It is quite clear that without laws, neither the market nor society would last for long. There won’t be much of a market left if a company can use hired goons to beat up competitors and the police won’t do anything about it. If the courts won’t enforce contracts, I will not have the confidence to trade with anonymous people, and the complex web of transactions in society will break down. If IIPM promises something and does not deliver, then it has committed fraud and should be punished. If it puts out false statements in its advertisements, then it should be penalised for that. Prosecuting crime, prosecuting fraud, enforcing contracts, these are the things a government should do. There is very little dispute about these things.

But there is something common about all these things – all of them punish the crime after they occur. Now, if I were to suggest that in order to prevent crimes from taking place, citizens should have to register and seek permission from the police before moving from one place to another, most people will be rightly outraged. During the British era, some tribes had to do that and it is correctly considered an abhorrent practice.

Similarly, it is one thing to penalize libel after publication, but I am sure most journalists would fight tooth and nail against any measure that will require them to clear their copy with a bureaucrat before publication, just to ensure that there is no hint of libel.

Most people will agree that not only will such actions violate people’s rights, they will also be ineffective. The time spent by the police scrutinizing applications for moving from one place to another is time taken away from investigating actual crimes. The resources you spend on censoring content is resources you haven’t spent on the courts. These measures will only end up harrassing ordinary citizens, lead to increase in discretionary powers of officials and give people an incentive for corruption. A person who has no intention of committing a murder will still be tempted to pay up to speed up his application.

For the same reason, it is one thing to prosecute fraud by businesses after they are committed; it is another to insist that they take permission before they start business. It has all the disadvantages I’ve listed above – they presume that you are guilty, they give too much discretionary powers to officials, subjective rather than objective criteria end up being used, honest people end up being hassled, they end up fueling corruption, etc. In addition, these measures are well and truly anti-competitive. By making it difficult to set up a business, it reduces the number of competitors and hurts the consumer. Established businesses love these regulations for that very reason.

Quite clearly, IIPM is in such a market. The restrictions on setting up an educational institute are so onerous that you have to be a crook or a politician to be able to establish one. It is next to impossible for an honest person to build and maintain a private university – I mean, if you have to pay crores in bribes for permissions and stuff, will anyone run a school for anything except for money?

So here is a distinction I am proposing. Good regulations punish harm after it has occurred. Bad regulations require everyone, including honest people to ask for permission before they do something. The former is based on a presumption of innocence. The latter effectively presumes guilt. The former is essential to a free market. The latter destroys the free market. So if you are one of those NHBs who support the free market, but with appropriate regulations, you should support the good regulations and oppose the bad ones as much as I do. Do you? Or have I presumed too much?

26 thoughts on “Regulations, schegulations

  1. Thanks Ravikiran, good post, sheds clarity on the subject. If I may add my two bits, the law should be there to ensure that no one does anything to harm anyone else, and that’s it. Beyond that, economic and social freedom should be non-negotiable. The criminal code and tort laws should thus take care of what infractions an “evil corporation” may commit. No further regulation should be required.

    TRAI is a classic example of an unnecessary regulator distoring the marketplace.

  2. Oh, mercy. Lovely post sir. Would be nice if u mentioned alittle somehting about those awful private sector quotas that are being announced (sniff). 🙁

  3. Ravikiran,

    I understand what you’re trying to say but I fear I find the litmus test you propose to distinguish the good (the noble law) from the bad (foul underhand regulation) somewhat simplistic.

    Consider a happy, free market economy which on day 1 starts out with a set of laws upholding the moral right. Very soon businesses are formed, and very soon disagreements arise. The courts find a case comes before them where two parties had agreed to jointly run a business, except that one of them failed to uphold their side of the agreement. Unfortunately, no one had written anything down (in this utopian, free society a verbal agreement was all that was necessary to start a business).

    Still after many months of investigation by the police and calling witnesses, guilt was proven beyond reasonable doubt and a just punishment meted out. Exhausted the courts and law enforcement agencies took a day off. The next day the same thing happened- another disagreement, nothing written down. And the next.

    And so with great reluctance, the court decided that all businesses must have a written contract drawn up, if they wish justice later. For the common good of course, and to make law enforcement practicable. And thus the snake crept into the garden of Eden and the first regulation was born. For is not forcing two parties to sign a contract *before* creating a legal business that vile abomination- a regulation?

    And so I would like to know, how would you avoid this happening? Isn’t this inevitable? How can you possibly not have any regulations? At what point do we have too many?

  4. Anant, litigation is painful, not just for the courts, but also for the litigants. Why wouldn’t they draw up a contract? Masochism? In fact, you will notice that it is places like India where contracts are not enforced that people do business in this informal manner. If people have the confidence that contract enforcement will take place, they will draw up contracts.

    Secondly, what exactly is the regulation needed in such a case? There is no need to actually prohibit transactions that do not have a contract in place. If I want to take that risk, it is mine. All that is needed is a court’s decision that if contracts are vague, it will summarily refuse to hear it. That is only fair. If you don’t have a contract, you can’t expect it to get enforced. That is not an additional “regulation”.

    Thirdly, rather than banning something, isn’t it a better idea to actually recover court and investigation costs from the litigants?

    Fourthly, you actually have a good point hidden there – it relates not to forcing people to sign contracts, but in cases where traditionally, some contracts are implicit. For example, one cannot insist that every right and responsibility of partners in a marriage be written into a nuptial contract. Many of these implied, drawn from tradition. In such a case, should a government codify those responsibilities on its own? Difficult question, but I will tackle it in a post. But I hope this answers your specific point.

  5. Ravikiran, I understand exactly where you’re coming from but simply think its impractical.

    For example, once burned, certainly everyone would draw up a contract on paper and probably want it signed by three witnesses and attested by the court as well. The point is – Not everyone is smart enough to think of that in the first place.

    All too often, when starting out, the trust is implicit, its understood, and there will be cases where things get vague. (Even today, there often are). A legal system and a government that refuses to hear such cases is (while probably rational) somewhat unfeeling. In a democracy, I doubt such a system would last too long. Hence the regulation- to try and reduce the number of people doing the silly thing. Certainly its not necessary, but the alternative, when you recognize that courts would *have* to allow some leeway is even worse.

    Or consider a different example. Lets say a new technology is created which uses a particular radio frequency that is also used by local radio stations. In the absence of any regulation you would have manufacturers of the new device come in, pick the most convenient frequencies to use, interfere with radio stations, cause disrupted public services for a while and finally (probably) work it out with the radio transmitters and divide broadcasting frequencies in some reasonable way. Its an open question as to how long this would take, especially across the country, and how other factors such as the relative bargaining strengths of the different parties would affect the ‘steady state’ solution.

    If you were in government and knew of this technical issue, would you not feel it sensible to regulate a priori. To say that all new manufacturers of this mystery device must request permission to use a particular frequency for instance? How would you like defending your decision not to do this when everyone is miserable in the interim before the two parties sort out the problem? And finally, even if you did feel that regulations are so subject to misuse and have so many drawbacks that they should be avoided like the plague- is that really a position based on objective facts that everyone can agree on? Or is that more a gut feeling that the policy maker in question might or might not agree with.

  6. But what is the regulation you are proposing? No two people should deal with each other without a contract approved by a bureaucrat?

    In the second case, defining property rights is a legitimate government function. When new technologies come up, new forms of property comes up. But even in that case, we should deal with it the way we currently deal with other kinds of property. Just auction off the spectrum once and then what they do with it – use it or sell it to others, is the owner’s concern. There is no need to set up a regime where every action on it has to be approved by a bureaucrat. It is the latter form of regulation that is corrupting.

  7. Thinking over it, I realise that your spectrum question illustrates the advantage of my distinction even more than I had realised. I mean, the faux distinction between “laws” and “regulations” would have put any “regulation” of the telecom sector in the unacceptable range. On the other hand, the distinction I am making tells the government what to do – make clear rules beforehand which will define the rights of everyone concerned, make it possible for the players to comply with it, and leave it to the courts to sort out disputes. As against setting up vague rules that depend on interpretation by bureaucrats.

  8. Oh fair enough, I agree. By all means set up rules beforehand that tell people what to do. You may or may not not want to auction off spectrum (there are issues with that as has happened with Nokia and Siemens today for example) but very possibly you may decide to have some other scheme which is independent of human intervention in the form of a bureaucrat.

    And just as you might define a clear rule to deal with the spectrum issue (and ideally a rule that doesnt involve the govt. actively), asking people to sign contracts for example is also a clear rule. (Which again doesn’t involve the govt.).

    However, I don’t see how its self evident that all possible situations could be covered without human intervention. For example suppose you said that a manufacturer can set up a production line without royalties provided the process differs from the patented process. In that case, you’d need someone to confirm this difference *before* the production starts (or at least it might well make sense to avoid major problems for the new business and the old one later).

    To me this is very much a semantic issue- You’re willing to countenance reasonable government action in different situations but assume that the sensible course can always be put down on paper and followed like a computer program. Perhaps you’re right, but I don’t see that as necessarily true. Furthermore, when it is possible, I’d say it still ought to be called a regulation but we could go ahead and call it a law if thats more acceptable. Finally lets say I did have a sector which required a bunch of these special rules (even if laid down in advance on paper). I might well decide to set up a special body to make sure those rules are obeyed and to decide if they’re working well. And then you’re dangerously close to having a regulatory authority.

    And no, I’m not proposing any regulation in particular and certainly not that every action should involve a bureaucrat. All I’m saying is, that if a regulation is a hoop you must jump through *before* doing something, then those hoops might well make a lot of sense.

  9. “There is no need to set up a regime where every action on it has to be approved by a bureaucrat. It is the latter form of regulation that is corrupting.”

    Thinking over it, thats a much more complex statement you’ve made now. It begins with the characterization of an extreme (who’s been talking about this mythical regime or defending it) and goes on to refer to a particular shade of regulation you’re opposed to. Which is an entirely different thing to the brave new world you were defending in your post where men were men and regulations were scum.

  10. Yes, but by then one firm has set up a huge factory, distribution network, employed staff…the works. Perhaps they can no longer be profitable paying royalties. Perhaps the other firm doesnt even want to license the process. Perhaps they were unable to decide for sure whether or not the process was sufficiently different and hence went ahead, thus getting into trouble.

    Is it so unreasonable to prevent the domino effect that would result from suing by simply requiring this potential problem to be forestalled in the beginning?

  11. So if some companies end up paying high penalties or even having to shut down their processes because they infringed copyright, other companies will be careful in the future and check before they start their new line. We end up doing exactly what permissions are supposed to do without the overhead.

  12. I’m not so sure. In the real world those companies would fight tooth and nail, and cases would drag on forever. If justice were done, years later, and one firm shut down, hundreds of innocent people would end up becoming innocent casualties. And as I said, while it seems likely that the end result would be that other companies would routinely check, no one can possibly know how long that end result to take to occur.

    In the meantime, the government needs to take a call. How much harm could occur? Do they have the right to knowingly expose people to possibly immense harm in the hope that after the turbulence settles they achieve the same result as regulations? How long (crucial question) would this settling take?

    I do not think in those frames of reference it is at all obvious what a democratic government answerable to the people should do. Reasonably, you’d take it case by case and decide when you need regulating and when you can afford the interim damage in exchange for a simpler system.

    And therefore with everyone acting reasonably, you’d end up with a regulated market.

  13. In the real world? Again you are assuming that bureaucrats will take quicker decisions than the people who are really interested in the success of their business. There are thousands of patents and millions of ways to infringe them. Do you think it is humanly possible for the government to amass an array of experts in every conceivable field who will be able to scrutinize all applications and approve or disapprove of them in a way that will be both uncontroversial and quick?

    The only way your work is if you set up a quasi-judicial process, i.e. if the bureaucrat in question calls in expert witnesses from both sides and holds a hearing. The difference between my solution and your solution in that case is that I will want to do it only in specific controversial cases while you will end up delaying every single case.

  14. We’re arguing at cross purposes here. I’m not contesting at this time your claim that in many cases the market will eventually do what regulations seek to achieve. I’m not even contesting that for the most part this steady state will result in the market regulating itself quicker than when forced to from outside.

    What I am pointing out is that it is not possible to know how long it would take for the market to stabilize. How different those times would be across a country. What other factors might delay this convergence. That is, I am talking of the time when there are still plenty of disputes over patents, when a organized group of experts hasnt arisen by consensus, when some parts of a country are behind others in this respect and when cases are still dragging on.

    When you account for those uncertainties, account for the fact that very likely a regulated system will be better than an unregulated market *during the period of transition*, that therefore significantly less harm might be caused during this period (which I stress again is of unknown duration)- then it does not remain unreasonable for a government in many cases to put regulations in place.

    A democratic government might well be forced to do this. In fact it would take a complete lack of accountability to ever really implement a ‘no regulation’ regime of the kind you propose. And thats why it cannot happen.

    Your way requires upheaval for an unspecified duration and of uncertain magnitude on the way to an end. A society under those conditions would constantly be facing unheavals and turbulence simply because there are constantly new sectors undergoing this transition. The other extreme is a morass of regulation that stifles the life out of everyone and everything. In the middle you’d get a market with a healthy amount of regulation- or at any rate an inevitable amount of regulation, given the accountability the government presumably must have.

  15. But Anant, regulation is also not implemented by God. It takes years and decades of experience with the democratic process, decades of trial and error to come up with an effective regulatory regime. We have seen this – it has taken us 50 years and we still haven’t managed to get our government accountable. The Americans have been at it for 200 years and you will still hear them complain about their government.

    The logic that you are giving, if applied to the process of government, would require it to start from zero regulations and only add on regulations when there is an absolute need for it, with the onus of proving the need for every single regulation falling on the proposer.

  16. Ravi: Apologies for a slightly unrelated comment. I had a query on regulations but I couldnt find your email id. So I’m taking the liberty to copy my post below. Do let me know if you’ve any thoughts on the same.

    The financial auditing system provides a decent mechanism to regulate the financial reporting of companies. Interesting that such an instance exists of a state-less distributed regulation system that does seem to work – at least better than one can expect from state regulators. Three questions I’d like answered:

    1. Is there any other instance of such a regulation system?
    2. Why cant this work in other areas that require regulation? (For eg, I dont see the state regulating building construction efficiently or effectively)
    3. How did this financial auditing system come into being?

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