A Response to Eidenmüller’s Defense of Regulatory Competition in the Fight against COVID19

In a recent post on the OBLB, Horst Eidenmüller argues that it is (or might be) desirable that states put forward different regulatory responses—for example with respect to containment measures—to the COVID19 pandemic. His larger point is that a form of regulatory competition among states is beneficial in the fight against the virus. The thesis is essentially that, due to lack of information and clarity on the optimal strategy to fight the emergency, and in light of the different conditions of each jurisdiction, different approaches might offer solutions better tailored to specific national needs. In addition, according to this perspective, heterogeneous approaches allow ‘to experiment’, to study alternative responses, and learn from the experience of other countries. In Eidenmüller’s opinion, this lack of coordination and regulatory competition might lead to a race to the top both in terms of healthcare and economic policies. He is not too concerned about externalities, arguing that the risk that a less rigorous state exports the virus is limited because borders are locked; and that the risk of economic spillovers of bad policies to other countries is equally low because the crisis affects ‘the real economy’, and not ‘systematically important financial institutions or the financial system’. The piece concludes by positing that ‘externalities imposed on the real economy are limited in scope’, and optimistically observes that ‘global supply chains are still working reasonably well’.

Professor Eidenmüller, like the undersigned and many readers of this Blog, comes to this issue with expertise in insolvency law, corporate law and financial markets. In those contexts, regulatory competition is a well-known and well-documented phenomenon. For example, corporations are known to shop around among different jurisdictions in order to choose the best corporate laws or insolvency regime. There is a robust debate about whether this kind of competition is beneficial. Even supporters of the race-to-the-top theory, however, agree that regulatory competition can have virtuous effects only if certain conditions are met. Those preconditions include limited transaction costs in choosing and changing the applicable rules, a certain degree of information efficiency to evaluate the nature of the different rules and their effects, and correct incentives for decision-makers, investors, and policy makers.

To apply this framework to the global human, social, economic, and political tragedy caused by the pestilence is an original and provocative, but also disturbing, idea that forces readers to think. That is exactly what good scholars aim to do. In this respect, Horst Eidenmüller’s post is commendable.

It cannot be entirely set aside, however, that what is being pondered and proposed implicates not only the cost of capital or investors’ protection, but rather thousands of dead people, massive unemployment, and social havoc. It is the discomfort of this observation that prompts me to respond. The basic idea seems to me not sufficiently supported by the theory or hard evidence, and potentially dangerous.

As a starting point, it is easy to see some sources of inspiration for the notion of COVID19 regulatory competition. No coordinated response to the virus has been developed, and at best there has been some partial coordination at the regional level. The international order failed to elaborate a timely and unitary reaction to the crisis; and supra-national or international organizations have shown their deficiencies. The Nation-State has emerged as the entity most capable of ‘doing something’.  If these observations are all fair and right, they are also obvious. I can also concede that, clearly enough, observing different reactions and their relative effectiveness improves the ‘information package’ and fosters a discovery of possible countermeasures. None of these concessions, however, provide any clear policy suggestion: They do not support the desirability of regulatory competition and, in fact, suggest that greater coordination, especially in Europe, is imperative, as argued by many economists and health-care experts, and proposed through important initiatives. While many things could be said about the moral considerations of allowing the current crisis to be a laboratory for regulatory competition, I will confine myself here within the playing field Eidenmüller chose and discuss some aspects of his reasoning.

First, supporters of competition among jurisdictions agree that uniformity, reliability, comparability and transparency of the information collected and shared is a precondition for any beneficial effect of regulatory arbitrage. This precondition presents a likely insurmountable obstacle in this context. The current crisis is rife with questions about how different countries count contagions, deaths, different types of care, and the limited comparability among statistics; there are also questions about how to assess the actual effect of containment measures. In light of these information asymmetries, there are doubts concerning the lessons that can be derived by observing what other jurisdictions are doing. As a matter of fact, if the last couple of months teach us something, it is that many of the states in which the contagion has been delayed have taken at best limited note of foreign experiences, reacted slowly, and wasted precious days, weeks, and even months that could have avoided an unthinkable number of deaths. Even assuming information efficiency, waiting to see how different approaches work and study them, in this context, is a luxury that we simply cannot afford: time is of the essence. At a minimum, greater uniformity and transparency in collecting and sharing information on the epidemic and the effects of regulatory responses are necessary, something that requires close international cooperation and/ or supra-national bodies. 

Second, Eidenmüller dismisses too easily the problem of externalities, which is likely very significant. As for the health contagion part, surely borders are (more or less) closed now, but not perfectly. More importantly, they cannot stay this way forever. When the borders are reopened, even gradually, the risks of one country will become (again) the risks of another. Can it really be argued that we should not worry because we live in the very emergency situation that might lead to economic (not to mention social, political, cultural) Armageddon? With respect to the economic contagion issues, it is perilous to downplay the systemic risks that directly or indirectly derive from the ‘real economy’. I would be very cautious in minimizing the possible effects on banks and other financial institutions of a Main Street shutdown: in fact, most central banks appear to agree. Global supply chains are international and interconnected. The fact that so many countries are having problems even obtaining essential health care devices and protective gear is tragic proof of this fact.

Third, there are numerous areas in which a coordinated reaction among states would be beneficial. Think ventilators. The fact that individual countries try to buy them (often from abroad) reduces their bargaining power and even forces them to bargain against each other, to their detriment (and the exclusive benefit of vendors). It is hard not to believe that if the EU were able to negotiate fairly for all EU countries, it could have more leverage vis-à-vis providers, especially when ‘competing’ (here, yes), with very big economies like China or the US, or small but very rich countries, like some Arab states that could offer high prices for a relatively limited number of devices.

This is true in many fundamental areas of the response to the pandemic—medical research is another example. How can these possibly centralized or at least coordinated actions be reconciled with heterogeneous containment measures on other levels? For example, how could this hypothetical European purchaser allocate ventilators or masks according to efficient and equitable parameters (population, contagion, etc) if some states can limit their containment measures more than others in order to protect their economies? The answer could be that the ‘distribution’ of devices would be somehow conditional on the adoption of certain rules, but isn’t this exactly a form of international coordination that is the opposite of regulatory competition?

Another reason why regulatory competition is counter-indicated in the current crisis concerns free riding, incentives, collective action, and moral hazard. If some countries, and especially the ones that are hit first, adopt stringent containment measures, the benefits go to other countries that are lucky enough to be initially less affected. This effect reduces the incentives for all to adopt resolute and early measures, hoping to be spared also thanks to the sense of responsibility of others, as it has largely happened and is still happening.

As a side note, free riding, in this context, is not only unfair and inefficient, but it is also likely to promote acrimony and retaliation. States affected more profoundly, whose efforts might have helped others to limit negative economic consequences, might become very protective of their markets. Are we ready to accept a (further) disruption of the international market for corporate control, or of the flow of goods and services, even once the situation will hopefully be normalized? Or are we naïve enough not to believe that the more states are left to act alone in this predicament, the more they will think twice before reopening to others?

Again, when contrasting the current scenario with ‘normal’ regulatory competition in, for example, company law, we should never forget that the subjects of regulation—the citizen of the different jurisdictions—are by definition not allowed to ‘shop around’. FCA could move from its state of incorporation and tax center from Italy to other European countries, but quarantined people cannot even exit their homes. This distinction, again, affects the incentives of local policymakers and undermines the potential benefits of regulatory competition. As we have already started to see and as history teaches us, emergency situations governed at the local level often open the door to autocratic inclinations.

Finally, if Eidenmüller’s reasoning is right, why should we stop at the national level? Why not allow every single state in federal states or every region, city, town or neighborhood, to adopt the measures that they consider proper? Is there an optional dimension for the decision maker? Could we just side-step this question simply noting that the State is the only political actor equipped to take action and enforce its commands?

There are other potential challenges to the very notion that regulatory competition could be useful in this crisis, based on the very hypothesis and tenets of the model. The political and social arguments are even stronger and make praising regulatory competition even more dangerous. The good faith intellectual provocation might be distorted and abused, and there is a short step between the words ‘competition’ and ‘nationalism’ in this context. I conclude by agreeing with the Italian Prime Minister, who recently claimed that we are not writing a page of an economics paper, but a page of a history book. In that book, I would prefer to be in a footnote advocating unity, coordination, cooperation and—yes—solidarity.

Marco Ventoruzzo is Professor of Corporate Law at Bocconi University, Milan.