Tuesday 7 February 2017

Principles of Regulation - A Juggling Act

A regulator would have to juggle between a number of stakeholders in formulating regulations which, on the overall basis, should serve the interests of the public which not stifling business. While the concept is straight forward enough, the implementation could be challenging for few reasons.

First challenge would be for regulators to understand how the market operates. As regulation is required due to market failures, where market forces are not able to set equilibrium levels which are fair to suppliers and consumers, regulators must have a good understanding of market mechanisms, building blocks and key issues. Any regulation which is designed without due consideration on these factors would carry the risk of being inefficient.

Coincidently, there was a conversation this morning of whether the Price Control and Anti-Profiteering Regulation which introduced recently would benefit the public at large or would have the unintended consequences of raising cost of doing business in Malaysia. The conversation could be downloaded here.

Second is about having clear objectives of the regulatory outcomes which are supposed to address the identified market failure. Without the clear objectives, regulators would lose the sense of direction and could end up creating solutions looking for problems. This is particularly true for regulations which are adopted from other jurisdictions to align our legal frameworks and business practices with certain international standards. 

If regulators do not understand the contexts surrounding the failures which are intended to be addressed by the adopted regulation, its application in markets where the surrounding practices are different or the pattern of outcomes are not the same would carry the risks of introducing regulations which are not effective but creating unnecessary burdens to business entities.

Third is about ensuring the measures introduced are no more burdensome than necessary. This is to ensure regulators try to find ways which are simple and easy for businesses to comply with the regulation, not requiring high compliance cost and able to mitigate the identified market failures.

Sometimes, due to pressure from various lobby groups or sue to political interests, regulations are stretch to go beyond just addressing market failures. For example, under the pretext of ensuring consistent quality, certification of a process could only be done by one business entity. An example of this is the motor vehicle inspection services in Malaysia. Instead to defining the technical requirements which could be achieved by certified workshops, the concession to inspect commercial vehicles is given to one company only. So, in addition to ensuring quality of inspection, a monopoly is also created by the regulation.

As mentioned above, regulators would have to balance between conflicting interests of various stakeholders in addition to lobby groups which want to benefit economically or politically from the regulation being considered. This requires regulators to have high level of integrity, independence and professionalism to ensure they do not go beyond what is necessary where on group of stakeholders lose more then others because of factors which are not related to market failures. Would this be possible?

There is one kind of regulators which are exposed to inherent conflicts of being regulators and having self-interests at the same time, professional bodies. While  naturally they are supposed to regulate their members to ensure public benefits are not compromised, the fact that some of the professionals who set standards are themselves practitioners could be scary. This is the reason why the self-regulatory model is challenged and for some services such as audit of public interest entities, an independent regulatory body is set up to ensure the conflict is managed.

As a conclusion, a good regulation is the one which market failures are addressed in ways which is no more burdensome than necessary. In achieving this objective, regulators must be professional and independent and have deep understanding of the market which it regulates. They must also be able to withstand pressures from lobbyists and politicians who want to stretch regulations beyond their original intended purposes.

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