Theories of Regulation Lesson 5

Outline Definition of Regulation Process of Regulations Regulatory Agency Employees Theories of Regulation

Definition Definition of Regulation “A government imposed limitation on the behavior of individuals or organizations.” President and legislature create regulations and the regulatory agencies Regulatory agency enforces the limitation

Definition Regulatory agencies are influenced by Politicians Regulatory agency employees Firms Interest groups

Process of Regulation Various groups in society strive for control or influence over regulatory agencies Consumer groups – want lower prices Incumbent firms – want high stable profits Also restrict international trade Also restrict labor unions Competitors – want more liberalized markets

Regulatory Agency Employees Careerist Wants agency to exist and grow Careerist wants simple rules to avoid problems Politician Will leave agency for other office Politician wants to please interest groups Professional Will move on to other work Professionals want more complex rules Complex rules create demand for smarter professionals Professionals are paid more

Theories of Regulation Different theories explain the relationship between the public and regulatory agencies Public Interest Theory Capture Theory Principal Agent View Parkinson’s Law

Public Interest Theory Government creates a regulatory agency. Government wants to correct a problem in a market Example 1 - One firm, a monopoly, controls a market, preventing market competition Unregulated monopoly increases prices and reduces output Gov. regulates monopoly

Public Interest Theory Example 2 - Firms producing contaminated foods Gov. regulates food, reducing food contamination Regulation increases “social welfare” Improves society

Capture Theory First variation Firms in an industry has a demand for regulation. Firms are friends with the regulatory agencies Regulatory agencies strongly influence the President and legislature Industry “captures” the government

Capture Theory The industry controls the regulatory agencies. Industry wants high prices and low output Industry wants to capture consumer surplus

Capture Theory Second variation Firms or an interest group capture the regulatory agencies United States Politicians want to be re-elected to office Political campaigns costs millions of dollars Firms and interest groups contribute campaign funds

Capture Theory Politicians write favorable laws for firms or interest groups Regulatory agencies follow and enforce the laws

Principal Agent View Government bureaucracies do not serve the purpose that they were created for Regulatory agencies are concerned about maximizing their power, influence, and prestige Agencies could be: Dysfunctional Corrupt

Parkinson’s Law C. Northcote Parkinson, British economist Noticed as the British Empire became smaller, the number of employees in the Colonial Office increased Less work means more workers??? Note – Colonial Office administered the British Empire

Parkinson’s Law Law - Government agencies expand over time The expansion has no relationship to the amount of work that needs to be done Regulatory agencies expand approximately 5% per year A private firm expands a business to expand sales, services, or new products. Expansion is profit driven Expansion means more work

Parkinson’s Law Parkinson’s Law applies to many gov. agencies Why? 1. “Expenditures rise to meet income” No matter the amount of government funding for a regulatory agency, the agency always spends the money. Gov. agencies want more and more funding!

Parkinson’s Law 2. “Work expands so as to fill the time available for its completion” If a bureaucrat needs 4 hours to complete a task and has an 8-hour work day, the bureaucrat will expand the task into 8 hours

Parkinson’s Law 3. Bureaucrats like “to multiply subordinates, not rivals” A bureaucrat can elevate himself as manager by hiring subordinates To hire subordinates, bureaucrats “create work for each other” Expand paperwork and broaden regulations If bureaucrat hires a rival, then that rival also competes for a promotion

Parkinson’s Law Thus, the size, scope, and mission of gov. increases each year U.S. government agencies increase 5 to 10% per year

Conclusion My opinion Public Interest View dominates for new or re-structured regulatory agencies Capture Theory, Principal Agent View, and Parkinson Law start to dominate over time as regulatory agency matures

References I have the Economist article 1. Parkinson, C. Northcote Parkinson's Law. Cambridge and Massachusetts: The Riverside Press 2. Parkinson, C. Northcote. November "Parkinson's Law." The Economist