1994-03-10 NPR Monograph 7: Regulatory Systems -- Part 2

[David Farber <farber@central.cis.upenn.edu>]

                Accompanying Report of
            the National Performance Review


             OFFICE OF THE VICE PRESIDENT


                   Washington, DC
                   September 1993


 ***********************************************************
 REG02:
 Encourage More Innovative Approaches
 to Regulation


 Background


 One of the biggest challenges federal regulators face
 is choosing the best tool to solve the problem. In
 many cases, non-regulatory approaches may be the best
 solution. These include efforts to spur technological
 innovation, information disclosure, and consumer
 education. For example:


 --To address the problem of airline delays, the
 Department of Consumer Affairs at the Department of
 Transportation (DOT) publishes the monthly Air Travel
 Consumer Report comparing actual and scheduled
 arrivals and departures.[Endnote 1]


 --For 8 years, the Department of Agriculture's
 Food Safety and Inspection Service has operated a
 toll-free food-safety hotline, to provide meat and
 poultry consumers with information regarding food-
 borne illnesses[Endnote 2]


 --The Environmental Protection Agency (EPA) served
 as a catalyst in the creation of a "Golden Carrot"
 program--a private-sector initiative to spur
 development of a more energy-efficient and
 environmentally friendly refrigerator by providing
 monetary rebates to the manufacturer of a winning
 design[Endnote 3]


 --Regulation by state or local governments may
 also be an alternative to direct federal regulation.


 If regulation is necessary, agencies must balance a
 number of considerations in selecting the best
 regulatory approach, including fairness,
 enforceability, and impact on regulated industries.
 One of the major factors regulators must consider in
 choosing among alternative approaches is the cost to
 the regulated industry and to the government.


 REDUCING COST OF REGULATION. The government is
 obligated to see that the money spent to achieve
 health, safety, environmental, economic, and social
 objectives is spent wisely. Regulation to achieve
 these goals imposes significant costs on those being
 regulated.[Endnote 4] For example, industries may be
 required to pay for installing equipment to reduce
 pollution, for investing in monitoring systems to meet
 worker health standards, and even for hiring additional
 personnel to maintain compliance records.


 EPA estimates that the proportion of the gross
 national product (GNP) devoted to environmental
 protection alone will rise from 1.9 percent in 1990
 to 2.7 percent in the year 2000, with the private
 sector bearing most of these costs.[Endnote 5] The National
 Highway Traffic Safety Administration (NHTSA) and the
 Federal Highway Administration (FHWA) estimate that
 between 1966 and 1990 the federal and state
 governments and the automobile industry spent an
 average of $6.[Endnote 5] billion annually on highway,
 traffic, and motor vehicle safety.[Endnote 6]


 Agencies have traditionally used command-and-control
 regulations. Under this approach, the agency dictates
 what individual firms must do to meet an established
 standard or goal and enforces those dictates. For
 example, environmental regulations may require the
 use of specific pollution control devices; inspection
 systems may require performance of specific
 procedures; or agency officials may themselves decide
 on allocation of rights to exploit natural resources.
 No doubt exists that a command-and-control approach
 is appropriate--and indeed necessary--in certain cases.
 For example, where risks that would result from
 noncompliance are high, as in the regulation of
 nuclear power, command-and-control may be the only
 feasible regulatory approach.


 Experience has shown that in some situations,
 however, costs of meeting regulatory goals can be
 significantly reduced by choosing approaches that
 rely more on market mechanisms. Such mechanisms place
 more decisions in the hands of the private sector,
 provide greater flexibility to regulated industries,
 and encourage innovation. Market-oriented regulation
 decentralizes decisionmaking, allowing the market to
 find the most cost-effective solution to a particular
 regulatory goal. Unlike command-and-control, market-
 oriented regulation provides greater flexibility to
 regulated industries and encourages innovation.


 INCREASING EFFECTIVENESS OF REGULATION. Tapping the
 forces of the market can also produce more effective
 regulation. Deposit-refund systems for beverage
 containers ("bottle bills"), which have been mandated
 by a number of states, demonstrate how powerful
 economic incentives can be in influencing the
 behavior of large numbers of people. Heightened
 public awareness about the problems which regulation
 attempts to address can also have an impact on the
 degree to which overall objectives are attained. For
 example, automakers are now competing to provide
 safety features, such as airbags and anti-lock
 brakes.


 How a regulation is designed has implications for its
 enforceability, which is often critical to overall
 effectiveness. The deposit-refund system relies very
 little on traditional enforcement mechanisms.
 Effectiveness of command-and-control regulations, on
 the other hand, depends directly on enforcement. Lax
 enforcement is likely to lower compliance
 significantly. Because enforcement resources are
 limited, agencies should also consider innovative
 approaches to enforcement, such as use of auditors,
 to improve regulatory programs.[Endnote 7]


 USING MARKET-ORIENTED APPROACHES. Among the
 regulatory approaches that allow greater flexibility
 for the private sector and make use of market forces
 are:


 --performance standards,


 --marketable permits,


 --monetary incentives, and


 --information disclosure.[Endnote 8]


 "Performance" standards are generally preferable to
 "prescriptive" or "design" standards because they give
 the regulated industry the flexibility to determine
 the best technology to meet established standards.
 For example, a design standard for ladders might
 specify the materials and exact dimensions to be
 used, whereas a performance standard might simply
 require that the ladder support a minimum weight and
 provide a minimum degree of stability. The
 Occupational Safety and Health Administration (OSHA)
 has sometimes been criticized for prescriptive design
 standards for plants and equipment relating to worker
 safety.[Endnote 9] In 1990, OSHA initiated rulemaking on
 ladders and scaffolding to convert to performance
 standards where possible. The proposal followed
 complaints by industry that current standards
 provided insufficient flexibility and inhibited
 technological developments.[Endnote 10]


 The EPA's "bubble" concept for limiting pollution
 emissions is a type of performance standard. Under
 the bubble concept, overall emission limits are
 established for a single facility or a group of
 facilities, rather than from each source in the
 facility. This allows companies greater flexibility
 in choosing which emissions source(s) to reduce to
 meet the overall limit for emissions from the bubble.
 EPA estimated that facilities under the 80 or so
 bubbles established prior to 1986 saved $435 million
 in meeting emissions standards.[Endnote 11]


 "Marketable permits" allow the market, rather than the
 government, to distribute scarce resources. The 1990
 Clean Air Act Amendments establish an allowance
 trading system for sulfur dioxide emissions from
 utilities, in an effort to reduce acid rain.[Endnote 12]
 Utilities are allowed to trade initially allocated
 allowances, each representing one ton of emissions.
 This allows more of the reduction in emissions to be
 done by those plants that can reduce emissions at
 lower costs. EPA estimates that this system will save
 from $700 million to $1 billion per year.[Endnote 13]


 In 1985, DOT issued a rule allowing airlines to buy
 and sell airport takeoff and landing rights (slots)
 at four major airports.[Endnote 14] Previously, these slots
 had been allocated by a committee, which frequently
 deadlocked. Under the new system, the value of the
 slots is determined by the market, which should
 allocate them most efficiently. Similarly, in 1990,
 the National Marine Fisheries Service implemented a
 transferable quota system for allocating fishery
 harvesting privileges in the New England and Mid-
 Atlantic regions.[Endnote 15]


 "Monetary incentives", if correctly set, can be
 effective in influencing behavior. More than 100
 communities now charge for garbage collection on the
 basis of volume. Because households have an incentive
 to reduce the amount of garbage generated, the effect
 has been to reduce tonnage collected and to increase
 recycling. Many states and counties also tax auto
 tires to pay for disposal. In a like manner, 10
 states have implemented deposit-refund systems for
 lead batteries to ensure proper disposal.[Endnote 16]


 "Information disclosure" provides consumers with
 information they need to make informed choices.[Endnote 17]
 Labels, routinely required on such products as over-
 the-counter drugs and pesticides, are probably the
 most common form of information disclosure. NHTSA
 provides information on tire safety to consumers by
 requiring manufacturers to grade and mark tires based
 on a testing protocol to measure traction, treadwear,
 and temperature resistance, factors relating to
 safety.[Endnote 18]


 Information disclosure requirements can also provide
 an incentive to industries to move toward regulatory
 objectives. For example, the Federal Trade
 Commission's introduction of standard test procedures
 for tar and nicotine content in cigarettes helped
 lead to the introduction of low-tar cigarettes.[Endnote 19]
 The Emergency Planning and Community-Right-to-Know Act of
 1986[Endnote 20] requires companies to disclose information
 on the use and release of hazardous chemicals. EPA
 attributes a significant portion of the 31 percent
 decrease in air emissions of these hazardous
 chemicals to voluntary reductions brought about by
 increased industry and public awareness of emission
 levels.[Endnote 21]


 NEED FOR CHANGE


 Federal agencies, for a number of years, have been
 encouraged to use alternative approaches to
 regulation, including more market-oriented
 regulation. President Carter in a 1980 Presidential
 Memorandum directed the agencies to find areas where
 alternative techniques could be used in both existing
 and new programs. Carter's Regulatory Council created
 a short-lived Project on Alternative Regulatory
 Approaches, which published a series of guides
 describing alternative approaches.[Endnote 22] Under his and
 later executive orders, agencies were required to
 include, in their regulatory analyses of all major
 rules, a discussion of alternative approaches
 considered. Presidents Reagan and Bush also supported
 use of market-oriented approaches.


 Despite more than a decade of high-level support,
 innovative approaches are not widely used by
 agencies. There are a number of constraints to more
 widespread use. Congress and agencies commonly
 respond to problems by pulling the familiar command-
 and-control tool out of the toolbox. It is always
 easier to model a new program after an old one, and
 most often, existing regulations are command-and-
 control. Lack of information and knowledge about when
 other tools should be used is a significant
 constraint to introduction of innovative techniques.
 Even where agency staffs have expertise in designing
 innovative regulation, their ideas may not be
 accepted without strong support from agency
 leadership. Agencies generally do not actively ask
 for ideas for regulatory approaches from the
 regulated industry or interest groups. On the other
 hand, regulated entities may prefer command-and-
 control regulations or prescriptive standards over
 performance standards because they provide more
 specific details on the requirements for compliance.
 Finally, statutes may not give agencies sufficient
 discretion in designing a regulatory approach.


 ACTIONS


 1. Establish use of innovative regulatory approaches
 as administration policy. (2)


 The President should direct agency heads to use
 innovative regulatory approaches whenever they are
 appropriate. This is consistent with the new
 regulatory review executive order. Wider use of such
 approaches to regulation can lower the costs of
 meeting regulatory goals by giving regulated entities
 more flexibility and increasing the economic
 efficiency of regulations. However, innovative
 approaches are not the best solutions in some
 circumstances. Agencies should analyze the strengths,
 weaknesses, and limits of particular approaches to
 match the best regulatory approach to the problem.


 Redirecting the regulatory system from the command-
 and-control end of the regulatory spectrum toward
 more flexible and market-oriented approaches will
 require strong leadership. The President should also
 direct the Regulatory Coordinating Group to work with
 Congress and policy makers to incorporate more
 innovative approaches in legislation and regulation.
 A standing task force on innovative approaches could
 assist this effort, and would provide a good forum
 for communication among government regulators.


 2. Develop a Deskbook on Regulatory Design. (1)


 The Chair of the Regulatory Coordinating Group (RCG)
 should oversee the development of a "Deskbook on
 Regulatory Design" for legislative and regulatory
 staffs, which should be completed in less than one
 year. The "Deskbook" would improve understanding of the
 full range of alternative approaches by providing
 both policymakers and staff with ready information
 about the range of regulatory approaches. It would
 also identify resource people within agencies who
 could assist others in development of innovative
 approaches. Project staff should work closely with
 congressional regulatory specialists in developing
 the Deskbook.


 The Deskbook should describe in detail the conditions
 under which each approach should be considered.
 Possible combinations of approaches should also be
 discussed. In this context, the Deskbook should
 highlight the strengths, weaknesses, and limitations
 of each approach. Market-oriented approaches, though
 they may be more economically efficient, can be
 difficult to design and are not appropriate in all
 circumstances.[Endnote 23] In drafting the "Deskbook",
 the RCG should consult on existing sources, such as the
 handbooks prepared by the Regulatory Council in the
 1970s and the experience of Germany and other
 European countries.[Endnote 24]


 The Deskbook should also provide an in-depth survey
 of how innovative approaches have been used in both
 federal and state governments. Case studies should be
 used for each approach. Case studies should look at
 not only the design of the regulation, but also the
 effectiveness of implementation.[Endnote 25]


 Attention should also be paid to other innovative
 features, including tiering, or tailoring regulatory
 requirements to match circumstances of the regulated
 entities. Agencies may, for example, use cut-offs
 (e.g., number of employees) in applying certain
 regulatory requirements or may make appropriate
 provisions for small businesses (e.g., short forms
 for reporting requirements).


 The Deskbook should be designed in a format to
 accommodate new information, so that it can be
 regularly updated. In addition to printed versions,
 the Deskbook should be made available in electronic
 format to maximize its usefulness. An electronic
 format could be updated more frequently and could
 provide more extensive information, such as actual
 texts of regulations, as well as additional
 commentary on the development and monitoring of such
 regulations.


 CROSS-REFERENCES TO OTHER NPR ACCOMPANYING REPORTS


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