Abstract
George Stigler’s “The Theory of Economic Regulation” (Bell J Econ Manag Sci 2(1):3–21, 1971) is a landmark in the economics of regulation. It used simple public choice reasoning to set out the “capture theory” of regulation whereby “… as a rule, regulation is acquired by the industry and is designed and operated primarily for its benefit.” This article, summarizes the context within which Stigler (1971) appeared and evaluates its long run impact. A central argument is the need to distinguish “acquired” from “designed and operated.” The rule that regulation is produced in response to industry pressure seems honored mainly in the breach. Maintenance of the institutional status quo seems the more common industry goal. However, once the status quo is altered, the industry interest will, as Stigler argued, receive disproportionate weight. I discuss and analyze the varying impact of industry interests over three significant regulatory transitions—in transportation, pharmaceuticals and banking. I conclude that the durable impact of Stigler (1971) comes from the public choice framing and the consequent importance of organized interests to analysis of regulation.
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Notes
Stigler gradually abandoned the ineffective regulator under the weight of contrary evidence. But it took some doing. I was his Ph.D. student during that transition. My dissertation topic was the effect of federal insurance of bank deposits on entry into commercial banking (effectively you needed a grant of insurance to start a new bank). For a half year or so I worked on my own, learning about the history, assembling data, running regressions and writing it all up for Stigler’s perusal. I could not avoid the conclusion that deposit insurance had substantially reduced the rate of entry into banking. He had one comment: “This is fine for preliminary work. Come back in another six months with the right answer.” Facts are stubborn. I never could get the right answer, and fortunately for me he eventually relented.
But uncited.
When I taught the subject, I would ask the class a simple question: can you name the agency that regulates electricity rates in this state? Very few students could answer correctly. To those who did I posed the following: can you tell me whether, on the whole, the decisions of the … Commission benefitted or harmed you? I never got any answer.
For example, the Department of Transportation covered the carriers; Commerce, Agriculture and Interior covered the shippers, and so on.
The companion effort to deregulate airlines shares a similar history. It was part of the abortive effort in 1970–1971 that I have described above. It was revived in the Ford Administration and supported by its successors. Bipartisan support arose in Congress for both surface and air transport deregulation. For example, the airline bill was written by a committee chaired by Sen. Edward Kennedy and passed with overwhelming Republican and Democrat majorities.
Many years after railroad regulation was reformed, I shared a podium with some industry executives. They were uniformly supportive of the new status quo, and their major political battle was to defend against pressure for re-regulation.
In Peltzman et al. (1989) I try, with mixed results, to apply the economic theory to the deregulation events of the 1970s and 1980s. I argued that the economic theory could understand deregulation as a response to shrinking regulatory rents and that that scnario applied to railroads and airlines and later on, to some extent, to telecommunications. But it hardly applied to common carrier trucking, where the rents were growing until Congress took them away.
Efficacy meant that the drug worked as the manufacturer claimed.
The decision could be appealed in court, but courts have been deferential to such regulatory judgments.
Accounting for the opportunity cost of capital tied up for 12 years roughly doubles the cost.
The US size threshold was $50 billion, and it also included investment banks and insurance companies.
The US GSIFIs include six banks and two investment banks (Goldman Sachs and Morgan Stanley). The commercial bank GSIFIs are JP Morgan Chase, Bank of America, Citigroup and Wells Fargo, which collectively hold around 40% of domestic bank deposits. Two “trust banks” (which specialize in institutional asset custodianship and servicing) – BNY Mellon and State Street – also are GSIFIs.
Here the regulator – the US Federal Reserve Board – estimates the impact of various adverse macroeconomic scenarios on the bank’s portfolio. The Fed does not disclose the scenarios or the model linking them to the portfolios.
They could include, e.g., higher capital and liquidity requirements, including restrictions on dividends. Stress testing is not limited to GSIFI banks, but they are the main targets of concern.
The rule prohibits banks from trading securities for their own account (versus trading to accommodate the needs of a client). Drawing a line between the two kinds of trading proved difficult. The rule was not finalized until 2013, and it subsequently has been amended several times.
As “the plural of anecdote”, I only heard him say it, so it is left as an exercise for the reader to find the written quote, if any.
For example, by mandated “cooling off” periods between exit from a regulatory position and employment by a regulated firm.
From a presentation by Lloyd Blankfein, CEO of Goldman Sachs to the Credit Suisse Financial Services Conference, February 10, 2015.
For example, close to 10% of all Google Scholar cites to the article (1270 of the 13,521 that showed up in an early 2021 search) are from 2019 and later.
Other elements might include the political background. Three waves of new federal regulatory agencies swept US history – the Woodrow Wilson Progressive Era, the Franklin Roosevelt New Deal and the Nixon presidency. All of them were the product of Democratic congressional majorities.
This is the “bootlegger and Baptist” equilibrium (Yandle 1983) whereby the economic interest of the producers (the bootleggers) in output restriction (prohibition) coincides with the ostensibly more highly minded interest of the greens (the Baptists).
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Peltzman, S. “The theory of economic regulation” after 50 years. Public Choice 193, 7–21 (2022). https://doi.org/10.1007/s11127-022-00996-0
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DOI: https://doi.org/10.1007/s11127-022-00996-0