Randomizing Regulatory Approval for Diversification and Deterrence (WP-13-19)
Charles F. Manski
Modern societies legislate numerous requirements for regulatory approval of private activities. This paper develops two arguments for randomizing regulatory approval: diversification and deterrence. Diversification may be appealing when regulatory agencies make approval decisions under uncertainty. It enables an agency facing uncertainty to limit potential errors, much as portfolio diversification protects an investor who is uncertain of the returns to alternative investments. It also generates randomized experiments that may enable an agency to improve its decision making over time. The deterrence argument arises when the nature of an approval process affects private decisions to seek approval for contemplated activities. Randomization enables an agency to control the likelihood of approval. An agency may seek to choose an approval rate that encourages submission of applications for socially beneficial activities and deters applications for deleterious ones. To study the circumstances in which diversification and/or deterrence motivate randomized approval, the researcher brings to bear basic elements of normative public economics and decision theory.