In Praise of Ex Ante Regulation

Abstract

Timing is an important consideration in regulatory design. Corrective taxes are usually imposed before or contemporaneously with the harmful activity they are aimed at preventing, while tort awards are assessed ex post, in its aftermath. Patents and research grants both can encourage innovation, but patents pay off only after the invention is marketed. In a world of perfect information, fully rational actors, and complete credit or insurance markets, time would not matter. In the real world, though, the failure of one or more of these assumptions can change dramatically the impact of a regulatory option. For example, prior commentators have largely favored ex post incentives on the ground that government has much better information after the regulated activity is complete.

This Article argues that the consensus in favor of ex post regulation overlooks some important considerations. Ex post regulation does provide useful additional information when regulated parties are heterogeneous, but also carries significant and sometimes prohibitive social cost, especially when externalities are produced by limited-liability firms. Further, drawing on results from mathematical simulations, I show that the costs of heterogeneity can be sharply reduced with even modest up-front information. I apply these insights to a series of examples, including the obesity crisis, the regulation of systemic risk in the banking sector, state fiscal failures, and the design of the IP system.

Keywords: choice of instruments, ex ante, ex post, pigouvian tax, judgment proof, corrective taxation, patents vs. prizes, fat tax, law & economics

JEL Classification: D62, H23, K23, K32