Modern Regulation and Complexity


Published on

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.

Published in: Business, Technology
  • Be the first to comment

No Downloads
Total views
On SlideShare
From Embeds
Number of Embeds
Embeds 0
No embeds

No notes for slide

Modern Regulation and Complexity

  1. 1. Complexity and Modern Regulation Dr. Johannes Meier Tufts, 13 November 2008
  2. 2. The beauty of complexity (I) Seite Source: http:// 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. 3. The beauty of complexity (II) Seite Source: Subway Map NY 1972 Introduction
  4. 4. The beauty of complexity (III) Seite Introduction
  5. 5. Complexity and economy <ul><li>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 </li></ul><ul><li>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. </li></ul><ul><li>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 </li></ul>Seite Introduction
  6. 6. Managerial failure to deal with complexity? Failure of regulation? Seite
  7. 7. Complexity and regulation Seite News reference volume „complexity“ News reference volume „regulation“ Source: google trends Introduction
  8. 8. How to deliver regulatory quality in highly complex and constantly changing environments? <ul><li>The challenge </li></ul><ul><li>Lessons from systems thinking </li></ul><ul><li>Lessons from systems architecting </li></ul><ul><li>Implications for modern regulation and leadership </li></ul><ul><li>What are root causes for current deficits in regulation? How can we transform systemic thinking into systemic regulation? </li></ul><ul><li>How is it possible to reduce complexity in the policy making and regulatory processes and remain goal-oriented without falling into the „simplicity trap“? </li></ul><ul><li>Do we need new government processes, institutions and leadership? </li></ul>Seite
  9. 9. <ul><li>The challenge: dealing with increasing complexity in modern regulation </li></ul><ul><li>Lessons from systems thinking </li></ul><ul><li>Learning from the art of systems architecting </li></ul><ul><li>Implications for a modern regulation and political leadership </li></ul>Seite Agenda
  10. 10. Regulation and whining Seite <ul><ul><li>Three half-truths </li></ul></ul><ul><ul><li>(mostly found in the liberal mind) </li></ul></ul><ul><ul><li>Regulation leads to a loss of freedom of the individual </li></ul></ul><ul><ul><li>Regulation entails mostly high costs for the individual (and for companies) </li></ul></ul><ul><ul><li>Less regulation is better! </li></ul></ul>
  11. 11. Typical deficits of current regulation approaches <ul><ul><li>Lack of evidence on impact or dynamics of regulation </li></ul></ul><ul><ul><li>Complex interactions and side-effects among regulations </li></ul></ul><ul><ul><li>Focus on the individual case through detailed regulations </li></ul></ul><ul><ul><li>Lack of transparency on cost of regulation </li></ul></ul><ul><ul><li>Insufficient explanation of the reasons for the regulation </li></ul></ul>Seite
  12. 12. Does Public Choice Theory provide a good alternative? <ul><li>Assumption </li></ul><ul><li>Implication </li></ul><ul><li>Complication </li></ul><ul><li>Outcome </li></ul><ul><li>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. </li></ul><ul><li>Subjective and emotional aspects of public-sector performance rejected in favour of objective targets and numbers. </li></ul><ul><li>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“ </li></ul><ul><li>A system for liberating public-sector organisations turning into a burgeoning and dysfunctional stranglehold of bureaucratic control and compliance. </li></ul>Seite Source: Public choice protagonists James Buchanan, Anthony Dawns, William Niskanen
  13. 13. Central lesson learned from „deliverology“ <ul><li>Example: Social care in the UK </li></ul><ul><li>Call center referring case upon initial contact </li></ul><ul><li>Fragmented work; different departments (and budgets) dealing with different needs </li></ul><ul><li>Departments can meet their targets by passing cases on </li></ul><ul><li>Multiple failures to understand true needs of customers along the process </li></ul><ul><li>Tendency to „improve“ criticality of needs to get funding </li></ul><ul><li>End-to-end measures showing huge variance, dysfunctional performance despite star-ratings for all departments </li></ul><ul><li>Arbitrary targets are likely to increase ambiguity and encourage gaming. </li></ul><ul><li>Most targets do not represent the reality of a service from a customer‘s point of view. </li></ul><ul><li>Targets drive people to use their ingenuity to meet the target, not improve performance. </li></ul>Seite Source: John Seddon 2008
  14. 14. Seite Agenda
  15. 15. Systems thinking approach as an alternative <ul><li>Definition of purpose as starting point What is the purpose of this service from the customer‘s point of view? </li></ul><ul><li>Measuring end-to-end performance time series on what the system is able to do predictably and variation in the system </li></ul><ul><li>Analysis of variance Identifying the causes of variation provides a path to system improvement </li></ul><ul><li>Improvement ideas Compliance with bad design, functional specialisations, front office – back office splits often critical issues </li></ul><ul><li>Controlling for reduction of variance </li></ul>Seite Source: 6Sigma
  16. 16. Implications of systems thinking for service design <ul><li>„ smartening-up rather than dumbing-down the front end“ </li></ul><ul><li>„ train against demand“ </li></ul><ul><li>„ make the worker the inspector“ </li></ul><ul><li>Putting waste elimination in focus </li></ul><ul><li> Remaining dilemma: Enabling the front-line does not eliminate the need to create an „order“ centrally </li></ul>Seite Source: Toyota production system
  17. 17. Seite Agenda
  18. 18. Example of an elegant architecture
  19. 19. Internet as example for managing complexity effectively <ul><li>Clear goals </li></ul><ul><li>Elegant design principles </li></ul><ul><li>Simple interface protocols </li></ul><ul><li>Clear roles </li></ul><ul><li>Fail safe communication network </li></ul><ul><li>Splitting messages in data packets that can be sent via different routes to be reassembled at the recipient </li></ul><ul><li>TCP/IP is the main invariant </li></ul><ul><li>Directory services, domain administration, routers, backbone provision etc. </li></ul>Seite “ Minimalist” IP enables some evolutionary pathways and disables others
  20. 20. In Architecting a System We… <ul><li>• Work for the client, and with the builder </li></ul><ul><ul><ul><ul><li>Classical conflict of interest mitigation </li></ul></ul></ul></ul><ul><li>• Create (or discover) both problem and essential solution structures </li></ul><ul><ul><ul><ul><li>Requirements as the consequence of joint problem/solution exploration </li></ul></ul></ul></ul><ul><ul><ul><ul><li>The small set of information that mostly defines value, cost, and risk </li></ul></ul></ul></ul><ul><li>• Develop information in all of the views needed to make the client’s decision </li></ul><ul><li>• Embrace “soft” as well as “hard” objectives </li></ul><ul><ul><ul><ul><li>We could talk about aesthetics versus reliability </li></ul></ul></ul></ul><ul><li>• In evolving systems, the architecture is in the invariants </li></ul><ul><ul><ul><ul><li>Architecture is in the things that don’t change, and in where change is deliberately enabled (or disabled) </li></ul></ul></ul></ul>Source: from M. Maier, E. Rechtin, The Art of Systems Architecting, 2nd ed. (2002)
  21. 21. Lessons from Architecting <ul><li>Architectural Problems… </li></ul><ul><li>• Exceed our ability to comprehensively analyze </li></ul><ul><ul><ul><ul><li>But, lack of analysis is fatal </li></ul></ul></ul></ul><ul><ul><ul><ul><li>But, optimization is a mirage </li></ul></ul></ul></ul><ul><li>• Are not purely social, nor purely technical problems </li></ul><ul><ul><ul><ul><li>Both the social and technical perspectives must be present, and harmonized, to be successful </li></ul></ul></ul></ul><ul><ul><ul><ul><li>Architecting starts from the stakeholders, and assumes the problem definition is inside the scope </li></ul></ul></ul></ul><ul><li>• Can be examined systematically and scientifically, if not rigorously </li></ul><ul><ul><ul><ul><li>Induction over disparate experience bases (heuristics) is very important </li></ul></ul></ul></ul><ul><li>• Have (when we are lucky) solutions that are happy compromises, but not perfect </li></ul>Source: from M. Maier, E. Rechtin, The Art of Systems Architecting, 2nd ed. (2002)
  22. 22. A heuristics based approach to systems architecture <ul><ul><ul><li>Clarity of goals </li></ul></ul></ul><ul><ul><ul><ul><li>KISS: Keep it simple stupid! </li></ul></ul></ul></ul><ul><ul><ul><ul><li>One insight is worth a thousand analyses. </li></ul></ul></ul></ul><ul><ul><ul><li>Organization of work </li></ul></ul></ul><ul><ul><ul><ul><li>The greatest architectures are the product of a single mind – or of a very small, carefully structured team. </li></ul></ul></ul></ul><ul><ul><ul><ul><li>Build in and maintain options as long as possible in the design and implementation of complex systems. You will need them. </li></ul></ul></ul></ul><ul><ul><ul><ul><li>In architecting a new program, all the serious mistakes are made in the first day. </li></ul></ul></ul></ul><ul><ul><ul><li>Avoiding risks </li></ul></ul></ul><ul><ul><ul><ul><li>The most dangerous assumptions are the unstated ones. </li></ul></ul></ul></ul><ul><ul><ul><ul><li>Do the hard parts first. </li></ul></ul></ul></ul><ul><ul><ul><ul><li>The greatest leverage is at the interfaces heuristic. Make a system evolvable by paying attention to the interfaces. </li></ul></ul></ul></ul>Seite Source: from M. Maier, E. Rechtin, The Art of Systems Architecting, 2nd ed. (2002)
  23. 23. Heuristics applying to social and political systems <ul><ul><ul><ul><li>It’s not the facts, it’s the perceptions that count. </li></ul></ul></ul></ul><ul><ul><ul><ul><li>Success is in the eyes of the beholder (not the architect). </li></ul></ul></ul></ul><ul><ul><ul><ul><li>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? </li></ul></ul></ul></ul><ul><ul><ul><ul><li>Cost rules. </li></ul></ul></ul></ul><ul><ul><ul><ul><li>In social systems, how you do something may be more important than what you do. </li></ul></ul></ul></ul><ul><ul><ul><ul><li>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). </li></ul></ul></ul></ul><ul><ul><ul><ul><li>It’s easier to change the technical elements of a social system than the human ones. </li></ul></ul></ul></ul><ul><ul><ul><ul><li>The best engineering solutions are not necessarily the best political solutions. </li></ul></ul></ul></ul><ul><ul><ul><ul><li>If the politics don’t fly, the system never will. </li></ul></ul></ul></ul>Seite Source: from M. Maier, E. Rechtin, The Art of Systems Architecting, 2nd ed. (2002)
  24. 24. <ul><li>The challenge: dealing with increasing complexity in modern regulation </li></ul><ul><li>Lessons from systems thinking </li></ul><ul><li>Learning from the art of systems architecting </li></ul><ul><li>Implications for a modern regulation and political leadership </li></ul>Seite Agenda
  25. 25. Five principles for modern regulatory leadership <ul><li>Strategic understanding: Leadership needs to have clear sense of goals and dynamics of impact </li></ul><ul><li>Transparency: Only regulation with end-to-end measures incl. cost of regulation is credible. </li></ul><ul><li>Delegation: Implementation authorities need freedom for finding adequate solutions within space defined by few invariants </li></ul><ul><li>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. </li></ul><ul><li>Customer perspective: The citizen-/company-perspective needs to drive communication and expectation management </li></ul>Seite
  26. 26. A more principle-based approach to addressing financial market failures <ul><li>Financial markets characteristics </li></ul><ul><li>Uncertainty of financial market decision-makers </li></ul><ul><li>Nonlinear feedbacks </li></ul><ul><li>Tight coupling of subsystems through mark-to-market valuations </li></ul><ul><li>Misalignment of interests and incentives in originate-and-distribute model </li></ul><ul><li>“ Unexpected”, dramatic market changes </li></ul><ul><li>Principles to be “lifted” from architecting </li></ul><ul><li>Addressing information failures by implementing cost-effective supplemental protections (e.g. warranties, certifications of quality) </li></ul><ul><li>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) </li></ul><ul><li>Addressing Failures Arising from misalignment by using independent, third-party servicers and other trust building processes </li></ul>Seite Source: Steven L. Schwarcz, Complexity as a Catalyst of Market Failure, A Law and Engineering Inquiry (2008)
  27. 27. The challenge for political leadership <ul><li>[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. </li></ul>Source: Richard Bookstaber, A Demon of our Own Design: Markets, Hedge Funds, and the Perils of Financial Innovation, (2007)
  28. 28. Determinants of successful political regulation and reforms based on case studies <ul><li>The performance and outcomes of reform politics do not depend on </li></ul><ul><li>the severity of existing problems a country has to cope with, </li></ul><ul><li>characteristics of the political system (e.g. successful and far-reaching reforms are possible in consensus governments as well as in majority-democracies). </li></ul><ul><li> Selection of adequate reform strategies / quality of reform management by the government is crucial! </li></ul><ul><ul><li>strategic process management </li></ul></ul><ul><ul><li>political leadership </li></ul></ul>Seite Source: Thomas Fischer, Andreas Kießling und Leonard Novy (ed.): Politische Reformprozesse in der Analyse, (2008)
  29. 29. Thank you for your attention Seite