Regulatory Fog: the Informational Origins of Regulatory Persistence
Abstract: Regulation, even inefficient regulation, can be incredibly persistent. We propose a new explanation for regulatory persistence based on "regulatory fog", where regulation obscures information about the effects of deregulation. This paper presents a dynamic model of regulation, in which the environment is stochastic such that the imposition of regulation can either be efficient or inefficient, and in which the regulator's ability to observe the underlying need for regulation is reduced when regulation is imposed. As compared to a full-information benchmark, regulation is highly persistent, even if there is a high probability of transition to a state in which regulation is inefficient. This regulatory persistence decreases welfare and dramatically increases the proportion of time the economy spends under regulation. The ability to perform deregulatory experiments can improve outcomes, but only if they are sufficiently inexpensive and effective, and regulation will still remain more persistent than in the full-information benchmark.