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Modern Regulation and Complexity

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Lecture given at Tufts University on 13 November 2008 on issues and methodological challenges faced my modern regulation given increasing complexity. The financial crisis provides a topical …

Lecture given at Tufts University on 13 November 2008 on issues and methodological challenges faced my modern regulation given increasing complexity. The financial crisis provides a topical background.

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  • 1. Complexity and Modern Regulation Dr. Johannes Meier Tufts, 13 November 2008
  • 2. The beauty of complexity (I) Seite Source: http:// xavier.informatics.indiana.edu/lanet-vi/gallery/Airports.html Introduction Airports was obtained from the  International Air Transportation Association (IATA) . Each node represents an airport and each edge is a regular flight between two airports. Colors are assigned according to the coreness: vertices with coreness 1 are violet, and the maximum coreness vertices are red, following the rainbow color scale. The node degree scale is also displayed, showing the maximum degree of the network.
  • 3. The beauty of complexity (II) Seite Source: Subway Map NY 1972 Introduction
  • 4. The beauty of complexity (III) Seite Introduction
  • 5. Complexity and economy
    • Complexity … portrays the economy not as deterministic, predictable and mechanistic; but as process-dependent, organic and always evolving. W. Brian Arthur, Complexity and the Economy, SCIENCE, Apr. 2, 1999 www.santafe.edu/~wbarthur/Papers/Pdf_files/Econ_&_Complex_Web.pdf
    • When financial markets exhibit properties of a complex system, the ability to predict consequences, such as cause-and-effect explanations for market movements, is frustrated by nonlinear feedback effects arising from interactivities among market participants. works.bepress.com/cgi/viewcontent.cgi?article=1007&context=steven_schwarcz
    • It used to be that banks became insolvent because their loans went sour. Now it is the complexity of assets that lets them down. … Banks simply became too sophisticated for their own good. Jon Danielsson, LSE, September 2008 www.voxeu.org/index.php?q=node/1723
    Seite Introduction
  • 6. Managerial failure to deal with complexity? Failure of regulation? Seite
  • 7. Complexity and regulation Seite News reference volume „complexity“ News reference volume „regulation“ Source: google trends Introduction
  • 8. How to deliver regulatory quality in highly complex and constantly changing environments?
    • The challenge
    • Lessons from systems thinking
    • Lessons from systems architecting
    • Implications for modern regulation and leadership
    • What are root causes for current deficits in regulation? How can we transform systemic thinking into systemic regulation?
    • How is it possible to reduce complexity in the policy making and regulatory processes and remain goal-oriented without falling into the „simplicity trap“?
    • Do we need new government processes, institutions and leadership?
    Seite
  • 9.
    • The challenge: dealing with increasing complexity in modern regulation
    • Lessons from systems thinking
    • Learning from the art of systems architecting
    • Implications for a modern regulation and political leadership
    Seite Agenda
  • 10. Regulation and whining Seite
      • Three half-truths
      • (mostly found in the liberal mind)
      • Regulation leads to a loss of freedom of the individual
      • Regulation entails mostly high costs for the individual (and for companies)
      • Less regulation is better!
  • 11. Typical deficits of current regulation approaches
      • Lack of evidence on impact or dynamics of regulation
      • Complex interactions and side-effects among regulations
      • Focus on the individual case through detailed regulations
      • Lack of transparency on cost of regulation
      • Insufficient explanation of the reasons for the regulation
    Seite
  • 12. Does Public Choice Theory provide a good alternative?
    • Assumption
    • Implication
    • Complication
    • Outcome
    • Politicians and civil servants only represent their own interests. Performance to be evaluated and incentivised to exploit selfishly competitive behaviour. Consumer interest as the means to drive a quasi-market.
    • Subjective and emotional aspects of public-sector performance rejected in favour of objective targets and numbers.
    • Trouble starting when an ambition is translated into an arbitrary number and driven down a hierarchy. Public-sector workers cheating their systems to meet their targets. „payment for results“ turning into „payment for activity“
    • A system for liberating public-sector organisations turning into a burgeoning and dysfunctional stranglehold of bureaucratic control and compliance.
    Seite Source: Public choice protagonists James Buchanan, Anthony Dawns, William Niskanen
  • 13. Central lesson learned from „deliverology“
    • Example: Social care in the UK
    • Call center referring case upon initial contact
    • Fragmented work; different departments (and budgets) dealing with different needs
    • Departments can meet their targets by passing cases on
    • Multiple failures to understand true needs of customers along the process
    • Tendency to „improve“ criticality of needs to get funding
    • End-to-end measures showing huge variance, dysfunctional performance despite star-ratings for all departments
    • Arbitrary targets are likely to increase ambiguity and encourage gaming.
    • Most targets do not represent the reality of a service from a customer‘s point of view.
    • Targets drive people to use their ingenuity to meet the target, not improve performance.
    Seite Source: John Seddon 2008
  • 14. Seite Agenda
  • 15. Systems thinking approach as an alternative
    • Definition of purpose as starting point What is the purpose of this service from the customer‘s point of view?
    • Measuring end-to-end performance time series on what the system is able to do predictably and variation in the system
    • Analysis of variance Identifying the causes of variation provides a path to system improvement
    • Improvement ideas Compliance with bad design, functional specialisations, front office – back office splits often critical issues
    • Controlling for reduction of variance
    Seite Source: 6Sigma
  • 16. Implications of systems thinking for service design
    • „ smartening-up rather than dumbing-down the front end“
    • „ train against demand“
    • „ make the worker the inspector“
    • Putting waste elimination in focus
    •  Remaining dilemma: Enabling the front-line does not eliminate the need to create an „order“ centrally
    Seite Source: Toyota production system
  • 17. Seite Agenda
  • 18. Example of an elegant architecture
  • 19. Internet as example for managing complexity effectively
    • Clear goals
    • Elegant design principles
    • Simple interface protocols
    • Clear roles
    • Fail safe communication network
    • Splitting messages in data packets that can be sent via different routes to be reassembled at the recipient
    • TCP/IP is the main invariant
    • Directory services, domain administration, routers, backbone provision etc.
    Seite “ Minimalist” IP enables some evolutionary pathways and disables others
  • 20. In Architecting a System We…
    • • Work for the client, and with the builder
          • Classical conflict of interest mitigation
    • • Create (or discover) both problem and essential solution structures
          • Requirements as the consequence of joint problem/solution exploration
          • The small set of information that mostly defines value, cost, and risk
    • • Develop information in all of the views needed to make the client’s decision
    • • Embrace “soft” as well as “hard” objectives
          • We could talk about aesthetics versus reliability
    • • In evolving systems, the architecture is in the invariants
          • Architecture is in the things that don’t change, and in where change is deliberately enabled (or disabled)
    Source: from M. Maier, E. Rechtin, The Art of Systems Architecting, 2nd ed. (2002)
  • 21. Lessons from Architecting
    • Architectural Problems…
    • • Exceed our ability to comprehensively analyze
          • But, lack of analysis is fatal
          • But, optimization is a mirage
    • • Are not purely social, nor purely technical problems
          • Both the social and technical perspectives must be present, and harmonized, to be successful
          • Architecting starts from the stakeholders, and assumes the problem definition is inside the scope
    • • Can be examined systematically and scientifically, if not rigorously
          • Induction over disparate experience bases (heuristics) is very important
    • • Have (when we are lucky) solutions that are happy compromises, but not perfect
    Source: from M. Maier, E. Rechtin, The Art of Systems Architecting, 2nd ed. (2002)
  • 22. A heuristics based approach to systems architecture
        • Clarity of goals
          • KISS: Keep it simple stupid!
          • One insight is worth a thousand analyses.
        • Organization of work
          • The greatest architectures are the product of a single mind – or of a very small, carefully structured team.
          • Build in and maintain options as long as possible in the design and implementation of complex systems. You will need them.
          • In architecting a new program, all the serious mistakes are made in the first day.
        • Avoiding risks
          • The most dangerous assumptions are the unstated ones.
          • Do the hard parts first.
          • The greatest leverage is at the interfaces heuristic. Make a system evolvable by paying attention to the interfaces.
    Seite Source: from M. Maier, E. Rechtin, The Art of Systems Architecting, 2nd ed. (2002)
  • 23. Heuristics applying to social and political systems
          • It’s not the facts, it’s the perceptions that count.
          • Success is in the eyes of the beholder (not the architect).
          • Four questions that need to be answered as a self-consistent set if the system is to succeed economically: who benefits? who pays? who provides? who loses?
          • Cost rules.
          • In social systems, how you do something may be more important than what you do.
          • When implementing a change, keep some elements constant as an anchor point for people to cling to (at least until there are some new anchors).
          • It’s easier to change the technical elements of a social system than the human ones.
          • The best engineering solutions are not necessarily the best political solutions.
          • If the politics don’t fly, the system never will.
    Seite Source: from M. Maier, E. Rechtin, The Art of Systems Architecting, 2nd ed. (2002)
  • 24.
    • The challenge: dealing with increasing complexity in modern regulation
    • Lessons from systems thinking
    • Learning from the art of systems architecting
    • Implications for a modern regulation and political leadership
    Seite Agenda
  • 25. Five principles for modern regulatory leadership
    • Strategic understanding: Leadership needs to have clear sense of goals and dynamics of impact
    • Transparency: Only regulation with end-to-end measures incl. cost of regulation is credible.
    • Delegation: Implementation authorities need freedom for finding adequate solutions within space defined by few invariants
    • Robustness: Architecture of regulation needs to be flexible and work in different – even in unforeseen – contexts which calls for enabling at all levels and decoupling of subsystems.
    • Customer perspective: The citizen-/company-perspective needs to drive communication and expectation management
    Seite
  • 26. A more principle-based approach to addressing financial market failures
    • Financial markets characteristics
    • Uncertainty of financial market decision-makers
    • Nonlinear feedbacks
    • Tight coupling of subsystems through mark-to-market valuations
    • Misalignment of interests and incentives in originate-and-distribute model
    • “ Unexpected”, dramatic market changes
    • Principles to be “lifted” from architecting
    • Addressing information failures by implementing cost-effective supplemental protections (e.g. warranties, certifications of quality)
    • Addressing Failures Arising from Nonlinear Feedback and Tight Coupling by de-coupling subsystems (e.g. full disclosure of asset portfolio as optional alternative to mark-to-market evaluations, establishing a liquidity provider of last resort)
    • Addressing Failures Arising from misalignment by using independent, third-party servicers and other trust building processes
    Seite Source: Steven L. Schwarcz, Complexity as a Catalyst of Market Failure, A Law and Engineering Inquiry (2008)
  • 27. The challenge for political leadership
    • [The] natural reaction to market breakdown is to add layers of protection and regulation. But trying to regulate a market entangled by complexity can lead to unintended consequences, compounding crises rather than extinguishing them because the safeguards add even more complexity, which in turn feeds more failure.
    Source: Richard Bookstaber, A Demon of our Own Design: Markets, Hedge Funds, and the Perils of Financial Innovation, (2007)
  • 28. Determinants of successful political regulation and reforms based on case studies
    • The performance and outcomes of reform politics do not depend on
    • the severity of existing problems a country has to cope with,
    • characteristics of the political system (e.g. successful and far-reaching reforms are possible in consensus governments as well as in majority-democracies).
    •  Selection of adequate reform strategies / quality of reform management by the government is crucial!
      • strategic process management
      • political leadership
    Seite Source: Thomas Fischer, Andreas Kießling und Leonard Novy (ed.): Politische Reformprozesse in der Analyse, (2008)
  • 29. Thank you for your attention Seite