Friday, April 23, 2021

Stigler's Economic Theory of Regulation: The Semicentennial

I've found that the word "regulation" is a sort of Rorschach test on which many people project their broader political beliefs. Some are deeply suspicious of any proposals that can be characterized as "deregulation," and predisposed to favor "regulation" even before knowing the details of the proposal. These people tend to begin with a belief that private market actors are almost also pushing up to and beyond the edge of what is good for society, and thus comfortable with a presumption that government pushback in the form or regulation may help.  Indeed, for the first three-quarters of the 20th century, during the rise of US regulatory agencies from near-zero to high prominence, this group was preeminent in how most academics and policy-makers thought about regulation. 

On the other side, another group is deeply suspicious of regulations, because they mistrust the ability of government both to diagnose problems with a market economy or to design solutions. Instead, they fear that government regulations often end up either supporting or offering loopholes for politically powerful interest groups. The patron saint of this second group is George J. Stigler, who 50 years ago published published "The Theory of Economic Regulation" in the Bell Journal of Economics and Management Science (Spring 1971, 2:1, pp. 3-21, available via JSTOR and other places on the web). Stigler later won the 1982 Nobel prize "for his seminal studies of industrial structures, functioning of markets and causes and effects of public regulation."

In the 1971 essay, Stigler made the case for what is now called "regulatory capture." Imagine that the government is thinking about passing a certain set of regulations, and about an ongoing agency to enforce and interpret these regulation. Then ask yourself: Who has the most incentive to spend large amounts of money, time and attention focused on every twist and turn, every subclause and comma, of these regulations? And to sustain this focus day after day, year after year? Stigler pointed out that politics and behind-the-scenes lobbying will play a big role in this process. Over time, the industries directly affected by regulation will have a strong incentive to play a prominent role in shaping regulations. Stigler writes: "A central thesis of this paper is that, as a rule, regulation is acquired by the industry and is designed and operated primarily for its benefit."

For those who would like a thorough review of the arguments for and against this theory, the Stigler Center for the Study of the Economy and the State at the University of Chicago held a webinar on the occasion of the 50th anniversary of Stigler's essay this last week, and four hours of video of the discussions are available.  Several of the participants have also published short essays available at the link. Here, I'll offer a brief sketch of the state of the argument. 

1) Stigler had a point. 

Stigler's 1971 essay offers lots of examples in which it seems plausible that regulation was being used by incumbents to stifle competition and thus to improve their own profits. As he points out, the Civil Aeronautics Board which at the time set prices for all airline flights and decided which flights would be allowed did had "not allowed a single new trunk line to be launched since it was created in 1938." He cited studies that the Federal Deposit Insurance Corporation had "reduce[d] the rate of entry into commercial banking by 60 percent." Federal regulation of trucking led to a situation in which the number of licensed carriers was declining over time, despite thousands of annual applications for certificates to license additional truckers. Stigler wrote: "We propose the general hypothesis: every industry or occupation that has enough political power to utilize the state will seek to control entry."

The deregulation wave of the late 1970s and 1980s affected airlines, trucking and banking. But other examples mentioned by Stigler live on. Government regulations, typically at the state level, require licenses for about one-fourth of all US jobs. A well-developed body of evidence (often looking at what is regulated or unregulated across states) suggests that in many cases, these regulations are less about protecting the public than about limiting competition. It seems likely that the building trade unions have used building codes to hinder new cost-saving technologies, including factory-built homes.  Government regulations in education give large advantages to established colleges and universities, and to the public K-12 schools, while limiting entry of new competition. Rules to limit certain imports of goods from abroad are typically driven by domestic industries concerned about foreign competition.

Indeed, every time a supporter of government regulation bewails how a special interest has invaded the process and caused a desired regulation to be blocked or diluted, they are in effect channeling their inner Stigler-style skepticism about the practical reality of the regulatory process.  Are supporters of added government regulation at all surprised that big health insurance companies lobbied for the Patient Protection and Affordable Care Act of 2010 and benefited after its passage? Or that in the aftermath of new regulations to reduce the risk of government bank bailouts, big banks gained market share at the expense of smaller institutions? 

Whatever the actual shortcomings of the private sector, and whatever the theoretical case for corrective government regulation, Stigler-style skepticism offers a useful corrective about what regulations are actually enacted. As Filippo Maria Lancieri and Luigi Zingales write in their short essay accompanying the Stigler Center symposium: 

The 1887 Interstate Commerce Commission was the first government agency to regulate an important sector of the US economy. By the 1900’s, there were 10 federal agencies, employing 15,000 workers. By 2019, the number of agencies rose to 117, employing 1.4 million workers. The 20th century could easily be labeled the century of regulation. ...  Most likely, the 20th century would have also ended as the century of regulation if it were not for George Stigler.

2) Stigler probably overemphasized the role of pure regulator capture, as opposed to regulatory problems created by poor information or ideological bias. 

In Andrei Shleifer's keynote address for the Stigler Center symposium, he makes the point that there can be lots of reasons why regulations have mixed or negative effects. It's not all about regulatory capture by the industry affected. As a recent example, Shleifer points to the waves of rules and regulations that have become prominent in COVID-19 pandemic. For example, there have been rules about masks, social distancing, and lockdowns. There were regulations about what kinds of COVID-19 tests could be sold or used. There were rules about what constituted adequate testing of vaccines. There were questions over whether to shut down the use of the Johnson & Johnson vaccine over the possibility of a heightened risk of blood clots. 

Shleifer's point is not to argue for or against specific rules, but just to point out that, in general, the differences of opinion on these rules were shaped by available knowledge (and ignorance), and by beliefs about what risks were acceptable (or not), and what messages the public was ready to hear (or not). In these regulations and probably in many others as well, the key dividing lines are more about issues of knowledge and ideology that about a Stigler-style regulatory capture scenario. Of course, this doesn't make Stigler's insights irrelevant, but it does suggest that his "theory of regulation" was focused only one one slice of the issues involved. 

3) Stigler's "theory of regulation" may overemphasize the potential for bad outcomes, to the extent that his 1971 article essentially fails to acknowledge potentially beneficial outcomes of regulation. 

Cass Sunstein makes this argument in his keynote address for the second day of the Stigler Center symposium, and also in a short article written to accompany the event.  He points to a number of specific regulations: for example, rules requiring accessibility to public areas for those with disabilities; or rules specifying the rights that airline passengers have when a flight is overbooked; or the rules that now require rear-view cameras in all motor vehicles; or rules that require the Post Office to collect data on certain packages arriving from overseas as part of the effort to reduce imports of opioids. With these and many other examples in mind, Sunstein writes: 

Stigler offered, but did not adequately defend, the proposition that “as a rule, regulation is acquired by the industry and is designed and operated primarily for its benefit.” That proposition is false. As a rule, regulation is not acquired by the industry, and it is not designed and operated for its benefit (primarily or otherwise). ... Surely there are such examples, but they are not “the general rule.” I conclude that the success and influence of Stigler’s argument owed a great deal, not to its accuracy, but to its iconoclasm, its sense of knowingness, its smarter-than-thou, cooler-than-thou cynicism (appealing to many), its mischieviousness, and its partial (!) truth.
Sunstein is fully aware of the politics behind regulation. But rather than defaulting to the conclusion that all regulations are captured by industry, he suggests instead a focus on why regulators hold the beliefs that they do. When asking whether regulators are right or wrong, Sunstein writes: 
But why, exactly, do they believe such things? There are two main answers. The first involves the information they receive: What do they learn, and from whom do they learn it? In some cases, “the industry” is relevant; in other cases, journalists matter; political parties, public interest groups, think tanks, and academics might matter as well. Some regulators live in echo chambers; others do not. In many cases, we might well be able to speak of “epistemic capture,” which occurs not when regulators are literally pressured (threatened or promised), but when what they believe to be true is only a subset of the truth, or not true at all. The second main answer involves the motivations of the regulators themselves. What do they want to believe, and what do they want to dismiss? ...  Understanding what people end up hearing and crediting, and also what they want to hear and credit, would enable us to make real progress in specifying the mechanisms that lead to regulation.

As Lancieri and Zingales wrote in their essay, "Stigler’s enduring legacy was opening the door for the political analysis of regulation." Perhaps today it seems obvious to everyone that political analysis of regulation is a useful and important task. But it wasn't obvious to everyone a half century ago.