Regulators Would Be Wise to Exhibit Hayekian Humility
In Greek mythology Procrustes was a rogue blacksmith, a son of the sea god Poseidon, who offered weary travelers a bed for the night, an iron one he built especially for guests. But there was a catch. If the visitor was too small for the bed, Procrustes would stretch the guest's limbs until they fit. If the visitor was too big, Procrustes would amputate limbs as necessary. Eventually, Procrustes met his demise at the hand of the Greek hero Theseus, who fit Procrustes to his own bed by cutting off his head.
The myth of Procrustes contains an important lesson for government officials, like me. It warns us against the human impulse to squeeze complicated things into simple boxes, to take complex and rapidly evolving technologies and the business models they enable and force them to fit our preconceived models.
It is exceedingly difficult to predict the path of technology and its effects on society. The massive benefits of one of the most influential technologies in history, the Internet, in large part have been a result of entrepreneurs' freedom to experiment with different technologies and business models. The best of these experiments have survived and thrived, even in the face of initial unfamiliarity and unease about the impact on consumers and competitors.
Because it is so difficult to predict the future, government officials must approach new technologies and new business models with a significant dose of what I call regulatory humility. Regulatory humility means recognizing the limitations of regulation and acting with an understanding of those limits. It also means looking to the effective tools we have at hand before we impose new, technology-specific regulations.
The idea that regulatory action has inherent limitations has been discussed before, most notably by F.A. Hayek in his 1945 paper, "The Use of Knowledge in Society." For me, Hayek's key insight was his recognition that regulators face a fundamental knowledge problem, which limits the effective reach of regulation. A regulator must acquire knowledge about the present state and future trends of the industry he or she regulates. The more prescriptive the regulation, and the more complex the industry, the more detailed knowledge the regulator must collect. But, Hayek argues, regulators simply cannot gather all the information relevant to every problem.
What limits the ability of regulators to collect necessary information? First, because such knowledge is generally distributed in bits and pieces throughout the industry, it is difficult to collect and analyze. Second, in most cases, critical information is not in a report or handbook but instead resides in the minds of the individuals or in the institutional structures of the relevant industry. That is, even members of the industry cannot fully explain how things get done. Much of human knowledge falls into this category and although many formal organizations, including regulators, rely heavily on such knowledge, they fail to recognize and capture it. In short, regulation cannot effectively capture much practical knowledge.
A third aspect of the knowledge problem is that even when a regulator manages to collect information, it quickly becomes out of date as the industry or technology continues to evolve. Obsolete data is-or should be- a particular concern for regulators of fast-changing technological fields.
This knowledge problem means that centralized problem solving by a regulator cannot make full use of the available understanding about a problem or keep this understanding up to date. Thus, in many cases, prescriptive regulation offers worse solutions than letting the market and private arrangements, like contracts, work.
Hayek's insight is no longer very controversial. Today, there is a consensus that markets and other private mechanisms are better at solving most economic problems. And even the most interventionist regulators often talk about preferring markets and "light touch" regulation. Yet, despite the lip service paid, regulators still too often instinctually react to apparent problems by proposing top-down solutions. This instinct is the opposite of regulatory humility. And to be more effective regulators, we must suppress it.
A key way for a regulator to practice regulatory humility but still be an effective protector of the public welfare is to focus on identifying and addressing substantial consumer harm that the market and private arrangements cannot address well on their own. Agencies have limited resources. We should generally spend those resources to stop existing or highly likely harms, rather than trying to prevent speculative or insubstantial harms. Even more importantly, trying to predict the future using incomplete and outdated knowledge may stymie innovation and prevent the creation of future benefits. We have seen many new technologies and business models grow across and around the boundaries of statutes and regulations, and trying to stuff them into the old boxes exacerbates the already risky effort to develop something new.
For fast changing technologies, agencies need tools that are nimble, transparent, and incremental. A good example is the FTC's case-by-case enforcement of the consumer protection and competition laws, which focus on preventing harm, rather than on dictating industry arrangements or products. This incremental approach, which we have been using for 100 years, has significant benefits. Consistent with Hayek's thesis about the knowledge problem, addressing only a specific case at hand requires far less information than, for example, an industry-wide rulemaking to address similar issues. This makes the knowledge problem more manageable. Furthermore, this ex post enforcement requires specific facts on the ground and a specifically alleged harm, allowing the agency's understanding of evolving industry practices and their impact on consumers and competition to also evolve and improve. Finally, it typically only directly applies to the party to the enforcement action. Overall, case-by-case enforcement focused on actual consumer harms reduces the potential unintended consequences of a regulatory action.
The lesson of Procrustes for regulators is that we should resist the urge to force things into simple regulatory boxes, focus on substantial consumer harms, and look to flexible tools that can address those harms in the face of complex and rapidly changing phenomena. In that way we can free fast-moving industries and technologies from the iron bed of regulation, avoid cutting off the benefits of innovation for our economy and citizens, and still protect consumers.
