Regulatory economics is the
economicsEconomics is the social science that studies the production, distribution, and consumption of goods and services. The term economics comes from the Ancient Greek from + , hence "rules of the house"...
of
regulationRegulation is "controlling human or societal behaviour by rules or restrictions." Regulation can take many forms: legal restrictions promulgated by a government authority, self-regulation, social regulation , co-regulation and market regulation. One can consider regulation as actions of conduct...
, in the sense of the application of
lawLaw is a system of rules, usually enforced through a set of institutions. It shapes politics, economics and society in numerous ways and serves as a primary social mediator of relations between people. Contract law regulates everything from buying a bus ticket to trading on derivatives markets...
by
governmentA government is the body within a community, political entity or organization which has the authority to make and enforce rules, laws and regulations.....
that is used for various purposes, such as
centrally-planning an economyA planned economy or directed economy is an economic system in which the state or workers' councils manage the economy. It is an economic system in which the central government makes all decisions on the production and consumption of goods and services...
, remedying
market failureIn economics, a market failure exists when the production or use of goods and services by the market is not efficient. That is, there exists another outcome where market participants' total gains from the new outcome outweigh their losses...
, enriching well-connected firms, or benefiting politicians (see
capture). It is not considered to include voluntary regulation that may be accomplished in the private sphere.
Regulation as a process
Public servicesPublic services is a term usually used to mean services provided by government to its citizens, either directly or by financing private provision of services. The term is associated with a social consensus that certain services should be available to all, regardless of income...
can encounter conflict between commercial procedures (e.g. maximising
profitIn economics, economic profit is the difference between a company's total revenue and its opportunity costs. It is the increase in wealth that an investor has from making an investment, taking into consideration all costs associated with that investment including the opportunity cost of...
), and the interests of the people using these services. (See
market failureIn economics, a market failure exists when the production or use of goods and services by the market is not efficient. That is, there exists another outcome where market participants' total gains from the new outcome outweigh their losses...
.) Most governments therefore have some form of control or regulation to manage this possible conflict. This regulation ensures that a safe and appropriate service is delivered, while not discouraging the effective functioning and development of businesses.
For example, the sale and consumption of
alcoholEthanol, also called ethyl alcohol, pure alcohol, grain alcohol, or drinking alcohol, is a volatile, flammable, colorless liquid. It is a psychoactive drug, best known as the type of alcohol found in alcoholic beverages and in modern thermometers. Ethanol is one of the oldest recreational drugs...
and
prescription drugA prescription drug is a licensed medicine that is regulated by legislation to require a prescription before it can be obtained. The term is used to distinguish it from over-the-counter drugs which can be obtained without a prescription...
s are controlled by regulation in most countries, as are the food business, provision of personal or residential care, public transport, construction, film and TV, etc.
MonopoliesIn economics, a monopoly exists when a specific individual or an enterprise has sufficient control over a particular product or service to determine significantly the terms on which other individuals shall have access to it...
are often regulated, especially those which are difficult to abolish (
natural monopolyIn economics, a natural monopoly occurs when, due to the economies of scale of a particular industry, the maximum efficiency of production and distribution is realized through a single supplier....
). The
financial sectorFinance is the science of funds management. The general areas of finance are business finance, personal finance, and public finance. Finance includes saving money and often includes lending money. The field of finance deals with the concepts of time, money and risk and how they are interrelated...
is also highly regulated.
Regulation can have several elements:
- Public statutes, standards or statements of expectations.
- A process of registration or licensing to approve and to permit the operation of a service, usually by a named organisation or person.
- A process of inspection or other form of ensuring standard compliance, including reporting and management of non-compliance with these standards: where there is continued non-compliance, then:
- A process of de-licensing whereby that organisation or person is judged to be operating unsafely, and is ordered to stop operating at the expense of acting unlawfully.
This differs from regulation in any voluntary sphere of activity, but can be compared with it in some respects. For example, when a broker purchases a seat on the
New York Stock ExchangeThe New York Stock Exchange is a stock exchange located at 11 Wall Street in lower Manhattan, New York City, New York, USA. It is the largest stock exchange in the world by United States dollar value of its listed companies' securities...
, there are explicit rules of conduct to which the broker must conform as contractual and agreed-upon conditions governing participation. The coercive regulations of the U.S. Securities and Exchange Commission, for example, are imposed without regard for any individual's consent or dissent as to 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 the subset of entities participating in the regulated activity.
Other examples of voluntary compliance in structured settings include the activities of
Major League BaseballMajor League Baseball is the highest level of play in North American professional baseball. Specifically, Major League Baseball refers to the organization that operates the National League and the American League, by means of a joint organizational structure that has developed gradually between...
,
FIFAThe International Federation of Association Football, commonly known by its French acronym, FIFA , is the international governing body of association football. Its headquarters are in Zürich, Switzerland, and its current president is Sepp Blatter...
(the international governing body for professional soccer), and the
Royal Yachting AssociationA rya is a traditional Scandinavian rug. The first ryas originated in the early fifteenth century as coarse, long-piled, heavy covers used by mariners instead of furs. As time progressed, the rugs have evolved to be lighter and more colourful. The insulation ryas provide protection against the cold...
(the UK's recognised national association for sailing). Regulation in this sense approaches the ideal of an accepted standard of
ethicsEthics is a branch of philosophy which seeks to address questions about morality, such as what the fundamental semantic, ontological, and epistemic nature of ethics or morality is , how moral values should be determined , how a moral outcome can be achieved in specific situations , how moral...
for a given activity, to promote the best interests of the people participating as well as the acceptable continuation of the activity itself within specified limits.
In the
United StatesThe United States of America is a federal constitutional republic comprising fifty states and a federal district...
, throughout the 18th and 19th centuries, the government engaged in substantial regulation of the economy. For example, in the 18th century,
mercantilismMercantilism is an economic theory that holds that the prosperity of a nation is dependent upon its supply of capital, and that the global volume of international trade is "unchangeable." Economic assets or capital, are represented by bullion held by the state, which is best increased through a...
production and distribution of goods were regulated by government ministries. Subsidies were granted to agriculture and tariffs were imposed. This type of intervention continued throughout the 19th century. From the time of the administration of President Franklin D. Roosevelt until the late 1970s, the regulation of
infrastructureInfrastructure can be defined as the basic physical and organizational structures needed for the operation of a society or enterprise, or the services and facilities necessary for an economy to function....
was considered necessary from the standpoint of
national securityNational security is the requirement to maintain the survival of the nation-state through the use of economic, military and political power and the exercise of diplomacy.Measures taken to ensure national security include:...
and well-being: whether in war or peace, a nation without adequate and reliable
transportTransport or transportation is the movement of people and goods from one location to another. Transport is performed by modes, such as air, rail, road, water, cable, pipeline and space...
, telecommunications,
public healthPublic health is "the science and art of preventing disease, prolonging life and promoting health through the organized efforts and informed choices of society, organizations, public and private, communities and individuals." It is concerned with threats to the overall health of a community based...
, banking, and
public utilitiesA public utility 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 state-wide government monopolies...
was considered inefficient, in some cases insecure, and the government assumed the responsibility to ensure that this infrastructure was adequate. It was considered imprudent to give this responsibility over to private hands without publicly imposed constraint.
In 1946, the U.S. Congress enacted the
Administrative Procedure ActThe Administrative Procedure Act is the United States federal law that governs the way in which administrative agencies of the federal government of the United States may propose and establish regulations. The APA also sets up a process for the United States federal courts to directly review...
(APA), which formalized means of assuring 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 reviewJudicial review is the doctrine in democratic theory under which legislative and executive action is subject to invalidation by the judiciary. Specific courts with judicial review power must annul the acts of the state when it finds them incompatible with a higher authority, such as the terms of a...
of agency action.
Theories of Regulation
The development and techniques of regulations have long been the subject of academic research, particularly in the utilities sector. Two basic schools of thought have emerged on regulatory policy, namely, positive theories of regulation and normative theories of regulation.
Positive theories of regulation examine why regulation occurs. These theories of regulation 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. In general, the conclusions of these theories are that regulation occurs because 1) the government is interested in overcoming information asymmetries with the operator and in aligning the operator’s interest with the government’s interest, 2) customers desire protection from market power when competition is non-existent or ineffective, 3) operators desire protection from rivals, or 4) operators desire protection from government opportunism.
Normative theories of regulation generally conclude that regulators should encourage competition where feasible, minimize the costs of information asymmetries by obtaining information and providing operators with incentives to improve their performance, provide for price structures that improve economic efficiency, and establish regulatory processes that provide for regulation under the law and independence, transparency, predictability, legitimacy, and credibility for the regulatory system.
Principal-agent theory addresses issues of information asymmetry, which in the context of utility regulation generally means that the operator knows more about its abilities and effort and about the utility market than does the regulator. In this literature, the government is the principal and the operator is the agent, whether the operator is government owned or privately owned. Principle-agent theory is applied in incentive regulation and multipart tariffs.
Regulation as red tape
The
World BankThe World Bank is an international financial institution that provides leveraged loans to poorer countries for capital programs, tied to neoliberal market restructurings...
'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 AfricaSub-Saharan Africa is a geographical term used to describe the area of the African continent which lies south of the Sahara, or those African countries which are fully or partially located south of the Sahara...
; the cost as a percentage of GNP (not including bribes) is 8% in the OECD, and 225% in Africa.
The Doing Business project has informed or inspired 120 reforms around the world. It has the World Bank's top-selling publication and accounts for half of all the media coverage of the World Bank Group.
The
Worldwide Governance IndicatorsBased on a long-standing research program of the World Bank, the Kaufmann-Kraay-Mastruzzi Worldwide Governance Indicators capture six key dimensions of governance between 1996 and present...
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" is one of the six dimensions of governance that the Worldwide Governance Indicators measure for more than 200 countries.
Deregulation
Main article: deregulationDeregulation is the removal or simplification of government rules and regulations that constrain the operation of market forces.Deregulation is the removal or simplification of government rules and regulations that constrain the operation of market forces.Deregulation is the removal or...
During the late 1970s and 1980s, some forms of regulation was seen as imposing unnecessary '
red tape"Red tape" is a derisive term for excessive regulation or rigid conformity to formal rules that is considered redundant or bureaucratic and hinders or prevents action or decision-making...
' and other restrictions on businesses. In particular, government support of cartel activity was seen as diminishing economic
efficiencyThe term inefficiency has several meanings depending on the context in which its used:*Algorithmic inefficiency - refers to less than optimum computer programs that might exhibit one of more of the symptoms of:-** slow execution...
. Regulatory agencies were often seen as having been
captureCapture may refer to:*Capture , to remove the opponent's piece or pawn from the board by taking it with one's own piece or pawn*Capture , situations in which a government agency created to act in the public interest instead acts in favor of other interests*Capture , a geomorphological phenomenon...
d by the regulated industries, as a means of diminishing competition between industry participants, and so not serving the
public interestThe public interest refers to the "common well-being" or "general welfare." The public interest is central to policy debates, politics, democracy and the nature of government itself...
. As a result, there has been a movement towards deregulation in a number of industries. These include transportation, communications, and some financial services.
One example is the international monetary system: it is now much easier to transfer capital between countries. As a result, the globalisation of markets has increased.
An accompaniment of deregulation has been 'privatisation' of industries which had been under previous government control. The privatized industries were to be subjected to market forces, and thus to be made more efficient. This program was widely pursued in Britain throughout the later years of the last century. Some argue that although this has increased choice in services, their standards have declined and wages and employment have been reduced.
Some, particularly libertarians, feel that there has been little progress on deregulation in recent decades, and that controls on small businesses, for example, are greater than ever. They feel that deregulation is an aspirational rather than a real intention.
Others, usually those on the
LeftIn politics, left-wing, political left, leftist and the Left are terms used to describe a number of positions and ideologies. They are most commonly used to refer to support for changing traditional social orders or for creating a more egalitarian distribution of wealth and privilege...
, have argued that deregulation has gone too far, and given too much power to corporations and special interests, while removing the power of the people's elected representatives. Therefore they support a process of re-regulation.
Many criticize the influence of Intellectual Property Rights and other sorts of national regulations on the internet and IT business (
software patentSoftware patent does not have a universally accepted definition. One definition suggested by the Foundation for a Free Information Infrastructure is that a software patent is a "patent on any performance of a computer realised by means of a computer program".
[In 2005, the European...]
s,
DRMDigital rights management is a generic term for access control technologies that can be used by hardware manufacturers, publishers, copyright holders and individuals to try to impose limitations on the usage of digital content and devices...
,
trusted computingTrusted Computing is a technology developed and promoted by the Trusted Computing Group. The term is taken from the field of trusted systems and has a specialized meaning. With Trusted Computing, the computer will consistently behave in expected ways, and those behaviors will be enforced by...
).
Criticism of economic regulation
Some economists, such as
Nobel prizeThe Nobel Prize is a Sweden-based international monetary prize. The award was established by the 1895 will and estate of Swedish chemist and inventor Alfred Nobel. It was first awarded in Physics, Chemistry, Physiology or Medicine, Literature, and Peace in 1901...
-winning economist
Milton FriedmanMilton Friedman was an American economist, statistician and public intellectual, and a recipient of the Nobel Memorial Prize in Economics...
as well as those of the
Austrian SchoolThe Austrian School is a school of economic thought that emphasizes the spontaneous organizing power of the price mechanism or price system...
, have sought substantially to limit economic regulation. They argue that government should limit its involvement in economies to protecting negative individual rights (life, liberty, property) rather than diminishing individual autonomy and responsibility for the sake of remedying any sort of putative "market failure." They tend to regard the notion of market failure as a misguided contrivance wrongly used to justify coercive government action to further various political agendas, such as
mercantilisticMercantilism is an economic theory that holds that the prosperity of a nation is dependent upon its supply of capital, and that the global volume of international trade is "unchangeable." Economic assets or capital, are represented by bullion held by the state, which is best increased through a...
or egalitarian goals.
These economists believe that government intervention creates more problems than it is supposed to solve -- as well-meaning as some of these interventions may be -- chiefly because government officers are incapable of accurate
economic calculationThe economic calculation problem is a criticism of socialist economics, or more precisely central economic planning. It was first proposed by Ludwig von Mises in 1920 and later expounded by Friedrich Hayek. The problem referred to is that of how to distribute resources rationally in an economy...
, lacking any reliable ability (or true incentive) to gather, integrate, or honestly evaluate the vast amounts of information that guide the "
Invisible HandIn economics, the invisible hand, also known as the invisible hand of the market, the term economists use to describe the self-regulating nature of the marketplace, is a metaphor first coined by the economist Adam Smith in The Theory of Moral Sentiments...
" of a
free marketA free market describes a market without economic intervention and regulation by government except to regulate against force or fraud. The terminology is used by economists and in popular culture. A free market requires protection of property rights, but no regulation, no subsidization, no single...
.
The Austrian School economists, beginning with Ludwig von Mises, see regulations as problematic not only because they disrupt market processes, but also because they tend only to bring about more regulations. According to Austrian theory, every regulation has some consequences besides those originally intended when the regulation was implemented. If the
unintended consequenceUnintended consequences are outcomes that are not the results originally intended by a particular action. The unintended results may be foreseen or unforeseen, but they should be the logical or likely results of the action...
are undesirable to those with the power to regulate, there exist two alternative possibilities: do away with the existing regulation, or keep the existing regulation and institute a new one as well to treat the unintended consequence of the old one. In practice, regulators very seldom even consider that the problems they detect may actually be the consequence of prior regulation, so the second option is preferred far more often than the first. The new regulation, however, has unintended consequences of its own which bring about this cycle anew. If unchecked, the result over time is regulation so extensive as to amount to a state run economy.
Laissez-faireThe general meaning of Laissez-faire is to allow events to take their own course, or to let people do what they choose. The term is a French phrase literally meaning "let it be" or "leave it alone"....
advocates do not oppose monopolies unless they maintain their existence through coercion to prevent competition (see
coercive monopolyIn economics and business ethics, a coercive monopoly is a business concern that prohibits competitors from entering the field, with the natural result being that the firm is able to make pricing and production decisions independent of competitive forces...
), and often assert that monopolies have historically developed only
because of government intervention rather than due to a lack of intervention. Specifically, every regulation has some associated cost of compliance. If these costs increase the total cost of operation enough to make new entry into a market prohibitive but allow existing firms to continue to generate a profit, the regulation effectively cartellizes or monopolizes the industry. When existing firms are able to lobby for regulation, this effectively becomes an opportunity to do away with competitive rivals.
Some economists argue that
minimum wageA minimum wage is the lowest hourly, daily or monthly wage that employers may legally pay to employees or workers. Equivalently, it is the lowest wage at which workers may sell their labor. Although minimum wage laws are in effect in a great many jurisdictions, there are differences of opinion...
laws cause unnecessary unemployment, for the same reason that a minimum price on anything will decrease the quantity of it that people purchase. If a minimum wage law is passed that makes it illegal to pay less than M per hour, employers will continue to keep on payroll only those workers whose hourly work brings in more than M in revenues. Consequently, those workers who are least productive, and therefore are likely to be paid the least before a minimum wage, are also the ones most likely to become unemployed after a minimum wage is implemented.
Another argument against regulation is that laws against
insider trading"You want more insider trading, not less. You want to give the people most likely to have knowledge about deficiencies of the company an incentive to make the public aware of that."said-Milton Friedman, laureate of the Nobel Memorial Prize in Economics...
reduce market efficiency and transparency. If a firm is "cooking the books," insiders, without restraint on insider trading, will take short positions and lower the share price to a level that aggregates both insider and outsider knowledge. If insiders are restrained from using their knowledge to make transactions, the share price will not reflect their insider information. If outsider investors (those whom such laws are supposed to protect) buy shares, their purchase price won't reflect the insider knowledge and will be high by comparison to the price after the insider information becomes public. The outsider wind up taking an avoidable loss. If insiders were allowed to trade freely, the price would never get as high to begin with, and outsiders would lose less money.
Another position held by most economists is that government-enforced
price-ceilingsIncomes policies in economics are wage and price controls, most commonly instituted as a response to inflation, and usually below market level....
cause shortages. If the public is willing to buy Q units of some good at price P, and the sellers of that good are willing to sell Q units at P, then in the absence of regulation, the market for that good will clear. That is, everyone who wants to buy or sell at price P will be able to do so. If a regulation imposes a price ceiling below P, sellers will be willing to sell some lesser quantity, Q - a, and buyers will be willing to buy some greater quantity, Q + b, at the new price. In addition to a shortage of a + b units, there is also the matter of deciding who should get the units offered, since at the regulation price, demand will exceed supply. Such situations typically generate a variety of means of avoiding the effects of the market imbalance, in effect clearing the market, including 'black markets'.
See also
- Administrative law
Administrative law is the body of law that governs the activities of administrative agencies of government. Government agency action can include rulemaking, adjudication, or the enforcement of a specific regulatory agenda. Administrative law is considered a branch of public law...
- Deregulation
Deregulation is the removal or simplification of government rules and regulations that constrain the operation of market forces.Deregulation is the removal or simplification of government rules and regulations that constrain the operation of market forces.Deregulation is the removal or...
- Trust-busting
Trust-busting is any government activity designed to break up trusts or monopolies. Theodore Roosevelt is the U.S. president most associated with dissolving trusts. However, William Howard Taft signed twice as much trust-busting legislation began during his presidency.Trusts were large business...
- Liberalization
In general, liberalization refers to a relaxation of previous government restrictions, usually in areas of social or economic policy...
- Price-cap regulation
Price-cap regulation is a form of regulation designed in the 1980s by UK Treasury economist Stephen Littlechild, which has been applied to all of the privatized British network utilities...
- natural monopoly
In economics, a natural monopoly occurs when, due to the economies of scale of a particular industry, the maximum efficiency of production and distribution is realized through a single supplier....
- market failure
In economics, a market failure exists when the production or use of goods and services by the market is not efficient. That is, there exists another outcome where market participants' total gains from the new outcome outweigh their losses...
- Public choice theory
Public choice in economic theory is the use of modern economic tools to study problems that are traditionally in the province of political science....
- Regulated market
A regulated market or controlled market, is the provision of goods or services that is regulated by a government appointed body. The regulation may cover the terms and conditions of supplying the goods and services and in particular the price allowed to be charged...
- Regulation
Regulation is "controlling human or societal behaviour by rules or restrictions." Regulation can take many forms: legal restrictions promulgated by a government authority, self-regulation, social regulation , co-regulation and market regulation. One can consider regulation as actions of conduct...
- Worldwide Governance Indicators
Based on a long-standing research program of the World Bank, the Kaufmann-Kraay-Mastruzzi Worldwide Governance Indicators capture six key dimensions of governance between 1996 and present...
External links
- World Bank "Doing Business project"
- Worldwide Governance Indicators Worldwide ratings of country performances on Regulatory Quality and other governance dimensions from 1996 to present.
- Simeon Djankov, Rafael La Porta, Florencio Lopez-de-Silanes and Andrei Shleifer (2002), "The Regulation of Entry", Quarterly Journal of Economics 117, Feb. 2002
- Move Over, Adam Smith: The Visible Hand of Uncle Sam Report concludes that the U.S. government surreptitiously intervenes in the American stock market
- Pharmaceutical Price Controls in OECD Countries Implications for U.S. Consumers, Pricing, Research and Development, and Innovation by U.S. Department of Commerce
- The Competitive Enterprise Institute
The Competitive Enterprise Institute is a non-profit libertarian think tank founded in 1984 by Fred L. Smith, Jr and based in Washington, D.C., USA. CEI's stated belief is that humans are best helped not by government regulation of commercial interests, but by humans being allowed to make their...
has a project on Regulation and Economic Liberty
- The Progress and Freedom Foundation houses the Institute for Regulatory Law and Economics (IRLE) in Washington, D.C.
Washington, D.C. , formally the District of Columbia and commonly referred to as Washington, the District, or simply D.C., is the capital of the United States, founded on July 16, 1790...
- Lawrence A. Cunningham, A Prescription to Retire the Rhetoric of 'Principles-Based Systems' in Corporate Law, Securities Regulation and Accounting(2007)
- Body of Knowledge on Infrastructure Regulation