Regulatory Reform Reconsidered

Gregory A Daneke, David J Lemak, Charles L Kennedy, Gerald Barkdoll

• Publisher: Taylor & Francis
• Year: 2019
• Print ISBN: 9780367285548
• eBook ISBN: 9781000309546
• Edition: 1
• Topic: Politics & International Relations
• Subtopic: Politics
• Index: Politics & International Relations

Bringing together a broad group of leading scholars, government officials, and corporate representatives, this book provides a critical analysis of recent regulatory reform efforts. The contributors focus on social and environmental regulation as they evaluate problems of costly and ineffective regulatory measures. They argue that, although some pr

Part I
Overview

Introduction

Debates over regulatory reform are among the most heated in both the practitioner and academic literature. The pros and cons of deregulation have been addressed by representatives of business, Congress, the White House, regulatory agencies and consumer groups, to mention but a few. Within academia, the controversy has attracted the attention of scholars and researchers from many diverse disciplines such as economics, political science, public administration, sociology, management, finance and law. This introductory section contains three papers which reflect this wide diversity of approaches to discussions of regulatory reform. While not completely comprehensive in terms of addressing all issues raised by each of the above mentioned disciplines, they do present a wide range of perspectives emanating from both practical experience and scholarly research.

The opening article by David J. Lemak focuses on "traditional" or economic regulation, providing a historical perspective which traces the theoretical underpinnings and actual practices of the older regulatory agencies. Rationales for, and explanations of regulatory behavior emanating from economics, political science, and public administration are reviewed and critiqued. The apparent anomaly of deregulation efforts initiated by the Nixon/Ford administrations, brought to fruition during the Carter years, and then seemingly stalled under Reagan is explored in depth. A new "ideological theory" of regulation is developed to provide a conceptual framework which is consistent with the events of the past fifteen years. Even though Lemak concentrates on economic regulation, the conceptual issues and theoretical perspectives are equally relevant to controversies surrounding proposed reforms in social regulation.

Christopher DeMuth, former Staff Director of the President's Commission on Regulatory Relief discusses the underlying causes of regulatory failure as well as the problems inherent in attempts to measure the effects of regulation on national productivity. The second portion of his paper starts with an explanation of the rationale for Executive Order 12291, the cornerstone of the Reagan administration's regulatory reform program. DeMuth then details six specific policies developed to implement EO 12291 and improve regulatory agency performance. All in all, this article presents a comprehensive summary of the why's and how's of current efforts at regulatory reform.

The last article in this section is a critical review of the evolution of social regulatory agencies by David J. Lemak. The history and rationales for the "new" regulation are traced from the early days of the Food and Drug Administration to the flurry of legislative activity in the 1970s. The performance of three major agencies, EPA, OSHA and NHTSA, is assessed in terms of social benefits and economic costs. Proposals for reform and examples of innovative solutions to social problems are examined. Lemak concludes that many of these reforms may hold some promise for improving public welfare in the short run, but long term gains cannot be accomplished by procedural/process oriented changes in the absence of more substantial structural changes.

Chapter 1
Whatever Happened to the C.A.B.?

The Theory and Practice of Economic Regulation

David J. Lemak

Typically, any description of the history and evolution of the regulatory process in the United States begins with Munn vs. Illinois in 1877 and proceeds neatly to the Interstate Commerce Act of 1887. Then the story usually goes something like this. The public distrust of both big business and big government led, quite logically, to the creation of an independent regulatory commission, the Interstate Commerce Commission, composed of apolitical experts who would use fair, judicial-like procedures to restrain unethical behavior in the private sector and protect the public interest. Unfortunately, the history, development and behavior of our regulatory agencies appears to be considerably more complex, clouded and illogical than textbooks would have us believe. Indeed, the very existence of the independent regulatory commission appears to be more the result of happenstance than of the manifestation of logical analysis by the Congress or executive branch:

The first commission - the Interstate Commerce Commission (ICC) - was originally part of the Department of the Interior: however, friction between the senator who guided the legislation establishing the ICC and the Harrison administration, combined with the desire of the Secretary of the Interior to avoid responsibility for the ICC led to its redefinition as an independent agency. The ICC's first chairman, a respected jurist, was responsible for establishing the formal procedures of the ICC, and the Congress did not attempt to interfere (Noll, 1971, p. 33).

History goes on to tell us that from these humble beginnings, regulatory activity grew in three rather distinct "waves," with the ICC being the harbinger of the first era in response to the concentration of economic power in the private sector. The second flurry of regulatory activity occurred, during the Great Depression as government sought to curb the evils of destructive competition by assuming the role of cartel manager in various and sundry forms - the National Recovery Administration, the Civil Aeronautics Board, the Federal Communications Commission, etc. Finally, the 1960s ushered in a third and vastly different set of regulatory legislation. The "old" or economic regulatory agencies were now joined by the "new" social regulatory agencies. The new agencies were a response to public demands for more socially responsible corporate behavior and improved quality of work life, since both issues had been generally ignored during the post WW II era (Greer, 1983).

More recently, and somewhat ironically, the call has gone out for less government intervention in the market place. The latest demands for a fourth wave of legislative action center around dismantling much of the existent national regulatory infrastructure. The first targets of deregulation efforts are the "old" or economic regulatory agencies. The academic and practitioner literature has been inundated with discussions of theories of deregulation, criticisms of regulatory failures, specific reform proposals and explanations of regulatory behavior. However, there are few, if any, common threads which integrate this diverse body of literature. It is hoped that this investigation will uncover some clues as to how we came from the Interstate Commerce Act of 1887 to the Airline Deregulation Act of 1978. Re-weaving this vast tapestry is the purpose of this current undertaking.

The Rationale for Regulation

The brief historical perspective presented earlier reflects the most common reasons espoused for the necessity of government intervention in the private sector:

1. To avoid the concentration of economic power resulting from anti-competitive behavior.
2. To prevent destructive competition while controlling "natural monopolies."
3. To insure that business bears the full costs of production (externalities).

All three rationales center around the notion of structural deficiencies inherent in the market system, and each surfaced as a primary thrust for each wave of regulatory activity. Other market failings are couched in terms of public goods (Stigler, 1975), income redistribution (White, 1981), quality of service (MacAvoy, 1979) and limited information (Thompson and Jones, 1982).

Probably the most common reason offered for the necessity of regulatory activity stems from the emergence of oligopolistic industries around the turn of the century. The anti-competitive, profit maximizing behavior of many firms after the industrial revolution resulted in massive concentrations of economic wealth in relatively few firms. In order to protect the public at large, as well as to protect certain small, powerless segments of the population from such predatory practices as monopoly pricing and price discrimination, government intervention emerged as a logical solution. The basic notion was that the power of the state could be used to ensure that private firms played by the rules of the market system game.

The events which culminated in the Great Depression focused lawmaker attention on the destructive capability of uninhibited competition. The fear of monopoly power subsided, as did antitrust activity, and private cooperation was encouraged until the late 1930s (Greer, 1983). The use of the regulatory agency to prevent cutthroat competition in the fledgling airline, communication and surface transportation industries appeared to be a rational response on the part of the federal government. The concept of "natural" monopolies which began to emerge in the 1920s also came to fruition. Because of economies of scale and/or the nature of the good/service, it was deemed efficient to have only one producer serve a given market To protect against monopoly pricing, government regulation was again seen as an effective countervailing power.

Until the early 1960s, most legislation dealing with regulation in the private sector was industry specific, and focused on economic activity of business firms. The third wave of "social" regulation was spurred by the concept of externalities. Issues such as consumer protection, employee safety, and ecology emphasized that business activities were often the source of costs which were borne entirely by third parties. Therefore, the costs of production were understated, and government action was initiated to ensure that corporations absorbed the costs associated with poor quality or dangerous products, unsafe working conditions and pollution. Since these regulatory activities cut across industries and because of the nature of the legislation, the term "new" or "social" regulation was coined.

While the above reasons reflect the main concerns of politicians and economists during each of the three noted periods, other examples of market failures were also identified. The concept of public goods - goods provided to all consumers by a single supplier - was also identified as rationale for government action. Because the nature of the good provided was such that either one or all benefited from it, and because costs were the same regardless of the number of consumers (e.g. national defense), traditional economic theory implied that the free market could not provide such goods (Stigler, 1975).

Regulation is also used to ensure that certain consumer groups and segments of the population receive services that would otherwise not be provided by the market Providing electricity and air carrier service to small rural communities are common examples. The costs associated with such markets normally exceed revenue, so regulation is used to enforce mandatory service. This represents a form of income redistribution since consumers in the profitable markets must pay more for their service to cover the higher costs of smaller markets (White, 1981).

A seldom noted, implicit reason for regulatory activity involves improving the quality and volume of service. This argument recognizes the regulated industries as the infrastructure for all other economic activity. As the economy grows, it is essential that the quality and volume of service provided by these industries grow at a comparable rate (MacAvoy, 1979).

Finally, a more recent rationalization attacks the free market assumption of perfect knowledge by buyers and sellers. The contention is that sellers have considerably more information at their disposal than does any single consumer, Therefore, regulation is used to compensate buyers for limited information in the market place (Thompson and Jones, 1982).

Tools of the Trade

In order to function effectively and compensate for market failings, regulatory agencies employ three basic types of control. First, to avoid excess profits but yet allow firms to earn a fair rate of return on invested capital, prices are set by the agency. In addition to limiting profits, this mechanism is used to redistribute income through cross subsidization pricing. Price controls were used extensively to limit the activities of big business during the first era of regulatory activity.

Agencies can also protect competitors from destructive competition by simply limiting the number of firms operating in any given industry. The Civil Aeronautics Board, for example, is alleged to have used this mechanism to an extreme by not allowing one new trunk line to be certified between 1938 and 1970 (Stigler, 1971). Indeed, the actions of both established (e.g. the ICC) and newer regulatory agencies (e.g. the CAB) during the 1930s seem to rely a great deal more on the use of this power, while decreasing emphasis on price controls.

Finally, regulatory agencies are able to control both the volume and quality of service. Price controls can be used to indirectly influence these factors. However, agencies such as the CAB and ICC have used the concept of "essential service" to maintain route structures which would have otherwise been abandoned (Carrow and MacAvoy, 1981).

Theories of Regulation

The concept of market failures which generated the rationales for regulation also provides the theoretical underpinnings for the public interest approach to regulation. Simply put, inherent flaws in the structure of some industries result in damage to the public welfare if these industries function in a free market context. Therefore, government intervention is required to provide essential goods and services at price and quality levels commensurate with what the market should provide in the absence of inherent flaws. The role of the regulatory agency is to protect the general public by the judicious exercise of its earlier noted powers based on objective, expert analysis of the respective industry. If one word could be used to describe the essence of the public interest theory, it would be "fairness." That is, producers are allowed to earn a reasonable (i.e., comparable to nonregulated industries) return on investments while consumers receive quality products/services at fair prices.

Unfortunately, as many authors have noted (Posner, 1974; Stigler, 1971; Thompson and Jones, 1982), this theory of regulation simply does not explain the behavior of regulatory agencies over the years. First, Posner (1974) notes that the public interest theory would predict regulatory activity in oligopolistic industries which produce substantial externalities. Clearly, such industries as surface transportation and financial institutions do not fit the above description. Second, there is a wealth of empirical evidence which supports the notion that interest groups and the regulated industries exert an inordinate amount of influence in regulatory agency policy making (Stigler, 1971). A revised version of the public interest theory suggests that the theory is not at fault. Rather, it is the poor management and ineptitude of the agencies which account for poor performance. However, empirical evidence suggests a means-ends inversion which demonstrates that regulatory agencies are fairly efficient in pursuing nonoptimal goals (Posner, 1974).

The interaction of the regulators and the regulated resulted in the formulation of a number of approaches best described as capture theories. All versions of this perspective on regulatory behavior share a common thesis. The regulated industries dominate the regulatory agencies, so that policy making is necessarily biased in favor of the regulated at the expense of the public welfare. The original version posits that the regulatory agencies were formed with the intent of safeguarding the public interest, but over time, the power and influence of the regulated firms overwhelm the relationship (Posner, 1974). A similar notion is espoused in the life cycle theory, but the focus is on the regulators, not the regulated. This version suggests that the formation of a new agency is accompanied by vigorous activity on the part of highly motivated defenders of the public interest. However, as time passes, the relationships become more stable and rigid, and the activities become more routine. As a result, the agency "grows old" and lethargic over time, and the zeal to protect the public eventually wanes (Bernstein, 1955). Finally, the most recent reformulation of capture theory also recognizes the intent of the regulators to faithfully discharge their legislative mandates. But because of a perverse incentive system and information sources which are supplied by the industries, policy making inevitably favors the regulated (Thompson and Jones, 1982).

Applauded by many political scientists, but generally scorned by equally as many economists, capture theory does offer a parsimonious, even logical explanation of regulatory behavior. Unfortunately, there is as much empirical evidence against the theory as there is supporting it (Anderson, 1980), First, regulatory agencies make policy in an environment of competing interests. While an individual consumer may not exert much influence on lowering the costs of moving his household possessions, large shippers clearly will be concerned with, and exert influence to keep the costs of surface transportation down. The regulated firms are not the only powerful voices to be heard (Thompson and Jones, 1982). Second, many agencies, like the ICC, deal with more than one industry. ...

Table of contents

• Cover
• Half Title
• About the Book and Editors
• Title
• Copyright
• Contents
• Preface
• Acknowledgments
• PART I OVERVIEW
• PART II PROBLEMS
• PART III PROSPECTS
• About the Authors