The Regulation and Self-Regulation of a Complex Industry

Abstract

I develop a model of policy making in complex domains where bureaucrats find it very difficult to establish autonomous sources of expertise, so regulators are highly dependent on the regulated industry and its willingness to engage in self-regulation. In the model, a legislative principal decides whether to delegate the power to an agency to regulate the activities of a firm or industry. The policy domain is complex in that knowledge of the implications of different policy choices is concentrated in the firm. The agency can learn about the policy environment only through monitoring the firm’s efforts at self-regulation. The main result is that, as policy becomes more complex, regulatory outcomes are increasingly biased toward those preferred by the firm. Moreover, when the agency has preferences that diverge from the firm’s, the firm invests less in its own self-regulatory efforts for fear that its policy investments will be expropriated.

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