Governments need to consider the limitations of performance standards when choosing regulatory strategies.
Performance standards have long been heralded as a superior approach to regulating business activity. Such standards impose legal obligations to avoid or achieve specified outcomes, but then leave it to each firm to determine how to meet their outcome obligation. An emissions limit is a paradigmatic example of a performance standard. It requires firms to reduce their pollution to below a specific level but does not mandate any particular method of pollution control. Firms are free to innovate and find the lowest cost means of achieving the regulatory goal.
Due to their flexibility and cost-effectiveness, performance standards have been advocated widely throughout the global community. And yet their supposed superiority remains largely theoretical, even conjectural. We know surprisingly little about how performance standards work in practice.
A realistic assessment of performance standards requires not merely an appreciation of their clear theoretical advantages but a pragmatic consideration of their downside risks as well. It is worth pausing to consider the pitfalls of performance standards. Experience with these standards in a variety of settings reveals four seldom-acknowledged limitations.
- Conflict. It is sometimes suggested that performance standards will result in less adversarial and more collaborative regulation because their flexibility makes them more reasonable. But this is hardly guaranteed. Although the U.S. Environmental Protection Agency (EPA) has issued many performance standards for emissions control, the agency has still found itself at the receiving end of much litigation filed by environmental groups and businesses over these standards. There is nothing inherent in performance standards that can reconcile the different interests at stake over regulation nor that can make organizations avoid pursuing their interests through litigation.
- Fraud and Gaming. Performance standards depend on the ability of government agencies to specify, measure, and monitor performance. But it is too little acknowledged how difficult, if not impossible, it can be to obtain reliable and appropriate information on performance in many circumstances. The recent Volkswagen emissions scandal—where the company evaded EPA’s performance-based nitrogen oxide emissions standards for seven years—demonstrates how the flexibility granted to regulated entities in achieving performance can be abused. The very flexibility that makes performance standards attractive may also be exploited by some firms to find ways to evade the regulation. Perhaps if regulators do not hear only unqualifiedly enthusiastic messages in support of performance standards, they might be more vigilant in the future about how they monitor compliance once regulated firms start to take advantage of these standards’ flexibility.
- “Teaching to the Test.” Regulated firms may also use performance standards’ flexibility to find ways to satisfy the letter of the law at the expense of the law’s purpose. With performance standards, the command “Do not exceed X level of performance” seems to translate to “Proceed to market your products or operate your facilities however you see fit, just as long as you do not technically exceed this standard.” Firms will seek to meet the standard in a way that optimizes their private interests, for instance, by minimizing costs of compliance. Of course, there is nothing intrinsically wrong with such behavior, but it does create the possibility that firms will find ways to meet regulators’ performance tests in ways that best satisfy industry’s goals but are less effective at meeting the societal goals of the regulation.
- Tunnel vision. Time and again, regulators have established performance standards based on consideration of a single value or goal, failing to recognize that firms might achieve the required goal by sacrificing other socially desired objectives. For example, regulators in the United States initially required that medicines and hazardous household products be sold in containers that met a performance standard for child resistance. When the companies complied, their containers turned out to be hard for adults to open too—with the result that many frustrated adults, once they managed to open their aspirin bottles, left them open and thus increased the risks of child poisoning. It took years before regulators developed a performance standard calling for both child resistance and adult accessibility. A similar history occurred with U.S. air bag requirements for automobiles. At first, the standard was based on a performance test conducted with crash-test dummies the size of the average adult male. Only after it became apparent that air bags meeting the standard created additional risk for children and smaller adults did the government develop a more sophisticated performance test for “smart” air bags.
Admittedly, problems such as tunnel vision, gaming, fraud, and conflict can arise with any type of regulatory instrument. Yet the nature of performance standards may exacerbate some of these problems, making them more likely. The way that performance standards focus attention on highly specified goals especially invites failure if compliance cannot be suitably monitored or if the mandated goals do not sufficiently reflect all of society’s concerns.
The seemingly unbridled enthusiasm that has been expressed for performance standards in the academic and policy literature may itself reinforce the pitfalls of performance standards. If policymakers are not made more cognizant of the potential downsides of performance standards, they may not take all the actions needed to avoid or counteract sources of policy failure. Once policymakers are aware of tendencies such as tunnel vision or teaching to the test, they can take additional steps to avoid them, such as by monitoring more closely how an industry takes advantage of performance standards’ flexibility.
In the end, it is still possible, of course, that performance standards might be on balance superior to their alternatives in certain settings. But a meaningful assessment of the desirability of performance standards in any setting will demand a frank acknowledgment of their potential pitfalls. If governments are to learn how to use performance standards well, they need to analyze carefully the full range of consequences that these standards—and their alternatives—can bring about under the relevant conditions. They need to anticipate performance standards’ pitfalls as well as their theoretical promise.