The Era of Re-Regulation is Upon Us

Although the nation’s attention is focused on the financial crisis it is worth thinking about how this mess will affect attitudes toward government intervention.

The July issue of The Atlantic magazine, published before the meltdown began, looks at the “11½ Biggest Ideas of the Year.” The return of regulation is one of them. After nearly three decades of growth-enhancing deregulation and regulatory reform, The Atlantic observes, “a major rethink is underway. … Regulation is back.”

Not only is regulation back in vogue, but regulatory competition also appears to be on its way out of fashion.

Regulatory competition creates rival centers of political and bureaucratic authority. This empowers businesses to choose which bureaucracy regulates them and likewise permits consumers to choose the regulator that affects them through their choice of sellers from whom they purchase products. These competitive pressures force bureaucrats to provide balanced and effective regulatory policies.

The Treasury Department’s comprehensive proposal to reform the regulation of financial-services companies does extend to insurance companies the same option that banks currently have to choose whether they are regulated at the federal or state level. Still, the overall thrust of the Bush Administration’s regulatory initiative seems to be in the opposite direction: regulatory consolidation and unification, increased regulatory coordination and harmonization and the elimination of multiple and overlapping centers of regulatory authority.

A careful reading of the Bush proposal suggests that over time the dual state/federal system of bank chartering would be transformed into a unitary federal one. State chartering would atrophy under the pressure of federal deposit insurance and other federal guarantees being used as carrots and sticks to nudge state-chartered institutions to the federal charter.

This isn’t surprising since regulatory competition has long been a bogy of regulators, who have a stake in maximizing their bureaucratic authority. They like to argue that without consolidated regulatory authority, competition among regulators results in a “race to the bottom.” For example, a 1993 internal Congressional Budget Office staff memorandum identified regulatory competition as one of four “problem areas of the current regulatory structure.”

Critics of regulatory competition are quick to scaremonger about a “race to the bottom” and “competition in laxity.” Sounds scary, but what does it really mean? Does such a “race” actually occur, and if so, does it really harm consumers? Or does competition simply prevent a race to the regulatory summit by breaking up concentrations of political power among regulators and bureaucrats the way economic competition breaks up concentrations of economic power in cartels and monopolies? Evidence suggests the latter.

To Georgetown University professor Dale Murphy, the evidence indicates that regulatory competition seldom actually leads to anything approaching a “competition in laxity.” He writes that even when competition among regulators produces minimal regulation there is no evidence that the outcome is suboptimal oversight or that consumers are harmed.

Pinning the current financial crisis on regulatory competition is a post-hoc-ergo-propter-hoc fallacy designed to divert attention from the real source of the problem: the worst monetary policy since the Great Depression.

Even the European Union, which is notoriously obsessive about stamping out tax competition by “harmonizing” member-states’ tax policies, has recognized that regulatory competition fosters improvement of regulatory regimes.

In areas as diverse as contract law, family law and transportation policy, banking, investment, and insurance, the EU has found that regulatory competition and diversity of regulatory regimes strike a balance that serves consumers’ interests.

The EU’s tradition of mutual recognition of member states’ regulatory regimes creates an integrated, union-wide market where consumers are free to purchase goods and services across national boundaries without regard to regulatory jurisdiction or company of origin.

Rather than stifling regulatory competition in the name of reform, the U.S. Congress should enhance and expand regulatory competition. For example, effective reform of insurance regulation would include creating an unbiased optional chartering system combined with a consumer-choice provision that breaks up the balkanized state-insurance markets by allowing consumers to select insurance products from any company they choose regardless of where that company is chartered or located.

Regulatory competition is not the problem; it’s part of the solution.

Dr. Hunter is a senior fellow at the Institute for Policy Innovation.