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Regulatory economics is the economics of regulation, in the sense of the application of law by government that is used for various purposes, such as centrally-planning an economy, remedying market failure, 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.

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Regulation as a process

Public services can encounter conflict between commercial procedures (e.g. maximising profit), and the interests of the people using these services. (See market failure.) 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 alcohol and prescription drugs 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. Monopolies are often regulated, especially those which are difficult to abolish (natural monopoly). The financial sector 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 Exchange, 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 Baseball, FIFA (the international governing body for professional soccer), and the Royal Yachting Association (the UK's recognised 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 the people participating as well as the acceptable continuation of the activity itself within specified limits.

In the United States, throughout the 18th and 19th centuries, the government engaged in substantial regulation of the economy. For example, in the 18th century, mercantilism 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 infrastructure was considered necessary from the standpoint of national security and well-being: whether in war or peace, a nation without adequate and reliable transport, telecommunications, public health, banking, and public utilities 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 Act (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 review 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.[1]

Regulation as red tape

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 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 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"[2] is one of the six dimensions of governance that the Worldwide Governance Indicators measure for more than 200 countries.

Deregulation

Main article: deregulation

During the late 1970s and 1980s, some forms of regulation was seen as imposing unnecessary 'red tape' and other restrictions on businesses. In particular, government support of cartel activity was seen as diminishing economic efficiency. Regulatory agencies were often seen as having been captured by the regulated industries, as a means of diminishing competition between industry participants, and so not serving the public interest. 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 Left, 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 patents, DRM, trusted computing).

Criticism of economic regulation

Some economists, such as Nobel prize-winning economist Milton Friedman as well as those of the Austrian School, 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 mercantilistic 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 calculation, lacking any reliable ability (or true incentive) to gather, integrate, or honestly evaluate the vast amounts of information that guide the "Invisible Hand" of a free market.

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 consequence 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-faire advocates do not oppose monopolies unless they maintain their existence through coercion to prevent competition (see coercive monopoly), 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 wage 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 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-ceilings 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

References

  • Journal of Regulatory Economics (1989 - ) [1]

External links

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