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- [00:00]
A
You're listening to Is Business Broken, A podcast from the Mehrotra Institute for Business, Markets and Society at Boston University Questrom School of Business. I'm Kurt Nickish. This year, the U.S. supreme Court rolled back a legal principle known as Chevron deference, a rule that for decades gave federal agencies latitude to interpret ambiguous laws. That court decision now makes it harder for government regulators to take action. And it's suddenly raising a bigger question. If government doesn't feel like it can set the guardrails, can industry set some for itself? Now, self regulation is not new. It has shaped everything from movie ratings to green building standards to the rules that let your devices connect over WI Fi, for instance. And sometimes self regulation works well, often it doesn't, for a number of reasons. But in a climate of government deregulation, this imperfect system is becoming more important. Over the next few episodes, we'll explore the rise of self regulation, what it is, exactly why it matters in this moment, and where this unfolding regulatory environment is leading businesses and society. Here to start this conversation is Andy King. He's the Alan and Kelly Questrom professor in Strategy and innovation at BU Questrom. And Tim Simcoe, David J. McGrath Jr. Professor in strategy and innovation at BU Questroom. Let's get into it. Tim, so great to have you here.
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B
Thanks. Nice to be here.
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A
And Andy, great to have you back.
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C
Thanks. Good to be back.
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A
Now, to some people, regulation can sound a bit dry. Let's start with a simple question. What exactly is self regulation? And maybe we can start with a tangible example that we all know.
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C
Well, what I like to think about is industry or communitarian self regulation, not self regulation of yourself. Not like I'm going to diet this week. That's not the self regulation we're talking about.
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A
Yeah. And if you like Google self regulation, that's the first thing that you actually see.
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C
I'm talking about rules of the game that are put into place without government. If you think about a sports league, they set rules for how the players will play. That's what has to happen. Sometimes in industry, we have cases where government hasn't created the rules or the rules are not working well. And so then people or groups of companies get together and create those rules.
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A
Okay, so the NFL is an example.
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C
I think sports leagues are an example. You can have standards, organizations, something Tim knows a great deal about, like that will set the rules of how you're gonna allow connectivity between things, or how practices will be done or how your accounting will be done. Sometimes they're almost infused in our culture. So if you think about when you go to dinner in a restaurant, you feel compelled to tip. There's no official rule, but there's like a social rule almost that is reinforced by the fact that everyone does it and you get strange looks if you don't. And so people then tip, even though it's not in their individual interest to do so.
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A
Okay, got it. Some other examples of this are like the Motion Picture association with ratings for movies. What else?
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B
Ratings are a great example. Certification programs based around ratings. When we walked in the front door of this building, it said it was LEED certified. That's a system for quantifying the amount, you know, the greenness of a built environment.
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A
Got it. And that's not a government regulation?
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B
No, that's run by a nonprofit industry association.
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A
Okay.
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B
And then there are the groups that set the technical standards that LEED uses to measure green. We have to agree on things such as just units of measure for heat dissipation or other characteristics of the building. There's technical standards that get set when your computer connects to a WI FI network. The two parts, usually the router and the chip that's speaking to it, are made by two different companies. So they have to actually agree to use the same rules in order for those things to communicate. Those standards are a type of self regulation.
- [04:32]
C
So one difference between Tim and I, who we've known each other forever and talked about this, is that Tim is often interested in things which do benefit. They're almost like commercial organization practices. Whereas I'm often interested in solving a social problem like there's too much pollution in the world or there isn't good intellectual property. So in my case, the potential benefits from violating, from cheating exist. And so you have to worry about cheating. Whereas in an interconnectivity rule, if you cheat well, then maybe your device doesn't work very well. And my side, if you cheat, maybe you lower your costs and you get away with something. And so we have to worry about the enforcement more.
- [05:14]
B
To bring it back to the two examples, once a bunch of companies agree on what the WI FI standard is, there's very little incentive for some company to build something that doesn't work with the current standard, because then they don't get the benefits of having their device work with everything else, and there's going to be less demand for it. Fewer people want to use it. That's pretty different than, say, the green building certification example we were using, where.
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A
You'D love to have the label but not actually pay for it.
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B
Precisely.
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C
And that happens a lot. So I studied the chemical industry's Responsible Care program, which was an attempt to improve the safety of manufacturing facilities after some very serious accidents. Well, of course we all benefit from the existence of this program. It keeps government offer back, makes us look better with consumers, and maybe collectively we benefit. But each individual would be very happy to get not do the things that they are supposed to do. So then you get into this monitoring and enforcing problem, which is much more difficult.
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B
Okay, but we started by saying we're not going to talk about self regulation in the sense of a person regulating themselves. This conversation brings us right back to that same problem. The self regulation that you see when you look up on Google and it tells you how to commit to a diet or exercise plan in some ways is not that different from the oh, we're going to live by the rules that we set for measuring the greenness of a building or sort of the absence of harmful chemicals that we're going to put out the tailpipe of our factory. Somehow you have to recognize that there's a benefit by sticking to those rules, even though you might want to cheat. And then what happens is to create commitment. Just like when you take a gym membership, maybe you commit to working out a little more. Industry will set up a bunch of institutions like a standard setting body or a nonprofit association or something. And the kinds of institutions that set standards for the easy case where there's very little incentive to cheat are not so different from the institutions for the complicated case where there's cheating. The big difference is that you have to have sort of auditing rules and certification in the latter case.
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A
Yeah, gotcha. Andy, One thing you brought up was just the fact that sometimes it's just a practice, but it's not even formalized. It's like an informal norm rather than a formalized rule or a certain number of things you have to do to get the Good Housekeeping seal of approval. Right. So let's start with norms like what do these informal practices look like? How do they even get started?
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C
Wow. You're asking me to become the ultimate godfather of sociology to figure out how.
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A
Culture and our society works in our economic system.
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C
In our economic system. And the answer in 25 words or less. Well, let's see. So historians have tried to understand how these institutions get formed. And one idea is that the institutions create a sort of social benefit and then those societies perform better over time. And there is pretty good empirical evidence that if you have good rules in place, you have these kind of cultural norms, your society works better and therefore is successful. One of the things that I remember people always astonished by when they came to the United States and as my students in the 90s and the aughts, was how much trust there was. You could put something online and you'd pay your money and your shoes would come, and it was just like, oh, my God, how did that happen? But that sort of sense that that's the norm, those are the rules, has proven to be very helpful because they work, Those systems get reinforced.
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A
Got it. Okay. Yeah. It's a lot less expensive when you don't have to bring a lawyer to every transaction.
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C
Exactly. Yeah, exactly. And you can look around the world and you can see these kind even things like there's a very strong. Here's another one not being corrupt, like rules about basic morality and decency. There's extremely strongly correlated with gross domestic product. So how well a country runs, and I think this is one thing people are very worried about, is can we maintain that those sort of unwritten practices about how you behave that then allow the economy to work very efficiently?
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A
Okay.
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B
I mean, the way I think about that problem, I feel like in economics, we've developed a bunch of theory that helps explain what allows some of these things to persist. But the question of where do they come from? Is a lot harder. Definitely the how do they persist? Question. The answer is often as long as you expect benefits in the future and you realize that those benefits may be cut off if you don't comply with the norm today, you can use this thread of being punished either just individually or collectively in the future to help support a norm that a community recognizes as valuable today. And then the where do they come from? Question. There's interesting studies that Abner Greif looked at the evolution of merchant guilds in the late Middle Ages. The sense I get in reading that literature is that people tried. They recognized a problem, such as when you're trading over long distances with city states that are under different government, they may just try to take your stuff when you show up. And they saw that that problem was cutting off benefits from trade. And so they just try. They tried to set something up, a set of rules or a way of punishing people who defected. And if it works, then they can use that thread of future punishment to keep the thing going.
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A
Got it.
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C
It's a nice example.
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A
Yeah. So when do we get beyond norms, and when does self regulation become a set of codified rules? Like, Tim, what's the tipping point that makes an industry to decide to formalize practices. And you know, what does it look like when that, when that happens?
- [11:28]
B
Yeah, I mean, I think if we focus on the kinds of standards that I've researched more. Andy mentioned this earlier. I've looked at technical standards and rules for product compatibility and those kinds of things. A lot of the institutions that create them emerged sort of around the time of the second industrial revolution. So there's these big international standard setting bodies that are still around, the International Telecommunications Union or the International Electrotechnical Commission or the Society for Automotive Engineers. And they emerged to address problems that were specific to new industries. How do you build a car? There's a bunch of problems you have to solve to engineering problems. And the SAE emerged to solve those problems. Or in electricity you have to decide is it going to be direct current or alternating current? How are we going to measure voltages? How are we going to make systems work across different countries? And so these groups emerged and sort of pioneered a model creating rules for making decisions that are based on consensus of industry participants. And that model has been around for a long time. It's changed a lot as we entered sort of the digital era. But the basic answer to your question is often as new technologies emerge, they provide new kinds of problems that have to be solved. And people will set up a new institution or a new standards organization to try and coordinate around those answers to those problems.
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A
Are they ever self serving? Do they ever try to lock new entrants out and just keep existing businesses in business because they're following the more expensive standard or the thing that works for them?
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B
There's all kinds of conflict in these organizations. So there's two kinds of conflict. Conflict or questions that emerge. One set of issues is around when does the whole activity tip into something like collusion? Yes, it happens. And it's. So we have government kinds of regulation and antitrust rules to try and help police that boundary for when firms getting together and cooperating tips into cooperating in ways that we don't like. And then there can be conflict within these groups too. Right. Sometimes one firm wants to go in one direction and another firm wants to go in a different direction. And they're going to have to figure out how to reach an agreement before we can have something like self regulation.
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A
Gotcha. So you brought up government. We're talking about regulation, and this is the first time we've brought up government as an entity here. Is it possible for all of this to work without government, for industry to regulate itself? I mean, you're giving some Examples where government, government has to step in. But how effective can industry self regulation be without government oversight?
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B
I think the answer depends on the kinds of problems that you're trying to tackle with self regulation. So we already spoke about norms. Norms emerged largely without a lot of government and the example of the old merchant guilds. In the middle ages, government was extremely weak and yet these organizations arose to try and help in some sense substitute for the weak government in governing trade. At the same time, there are problems that seem pretty much intractable for self regulation when the incentives to cheat on whatever the rule might be are so strong for certain kinds of companies and that creates harms.
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A
Like what?
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B
The one that comes to mind is sort of the global regulation of environmental externalities, certain kinds of pollution. The carbon problem is probably too big to be solved in any self regulatory way because it's very distributed across firms, across countries and it's hard to regulate. It's unclear even if government regulation can reach that one.
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C
Well, yeah, that took us in a nice dark place, Tim. So if I can combine your questions about what caused them and also the, the role of government and because in my side generally the things I study are bad stuff happens and then firms try to get together to make it the bad stuff less bad. So you have the.
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A
So that they don't get bad regulation too.
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C
Yes, exactly. And that's usually what happens. Usually there's a disaster. Usually there's the Bhopal accident, there's the Exxon Valdez accident, there's the Deepwater Horizon, there's global financial crisis, global financial crisis. There's a terrible project finance project that destroys a large section of a country or something like that. And then all of a sudden the people that are involved in that activity go, oh my God, this is going to tar us all with the same brush. You often hear this, tar us all with the same brush. Or we're all in this together, we need to do something together. So then they get together and they try to come up with a set of rules that they'll all abide. Now the interesting thing about that is that Tim would tell you that's a cartel, that is a collusion.
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B
Not every time.
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C
Not every time, but a lot of the time they're colluding, they're agreeing on a set of rules.
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A
It's political.
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C
It's political. And they could be raising costs because if they're perhaps doing more environmental protection or labor protection, they could actually be raising costs. But they're usually allowed to do it because they're doing it for the good. Those activities often happen because they're afraid of government regulation. So the Equator Principles was driven by concerns that the Basel II convention around banking would change the liquidity requirements. Responsible Care was driven by fear about regulation. In the United States you see those things over and over again. So the idea is we'll do a better job, enough better that you won't regulate us. That's the goal there and the one that has worked the best. Again, another accident. Three Mile island and the Institute for Nuclear Power Operators is very closely tied to the government. So the Nuclear Regulatory Commission actually acts as a kind of punishing agency. So government has a role in terms of a backstop threat and sometimes as a more active party.
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A
There's a public interest there to protect.
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C
There is a public interest there that's there to protect.
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B
Yeah, but part of what Andy's I think trying to get at is that there's this trade off between industry self regulation. Industry may have more information or better information to sort of make a regulation that is tailored to the problem at hand.
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A
And sooner probably too.
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B
Yeah, I think you could make a case for sooner better. But the thing is the government, you need a backstop. It is quite difficult sometimes for industry to fully commit. And you're also worried that they will choose the rule in a somewhat self interested way, which you hinted at. This cartel problem is are they setting a rule that's good for society or good for them given that they have an information advantage? The government is both a complement and a substitute to industry self regulation.
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C
So I've studied these for a long time and I think they can work. But I also worry about them greatly because there is a strong incentive for business to say don't regulate us, we'll regulate ourselves. And you look at even some of the history about climate change going back into the 70s, there was a pressure for government regulation and some well known business interests and organizations pressured for no, we're going to do this voluntarily and through a self regulatory process. You see that over and over and over again where either you'll say we're going to do this through this kind of organizational system of better rules and requirements and things, something like that, or you'll see the argument for transparency. The self regulation we're going to do is we're not going to actually set any rules, but we're going to voluntarily disclose all kinds of information and then that will allow consumers and others to enforce on them. And both of those things have been used quite aggressively to forestall government regulation. And I Think also as a means of arguing that we don't need government regulation, that the market can correct itself. And despite the fact I study these things and they do sometimes work, there are a lot of times when that's not the case.
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A
Yeah. So what are the limits?
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C
First of all, you need some kind of credible monitoring. It often has to be third party because otherwise how do we know? Then you need graduated sanctions. So sometimes what happens is they'll say, well, yes, if they violate our rules, we throw them out. And you'll ask them, well, how many times have you thrown somebody else? We've never thrown anyone out because that's sort of the nuclear option, so we're afraid to throw them out. What you need is sanctions that go from a slap on the wrist to throwing you out, because you'll then implement some of those. And often you need some kind of forum for negotiating and changing the rules that are in place. These are my summaries of a Nobel Prize winner, Eleanor Ostrom.
- [21:01]
B
She developed that set of guidelines for how to build a self regulatory body to address a specific kind of problem, which is like an environmental problem or governing what she calls a common pool resource, a fishery, for example. I think that they're not all exactly applicable to the kinds of things that are more self enforcing which we talked about. So back to WI Fi or cellular standards. Their industry may need a less heavy kind of commitment to auditing and monitoring and graduated sanctions because for the most part the problem is solved. Once you can get to a consensus on what the rule is going to be, then everyone has an incentive to sort of comply with that rule.
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A
Yeah, let's talk about something very current. The Supreme Court in the US is signaling the potential end of Chevron deference through a number of decisions. That's basically something that gives federal agencies power to interpret ambiguous laws. How has this legal shift in what the executive branch has at hand, how has that changed the conversation about who should be regulating the government versus industry itself?
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B
My sense is that it's perceived as pushing more regulatory activity back towards industry actors. Right. So agencies in the executive branch, whether it's the EPA or the Consumer Financial Protection Bureau or any other, will find it harder to make regulations that are specific and have them stick, because courts are going to be more likely to intervene in the details of those regulations.
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A
So if you have a beef with what a federal agency says you should be doing, you can take it to the court and it may just not stick.
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B
You have a much better chance of overturning a regulation that was put into the code of federal procedures by.
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A
Got it. So for better, for worse, like it or not, that's just kind of the new rules of the game.
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B
And so self regulatory kinds of activity may be able to fill the gap that emerges. I think that the political conversation seems to suggest if people think it's just going to open a hole, so maybe there won't be any regulation, but it may be that sort of the fallback is on private self regulatory kind of activity.
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A
Okay. So we may see more industry self regulation because or at least it becomes more important.
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B
Right, right. Because if the agencies, if there is a, a real need for a rule or a norm or a convention and it's not being dictated by an agency, then private actors are likely to find some way to try and put a solution together.
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A
Got it.
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C
I want to speak from the heart here, not from Professor King for a minute.
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A
Okay.
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C
Because when I hear what's going on and the greater difficulty of regulation and the greater ability for people to push on any regulation, say it's unclear and therefore it shouldn't be followed, that really worries me particularly on all the environmental kinds of things that I study. And what it feels like has happened for many years is a pressure to demonize government regulation and prioritize industry self regulation, elevate industry self regulation, often without sufficient justification. We have a lot of industry self regulations that either don't work or nobody knows if they work on the environmental front, not on this kind of coordination front like Tim. And it's, you know, all go all the way back to Ronald Reagan with you know, the most frightening things in the English language is I'm from the US Government and I'm here to help you. That whole idea I think is very, very misguided. And then the repeal of Chevron or the weakening of Chevron adds to that. And I don't see that for many of the things that I'm interested in. Industry self regulation is going to be able to step in and substitute. At best it's going to provide clearer language about how the regulation might be interpreted. Like if they have a standard, well, here's the industry standard. So maybe you can help interpret what the government standard is. But I think this is just an attack on the kinds of regulation that we need as a society to make it work.
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A
Can you give me some examples?
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C
We live in Boston. You can walk around the Charles river, it is clean. You can go windsurfing on the Charles river. It used to have tremendous pollution. And we had the Clean Water act and the Clean Air Act. Those things were incredibly beneficial. It's one of the reasons why cities plus the catalytic converter law are now livable. People didn't want to live in the cities. They want to live in the suburbs because it was clean. Now the cities are largely clean and they've become extremely expensive places to live as a result.
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A
Because they're in high demand.
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C
They're in high demand. And they're high demand because now life in the city is attractive. You know, you're not covered in soot and smog and this kind of thing. Those regulations used to be nonpartisan. The Clean Water Act, Clean Air act passed under Richard Nixon. Those ideas, I think are important ones. And you now see regulation being government regulation attacked on all fronts. You see the abundance movement talking about how, where is my flying car? I should have a flying car. And regulation has gotten in the way. And you see people on the right pushing it and saying there's been too much government regulation and slow things down. It's a worry for me. A free market works well when it is well regulated. And I fear that self regulation is great, but it can be used as a means to just destroy all kinds of rules.
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A
That's super interesting and I might not have guessed it from some of our previous episodes.
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C
Yeah, I'm a complex of.
- [27:21]
A
Yes, you are. Yeah. You contain multitudes.
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C
Andy, you may want to respond.
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B
Well, yeah, I mean, I think the leading case is pretty clearly for where you should be worried that the pendulum metaphor is right and all we're going to get is less regulation would be environment and safety.
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C
Definitely.
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B
Okay. Those are areas where it is important to have pretty strong kinds of monitoring and enforcement in place to prevent fly by night and safety broadly construed. I think another place where I am quite worried that the deregulatory push is not going to be filled by very effective industry self regulation is in financial services areas where we regulate to prevent less informed consumers from being ripped off. On the other hand, I think there are areas where you can make a credible case that the government has overstretched. Sort of. Given the informational advantages that we talked about earlier, I think people have made a pretty good case that sort of local regulation, for instance, of building has prevented supply from expanding and pushed up house prices in certain places.
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C
Right. So that I have to.
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B
It's hard to talk about this in a universal way. You know, sort of the problem with Chevron and Loper Bright is that they are very expansive. I mean they are kind of universal rules that pushed back on government regulation.
- [28:56]
A
You both have talked about some of the concerns that you have about the new regulatory climate. The pressure's on in some ways for more industry self regulation. You're questioning how well industries or businesses are going to be able to step up to do it effectively in a climate of deregulation. On the government side, what pros do you see to the climate that we're in now and in the future we're headed towards?
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C
I mean, I have seen too many of these cases where an industry self regulation is baloney. Where you go into a factory and you say, oh, you're supposed to be the coordinator for the industry self regulation. They say, I am. I didn't know that it's that kind of thing. It's window dressing and a lot of lip service.
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A
And then, you know, it's just.
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C
And I worry about that a lot. And I worry that that's the direction this is going to go. If I'm going to find a small sliver of hope beaming down into the cave, it is this. I would rather have dysfunctional industry self regulation or self government than state power, state dictatorial power. Maybe the very self regulatory forces can be a buffer against this dictatorial state power. It's a little bit like the old small government versus centralized government because self regulation is small government. It's no government. Government is backstop. So maybe this will help turn the movement a little bit. I mean, I'm more worried about loss of democracy right now.
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A
Well, you could have 50 different experiments going on in state regulation too.
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C
You could have different experiments. Okay. One other source of hope that maybe is a little better.
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A
Okay.
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C
There are people trying this all over the place. There are people trying getting together their local community to save the local turtles by changing their driving practices or something like that, or to protect the local lobster industry. What are the rules going to be? Or how are we going to preserve this forest? Or can we. This happens everywhere inorganically. And so there are millions of people working on little projects around this. And those are going to make a difference whether they're going to. You know, I'm deeply skeptical that they will solve our planetary kinds of problems. And those are ones I really wish we were working on. But human beings are going to create order and they're going to create rule systems that make their lives better. And so that's a bright spot, I think.
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B
I was thinking along similar lines that there's folks who tell us that part of what's behind the current era of polarization is sort of the decline in institutions where people socialize across boundaries and in some ways localized efforts to create rules. You could make the argument they get crowded out by top down regulation and that if an argument for a bright spot is that as you withdraw some of the stuff that's coming from the federal government, people have to step into that void and it sort of rebuilds this muscle for developing local social interactions, figuring out how you're going to solve a problem as a community. But I share Andy's skepticism. That insight scales up to sort of our big national and global kinds of problems that you're going to need a regulator with some teeth to solve.
- [32:47]
A
Tim and Andy, this has been great. Thanks so much for coming on the show and talking about this.
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C
Thanks for having us.
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B
Happy to do it.
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A
That's Andy King and Tim Simcoe. In the next few episodes we dive further into self regulation, exploring the changing role of government and like it or not, what the real world consequences are. That's coming up. To get those episodes and more, please follow the show on Apple Podcasts, Spotify or wherever you listen. And thank you for listening to Is Business Broken? I'm Kurt Nickich.