Tag Archives: Regulatory Analysis

Should SEC Be in Charge of Foreign Policy

Last week, the United States District Court for the District of Columbia ruled in SEC’s favor on the Conflict Minerals rule. The rule requires public companies to track their sources of coltan, cassiterite, wolframite, gold and derivative minerals. These so-called “conflict minerals” are often used to finance violent armed groups in the Democratic Republic of Congo (DRC). SEC ‘s rule aims to reduce funding that flows towards these armed groups. Yet despite its laudable goals, the rules will likely fail due to poor analysis:

  • The rule fails to examine the extent of the problem. The rule seeks to reduce funding for armed groups in DRC but fails to examine whether the identified minerals actually constitute a major source of funding for these groups. If they are not, targeting other sources of funding could be more effective.  Similarly, if the armed groups can easily shift to alternative funding sources (DRC is rich in minerals that are not on SEC’s list), the rule’s benefit would be rather limited.
  • The rule presents no alternatives. One can easily think of other ways to reduce armed violence in DRC, including military assistance to DRC’s government or US-led operations to disrupt arms flows into the country. It is difficult to say whether SEC’s approach is more effective when the rule presents no alternatives that its decision could be compared to.
  • The rule fails to estimate benefits. In contrast to its elaborate discussion of the rule’s costs, SEC devotes less than a page to describe the rule’s benefits (only to acknowledge that it is unable to quantify the benefits due to lack of data). While few would expect SEC to have internal expertise on armed conflicts in Africa, the agency’s failure to solicit expert opinions from external sources is inexcusable.
  • The rule makes no plans to measure its effectiveness. In light of the SEC’s admission that it lacks data to estimate the rule’s effectiveness in reducing violence in DRC, one would expect the agency to identify specific metrics to measure success and to establish plans to collect data on the rule’s progress. Yet, SEC seems uninterested in whether its rule will actually produce positive outcomes.
  • The rule makes no plans for retrospective review. Even the best-intentioned regulations can lead to unintended consequences. Given that SEC knows so little about the area that it is regulating with this rule, the chances for things to go wrong are even higher. In fact, some commenters suggested that the rule’s burdens may fall mostly on ordinary citizens and not the armed groups that the rule targets. It is possible that the rule may do more harm to ordinary Congolese than good. Since SEC makes no place to reexamine the rule, it will likely remain in place regardless of its merits.

Troublingly, the court sided with SEC, singing off on the agency’s virtually non-existent economic analysis. My colleague Hester Peirce commented last week:

Although the court did not believe that the SEC had to do cost-benefit analysis for this particular rule given that Congress–not the SEC–made the public interest finding for this rule, the court signed off on the SEC’s analysis. The court reasoned that the SEC’s consideration of efficiency, competition, and capital formation sufficed; “to suggest that the [Securities] Exchange Act mandates that the SEC conduct some sort of broader, wide-ranging benefit analysis simply reads too much into this statutory language.” The need to assess benefits, according to the court, is particularly weak when–as here–a rule’s benefits are supposed to be humanitarian.

 The court’s assertion that humanitarian benefits need not be assessed is startling. One can reasonably argue that benefits of reduced violence cannot be easily monetized. Yet, the reduction in violence can and should be measured. How else would SEC know if its rule is having any impact?

Proponents of better economic analysis are often criticized that they only care about costs. As this example demonstrates, a better analysis can lead to a better rule – the one that actually saves lives.

Why Regulations Fail

Last week, David Fahrenthold wrote a great article in the Washington Post, in which he described the sheer absurdity of a USDA regulation mandating a small town magician to develop a disaster evacuation plan for his rabbit (the rabbit was an indispensible part of trick that also involved a hat). The article provides a good example of the federal regulatory process’ flaws that can derail even the best-intentioned regulations. I list a few of these flaws below.

  1. Bad regulations often start with bad congressional statutes. The Animal Welfare Act of 1966, the statute authorizing the regulation, was meant to prevent medical labs from using lost pets for experiments. Over time, the statute expanded to include all warm-blooded animals (pet lizards apparently did not merit congressional protection) and to apply to zoos and circuses in addition to labs (pet stores, dog and cat shows, and several other venues for exhibiting animals were exempt).The statute’s spotty coverage resulted from political bargaining rather than the general public interest in animal welfare. The USDA rule makes the statute’s arbitrariness immediately apparent. Why would a disaster plan benefit circus animals but not the animals in pet stores or farms? (A colleague of mine jokingly suggested eating the rabbit as part of an evacuation plan, since rabbits raised for meat are exempt from the regulation’s requirements).
  2. Regulations face little oversight. When media reported on the regulation’s absurdity, the USDA Secretary Tom Vilsack ordered the regulation to be reviewed. It seems that even the agency’s head was caught off guard by the actions of his agency’s regulators. Beyond internal supervision, only a fraction of regulations face external oversight. Of over 2600 regulations issued in 2012, less than 200 were subject to the OMB review (data from GAO and OMB). Interestingly, the OMB did review the USDA rule but offered only minor revisions.
  3. Agencies often fail to examine the need for regulation. In typical Washington fashion, the agency decided to regulate in response to a crisis – Hurricane Katrina in this case. In fact, the USDA offered little more than Katrina’s example to justify the regulation. It offered little evidence that the lack of disaster evacuation plans was a widespread problem that required the federal government to step in. In this, the USDA is not alone. According to the Mercatus Center’s Regulatory Report Card, which evaluates agencies’ economic analysis, few agencies offer substantial evidence justifying the need for promulgated regulations.
  4. Agencies often fail to examine the regulation’s effectiveness. The USDA’s plan to save animals in case of a disaster was to require owners to draw up an evacuation plan. It offered little evidence that having a plan would in fact save the animals. For example, the magician’s evacuation plan called for shoving the rabbit into a plastic bag and getting out. In the USDA’s view, the magician would not have thought of doing the same had he not drawn up the evacuation plan beforehand.
  5. The public has little influence in the process. By law, agencies are required to ask the public for input on proposed regulations. Yet, small businesses and individual consumers rarely have time or resources to keep an eye on federal agencies. In general, organized interests dominate the commenting process. The article describes the magician’s surprise to learn that he was required to have a license and a disaster evacuation plan his rabbit, even though the regulation was in the works for a few years and was open for public comments for several months. Most small businesses, much like this magician, learn about regulations only after they have passed.
  6. Public comments are generally ignored. Most public comments that the USDA received argued against the rule. They pointed out that it would impose substantial costs on smaller businesses. The agency dismissed the comments with little justification. This case is not unique. Research indicates that agencies rarely make substantial changes to regulations in response to public comments.

A Hidden Opportunity Cost of Regulatory Compliance: Management Time

At the federal level, regulators in many agencies attempt to estimate the impacts that new regulations would have on businesses, even if the average quality of these analyses is typically poor.  But these impact analyses rarely consider a conceivably major cost: the opportunity cost of business owners or managers who have to spend their time dealing with regulations.

One of the simplest costs that regulators consider, for example, is paperwork: how much more paperwork will be imposed on businesses as a result of a new regulation?  Indeed, the paperwork burden is sometimes the primary cost considered in these analyses, as was the case in this rule proposed by the Department of Labor towards the end of 2011.  This proposal addresses requirements for affirmative action and non-discrimination that apply to federal contractors, proposing, among other things, to “strengthen the affirmative action provisions, detailing specific actions a contractor must take to satisfy its obligations. [The proposal] would also increase the contractor’s data collection obligations, and establish a utilization goal for individuals with disabilities to assist in measuring the effectiveness of the contractor’s affirmative action efforts.”

Just consider one part of the summary of that proposed rule: “increase the contractor’s data collection obligations.” If you read on in the Federal Register notice (search for the term “12866” to get to the analysis section), you’ll find that the Dept. of Labor assumed that contractors have people in place to perform the increased data collection obligations. So for the analysis, the Dept. of Labor simply added some paperwork time to each contractor, and calculated how much the extra employee time would cost each contractor.

But here’s the catch.  What if the contractor has to hire a new employee to handle this?  The costs of searching for a new employee can be substantial.  A recent post in the St. Louis Business Journal featured Steve Baden, president of Royal Banks of Missouri, discussing the difficulties in finding and hiring a compliance officer – an employee whose job it is to oversee regulatory compliance, which certainly includes vast amounts of paperwork.  Baden said that the process of hiring a compliance officer took him “a year of interviews to find someone qualified and cost [him] six figures.”

Management time is expensive.  Business owners are the entrepreneurs that help create economic growth through innovation.  When they have to spend their time searching for compliance officers or filling out paper work, they are not spending their time finding new ways to improve their businesses or starting new ones.  This is a real cost of regulation, and one of the reasons that the accumulation of regulations can stifle an economy.

Furthermore, any employee’s time—whether it’s a new employee or one who already worked for the contractor—is also valuable time.  When Steve Baden has to hire a full-time compliance officer in order to navigate the paperwork maze created by regulations, that individual hired to ensure compliance will not do some other productive activity with her time.  How valuable is it to society to have highly skilled individuals spending their time collecting data or filling out paperwork to show compliance with regulations?  Time used on regulatory compliance is necessarily not time used elsewhere. Without the million-plus restrictions created by federal regulations, countless compliance officers would be gainfully employed in roles that create better value in the economy.

One of my mentors once stated that he could create jobs by hiring people to trim his lawn with toenail clippers (warning: links to a Penn & Teller episode, and they do not refrain from using vulgar language).  But that’s probably not the most productive use of their time.  The fact that an action creates jobs does not mean the skills and efforts of individuals are used in the best possible way, nor does it mean that there is necessarily a net gain in jobs.  The creation of a regulatory compliance job may be offset by elimination of one or more jobs elsewhere because of increased operating costs.