Breaking the Spell of Regulatory Competition: Reframing the Problem of Regulatory Exit

Abstract

Regulatory competition is increasingly becoming the dominant argument on regulatory structure in both the debate on federalism in the United States and that on subsidiarity in the European Union. The argument, briefly put, is that regulatory competition might produce efficiency benefits that justify yielding federal or harmonized regulation in favor of decentralizing governance. The present direction in this debate is to identify in which contexts and under what circumstances these efficiency benefits are likely. This paper intends to contribute to this debate by analyzing the proposition that regulatory competition can be understood as an argument of regulatory structure modeled on the principles of market order. The purpose of this paper is to clarify but ultimately to challenge the wisdom of this intriguing argument. Regulatory competition is an intriguing and sophisticated argument which, as it deals with interpreting the complex dynamic between political and economic integration, deserves to be spelled out in full and with considerable care. The persuasive force of regulatory competition as an academic proposition however lies in the double efficiency argument hidden in it. Regulatory competition can be and is most often understood as a macro-argument for federal governance structures in that these allow for extrinsic efficiency benefits in the form of experimentation and innovation at a broad scale (economies of scope). But regulatory competition can also be framed as a force for improving the intrinsic efficiency of regulations by allowing actors to structure their need for economic coordination to their own liking, thus incorporating the preferences of consumers into the structure of regulation (a micro argument). The debate in the US after several critiques which expressed frustration at the broadness and inexactness of the initial macro arguments has steadily moved on to focus on the micro argument which attempts to detail the instances and conditions under which regulatory competition might indeed work to improve the intrinsic efficiency of regulation. Regulatory competition, to the extent that actors internalize the costs of their decision, has come to be viewed as a largely untapped mechanism for improving the efficiency of rules in a potentially wide range of legal domains. The European debate appreciates regulatory competition in light of the common market and the effort to reduce regulatory trade barriers. Regulatory competition is treated here under the nomers of standortwettbewerb, competition among rules, institutional competition or competition over organizational arrangements. Regulatory competition is argued essentially in its macro form: Negative integration leads to economic flows of mobility unleashing arbitrage over regulatory policies. The room left for this type of arbitrage by existing harmonization measures is the topic of continuing discussion among commission officials, political scientists and economists. Generally, the European Commission perceives regulatory differences to be undesirable as it will interfere with the common market or result in-what is seen as-unfair competition. Hence, the Commission has embarked upon harmonization commonly without reference to the scale of economic arbitrage to be expected. We may observe this from Commission efforts in fields as disparate as taxation (where economic arbitrage is very much prevalent) and social or environmental regulation (where economic arbitrage is much less strong). It seems that regulatory competition plays a role only in so far as it allows the Commission to construct it as a credible threat to the ability of individual member state governments to pursue national policies unilaterally. The political use of the regulatory competition argument in this way seems to favor cooperation rather than competition. Political scientists explain regulatory competition as a game in which national regulators are interested in bringing forward national policy approaches at the EU level which minimize the degree of institutional adaptation to European legislation and possibly confers a competitive advantage to domestic producers. Economists construct regulatory competition as an allocative efficiency argument made possible by the existence of different centers of rule-production in Europe. To the extent that rules or regulations have economic implications inducing arbitrage or the threat of arbitrage, competition among rules is seen to correlate with the-perceived-number of exit options offered by the internal market. Normative welfare economics and the Tiebout model suggests that legal heterogeneity may create regulatory arbitrage as a result of the normal arbitrage occurring in the markets, thus hitching regulatory competition on the process of market competition and producing additional avenues for improving regulatory efficiency. To be sure, regulatory arbitrage is limited by progressively increasing opportunity costs that would limit the scope of such arbitrage (consumers would move until the erosion of the tax base would threaten the possibility of providing the desired public goods). In addition, externalities limit the case for allocative efficiency of regulatory heterogeneity further and justify efforts for positive integration at a higher political level that can internalize the costs of negative externalities. This essay aims to analyze the positive and normative claims put forward by regulatory competition theorists on both sides of the Atlantic. It is structured as follows. Part II starts with an account of the Tiebout model-generally considered to be the analytical backbone of regulatory competition arguments. It preludes the discussion on regulatory competition by developing a caveat on the Tiebout hypothesis of voting with feet focusing on the inadequate conception of politics within the model. Part III discusses regulatory competition in its macro form and uses the European debate on regulatory competition to elucidate factual mechanisms of arbitrage which are supposed to underpin the competitive process. Regulatory competition in this context is seen as embedded within institutional efforts toward economic integration and mutual recognition. This portion of the essay examines the internal logic of the argument and argues that even if regulatory competition were to operate as conceived, the factual mechanisms of economic arbitrage in a regulatory market do not justify the application of normative welfare economics to demonstrate an invisible hand in the market for regulations. Part IV develops an external critique focussing on the behavorial assumptions (derived from economic theory) that structure regulatory competition theory. It argues for relaxing these assumptions and working toward a more credible and richer set of hypotheses about regulatory behavior. It discusses regulatory competition in its micro form and examines the conditions structuring the problematic proposition that regulatory competition ipso facto is a force that can attribute to intrinsic regulatory efficiency. Part V attempts to formulate the case of regulatory competition from the perspective of post-international politics. Part VI finally recapitulates the theoretical argument made so far and develops some of its positive and normative implications. The article concludes by outlining a new investigative orientation to the problem of regulatory exit and by demonstrating some ramifications of the argument for policy purposes.