Chidem Kurdas
How did regulators miss the massive Volkswagen diesel emissions fraud for so long? Here is an explanation, from my book Ponzi Regulation:
“Any attempt to make sense of the regulatory state has to ask, what are its agents capable of doing? …. One thinker who took a hopeful view of bureaucratic functioning was Herbert Simon, who …argued that organizations can expand human rationality. …
Simon and his colleagues Richard Cyert and James March analyzed the functioning of organizations from the point of scarce cognitive resources. How do members of an organization behave, given that mental facility is limited? A key behavioral insight is that people try to avoid uncertainty. Making decisions under uncertainty is difficult, so we try to evade such decisions.
Cyert, March and Simon came up with a “Gresham’s Law” of organization. The original Gresham’s Law says bad money drives out good money. Gresham’s Law of organization says routine will drive out non-routine. Routines involve little or no uncertainty and economize on knowledge and cognitive processing…. Once you have a routine, following it requires little thought, like decisions from a known menu. For individual members of an organization, routines are easy and efficient.
People who make their way up a bureaucratic ladder become experts at side-stepping non-routine challenges as much as possible. Having to go out of the regular pattern is both difficult and dangerous; someone who does this frequently will be regarded as unsafe and is unlikely to be promoted in a hierarchical organization. …
Gresham’s Law of organization implies that bureaucrats will attend to the most routine parts of regulation and go through highly programmed motions…..”
Like, say, testing diesel emissions in a certain established way, rather than in other ways. Volkswagen’s smart alecks figured out how to fool this method by programming car computers.
For years regulators did not do the road tests that would reveal a discrepancy. Eventually information from other sources suggested that VW diesel emissions were much greater than measured by regulators and road tests confirmed it.
What is the remedy? Neither Simon nor anyone else has really found one. Minimizing the need for bureaucratic action would reduce the damage of Gresham’s Law of organization and myriad other dysfunctions, but in recent decades if anything governments have maximized the scope of bureaucracy.
HedgeFundSmarts 
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