Tuesday, April 12, 2011

Why regulation should be about transparency, not outcomes

Credit cardsImage via WikipediaTake cover, there be ranting ahead.


Make regulations about transparency, not outcome.

Here's an example. My favorite local ordnance is one that requires the local health department to grade restaurants on their adherence to the health code, and then post those letter grades in the front doors of the restaurants. In other words, if you just barely passed your health inspection last month, every subsequent customer will see that barely passable C in your front window -- and many will decide not to walk through the door. (For the record, there are no D grades. Restaurants that score below 90% on the health metrics get shut down until they comply.)

I promise you, the posted C and even B grades have cost these restaurants far more than any fine ever could. I have friends that refuse to return to B-grade establishments even after they've cleaned up their acts. Conversely, I have friends of dubious wisdom who can't resist the sketchy Chinese buffet even with the scarlet letter C in the window. (I don't tend to let these friends choose our lunch spots.) This is Adam Smith at his finest -- arming the public with information and letting the market determine the outcome.

This same principle has worked at the Congressional level, as well. The most effective portion of recent credit card regulatory reform was a requirement to disclose how much extra card users would pay if they only made the minimum payment every month. In other words, once it was made transparent how much buying on credit costs, consumers stopped buying so much on credit.

Imagine if this same principle were applied to credit card applications. You wouldn't even need letter grades, just a big fat pair of numbers at the top of the application: The percent extra the average card user pays for each purchase and (for those that don't do well in math) how much more you'll pay for every $100 worth of goods you purchase on the card. Call it the Benjamin Equivalent. If the average purchase includes a 25% interest premium (on average), then you're spending $125 for every $100 worth of stuff you buy. Would you sign up for that card? If you got two applications the same day, and one had a $112 Benjamin Equivalent as opposed to the $129 BE, which card would you apply for?

Extend this same basic transparency principle to, say, skyrocketing college loan debt. How many underemployed PhDs would we have -- to say nothing of Associate-degreed victims of for-profit scam colleges -- if every college application included two figures: how much the average graduate earns per month, and how much the average graduate will have to pay per month to retire their student debt in the federally mandated ten-year time horizon.

If my degree nets me a $2,000 per month salary bump and my loan costs me $600 of that, I might more seriously reconsider going for that degree -- at least at that price. Seeing the cost and the benefit side by side will allow the student to make an informed decision, and my bet is we'll either see a rapid flattening of the tuition curve or a lot more people becoming entrepreneurs as opposed to lifetime students.

This effect would be squared if students were greeted with similar statistics when declaring a major -- I expect we'd have a lot fewer Art History doctorates and a lot more independent bookstores, which I count as a net gain.

More to the point, if students didn't alter their behavior when confronted with these stats, colleges would be justified in charging their seemingly outrageous tuition rates.

The principle of transparency isn't limited to fiscal transactions, either. Studies have shown that adding nutritional information to fast food menus doesn't deter people from eating there. That's probably because nutritional stats are too abstract -- which is why Weight Watchers uses a simpler and more transparent Points System instead. Ask any new Weight Watchers enrollee about the first time they learned the point value of a Big Mac and the subsequent effect it had on their eating habits. If I could, I'd have a Weight Watchers value slapped on every food item ever sold.

There's a key metric for every presently regulated good or service, and there's no harm in requiring its disclosure.
  • Cigarettes? How about listing the number of minutes taken off your life by smoking one.
  • Energy consumption? Deaths per kilowatt-hour seems like a good start. (This may have foreign policy implications, as well.)
  • Pharmaceuticals? Performance compared to placebo gets my vote.
Abandoning the arms race of specific prohibitions vs. newfound loopholes would simplify the legal code, if nothing else. It also holds consumers and producers accountable for their roles in each transaction -- the former has to be honest about the effect of the product being sold, and the latter must accept responsibility for consuming a good knowing full well the typical consequence.

Show me a government that crafts regulations based on those metrics, and I'll show you government regulations that are celebrated rather than scorned.

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