Hayek and regulation

I’ll be giving a seminar to the CIS tomorrow on Hayek and regulation. Somewhat to my surprise, The Australian asked me for an op ed, but then the editor got squeezed for space. As she wanted to run it on the day I gave the paper it got quite chopped about, though I hope the meaning made it through.

The full piece is below the fold.  You may have read it first in The Australian, but you read it all on Troppo.

If you’re reading this in Sydney and can make it to the CIS at St Leonards by 4.30pm today, you can hear me and some other people delivering our views on Hayek and his relevance for today.

Hayek and regulation

There are two figures I think of when I think about regulation. The first is Lord Acton. Hes famous for one of the best quips about politics and government until the advent of that torrent of insights provided by Yes Minister.

Lord Acton suggested that rowing was an excellent preparation for public life because it enabled you to go in one direction . . . while facing in the other.

That explains a lot of whats wrong with regulation. Politicians face in one direction one day chiming in with their concern about over regulation. In this spirit they introduce disciplines on regulation making for instance requiring all regulation to be vetted by Regulatory Impact Statements or RISs.

Only to ignore them. Requirements for RISs were introduced by Labor in 1986. Nearly ten years later just 8 percent of regulations requiring an RIS had an adequate one.

Was the Coalition any better? Im afraid not.

It got into power promising to cut red tape by 50% without having any idea how to do it. It then introduced a GST which John Howard had rejected as Treasurer in 1981 as a paperwork nightmare for business.

The Howard Government conducted two major reviews of Red Tape. While the second one was deliberating it put Workchoices through the Parliament with an RIS that read like a corporate brochure. It was rejected by the gatekeeper organisation, then the Office of Regulation Review (ORR). When the Government amended its Workchoices legislation with its fairness test before the election, its RIS was similarly inadequate.

So its not surprising that, as the British Chambers of Commerce observed about the UKs efforts with regulation reform recently, Labour and Conservative governments proceed with apparent enthusiasm, learn little or nothing from previous efforts and have little if anything to show from each initiative.

But I think theres an even more profound problem than the Lord Acton problem. I call it the Friedrich Hayek problem. Hayek blew the whistle on the fundamental problems of central planning. He anatomised the way in which the cheerleaders for communism glorified the knowledge of the engineer the person who can work it all out in theory.

Engineers, Hayek argued, brought one kind of knowledge. But their knowledge was dangerously incomplete. Hayek argued that the high level scientific knowledge that was used to centrally plan both physical structures and social institutions from the top down must be combined with the local and often social knowledge of those on the ground of traders in the market.

Had he turned his mind to it, I think he might have thought that our apparatus for managing over-regulation is a tad too heavily weighted towards the high level knowledge of the engineer or in this case the policy designer. Seen in that light, the RIS process remains a creature of central planning a top down routine that central planners have set up to try to prevent other arms of the bureaucracy from centrally planning badly. That isnt to argue against the RIS, but rather to point out its limitations.

Consider the RIS for the Howard Governments big bang tax reform in 2000. It reposed on the ORRs website as a model of a good RIS: This for piece of regulation that sparked off Australias only red tape revolt!

One need only write an RIS to know that, while they can be a useful discipline, it is impossible to anticipate how particular regulatory structures will work except by observing them in action.

Hayek theorised, quite rightly that central planning is a dysfunctional way to run an economy that markets are much better at utilising the local information that central planners cannot be aware of and have minimal incentives to take advantage of.

But really large organisations are necessarily centrally planned. And since at least the time of the big American railroad corporations, theyve been wrestling with the dilemmas of central planning themselves. One particularly promising development occurred in Toyota in the 1950s and 60s.

Under the influence of American statistician Edwards Demming Toyota pioneered a system in which management the central planners went to then unusual lengths to get both feedback and engagement from their workers on the assembly line, their customers and their suppliers.

This wasnt a suggestion box in the corner of the factory. Toyota formed their workers into quality circles and paid them to meet regularly to constantly strategise ways of improving their productivity, their service to the company and its customers.

Im guessing they hadnt read Hayek, but they understood the importance of supplementing the scientific knowledge of the engineer, and the directive commands of the manager with the local knowledge and ingenuity of the workers on the line and of others in the extended production system that forms the firm and all its immediate relationships.

If wed thought like Toyota, we wouldnt have imagined that a great RIS could solve all the problems that might arise with a big overhaul of our tax system together with the BAS a whole new interface between taxpayers and government.

We would not just have consulted business as is required by an RIS. We would have engaged business and taken their feedback seriously. We would have put the newly designed BAS through comprehensive trials with businesses in the way that Toyota would test prototype cars and test run its assembly of new models.

Then wed build in the capacity for ongoing review and optimisation. Hayek was right about the inadequacies of central planning. If the last quarter of the twentieth century marked Hayeks ascendancy, when we realised his insights about the necessary limits of government, perhaps the next few decades might be dedicated to taking those insights further than he took them himself.

Given that large islands of central planning are inevitable in a modern economy within large firms and within governments (whatever their size), we need to take a leaf out of Toyotas book and start finessing the inevitable dilemmas that central planning throws up.

Nicholas Gruen is presenting a paper entitled Finessing the dilemmas of central planning. Can Hayek help us regulate better? to the Centre for Independent Studies seminar on Hayek today.

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skepticlawyer
13 years ago

Good stuff, Nick. I think many of Hayek’s insights are very useful for lawmakers generally. The paper I’m writing at the moment is an elaboration of the idea that laws should only be enacted when there are equal or better reasons for obeying (x) law than the reasons an individual citizen has when acting alone.

Sinclair Davidson
13 years ago

Looking forward to it. It seems that you want to bureaucratise Hayek. I’m sure some of the ferals would say that can’t be done at all, but policy entrepreneurs could succeed in some areas (Toyoto being an example, although diminshing returns sem to have set in quickly and replication of quality circles have not always worked well). I wondering though how your argument here matches up to the 2020 big idea you have?

Fyodor
13 years ago

You’ve taken the wrong message from Toyota’s experience, Nicholas.

Kaizen is far more than passing information up to central planners. In fact, that’s entirely the wrong way to look at it. Kaizen requires devolution of power and responsibility to line managers and individual staff members. It means giving a factory floor worker the authority to shut down a factory line if quality issues arise. This is the antithesis of central planning, as exemplified by Ford and Alfred Sloan’s GM; it is decentralised management.

The lesson from Toyota is not that we can “fix” central planning. IMO, the lesson is that we should regularly challenge the assumption that central planning is required in the first place, with obvious implications for regulation. This is a far more Hayekian stance than you have taken.

NPOV
NPOV
13 years ago

Giving lower-level workers more authority is surely one way of introducing an element of competition into a large organisation: not that there are necessarily rewards for being the best factory floor unit, but if you have a whole series of units operating under slightly different guidelines, upper management could then base decisions on what make for good general guidelines based on which units were producing the best result. Of course you still have the problem of management being responsible for determining what is “best” (i.e. essentially, guessing what customers want, or at least, what they can be best persuaded to want), but that’s obviously a skill that management need to have.

OTOH, some of the biggest and most successful companies in the world are essentially centrally-planned. If Walmart can coordinate nearly 2 million workers into a profitable enterprise, it’s curious why central-planning can’t work for entire nations of a similar size.

john tons
john tons
13 years ago

The problem that also needs to be raised is that whilst central planning does not work nor does relying on Adam Smith’s invisble hand – undue reliance on the invisble hand will result in that self same hand choking the life out of a society.
The problem with the free market is that it is based on the assumption that market players are absolutely rational decision makers whose capabilities of reasoning and memorizing are unlimited. There is always a role for governments to have a hands on role; as long as they do not assume that they are infallible and are prepared to make ongoing adjustments in the light of the inevitable unexpected outcomes.

NPOV
NPOV
13 years ago

Nicholas, obviously someone has to make a decision as to exactly what sort of cars to make, based on what will sell. Management presumably make use of all available resources to do that (including their employees), but at the end of the day it is just a glorified guessing game, not substantially different to any other business.

jc
jc
13 years ago

The problem with the free market is that it is based on the assumption that market players are absolutely rational decision makers whose capabilities of reasoning and memorizing are unlimited.

I wouldn’t argue that. markets explains exchange between people. And why would you think government action is more rational?

NPOV
NPOV
13 years ago

I’d argue most people obviously do accept that governments are better than we individually are at making rational decisions of a sort likely to affect large numbers of people, or we wouldn’t vote for them. And much as I have no time for the current federal Liberal party, I don’t doubt that it did a better job of running the country than I would have.

Brendan Halfweeg
Brendan Halfweeg
13 years ago

The problem with the free market is that it is based on the assumption that market players are absolutely rational decision makers whose capabilities of reasoning and memorizing are unlimited.

There is a utilitarian argument that is pro-market that recognises that voluntary transactions between individuals to be preferable to coerced transactions. Simply, that when individuals, or even groups of individuals act independently to each other, their ability to innovate and manage risk is enhanced, and on the flip side, when individuals and groups of individuals get things wrong, the impact is generally less because the market provides alternatives and will renew the mismanaged capital through creative destruction and renewal. When centrally planned economies go wrong you end up with rations and queues.

Actually, there is another point in which I disagree with you as well, since individuals do not need to have full knowledge in which to make a decision because they are part of a market. They can take their cues for making a decision based on the actions of others, with a major information marker being price.

jc
jc
13 years ago

Id argue most people obviously do accept that governments are better than we individually are at making rational decisions of a sort likely to affect large numbers of people, or we wouldnt vote for them.

They do screw up, N. Aboriginal affairs has been a mess for the past 30 years. Take a look at the media laws and see if you can make head or tail of them? Some of the sections actually contradict each other.

Nabakov
Nabakov
13 years ago

Speaking of regulation, have you been following the emerging issue of rejigging Australia’s national aviation policy Nick?

That might be worth a post down the track with a bit of debate/discussion thread that may be digested by others.

I’m happy to suggest some starting points.

Simply, that when individuals, or even groups of individuals act independently to each other, their ability to innovate and manage risk is enhanced, and on the flip side, when individuals and groups of individuals get things wrong, the impact is generally less because the market provides alternatives and will renew the mismanaged capital through creative destruction and renewal.

Absolutely right…in theory. In practice, markets in this globalized world are often dominated by major actors who when they get things wrong, trigger destruction that is not often creative at all. And then get bailed out by taxpayer money.

Exhibit A: The subprime fuckup.

When centrally planned economies go wrong you end up with rations and queues.

As opposed to foodstamps and mortage foreclosures?

Look I’m all for free markets and capitalism (which are two discrete and distinct entities) which are now delivered the most incredible wave of prosperity, creativity and opportunity in human history.

But they are processes and tools not blind ideologies and value-free visions.

Take a look at the media laws and see if you can make head or tail of them? Some of the sections actually contradict each other.

Yep, they’re a total mess. Decades of Governments of all stripes pandering to, panicing about and pissing around with powerful media interests and new technologies have turned it all into a complete dog’s breakfast.

Personally I think Australia’s media laws should take up no more than about five pages of single-spaced 12 point Times New Roman. Mainly dealing with what areas of the electromagnetic spectrum should be quarantined off for emergency and essential services traffic. And of course for mobile phone companies and wifi providers.

Beyond that, open slather I reckon. I’m really looking forward to interrupting everyone within a 1 km radius watching “Sixty Minutes” with a pirate TV broadcast. It’s surprisingly easy to do techwise. Just the fines for interrupting sanctioned commercial use of the airwaves are stiff and rigorously enforced.

I speak as someone who once, with a bunch of others, jammed all Channel 9 TV reception in the Melbourne CBD for about 45 minutes with footage of Sterlac dangling by flesh hooks from a crane to the tune of Roger Whittaker’s “Dang Me, They Oughta Take A Rope And Hang Me” interspersed with me reading generic news in a balaclava. Boy, did the cops turn up fast to put a stop to that little prank. Never caught us though and the Herald-Sun later blamed it on TISM – who never issued a denial, the sneaky credit-seizing bastards.

Media anarchy for all!

melaleuca
13 years ago

Central planning has a deservedly bad rap but it wrong to think it can never be done well. Greenie types such as myself like to cite Curitiba, Brazil (pop. 3.2 million) as an example of excellence in central planning. A Master Plan was developed by mayor Jaime Lerner and his team for the city in 1971 and has been a brilliant success in terms of open space, transport, education, poverty reduction, housing and so on- see here for details http://www.pbs.org/frontlineworld/fellows/brazil1203/

Lerner was an architect and his successors have included 3 urban planners and 1 civil engineer who have continued on with the good work.

Rather than cynically gripe about the hopelessness of central planning I think it would be more profitable to learn from those few who have achieved excellence.

skepticlawyer
13 years ago

I speak as someone who once, with a bunch of others, jammed all Channel 9 TV reception in the Melbourne CBD for about 45 minutes with footage of Sterlac dangling by flesh hooks from a crane to the tune of Roger Whittakers Dang Me, They Oughta Take A Rope And Hang Me interspersed with me reading generic news in a balaclava. Boy, did the cops turn up fast to put a stop to that little prank. Never caught us though and the Herald-Sun later blamed it on TISM – who never issued a denial, the sneaky credit-seizing bastards.

That was you? Best. Prank. Evah. I dips me lid!

Brendan Halfweeg
Brendan Halfweeg
13 years ago

In practice, markets in this globalized world are often dominated by major actors who when they get things wrong, trigger destruction that is not often creative at all. And then get bailed out by taxpayer money.

That is not free markets, that is political interference. Regulation of private enterprises often permit corrupt and fraudulent businesses hide between compliance. When private organisations fail, politicians who have long taken credit for the good times, seek to offset the damage of private bad decisions through bailouts and other rent seeking enabling activities. I do not advocate this at all. When the state shows a propensity for interference, it can legitimise excessive risk taking, such as what recently occured in the UK with Northern Rock.

The economy is bigger than any actor, including the state. However, it is only the state that has the power to coerce all players, and change the playing conditions.

jc
jc
13 years ago

Nabs:

The subprime lending cluster bomb was mostly about government intervention.

The US housing market is actually quite interventionist with a number of agencies involved in mortgage lending causing all sorts of market distortions In fact its far, far more interventionist than ours.

There is a wide perception that FHLMC securities are backed by some sort of implied federal guarantee, and a majority of investors believe that the government would prevent a disastrous default. Vernon L. Smith, 2002 Nobel Laureate in economics, has called FHLMC and FNMA “implicitly taxpayer-backed agencies.” [2] The Economist has referred to “[t]he implicit government guarantee”[3] of FHLMC and FNMA.

Freddie Mac is leveraged at over 30:1

The Fed left interest too low for too long thereby causing some fairly significant credit mis-pricing.

They were kept between 1% and 2% for about 3 years in the early part of the decade. Talk about monetary mismanagement by the Fed.

There was also the little discussed intervention by Federal authorities including the bloody Fed and other agencies such as the HUD coercing and later demanding that banks stop their “racist” lending practices (in the late 90s) as they were turning down a high number of minority loan applications. This had the effect of loosening up lending standards.

Take all these factors together and this becomes another example of people calling market failure when muddleheaded intervention and bad policy paves the road to hell.

NPOV
NPOV
13 years ago

Having regulation in place and having it meaningfully enforced are two different things however. Much as I agree a fair amount of the blame for the state of the financial markets and the U.S. economy in general can be apportioned to poor decisions by the government and the federal reserve, it still remains the case that a large amount of credit was sold to people that clearly couldn’t afford it, in deals that were either illegal or almost certainly should be, given they were obviously taking advantage of the fact that customers were not able to properly comprehend the longer-term financial consequences (the applies everywhere from poorer households taking up ARMs to financial institutions buying up CDOs).
If so much illegal dealing was going on anyway, then it’s as good as being a basically unregulated market.

jc
jc
13 years ago

If so much illegal dealing was going on anyway, then its as good as being a basically unregulated market.

Funny, but in the old days we called that fraud.

NPOV
NPOV
13 years ago

Well, precisely. So you are accepting that preventing fraud requires active government intervention?

jc
jc
13 years ago

You mean like court action? Sure. But there is well developed established laws against fraud.

NPOV
NPOV
13 years ago

But who’s going to initiate court action when dodgy credit providers are selling loans to poor families that can’t really afford them?

jc
jc
13 years ago

Haul them all into court and let a judge or grand jury figure it all out.

It just isn’t poor families by the way. There were lots of people taking spec positions buying numerous houses at a time using dodgy info on their low doc loan applications and the brokers were lying. it was purposeful deliberate fraud in numerous cases as a Deutsche bank research paper points.

Here:

The speculation numbers reported by the WSJ are almost beyond belief. About 20% of mortgage fraud involved “occupancy fraud,” or borrowers falsely claimed they intended to live in a property, according to an analysis by BasePoint Analytics, a provider of fraud-detection solutions in Carlsbad, Calif. Another study, by Fitch Ratings, looked at 45 subprime loans that defaulted within the first 12 months even though the borrowers had good credit scores. In two-thirds of the cases, borrowers said they intended to live in the property but never moved in. The lenders knew this was happening and did nothing to proactively prevent it. Home builders have reached similar conclusions.

http://www.princeofwallstreet.com/2008/02/19/speculation-and-fraud-in-mortgage-lending-turning-a-blind-eye/

It’s a blog run by some young kid investment banker.

jc
jc
13 years ago

I don’t mean haul poor people into court as most probably didn’t know what they were signing, but the brokers originating the loan have a little to answer for

NPOV
NPOV
13 years ago

That doesn’t answer my question – which was “who’s going to initiate court action”?

jc
jc
13 years ago

The banks, the security owners. The DA’s can initiate charges on their own.

NPOV
NPOV
13 years ago

Ok, but, as far as I know, DA’s have not been initiating court action against dodgy credit providers. Hence you appear to be arguing that the government isn’t intervening when it should be?

jc
jc
13 years ago

N

You need to give this show a little time to play out. it does take a while for cases to get to court. This isn’t Law and Order repeats you know. Stop being so impatient :-)

I would exactly call judicial actions government intervention.

Anyways you have just had government intervention with the Fed’s actions over Bear Stearns as well Opening the Fed window to investment banks junk paper.

Take advantage of it by buying bonds issued by US banks or investment banks as theyre trading at very attractive yields. Since the Bear Stearns bailout bond and debt holders now have an implicit US government guarantee. And therefore risk reward wise it can’t get better than that. Just thank Uncles Ben and Sam for the gift.

jc
jc
13 years ago

Ummm

I WOULDN’T call…….

NPOV
NPOV
13 years ago

How is DA’s initiating court action against businesses (and/or private individuals) not a form of government intervention? Indeed, isn’t anything that the government does interventionism by definition? Mind you, I don’t personally consider intervention a dirty word.

And yes, obviously there has been a fair bit of intervention already (though presumably as you know the Federal Reserve doesn’t technically act as a government body).

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[…] Nicholas Gruen had an interesting piece in The Australian on Thursday which argued that Hayek’s theory of the distribution of knowledge in society could provide a guide to better regulation. (A longer version is at Club Troppo) […]