Markets vs. Regulation

Many of us think about regulation in somewhat dichotomous terms, namely as a choice between free markets and government regulation.  Under the standard view, the market optimally provides many goods and services.  In the competition of various firms pricing their goods and services, the “hidden” hand” of the market will lead to optimal allocation of societal resources.  BARACK ORBACH, REGULATION: WHY AND HOW THE STATE REGULATES § 2.2 (1^st ed. 2013).  However, markets often suffer from imperfections, providing a justification for government intervention by means of regulation.  Bryan Caplan, Market Failure Theory as Reproach to Government Practice, THE LIBRARY OF ECONOMICS AND LIBERTY (Jan. 14, 2019).[1]

The array of market imperfections government can seek to “correct” include, for example: the presence of externalities, i.e., market participants’ imposition of social costs for which they are not accountable, and imperfect information.  See, e.g., SAMUEL ESTREICHER & DAVID L. NOLL, LEGISLATION AND THE REGULATORY STATE 9-20 (2d ed. 2017); STEPHEN BREYER, REGULATION AND ITS REFORM 15-35 (1982).[2]  Government intervention often involves rulemaking that imposes substantive standards upon industry.  However, our methods of regulation have been supplemented to include the occasional substitution of market-based incentives for more conventional command-and-control techniques. See, Timothy A. Wilkins & Terrell E. Hunt, Agency Discretion and Advances in Regulatory Theory: Flexible Agency Approaches Toward The Regulated Community As A Model For The Congress-Agency Relationship, 63 GEO. WASH. L. REV. 479, 482-92 (1995).[3]  But market-based incentives simply provide a means by which government can harness market competition to remedy some of the baleful effects an undiluted competitive market would otherwise produce.  So even the market-based incentives approach leaves the tradition “market vs. regulation” dichotomy intact.

Concomitantly, under the market/government regulation binary, private entities, particularly market participants, should not assume the role of regulators, and those that do should be kept on a tight leash.  When market participants stop acting like competitors and instead collaborate to impose broader industry standards, even under government auspices, scholars and judges become suspicious.[4]  See, Aaron Edlin & Rebecca Haw, Cartels by Another Name: Should Licensed Occupations Face Antitrust Scrutiny?, 162 U. PA. L. REV. 1093 (2014); North Carolina State Board of Dental Examiners v. Federal Trade Commission, 574 U.S. 494 (2015)(anti-trust immunity for state licensing boards); A.L.A. Schechter Poultry Corp. v. United States, 295 U.S. 495, 537 (1935)(non-delegation doctrine).[5]  We are also suspicious when business entities seeking legislative or regulatory action, suspecting them of “rent-seeking,” i.e., a manipulation of the market to capture consumer surplus that would be competed away without government intervention.  See, e.g., Jonathan R. Macey, Promoting Public-Regarding Legislation Through Statutory Interpretation: An Interest Group Model, 86 COLUM. L. REV. 223-24, 227-33 (1986); Frank H. Easterbrook, Foreword: The Court and the Economic System, 98 HARV. L. REV. 14-18 (1984).

A Third Way

Engineering Rules: Global Standard Setting Since 1880, the focus of this symposium, describes the history of a third way, voluntary standard-setting by an array of largely private professionals and business entities.  The literature on such voluntary standard-setting processes is apparently quite well-developed. The standard-setting story, as related by the authors of Engineering Rules, JoAnne Yates and Craig N. Murphy, begins in the 1880s, as the books title suggests.  It involves many twists and turns reflecting broader 20^th and 21^th Century trends, among them war, economic unrest, global integration, and the rise of the digital society.

The story reflects standard-setters complex mixture of idealism and aspirational goals on the one hand and pragmatism on the other.  Thus, as Yates and Murphy note, the standardization movement was largely initiated by engineers who considered performing public service an avenue for enhancing engineering’s status as a profession.  Indeed, one of the first major debates among standard-setters involved allowing business entities to formally participate in their standard–setting processes.  Pragmatism was central to the decision; without business participation any standards produced were much less likely to attain widespread adoption.  At various points over the course of time devotees of standardization saw their efforts as a means of enhancing the competitiveness of their countries’ industry vis-à-vis those of other countries, improving the conditions of laborers, enhancing economic growth, contributing to their nation’s war efforts when conflicts raged and encouraging peace and avoidance of war when such conflicts ended, enhancing the internationalist post-World-War-II vision, and facilitating the development of the Internet as a radical change in the way people interacted.

The authors’ focus is not so much on the substance of the standards themselves, but the processes constructed by and norms under which standardization organizations operated, i.e., the “due process” of standard-setting.  Thus, Yates and Murphy discuss such issues as:

1. participation of business and government entities in the standardization process,
2. the formality or informality of standard-setting bodies’ processes for developing and considering standards,
3. equality of representation and norms of balance among various interests,
4. the need to reach consensus before acting,
5. norms of respect for differing opinions,
6. the choice between developing national or international standards,
7. decisions regarding whether standards should be voluntary, and later whether they would be crafted in ways that governments could incorporate by reference, and
8. the development of the norms that participants, in their discussions and decisions within the standard-setting bodies, were to be primarily driven not by their own parochial concerns but by considerations of technical merit.

In laying out this story, the authors sprinkle their own insights, such as their comparison of the processes of the pre-World-War-I standard-setting organizations with the theory of “deliberative democracy.”[6]  ENGINEERING RULES, at 106-109.  The authors also weave in flattering, sometimes even endearing, portraits of important standardization entrepreneurs, such as Charles le Maistre, Olle Sturén, John Wolfe-Barry, Ralph Showers, and Alice Tepper Marlin.  On the other hand, when traditional regulatory agencies make a rare appearance in Yates and Murphy’s narrative, they often get in the way.  See, e.g., ENGINEERING RULES, at 182-85, 226-27.

As it turns out, standardization is often not a zero-sum game.  Early in Engineering Rules, the authors identify three somewhat distinct goals of standardization, namely safety, interoperability, or performance. ENGINEERING RULES, at 34.  Though a standard might fit into more than one category (performance standards might often increase safety), it is striking how much of the standardization movement, and the successful standard-setting efforts, focus on issues of interoperability and performance.  With respect to these two interests, producers and organizational purchasers of goods share a common interest.  Interoperability allows for greater competition among producers because their component parts are compatible with the machines and devices produced by others.[7]  Large institutional consumers desire high quality interoperable parts that perform consistently.  Indeed, in such circumstances, almost all market participants probably value having a definite, uniform rule even more than having the particular rule most favorable in terms of their own narrow parochial interests.  The standardization efforts Yates and Murphy chronicle seem largely to ameliorate one particular type of market failure, namely imperfect information.  Standards provide a means by which purchases can assure themselves of the quality and suitability of products offered to them for purchase.

However, in these standardization efforts certain groups of “stakeholders” are largely represented derivatively, if at all (as Yates and Murphy acknowledge, see ENGINEERING RULES at 109).  Such groups include (a) individual consumers who purchase products, (b) customers of common carries or other companies who deliver services by using complex devices (in the case of common carriers, various sorts of vehicles used for mass transit), and (c) workers who operate machinery purchased by their industrial employers.  Such individuals, or groups devoted primarily to their interests, seem rarely to receive formal recognition as stakeholders in standard-setting processes.  Rather their interests are represented by engineers, particularly academic engineers, or by large institutional purchasers who are harmed as well by low quality products.

Can The Third Way Regularly Address Issues Beyond Interoperability and Product Performance?

But can the standards movement successfully confront concerns outside the context of interoperability and product performance?  Government regulation often does not focus on interoperability and product performance issues, but rather on addressing externalities or correcting imbalances in power.  These issues may be perceived to be more of a zero-sum game by “stakeholders.”  Aside from standard-setters’ early success with establishing safety standards for steamboats,[8] a relatively small portion of the standardization efforts seems to have focused on safety issues. (Granted, safety and performance are intertwined concepts).

The “third wave” of standard-setting, occurring from the 1980s to the 2000s, extended beyond product standards.  This “third wave” not only encompasses standards for business processes, namely the ISO 9000 series of standards (for Dilbert’s take on ISO 9000 see here), but also standards governing environmental issues and industrial labor conditions.  The impetus for ISO 9000 business process standards were businesses dependent on a global supply chain that needed to have confidence in potential suppliers and other business partners.  It was also nurtured by businesses that had not developed a global reputation and could provide comfort to potential foreign customers by having the ISO 9000 “seal of approval.”  The environmental standards and the industrial labor standards, which expanded the pool of stakeholders, have had some, but dramatically less success than the business process standards (at least in terms of the number of companies seeking certification that they have complied with those standards).  Certainly, the federal government’s attempt to mimic private standard-setting processes, namely negotiated rulemaking, seems to have had limited success.  See generally, JEFFREY S. LUBBERS, A GUIDE TO FEDERAL AGENCY RULEMAKING 217-25 (6^th ed. 2018).

Perhaps we in the administrative law world should give more attention to the standard-setting movement and its interaction with government agencies and government regulatory efforts.[9]  Yates and Murphy’s impressive historical survey of the movement seems a good place to start for anyone motivated begin such and exploration.

But Wait, There’s More!: Standards and Personal Injury Litigation

The remainder of this post focuses on the judicial approaches to customary business practices in general, and standards in particular, in the personal injury context.  Courts are reluctant to find compliance with standards dispositive when adjudicating personal injury cases, except in medical malpractice cases.  This may be due, in part, to a concern about the rigidity of rules and a commitment to jury assessment of the reasonableness of defendant’s conduct or of a product design’s balancing of risk and utility in the context of particular accidents.[10]  Rules inherently provide the “wrong” answer in some individual cases.  But there is more than discomfort with rules at play.

In professional malpractice cases, the standard of accepted practice governs.  RESTATEMENT (THIRD) OF TORTS §299; RESTATEMENT (THIRD) OF TORTS: PHYSICAL & EMOTIONAL HARM §13, comm. b (2010).  The accepted practice need not even have been recorded, much less memorialized in any formal written standard.  By contrast, compliance with government regulations, while relevant to the reasonableness of a defendant’s conduct, is generally not dispositive on the issue.  Id., at §16.  However, failure to comply with safety regulations, absent some explanation, establishes the defendant’s breach of duty.  Id, at §§14 & 15. Courts are even more skeptical of industry customs. Compliance with industry custom does not establish the reasonableness of defendant’s actions; violation of such customs does not establish defendant’s unreasonableness.  Id, at §13.  And in products liability cases, some courts hold that evidence of industry customs is irrelevant, and thus inadmissible, on the theory that strict products liability is not based on negligence concepts.[11]  Presumably, even standards incorporated by reference in statutes or regulations would provide defendants in negligence and strict liability cases no more of a defense than either industry custom or statutes/regulations considered separately.  See, Wagner v. Clark Equipment Co., 243 Conn. 168, 186-191, 700 A.2d 38, 48-51 (1997)(regarding ANSI standards for forklifts incorporated by reference in OSHA regulations).

The rule that compliance with industry custom is not dispositive has a long history, predating the start of the standardization movement.  Chief Justice Lemuel Shaw’s mid-Nineteenth Century opinion for the Massachusetts Supreme Judicial Court in Bradley v. Boston & Me. R.R., 56 Mass. 539 (1848), provides an early exposition of the rule.   No lesser luminaries than Oliver Wendell Holmes, Jr. and Learned Hand have offered pithy reaffirmations of the rule.  Texas & Pac. Ry. v. Behymer, 189 U.S. 468, 470 (1903)(“what usually is done may be evidence of what ought to be done, but what ought to be done is set by the standard of reasonable prudence, whether it is usually complied with or not”); The T.J. Hooper, 60 F.2d 737, 740 (2d Cir. 1932)(“a whole calling may have unduly lagged in the adoption of new and available devices”).  The Restatement (Third) provides a more contemporaneous explanation:

The prospect of unreasonable conduct by all potential defendants who engage in a line of activity is especially great when potential victims do not enter into contractual or other consensual relationships with those defendants. In these circumstances, defendants may feel little immediate need to provide potential victims with appropriate protection.

RESTATEMENT (THIRD) OF TORTS: PHYSICAL & EMOTIONAL HARM §13, comm. b.  Perhaps the best explanation for the distinction between the treatment of industry standards and professional practice standards was offered by the Arizona Supreme Court in Rossell v. Volkswagen, 147 Ariz. 160, 166, 709 P.2d 517, 524 (1985), cert. denied, Volkswagen of America v. Rossell, 476 U.S. 1108 (1986).  There, the Court asserted:

[W]e decline to transform defective design cases into malpractice cases. . . . Special groups will be allowed to create their own standards of reasonably prudent conduct only when the nature of the group and its special relationship with its clients assure society that those standards will be set with primary regard to protection of the public rather than to such considerations as increased profitability. We do not believe that automobile manufacturers fit into this category.[12]

Rossell v. Volkswagen, 147 Ariz. at 166, 709 P.2d at 524.

The Restatement does at least recognize the work of private standard-setting organizations.  But at best it seems to treat privately-based standards as entitled to no more weight than less formally developed and uncodified industry standards.  RESTATEMENT (THIRD) OF TORTS: PHYSICAL & EMOTIONAL HARM § 13, comm. e.  And at worse, such standards may be considered inadmissible hearsay evidence.  See, id. & Reporter’s Notes.

Engineering Rules may suggest that that merely treating voluntary standards produced by standard-setting bodies as an indistinguishable subset of industry practices and customs is unwarranted.  The rigor of standard-setting process described in the book suggests that the standards that emerge from such processes warrant more favorable consideration than more informal and less rigorously developed industry practice.  In particular, Engineering Rules suggests that the norms and practices of standard-setting processes may make disregard of individual consumers’ interests far less likely.

However, again, standard setting agencies’ ability to formulate safety standards, as opposed to performance or interoperability standards, remains in doubt.  Moreover, courts may need to distinguish between standards promulgated by various standard-setting organizations, since some organization’s processes may be less rigorous than others.  And courts might shy away from giving standards more respect to avoid such “administrative” burdens.[13]

Engineering Rules may also provide some perspective on whether compliance with regulations should be considered dispositive as well.  Though there are calls for recognizing a regulatory compliance defense in limited circumstances, see id. at §16, comm. f and Reporter’s Notes; Wilson v. Piper Aircraft Corp., 577 P.2d 1322, 1332 (Or. 1978)(Linde, J., concurring), the rule that compliance with regulation is not a defense still holds sway.  One of the reasons may be the retentionist bias in our legislative and regulatory systems.  Even if a regulatory standard accurately reflects the state or the art when initially adopted, the bias toward inaction in the legislative and regulatory processes suggests that the rule will become out-of-date and far less than optimal long before it is successfully revised.[14]  Yates and Murphy suggest that private standard-setting organizations can be far more nimble in adapting to technological change, and that such organizations regularly revise their standards in light of technological advances.[15]  This suggests that with respect to private voluntary standards incorporated by reference, at least one reason for a reluctance to adopt a regulatory compliance defense may be absent.

Moreover, concerns about agency capture and legislative favoritism to business interests are another reason for skepticism that safety statutes and rules reflect optimum safety rather than the success of an industry’s lobbying efforts to protect its own self-interest.  But Engineering Rules suggests that private voluntary standards should not merely be considered the equivalent of industry lobbying to blunt or diminish the effectiveness of safety regulation.

Conclusion

Engineering Rules is very readable (“there’s no math on the test”), but is not an easy read.  The authors are too meticulous and attentive to detail and the web of standard-setting organizations too complex for that.  Yet the story Yates and Murphy recount is interesting, and reveals a whole new type of “rulemaking” of which many experts in administrative law (and torts) are probably largely unaware.

This post is part of a symposium reviewing JoAnne Yates and Craig N. Murphy‘s Engineering Rules: Global Standard Setting since 1880 (John Hopkins University Press). Previous posts in the symposium can be viewed here.

[1] To be precise, Caplan seems to favor subsidies and targeted taxation over command-and-control regulation.

[2] See, Executive Order 12,866, Regulatory Planning and Review, §§1(a), 1(b)(1)(Sept. 30,1993)(discussing market failure as a justification for regulation).

[3] [3] See, Executive Order 12,866, at §1(b)(3)(directing agencies to consider adopting alternatives to direct legislation).

[4] That said, self-regulatory organizations, like securities exchanges, play a significant role in securities regulations.  A major function of such organizations is to provide the necessary infrastructure for an organized market to exist, i.e., to establish and enforce “the rules of the game.”

[5] Schechter Poultry primarily involved anti-competitive “codes of fair competition.”  Interestingly, however, in holding that government power could not be delegated to private entities, the Court appeared to distinguish a precedent finding a delegation of the power to establish a uniform engineering safety standard to an industry association a constitutionally permissible delegation of authority.  295 U.S. at 537.  In particular, in St. Louis, Iron Mountain & S. Railway Co. v. Taylor, 210 U.S. 281, 286 (1908), the Court had upheld a provision of the Safety Appliance Law authorizing the American Railway Association “to designate to the Interstate Commerce Commission the standard height of drawbars for freight cars.”

[6] Somewhat analogous to the efforts of engineers described by Yates and Murphy, lawyers have developed a range of groups and associations that work to improve, rationalize, or codify law, such as the American Law Institute, the American Bar Association, and other more local bodies.  (Indeed, the American Law Institute, began somewhat in the same time frame as the first-wave of engineering standardization.)  At least some of the norms Yates and Murphy identify in Engineering Rules can be seen in the operation of such law reform organizations, albeit law has traditionally been much less international than engineering.

[7] Requiring interoperability is one means of breaking a monopoly’s power.  For example, the requirements imposed upon incumbent local exchange carriers (“ILECs”) to provide unbundled access to their facilities and equipment to any requesting telecommunications carrier seeking interconnection was designed to reduce the monopoly power of ILECs (most of which descended from the Bell telephone monopoly). See HARVEY L. ZUCKMAN, ET AL., MODERN COMMUNICATIONS LAW §9.2(A)(2)(c)(1999)(discussing the obligations imposed on ILECs by the Telecommunications Act of 1996, Pub. L. 104-104, 110 Stat. 56).

[8] According to administrative law scholar Jerry Mashaw, the regulatory efforts to address steamboat boiler explosions began long before the period in which standard-setters sought to address the problem.  The regulatory efforts began with the Steamboat Inspection Act of 1938, and continued after Congress enacted the Steamboat Inspection Act of 1852.  JERRY L. MASHAW, CREATING THE ADMINISTRATIVE CONSTITUTION: THE LOST ONE HUNDRED YEARS OF AMERICAN ADMINISTRATIVE LAW 187-208 (2012).

[9] Of course, some administrative law scholars have been involved intently in considering incorporation of private standards by reference in regulations, though largely from the perspective of ensuring transparency and access to such standards.

[10] See Kenneth S. Abraham, Custom, Non-Customary Practice, and Negligence, 109 COLUM. L. REV. 1784, 1819 (2009).

[11] See, 2A AMERICAN LAW OF PRODUCTS LIABILITY 3D, §30:48 (available on westlaw); Lewis v. Coffing Hoist Div., Duff-Norton Co., Inc., 515 Pa. 334, 343, 528 A.2d 590, 594 (1987); but see, Tincher v. Omega Flex, Inc., 628 Pa. 296, 104 A.3d 328 (2014)(potentially undermining Lewis’ underpinnings).

[12] The Court continued: “This is no reflection upon automobile manufacturers, but merely a recognition that the necessities of the marketplace permit manufacturers neither the working relationship nor the concern about the welfare of their customers that the professions generally permit and require from their practitioners.”

[13] Kenneth S. Abraham, supra note 10, at 1800-1802 (explaining that theories that distinguish among industry standards may not have been adopted because of the difficulty of applying them).

[14] And, of course, the retentionist bias suggests that even the initial statute or regulation is likely to reflect something less than the state of the art.

[15] Indeed, Yates and Murphy note, standard-setting process were revised by standard-setters focusing on the Internet in light of the pace of technological change in that realm. ENGINEERING RULES, at 255-260.