Regulatory Administrative Institutions MPA 517 Lecture-3 1

Recap Why Regulations? Types of regulations Importance of regulation in country 2

Why Regulations Regulation creates limits, constrains a right, creates or limits a duty, or allocates a responsibility A regulation or administrative rule, issued by an organization, used to guide or prescribe the conduct of members of that organization; can specifically refer to acts in which a government or state body limits the behavior of businesses 3

Third-party regulation Some regulatory bodies designate third parties to provide approvals for specific types of products before they are allowed to be sold and/or used in the specific regulator's area of responsibility. 4

Example PTA and State Bank of Pakistan The introduction of third party payment networks also known as MPSP (Mobile Payment Service Providers) would be of immense advantage since these third- party payment handing agents can work with many providers, rather than the closed networks. We could foresee opportunities for service providers (both from Banks and Mobile Sector) who move quickly to create new products, especially if they can establish shared networks of third party agents. 5

Today’s Lecture Regulatory economics Regulatory Capture Externality Negative externality Positive externality 6

Regulatory economics Regulatory economics is the economics of regulation, in the sense of the application of law by government for various purposes, such as centrally-planning an economy, remedying market failure, enriching well- connected firms, or benefiting politicians. It is not considered to include voluntary regulation that may be accomplished in the private sphere 7

Regulatory Capture Countering, overriding, or bypassing regulation is Regulatory Capture where a regulatory agency created to act in the public interest, instead advances the commercial or special concerns of interest groups that dominate the industry that the agency is charged with regulating 8

Regulatory Capture The probability of regulatory capture is economically biased, in that 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. Thus the likelihood of regulatory capture is a risk to which an agency is exposed by its very nature 9

Regulation Public services can encounter conflict between commercial procedures (e.g. maximizing profit), and the interests of the people using these services, as well as 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. This regulation ensures that a safe and appropriate service is delivered, while not discouraging the effective functioning and development of businesses. 10

Externality In economics, an externality is the cost or benefit that affects a party who did not choose to incur that cost or benefit For example, manufacturing activities that cause air pollution impose health and clean-up costs on the whole society, whereas the neighbors of an individual who chooses to fire- proof his home may benefit from a reduced risk of a fire spreading to their own houses. 11

Externality If external costs exist, such as pollution, the producer may choose to produce more of the product than would be produced if the producer were required to pay all associated environmental costs. If there are external benefits, such as in public safety, less of the good may be produced than would be the case if the producer were to receive payment for the external benefits to others. 12

Externality For the purpose of these statements, overall cost and benefit to society is defined as the sum of the imputed monetary value of benefits and costs to all parties involved. Thus, unregulated markets in goods or services with significant externalities generate prices that do not reflect the full social cost or benefit of their transactions; such markets are therefore inefficient. 13

Negative Externality A negative externality (also called "external cost" or "external diseconomy") is an action of a product on consumers that imposes a negative effect on a third party; it is "external cost". Many negative externalities are related to the environmental consequences of production and use. 14

Examples Air pollution from burning fossil fuels causes damages to crops, (historic) buildings and public health. Water pollution by industries that adds effluent, which harms plants, animals, and humans. Noise pollution which may be mentally and psychologically disruptive. Systemic risk describes the risks to the overall economy arising from the risks that the banking system takes. A condition of moral hazard can occur in the absence of well-designed banking regulation, or in the presence of badly designed regulation 15

The harvesting by one fishing company in the ocean depletes the stock of available fish for the other companies and overfishing may be the result Consumption by one consumer causes prices to rise and therefore makes other consumers worse off, perhaps by reducing their consumption Antibiotic use contributes to antibiotic resistance, reducing the future effectiveness of antibiotics. Individuals do not consider this efficacy cost when making usage decisions, leading to socially sub-optimal antibiotic consumption. Government policies proposed to preserve future antibiotic effectiveness include educational campaigns, regulation, and patents. 16

Positive externalities Increased education of individuals can lead to broader society benefits in the form of greater economic productivity, a lower unemployment rate, greater household mobility and higher rates of political participation An individual who maintains an attractive house may confer benefits to neighbors in the form of increased market values for their properties In an area that does not have a public fire department, homeowners who purchase private fire protection services provide a positive externality to neighboring properties, which are less at risk of the protected neighbor's fire spreading to their (unprotected) house A beekeeper keeps the bees for their honey. A side effect or externality associated with such activity is the pollination of surrounding crops by the bees. The value generated by the pollination may be more important than the value of the harvested honey 17

Summary Regulatory economics Regulatory Capture Externality Negative externality Positive externality 18

Next Lecture Five Areas of Government Regulation of Business – Advertising – Employment and Labor – Environmental – Privacy – Safety and Health 19