Regulatory economics

Economics of regulation

Regulatory economics is the application of law by government or regulatory agencies for various economics related purposes, including remedying market failure, protecting the environment and economic management.

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." These draw on sociologists (such as Max Weber, Karl Polanyi, Neil Fligstein, and Karl Marx) and the history of government institutions partaking in regulatory processes. "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." *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 of principal agent problems. Principal agent theory addresses issues of information asymmetry. 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.

The World Bank's Doing 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 the OECD, compared to 60 in Sub Saharan Africa; the cost as a percentage of GNP (not including bribes) is 8% in the OECD, and 225% in Africa. The Worldwide 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" is one of the six dimensions of governance that the Worldwide 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.

Overly complicated regulatory law, increasing inflation, concern over regulatory capture, and outdated transportation regulations made deregulation an appealing idea in the US in the late 1970s. During his presidency (1977 1981), President Jimmy 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. President Ronald Reagan took up the mantle of deregulation during his two terms in office (1981 1989) and expanded upon it with the introduction of Reaganomics, 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 the Savings and Loan Crisis of the late 1980s and 1990s. 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. Others support continued regulation on the basis that deregulation of the financial sector led to the 2007 financial crisis and that regulations lend stability to the economy. In 2017, President Donald Trump signed an executive order that he claimed would "knock out two regulations for every new regulation." 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." 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.

The regulation of markets is to safeguard society and has been the mainstay of industrialized capitalist economic governance through the twentieth century. 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.

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. 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.