Private Regulation

http://www.futureofcapitalism.com/2010/03/private-regulation

One theme we've been exploring here lately -- and a timely one as Congress debates imposing new rules on the health care industry and on financial institutions -- is the concept of private regulation. We highlighted an op-ed piece by Emily Schaefer comparing the National Highway Traffic Safety Administration (government) and Consumers Union (private). And in response to a reader comment arguing that government regulation is needed because most people can't really be expected to become experts and "understand much of what is in the fine print of a credit card, mortgage or health insurance policy," we replied that:

If you are looking for a restaurant, say, you check Zagats or the Michelin guide or a trusted newspaper restaurant reviewer. Or a hotel, you check tripadvisor or oyster.com or AAA or Mobil or Fodors or Frommer's or Let's Go or Lonely Planet. If you are buying a car or an appliance you check Consumer Reports. Morningstar rates mutual funds. Government regulations end up giving consumers the illusion of safety (Madoff is registered with the SEC so how bad could it be; this restaurant is inspected by the board of health so how bad could it be?) but in fact the regulators often fail, because they have little or no competition or incentive. The more government sets these regulations, the more it crowds out entrepreneurs who might profit by providing useful information to consumers. So instead of founding a Zagats for consumers to choose doctors or health insurers or credit cards, smart people end up deciding to do something else instead. Consumers don't have to be experts; they just have to be able to consult an expert (like the Times restaurant reviewer) or aggregate their own wisdom with those of others into a wisdom-of-crowds like phenomenon like Zagat.

I recently discovered another example of private regulation of a complex business: Brightscope, a company and Web site set up to help companies and employees understand and rate the performance of their pension plan providers. If you think credit cards, health insurance, or mortgages are complicated, they look basic compared to the company retirement plans, as anyone who has ever had to complete testing to see whether a plan is "top-heavy" or had to pay a legal fee to hear a lawyer talk about "ERISA" can tell you. The plan providers, even the best of them, are already starting to fight back. The point is that in capitalism, the market has a way of self-correcting. Society can deal with unscrupulous or incompetent or even competent financial services companies by hiring regulators plentiful and smart enough to police them. Or it can allow private entrepreneurs to figure out ways to provide useful information to consumers that make it easier for consumers to navigate choices that would otherwise be more complicated. Or it can do a mixture of the two. I do think there is a role for some government regulation, particularly enforcement of anti-fraud law. But I also think that the potential of private regulation is all too often overlooked.

by Ira Stoll  |  Mar 17, 2010 at 9:58 pm Related Topics:  Auto Industry, Capital Markets Regulation, Health Care, Press receive the latest by email: subscribe to the free futureofcapitalism.com mailing list