The Australian Football League (AFL) is looking at claims of ‘tanking’ – again. See here. In brief, the AFL used to give a priority draft pick to a team that won four or fewer games. So if, at round 16 (out of 22), a team was sitting on, say, 3 wins, and could not make the finals, it had a big incentive to make sure it won no more than 4 games overall (maximum of one more win for the season).
The AFL’s failed regulatory scheme (because that is what it was!) provides two broader lessons for regulators:
- Incentives matter; and
- Don’t write regulatory rules that are unenforceable.
It shouldn’t surprise anyone that incentives matter. But the incentive implications of regulations are sometimes ignored. Create incentives for football teams to lose games and they will lose games. Create incentives for electricity network owners to ‘cherry pick’ regulator’s decisions and they will do so (hence the current review of the appeals process for the Australian Energy Regulator’s decisions). Create incentives for a vertically integrated telephone company to undermine its rivals through the access regime and that is what will happen. Pretty obvious. But the last 20 years of Australian telecommunications regulation shows that the ‘pretty obvious’ incentive effects may be ignored when markets are restructured.
The second lesson is more subtle. Those who write regulations often ignore the difficulty of separating ‘legitimate’ and ‘illegitimate’ activities. ‘Tanking’ is deliberately losing a game or games to manipulate the draft system. It is bad and should be stopped. But rotating players, trying players in new positions, giving young players more game time, resting players with ‘niggling injuries’ and so on, are all legitimate coaching decisions for a struggling team. The fact that they all raise the probability that a team will lose …..
Much utility regulation is based around giving a ‘fair level of profit’ to the regulated firm. But this is immeasurable. Similarly, access regulation is based on the ‘efficient’ access price. Again, immeasurable. Many of the regulatory debates are a waste of time as people argue about how to best measure something that they cannot measure. For example:
- Which version of CAPM should be used to determine the ‘appropriate’ return on equity or should a different model be used?
- What is the appropriate minimum retail price that a vertically integrated firm can charge given the access price (so-called imputation rules)?
A better regulatory outcome is to set a clear set of rules around things that can be measured cleanly and that will not create perverse incentives. And by the way, one set of perverse incentives is created by having ‘reviews’ that continually fiddle with the regulatory rules.