The Regulatory Interdependencies

Regulated bodies in a market react differently to new proposed regulations. They often fight new rules but not outrightly since such wars easily attract public attention. However, according to the regulatory capture theory, laws work in the best interest of the regulated parties most of the time. Regulations that work to eliminate unfair competition in the market sufficiently illustrate this.

The regulatory differences across different economies can result in movement in the location and behavior of the regulated entities because of regulatory competition and regulatory arbitrage. Regulatory competition refers to the clamor among regulators to lay out an environment meant to attract investment entities. Regulatory arbitrage, on the other hand, is a situation where the regulated parties identify and utilize some regulations that may allow them to leverage the differences in economic outcomes to their benefit.  Moreover, regulatory arbitrage involves the use of variation in the regulatory definition in foreign and domestic regulatory arrangements to the advantage of the firms.

Therefore, there is a need for interdependence in the regulations on similar issues and activities globally since many regulatory aspects are the same internationally. Examples of these aspects are systematic financial risk, money laundering, and climate change. However, in some countries, domestic regulators employ varying techniques in creating and applying the regulations on some of these issues. This causes a difference in the regulation of the same issue across countries.

As a result, regulatory difference may be deemed as regulatory competition. Consequently, this reduces the efficiency of regulation in some countries. Moreover, regulatory competition may lead to the “race to the bottom” aspect, in which case, countries consistently decrease their regulatory levels to attract numerous companies.

Effect of Regulatory Interdependence

Regulatory interdependence helps in recognizing the actuality and implications of the different trade-offs and the choices among regional, national, and local regulators.

For instance, global warming and pollution possess externalities, whose effects are not only felt within but also without the jurisdictions of the affected countries. That is, countries contribute to and are affected differently by global warming and pollution. One of the possible economic solutions to this problem might be tax pollution, which might be different from one country to another and thus prompt the need for an interdependent regulation.

Question

A regulatory body in an emerging market is looking to increase the number of investors in its capital markets. To achieve this, the regulator eases the regulations on entry (lowers the market entry fee), reducing the level of the disclosures required, and reducing the frequency of financial reporting. According to this information, the aspect described is most likely to be:

1. Regulatory capture.
2. Regulatory experiment.
3. Regulatory competition.

Solution

The correct answer is C.

Regulatory competition involves regulators competing to provide a regulatory environment that is attractive to certain entities.

Reading 10: Economics of Regulation

LOS 10 (f) Describe regulatory interdependencies and their effects.