Posner - Theories of economic regulation

Summary
The article analyzes theories concerning the pattern of government regulation of the economy.
It argues that the public interest theory and the political scientists' versions of the interest
group theory are unacceptable in their present form. The conclusion is that the economic
regulation theory, while promising, requires both more analytical development and new sorts of
empirical investigation before it can be accepted as an adequate positive theory of regulation

Introduction
It has been a challenge to describe the term of “economic regulation”, but it can be defined as
the taxes and subsidies of all sorts as well as to explicit legislative and administrative controls
over rates, entry, and other facets of economic activity.
Theories of economic regulation:

1. Public interest  This theory holds that regulation is supplied in response to the

demand of the public for the correction of inefficient or inequitable market practices
2. “Capture” theory  this theory holds that regulation is supplied in response to the
demands of interest groups struggling among themselves to maximize the incomes of
their members
a. There are other few variations of this theory, among them, are the political and
economic theories (explicadas mas abajito).

The public interest theory of regulation

The original theory

Assumptions about the economic policy:

1. Economic markets are extremely fragile and apt to operate very inefficiently if left alone
2. Government regulation is virtually costless

With these assumptions, it was very easy to argue that the principal government interventions
in the economy were simply responses of government to public demands for the rectification of
palpable and remediable inefficiencies and inequities in the operation of the free market.
However, were this theory of regulation correct, we would find regulation imposed mainly in
highly concentrated industries (where the danger of monopoly is greatest) and in industries
that generate substantial external costs or benefits, but we do not. Years of research have
demonstrated that regulation is not positively correlated with the presence of external
econotimies or diseconomies or with monopolistic market structure
The conception of government as a costless and dependably effective instrument for altering
market behavior is considered as a failure; particular schemes of government regulation can’t
be explained on the ground that they increase wealth.
A reformulation
The disappointing performance of the regulatory process is the result of particular weaknesses
in personnel or procedures that can and will be remedied (at low cost) as the society gains
experience in the mechanics of public administration.
Reformulation: The public interest theory regulation the public interest theory of regulation
holds that regulatory agencies are created for bona fide public purposes, but are then
mismanaged, with the result that those purposes are not always achieved.

 Esta es la excusa de esta teoría para que la regulació n no funcione

According to Posner, this is unsatisfactory on three grounds:

1. It fails to account for a good deal of evidence that the socially undesirable results of
regulation are frequently desired by groups influential in the enactment of the
legislation setting up the regulatory scheme. Sometimes the regulatory statute itself
reveals an unmistakable purpose of altering the operation of markets in directions
inexplicable on public interest grounds.
2. The evidence that has been offered to show mismanagement by the regulatory agency is
surprisingly weak. Much of it is consistent with the rival theory that the typical
regulatory agency operates with reasonable efficiency to attain deliberately inefficient
or inequitable goals set by the legislature that created it. The proclivity of some agencies
for concentrating their resources heavily on cases of small individual consequences is
consistent with an efficient allocation of resources within the agency. Employees of
regulatory agencies have the same incentives as those who work for private firms.
3. No persuasive theory has yet been proposed as to why agencies should be expected to
be less efficient than other organization.

A further reformulation of the public interest theory

The idea that regulation is an honest but frequently an unsuccessful attempt to promote the
public interest becomes somewhat more plausible if we introduce two factors often ignored:

1. The intractable character of many of the tasks that have been assigned to the regulatory
agencies. The clearest example is the regulation of price levels under public utility and
common carrier statutes. Although agencies are asked to do the impossible and it is not
surprising that they fail, and in attempting to succeed distort the efficient functioning of
the regulated markets, this does not explain why legislatures assign such tasks to
agencies.
2. The cost of effective legislative supervision of the agencies' performance. The costs of
legislative bodies are increasingly high because bargaining among a number of
individuals is a costly process (not in terms of money, but in efficiency). For this reason,
legislative bodies delegate functions to agencies or create new ones, only to not
monitoring properly the agencies previously created

Behavioral assumptions of the public interest theory

A problem with any version of the public interest theory is that the theory contains no linkage
or mechanism by which a perception of the public interest is translated into legislative action.
There are two possible ways around this problem:

1. One emphasizes the moral differences between private and political action. The
assumption that market behavior is normally motivated by fairly narrow considerations
 of self interest is plausible, because most market decisions are social goods rather than
bads. Where, however, an individual votes for policies designed to exploit his fellows, he
can hardly avoid confronting the moral implications of his action and the moral code
may constrain him from voting in that manner.
o En temas de votaciones, no solo hay una relació n de costo – beneficio, sino
también una mirada a la moralidad de la conducta.
2. A second approach is to observe the potentiality for collusion among politicians; if they
use their power to impose their policy preferences, it plausible to suppose that some
policies are adopted because they conform to the public interest - as conceived by the
politicians-.

Some versions of the capture theory

The Marxists and the muckrakers

The theory that economic regulation is not about the public interest at all, but is a process by
which interest groups seek to promote their (private) interests, takes several distinct forms:

1. Marxist theory: regulation comes from the influence of big capitalists, since they control
all institutions
2. La otra la explican en el título de abajo:

The political scientist’s formulations

This theory emphasizes in the importance of interest groups in the formation of public policy,
however, there is no theory to support this idea. The theory is that over time regulatory
agencies come to be dominated by the industries regulated (in practice, It can be
indistinguishable from some versions of the public interest theory).
Critics to the theory:

1. Not every agency is characterized by a pristine virtue; often there is no occasion for
conquest
2. The theory has no predictive or explanatory power at all when a single agency regulates
separate industries having conflicting interests.
3. The capture theory ignores a good deal of evidence that the interests promoted by
regulatory agencies are frequently those of customer groups rather than those of the
regulated firms themselves.

The economic theory of regulation

This theory discards the unexplained, and frequently untrue, assumption of pristine legislative
purpose; it admits the possibility of "capture" by interest groups other than the regulated firms;
and it replaces the "capture" metaphor, with its inappropriately militaristic flavor, by the more
neutral terminology of supply and demand. But it insists with the political scientists that
economic regulation serves the private interests of politically effective groups.
The economic theory insists that regulation can be explained as the outcome of the forces of
demand and supply
A closer look at the economic theory of regulation

The theory
This theory is based on 2 insights:

1. Since the coercive power of government can be used to give valuable benefits to
particular individuals or groups, economic regulation can be viewed as a product whose
allocation is governed by laws of supply and demand.
2. The second insight is that the theory of cartels may help us locate the demand and
supply curves. This theory identifies 2 costs of cartelization:
a. Cost to the sellers of arriving at an agreement on the price to be charged by and
the output of each seller
b. Cost of enforcing the cartel agreement against nonparticipants or defectors.

 Cartels are plagued by "free rider" problems

o En los carteles siempre va a estar la tentació n de vender a un precio má s bajo del
acordado, así sea que los otros se den cuenta, tipo “fue lindo mientras duró ”
porque ese tiempo va a ser profitable para ellos.
 The members of the industry must agree on the form of regulation. And just as the
individual seller's profits are maximized if he remains outside of the cartel (as long as
his competitors remain inside), so any individual or firm that would be benefitted by a
type of regulation will have some incentive to avoid joining in the efforts of his group to
obtain the regulation. In the regulatory sphere, the fewer the prospective beneficiaries
of a regulation, the easier it will be for them to coordinate their efforts to obtain the
regulation.
o En este mismo sentido, Posner dice que los carteles funcionan cuando son entre
pocas personas
o En esto también es relevante la homogeneidad de los intereses de sus miembros
 Casual observation suggests that highly concentrated industries are actually less likely
to obtain favorable regulation than less concentrated industries,26 reversing the usual
expectation with regard to the incidence of cartelization.
Reasons why the pattern of regulation is different from the pattern of private cartelization:

1. The demand for regulation (derived from its value in enhancing the profits of the
regulated firms) is greater among industries for which private cartelization is an
unfeasible or very costly alternative-industries that lack high concentration and other
characteristics favorable to cartelizing
2. Whereas cartelization is the product purely of the cooperative action of the firms,
favorable regulation requires, in addition, the intervention of the political process. the
political dimension of regulation requires two modifications of the theory of cartels as
applied to regulation:
a. Each member of an industry will have an interest in participating in the coalition
seeking protective regulation when there is significant asymmetry among the
positions of industry members.
 Para tratar de contrarrestar el problema del free rider
b. The determinants of political influence must be worked into the supply side of
the market in regulation. It’s important to determine three distinct forms of
political systems of democratic countries:

 "entrepreneurial:" favorable legislation is sold to the industries that

value it most. The costs of cooperative action are irrelevant under this
 system: the government can use its taxing or other powers of coercion to
enable the industry to overcome any free-rider problem it might have, in
order that the industry can raise the maximum purchase price for the
legislation.
 "coercive:" legislation is awarded to groups that are able to make
credible threats to retaliate with violence (or disorder, or work
stoppages, or grumbling) if society does not give them favorable
treatment.
 "democratic:" legislation is awarded by the vote of elected
representatives of the people. In this system, the free rider problem
remains

 The foregoing analysis suggests that while the characteristics that predispose an
industry to successful cartelization may also help it to obtain favorable government
regulation, one characteristic that discourages cartelization-a large number of parties
whose cooperation is necessary to create and maintain the cartel encourages regulation.
For the small groups of industries trying to cartelize: (1 ) even a naturally monopolistic industry
would gain from legislation that increased the demand for its product (e.g., by suppressing
substitutes) or prevented entry;"' (2) even if the members of the regulated industry do not gain
from regulation, other groups, for example groups of customers, may; and (3) concentration or
monopoly may itself be the result of regulation.
As part of the search for a harder-edged theory of regulation, it has been suggested that the
geographic concentration of the people who would benefit from favorable regulation is an
important element since a legislator will exert greater efforts on behalf of a voter bloc large
enough to influence the outcome of an election materially.

The evidence
There are a fair number of case studies-of trucking, airlines, railroads, and many other
industries-that support the view that economic regulation is better explained as a product
supplied to interest groups than as an expression of the social interest in efficiency or justice.
The following are notes made by Posner about how the regulatory process is well designed to
achieve the ends by the economic theory of regulation:

1. The delegation of regulatory authority by legislatures to administrative agencies and not

courts based on the agency’s specialization and its independence from political control
o Con esto no se refiere al control político como nosotros lo conocemos, sino que
se refiere a que las cortes son má s difíciles de corromper
Shortcomings of the empirical evidence that supports the economic theory of regulation:

1. Most of the evidence is consistent with any version of the interest group theory
2. The empirical research has not been systematic
3. Some of the case studies of regulation have produced evidence difficult to reconcile with
the economic theory – related to studies which indicate that maximum price regulation
has no effect on the price levels of public utilities-
4. The empirical evidence depends heavily on a confident rejection of the public interest
rationales in which all legislation is cloaked
5. The effects of economic regulation are difficult to trace
6. Rhetoric of the public interest, in which discussions of public policy are conducted and
the policies themselves, framed.
Conclusion
Neither theory can be said to have, as yet, substantial empirical support, however, the success of
economic theory in illuminating other areas of nonmarket behavior leads one to be somewhat
optimistic that the economic theory will eventually jell: the general assumption of economics
that human behavior can best be understood as the response of rational self-interested beings
to their environment must have extensive application to the political process.