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Regulation
If increasing returns to scale cause monopoly to form, antitrust policy may not be appropriate. With increasing returns, one large firm can produce at lower costs than several smaller firms. Monopolies that form for this reason are called natural monopolies. Breaking them up into smaller firms makes no economic sense because it increases costs, and perhaps price. When economies of scale are the source of monopoly, some economists have argued that regulation may be appropriate policy.
Government regulation can take many forms, but all involve putting limits on what a business (or consumer) can do. Certain activities, prices, or products become illegal and others become mandatory. Economic theory suggests that the ideal form of regulation for a monopoly would be to force it to set its price equal to its marginal cost. Forced to price as if it were a price taker, the monopoly should find it profitable to increase output to the economically efficient level. Life, however, is more complicated than theory.
The publicly-stated goal of regulation is to improve the well-being of the public. If economists were
convinced that publicly-stated goals were achieved, they
would find the topic of regulation rather boring. But their
private-interest view of government gives a rather different
view of how regulation works than the view with which most
people are familiar. In the private-interest view,
regulation only comes into being when it is in the private
interests of the legislators to bring it into existence.
Because legislators are elected in a democracy, it is in their interests to do those things that contribute to their re-election. To be re-elected, legislators need votes, and to obtain votes, they need campaign funds and volunteer workers. (Some legislators come from districts that are relatively safe, and these legislators may have more leeway in voting their prejudices, ideology, or whims than others who are in less-safe districts.) Groups that seek regulation must be able to supply either votes or money or both. Because there is a cost to getting regulation, a group will not seek it unless the issue is of considerable importance to the group. Due to the free-rider problem, groups that are very large and in which each individual has only a small stake in the central issue are difficult to organize. Also, if an issue is of only small importance to an individual, it is unlikely that he will vote on the basis of a candidate's stance on that one issue because there are so many different issues on which most candidates take a stance.
One group that can often be organized is a group that is
or will be regulated. The effects that regulation has on
them will be very visible to this group, and the group is
usually relatively small relative to other groups that are
affected by the regulation. As a result, some economists
have proposed that regulation often comes about because it
is sought by the very groups that are regulated. The most
prominent proponent of this view was George Stigler.
This idea may seem to contradict common sense. Regulation involves a reduction in choice and thus should
make those regulated worse off. However, recall the model of
the prisoner's dilemma. In a case of this sort,
decision-makers will be willing to have their choices
restricted, provided that all others have their choices
restricted in the same way. Thus, if regulation can increase
prices by restricting competition, either through a minimum
price or control of entry and substitutes, there are
potential gains for sellers. There are risks and costs
involved in obtaining regulation, however. First, there are
costs of organizing and lobbying. If a group is large, there
may be free-rider problems (though the potential for
unfavorable treatment if the regulation is passed may help
offset this). Then, once regulation is in place, it may not
work precisely the way that those who sought it thought it
would. Outsiders will be involved in the industry, and there
is the possibility that they may be unfriendly. Also,
regulation involves red tape, which may be a cost to those
who are regulated.
The interest group will be successful in establishing
regulation if it can promise the legislators substantially
more votes or money (usually campaign funds to obtain more
votes, but not always) than the opponents of the regulation
can. The reason it will be able to control the regulatory
agency, or "capture" it, involves the behavior of a
different part of government, the bureaucrats.
The economic hypothesis assumes that the bureaucratsnon-elected government officialsare motivated
on the basis of narrow self-interest. (Did you expect any
other assumption?) They serve in an organized grouptheir
agency or departmentand in many ways their behavior will
be shaped by the constraints the agency faces, just as the
behavior of those in a corporate business is shaped by the
constraints the business faces. The regulatory agency must
purchase resources, including services of lawyers,
accountants, and economists. It must produce an output,
which is the regulation. Finally, it must obtain funds for
its continued existence. The funds it obtains depend
ultimately on its product, regulations. If the regulations
are made sloppily, they may be challenged in the courts and
overturned. If this happens too frequently, the agency may
attract unfavorable attention and this may result in funds
being cut. Or, if its regulations unfavorably affect
organized special-interest groups, these groups will through
lobbying efforts try to cut the funds that the agency is
given or try to change the personnel who run the agency.
The bureaucrats who make up the regulatory agency have a
variety of goals, just as those who make up a corporation
have a variety of goals. In both cases, some of those goals
can be realized only if the agency survives. Bureaucrats who
threaten the survival of their organization will face
dismissal if that can be done, or face strong pressures to
change behavior. Unlike the customers of a business firm,
who can "leave" and take their business elsewhere if the
product does not satisfy them, "customers" of a regulatory
agency cannot leave. But they can voice their complaints and
in general try to make life miserable for those responsible.
Thus, we see that many economists have been skeptical
that regulation achieves its promised effects. But is this
skepticism about regulation consistent with facts that are
available? Can cases be found in which those regulated
sought regulation? What evidence is there that those who are
regulated want to be regulated? Only if the answers
to these questions suggest that the economic approach
has some validity is it worthwhile to discuss what it
implies for economic efficiency.
Copyright Robert Schenk
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