The problem with ‘expert’ regulation

President TrumpDonald John TrumpBusiness, ballots and battling opioids: Why the Universal Postal Union benefits the US Sanders supporters cry foul over Working Families endorsement of Warren California poll: Biden, Sanders lead Democratic field; Harris takes fifth MORE’s attempts to change the way we regulate in America are about to get more difficult with a divided Congress. Even so, there remains much he can do from his perch atop the executive branch of U.S. government. Enormous power has been delegated to expert regulators who answer to the president, and their power has the potential to do good or ill, depending on how it is used.

Federal agencies have been granted this lawmaking power by our elected representatives. And while this concerns many who worry about democratic accountability, the logic is that regulators possess proficiency and detailed knowledge that lawmakers lack.

Perhaps nowhere is this agency expertise more on display than when regulators produce technical reports like benefit-cost analysis (BCA), which is used in the design and selection of regulations. Regulators have used this kind of analysis for decades, including to justify some of the most expensive federal rules. But are regulators using their expertise wisely?

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The Office of Management and Budget (OMB) recently claimed regulations last year imposed $3.3 to $4.9 billion in annual costs to the U.S. economy. Those estimates, made by analysts at federal regulatory agencies, sound big, but the BCAs produced alongside the rules projected annual benefits that are even bigger — between $13.6 and $27.3 billion, for a net yearly gain to society of $8.7 to $24 billion.

Yet if this kind of analysis is regulator expertise in action, then the trust we place in agencies is misplaced. These numbers rest on shaky — even missing — theoretical foundations.

A reasonable person might look at the OMB’s $24 billion number and conclude it has meaning. But despite being expressed in dollars, it has no intelligible meaning. The government’s BCA is not actually measuring money. In fact, it is not clear what it measures.

The reason is complicated, but it has to do with a confusing aspect of analysis called “discounting.” Discounting is leading to wildly misleading, and also inaccurate, regulatory analysis.

Financial analysts know that money can be invested and earn interest over time, so a dollar earned today is superior to a dollar earned tomorrow. This serves as the basis for discounting cash flows when analyzing investments. 

But BCA is different. Analysts aren’t just discounting money.

To assess the effects of a regulation, regulators assign a dollar value to its benefits, and then they discount them in the same way that financial analysts discount cash flows. This occurs even when those benefits aren’t money — such as when lives are expected to be saved from a regulatory change.

Lives, of course, can’t be invested in an account, so the rationale for discounting them is less clear than with money. And even though the money we spend trying to save lives could otherwise be invested, that doesn’t justify discounting people’s welfare either.

And yet, this is exactly what the so-called experts are doing.

These practices are of questionable morality, which by itself should raise concerns. But even leaving issues of ethics aside, current discounting methods make it nearly impossible for regulators to find the policy option that produces the highest return for society, or what economists call the “efficient” policy. Identifying efficiency improvements is the core purpose of BCA.

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Efficiency occurs when the value of the gains a policy creates exceed the dollar value of the losses by the greatest amount possible. But the government’s haphazard approach leads it to abandon this elemental measure of economic welfare. That’s because the act of discounting layers a scheme of basically arbitrary weights on top of a rule’s expected gains and losses. The end result is a number without clear meaning. 

If you’re confused by any of this, you’re not alone, which is precisely why the trust we place in regulators is so easily abused. Expertise can be used to advance a meaningful social agenda guided by a careful assessment of costs and benefits. Or, it can just as easily be used to advance a narrow and private agenda.

A private agenda need not be financially motivated either. It could come from regulators’ personal sense of duty or obligation to “do good,” for example. Even still, such private motivations have no place interfering with the integrity of an analyst’s calculations.

What is really driving regulatory agencies? Regulators have certainly demonstrated they are experts when it comes to sowing confusion. Yet expertise is sorely missing when it comes to evaluating the costs and benefits of regulations. We’ll just have to hope our trust in the “experts” isn’t misplaced.

James Broughel is a senior research fellow with the Mercatus Center at George Mason University and editor of the recent Mercatus Symposium “Three Approaches to the Social Discount Rate.” Follow him on Twitter @JamesBroughel.