Friday, August 17, 2012

Alternatives to regulation: voluntary regulation vs. Imposed natural finance obligations

While government regulation is not the worst invention by any means, it does have several practical disadvantages, and worth considering alternatives:

  • Bureaucratic.  Rules and permissions can be arbitrary and wrong.
  • Expensive. the bureaucracy, enforcement,  compliance, and punishments have costs
  • Capture.  Legal and illegal bribes to the regulators or the politicians that appoint them can allow regulators to serve the regulated and prevent competition to its benefactors.
  • Broken Framework.  Implementing new needed regulations wrongly presupposes that truth is a strong enough force to stand up against industry/lobbyist interests.
The common alternative proposed by libertarians is that we should resort to suing each other whenever something bad happens.  While this eliminates the bureaucratic and capture problems of regulation, in its simplest form has its own problems:
  • Its not really cheaper: Saving from bureaucratic salaries are offset by double sided legal and investigation costs.
  • Loss of monitoring function: It is easier to get away with harming neighbours if there is no agency actively monitoring damage or compliance.
  • Punishment needs to be based on damage caused rather than negligence/malice of the responsible.  Lives need to be ruined even when harm is accidental.
  • Punishment must be more severe:  If it is easier to get away with harm, people who are responsible for harm must have their lives ruined more severely.
  • Damages caused may exceed the ability to pay of the responsible.
The core of the rest of this post will explore two compatible solutions that solve the above problems.  Though explained in greater detail later, natural finance obligations are used here as an instrument of economic servitude alternative to cash court judgements or corporate dispossession.  It solves the problem of damages exceeding the responsible party's ability to pay.  Voluntary regulation is regulation voluntarily adopted by the regulated in order to reduce the punishment that might occur if some harm is caused.

Let's start with some common everyday regulation that appears to have value, before we look at serious failures:

Driving regulations
These are generally useful at preventing accidents and harm.  License tests, Speed limits, seat belts, working brakes and signals, drunkedness limits.  The libertarian alternative, if we continue to socially value preventing accidents and traffic fatalities, would have to increase the punishments when an accident occurs.  In a libertarian world, only after the fact blame for accidents would be regulated.  While people should have the right to individually decide on traffic laws and regulations they observe, voluntary compliance with licensing requirements and vehicle safety would significantly benefit their insurance rates.  Even "scary big brother" ideas such as breath-alcohol and speed monitoring could be voluntarily accepted for their benefits on insurance rates, and accountability/excuses if accused of being responsible for an accident.  In the end, I believe most people would choose the voluntary regulation in the case of driving regulations, which perhaps only makes the choice illusory.

I actually believe that driving regulations are the least in need of replacement.  But in the case of industrial regulations I will show that society can be much better protected by essentially applying the old libertarian idea of reducing accidents by placing a sharp spike pointed at the driver on every steering wheel.

Building Permits
While knowing that a home complies with building codes for snow, wind, earthquake and fire resistance can be valuable peace of mind for many buyers, some building regulations (such as minimum size) have zero value to builders or buyers, preventing energy efficiency and affordability choices.  All of the safety concerns can be independently certified, and include marketing features beyond code compliance (premium plywood/HVAC/other materials used) that may enhance the expected longevity or perceived quality of the home.

Whether the certifying agencies are government agencies or private is not important.  The choice of choosing not to obtain certifications can reduce the costs to knowledgeable buyers or transfers among friends and family.  Most importantly of all, it frees up building choices.  And somewheat importantly, if the certification process is corrupt, too expensive and useless then the certifications will not be considered valuable enough (in enhanced property value) to obtain.

Playgrounds can either be fun and dangerous, or safe and boring.  Regulating against needlessly dangerous equipment has some obvious benefits, but overall, regulation can make everyone unhappy in the case of playgrounds.  Certification of equipment safety levels and implied waivers of liability seem to be a more appropriate approach than ensuring that only the safest, most boring, equipment is put in.

A pause for some concepts...

Natural Finance Obligations
Natural finance obligations are usually voluntary loans.  They are soft loans in that they carry no hard repayment obligations (no fixed amounts on fixed dates).  They are instead, repaid based on incoming company cashflow, and ability to repay.  Repayments are obligatory and enforced by a 3rd party comptroller.  The loans are in queued priority with the first loans fully repaid all principal and interest before any repayments of future loans are made.  A general rule of thumb is that 20% of company's operating contributions can be set aside to pay employee/management bonuses or deferred compensation, or used to pay shareholders, or held as an operating reserve.  The other 80% of contributions should go to natrual finance obligation holders.

The remedy of dispossession
While dispossessing a property or entire company is not a very libertarian or even pluto-democratic remedy, it is entirely appropriate whenever the damages inflicted by a company exceed its ability to compensate for them.  The traditional plutocratic remedy is to award a large amount, through civil court.  The consequences are likely to result in bankruptcy, company liquidation, and loss of employment for all involved, and, relevantly, failure to pay most of the ordered amount.  The limited liability nature of corporations also allows corporations to create shell subsidiary companies (that never hold assets) in order to conduct evil/risky operations, and the law must diligently guard against such strategies both in its traditional plutocrat state, and under the remedy of dispossession.

Social dispossession
When the harm is to society at large, the natural remedy is for dispossession of the offending institution into social control.  Social dispossession should be considered when the infraction is so egregious that the company cannot compensate those victimized by its carelessness.  Beyond political dogma that demonises social ownership, there are some real disadvantages:

  • No guaranteed management competency.  Backdoor political appointees to management are likely to destroy value in enterprise.  This can be helped with natural governance principles (directly elected independent functions)
  • Split ownership is difficult.  Some members of society may be more directly harmed by the cause of the disposession, and so might equitably be assigned some of the shares.  The problems of split ownership may make that stake relatively worthless.  In addition to all other non-dividend-maximizing corruptions a majority shareholder can abuse minority shareholders with, a government majority shareholder could also have non profit maximizing objectives.
  • Key employees and former shareholders will be demotivated.  Shareholder employees with key product and technical knowledge will need addressing their motivational package after their shares are disposessed.
  • Just because a damage award is too expensive to pay now, doesn't mean it couldn't be paid over time.  Dispossession becomes too onerous a punishment in these cases.  Courts are incapable of adjusting damages down to an ability to pay.
Natural finance obligations as an alternative to social dispossession
A natural finance obligation's key advantage over social dispossession is keeping the organization intact, and dealing with the split ownership problem.  It is roughly equivalent to requiring the penalized institution to pay out most of its existing cash, and 80% of future profits to the obligation holders until they are fully paid off.  It can and should be set at 0% interest growth, because the speed at which it is repaid is not up to management discretion.

Not only can the beneficiaries of a natural finance obligation be split into any number of groups without discrimination to any member, but the financing of the obligation can come from many parties, and can be modified over time.  For instance, in addition to the company and its insurers, the bond can be collateralized by well paid executives over time displacing the other backers.

Even if it takes 20 years to pay off a penalty through a natural finance obligation, shares should still retain value, because the shares will revert to their "full value" when the obligation is repaid.  This addresses the organizational sustainability, management and motivational issues, but at least as importantly, allows financing potentially larger penalties than existing assets could support.

Some corporate regulatory failures....

Massey Energy Martin County sludge spill

Instead of regulation, a high risk coal mining project should require bonded assets/insurance backing that triggers in the event of a disaster.  A potential natural finance obligation is a claim on future earnings and so can be bonded more cheaply than tangible existing assets.  Its easier for society to list all possible bad consequences and its associated penalties than it is to mandate safety rules.  The coal mine and its insurer will be motivated to adopt every worthwhile safety precaution.

BP event horizon gulf oil spill
BP/Transocean benefitted from lax regulations in that there was no requirement (that exists in other countries) to have a backup relief well, and they possibly violated existing regulations by having a defective shutoff valve.  After the incident, they've benefitted from a cozy and helpful US government.

Collectively, I believe society feels that if a company cannot safely operate, then it should choose not to.  From an economic/social finance only perspective, the benefits of oil production can be outweighed by the costs to tourism, fishing and property values.  This alternative to regulation is essentially a company affirming "Let me operate however I wish, but if that operation results in social damages, I will pay significant restitution and penalties"

The core failure of pro-active regulation is that it is decided by politicians who's friendship has been purchased by the potential regulated industry/lobbyists.  They naturally argue that their operations are safe enough, and they don't need additional rules, but their opinion is always worthless in relation to the truth (same statement/position would be made whether true or not).  So its better to not even entertain discussion on what is safe, and simply punish accidents/events.

A nuclear industry that is safe 49/50 years is not safe.  The Japanese government should seize/disposess all shares of the fukushima operator Tepco.  While there is an extremely serious objection that such action would have no legal basis whatsoever, let the shareholders sue, but countersue for the $trillion in damages and cleanup costs.  The net effect to Tepco shareholders (worthless shares) is the same, but Tepco itself can continue providing expertise in the cleanup instead of being bankrupt.

A more important action in every country engaged in nuclear power is to declare today that anyone who wishes to continue producing nuclear  power must put up a bond of insurance/assets/future income not in the event they are found at fault of a disaster, but in the event of a disaster.  The industry's opinion of nuclear safety is irrelevant if they are unwilling to personally indemnify society for its possible failures.

The current US political playbook on nuclear energy, which is corrupt and should be unnacceptable, is to wait until fukushima is forgotten before reinstating nuclear energy permits in order to feed the American public's "much beloved" nuclear weapons arsenal.

financial crisis
The financial industry willfully and wrecklessly issued poor mortgages because they controlled zombie muppets that would buy any mortgage no matter how worthless.  This directly caused the US housing collapse, and cascading world financial crisis of 2008.  Our politically appointed authorities have found that no laws were broken, and that none of their overlords deserve the indignity of arrest or trial.

A lot of lips are moving regarding how to prevent a future crisis, and the peaceful group formed on the importance of the injustices committed have literally been labeled terrorists.  No regulatory reforms have been implemented, and the ones that has been scheduled (Dodd-Frank act) have an energy to the lip moving against them to suggest that the industry hopes to overturn them.

Instead of arguing about regulation, putting the ownership of the banks at stake would definitely curb any wrecklessness by management.  Part of the too big to fail protections is the concept that the economy suffers if banks are ever punished because they can't shower the rest of us with money if they have less of it.  The threat of social dispossession becomes more appropriate because it doesn't harm the rest of the economy.

A global warming/climate change solution
This is more of an aside, but the debate about whether climate change exists would be irrelevant if the energy companies accept a very large (collateralized/bonded) bet that climate effects will occur.  Their opposition has been key to preventing regulation and measures designed to combat climate change, and their opposition is rooted rhetorically in denying its existence.

NASA has a reputation for a culture of safety.  It stems from in large part to their future funding is dependent on success, but a common trait of intelligent people and science in general, is placing a high value on human life.  Great pride should be taken for NASA's early success in human space missions, and pride for reassessing the costs/benefits and eliminating human space missions when its budget was adjusted.

While naive analyses might say that NASA is safety focused because its lacks a profit motive, more important factors for its safety focus is that it lacks the ability to hide failures, escape blame, accountability and consequences of failures, and lack of budget provisions for campaign donations to overturn findings of blame for failures.

Voluntary regulation implementation
The core social safety proposal being made is that companies are forced to abide by rule "if socially damaging event x happens then $y must be paid"  The $y can be put up by any party other than the company (insurance company likely), and beneficiaries c/would be split by national and local communities, and those more directly affected.

One issue with the approach would be that a company utterly devoted to safety precautions could still incur a ruinous accident.  This is where voluntary regulation or voluntary safety measures come in.

In exchange for adopting safety measures, the company can negotiate the $y amount down in addition to hopefully reduce the chance of event x occurring.  Both of these effects would lower its insurance premiums it is paying any 3rd party to collateralize its potential event obligation.  An alternative to negotiating down the $y amount, is simply cataloging safety measures undertaken so that in the case of event x it can argue why $y should be lowered on the basis of its precautions.

If the company is not insured, it is incredibly vested in preventing x.  And if it is insured, then its insurance provider is incredibly vested in supervising and authorizing behaviour.  For Natural Financed companies, the 3rd party comptrollership role is suited to dealing with multiple parties and obligations, and can assist in ensuring compliance.

the simplification of regulatory approvals
Currently, when a controversial project has safety fears, political contributions can significantly influence its approval.  More controversial projects may have their timing of approval delayed, but in the end the committee will announce that their safety concerns have been met, and they have confidence in the operator's safety plan.  Statements that are fundamentally unassailable due to being judgments based on comprehensive mostly private facts.  No public visibility or accountability of the committee members means that they are unlikely to have their actions reviewed in the event of a disaster.

In the case of Massey Energy's sludge spill, the fine involved was $55k. If an approval committee instead of assessing the probable simply stated that if the project fails to prevent dumping 1B gallons of toxic sludge it will pay a penalty of $55k, the statement would be viewed as obviously absurd and corrupt.

Decisions that focus on the possible and the penalties for the possible are necessarily more transparent and reviewable than private assessments of probability.  The entirety of the regulatory assessment fits into a headline, instead of a balance of secret deliberations.

government vs private involvement
3rd party safety certifications adds credibility to any safety claim.  Private safety certifiers are likely to be corrupted by wanting to please their clients and be too easy on them.  Government certifiers can be corrupted the same way or through the political process.  The main rationale of proposing natural governance (independent directly elected functional governance) was to eliminate government monopoly and hidden political manipulation of regulatory functions while not resorting to submission to private (certification) mafias.

In the context of certification agencies, natural governance would allow overlapping and competing socially accountable functions.  There would be no absolute requirement of social funding.  It would add over the private alternative, direct electoral accountability to guard against corruption of their mandate and presumptive duty.  A private company is only accountable to its customers and shareholders and so unsuitable to be trusted for social care, no matter how cute the baby animals in its advertisements are.

safety innovation
Another issue with our current regulatory framework is that safety innovation can be politically blocked by industry.  Even small industries.  A prime example is the table saw that shuts itself off instantly when it is about to cut through a human finger.  According to the 2nd video there, 1 in 20 table saws ever sold has mamed someone.  While this is an obviously great idea, there were substantial initial marketing struggles that may be partially blamed on it being too good an idea where the inventor wanted to be rewarded too much.  At any rate, saw manufacturers didn't want to implement it because they didn't have to (Saws like playgrounds carry a waiver of liability due to inherent danger), and the regulatory agency refused to mandate the safety feature, despite the fact that the CPSC's own data show that 3-4000 idiots per year have table saw related amputations and need protection from themselves.

The way this alternative regulation proposal (I'll eventually refer to it as Natural regulation to keep the lazy naming scheme) advances such safety innovation:

  • Individuals can still choose to use more dangerous equipment if they are confident in themselves.
  • A direct and obvious economic appeal can be made to liability and insurance rates.
  • If there is active oversight of operations of your business by an insurer then there will be highly responsive reactions to potential safety innovations.
  • Customers that bear liability from using supplier equipment ( who don't) could get more helpful suppliers.
  • You don't waste 1 to 2 years of time trying to convince bureaucrats to do the right thing.

Pre-addressing criticism
The loudest argument against "natural regulation" is that it will prevent industry and economic activity due to companies being too afraid of projects and their potential liability to proceed with them.  The question to answer though is "Would you allow BP to proceed with its Event Horizon project knowing the outcome?"  Even if that outcome occurred only 1 in 5 times, it would still be better for the world if BP had been too fearful to conduct it.  Also relevant though, is that BP would still have wanted to undertake the project with more expensive safety measures.  My understanding from the reports on the incident, was that the accident was influenced by cutting corners rather than the project being infeasible from a safety perspective.

Political implementation
Given that this proposal would reduce the benefits of political campaign donations, its easy to predict that current politicians will not favour it.  But if we pay attention to the lip moving, ...

Republicans speak of personal liberty, lower taxes, and even the elimination of regulatory agencies.  Democrats speak of making the country/people safer, and protecting the environment.  I think their opposition would expose hypocricy.

The most important point of this paper is showing that the general libertarian approach to regulation is not necessarily a pro-polluter one.