Regulatory economics

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Regulatory economics is the application of law by government or regulatory agencies for various economics-related purposes, including remedying market failure, protecting the environment and economic management.

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Regulation

Regulation is generally defined as legislation imposed by a government on individuals and private sector firms in order to regulate and modify economic behaviors. [1] Conflict can occur between public services and commercial procedures (e.g. maximizing profit), the interests of the people using these services (see market failure), and also the interests of those not directly involved in transactions (externalities). Most governments, therefore, have some form of control or regulation to manage these possible conflicts. The ideal goal of economic regulation is to ensure the delivery of a safe and appropriate service, while not discouraging the effective functioning and development of businesses.

For example, in most countries, regulation controls the sale and consumption of alcohol and prescription drugs, as well as the food business, provision of personal or residential care, public transport, construction, film and TV, etc. Monopolies, especially those that are difficult to abolish (natural monopoly), are often regulated. The financial sector is also highly regulated.

Regulation can have several elements:

Where there is non-compliance, this can result in:

Not all types of regulation are government-mandated, so some professional industries and corporations choose to adopt self-regulating models. [1] There can be internal regulation measures within a company, which work towards the mutual benefit of all members. Often, voluntary self-regulation is imposed in order to maintain professionalism, ethics, and industry standards.

For example, when a broker purchases a seat on the New York Stock Exchange, there are explicit rules of conduct, or contractual and agreed-upon conditions, to which the broker must conform. The coercive regulations of the U.S. Securities and Exchange Commission are imposed without regard for any individual's consent or dissent regarding that particular trade. However, in a democracy, there is still collective agreement on the constraint—the body politic as a whole agrees, through its representatives, and imposes the agreement on those participating in the regulated activity.

Other examples of voluntary compliance in structured settings include the activities of Major League Baseball, FIFA, and the Royal Yachting Association (the UK's recognized national association for sailing). Regulation in this sense approaches the ideal of an accepted standard of ethics for a given activity to promote the best interests of those participating as well as the continuation of the activity itself within specified limits.

In America, throughout the 18th and 19th centuries, the government engaged in substantial regulation of the economy. In the 18th century, the production and distribution of goods were regulated by British government ministries over the American Colonies (see mercantilism). Subsidies were granted to agriculture, and tariffs were imposed, sparking the American Revolution. The United States government maintained a high tariff throughout the 19th century and into the 20th century until the Reciprocal Tariff Act was passed in 1934 under the Franklin D. Roosevelt administration. However, regulation and deregulation came in waves, with the deregulation of big business in the Gilded Age leading to President Theodore Roosevelt's trust busting from 1901 to 1909, deregulation and Laissez-Faire economics once again in the roaring 1920s leading to the Great Depression, and intense governmental regulation and Keynesian economics under Franklin Roosevelt's New Deal plan. President Ronald Reagan deregulated business in the 1980s with his Reaganomics plan.

In 1946, the U.S. Congress enacted the Administrative Procedure Act (APA), which formalized means of ensuring the regularity of government administrative activity and its conformance with authorizing legislation. The APA established uniform procedures for a federal agency's promulgation of regulations and adjudication of claims. The APA also sets forth the process for judicial review of agency action.

Regulatory capture

Regulatory capture is the process through which a regulatory agency, created to act in the public interest, instead advances the commercial or special concerns of interest groups that dominate the industry it is meant to regulate. [2] The probability of regulatory capture is economically biased: vested interests in an industry have the greatest financial stake in regulatory activity and are more likely to be motivated to influence the regulatory body than dispersed individual consumers, each of whom has little particular incentive to try to influence regulators. Regulatory capture is a risk to which an agency is exposed by its very nature. [3]

Theories of regulation

The art of regulation has long been studied, particularly in the utilities sector. Two ideas have been formed on regulatory policy: positive theories of regulation and normative theories of regulation.

The former examine why regulation occurs. These theories include theories of market power, "interest group theories that describe stakeholders' interests in regulation," and "theories of government opportunism that describe why restrictions on government discretion may be necessary for the sector to provide efficient services for customers." [4] These theories conclude that regulation occurs because:

  1. the government is interested in overcoming *information asymmetries and in aligning their own interest with the operator,
  2. customers desire protection from market power in the presence of non-existent or ineffective competition,
  3. operators desire protection from rivals, or
  4. operators desire protection from government opportunism.

Normative economic theories of regulation generally conclude that regulators should

  1. encourage competition where feasible,
  2. minimize information asymmetry costs by gathering information and incentivizing operators to improve their performance,
  3. provide for economically efficient price structures, and
  4. establish regulatory processes that provide for "regulation under the law and independence, transparency, predictability, legitimacy, and credibility for the regulatory system." [4]

Alternatively, many heterodox economists and legal scholars stress the importance of market regulation for "safeguarding against monopoly formation, the overall stability of markets, environmental harm, and to ensure a variety of social protections." [5] These draw on sociologists (such as Max Weber, Karl Polanyi, Neil Fligstein, and Karl Marx) and the history of government institutions partaking in regulatory processes.[ citation needed ] "To allow the market mechanism to be sole director of the fate of human beings and their natural environment, indeed, even of the amount and use of purchasing power, would result in the demolition of society." [6]

*Information asymmetry deals with transactions in which one party has more information than the other, which creates an imbalance in power that at the worst can cause a kind of market failure. They are most commonly studied in the context of principal-agent problems.[ citation needed ]

Principal-agent theory addresses issues of information asymmetry. [7] Here, the government is the principal, and the operator the agent, regardless of who owns the operator. Principal-agent theory is applied in incentive regulation and multi-part tariffs. [4]

Regulatory metrics

The World Bank's Doing Business database collects data from 178 countries on the costs of regulation in certain areas, such as starting a business, employing workers, getting credit, and paying taxes. For example, it takes an average of 19 working days to start a business in the OECD, compared to 60 in Sub-Saharan Africa; the cost as a percentage of GNP (not including bribes) is 8% in the OECD, and 225% in Africa.

The Worldwide Governance Indicators project at the World Bank recognizes that regulations have a significant impact in the quality of governance of a country. The Regulatory Quality of a country, defined as "the ability of the government to formulate and implement sound policies and regulations that permit and promote private sector development" [8] is one of the six dimensions of governance that the Worldwide Governance Indicators measure for more than 200 countries.

The cost of regulations increased by above 1 trillion and can explain 31-37% of the rise in industry concentration. [9]

Deregulation

In modern American politics

Overly complicated regulatory law, increasing inflation, concern over regulatory capture, and outdated transportation regulations made deregulation an appealing idea in the US in the late 1970s. [10] [11] During his presidency (1977-1981), President Jimmy Carter introduced sweeping deregulation reform of the financial system (by the removal of interest rate ceilings) and the transportation industry, allowing the airline industry to operate more freely. [12]

President Ronald Reagan took up the mantle of deregulation during his two terms in office (1981-1989) and expanded upon it with the introduction of Reaganomics, which sought to stimulate the economy through income and corporate tax cuts coupled with deregulation and reduced government spending. Though favored by industry, Reagan-era economic policies concerning deregulation are regarded by many economists as having contributed to the Savings and Loan Crisis of the late 1980s and 1990s. [13]

The allure of free market capitalism remains present in American politics today, with many economists recognizing the importance of finding balance between the inherent risks associated with investment and the safeguards of regulation. [13] Some, particularly members of industry, feel that lingering regulations imposed after the financial crisis of 2007 such as the Dodd-Frank financial reform act are too stringent and impede economic growth, especially among small businesses. [14] [15] Others support continued regulation on the basis that deregulation of the financial sector led to the 2007 financial crisis and that regulations lend stability to the economy. [16]

In 2017, President Donald Trump signed an executive order that he claimed would "knock out two regulations for every new regulation." [17] Trump made the claim: "Every regulation should have to pass a simple test. Does it make life better or safer for American workers or consumers? If the answer is no, we will be getting rid of it." [17]

Counterparts

A common counterpart of deregulation is the privatization of state-run industries. The goal of privatization is for market forces to increase the efficiency of denationalized industries. Privatization was widely pursued in Great Britain throughout Margaret Thatcher's administration. [18] Though largely considered a success and considerably reducing government deficit, critics argue that standards, wages, and employment declined due to privatization. Others point out that lack of careful regulations on some of the privatized industries is a source of continued problems. [19] [20]

Controversy

Proponents

The regulation of markets is to safeguard society and has been the mainstay of industrialized capitalist economic governance through the twentieth century. [21] [ citation needed ] Karl Polanyi refers to this process as the 'embedding' of markets in society. Further, contemporary economic sociologists such as Neil Fligstein (in his 2001 Architecture of Markets) argue that markets depend on state regulation for their stability, resulting in a long term co-evolution of the state and markets in capitalist societies in the last two hundred years.

Opponents

There are various schools of economics that push for restrictions and limitations on governmental role in economic markets. Economists who advocate these policies do not necessarily share principles, such as Nobel prize-winning economists Milton Friedman (monetarist school), George Stigler (Chicago School of Economics / Neo-Classical Economics), Friedrich Hayek (Austrian School of Economics), and James M. Buchanan (Virginia School of Political Economy) as well as Richard Posner (Chicago School / Pragmatism). Generally, these schools attest that government needs to limit its involvement in economic sectors and focus instead on protecting individual rights (life, liberty, and property).[ failed verification ] This position is alternatively summarized in what is known as the Iron Law of Regulation, which states that all government regulation eventually leads to a net loss in social welfare. [22] [23]

Some argue that companies are incentivized to behave in a socially responsible manner, therefore eliminating the need for external regulation, by their commitment to stakeholders, their interest in preserving reputability, and their goals for long term growth. [22]

See also

Related Research Articles

In economics, a free market is an economic system in which the prices of goods and services are determined by supply and demand expressed by sellers and buyers. Such markets, as modeled, operate without the intervention of government or any other external authority. Proponents of the free market as a normative ideal contrast it with a regulated market, in which a government intervenes in supply and demand by means of various methods such as taxes or regulations. In an idealized free market economy, prices for goods and services are set solely by the bids and offers of the participants.

Privatization can mean several different things, most commonly referring to moving something from the public sector into the private sector. It is also sometimes used as a synonym for deregulation when a heavily regulated private company or industry becomes less regulated. Government functions and services may also be privatised ; in this case, private entities are tasked with the implementation of government programs or performance of government services that had previously been the purview of state-run agencies. Some examples include revenue collection, law enforcement, water supply, and prison management.

<span class="mw-page-title-main">Deregulation</span> Remove or reduce state regulations

Deregulation is the process of removing or reducing state regulations, typically in the economic sphere. It is the repeal of governmental regulation of the economy. It became common in advanced industrial economies in the 1970s and 1980s, as a result of new trends in economic thinking about the inefficiencies of government regulation, and the risk that regulatory agencies would be controlled by the regulated industry to its benefit, and thereby hurt consumers and the wider economy. Economic regulations were promoted during the Gilded Age, in which progressive reforms were claimed as necessary to limit externalities like corporate abuse, unsafe child labor, monopolization, pollution, and to mitigate boom and bust cycles. Around the late 1970s, such reforms were deemed burdensome on economic growth and many politicians espousing neoliberalism started promoting deregulation.

Regulation is the management of complex systems according to a set of rules and trends. In systems theory, these types of rules exist in various fields of biology and society, but the term has slightly different meanings according to context. For example:

<span class="mw-page-title-main">Public utility</span> Organization which maintains the infrastructure for a public service

A public utility company is an organization that maintains the infrastructure for a public service. Public utilities are subject to forms of public control and regulation ranging from local community-based groups to statewide government monopolies.

<span class="mw-page-title-main">Moral hazard</span> Increases in the exposure to risk when insured, or when another bears the cost

In economics, a moral hazard is a situation where an economic actor has an incentive to increase its exposure to risk because it does not bear the full costs of that risk. For example, when a corporation is insured, it may take on higher risk knowing that its insurance will pay the associated costs. A moral hazard may occur where the actions of the risk-taking party change to the detriment of the cost-bearing party after a financial transaction has taken place.

Corporate governance is defined, described or delineated in diverse ways, depending on the writer's purpose. Writers focused on a disciplinary interest or context often adopt narrow definitions that appear purpose-specific. Writers concerned with regulatory policy in relation to corporate governance practices often use broader structural descriptions. A broad (meta) definition that encompasses many adopted definitions is "Corporate governance describes the processes, structures, and mechanisms that influence the control and direction of corporations."

<span class="mw-page-title-main">X-inefficiency</span>

X-inefficiency - is a concept used in economics to describe instances where firms go through internal inefficiency resulting in higher production costs than required for a given output. This inefficiency is a result of various factors such as outdated technology, Inefficient production processes, poor management and lack of competition resulting in lower profits and higher prices for consumers. The concept of X-inefficiency was introduced by Harvey Leibenstein.

Rent-seeking is the act of growing one's existing wealth by manipulating the social or political environment without creating new wealth. Rent-seeking activities have negative effects on the rest of society. They result in reduced economic efficiency through misallocation of resources, reduced wealth creation, lost government revenue, heightened income inequality, risk of growing political bribery, and potential national decline.

In economics, a government monopoly or public monopoly is a form of coercive monopoly in which a government agency or government corporation is the sole provider of a particular good or service and competition is prohibited by law. It is a monopoly created, owned, and operated by the government. It is usually distinguished from a government-granted monopoly, where the government grants a monopoly to a private individual or company.

In general, compliance means conforming to a rule, such as a specification, policy, standard or law. Compliance has traditionally been explained by reference to the deterrence theory, according to which punishing a behavior will decrease the violations both by the wrongdoer and by others. This view has been supported by economic theory, which has framed punishment in terms of costs and has explained compliance in terms of a cost-benefit equilibrium. However, psychological research on motivation provides an alternative view: granting rewards or imposing fines for a certain behavior is a form of extrinsic motivation that weakens intrinsic motivation and ultimately undermines compliance.

Government failure, in the context of public economics, is an economic inefficiency caused by a government intervention, if the inefficiency would not exist in a true free market. The costs of the government intervention are greater than the benefits provided. It can be viewed in contrast to a market failure, which is an economic inefficiency that results from the free market itself, and can potentially be corrected through government regulation. However, Government failure often arises from an attempt to solve market failure. The idea of government failure is associated with the policy argument that, even if particular markets may not meet the standard conditions of perfect competition required to ensure social optimality, government intervention may make matters worse rather than better.

A regulatory agency or independent agency is a government authority that is responsible for exercising autonomous dominion over some area of human activity in a licensing and regulating capacity.

Financial sector development in developing countries and emerging markets is part of the private sector development strategy to stimulate economic growth and reduce poverty. The Financial sector is the set of institutions, instruments, and markets. It also includes the legal and regulatory framework that permit transactions to be made through the extension of credit. Fundamentally, financial sector development concerns overcoming “costs” incurred in the financial system. This process of reducing costs of acquiring information, enforcing contracts, and executing transactions results in the emergence of financial contracts, intermediaries, and markets. Different types and combinations of information, transaction, and enforcement costs in conjunction with different regulatory, legal and tax systems have motivated distinct forms of contracts, intermediaries and markets across countries in different times.

A regulated market (RM) or coordinated market is an idealized system where the government or other organizations oversee the market, control the forces of supply and demand, and to some extent regulate the market actions. This can include tasks such as determining who is allowed to enter the market and/or what prices may be charged. The majority of financial markets such as stock exchanges are regulated, whereas over-the-counter markets are usually not at all or only moderately regulated.

Regulatory capitalism suggests that the operation maintenance and development of the international political economy increasingly depends on administrative rules outside the legislatures and the courts. In other words, it tells us that capitalism is a regulatory institution – one that is being constituted, shaped, constrained and expanded as a historically woven patchwork of regulatory institutions, strategies, and functions.

<span class="mw-page-title-main">Jersey Competition Regulatory Authority</span> Jersey Competition Regulatory Authority (JCRA) is Jerseys competition regulator.

The Jersey Competition Regulatory Authority (JCRA) is the competition, postal, and telecommunications regulatory authority for Jersey, a British Crown Dependency located in the English Channel.

In economics, a government-granted monopoly is a form of coercive monopoly by which a government grants exclusive privilege to a private individual or firm to be the sole provider of a good or service; potential competitors are excluded from the market by law, regulation, or other mechanisms of government enforcement. As a form of coercive monopoly, government-granted monopoly is contrasted with an unregulated monopoly, wherein there is no competition but it is not forcibly excluded.

An electric utility is a company in the electric power industry that engages in electricity generation and distribution of electricity for sale generally in a regulated market. The electrical utility industry is a major provider of energy in most countries.

Utility ratemaking is the formal regulatory process in the United States by which public utilities set the prices they will charge consumers. Ratemaking, typically carried out through "rate cases" before a public utilities commission, serves as one of the primary instruments of government regulation of public utilities.

References

  1. 1 2 OECD Statistics Directorate. "OECD Glossary of Statistical Terms - Regulation Definition". stats.oecd.org. Retrieved 2017-02-21.
  2. ↑ Achola Kevin
  3. ↑ Gary Adams, Sharon Hayes, Stuart Weierter and John Boyd, "Regulatory Capture: Managing the Risk" Archived 2011-07-20 at the Wayback Machine ICE Australia, International Conferences and Events (PDF) (October 24, 2007). Retrieved April 14, 2011
  4. 1 2 3 Body of Knowledge on Infrastructure regulation Theories of Regulation.
  5. ↑ Taylor, Richard (2013). "Competition Versus Regulation in the Post-Sunset PSTN". doi:10.2139/ssrn.2242636. S2CID   109965340.{{cite journal}}: Cite journal requires |journal= (help)
  6. ↑ Polanyi, Karl (1944). The Great Transformation: The Political and Economic Origins of Our Time.
  7. ↑ Laffont, Jean-Jacques; Tirole, Jean (1993). A Theory of Incentives in Procurement and Regulation. MIT Press. ISBN   9780262121743.
  8. ↑ "A Decade of Measuring the Quality of Governance" (PDF). Archived from the original (PDF) on 2008-04-08.
  9. ↑ Singla, Shikhar, Regulatory Costs and Market Power (February 23, 2023). LawFin Working Paper No. 47
  10. ↑ Crain, Andrew D (2007). "Ford, Carter, and Deregulation in the 1970s". Journal on Telecommunications & High Technology Law. 5: 413–447.
  11. ↑ Sherman, Matthew (July 2009). "A Short History of Financial Deregulation in the United States" (PDF). Center for Economic and Policy Research. Retrieved February 26, 2017.
  12. ↑ Biven, W. Carl (2003-10-16). Jimmy Carter's Economy: Policy in an Age of Limits. Univ of North Carolina Press. ISBN   9780807861240.
  13. 1 2 Johnston, Van R. (2013). "The Struggle for Optimal Financial Regulation and Governance". Public Performance & Management Review. 37 (2): 222–240. doi:10.2753/pmr1530-9576370202. S2CID   153455946.
  14. ↑ Insights, Forbes. "Regulatory Environment Has More Impact on Business Than the Economy, Say U.S. CEOs". Forbes. Retrieved 2017-02-28.
  15. ↑ Rose, Nancy L. (2014). Economic Regulation and its Reform. Chicago and London: University of Chicago Press. pp. 1–24. ISBN   978-0-226-13802-2.
  16. ↑ "Breaking the Impasse on Dodd-Frank | Brookings Institution". Brookings. 2017-02-28. Retrieved 2017-02-28.
  17. 1 2 Donald Trump
  18. ↑ Gamble, Andrew (1988-01-01). "Privatization, Thatcherism, and the British State". Journal of Law and Society. 16 (1): 1–20. doi:10.2307/1409974. JSTOR   1409974.
  19. ↑ Groom, Brian (December 2011). "Privatisation defined Thatcher era" . Financial Times. Archived from the original on 2022-12-11. Retrieved March 3, 2017.
  20. ↑ Hudson, Michael (2013-04-10). "Margaret Thatcher Was a Privatization Pioneer, and This Is the Story of How Her Agenda Did Nothing But Make Life Worse for Millions of People". AlterNet. Retrieved 2017-03-03.
  21. ↑ Polanyi, Karl (1944). The Great Transformation. Boston: Beacon Press. p. 44.
  22. 1 2 Armstrong, J. Scott; Green, Kesten C. (2013-10-01). "Effects of corporate social responsibility and irresponsibility policies" (PDF). Journal of Business Research. Strategic Thinking in Marketing. 66 (10): 1922–1927. CiteSeerX   10.1.1.663.508 . doi:10.1016/j.jbusres.2013.02.014. S2CID   145059055.
  23. ↑ Green, K. (Dec 2012). "Should government force companies to be responsible?". Review - Institute of Public Affairs. Melbourne 64.4: 44–45.

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