Regulation restricts the action of economic agents—in general. It is omnipresent. Why does regulation exist? In a free-market economy, why does the government choose to place restrictions on the decisions of certain agents and actions?
George Stigler (1911-1991) introduced his “Theory of Economic Regulation” in 1971 trying to answer this question in a well-established framework, on the basis of some previous empirical arguments such as Normative Analysis as a Positive Theory (NPT) or Capture Theory (CT).
when you see that a paper has over 16k citations and has 24 version—it’s the universe signaling READ IT.
Here’s what the paper is about:
Previously, it was criticized that sometimes regulations fail to address general public interest: for example, the gasoline import quota is bad for the national security and consumer surplus, and that it only benefits the oligopolies.
So many economists, for example, have denounced the ICC for its pro-railroad policies that this has become a cliche of the literature.
Stigler argues that this is natural in the first place—that regulations emerges because interest parties pushes their supported political representatives to promote them. The paper’s central thesis is that regulation is often sought by industries and designed primarily for their benefit, rather than for the public good.
assumptions
The regulatory authority has the power to coerce.
An interest group that can convince the regulatory authority to use its power of coercion for the benefit of that group can improve the group’s well-being.
Economic agents are utility maximizers:
interest groups attempt to enhance its well-being by securing favorable regulation from the authority that serves to redistribute wealth from others to the interest group.
The authority (or, the political systems) on the other hand, seeks financial and public support of the interest groups.
Let’s take democracy for granted—still, it is unreasonable to require every individual agents to vote over every regulatory decisions. But the democratic decision process must involve all the community, not simply the ones who are directly concerned with the particular regulatory issue (for example, a vegeterian citizen may still have to be involved in the decision of regulation over the consumption of horse meat in California). This impossibility requirement for efficiency is resolved by having numerous levels of government, quote the original paper:
The representative and his party are rewarded for their discovery and fulfillment of the political desires of their constituency by success in election and the perquisites of office.
If the representative denies ten large industries their special subsidies of money or governmental power, they will dedicate themselves to the election of a more complaisant successor: the stakes (well, their careers) are that important. This does not mean that every large industry can get what it wants or all that it wants: it does mean that the representative and his party must find a coalition of voter interests more durable than the anti-industry side of every industry policy proposal. A representative cannot win or keep office with the support of the sum of those who are opposed to: oil import quotas, farm subsidies, airport subsidies, hospital subsidies, unnecessary navy shipyards, an inequitable public housing program, and rural electrification subsidies.
Excellent point! Mr. Stigler should be hired as the consultant writer for House of Cards.
several ways industries seek benefits from the state:
- Direct Subsidies: While direct monetary subsidies are beneficial, industries often avoid them because they would need to be shared with new entrants, diluting the benefits.
- Control Over Entry: Industries prefer regulations that limit new competitors, such as import quotas or licensing requirements, which help maintain higher prices and profits.
- Influence on Substitutes and Complements: Industries lobby for policies that favor their products over substitutes and support complementary industries.
- Price-Fixing: Even industries with entry controls seek price regulation to ensure higher returns.
in conclusion…
The paper emphasizes the rational behavior of political systems, where industries use the state’s coercive power to their advantage, often at the expense of broader societal interests. The analysis concludes that regulatory policies are shaped by the economic interests of powerful groups rather than by the public interest.