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Regulation: The Evidence
Economic historians and students of regulation
have found substantial evidence that the railroads supported
the establishment of the Interstate Commerce Commission,
that utility companies supported the establishment of state
utility regulation, and that various occupational groups
have usually been the main proponents of occupational
licensure. Further, there have been a number of studies
showing that occupational groups earn more in states in
which they are regulated than in states in which they are
not. Finally, those groups that are regulated often oppose
most vigorously efforts to repeal regulation.
However, there are some regulations that have not been
supported by those who are regulated. Regulations that
affect many different industries--such as regulation
intended to promote worker safety, equality of employment,
and pollution cleanup--have not generally been sought by
groups that are regulated. Nonetheless, there is
considerable evidence that much regulation fits the
private-interest hypothesis more closely than the
public-interest hypothesis.
The private-interest theory of regulation suggests that
much regulation will create economic inefficiency. A
considerable amount of regulation involves industries that
have a substantial amount of competition (such as
agriculture, transportation, and oil and gas production),
and both the theoretical and empirical evidence suggest that
this regulation will lead to higher prices and lower
quantities, which is economically inefficient. The adverse
effects of regulation can be partially offset by competition
in service if competition is not allowed in price. Thus,
airlines, which could compete only to a limited extent on
price during the years in which they were tightly regulated,
could and did compete on the quality and quantity of
service. They advertised the quality of meals, the frequency
of flights, the courtesy of stewardesses, and the
availability of movies.
Paradoxically, regulation of competitive industries may
in the long run offer no financial benefit to those
regulated, but repealing it may cause considerable harm to
the industry. For example, taxi service is regulated in New
York City, and the number of cabs is limited. To operate a
cab, one must have a permit to operate, called a medallion.
Someone entering the industry must buy a medallion from
someone who already owns one. The value of this medallion
reflects capitalized value of the greater-than-competitive
returns that regulation brings. A new entrant thus finds
only a competitive return in the industry once the cost of
the medallion is taken into account. (In recent years,
medallions have cost more than $50,000.) If regulation
ceased, those taxi owners now in the market would suffer a
capital loss because their medallions would cease to have
value. The only taxi owners who seem to have truly benefited
from regulation were those in business at the time
regulation began. They were able to capture the full benefit
of the regulation, leaving none for those who entered the business later.
Although theory says that regulation of monopoly can increase economic efficiency, empirical studies have not yet shown that this regulation actually increases efficiency in practice. Ideal regulation from an economic efficiency standpoint requires that a monopoly set its price equal to its marginal cost. However, marginal cost figures make sense only if the firm is minimizing its costs, and once the government starts trying to lower price to marginal cost, the firm has an incentive to increase costs. As a result, government almost never tries to set price equal to marginal cost.
The alternative that is usually used is for regulators to
allow a monopoly only a competitive return on its
investment. This type of regulation gives the firm two
incentives, neither of which is socially desirable: to
increase costs (through higher salaries and perquisites, for
example) and to invest more than they need to. Regulation
almost always contains provisions protecting the regulated
monopolist from any competition. Theoretically, one can show
that under certain conditions the public is served when
monopoly is protected, but whether the conditions needed to
make this argument hold exist in the case of any regulated
monopolies is uncertain.
A strong case for nonprice regulation (such as
environmental, safety, and health) can also be made on
theoretical grounds, but again there is doubt about the
extent that actual regulation lives up to its theoretical
potential. Part of the problem is lack of good data with
which to test hypotheses about the effects of this
regulation. Economists have been unwilling to accept
regulation as desirable simply because its publicly stated
goals are desirable. They have tended to argue that the
regulation will have desirable effects only if the proper
incentives are created.
An example of a case in which incentives may not be ideal
is the program of approving new drugs that the Food and Drug
Administration runs. To be approved for use in the United
States, a new drug must undergo a series of time-consuming
and expensive tests to show that it is safe. This procedure
means that unsafe drugs are unlikely to be allowed onto the
market. An example was the drug Thalidomide, which was
released in Europe but never approved for use in the United
States. Thalidomide caused serious deformities in infants
when taken by mothers during early stages of pregnancy. But
this procedure also means that safe drugs that could save
lives will be delayed (and hence lives will be lost), and
drug companies have little incentive to develop drugs for
rare diseases because the cost of testing diminishes the
probability of ever making a profit. This structure of
approval is almost inevitable. Deaths and problems that an
unsafe drug causes are highly visible and widely publicized.
They will cause unfavorable publicity and embarrassment to
the agency, including perhaps congressional inquiries.
Deaths caused by the unavailability of drugs are far less
noticeable and do not attract the same intensity of publicity.
The subject of regulation is a changing and developing
field, and all conclusions it has reached are subject to
change. The basic theory sketched here only scratches the
surface of this subject. Regulation is subject to a variety
of influences besides the interests of those who are
regulated, and these interests can modify regulation in a
variety of ways. Further, when a regulatory agency is
securely established, it can have considerable leeway in
opposing the interests of those who are regulated.
The most important point that emerges from economic study
of regulation is that the publicly-stated rationale for
government action may differ from its true purpose, and that
intended results may differ from actual results. Arguments
that ignore these distinctions may have wide appeal to the
general public, but they will not be taken seriously in
scholarly discussion.
Copyright Robert Schenk
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