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Deregulation

Regulation consists of the imposition of economic controls by government agencies on private business or on individual behavior. Deregulation then consists of the elimination or the loosening of these controls. The focus here is on one kind of regulatory activity, and its demise, namely on controls aimed at affecting the entry and exit of firms into and out of an industry and the prices charged to consumers of that industry's goods or services.

A significant (aging and largely discredited) literature devotes itself to public interest explanations of regulatory and deregulatory activities, based on Paretian welfare economics, buttressed by the potential compensation test for efficiency in cost-benefit analysis. This entry ignores the public interest approach and focuses attention instead on modern private interest theories of regulation and deregulation.

A Stylized Model of Regulation and Deregulation

In this approach, Robert McCormick and Robert Tollison modeled politicians as providing a brokering function in the political market for wealth transfers. Special interest groups capable of effective economic organization “demand” such transfers. Other more general groups, incapable of effective economic organization, “supply” such transfers, albeit at a political price. Politicians effect political market equilibrium, balancing benefits against costs at the margin, to maximize their own utility functions, weighted variously in terms of expected wealth and expected votes.

The concepts of “demand” and “supply” in this stylized model require a somewhat special interpretation. “Demand” consists of willingness to pay, either in the form of money transfers or votes, of wellorganized special interests (rent-seekers) in return for wealth transfers carrying a positive net present value to the group or groups concerned. Such positive returns represent rent and not profit, because the overall wealth of society is diminished and not enhanced by rent-seeking activities. The rent-seekers who typically represent “demand” are not restricted to ultimate beneficiaries, such as the owners and employees of the regulated cartels. They are joined—indeed in some cases manipulated—by the departments and agencies of government whose budgets are enhanced by their participation in the wealth transfer process.

“Supply” consists of the inability or unwillingness of those from whom wealth transfers are sought, at the relevant margin, to protect themselves by countervailing offers of money transfers and votes to the brokerage mechanism. The existence of “supply” does not imply an absence of rent protection outlays, because political market equilibrium is not necessarily equivalent to market domination. Moreover, the concept of “supply” as applied in this model contains connotations of coercion that are absent in the standard textbook definition.

The Economic Theory of Regulation

Following a flawed start by George Stigler (1911–1992), Sam Peltzman correctly formulated the economic theory of regulation in 1976. He deployed a prototype version of the stylized model outlined above. Peltzman derived an equilibrium in which the utility-maximizing politician or regulator allocates benefits across groups optimally, in accord with the usual marginal conditions. The dominant political strategy, in general, is not one of complete cartel protection. Instead, the politician or regulator allocates benefits across consumer and producer groups so that total political utility is maximized.

The economic theory was refined in 1983 by Gary Becker, who argued that deadweight losses limit the effectiveness of interest groups in regulatory markets and serve as constraints on inefficient regulatory policies. Rising marginal deadweight losses progressively enfeeble the winners relative to the losers. Becker's reformulation produces a political equilibrium with some deadweight loss, but it suggests a bias against the unbounded deadweight loss implied by Peltzman's theory. In effect, according to Becker, the political process is drawn toward efficient modes of wealth redistribution in general, and to efficiencyenhancing regulation in particular.

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