Tight regulation vs discretion: A pitch for transparency of rules

Incomplete contracts and regulations in a world of uncertainty cause overregulation. Laying bare the pitfalls of regulations and discretion, the Economic Survey 2020-21 says it costs too much to foresee and describe appropriately the contractual outcomes for all (or even most) of the conceivable states of the world.

“Thus, the reality of incomplete contracts leads to inevitability of incomplete regulation. This makes some discretion unavoidable,” it said. In a complex and uncertain world, the actual outcomes or situations do not fit into neat boxes assumed in the regulation. Hence, the supervisor has to exercise some judgement. There is widespread belief that detailed regulations reduce discretion. On the contrary, complex rules and regulations create more discretion because of multiple ways.

A complex, uncertain world makes discretion inevitable where overregulation leads to excessive and opaque discretion. Citing studies, the Survey says discretion increases with the degree of regulation. “Specifically, ex-ante regulation cannot substitute for ex-post supervision; in fact, more ex-ante regulation only serves to dilute the quality of ex-post supervision by fostering opaque discretion.”

To keep supervisors accountable while giving them discretion, it explores three possible ways: Strengthen ex-ante accountability, bring transparency into the decision-making process, and build resilient expost resolution mechanisms.

The Survey pitches for enacting Transparency of Rules Act to end any asymmetry of information regarding rules and regulations faced by a citizen. This was initially proposed by the

Economic Survey 2016-17. The reform solves the problem that rules frequently change and often citizens have to follow a long paper trail of circulars and notifications.

Under this Act, all departments will need to mandatorily place citizen-facing rules on their website. Officials will not be able to impose any rule not explicitly mentioned on the website. The Survey notes bureaucracies will naturally tend to substitute supervision with mechanical regulations. It cites the practice of selecting L1 or the lowest bidder for government contracts.

“The L1 system persists because of the regulatory default problem. No decision-maker wants to exercise discretion for fear of future questioning. This criterion may appear simple and quantifiable. However, in a complex world where it may not be possible to define everything in the pre-procurement process, it is advisable to leave some discretion in the hands of administrators, along with maintaining enough transparency and active supervision,” says the Survey.

The other instance is the listing of public sector companies. Discretion exercised ex-ante in the initial public offering (IPO) of publicly listed companies often gets questioned “with the benefit of hindsight when the IPO is oversubscribed and/or the first day gain is large”. It, however, points out “the market value of an unlisted entity is unknown. Even after employing the best of valuation techniques, effort, and resources, the actual value of an entity is uncertain until it is traded in the market. It is not uncommon to see stocks being over-subscribed (or undersubscribed) and their prices move up (or down)”. Oversubscription and first-day gains for IPOS in the private sector are also quite significant, reflecting the uncertainty involved in predicting the listing price.

"THE REALITY OF INCOMPLETE CONTRACTS LEADS TO INEVITABILITY OF INCOMPLETE REGULATION. THIS MAKES SOME DISCRETION UNAVOIDABLE," SAYS THE SURVEY