Regulatory Lines and Cost-Benefit Lessons
Regulatory Lines and Cost-Benefit Lessons
Ganga Prasad G. Rao
http://myprofile.cos.com/gangar
Trekking is for lovers, or so one would believe. Why else would anyone walk miles of treacherous serpentine paths to be stung by spines and bees, suffer sunburns and risk exhaustion, only to turn around and walk what would be the equivalent of twice those miles? Brett though, was an exception. His love for trekking was an expression of his freedom, and distaste for the mundane and the routine. Working for the Strategy Group within the Industry-Government Regulatory Panel, IGRP, was supposed to be a breeze. Some considered it a liaison job and looked down upon him, but Brett, the Regulator on the Panel, did not care to stoop low and respond. Instead, what bothered him now, as he ambled along the trekking path, was the perpetual pressure to come up with new concepts and ideas that were at the same time incrementally more efficient, more equitable, and did not engender externalities. Ain’t that the responsibility of those smart-ass Harvard Graduates? Those 7-figure salaried ‘Royal class' who would catch a cold if they as much looked at Commoner graduates? But, sanity got the better of his jealousy, and he instead trained his thoughts at how he could impress the bosses in the Government and the Industry with his imagination and land the much coveted Chair of the Regulatory panel over the Ivy-league favourites. Early on, he realized he'd have to focus on ideas that expanded the economic pie rather than those that merely transferred revenues and rents from one section of society to another. Ask any economist what expands the pie, and his answer would be: Technological Innovation, Resource exploitation and WTP gains following income expansion. But were there sufficient incentives in the system to seek those innovations and fulfill the WTPs? And how would one set the ball rolling?
Pacing himself through the rugged terrain, Brett began at the top of the pyramid – the Judges, arguably the cream of the society in knowledge, expertise and social jurisprudence, whose charge it was to monitor their domain (whether societal or industrial) and determine if the extant constitutional system of laws, rules and regulations was enforced and monitored for intended outcomes, and who further ensured that the system anticipated loopholes and exceptions, and reformed/updated itself to scientific, health, technological and social developments.Judges on the Government side dealt with Social-, Environmental-, Health- and Safety- Externality, (SESH) issues, while those on the side of the Industry focused on more mundane issues such as Efficiency, Growth, Profits, Price, Inflation and Competition. In the course of their judgeship, the Judges came upon those cases, pleas,and plaints that stood out for the lacunae and inadequacies they revealed in the existing system - cases from which they would draw their specific lessons, and draw juridical generalizations as appropriate. As Brett imagined, the Judges would, during the proceedings, and post judgement, dwell upon the origins of the Case, examine what principles – economic, constitutional, or regulatory, were violated and why. They would ruminate on which law or Institution failed, for what reason, and on the recourses available to resolve the matter, including in particular, the necessity of additional legal stipulations or programs. Required to ensure a resolution even if in future, the Judges issued either a 'Stricture', or a 'Recommendation' to the Executive (if a SESH matter), or an ‘Issue Paper', if it concerned the Industry. The Stricture/Recommendation carried, explicitly or implicitly, the authority to structure an appropriate program, policy or regulation,at public cost.
Winding a path through the alternating rocky terrain and shrubs, Brett gave a free lien to his thoughts, or should we say, imagination. Now, the President, as the Head of the Executive, and seized as he was with governing the state, took note of the stricture/recommendations from the Judge. In fact, as he perceived it, he could, with a little bit of political and regulatory acumen, 'monetize' the recommendations, even the stricture, as a line item for a policy/regulatory program in his budget(Why, he could even have the Fed print money for the program! Did it not result in social gain?). Elsewhere, the Industry Judge penned an Issue paper to elucidate his thoughts upon a matter of particular concern between the Industry and the Government. The Issue paper evoked academic and professional responses that provided the grist for research discussed as Working papers at seminars and conferences. If a domestic issue, the Industry Association pursued it with the concerned Ministry or Department of the Government to obtain a just resolution. But when it involved MNCs, trade policy, or issues in the international arena, the Issue- and Working papers were forwarded to the World Bank which sponsored a grant to seek a policy resolution. The Bank came out with a Policy Study in public, and privately issued a Policy Line and a Lobby line consistent with the shadow value of the recommended policy remedy/reform. The Lobby Line, targeted at Policy-makers and legislators, wound its way through Ministries and the Parliament if a 'short-run issue', and if long, through the Planning/Investment/Competition Commission and influential Think-tanks. The Bank split its Policy Line between, on one hand, a fund to underwrite the cost of regulation and cover the one-time cost of regulatory compliance, and on the other, a strategic allocation of funds between long-term equity investments and liquid financial instruments, so it could reward the nation if it chose to accept the suggested policy reform, or reverse its liquid positions to send a message, if otherwise.
With the shrubs behind, and the sun beating down upon him, Brett trekked the straight path toward the local peak. He let his imagination loose again. And so when the Prez began his search for a Regulator to give shape to the Judge’s directions, the word spread faster than an earthquake would over the continental divide. Despite the competition from his Ivy League detractors, Brett fancied his chances, for he had developed a unique, patented regulatory ‘recipe’ that was the better for not following established theory. His regulatory twist involved consciously pairing SESH program lines with Industrial policy reform lines; the trick being to exploit the synergies of efficiency upgrades - the goal of policy reform - with equity enhancements deemed necessary to resolve the Judge’s SESH advisory. Brett, knowing most policy reform that enhanced efficiency tended to impact equity negatively, was careful in the choice of the Equity program to pair with Policy Reform. In general, he found it advantageous to choose Equity programs that involved those impacted by past externalities generated by the target sector of the policy reform. It was a half-way solution to internalize equity in to cost-benefit computations. But Brett didn’t stop with the Equity enhancement. He even went so far as to modify the Net Benefits criterion to suit the realities of political decision-making within a multi-party democracy. Realizing that the Executive would not mind either un-allocated funds, or the flexibility to cross-assign those unallocated funds as necessitated by the particular politico-economy context, he enhanced the net benefits criterion by adding to it the Residual Policy line. Vide this criterion, the Regulator would choose that option which obtained large,but not the largest net benefits, and yet, left a substantial Policy line unspent with the Executive. In addition, and in lieu of the sacrifice of the option with the largest net benefit, Brett counted in to his criterion, the overlap of equity impacts from each policy option with various SESH lines. Essentially, Brett counted in to his criterion, the avoided expenditures from the various SESH lines due the choice of a (sub)-optimal regulatory policy option. Thus designed, the ‘Brett Enhanced Net Benefits’, BENB Criterion, chose that combination of Policy option & SESH line that maximized a combination of efficiency, equity and the option value of holding unallocated resources.
The trek ahead was decidedly risky, with steep rock faces; in fact, Brett deemed rock-climbing skills essential.But Brett wouldn’t let the risks limit his professional fancies. If the Executive favoured him with the contract, he’d forthwith sub-contract with Consultants to ‘flesh out’ the costs, benefits and equity impacts of alternative regulatory options exploiting the Policy reform line, each different in scope and principles. If one proposal hinged on flexibility, another banked on scale and scope economies; yet another on prospective and contingent M&A activities, and even one that permitted a Monetary/Coasian Property rights resolution. These alternative regulatory proposals would compete for resources from the same Policy Line – the line issued by the World Bank or the National Industry Trade Association, and obtain different amounts of efficiency gains albeit with positive or negative equity impacts.
Finally, Brett made it … to the top of the scarp. Had the trek been worth it thus far? Why sure, for Brett had before him, if ethereally, a concise table that listed the costs and benefits of various regulatory options as evaluated by his consultants. The regulatory options competed for the same Policy line (issued by the Executive in response to a Stricture/Recommendation) and generally varied with regard to Costs (Spending), Benefits,and Net benefits. To these regulatory options he paired 4 different SESH Equity Lines representing 4 different equity programs, each with its own intended group of recipients. Next, Brett noted the extent of the incidence of the impacts of the 4 regulatory options with the intended group of SESH Equity line recipients. Applying the BENB Criterion, Brett chose that regulatory option-SESH program combination which maximized the sum of Efficiency gains, Equity overlap and unspent Regulatory Resources (and expressly excluded the SESH resources that remained untouched in his proposal).
At this point, and relaxing on the Mesa top in the warm afternoon sun, Brett found it useful to elucidate his concept with a real-life example. He chose the case of the health impacts of exposure to mercury and lead. The Judges had ruled that recent advances in medical sciences had established that the two metals, long suspected to be neuro- and geno-toxic, were indeed so at a concentration a further two magnitudes lower. In their recommendation to the Public Health Advisory Committee, the Judges endorsed the case for a tightening of exposure limits; they also explicitly supported compensating a wider swathe of the affected population. As an IGRP Regulator, Brett found this SESH recommendation of particular relevance, working as he was with a regulatory initiative to subsidize the capital cost of more efficient Combined cycle technology at thermal power plants; thermal plants being a significant source of mercury in the air.
Likening the Capital Cost subsidy to a Policy Line of $500M, and considering the various SESH lines, (including Mercury SESH line) Brett examined the 4 regulatory options. If he were fresh from Graduate school (or, one so orthodox he hadn't lost his virginity in the profession!), Brett would have been inclined to go with Option 4 for the largest Net Benefits that it obtained. However, as one walking the fine line between Judges, the Executive, the Industry Association, and for good measure, the World Bank, he tentatively chose the more pragmatic path that recognized, over and above Net Benefits, the worth of resources yet unspent (Net Benefits+Residual Policy Line, NBRPL). This criterion yielded Options 1 and 2 as equal favourites. But Brett was yet short of his optimum. Hadn't he envisaged exploiting any incidental overlap of equity benefits from the Capital cost subsidy policy with benefits intended for recipients of the various SESH lines? To examine that possibility, Brett further added to NBRPL, the Equity overlap (Regulatory benefits that doubled as Equity compensation) as determined for each SESH constituency. Now, the BENP criterion represented the sum of Net Benefits, Residual Policy Line, and SESH Equity overlap. Thus modified, the BENP criterion homed in on Option1 + SESH Line 4 as the optimum regulatory initiative. The BENP Score of $550M represented the sum of $200M in net benefits, $250M in unspent regulatory resources, and $100M in redundant SESH compensation due overlap in Mercury benefits. Put another way, the choice represented the benefits of avoided mercury pollution from adopting Combined Cycle technology that precluded a redundancy of compensation to the (potentially) Mercury-exposed from the Mercury SESH line. The chosen option obtained large efficiency gains to the industry, while ensuring a significant equity pay-off for an environmentally-denied group, and left the World Bank and the Executive with substantial leeway in the allocation of unspent Regulatory and Equity monies.
Brett was confident his paired approach would be optimal for an economy seeking to expand its pie efficiently, while simultaneously enhancing equity in the society. Proud of the universality of his approach, Brett hoped it'd turn the IGRP scales in his favor. With that hope and anticipation, he packed up for the long trek back home.....
Gotta beat the Monday morn congestion hour charges !
Ganga Prasad G. Rao
http://myprofile.cos.com/gangar
Trekking is for lovers, or so one would believe. Why else would anyone walk miles of treacherous serpentine paths to be stung by spines and bees, suffer sunburns and risk exhaustion, only to turn around and walk what would be the equivalent of twice those miles? Brett though, was an exception. His love for trekking was an expression of his freedom, and distaste for the mundane and the routine. Working for the Strategy Group within the Industry-Government Regulatory Panel, IGRP, was supposed to be a breeze. Some considered it a liaison job and looked down upon him, but Brett, the Regulator on the Panel, did not care to stoop low and respond. Instead, what bothered him now, as he ambled along the trekking path, was the perpetual pressure to come up with new concepts and ideas that were at the same time incrementally more efficient, more equitable, and did not engender externalities. Ain’t that the responsibility of those smart-ass Harvard Graduates? Those 7-figure salaried ‘Royal class' who would catch a cold if they as much looked at Commoner graduates? But, sanity got the better of his jealousy, and he instead trained his thoughts at how he could impress the bosses in the Government and the Industry with his imagination and land the much coveted Chair of the Regulatory panel over the Ivy-league favourites. Early on, he realized he'd have to focus on ideas that expanded the economic pie rather than those that merely transferred revenues and rents from one section of society to another. Ask any economist what expands the pie, and his answer would be: Technological Innovation, Resource exploitation and WTP gains following income expansion. But were there sufficient incentives in the system to seek those innovations and fulfill the WTPs? And how would one set the ball rolling?
Pacing himself through the rugged terrain, Brett began at the top of the pyramid – the Judges, arguably the cream of the society in knowledge, expertise and social jurisprudence, whose charge it was to monitor their domain (whether societal or industrial) and determine if the extant constitutional system of laws, rules and regulations was enforced and monitored for intended outcomes, and who further ensured that the system anticipated loopholes and exceptions, and reformed/updated itself to scientific, health, technological and social developments.Judges on the Government side dealt with Social-, Environmental-, Health- and Safety- Externality, (SESH) issues, while those on the side of the Industry focused on more mundane issues such as Efficiency, Growth, Profits, Price, Inflation and Competition. In the course of their judgeship, the Judges came upon those cases, pleas,and plaints that stood out for the lacunae and inadequacies they revealed in the existing system - cases from which they would draw their specific lessons, and draw juridical generalizations as appropriate. As Brett imagined, the Judges would, during the proceedings, and post judgement, dwell upon the origins of the Case, examine what principles – economic, constitutional, or regulatory, were violated and why. They would ruminate on which law or Institution failed, for what reason, and on the recourses available to resolve the matter, including in particular, the necessity of additional legal stipulations or programs. Required to ensure a resolution even if in future, the Judges issued either a 'Stricture', or a 'Recommendation' to the Executive (if a SESH matter), or an ‘Issue Paper', if it concerned the Industry. The Stricture/Recommendation carried, explicitly or implicitly, the authority to structure an appropriate program, policy or regulation,at public cost.
Winding a path through the alternating rocky terrain and shrubs, Brett gave a free lien to his thoughts, or should we say, imagination. Now, the President, as the Head of the Executive, and seized as he was with governing the state, took note of the stricture/recommendations from the Judge. In fact, as he perceived it, he could, with a little bit of political and regulatory acumen, 'monetize' the recommendations, even the stricture, as a line item for a policy/regulatory program in his budget(Why, he could even have the Fed print money for the program! Did it not result in social gain?). Elsewhere, the Industry Judge penned an Issue paper to elucidate his thoughts upon a matter of particular concern between the Industry and the Government. The Issue paper evoked academic and professional responses that provided the grist for research discussed as Working papers at seminars and conferences. If a domestic issue, the Industry Association pursued it with the concerned Ministry or Department of the Government to obtain a just resolution. But when it involved MNCs, trade policy, or issues in the international arena, the Issue- and Working papers were forwarded to the World Bank which sponsored a grant to seek a policy resolution. The Bank came out with a Policy Study in public, and privately issued a Policy Line and a Lobby line consistent with the shadow value of the recommended policy remedy/reform. The Lobby Line, targeted at Policy-makers and legislators, wound its way through Ministries and the Parliament if a 'short-run issue', and if long, through the Planning/Investment/Competition Commission and influential Think-tanks. The Bank split its Policy Line between, on one hand, a fund to underwrite the cost of regulation and cover the one-time cost of regulatory compliance, and on the other, a strategic allocation of funds between long-term equity investments and liquid financial instruments, so it could reward the nation if it chose to accept the suggested policy reform, or reverse its liquid positions to send a message, if otherwise.
With the shrubs behind, and the sun beating down upon him, Brett trekked the straight path toward the local peak. He let his imagination loose again. And so when the Prez began his search for a Regulator to give shape to the Judge’s directions, the word spread faster than an earthquake would over the continental divide. Despite the competition from his Ivy League detractors, Brett fancied his chances, for he had developed a unique, patented regulatory ‘recipe’ that was the better for not following established theory. His regulatory twist involved consciously pairing SESH program lines with Industrial policy reform lines; the trick being to exploit the synergies of efficiency upgrades - the goal of policy reform - with equity enhancements deemed necessary to resolve the Judge’s SESH advisory. Brett, knowing most policy reform that enhanced efficiency tended to impact equity negatively, was careful in the choice of the Equity program to pair with Policy Reform. In general, he found it advantageous to choose Equity programs that involved those impacted by past externalities generated by the target sector of the policy reform. It was a half-way solution to internalize equity in to cost-benefit computations. But Brett didn’t stop with the Equity enhancement. He even went so far as to modify the Net Benefits criterion to suit the realities of political decision-making within a multi-party democracy. Realizing that the Executive would not mind either un-allocated funds, or the flexibility to cross-assign those unallocated funds as necessitated by the particular politico-economy context, he enhanced the net benefits criterion by adding to it the Residual Policy line. Vide this criterion, the Regulator would choose that option which obtained large,but not the largest net benefits, and yet, left a substantial Policy line unspent with the Executive. In addition, and in lieu of the sacrifice of the option with the largest net benefit, Brett counted in to his criterion, the overlap of equity impacts from each policy option with various SESH lines. Essentially, Brett counted in to his criterion, the avoided expenditures from the various SESH lines due the choice of a (sub)-optimal regulatory policy option. Thus designed, the ‘Brett Enhanced Net Benefits’, BENB Criterion, chose that combination of Policy option & SESH line that maximized a combination of efficiency, equity and the option value of holding unallocated resources.
The trek ahead was decidedly risky, with steep rock faces; in fact, Brett deemed rock-climbing skills essential.But Brett wouldn’t let the risks limit his professional fancies. If the Executive favoured him with the contract, he’d forthwith sub-contract with Consultants to ‘flesh out’ the costs, benefits and equity impacts of alternative regulatory options exploiting the Policy reform line, each different in scope and principles. If one proposal hinged on flexibility, another banked on scale and scope economies; yet another on prospective and contingent M&A activities, and even one that permitted a Monetary/Coasian Property rights resolution. These alternative regulatory proposals would compete for resources from the same Policy Line – the line issued by the World Bank or the National Industry Trade Association, and obtain different amounts of efficiency gains albeit with positive or negative equity impacts.
Finally, Brett made it … to the top of the scarp. Had the trek been worth it thus far? Why sure, for Brett had before him, if ethereally, a concise table that listed the costs and benefits of various regulatory options as evaluated by his consultants. The regulatory options competed for the same Policy line (issued by the Executive in response to a Stricture/Recommendation) and generally varied with regard to Costs (Spending), Benefits,and Net benefits. To these regulatory options he paired 4 different SESH Equity Lines representing 4 different equity programs, each with its own intended group of recipients. Next, Brett noted the extent of the incidence of the impacts of the 4 regulatory options with the intended group of SESH Equity line recipients. Applying the BENB Criterion, Brett chose that regulatory option-SESH program combination which maximized the sum of Efficiency gains, Equity overlap and unspent Regulatory Resources (and expressly excluded the SESH resources that remained untouched in his proposal).
At this point, and relaxing on the Mesa top in the warm afternoon sun, Brett found it useful to elucidate his concept with a real-life example. He chose the case of the health impacts of exposure to mercury and lead. The Judges had ruled that recent advances in medical sciences had established that the two metals, long suspected to be neuro- and geno-toxic, were indeed so at a concentration a further two magnitudes lower. In their recommendation to the Public Health Advisory Committee, the Judges endorsed the case for a tightening of exposure limits; they also explicitly supported compensating a wider swathe of the affected population. As an IGRP Regulator, Brett found this SESH recommendation of particular relevance, working as he was with a regulatory initiative to subsidize the capital cost of more efficient Combined cycle technology at thermal power plants; thermal plants being a significant source of mercury in the air.
Likening the Capital Cost subsidy to a Policy Line of $500M, and considering the various SESH lines, (including Mercury SESH line) Brett examined the 4 regulatory options. If he were fresh from Graduate school (or, one so orthodox he hadn't lost his virginity in the profession!), Brett would have been inclined to go with Option 4 for the largest Net Benefits that it obtained. However, as one walking the fine line between Judges, the Executive, the Industry Association, and for good measure, the World Bank, he tentatively chose the more pragmatic path that recognized, over and above Net Benefits, the worth of resources yet unspent (Net Benefits+Residual Policy Line, NBRPL). This criterion yielded Options 1 and 2 as equal favourites. But Brett was yet short of his optimum. Hadn't he envisaged exploiting any incidental overlap of equity benefits from the Capital cost subsidy policy with benefits intended for recipients of the various SESH lines? To examine that possibility, Brett further added to NBRPL, the Equity overlap (Regulatory benefits that doubled as Equity compensation) as determined for each SESH constituency. Now, the BENP criterion represented the sum of Net Benefits, Residual Policy Line, and SESH Equity overlap. Thus modified, the BENP criterion homed in on Option1 + SESH Line 4 as the optimum regulatory initiative. The BENP Score of $550M represented the sum of $200M in net benefits, $250M in unspent regulatory resources, and $100M in redundant SESH compensation due overlap in Mercury benefits. Put another way, the choice represented the benefits of avoided mercury pollution from adopting Combined Cycle technology that precluded a redundancy of compensation to the (potentially) Mercury-exposed from the Mercury SESH line. The chosen option obtained large efficiency gains to the industry, while ensuring a significant equity pay-off for an environmentally-denied group, and left the World Bank and the Executive with substantial leeway in the allocation of unspent Regulatory and Equity monies.
Brett was confident his paired approach would be optimal for an economy seeking to expand its pie efficiently, while simultaneously enhancing equity in the society. Proud of the universality of his approach, Brett hoped it'd turn the IGRP scales in his favor. With that hope and anticipation, he packed up for the long trek back home.....
Gotta beat the Monday morn congestion hour charges !
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