The idea of regulatory capture is a good one, and it’s the principal explanation that academic economists offer for why regulators often — as a rule, in fact — don’t act as firm and wholly independent judges of those they’re meant to regulate. Whether they’re working to make manufacturers meet safety standards, or banks avoid undue risks, regulators rarely act as stern overseers, and often end up softening regulations to appease industry desires. It’s not generally because they’re incompetent or corrupt (although that’s sometimes true). Regulators are human beings, and hold opinions which can be influenced by others. They happen to interact mostly with those they regulate, and so end up getting influenced by the regulated — not surprisingly, in ways that favor those parties.
For example, regulators need information to do their jobs, and cooperation with those they regulate is a good way — probably the best way, and almost certainly the easiest — to get it. They try to get along with those they regulate, and that implies some give and take, some understanding and sympathy. Moreover, as regulators needn’t always remain regulators, prospects for later employment also play a role. A while back, my Bloomberg Views colleague Megan McArdle summarized the natural logic of regulatory capture. It’s not really surprising at all (although it may be surprising that we don’t do more to at least try to avoid it).
Economists are rightly proud of this analysis. It’s an example where thinking carefully about ordinary human behavior, as people do their best to meet their goals and get along with one another, goes a long way to explaining an important phenomenon. However, I suspect that economists may be less happy , possibly even a little alarmed, with the direction in which one of their tribe — Luigi Zingales of the University of Chicago — suggests the analysis ought to be extended.
What about economists themselves? Are they the free authors of their ideas, or are they, like regulators, significantly influenced in their thinking by their interactions with business interests? Zingales suggests the latter — and argues that we should, therefore, consider economists’ views with considerable skepticism. Overall, he concludes, the profession and its publications most likely display a significant pro-business and pro-markets bias, because many economists are captured.
It’s not hard, he points out, to imagine how it could happen, in pretty close analogy to what happens with regulators. For example, if you’re an academic economist, you’ll be strongly aided in your research by having easy access to valuable proprietary data. Getting that data means — as it often (though not always) does for regulators — being trusted by industry sources to cooperate. Economists thereby have an incentive to temper their conclusions about industry, or at least their public expression of such conclusions, to assure further cooperation. Business people also make up a significant part of the audience for academic economics. They’re likely to boost the popularity and acclaim of research with pro-industry conclusions.
What’s more, having more positive views of industry is also more likely to lead an economist toward consulting opportunities or jobs in industry. To take one example, suppose you’re an economist interested in the factors determining executive pay, and you hope one day to be hired to a corporate board, or to find work as a consultant on executive compensation. You will clearly be more likely to find positions if you’re not critical of current levels of CEO pay, and instead argue that it’s just and economically warranted. Economists have strong financial incentives to justify the level of executive compensations.
Plausible. But is there any empirical evidence this really happens? Yes, and Zingales looks at several different threads. For example, he looked at the 150 most downloaded papers from the Social Science Research Network (SSRN), identified by search for the phrase “executive compensation,” and taken from before the financial crisis (2008). He classified the papers as “positive” if they viewed the current level of compensation is justified or too low, and negative if too high, and then compared the frequency of positive versus negative views in different journals — economics, finance, management and law. The results show, as he writes, that “Articles published in major economic journals (such as the JPE, QJE, and AER) tend to have a clear pro-business bias with respect to the rest of the sample. Moreover, managerial reviews tend to publish fewer articles where the conclusion is compensation should be lower. The finance journals and law reviews do not exhibit any significant bias.”
Zingales looked at other data to test the idea that close contact with industry might bias researchers in a particular direction. The University of Chicago Initiative on Global Markets (IGM) (he is a director) asks a panel of expert economists various policy-related questions each week. For example, do you agree with the statement that “The typical chief executive officer of a publicly traded corporation in the U.S. is paid more than his or her marginal contribution to the firm’s value?” That is, are CEOs overpaid? The survey responses show that, on average, an economist who serves on a corporate board is four times more likely to disagree than one who does not.
Zingales also notes that articles offering positive conclusions about the level of executive compensation in general receive more citations (measured either by Google or SSRN) than do articles offering negative conclusions.
Of course, one can make arguments about which way the causality runs. Maybe economists in contact with industry just know more about it, and therefore see much more clearly the truth of how deserving executives really are. Possibly. But it is all quite suspicious, I would say (and Zingale implies as much). Overall, he concludes, “… these results suggest that the optimal strategy for a junior faculty who works on executive compensations and wants to maximize her chances to get tenure is to write articles that show that the level of compensation is appropriate and the sensitivity to performance should be increased. ”
This doesn’t mean, of course, that all economists are captured. There are obviously many academics who write papers criticizing industry practices. But these effects, Zingale suggests, may exert a deep influence over the profession, by systematically influencing the kinds of advice that economists offer to policy makers, or even the ideas they allow to enter their discussions:
Let’s consider an example. Suppose that banks need to be regulated to curb the too-big-to-fail problem. Suppose there are two methods. One that solves the problem completely, but it is very costly for banks. The other that provides only a partial solution, but it is much less costly to banks. Which approach would an economist, who has no interest in money, but it solely motivated by the desired to be famous, advocate? Obviously, the second one. By advocating the first one, she would be considered unrealistic and “out of the real world.” She will not be invited at major conferences sponsored by banks or by regulators who are in cahoots with banks, her papers would probably be rejected from the major economic journal where economists who are more attuned with the industry needs will referee her paper and publish their “more realistic” schemes. When some version of the inferior scheme is approved, the academic economists first proposing it will receive fame and glory, while the advocate of the right scheme will be ignored. When the scheme, many years later, will show its shortcomings, the fault will all be attributed to the politicians who implemented it wrongly. The academic supporters will still enjoy the reputation for “having done something.”
In fact, these concerns start to be internalized in the economic discussion, in the form of political economy constraints. Academic analysis of policy issues is not satisfactory if it does not incorporate the political constraints imposed by lobbying. In other words, models that do not consider sufficiently the power of vested interests are not acceptable. In a Brookings Papers meeting I was criticized for my political naiveté, because “to take public positions on important policy issues without knowledge of the political process is a big mistake,” where “political process” should be read as political constraints imposed by lobbying.
That latter comment I find extremely disturbing.
Many economists claim their field is a science. I hope they will be moved by this analysis to start talking about this issue. The most important remedy to reduce capture, Zingales suggests, is awareness by economists that the risk exists in the first place. “Until we admit that we can be captured by vested interests,” he writes, “the risk of capture cannot be addressed.”