Regulation according to Lateral Economics: the transcript

Because I managed to say some things in the interview of the report on Regulation and Innovation more compellingly than had been said in the report (pdf) or in the op ed of the report, I was about to try to hunt someone down in India to transcribe the relevant part of the program. Anyway, the General Manager of Peach Home Loans used to be in the transcribing business, so I asked him to recommend someone. He suggested I try the business he started and then sold. Transcriber Online. I did this and turned up at a website that was a complete mess with Firefox. Unimpressed but undaunted, I pointed towards the relevant url on the Radio RN, Counterpoint website in an introductory feedback form and asked for a quote.I never got a quote.

But a few hours later I got back the transcript. No quote or invoice was issued. So as you might imagine, it’s the very least I can do to heartily recommend the service. I’ve not been through the transcript which is over the fold with a fine tooth comb. But I didn’t see any obvious errors. And I can’t fault it for value for money.

Deregulation

Michael: Well lets talk about regulation. Its tempting to think all regulation is bad, but of course its not, indeed its a two-edged sword; sometimes it is bad, it suppresses energy, but at other times its actually necessary to increase competition, even sometimes to encourage innovation. Now am important question is whether these distinctions are sufficiently understood and, indeed, reflected in government practice, and our next guest says theyre not.

Nicholas Gruen is an economist who used to be with the Productivity Commission; he now runs a consultancy called Lateral Economics, and he was with us a few weeks ago talking about prosperity and some of its problems. Well this week he releases a report on regulation commissioned by the Victorian government, and he joins us again.

Nicholas, welcome back.

Nicholas: Hi, Michael.

Michael: Lets venture into the subject of regulation by having a look at the federal governments Office of Regulation Review and its state equivalents. What do these agencies actually do?

Nicholas: Okay, well, the Office of Regulation Review, as is the way with these things, has recently been renamed to be the Office of Best Practice Regulation. Its been around for about twenty years and there are, um, equivalents in each of the states. And of its most fundamental task is to oversee the whole regulatory, the whole process of regulation, and in particular to, to help with the administration of a policy which was called in 1986 by Bob Hawke minimum effective regulation, and the most central part of that policy is to require all new regulation of any significance to be accompanied by a Regulatory Impact Statement – and, you know, your listeners will have heard of Environmental Impact Statements and so on – this is one of those. And the idea is that those Regulatory Impact Statements will subject new regulation to rigorous cost benefit analysis, and the idea is that that means that if we stop all the bad regulation well be left with good regulation.

Michael: And is it fair to say that the, the setting up of this and some of the other agencies back in the 80s represented a healthy awareness of some of the problems of regulation?

Nicholas: Oh, absolutely. And, ah I mean this was on the back of the scholarship of people from the Chicago School of Economics, people like George Stigler, who showed in the 50s and 60s that an awful lot of regulation that governments have got themselves involved in actually managed to make things worse, and it managed to do that in a whole bunch of ways, one way which of course is regulatory capture. So Stigler was able to show theres some controversy about the ¹, as you might imagine but he was able to show fairly plausibly that states which had had price regulation to limit the monopoly power of utilities in fact seemed to have higher prices than states which didnt. So the, the the general message is watch out for dysfunction in regulation, watch out for unintended consequences because even in some of the best intentioned, a seemingly most obvious regulation, youll get unintended consequences, mostly perverse ones, in spades.

Michael: Now in a second were going to talk about some of the problems that still remain

Nicholas: Thats right. The unintended consequences of trying to address the unintended consequences.

Michael: ². But just briefly, um, presumably these government agencies did have some good impact on, on regulation making, did they.

Nicholas: Well, ah, I think they did. Its quite hard to Its quite hard to detect it. There have been reviews of these agencies, usually by reasonably sympathetic parties from, from associated agencies so that I recall the Office of Regulation Review had a review by someone seconded from the Treasury and so on, and they, they move in similar orbits, and the conclusion was, look, it seems to be doing quite a good job insofar as its able to. I think the regulatory agencies would argue that they are not given enough authority by politicians, and I think theres a lot to that. But I really think theres a lot theres a much bigger story to be told really.

Michael: Yeah. So lets accept that there is a healthy awareness in the bureaucracy and outside it of the problems of excessive regulation, but, but given that, what are the problems that remain, and in particular whats what are the ones that youre concerned about now?

Nicholas: Well I guess I would say that the re-regulation or the regulation that weve changed by essentially deregulating has been a great success. Where we know that regulation needs to remain I dont think weve I dont think that these app-, the apparatus that weve constructed to try and stop bad regulation has focused enough on the wherewithal of getting good regulation, and I guess, you know, I think of Michelangelo who was asked how he made all those marvellous sculptures and he said, well, you know, really we start with a block of marble and we just get rid of all the marble that I dont need and there it is, theres the masterpiece. I dont think thats the way I dont think weve, weve addressed that question of how do we regulate well, how do we regulate really excellently in areas where were going to need regulation until the cows come home, and there are plenty of those consumer protection, investor protection, health, safety, environment, just to, just to start.

Michael: Okay, so there was an argument about, about whether where we should and shouldnt have regulation, now we should be having an argument about, okay, we have to have regulation, how do we do it. Now you see current forms of regulation as having something in common with Taylorism, dont you, the rigid management practices that were advocated by Frederick Taylor.

Nicholas: Yes, indeed, so that I mean the, the, the example of Taylorism in management is, is again, I mean you can refer not just to Taylor but also to Frederick Haigh(?) who talked about the limitations of central planning. The problems are exactly the same, which is that if you have a highly complex system you can do as much work at the top as you like, you basically dont have the information to get it right and you and the managers very often dont have the right incentives. So what happened with Taylorism, what happened with this idea that basically you get the engineers in to design a system that runs as a factor and they design it in minute detail and they have all the parts that will arrive from the suppliers all specified in minute detail and then they hold an auction, all that basically disappeared in the, ah, in the 1950s and 60s when the Japanese, with the help of an American statistician and quality controller called Edwards Deming, decided that really the way to think about making a car was to say, well, what were really doing here is coordinating 90,000 manufacturing operations and we cant get the engineers to get all that right, what were going to have to do is were going to have to harness the natural enthusiasm of our workforce, if we manage them correctly, arrange them into teams and ask them and say to them what can you do, youre the guys with the information, youre the guys with the ideas about how to run things at the coalface, and weve got to try to weve got to try to empower those people. And as you, as you know, at the, at the limit of this sort of thing really quite extraord- these managers will go to quite extraordinary lengths to do that, including enabling any individual worker on a line with 1000 workers to pull a cord and completely stop the line if, if a problem hasnt been fixed. So its a very different way of looking at things and its, its inspired by the idea that weve really got to turn things upside down if necessary to get those incentives down to the people who are doing the work right at the coalface.

Michael: Okay, and that has happened to a very significant extent in industry and management, and now if I understand you correctly, youre advocating that the same sort of approach should be applied to regulation.

Nicholas: Thats right. And Im Im forever warning against applying analogies too crudely between private sector behaviour and government, but, but certainly I think we need to start with that idea, and if you look at the idea of a Regulatory Impact Statement, well what does that tell you, it tells you that our solutions so far to over-regulation has been, guess what, I mean Im sorry to sound like its the words of Sir Humphrey, but Regulatory Impact Statements in fact are form, are a form of regulation. Theyre a form they regulate regulators. So in order to try and deal with the problem of red tape and the problem of regulation we came up with another form of regulation which again exists right at the top.

Michael: Okay, so what should we do? What would a post-Taylorist form of regulation look a bit like?

Nicholas: Well I think we have to Some experiments have been made with trying to give firms rights to alternative compliance. I think we have to try to create a situation where a firm can put its hand up and say, listen, were doing just what were delivering what you want, that is consumer, you know, consumer awareness, consumer protection, were doing it in our way and what youve asked us to do is really, really dumb; we want to do it this way and were quite happy for our process to be audited and so on. So an example of this is that you may be aware from AAMIs advertising that they have a they, they began the process in Australia of having customer charters. In fact they had their customer charter launched by Allan Fels when he was the Chairman of the ACCC to some ³ and raising of the eyebrows. Now theyve That is a very dire Thats a form of internal regulation in which AAMI commit to a whole range of performance standards which are then audited by KPMG and they then report publicly on those standards, and if they dont meet those standards they tell you what theyre going to do including pay you some money. Now along came Financial Services Reform and AAMI had to spend over a million dollars retraining their staff to in effect provide service which was worse than they were providing but at least met the regulatory regime that we had, we had mandated as a minimum standard. Now that regulation that regulatory regime had passed the Regulatory Impact Statement.

Michael: ². So youre what youre calling for I guess is, ah, is that the government regulators when theyre talking to business should put the focus on, on outcomes rather than regulating to

Nicholas: Well

Michael: specified processes.

Nicholas: Yeah, thats just the beginning, and weve already got there. What I think they should also be doing is put the focus on responsiveness, and once you have regul- Weve got to move away from this idea of getting it all perfect and then introducing the perfect system and say what they said at Toyota, which is, look, the only way you get a really good system is you start with a good system and then you continually optimise it, and that process goes on forever, and if someone wants to put their hand up youve got to, youve got to actually go youve got to actually go to a great deal of effort to, to really pay honour to that sort of, that to the to that sort of information that is coming in. If you think about a business providing information to government, um, I mean why would they do it. They know that theyll go through years of heartache, and if the, if the best if the best comes to the best and government listens, theyve done a favour for all their competitors as well. So youre actually youre actually This is a really tough problem, and Im not telling you Ive got a silver bullet, but what I am telling you is we really havent we havent really thought about it much.

Michael: I guess the approach that youre suggesting involves a certain amount of trust, doesnt it; I mean were, were assuming in this that the businesses would have an incentive, they would go out and, and work hard to get this right.

Nicholas: Well, no. Its the old line that Ronald Reagan used about Gorbachev, trust but verify. You wont find, although there are lots of feel-good rhetoric about the Toyota production system, it was built it was built from the insights of a statistician. So what this is about is quality feedback, measuring outcomes. Um, it is definitely true that youre trying to aim for really high morale rather than low morale. Youre trying to aim for compliance not exactly out of the goodness of peoples heart but because you want to harness peoples desire to do a really good job, but, but youve at the same time youre carefully measuring what people are doing, and youre not doing that to be punitive towards them if they do the wrong them, youre doing it because people actually want to do the best they can. They may not want to work the hardest they can or whatever, but they, they want to do a good job. And so part of this system within management is to empower workers, not just by letting them stop the line if somethings gone wrong but by measuring and by allowing them to measure what theyre doing and use that feedback to get better and better at what theyre doing.

Michael: Nicholas, just one last quick question on another matter, I mean to what extent do we actually review our regulation? I mean a regulation comes in a few years ago, its been approved by the

Nicholas: Yep.

Michael: the agencies, do we actually ever go back on a

Nicholas: Yeah, we do.

Michael: regular way and look at it?

Nicholas: We have a process of rolling reviews but its terribly difficult to address every- its got the same Taylorist problem, which is that you have a whole review of, say, financial, the UCCC, the Uniform Credit Code or something, and there are a massive number of issues there and its all a big review and its all done and, and, and packaged up and a report comes out. Thats quite different to the sort of, ah, to the sort of individual optimising things that Im talking about. I mean I can give you a, just a magnificent example of how the Regulatory Impact Statement system worked on this subject when in 1994 I was on the Productivity Commission

Michael: Look, Im sorry, Id love to hear it but

Nicholas: Okay.

Michael: Im afraid were just about out of time.

Nicholas: Right, yeah.

Michael: So, Taylorism rules anyway for the moment.

Nicholas: ². Okay.

Michael: Nicholas, thanks very much for joining us.

Nicholas Gruen there from Lateral Economics, and weve been talking about his paper on regulation thats released this week.

Youre listening to Counterpoint on ABC Radio National.

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