December 7, 2021

I would never want to work as a ‘Regulator’.

You oversee companies that you do not work for. Getting only the data and access that the companies agree to share with you. Second guessing industry executives that think they are way smarter than you and make a lot more money. And when you ‘do your job’ by flagging a potential issue, then you are the jerk slowing down the American economy.

On top of all that, for many ‘regulators’, their professional goal is to eventually be hired by the company they are paid to regulate.

The way regulation works in this country is a mess.

Of course, some regulation is needed for a country to operate safely, successfully, and sustainably. Regulators, like the Federal Aviation Administration (FAA) have an important job to do.

Over time, misplaced sympathies within regulatory bodies lead to disasters like the recent Boeing crash in Ethiopia. This is an example of a big systemic risk that people should pay attention to: regulatory capture.

Air travel is generally very safe. Much credit has been given to the FAA, the world’s premier aviation regulator for decades. And until recently, the Boeing 737 was considered the safest airplane in the sky. Now, both Boeing and the FAA are under the microscope and their reputations are seriously damaged. What happened?

Instead of monitoring, restraining, and guiding aviation companies, the FAA, over a period of years, relaxed to the point of not doing their jobs adequately. They began allowing Boeing (and others) to self-certify on safety issues. In short, the FAA experienced regulatory capture and gradually stopped doing their jobs.

A typical argument in defense of self regulation sounds like this: Boeing has been trading on its sterling safety reputation for many years, and they wouldn’t do anything to jeopardize that reputation. It sounds good in theory, but practical experience tells us this view is wrong. Boeing wants to sell more planes — that’s what they do. Nobody at Boeing wanted a crash, but executives’ incentives encouraged them to underestimate the risks of a new airplane model and to overestimate the efficacy of their risk mitigation strategies.

This kind of skewed risk assessment is pretty much universal to all people, no matter how good their intentions. That’s why we create regulators like the FAA. It’s their job to prevent aviation companies from making these kinds of mistakes. We set public standards that take some amount of critical decision making out of the hands of people who have contrary incentives. It’s a system that can work pretty well, if it’s used properly.

But the system breaks when regulators get chummy with their subjects. They’re not meant to promote the success of American companies like Boeing. Industry loves to have partnership relationships with regulators, but a tough and adversarial relationship has great benefits. Strong regulators force companies to achieve levels of quality and risk mitigation that they just won’t reach on their own because it’s costly to go the extra mile.

Regulatory capture is a danger across industries and sectors. Regulators are naturally sympathetic to the desires of their once and future employers, and the revolving door can lead to dangerous erosion in safety standards. We’ve seen it in the financial services industry, oil drilling, big tech, and more. As investors, consumers, and taxpayers, we should all pay attention to the quality and independence of regulators. Sometimes, they’re indispensable.

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