Memorandum
Date: July 11, 2002
To: Foundations of the Regulatory State students
From: Avery Katz
Re: Feedback on Spring 2002 exam
This memo sets out what I considered to be the main issues raised by our spring 2002 RegState exam. The memo was composed after I read your exam papers, and so incorporates many of the points that you came up with in writing the exam, as well as those I had identified in advance. Thus, it goes beyond what I expected any individual student to produce on his or her exam paper.As on the practice memo assignments, the goal of the exam was for you to apply the concepts and ideas we studied in class to the particular policy issues raised by the individual problems. Thus the key to a strong performance was finding the appropriate balance between the general and the specific. Similarly, the exam questions all were based on issues that were analogous to, but in some ways different from, the topics we discussed in class, so a good answer would have paid attention to both the similarities and the differences. Furthermore, as I indicated in my comments on exam preparation, a good answer should take counterarguments seriously, and should make sure to distinguish between stronger and weaker arguments and between more and less important issues.
Pending permission from the authors, I will also post on the website the
top student answers to each of the questions to the exam. What made these answers the best was their coverage of arguments, detail and sophistication in their use of facts and in seeing both sides of the issues, clarity in organization and explanation, and the way they demonstrated mastery of concepts from the course. If you drew different inferences from the given facts than the top answers did or chose to discuss different issues, you wouldn't have lost points, unless your inferences were unreasonable or your choice of issues inappropriate.Your individual exams will be available for inspection after July 8 at the office of my assistant, Nadine Baker (600/1 JG, 4-7594). I did not make many written comments on the exams themselves; instead, I used a system of symbols to indicate my reaction to particular arguments and inferences. A key to these symbols is attached. I also kept a score sheet containing my own notes on each exam. If you want to discuss your individual exam, please feel free to contact me. You will find it useful, however, to read this model answer as well as the top answers before we meet.
It was a pleasure teaching the class, and I wish you all well. Please keep in touch.
Question 1: Summary of suggested answer
This was in my opinion the most challenging question on the exam, since it was not directly on point to any of the class readings or discussions, and was tied as much to the issue of energy independence — a foreign policy goal — as to environmental issues. Additionally, there were so many specific policy issues raised by the two rival energy plans, that space was at a particular premium. It was especially important, accordingly, for you to write concisely and to leave adequate room to cover most of the main points of controversy.Because the question asked you to advise a centrist politician on a feasible legislative compromise, it was important to take account of the constraints imposed by the relevant political coalitions, and to take seriously arguments on both sides of the mainstream political position (in contrast to question #3, which placed you explicitly in an advocacy role). Essays that firmly advocated an uncompromising environmentalist position or that omitted or slighted countervailing considerations, accordingly, were not appropriate for this role and thus received less credit than essays that attempted to address the concerns of a broader set of political actors.
Now to the main issues raised by the question.
1) Drilling in the Arctic National Wildlife Refuge (ANWR)
This issue presents a straightforward conflict between relatively quantifiable material and commercial values on the one hand and less easily quantified environmental considerations on the other. Thus, it provided an opportunity to discuss issues of commodification, the incommensurability of values, scientific uncertainty, the special nature of environmental values, intergenerational equity, and other problems with standard cost-benefit analysis. Essays that discussed how these considerations related to ANWR specifically were more effective than those that discussed their relevance to environmental policy generally.
In addition, because you were told that the issue carried significant symbolic weight, it was important to consider the role of symbolism in regulatory policymaking, as it relates to issue definition, the formation and mobilization of political coalitions, the shaping of community values and discourse, commitment to future actions, and the like — and not just to dismiss the symbolism as cheap political talk.
This was the place on the exam where students were most prey to the temptation of relying excessively on outside material. While the ANWR issue has achieved great prominence and is a hot-button issue, the exam was supposed to test your ability to apply concepts from the course, not your command of the main arguments and factual assertions currently circulating in political and journalistic discussions of the issue. To the extent that referring to such material enabled you to apply ideas from the course with greater clarity and depth, it could strengthen your answer, but to the extent that it substituted for or crowded out the discussion of course concepts, it tended to detract from it.
2) Fuel efficiency / renewable energy sources / conservation regulations
Though these various proposals raise somewhat different political and technical considerations, they can usefully be grouped together because they all relate to government-mandated conservation and thus raise several similar conceptual issues, the first of which is the justification for such mandates in the first place. The most obvious such justification is externality; the production and consumption of fossil fuels creates pollution that imposes injury on persons not party to the decision to use the fuel and who do not directly benefit from its use. This justification, however, does not seem to be the main current impetus for the bill, the political discussions of which have focused on energy independence and the social value of conservation for the future; and here the case for market failure is a little less clear. Individuals and businesses already have an incentive to take into account the risk of price increase and supply disruption when they decide whether to make investments to reduce their use of petroleum-based energy (e.g., by installing insulation, or switching to other fuels or to less energy-intensive technology). To the extent that the costs of energy dependence are suffered by those making these investment decisions and the decisionmakers are well informed regarding potential costs and benefits, there is no efficiency reason for the government to intervene in their choices. On the other hand, to the extent that there is there is some collective national benefit resulting from reducing dependence on foreign energy sources (such as greater freedom to pursue other foreign policy goals or to reduce military expenditures), this collective benefit is a public good; and each individual when deciding whether to conserve has an incentive to act as a free rider on others' efforts. Some state coercion may be needed, accordingly, to reach a collectively beneficial result.
There is also an important non-efficiency rationale for state-promoted conservation — namely, to change community values in the direction of what many view as a substantively more desirable way of life. This goal is an important one for many environmentalists but, as contemporary political debates show, it remains controversial and probably does not yet reflect centrist public opinion.
Arguments that justify regulation in general, however, course, don't by themselves suffice to make the case for specific regulations in particular, for the costs of those regulations may exceed the benefits. E.g., the reason that electric utilities do not currently use much non-renewable fuel is that the extra costs of doing so exceed their private benefits. Of course, as we have just argued, the social benefits of energy conservation probably exceed the private benefits, but the social costs may be even larger. Thus some discussion of cost-benefit analysis or at least cost-effectiveness analysis of particular regulations is appropriate, as would be discussion of consideration of enforcement and administrative considerations.
At this point it would have been useful to discuss and apply the ideas we discussed in relation to the optimal mode of regulation, and in particular the choice between centralized command-and-control systems that prescribe a particular means of compliance, and more decentralized institutional approaches. E.g., if the social goal is simply to reduce oil consumption then there is no obvious reason to favor substitution of other fuels over adoption of more energy-efficient technology or reductions in consumer demand. In this regard, a simple tax on oil consumption (or a tradable permit system, if one could be established) would give equal incentives along all these dimensions and would allow consumers and producers to choose which method was most cost-effective from their individual viewpoint. Conversely, if there is reason to think that the alternative ways of conserving petroleum have different social costs or consequences (e.g., if a tax on oil would induce substitution to coal, resulting in an increase in harmful air pollutants), this would argue against leaving the choice among compliance methods up to individual decision. Still, in situations where information about the consequences of regulatory compliance is dispersed, centralized regulation will be less than first-best efficient.
3) The bill as a whole
It was also important to discuss the distribution of benefits and burdens resulting from the various proposals, both as they relate to the normative goal of distributive justice, and as they relate to the proposals' political feasibility. E.g., while the Congress might not be able to muster a majority for an energy or gasoline tax, they might be able to form a winning coalition by including subsidies to a set of politically influential producers (such as Eastern coal interests in the case of the Clean Air Amendments of 1977, and possibly grain producers in farm states in the case of ethanol). Whether the necessary compromises for attaining a majority are worth it in efficiency and distributional terms is a matter for debate, and those essays that presented arguments on both sides of the debate before reaching a conclusion were again the most effective.
Question 2: Summary of suggested answer
This was the most straightforward question on the exam, in that it called for fairly direct application of concepts from the workplace health and safety unit — incomplete information, bounded rationality, and the like — and that you were also explicitly told how to organize your answer. Accordingly, the class as a whole did quite well; and the average score on this question was the highest for the three questions on the exam. The main twist was that because the problem of pension regulation deals with financial rather than physical losses, arguments for overriding free and informed choices and for insulating those choices from market institutions were somewhat less strong than they are in the health and safety setting.There were several policies you might have discussed; the four most obvious were (1) laissez-faire (i.e., no new regulation), (2) providing investors with better information, (3) direct regulation of pension investment funds, and (4) some form of government-mandated or supplied pension insurance. A number of students discussed a fifth possibility — private liability ex post under tort and contract — but the difficulty of achieving compensation in the event of corporate insolvency was a fairly straightforward and devastating objection to this last approach. It was also fine to discuss other proposals, so long as you discussed both advantages and disadvantages and made use of course concepts in doing so. The main pitfall was going into excessive administrative detail, or offering multiple proposals that were really just slight variations on a single theme.
1) No new regulation
While you need not have discussed laissez-faire as one of your three alternative policies, it is a logical starting point because it allows one to set out the main justifications for regulation and hence the problems that such regulation should address. These justifications include incomplete information, bounded rationality, the externality that uninsured retirees impose on their friends and families and on the social safety net, frictions and imperfections in the bargaining relationship between employers and employees, and the arguably special character of retirement income as a primary good that ought to be guaranteed to all citizens as a matter of individual dignity. While an unregulated pension system would have the advantage of allowing workers the freedom to trade off the security of their pensions against other possibly compensating advantages (higher wages, greater expected portfolio return, etc.), the evidence suggests that many workers do not make their retirement investment decisions with anything like the full information and deliberation that the idealized market model assumes. Furthermore, even if workers had access to all relevant information and were able to evaluate it in a fully rational way, they would still lack adequate incentives to take into account the consequences to public and charitable welfare budgets in the event that the risks they take turn out badly.
On the other hand, some minimal safety net may suffice to satisfy the above concerns; and there are also advantages to allowing workers some individual control over their pension investments. These advantages include, in general, the ability to tailor investment decisions to the individual needs of the investor, and more specifically, the value of employee stock ownership plans in providing a low-cost source of capital, building institutional morale, and helping to align better the interests of workers with those of the firm as a whole (though this last consideration is probably more important for managers and high-level employees than for the work force as a whole). In addition, greater individual freedom to make an important life decision counts as an important value in itself from a libertarian viewpoint. A regulatory program would take these countervailing considerations into account in some way, if possible.
2 Information-based policies
To the extent that the main problem with an unregulated pension system is poor investor information, an obvious response is to address the knowledge gap directly. This could be done in various ways, e.g., having some government agency produce and distribute relevant educational materials, requiring employers supply such information or to make specific kinds of disclosures to their employees relating to investment risk, or by subsidizing or requiring employers to subsidize the acquisition of third-party investment advice.
These various approaches carry with them the standard advantages and disadvantages of centralized and decentralized regulatory systems. Government-provided information has the advantage of ensuring that all workers are exposed to a basic and standardized body of investment advice, and it avoids the problems of enforcing disclosure mandates against resistant employers. On the other hand, standardized advice suffers from its one-size-fits-all approach, which provides similar information to all investors regardless of their particular needs. Employer disclosure would better tailoring of the disclosed information and more specificity, but suffers from the disadvantage that employers face a conflict of interest in making such disclosures and thus may have an incentive to withhold or distort important information. Supplying (or requiring employers to supply) independent investment advice avoids both of the aforementioned disadvantages, but it is probably the most expensive alternative and may entail wasteful duplication of effort.
The efficacy of information-based policies, furthermore, depends on the assumption that investors will appropriately process and act on the information they receive. If cognitive or other psychological factors prevent workers from evaluating the actual risks they face (e.g., if cognitive dissonance leads them to overestimate their company's prospects, or conversely if decision heuristics such as the availability effect lead them to place excessive weight on recently publicized events such as the Enron debacle) then providing them with information will foster neither liberty nor efficiency goals, and a more coercive regulatory approach may be in order (so long as those making decisions under such regulatory schemes are not subject to similar or worse heuristics and biases.)
As observed earlier, information-based policies also do not address the potential externality that overly risky investment decisions place on third parties and on the public welfare system; and in addition, the possibility that employers might use their superior bargaining power to coerce employees to invest excessively in company stock might also justify a more interventionist regulatory policy (although one would need to explain why such employers would not prefer to exercise their supposed bargaining power by demanding wage reductions rather than excessive stock purchases.)
3. Direct regulation of investment choice
Direct regulation of investment choice might take many forms, including mandating some degree of diversification, restricting investment in the stock of one's employer, or less invasively, prohibiting anti-alienation rules of the sort that forced Enron employees to hold onto their stock as its price fell. In addition, to the extent that one found the Enron collapse primarily objectionable on distributional grounds, another possibility would be to enact nondiscrimination regulations that would require high-level employees to be bound to their stock investments to the same extent as lower-level employees (though the high-level employees' greater sophistication and easier access to securities markets would probably still give them an advantage in escaping a falling market.)
The advantages of direct regulation is that it escapes many of the limitations of information-based regulation, and to the extent that it actually forces diversification, guards against the worst risks of an unbalanced investment portfolio. The down side is that such regulations may be overly cautious, insufficiently attentive to the advantages of employee stock ownership plans, insufficiently flexible in the face of changes in the investment environment over time, and, depending upon the specific administrative organization they create, overly susceptible to political influence or rent-seeking in the selection of permissible investments (e.g., if investment were directed to firms that happened to be political allies of the administration in power.) In addition, one must count as disadvantages the administrative costs of oversight and enforcement.
A number of students, including the authors of two of the top essays posted on line, suggested encouraging diversification or other types of prudent investment behavior through tax incentives rather than through direct command-and-control regulation. For example, instead of prohibiting employees outright from sinking too high a fraction of their pensions into employer stock, we could deny tax-favored status to investment plans that exceeded such limits or that were otherwise inadequately diversified. The advantages of using tax incentives include possible savings on enforcement costs and greater flexibility and freedom for those who opt (at a cost) not to follow the regulations. Possible disadvantages include undesirable distributional consequences (e.g., a decrease in tax receipts requiring other taxes to be raised, and differential effects on taxpayers in different brackets) and the prospect that uninformed workers will continue to make unsafe investments, notwithstanding the negative tax consequences, with the result that they will be even worse off than before.
4. Government insurance
A fourth way to protect workers against risk to their retirement funds is for the government to offer or require pension insurance, much in the same way that it requires banks to ensure their deposits with the FDIC. Alternatively, the government could provide the equivalent of such insurance by a variety of policies ranging from providing subsidies to employees of failing firms all the way to full-fledged socialization of the pension system along the lines of Social Security.
The main advantage of such insurance would be that it would cushion workers against the risk that their retirement funds would fall significantly in value (and this is a risk faced even by diversified portfolios.) The main disadvantage (apart from the costs of funding and administering the program, and the restriction of liberty in the event of a mandatory plan) is that it would be subject to adverse selection and moral hazard. Specifically, to the extent such insurance was voluntary, it would be most attractive to workers and firms whose stock is at the greatest risk, so that those with average or below-average risk might rationally decide not to participate. This result would raise the costs of the plan and would defeat the purpose of offering insurance to all. If the plan were mandatory, it might still reduce firms' and investors' incentives to choose investments carefully and to undertake a prudent level of risk (much in the same way as unrestricted subsidized deposit insurance led to excess risk-taking and business failure in the savings and loan industry in the late 1980's). The resulting incentive for increased risk-taking might, therefore, require some supplementing such an insurance program with some form of command-and-control regulation to limit the ultimate risk.
Question 3: Summary of suggested answer
This question presented the most straightforward subject matter — we spent an entire class period late in the semester discussing the issue of prescription drug insurance, and most of the substantive concepts needed to analyze the question were covered in that discussion. What was most challenging about the question was its format, which asked you to translate those concepts into language appropriate for a general audience of voters and to weave them into an argumentative case. In addition, because the Democratic and Republican proposals follow more or less similar approaches and differ mainly in degree, the question ideally called for you to make fairly specific arguments about where the tradeoffs between competing policy goals should be drawn.
This question also left you the most room for creativity, and your answers here were among the most interesting and entertaining (and in some cases the most thoughtful as well) on the exam. Along with this room for creativity, however, came certain pitfalls, one of which was oversimplification. Certainly it was necessary for you to simplify technical arguments in translating them for a popular audience, but the best answers included the essence of the underlying policy argument in their translation. Some of your essays affected a cynical stance in presenting deliberately demagogic or misleading arguments; this was a permissible approach to the question (and could be effective) provided that you also explained what the oversimplifications were and why you were choosing these simplifications over others, and discussed the risks of presenting misleading arguments.
A related and common pitfall was excessive one-sidedness. You were indeed asked to produce a piece of advocacy, but given that the audience could be expected to raise or be exposed to counterarguments from political opponents, it was useful and in some cases important to anticipate and respond to such counterarguments, or to defuse them in advance. Additionally, since the rival proposals in many ways just differ in degree, it was important not to make overdrawn criticisms of the opposing proposal that could just as well apply to one's own position.
Ideally, your three or four proposed advertisements should have dealt with the main substantive issues relating to health care regulation, including distributional politics and the substantive problems of insurance markets and health care institutions (e.g., adverse selection, moral hazard, incomplete information, and the fiduciary problem). Some essays focused excessively on a single issue, for example presenting three ads that were basically variations on the distributional theme addressed to a single target audience. It was possible for such essays to be effective if they indicated what issues they were choosing to overlook and explained why repetition rather than a diversified set of arguments made for the best rhetorical strategy, but absent such explanations, the more likely effect was that of repetitiveness.
Several students disregarded the exam instructions and presented detailed scripts for their proposed advertisements, even though you were explicitly told that you did not have space for this and that you should focus on explaining how and why you were proposing the arguments you did. In some cases these scripts were very entertaining to read and it was obvious that you put significant effort and imagination into them, but to the extent they did not self-reflectively discuss their underlying substance and rhetoric, I could give them only limited credit .
Because the question left room for you to go in various directions, I am not presenting a model answer here as such (and as it turned out I did not use a checklist in grading this question.) Instead, I have posted the top answers as representative models, along with the preceding general comments about rhetorical and argumentative strategy.
Key to symbols used to mark exams:On some exams I also circled particular words or phrases that I found questionable or unclear, or that were misspelled.
good point or argument ! excellent point or argument ~ fair point, or incompletely or unclearly expressed – weak point … point needs elaboration " point already made, repetitive, or unnecessarily restating facts ? unclear ?? very unclear, confused, mixing together separate points x mistake of law, misstatement of fact, misuse of term x? point appears mistaken # irrelevant or tangential point #? point's relevance unclear ns non sequitur: conclusion does not follow ff fighting facts: contradicting stated facts or making assumptions inconsistent with them ll laundry list: throwing in relevant and irrelevant arguments alike, without distinction lec lecturing: abstract discussion unconnected to or unnecessary for the problem at hand ua unsupported assertion / unidentified assumption vb verbose; too much space devoted to the point or points in question vg discussion is overly vague or overly general conc conclusory; result of argument stated without reasoning sa straw argument: overly weak or caricatured argument set up for sake of rebuttal exag otherwise good point is overstated or exaggerated c-a? fails to discuss obvious counterargument