Four ways to reform regulation and the administrative state

We sit at the cusp of a new administration, which appears likely to turn the political tides in a more pro-regulatory direction, if only to pursue policy aims stymied by a deadlocked legislative branch. This prospect best illuminates the critical necessity of regulatory reform in the name of democratic accountability, and examining where we are.

Governmental regulation of the private sphere has three broad objectives when applied within a modern market economy:

• Addressing market failures or otherwise facilitating the promotion of “public goods” under circumstances in which rational actors may collectively act in a manner detrimental to society’s interests. For example, a commercial bank may elect to hold limited capital reserves in the belief that doing so is a risk worth taking; if all banks were to do so, the risk and consequences of a potential financial system collapse may warrant requiring all banks to hold some minimum level of capital.
• Favoring or disfavoring certain interest groups, in a manner less transparent than direct legislation or transfer payments.
• Driving normative outcomes, similar to (and often in place of) tax and fiscal policy, in the sense of mandating or restricting (or incentivizing/disincentivizing) certain behavior. 

We can agree that all but the most rock-ribbed of small government libertarians support this first objective, and that anyone interested in good governance views the second as an aberrant vestige of the spoils system of the 19th century, however enduring its misuse. But what are we to make of the third — or, more specifically, where has its proliferation led us?

Consider the origins of our current regulatory regime. A society’s laws are meant to reflect its values and customs, whether actual or aspirational. In a democratic republic, these laws are passed by citizens’ legislative representatives and, in the United States, are implemented and enforced by the executive branch of the relevant level of government. In a large and complex market economy, these tasks require a significant infrastructure, the rulemaking component of which manifests in the form of an expansive regulatory bureaucracy. The rationale for an ever-expanding regulatory footprint is that issues arising from any given legislation are so unforeseeable, with permutations unknowable at the time such laws are passed, that it is unreasonable to fully detail legislation at the time of its passage. 

While such an approach is superficially understandable, it has several obvious defects. It leaves administrative rulemaking in the hands of individuals and departments unaccountable to the democratic process. This lack of accountability is further exacerbated by the permanence of the so-called “administrative state,” whose tenure is not subject to electoral outcomes or longer-wave ideological movements. These, in turn, contribute to a structural interest in self-perpetuation, as without democratic oversight, the rule-makers typically will make more rules — which requires more (and better paid) rule-makers, and the cycle repeats.

The end result is a government incapable of governing itself, much less its polity. One need not subscribe to the existence of a “deep state” or related conspiracies to find many troubling and recent examples of executive branch employees acting at cross purposes to — or at least not properly directed by — the elected officials they ostensibly serve. A government unable to properly direct its own activities to the ends endorsed by democratic outcomes undermines faith in the democratic process, and raises legitimate questions as to whether elections truly matter. 

In the commercial sphere, this lack of accountability among governmental overseers increases the perceived risk of capricious and unpredictable regulatory outcomes, inhibiting dynamism, innovation and capital formation, while fostering conservatism. The dysfunctional relationship between regulator and regulated also encourages “regulatory capture,” where the regulator serves the regulated party’s interest — a symbiosis that can run in both directions, forming a sort of mutual aid society in which public interest is an afterthought.

What can be done?

At the federal level, a number of recent administrations — typically but not always Republican — have pursued regulatory rollback, with mixed results. The Trump administration has made a hallmark of slowing the volume of new regulations, and touted its efforts at deregulation. While commendable, absent meaningful reform, a structural bias for expanded regulation will remain under any administration. Moreover, whether one is “pro” or “anti” regulation generally, or within specific spheres of activity, the issue is not only one of how much regulation, but the substance and quality of regulatory initiatives and the process by which regulations are implemented. Here’s a simple framework for how our regulatory construct and environment might be improved:

• Write better-researched and more detailed laws. Many federal laws appear crafted by design to leave their implementation purposefully ambiguous, allowing rule-makers to fill in the blanks. This is a willful abdication of congressional responsibilities.
• Use tax and fiscal policy when appropriate. The term “unfunded mandate” stems from the administrative state’s imposition of financial obligations on the private sector in opaque, indirect ways. While small government conservatives may prefer to be neither regulated nor taxed, the latter is at least intellectually honest as it is more easily quantified — and combated.
• Rediscover subsidiarity. State and local governments are closer to those they govern, and a greater degree of regulatory efficiency and responsiveness should ensue from a better understanding of local conditions. The notion of bureaucrats sitting in a distant administrative capital is not entirely the stuff of Russian literature.

• 21st century civil service reform. The landmark Reform Act of 1883 is what historians typically refer to in speaking of civil service reform — the replacement of the “spoils system” with a permanent, professional, merit-based bureaucracy. Over a century later, that bureaucracy has metastasized into a rogue vampire squid, which sports its own legal system in the form of administrative law judges who sit atop a parallel judicial branch designed to adjudicate disputes involving executive branch rulemaking. Any reform should consider how to make a sprawling, inefficient administrative state less partisan, more responsive and democratically accountable.

Modern economies require a transparent and efficient bureaucracy capable of regulating a dynamic society in a fashion consistent with its laws. It is essential that our legislature — our most directly democratically answerable branch of the federal government — reassert its responsibility for passing legislation that can be interpreted and enforced by the executive branch without encouraging further expansion of an imperial presidency and the circumvention of opportunities for bipartisan compromise.

Richard J. Shinder is a financial services executive in New York and founder of Theatine Partners, a financial consultancy. In a 25-year Wall Street career, he has worked in various advisory, principal and managerial roles for firms including The Blackstone Group, Goldman Sachs and Perella Weinberg Partners, among others.