Trust and Regulation

Regulation is a social substitute for trust.

That’s not a moral statement, just a factual one.

Sometimes the relationship between trust and regulation is obvious We submit to the regulation of traffic laws because we can’t trust everyone will simultaneously interpret the rules of the road similarly. And, when stoplights fail, we trust the regulation of traffic cops, whose very jobs are the result of a citizenry’s decision to be regulated.

Another regulatory no-brainer would seem to be the “commons,” i.e. a situation where, at the margin, it’s in everyone’s personal best interest to behave selfishly. Except that, when everyone does so, everyone turns out the loser. (In game theory, the “prisoner’s dilemma” spells this out). We can’t trust everyone (or even most people) to do what’s socially good, so we submit to regulation.

So it is we end up with regulated airspace and water tablesthough there are still crazies who insist they should be able to fly anything anywhere anytime, and drill any water drillable beneath their half acre of Arizona; plus, we still over-fish.

Closely related are natural monopolies, e.g. utilities (except, bafflingly to me, water companies in the UK). These businesses left unregulated will drift, often quickly, to monopolies. Much of regulatory debate is how to balance society’s interest vs. the normal trappings of markets. (Can we trust Microsoft to innovate? Airlines to share route rights? Telecom companies to share scale economies?)

The right degree of regulation for natural monopolies would be an easy matter for industrial economists, if only political ideologues nattering about free markets vs. socialism would leave them alone.

Much less is clear when it comes to naturally competitive markets in which people and companies behave in an untrustworthy manner toward customers, shareholders, employees and society. Here the issues become more clearly trust-related.

Can we trust the stockbroker’s motives when he recommends a stock? The food company’s label of ‘organic?’ Can we trust that the insurance company will be there when it’s claim time? Can we trust that a corporate email sent in confidence will be treated as such? That a doctor’s prescription is not unduly influenced by a pharmaceutical company?

Here are a few social policy rules of thumb for thinking about the relationship between trust and regulation.

1. Trust—where possible—is preferable to regulation. It avoids moral hazard; it is cheaper; and it is specific to the situation at hand.

2. Industry associations have a potentially powerful role to play. Too often they see their role as defenders of their constituents against regulation, rather than the far more constructive and long-term perspective of evolving powerful self-regulation. (I have blogged on this topic before; for mortgage banking, see my blogpost here; ; for financial planning, see here. Or, simply look at the regulatory nightmare the pharmaceutical industry has become, largely by failure to self-regulate.)

3. Certain industrial economics criteria cry out for regulation. If no one—investor, regulator, customer—has an integrated interest across a sector of business, then the situation is rife for abuse. The securitized mortgage industry had no one with an integrated perspective.  Regulation becomes by default attractive in such cases.

4. All else equal, short-term perspectives destroy trust and invite regulation.

5. Transparency may be the least costly form of regulation. It works best when obvious  It works best when obvious: e.g., "smoking causes cancer," or "these assets were marked to market."  Transparency as "the fine print" loses its power quickly. 

6. If an industry is fond of saying things like “caveat emptor,” or “hey it’s not illegal,” or “we’re only giving the consumer what they want,” look out. This is defensive language, typically used against stakeholder complaints—Big Tobacco, Big Food, and, I suspect, melamine producers in China.

7. Personally, I think business-school faculty have a huge responsibility. In an increasingly hyper-linked world, the competition-centric ideology taught as “strategy” is increasingly dysfunctional. It destroys trust by teaching that the natural state of business is to compete against our suppliers and customers, rather than to collaborate with and serve them.

By destroying trust, it invites regulation. Which, as stated in point one above, is the less preferable of the two.

Business, heal thyself; it’s better for all.

2 replies
  1. Tammy Lenski
    Tammy Lenski says:

    Charlie, I found this post compelling because I’ve worked for so many years with organizations that have gone the regulation path as a way to manage people’s behaviors inside the organization. I see regulating behavior in the workplace very akin to the tax code — by the time you’re done, you’ll have an employee handbook so thick no one really knows fully what’s in there.

    In my world as a conflict resolution consultant, I would love to see organizations truly confront and engage the differences that eat away at trust, instead of the avoidant path of more rules and regs.

    Reply
  2. peter vajda
    peter vajda says:

    Hi, Charlie,

    Insightful post and thank you. You offer lots to think about.

    Your graphic, for me, is a metaphor which points to much of the upset – ethical, moral, financial, economic – we are experiencing these days and relates to issues of trust and how we relate to one another.

    The question (related to the graphic) is: “Are the lines in or out?” The response reflects the mind-set with which one approaches not just tennis, but life at work, at home and at play. There are two choices.

    One. If our mind-set is that of “life is a zero-sum game”, that if you get yours, I won’t get mine, then my line calls will always serve to “benefit  me” (sometimes in and sometimes out, depending…and I’ve played lots of tennis with folks like this over the years). Zero-sum folks interact from a fear-based place, living a life based on greed, egoism, hubris, disconnection and dishonesty.

    Two. If we view life, for example, from the Buddhist perspective, that we are all interconnected, then the line calls will always be consistent, and right, no matter who gets the point. The Thai monk Bhikkhu says, “The entire cosmos is a cooperative…when we realize the world is a mutual, interdependent cooperative enterprise…then we can build a noble environment. If our lives are not based on this truth, then we shall perish.”  Economically, we may be headed in that direction. Hmmm.

    The notion of interconnectivity in the realm of economics is reflected in “spiritual capitalism” or “spiritual economics” where ethics plays the important role of defining goals and constraints. Spiritual capitalism and economics would require: non-violence, non-stealing, telling the truth, and a focus on right livelihood (e.g., making money honestly without cheating or misleading advertising). The underlying principle of spiritual capitalism focuses on being “stewards” of wealth, accumulating wealth ethically, and not becoming attached to it, generously using wealth for the good of all.

    Underneath spiritual capitalism or spiritual economics is the principle that economics and a moral and spiritual life are neither separate nor mutually exclusive. There is no emphasis on “self-benefit.” The “lines” are honestly and ethically in or out.

    Funny, “interconnectedness” is an interesting concept. On the one hand, when seeing life from a financial or business perspective, folks choose to “get it — i.e, when Wall Street sneezes, the world catches cold. On the other hand, i.e., the "spiritual" perspective, folks get "amnesia", go "dumb", refuse to “get it” — too airy fairy, too soft, to new agey and all that- absolving one from needing to choosing to consciously come from a place of ethics, morality or taking the high road when doing business.

    So when you refer to trust vis-à-vis stockbrokers, food companies, insurance companies, and doctors prescriptions, much depend on the perspective with which they come to making their “calls”.

    When you refer to business schools (“…the competition-centric ideology taught as “strategy” is increasingly dysfunctional…”), the zero-sum game approach often trumps collaboration, cooperation and, the quality of trust and relating that collaboration, etc., warrant.

     You end by suggesting, “Business, heal thyself; it’s better for all.” The challenge is for folks to understand this “healing” cannot and will not happen “financially” and “economically”, until it happens spiritually (i.e, ethically and from a deeper, core-connected value system and understanding the nature of interconnectivity).

    And until that time, most folks will be calling the lines in and out selfishly, unethically and as it serves their own benefit – “If you win, I lose” and my ego and/or wallet cannot allow that to happen.”

    The world is, indeed, catching cold…and it may not be too long before it morphs into pneumonia…and worse.  Game, set and match!

    Line calls are an interesting phenomenon and snapshot of life.

    Reply

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