Thursday, June 4, 2009

It's the incentives, stupid

As someone who teaches students to anticipate self interested behavior, why am I always suprised and disappointed when I run into it?
QUESTION: The U.S. government does a reasonably good job of regulating things like the safety of airplanes and foods. Why, then, does it do such a lousy job of regulating the financial system?

ANSWER: "Capture." For those not up on regulatory theory, this refers to the notion that regulators become captive of the industries they regulate. Noting that Fannie Mae and Freddie Mac spent $100 million on campaign contributions over the last 10 years,


  1. Who says they do a pretty good job of regulating airline safety and food? Competition, it seems to me, is the overriding factor driving airline and food safety. But I guess we can never tell.

  2. Um, how much do airlines contribute? Why wouldn't the FAA be captured? Perhaps the link between an airline's planes falling out of the sky and future demand for their service is clearer than between Fannie and Freddie failing and future demand for their services.

    Similarly, if anything, the FDA seems to be captured by the AMA rather than big pharma even though the later throws cash around left and right. We might expect the FDA to do a better job if only it were captured by big pharma.