Perverse Incentives Promote Disasters

In the wake of any industrial accident there follows a predictable chorus of pundits lamenting “market failure” in order to justify further interference of the state into every facet of business function. On the surface this might sound plausible, surely we need Big Brother looking over our employer’s shoulder to make sure everything is safe, right? The only problem with this narrative is that the pundits tend to conveniently omit the crucial fact that such disasters happened on the watch of government. There is no place in the world immune to at least some level of government oversight related to safety. Even in Bangladesh where there has been a recent spate of factory fires and building collapses they at least had building codes even if they weren’t followed. And there in lies the rub. The people entrust their government with the task of ensuring their safety (a dubious decision at best) but when that same government fails to adequately carry out that mandate and such failure is the proximate cause of some disaster oddly blame is 100% shouldered by the regulated entity rather than the regulator. If you had a jail in your community that routinely had prisoners escaping and killing people it seems like at some point the people running the prison should share in the culpability.

So whether it is financial misdeeds on Wallstreet, a factory explosion in West Texas, or a building collapse in Bangladesh, we see the same failure of the state regulators to do their job. But the regulators are just employees, they can’t be held personally liable. And their employer is the state, and the state can’t be held liable. So where does that leave us? No one is responsible. What is the solution? Rub some bacon on it – err I mean throw some more money at it.

If regulators fail, then they just get more money and scribble down yet more regulations based on their clairvoyant 20/20 hindsight; more words on paper that will be ignored by more regulators in the future. The perverse incentive of this system should be obvious and yet it continues. The perverse incentive is that (a) failure is rewarded with (b) more resources; therefore failure is what is incentivized. Now that is not to say that all the regulators individually are these evil monsters failing on purpose in hopes of one day obtaining a raise. But what it does mean is that the system itself cannot cure itself. A market system is self-regulating in that failing firms (assuming they are not bailed out by the government) disappear into the graveyard of failed businesses. In a market based regulatory system failure means you lose all your money and go out of business. Success means you make money and you stay in business. Competition among the successful firms drives further improvements. There is no competition in the monopolistic government run regulatory system; Soviet style stagnation reigns supreme. A successful private regulator (e.g. Underwriter’s Laboratories, Consumer Reports, etc) prevents harm and is rewarded for successfully doing so. Government can’t go “out of business” and so the same old failing system stays in place, at least until we vote in illusory “change” only to discover nothing has changed at all.