Randomizing regulatory approval for adaptive diversification and deterrence

This paper develops two arguments for randomizing regulatory approval of private activities: adaptive diversification and deterrence. Adaptive diversification may be appealing when regulatory agencies make approval decisions under uncertainty. At a point in time, diversification enables an agency to limit potential errors. Over time, it generates randomized experiments that enable an agency to learn and improve its decision making; this constitutes adaptive diversification. The deterrence argument arises when an approval process affects private decisions to seek approval for contemplated activities. Randomization enables an agency to control the likelihood of approval. An agency may seek to choose an approval rate that encourages applications for beneficial activities and deters applications for deleterious ones. To study the circumstances in which adaptive diversification and/or deterrence motivate randomized approval, I bring to bear normative public economics and decision theory.