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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 often called
natural monopolies. Breaking them up into smaller
firms makes no economic sense because it increases costs,
and perhaps price.
In these cases, economists have argued that regulation
may be appropriate. 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. 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 almost all 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.
Legislators are elected in a democracy, and it is in
their interests to do those things that contribute to their
re-election. (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.) To be re-elected,
legislators need votes, and to obtain votes, they need
campaign funds and volunteer workers.
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 at first 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
bureaucrats--non-elected government officials--are motivated
on the basis of narrow self-interest. (Did you expect any
other assumption?) They serve in an organized group--their
agency or department--and 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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