Is the revolving door of top regulators one of the reasons for a lack of good regulation? Based on her recent research, Elise Brezis comes to the conclusion that the revolving door and the bureaucratic capital created by regulators should be allowed as long as their behavior is only unethical but not illegal. This distinction casts in new light the deregulatory pressures that contributed to the 2023 bank failures.

Economic regulation follows a pendulum between periods of intervention and periods of deregulation. After crises, governments often receive public backing for more regulation. This happened after the 1929 Great Depression, the 2001 Enron scandal, the 2008 subprime mortgage crisis, and, most recently, the current 2023 SVB and Signature Bank failures.

But, during times of financial calm, the pendulum moves toward deregulation as the voices of the Stiglerians grow louder. Stiglerians generally oppose regulation because, in their view, the government is disproportionately responsible for anticompetitive market failures due to its susceptibility to special-interest capture. Indeed, according to Stigler, the main culprits of all government wrong-doing are the regulators, and the regulatory cure becomes worse than the problem. Since government regulation is a necessary evil, societies need to develop the capacity to regulate the regulator. 

Economist Luigi Zingales (and ProMarket’s founder) has suggested that one of the main instruments to regulating government officials is to regulate the “revolving door” of government officials who, after leaving public service, work for the industries they once regulated. Zingales has suggested that the revolving door should be reformed to reduce the power of firms and the potential of regulatory capture.

My research considers whether the revolving door should indeed be regulated. It analyzes the effects of the revolving door, focusing not only on the relationship between regulators and firms but also whether regulating the revolving door optimizes social welfare. 

There are two main ailments linked to the behavior of regulators, and both are related to the arguments for and against the revolving door. The first is that some of the decisions taken by regulators are simply erroneous due to the “lack of competence” of the bureaucrat. Some regulators are simply not qualified. This problem can arise because government salaries are often too low to attract high-quality and competent individuals. 

The second problem is that some decisions of the regulator are inaccurate, and it is not due to lack of competence but to “greed.” The regulator acts to increase their future compensation by inaction or issuing regulation favorable to certain companies or industries. This greed takes two forms: “regulatory capture,” or “abuse of power.”  

Regulatory capture, as put forward by Stigler, postulates the vulnerability of regulators to bribery, specifically. The regulator is “captured” during their term in office with promises from firms that after they leave office they can join the firm for high compensation. So, the regulator who is supposed to prevent monopolistic power acts in their own interest, and not in the interest of the people, as discussed in ProMarket’s George Stigler: 50 Years Later. 

For Stigler, the choice is dichotomous. Either regulators are captured, which should be forbidden, or all is well. The notion of ethics does not appear in Stigler’s theory of  regulation and behavior. To be even more blunt, Stigler, in his Tanner lecture on “Ethics or Economics?” wrote, “Economists have seldom spent much time exhorting individuals to higher motives or more exemplary conduct.” Stigler even claimed, the economist “needs no ethical system to criticize error: he is simply a well-trained political arithmetician.” In Stigler’s view, it is all or nothing. There is no room for tradeoff with regulatory capture. This view is problematic because regulatory capture is illegal in most countries, not frequent in developed countries, and probably not a primary motive which can explain the revolving door phenomenon. 

My research examines the revolving door in a different way by allowing economic thinking on regulation to consider ethics and values and introducing nuance to the greed motive. Specifically, my research differentiates between greed due to regulatory capture, which is illegal, and greed due to abuse of power, which is unethical.  Importantly, the abuse of power creates “bureaucratic capital,” or the influence and knowledge that government officials accumulate through their work in crafting and enforcing regulation and forming relations (their “contact list”) with other bureaucrats.  As the architect of these rules, regulations, and relationships, the regulator has knowledge of the system, including any loopholes that might exist. Greed is the catalyst for constructing bureaucratic capital, which increases regulators’ lifetime compensation. There may be an expectation that regulators convert their bureaucratic capital into compensation in the form of remunerative employment at private sector firms after leaving the public sector, but there is no presence of explicit bribery or quid pro quo. This activity is unethical but not illegal.

The difference between ethical and legal behavior is essential. It permits us to give precise answers to the following questions: Should we allow corrupt regulators? Should we allow unethical regulators? Should we reform the revolving door so that regulators may not work in firms they have regulated? 

The short answer is no, but the longer answer is more complex. The longer answer considers the tradeoff between these two elements linked to the revolving door: lack of competence and greed, which introduce costs and benefits to the revolving door. 

On the one hand, the revolving door solves the problem of hiring competent and qualified regulators in the civil service.  It is in the interest of the government to allow the revolving door, since regulators are heterogeneous in their abilities, and higher quality regulators enable higher productivity and economic growth. But in order to recruit high-quality regulators, governments must pay them well.  

However, salaries in the public sector are lower than in the private sector. An easy way to let regulators receive higher compensation, so as to attract higher quality civil servants, is by allowing the revolving door. The prospect of higher future compensation, after passing through the revolving door, enables the government to attract competent workers into the civil service. This is certainly an important positive effect of the revolving door.

On the other hand, the revolving door enables regulators to be greedy and receive compensation after their term in office. There are two different ways to address the greed motivation.  

 1.  If regulators are greedy—acting illegally by being captured by firms—then this behavior should be stopped. In this case, the existence of a tradeoff is irrelevant for the choice of optimal policy, and the revolving door should not be allowed since it leads to unlawful behavior and regulatory capture.

2. If regulators are greedy—acting unethically yet not illegally—and abuse their power by creating bureaucratic capital, we should consider the tradeoff between the positive effects of the revolving door—highly qualified regulators—and the negative effects of the revolving door—bureaucratic capital. The optimal solution then is to allow the revolving door because the benefits of competent regulators outweigh the costs of bureaucratic capital. Some greedy behavior should be accepted and some bureaucratic capital should be allowed. Still, my research finds that regulators create bureaucratic capital in excess of the optimal amount for society.

In other words, my paper highlights that distinguishing if a behavior is unlawful or unethical is of utmost importance for analyzing the optimal policy concerning regulators. Models of capture require that the revolving door be regulated to prevent corruption, while models of abuse of power, in which the regulator creates bureaucratic capital, leads to accepting the revolving door and a modicum of unethical behavior. The optimal solution, therefore, is not “zero tolerance” towards the unethical behavior embedded in the revolving door. 

The first conclusion of my research is that the answer to whether to regulate the revolving door is, simply, no. Deregulating the revolving door, however, leads to too much bureaucratic capital, which then gives rise to negative sentiments towards regulation and to phases of deregulation in times of financial calm. Moreover, the revolving door is concentrated in a few big firms. In the financial sector, the top five banks are responsible for about 80% of total revolving door movements, leading to an inequality of influence between firms. Goldman Sachs is the primary beneficiary of the revolving door process, accounting for almost 30% of the revolving door phenomenon. This revolving door phenomenon is also prevalent in the EU.

The second conclusion is related to a taxonomy of social behaviors. Individual actions can be divided into two types: lawful and ethical. The optimal solution to behavior related to legal matters is zero tolerance for illegal activity. Matters of law should be absolutely regulated, and we should not take into consideration possible tradeoffs. However, policies related to ethical matters should not try to adopt absolute solutions. Ethical dilemmas are not solved by choosing zero tolerance. This is the case for the revolving door. 

Indeed, the reason for this non-zero-tolerance solution to regulating the revolving door is that while bureaucratic capital is wasteful for society, it enables governments to hire regulators who are more competent and efficient. Restricting the revolving door would mean lowering the quality of civil servants, which would lead to lower economic growth. There is a tradeoff between competence and greed. 

Ethical problems are not solved by choosing extreme solutions. We should allow some bureaucratic capital, which is unethical yet legal. The economy needs competent and qualified regulators who can face the challenges of an ever-changing world.

Articles represent the opinions of their writers, not necessarily those of the University of Chicago, the Booth School of Business, or its faculty.