Industrial Economic Regulation

A Framework and Exploration

Roger Sugden

• Publisher: Routledge
• Year: 1993
• eBook ISBN: 9781134917242
• Edition: 1
• Topic: Business
• Subtopic: Business General
• Index: Business

Leading industrial economists focus on the processes by which governments in market economies take actions to influence economic activity in firms and industries. They examine the basis of regulation, assessing the cases commonly made for and against regulation. Having established a coherent framework for analysis it explores key currnet issues, in

Part I

Government Power

1

Is Successful Regulation Possible?

Some Theoretical Issues¹

Jim Tomlinson

Advocates of the regulation of private industry are predisposed to believe that public agencies can achieve their regulatory aims, that the state has the capacity to be successful. Such an attitude can no longer be treated as axiomatic. In the last thirty or so years there has arisen a substantial literature which challenges the very possibility of public agencies delivering public purposes. The very idea of the achievement of the ‘public interest’ as a realizable objective has been systematically derided and attacked in this literature.

As always with academic discourse, it is very difficult to judge how significant this body of writing has been in influencing public policy. However, it would seem plausible to argue that it has been an important element in engendering that ‘fear of government’ (e.g. Thompson 1990, chapter 2) which has so infected the politics of many of the advanced capitalist countries in recent years. Be that as it may, advocates of regulation need to respond to the challenge of this literature, as it strikes at the foundations of their position, as indeed it strikes at the foundation of any form of public intervention in the economy. This chapter focuses on the theoretical assumptions of this literature.

The New Theory of Regulation

The attack on the possibility of successful regulation has come from two related but separable sources. On the one hand there is the literature concerned specifically with regulation, but also very much relevant is the public choice literature, though its concerns have been much wider than simply the issue of regulation.

Regulation of private industry has been a long-standing issue in American policy, unlike in Britain where, until the recent privatizations, nationalization was the dominant form of public intervention in industry.² This regulation, going back to the creation of the Interstate Commerce Commission in 1887, had normally been treated as an attempt to impose the public interest on industries where the forces of competition did not operate. Government stepped in to do what the normal operations of the private market were prevented from doing in a few exceptional cases.

This ‘market failure’ view of the benignity of regulation came under attack from a range of sources from the mid–1960s. A pioneer in this was the neo-Marxist historian Gabriel Kolko (1963, 1965) who reassessed pre–1914 American policy, and argued that the regulatory agencies of that era were ‘captured’ by capitalist interests who used them to subvert their purported public purposes.³

At almost exactly the same time as the appearance of Kolko’s work, regulation came under scrutiny and attack from the opposite end of the political spectrum, in the work of Stigler. The Journal of Law and Economics, with a sceptical attitude to regulation began publishing in 1958, but a key article in the development of the new regulation literature was published in that Journal in 1962 by Stigler and Friedland.⁴ The key question of this article was—does regulation make any difference to the behaviour of the industry regulated? This was examined for the case of electricity. The conclusion was that regulation had no discernible effects on the industry’s behaviour. The reasons were twofold, they argued. The industry does not, in the long run, have the monopoly power which is commonly assumed, but in any event the regulatory body does not have the ability to force the utility to operate at a specified combination of output, price, and cost—the utility can always evade the regulation’s intent. This scepticism about the effects of regulation (see also Stigler 1965) did not of itself involve a fundamental challenge to the regulatory ideal, but in 1971 he broadened the scope of the attack.⁵ The central thesis of the paper was that ‘as a rule, regulation is acquired by the industry and is designed and operated primarily for its benefit’ (Stigler 1975a: 115). This view was explicitly counterposed to the view that regulation was aimed at benefitting the public at large, or that regulation is irrational and inexplicable. In essence Stigler’s was a neo-classical economist’s version of the capture thesis. Whatever the origins and rhetoric of regulation, its effects will be to advance the interests of the industry regulated.

The capture theory of regulation can and has been arrived at from a variety of angles. Stigler would have had no difficulty in agreeing with Kolko’s argument that:

the intervention of the Federal government not only failed to damage the interests of the railroads, but was positively welcomed by them since the railroads never really had the power over the economy, and their own industry, often ascribed to them. Indeed the railroads, not the farmers and shippers, were the most important single advocates of federal regulation from 1877 to 1916.

(Kolko 1965:3)

However Stigler’s approach, in the American political and academic context, was to be much more significant. Most of the subsequent literature has built up on his approach.

Central to that approach was the idea that regulation is a good like a consumer good, with a demand and a supply function. Politicians supply regulation primarily in exchange for votes, industries demand it because of its capacity to coerce consumers or other producers. But once this approach was put forward it raised the question why should the supply of regulation only respond to the demand of producers. Peltzman (1976) argued that Stigler’s approach to the political process was insufficiently general, that consumers too had votes with which to ‘buy’ regulation, and that therefore regulation would respond to the politicians attempt to maximize votes from a variety of sources. So regulation would rarely be a case of simple capture by the industry, but on the other hand its outcomes would never reflect the public interest, but the interests of those crucial to the vote-maximizing aims of politicians.

Also very important in the generalization of this new approach was Posner. Like Peltzman he moved the debate away from a simple ‘capture by producers’ approach to emphasizing regulation as the product of coalitions between the regulated industry and some of its consumers, the former obtaining some monopoly profits from regulation, the latter obtaining lower prices, all at the expense of unorganized, mostly uninfluential consumer groups (Posner 1971; also Posner 1974). Posner’s particular contribution was to apply this approach to the analysis of the law, and generally to press the argument for the superiority of common law procedures for dealing with issues more often addressed by regulatory bodies (Posner 1977).

On the foundations of Stigler’s and Peltzman’s work has developed a whole ‘new economies’ of regulation which is represented in journals such as the Journal of Law and Economics, the Bell Journal, and the International Review of Law and Economics. Some of the complexities and difficulties of this school are returned to below, but enough has been said to bring out the generality of the approach, and its foundations in a profound mistrust of the state grounded in neo-classical economies’ maxims about human behaviour. This linkage logically takes us on to public choice.

Public Choice

Public choice can be defined as ‘the economic study of non-market decision making, or simply the application of economics to political science’ (Mueller 1989:1). Economics here means, of course, neoclassical economics, in other words the assumption that in politics as in all activities people are motivated by individual maximizing.⁶ Public choice aims to apply this approach to the specific actors of politics especially to voters, politicians and bureaucrats. To simplify the matter, the voter is thought of as a customer and the politician as a businessman/entrepreneur’ (Mueller 1989:1). Such a view of the political process has no single origin point, and can be found in Adam Smith (a point returned to below) and in modern times in such writings as Schumpeter (1954) and Downs (1957). The literature in the field is vast, though pride of place must still go to the Journal Public Choice, organ of the Virginia School and inspired by the work of Buchanan and Tullock. A summary of much of this is in Rowley (1987). The field covered is much greater than industrial regulation as traditionally conceived, and covers everything from voting procedures to public expenditure determination. But like the new economics of regulation, its cutting edge is a profound scepticism about the capacities of government to deliver anything sensibly considered the public interest, given the realities of self-seeking behaviour in politics.

One area of public choice analysis close to the concerns of regulation is the analysis of bureaucracy. In his pioneering book on this in 1971, Niskanen argued that bureaucrats were to be understood as ‘budget-maximizers’, because most of the benefits (pecuniary and non-pecuniary) they sought to obtain are correlated with bureaux and budget size. Coupled to this was the argument that those legislators charged with overseeing bureaux would tend to gain from larger bureaux because of the vote-generating possibilities of bureaux spending. Regulatory bodies, like other bureaux, would then expand excessively.

Later work by Niskanen complicated this picture but without altering the fundamental thrust:

the most important hypothesis derived from this theory is that government budgets are too large, that is, they will be larger than that preferred by the median legislator, and in a representative government, larger than that preferred by the median voter.

(Niskanen 1975:638)

Thus the new economics of regulation and public choice theory are closely related—indeed to a degree the former is a subset of the latter.⁷ In looking at them in more detail it is therefore appropriate to discuss some of the common elements before looking at each separately.

Back to Basics: Epistemology

Like many social scientists both the new economics of regulation school and public choice theorists attempt to defend their arguments by deploying epistemological policemen. As for many neo-classical economists, the people usually chosen for this role are Popper and Friedman. Whilst Popper and Friedman are plainly far apart in philosophical sophistication, they tend to be deployed in a similar manner in this kind of literature. This is simply summed up by Posner when he argues that, following Friedman (1953), ‘the true test of a theory is its utility in predicting or explaining reality’ (Posner 1977:13). The purpose of this argument is to deny the relevance of the realism of the postulates of a theory—what matters is simply its capacity in generating falsifiable hypotheses. A slightly more sophisticated version of this argument is deployed by the public choice theorist, Rowley, who cites Popper (1968) in his support. For Rowley:

the self-seeking postulate is employed in positive public choice essentially as an ‘as if’ proposition, which when combined with relevant auxiliary conditions, generates testable predictions concerning the political variables to exogenous change. To the extent that such predictions differ from those of alternative approaches, and conform more closely to the evidence, so the self-seeking postulate is justified, whether or not it reflects the reality of the political market behavioural calculus.

(Rowley 1987:2)

As always with epistemological arguments, the purpose in deploying Friedman and Popper is to rule out a priori certain kinds of argument. Just as Popper’s original aim was to rule Marxism and psychoanalysis out of court as scientific endeavours, so the anti-regulationists want torule out any questioning of their story about the motives of agencies in the public sector. In a strict ‘as if framework motives would be irrelevant, just as the motives of the owners of the firm are irrelevant in Alchian’s classic defence of the profit-maximizing model of the firm (Alchian 1950). All that would matter would be the congruence between the theories’ predictions and the observed outcomes.

Friedman’s version of this methodology is crude and easily rejected. It proposes a clear distinction between theory and observation which is unsustainable. It presupposes a world of experience separate from presupposition or conception which is unsustainable—observation can never be ‘neutral’. The argument is also incoherent because it suggests that experience is independent of knowledge, yet at the same time what is to count as experience producing knowledge can only be specified in knowledge (Hindess 1977, chapter 4).

Popper’s epistemology is plainly more sophisticated than Friedman’s. He, for example, has always rejected the possibility of a strict observation language, independent of theory. But the project of Popper is still to provide clear demarcation criteria between ‘scientific’ and ‘nonscientific’ discourses. Whilst this project has become more complex and refined over the years it has not provided a means of distinguishing good from bad theories on the basis of some universal criteria (Williams 1975). However vigorously he wields his truncheon, the epistemological policeman has feet of clay.

At one level of argument all this probably matters very little. Any passing acquaintance with the writings of the new regulationists will quickly reveal that they are not consistently ‘as if theorists. Rather, they normally have a missionary-like belief in the revelation that public sector actors maximize their own interests. Thus Stigler (1975a) suggests that no case of regulation which contradicts this hypothesis will be found: ‘Temporary accidents aside, such cases simply will not arise: our extensive experience with the general theory in economics gives us the confidence that this is so. Indeed there is no alternative hypothesis’. Where evidence does not support the hypothesis this does not come ‘from the “failures” of the hypothesis but from the extreme crudeness of the measures of benefits and costs’ (Stigler 1975a: 140).

So it is clear that some important proponents of the anti-regulation position do not believe in the defence of the position mainly by epistemological criteria. Nevertheless it is important to note that such criteria have been used, and for two purposes. One is to provide the basis for claims for scientificity—for ‘positive’ social science, such claims obviously requiring some demarcation criteria to establish what is non-scientific or normative. Such distinctions are in practice little adhered to by the anti-regulationists. For example as Rowley (1987:3) remarks The ideology of the Virginia School in essence is one of profound preference for market over non-market decisionmaking which permeates almost all of the writings of its scholars’.

The second purpose of this style of epistemological defence is to try and ev...

Table of contents

• Cover
• Half Title
• Title Page
• Copyright
• Contents
• List of figures and tables
• List of contributors
• Introduction: On Industrial Economic Regulation
• Chapter Abstracts
• Part I: Government power
• Part II: Economic rationale
• Part III: Information
• Part IV: Regulatory instruments
• Part V: Government collaboration
• Index