Regulatory economics is the application oflaw bygovernment orregulatory agencies for variouseconomics-related purposes, including remedyingmarket failure,protecting the environment and economic management.
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Regulation is generally defined as legislation imposed by a government on individuals andprivate sector firms in order to regulate and modify economic behaviors.[1] Conflict can occur betweenpublic services and commercial procedures (e.g. maximizingprofit), the interests of the people using these services (seemarket failure), and also the interests of those not directly involved in transactions (externalities). Most governments, therefore, have some form of control or regulation to manage these possible conflicts. The ideal goal of economic regulation is to ensure the delivery of a safe and appropriate service, while not discouraging the effective functioning and development of businesses.
For example, in most countries, regulation controls the sale and consumption ofalcohol andprescription drugs, as well as the food business, provision of personal or residential care, public transport, construction, film and TV, etc.Monopolies, especially those that are difficult to abolish (natural monopoly), are often regulated. Thefinancial sector is also highly regulated.
Regulation can have several elements:
Where there is non-compliance, this can result in:
Not all types of regulation are government-mandated, so some professional industries and corporations choose to adopt self-regulating models.[1] There can be internal regulation measures within a company, which work towards the mutual benefit of all members. Often, voluntary self-regulation is imposed in order to maintain professionalism, ethics, and industry standards.
For example, when a broker purchases a seat on theNew York Stock Exchange, there are explicit rules of conduct, or contractual and agreed-upon conditions, to which the broker must conform. The coercive regulations of theU.S. Securities and Exchange Commission are imposed without regard for any individual's consent or dissent regarding 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 those participating in the regulated activity.
Other examples of voluntary compliance in structured settings include the activities ofMajor League Baseball,FIFA, and theRoyal Yachting Association (the UK's recognized national association for sailing). Regulation in this sense approaches the ideal of an accepted standard ofethics for a given activity to promote the best interests of those participating as well as the continuation of the activity itself within specified limits.
In America, throughout the 18th and 19th centuries, the government engaged in substantial regulation of the economy. In the 18th century, the production and distribution of goods were regulated by British government ministries over the American Colonies (seemercantilism). Subsidies were granted to agriculture, and tariffs were imposed, without representation in the regulating government and sparking theAmerican Revolution. The United States government maintained a high tariff throughout the 19th century and into the 20th century until theReciprocal Tariff Act was passed in 1934 under theFranklin D. Roosevelt administration. However, regulation and deregulation came in waves, with the deregulation of big business in the Gilded Age leading to PresidentTheodore Roosevelt's trust busting from 1901 to 1909, deregulation and Laissez-Faire economics once again in the roaring 1920s prior to theGreat Depression, and intense governmental regulation andKeynesian economics under Franklin Roosevelt'sNew Deal plan. PresidentRonald Reagan deregulated business in the 1980s with his Reaganomics plan.
In 1946, theU.S. Congress enacted theAdministrative Procedure Act (APA), which formalized means of ensuring 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 forjudicial review of agency action.
Regulatory capture is the process through which a regulatory agency, created to act in the public interest, instead advances the commercial or special concerns of interest groups that dominate the industry it is meant to regulate.[2] The probability of regulatory capture is economically biased: vested interests in an industry have the greatest financial stake in regulatory activity and are more likely to be motivated to influence the regulatory body than dispersed individual consumers, each of whom has little particular incentive to try to influence regulators. Regulatory capture is a risk to which an agency is exposed by its very nature.[3]
The art of regulation has long been studied, particularly in the utilities sector. Two ideas have been formed on regulatory policy: positive theories of regulation and normative theories of regulation.
The former examine why regulation occurs. These theories 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."[4] These theories conclude that regulation occurs because:
Normative economic theories of regulation generally conclude that regulators should
Alternatively, many heterodox economists and legal scholars stress the importance of market regulation for "safeguarding against monopoly formation, the overall stability of markets, environmental harm, and to ensure a variety of social protections."[5] These draw on sociologists (such asMax Weber,Karl Polanyi,Neil Fligstein, andKarl Marx) and the history of government institutions partaking in regulatory processes.[citation needed] "To allow the market mechanism to be sole director of the fate of human beings and their natural environment, indeed, even of the amount and use of purchasing power, would result in the demolition of society."[6]
*Information asymmetry deals with transactions in which one party has more information than the other, which creates an imbalance in power that at the worst can cause a kind of market failure. They are most commonly studied in the context ofprincipal-agent problems.[citation needed]
Principal-agent theory addresses issues of information asymmetry.[7] Here, the government is the principal, and the operator the agent, regardless of who owns the operator. Principal-agent theory is applied in incentive regulation and multi-part tariffs.[4]
TheWorld Bank'sDoing 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 theOECD, compared to 60 inSub-Saharan Africa; the cost as a percentage ofGNP (not including bribes) is 8% in the OECD, and 225% in Africa.
TheWorldwide 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"[8] is one of the six dimensions of governance that theWorldwide Governance Indicators measure for more than 200 countries.
The cost of regulations increased by above 1 trillion and can explain 31-37% of the rise in industry concentration.[9]
Overly complicated regulatory law, increasing inflation, concern overregulatory capture, and outdated transportation regulations made deregulation an appealing idea in the US in the late 1970s.[10][11] During his presidency (1977-1981), PresidentJimmy Carter introduced sweeping deregulation reform of the financial system (by the removal of interest rate ceilings) and the transportation industry, allowing the airline industry to operate more freely.[12]
PresidentRonald Reagan took up the mantle of deregulation during his two terms in office (1981-1989) and expanded upon it with the introduction ofReaganomics, which sought to stimulate the economy through income and corporate tax cuts coupled with deregulation and reduced government spending. Though favored by industry, Reagan-era economic policies concerning deregulation are regarded by many economists as having contributed to theSavings and Loan Crisis of the late 1980s and 1990s.[13]
The allure of free market capitalism remains present in American politics today, with many economists recognizing the importance of finding balance between the inherent risks associated with investment and the safeguards of regulation.[13] Some, particularly members of industry, feel that lingering regulations imposed after the2008 financial crisis such as theDodd–Frank Wall Street Reform and Consumer Protection Act are too stringent and impede economic growth, especially among small businesses.[14][15] Others support continued regulation on the basis that deregulation of the financial sector led to the2008 financial crisis and that regulations lend stability to the economy.[16]
In 2017, PresidentDonald Trump signed an executive order that he claimed would "knock out two regulations for every new regulation."[17] Trump made the claim: "Every regulation should have to pass a simple test. Does it make life better or safer for American workers or consumers? If the answer is no, we will be getting rid of it."[17]
A common counterpart of deregulation is theprivatization of state-run industries. The goal of privatization is for market forces to increase theefficiency of denationalized industries. Privatization was widely pursued in Great Britain throughoutMargaret Thatcher's administration.[18] Though largely considered a success and considerably reducing government deficit, critics argue that standards, wages, and employment declined due to privatization. Others point out that lack of careful regulations on some of the privatized industries is a source of continued problems.[19][20]
The regulation of markets is to safeguard society and has been the mainstay of industrialized capitalist economic governance through the twentieth century.[21][citation needed]Karl Polanyi refers to this process as the 'embedding' of markets in society. Further, contemporary economic sociologists such as Neil Fligstein (in his 2001 Architecture of Markets) argue that markets depend on state regulation for their stability, resulting in a long term co-evolution of the state and markets in capitalist societies in the last two hundred years.
There are variousschools of economics that push for restrictions and limitations on governmental role in economic markets. Economists who advocate these policies do not necessarily share principles, such asNobel Prize-winning economistsMilton Friedman (monetarist school),George Stigler (Chicago School of Economics /Neo-Classical Economics),Friedrich Hayek (Austrian School of Economics), andJames M. Buchanan (Virginia School of Political Economy) as well asRichard Posner (Chicago School / Pragmatism). Generally, these schools attest that government needs to limit its involvement in economic sectors and focus instead on protecting individualrights (life, liberty, and property).[failed verification] This position is alternatively summarized in what is known as the Iron Law of Regulation, which states that all government regulation eventually leads to a net loss in social welfare.[22][23]
Some argue that companies are incentivized to behave in a socially responsible manner, therefore eliminating the need for external regulation, by their commitment to stakeholders, their interest in preserving reputability, and their goals for long term growth.[22]
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