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.
Complexity and Modern Regulation Dr. Johannes Meier Tufts, 13 November 2008
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.
The beauty of complexity (II) Seite Source: Subway Map NY 1972 Introduction
The beauty of complexity (III) Seite Introduction
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
Managerial failure to deal with complexity? Failure of regulation? Seite
Complexity and regulation Seite News reference volume „complexity“ News reference volume „regulation“ Source: google trends Introduction
How to deliver regulatory quality in highly complex and constantly changing environments?
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?
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!
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
Does Public Choice Theory provide a good alternative?
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
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
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
A more principle-based approach to addressing financial market failures
Financial markets characteristics
Uncertainty of financial market decision-makers
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)
[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)
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
Seite Source: Thomas Fischer, Andreas Kießling und Leonard Novy (ed.): Politische Reformprozesse in der Analyse, (2008)