April 4, 2010 6:21PM

Regulation and the Knowledge Problem

Glenn Reynolds, a law professor at the University of Tennessee but better known as Instapundit, writes in the Washington Examiner that the controversy over big corporations' reporting the impact of the new health care legislation on their tax bills illustrates the "Knowledge Problem" identified by Nobel laureate F. A. Hayek in "The Use of Knowledge in Society" and other writings. Hayek pointed out that the information needed to run an economy doesn’t exist in any one database or agency. It is scattered among millions of people and made available to others by means of the price system. Planning and regulation do away with the information embodied in prices and try to improve on market outcomes by making use of far less information.

Reynolds writes, "Recent events suggest that it's not just the economy that regulators don't understand well enough -- it's also their own regulations."

The United States Code -- containing federal statutory law -- is more than 50,000 pages long and comprises 40 volumes. The Code of Federal Regulations, which indexes administrative rules, is 161,117 pages long and composes 226 volumes.

No one on Earth understands them all, and the potential interaction among all the different rules would choke a supercomputer. This means, of course, that when Congress changes the law, it not only can't be aware of all the real-world complications it's producing, it can't even understand the legal and regulatory implications of what it's doing.

The new health care bill is going to increase the tax burden on large corporations that provide prescription drug benefits for their retirees. Companies are required by Generally Accepted Accounting Principles and Securities and Exchange Commission regulations to report any adverse changes in their expected tax liabilities. So several companies did so, producing headlines that weren't favorable to Obamacare. Rep. Henry Waxman, chairman of the House Energy and Commerce Committee, is summoning the CEOs of those companies to a show trial in Washington to intimidate other CEOs from announcing the costs of Obamacare -- at least until after the election.

Regulations interacting with each other with unanticipated effects -- that's the topic Jeffrey Friedman wrote about recently in Cato Policy Report, with regard to the financial crisis:

You may think that the government caused the financial crisis. But you don't know the half of it. And neither does the government....

The regulators seem to have been as ignorant of the implications of the relevant regulations as the bankers were....

Omniscience cannot be expected of human beings. One really would have had to be a god to master the millions of pages in the Federal Register — not to mention the pages of the Register's state, local, and now international counterparts — so one could pick out the specific group of regulations, issued in different fields over the course of decades, that would end up conspiring to create the greatest banking crisis since the Great Depression. This storm may have been perfect, therefore, but it may not prove to be rare. New regulations are bound to interact unexpectedly with old ones if the regulators, being human, are ignorant of the old ones and of their effects....

This premise would be questionable enough even if we started with a blank legal slate. But we don't. And there is no conceivable way that we, the people — or our agents in government — can know how to solve the problems of modern societies when our efforts have, in fact, been preceded by generations of previous efforts that have littered the ground with a tangle of rules so thick that we can't possibly know what they all say, let alone how they might interact to create another perfect storm.

In substance, there is a striking similarity between social democracy and the most utopian socialism. Whether through piecemeal regulation or central planning, both systems share the conceit that modern societies are so legible that the causes of their problems yield easily to inspection. Social democracy rests on the premise that when something goes wrong, somebody — whether the voter, the legislator, or the specialist regulator — will know what to do about it. This is less ambitious than the premise that central planners will know what to do about everything all at once, but it is no different in principle.

Read the whole thing here or in more attractive pdf here.