February, 2003

Regulatory Analysis Guidelines

  • Susan Dudley

    Director, George Washington University Regulatory Studies Center
  • Brian Mannix

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In February, the Office of Management and Budget (OMB) and the White House Council of Economic Advisors (CEA) released new draft guidelines to agencies for conducting regulatory analysis. In most cases, the guidelines follow generally accepted economic principles and are similar to guidelines issued in 1988 by the Reagan Administration and in 1996 and 2000 by the Clinton Administration. They require (1) a statement of the need for the proposed action, (2) an examination of alternative approaches, and (3) an evaluation of the benefits and costs of the proposed action and the main alternatives identified by the analysis.

The new guidelines provide more detailed guidance in several key areas, including the conduct of cost-effectiveness analysis as well as benefit-cost analysis, and treatment of uncertainty using formal probabilistic analysis. It is also refreshing that they encourage agencies to be transparent in their analysis and assumptions so that reviewers can understand and reproduce results. The guidelines should ensure greater consistency across agency analyses, and should facilitate more accurate annual reporting of regulatory costs and benefits as required by Congress.

Despite these good qualities, the draft also takes some curious turns that seem inconsistent with an administration philosophy that embraces markets and limited government. For example, the draft is arguably less demanding than either the Reagan or Clinton guidelines in its requirement that, before considering regulatory intervention into private markets, an agency must first identify a significant market failure (why the private sector can’t address the issues without regulation). The new guidelines cite "other possible justifications" for regulatory action, including "promoting privacy and personal freedom." It provides no example of when regulation (which, almost by definition, restricts personal freedoms) would be necessary to promote personal freedom.

The draft also suggests that "harmonization of U.S. and international rules may require a strong Federal regulatory role." What this means is unclear. Would the new guidelines endorse restrictions on promising new therapeutic or agricultural products to "harmonize" with European Union members who resist biotechnology techniques? U.S. foreign policy ought to stress our objective of exporting freedom, not importing government regulations--particularly regulations that lack an economic rationale apart from "everybody does it."

The draft guidelines venture into some controversial areas. On "ethical grounds," yet without any economic or empirical rationale, it advocates applying discount rates as low as one percent for measuring long-term (inter-generational) benefits and costs. Looking hundreds of years into the future is difficult, so let’s examine this approach by looking to the past. If we could go back in time, would we really ask our (relatively poorer) ancestors to set their money aside at a 1 percent return for our benefit? Indeed, would we even be better off if they had done so? They would have had to forsake many higher return investments to make this "investment in the future" and as a result, our standard of living would likely be lower today, even with the "inheritance" they left us invested at a one percent rate.

Rates of return that are required for private investments are already much higher than those routinely accepted by government agencies, in part because of the burden of taxation. President Bush’s proposed tax reforms make some effort to correct this harmful distortion. But those reforms will come to naught if government agencies are permitted to justify proposals that return benefits of only one percent, and do that only after decades or centuries pass. Such low-value government-mandated projects will displace ever greater amounts of private investment, raising the question of how the CEA can forecast long-term economic growth in excess of one percent annually, when it is so willing to displace the high-value private investment that drives economic growth.

The draft, like the Clinton guidelines before it, supports the use of the controversial benefit-valuation technique known as contingent valuation (CV). Noting that CV may be the only method available to estimate "non-use" values, the guidelines attempt to address its problems by enumerating "best practices" for conducting CV. But, as Boudreaux, Meiners & Zywicki (1999) show, the practical problems of CV cannot be resolved with better surveys because the technique itself is conceptually flawed. CV studies rest on the assumption that prices are absolute and static, when in reality they are relative and dynamic. They liken a reliance on CV because it is "the only analytical approach available" to the old joke about the drunk who looks for his car keys under the streetlight, because the light is better there than where he dropped them.