Political Competition and Economic Regulation

Peter Bernholz, Roland Vaubel

• Publisher: Routledge
• Year: 2007
• Print ISBN: 9781138806825
• eBook ISBN: 9781134086559
• Topic: Business
• Subtopic: Business General
• Index: Business

Organized, readable, technically sound and comprehensive from both theoretical and empirical standpoints, this book summarizes a vast amount of institutional, historical and descriptive detail.Using case studies from the US, Canada, Germany and Switzerland as well as the European Union and the global economy, this is the first book of its kind to e

1 The effect of interjurisdictional competition on regulation

Theory and overview

Peter Bernholz and Roland Vaubel

The hypothesis that interjurisdictional competition affects regulation can be traced back to Immanuel Kant’s ‘Idea of a Universal History from a Cosmopolitan Point of View’ (1784):

The states are already in the present day involved in such close relations with each other that none of them can pause or slacken in its internal civilization without losing power and influence to the rest . . . Civil liberty cannot now be easily assailed without inflicting such damage as will be felt in all trades and industries, and especially in commerce; and this would entail a diminution of the powers of the state in external relations . . . If the citizen is hindered in seeking his prosperity in any way suitable to himself that is consistent with the liberty of others, the activity of business is checked generally; and thereby the powers of the whole state are again weakened.

(p. 31)

In modern language, market interdependence and political competition among states constrain regulation because each government which interferes with the freedom of contract impairs the economic competitiveness of its country and weakens its own power including its military potential and its strength in international relations. Conversely, regulatory collusion among states would raise the level of regulation. If all governments regulate, no government has to fear a loss of economic competitiveness and of political power.

In Kant’s analysis, economic interdependence (‘close relations’) among the states is mainly due to interstate commerce. Max Weber (1923), with the benefit of hindsight at the industrial revolution, focused on the mobility of capital: ‘The separate states had to compete for mobile capital, which dictated to them the conditions under which it would assist them to power’ (p. 249).

Jacques Tiebout (1956), after the exodus from Europe in the 1930s and 1940s, stressed the mobility of labour (voting with the feet). All three forms of interdependence through the market have been subsumed under the term ‘exit’ by Albert Hirschman (1970).

However, governments do not only compete through the market, through political promises, threats and military measures. They also interact by generating (non-excludable) knowledge about efficient policy performance. This is especially important in democracies. The idea goes back to Lord Acton’s ‘History of Freedom in Antiquity’ (1877):

The distribution of power among several states is the best check on democracy. By multiplying centres of government and discussion it promotes the diffusion of political knowledge and the maintenance of healthy and independent opinion. It is the protectorate of minorities, and the consecration of self-government.

(p. 261)

This non-market interaction among governments has become known as ‘voice’ (Hirschman 1970) or ‘yardstick competition’ (Salmon 1987; Besley and Case 1995).¹

As Pierre Salmon explains in his contribution to this volume, political yardstick competition has to be distinguished from three other mechanisms which also involve interjurisdictional comparisons and are also not based on exit but which do not presuppose interjurisdictional comparisons by the voters:

1. emulation among office-holders aiming at the approval of their peers,
2. interjurisdictional comparisons not by voters but by governments trying to copy the successful innovations of other governments,
3. competition across jurisdictions among office-holders for the purpose not of re-election but of promotion to a position at a higher governmental tier.

Thus, the two necessary characteristics of political yardstick competition as understood here are, first, that the agents who make the interjurisdictional comparisons are the voters or, more generally, the providers of political support and, second, that office-holders are influenced by the comparisons because they seek electoral or political support to improve their chance of remaining in power.

Both types of interjurisdictional competition operate in the age of globaliza-tion and both are at the same time threatened by the increasing harmonization and centralization of regulatory policies in federal states and international organizations. If the adoption of common regulations does not require unanimity but merely a (qualified) majority, as is the case in federal states and some inter-national organizations, notably the European Union, regulatory collusion is replaced by the ‘strategy of raising rivals’ costs’.²

George Stigler (1970) was probably the first to point out that the majority of highly regulated states are interested and able to impose their high level(s) of regulation on the minority in order to weaken the latter’s competitiveness. Since, by doing so, the majority reduces regulatory competiton from the minority, the majority can afford to raise its own level of regulation as well. A formal analysis

shows that the resulting common level of regulation may easily be higher than the collusive (unanimous) level.³ The available evidence (for the EU and ILO) indicates that the highly regulated member states are more likely to vote for such common regulations and that the prevailing common level or regulation tends to exceed the average of the pre-existing national regulations.⁴

As George Stigler (1971) has emphasized, regulation tends to be demanded by well-organized interest groups, which want to be protected against market competition. This raises two important questions, first, how interjurisdictional competition or attempts to restrain it affect the political influence of interest groups and, second, whether these groups are themselves influencing the degree of interjurisdictional competition. The answer is controversial.

According to a famous argument that goes back to James Madison,⁵ political centralization by federation reduces the power of ‘factions’ or interest groups because the various regional interests tend to block each other. Such blocking is likely to occur but it is not the whole story. Well-organized groups pursuing diverse and partly contrary interests – say, unions and employers’ associations – may agree on government regulations – say, barriers to entering the goods market – at the expense of poorly organized third parties – say, consumers (Bernholz 1973). Moreover, similar interests represented in a majority of regions will be more influential at the federal or international level because, as we have seen, centralization reduces the scope for comparison (yardstick competition) and raises the cost of ‘exit’ for those who suffer from the regulation.

Madison’s conclusion has been supported by Mancur Olson (1966), but for a different reason. As Olson points out, political centralization weakens the incentive to organize an interest group because it reduces the share of the collective benefit which each member of the group can internalize. It also raises the cost of organizing the relevant interest group (because the group has more members) and the cost of lobbying (because the federal parliament has more members). Finally, centralization limits the lobbyists’ access to the political executive because there is only one instead of several (Bernholz and Breyer 1984: 364–7; Mueller in this volume).

However, there are also additional arguments to the effect that centralization raises the power of interest groups and the level of regulation demanded by them:⁶

1. Centralization weakens the individual voter’s incentive to acquire and use political information because the weight of the individual vote declines (‘rational ignorance’).
2. Centralization raises the voter’s cost of information because federal or international regulation is farther removed from his attention and less intelligible (especially if foreign languages are involved).
3. In federal or international negotiations among jurisdictions, interest group collusion seems less suspect or improper to the voters (Salmon 1987).
4. Centralization reduces the cost of lobbying for regionally homogeneous
5. interests because they have to address only one regulator (Laffont and Martimort 1998).
6. Centralization forces the elected politicians to delegate more regulatory power to bureaucrats who are more responsive to the demands of interest groups because they do not need to be re-elected (Crain and McCormick 1984).
7. Centralization increases the bureaucracy’s need for information supplied by interest groups (Nollert 1996).

Quite apart from interest group pressure, centralization, by reducing openness and exposure to external shocks, may weaken the voters’ demand for protection by internal regulation. Or, conversely, globalization and interjurisdictional competition among countries may increase the demand for protective state regulation and insurance for the same reason (Rodrik 1998; Heinemann in this volume).

Thus, from a theoretical point of view, we cannot determine whether inter-jurisdictional competition or, quite the contrary, political centralization favours deregulation. The answer is theoretically ambiguous, and it has been hotly contested for centuries. It is a question which has to be answered empirically.

This led us to assemble a number of case studies, both verbal and econometric, which analyse the historical evidence. Has federation in the United States, Canada, Switzerland, Germany and the European Union led to regulatory collusion and attempts to raise rivals’ costs? Has globalization lowered the level of regulation and, if so, in which fields? There is an extensive literature showing that tax competition tends to lower the level of taxation and government spending. Since government transfers and regulations are substitutes in catering for interest groups and protecting the median voter against risk, we might expect similar results for regulation. Is the case of regulation really analogous? If not, why not?

In the first case study John Addison reviews the political economy of federal, state and local labour regulation in the United States. The number of federal regulatory programmes covering labour standards, civil rights, occupational health and safety, labour relations and hiring and separation decisions has dramatically increased from 18 at the time of the New Deal to 40 in 1960 and some 180 by the mid-1990s. Before the New Deal legislation, from the 1860s onwards, there had been important state-level regulations of worker safety and compensation for injury in mining and manufacturing. However, after the New Deal, Addison detects a liberalization of superannuated legislation at the state level. For example, quite a few states repealed their prevailing wage laws, prevented their cities from establishing local minimum wages and, under the Taft–Hartly Act (1947), used their right to prohibit union shops by so-called right-to-work laws. As Norton (1986) shows, right-to-work laws are found in a large minority of states, and every one of them lies outside the Manufacturing Belt. At times, however, depending on the party in power at the federal level, labour unions find it easier to obtain regulation at the state or local level. In the field of wrongful dismissal legislation, the probability of state-level regulation has been shown to depend positively on the fraction of neighbouring states that have already adopted the regulation (Dertouzos and Karoly 1992, 1993). This is consistent with yardstick competition (but also with exit or common-cause interdependence).

Federal regulation provides several examples of the strategy of raising rivals’ costs. It has been conventional to attribute national legislation on minimum wages to the congressional majority of northern states wherein the envisaged minima were generally exceeded and which coalesced to suppress low-wage competition from the smaller number of southern states paying lower wages and which in turn voted against the Federal Fair Labor Standards Act (1938). Addison suggests that the raising rivals’ costs argument is yet more transparent in the case of the Davis–Bacon Act (1931) which imposed the prevailing local wage on workers from other states, notably on black construction workers from the South. Another example of raising rivals’ costs by federal labour regulation is the Occupational Safety and Health Act (1970). Addison discusses the economic evidence of Bartel and Thomas (1985, 1987) which shows that smaller firms and older plants experienced a significantly larger unit-cost effect. He also notes Pashigian’s analogous results for the Environmental Protection Act (1970). Finally, the strategy of raising rivals’ costs has also been detected in state-level regulation of workers’ safety and compensation before the New Deal (Fishback 2005). However, Addison concludes that we have far less information on the politico-economic causes of labour mandates than on their effects, and even the involvement of the various labour market actors has largely been adduced from the legislation’s pay-offs to them.

Dennis Mueller in his comment raises the question whether the US economy would be more efficient today if the power to regulate labour markets would have been reserved for the states or the federal government. He assumes that it is cheaper for an interest group to buy legislation from a state legislature than from Congress. However, as labour unions can be expected to be eventually powerful enough to get legislation through Congress, having the states be responsible for most regulation in labour markets may be a way to avoid some of the inefficiencies of labour market regulations.

Mueller’s reason for favouring state-level to federal regulation is not that he trusts yardstick competition (as opposed to interjurisdictional competition by exit) in this field. In a world in which democratic decisions are made using simple majority rule and well-organized interest groups can use the political process to advance the interests of their members over other members in the community, yardstick competition need not be welfare enhancing. Once one group of workers convinces its legislature that it should introduce some sort of labour regulation to protect them against ‘unfair competition’, the stage is set for the spread of this redistribution policy with its attendant inefficiencies to other communities. Winning votes in this way may be easier than trying to increase governmental efficiency and cut taxes.

Why is labour market regulation less restrictive in the United States than it is in Europe? In Mueller’s view this is due to the separation of powers between the President and two houses of Congress, the weakness of the parties, the absence of coalition governments, the single-member-district representation and the high mobility of labour (and capital?).

Gordon Tullock looks at various US regulations designed to protect domestic labour against foreign competition – including product regulations. He argues that such rent-seeking involves an error because it is inefficient, but that it is probably unavoidable because there are natural limits to the diligence and intelligence of the political decision makers. However, he sees ways of reducing such rent-seeking. He calls upon all economists to tu...

Table of contents

• Cover Page
• Title Page
• Copyright Page
• Contributors
• 1 The Effect of Interjurisdictional Competition on Regulation
• 2 Politico-Economic Causes of Labour Regulation in the United States
• 3 Interjurisdictional Competition in Regulation
• 4 Labour Market Regulation in the EU-15
• 5 Political Competition and Economic Regulation in German History
• 6 Regulatory Competition and Federalism in Switzerland
• 7 The Drivers of Deregulation in the Era of Globalization