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14 December 2016
Authors: Darmesh N., Mahanbet N.

Regulatory economics is the economics of regulation, in the sense of the application of law by government or an independent agency 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.

Regulatory capture is the process by which 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. 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 [1].

Public services can encounter conflict between commercial procedures, 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.

For example, the sale and consumption of alcohol and prescription drugs are controlled by regulation in most countries, as are the food business, provision of personal or residential care, public transport, construction, film and TV, etc. Monopoliesare often regulated, especially those that are difficult to abolish (natural monopoly). The financial sector is also highly regulated [2].

Regulation can have several elements:

  • Public statutes, standards or statements of expectations.
  • A process of registration or licensing to approve and to permit the operation of a service, usually by a named organisation or person.
  • A process of inspection or other form of ensuring standard compliance, including reporting and management of non-compliance with these standards: where there is continued non-compliance, then:
  • A process of de-licensing whereby that organisation or person is judged to be operating unsafely, and is ordered to stop operating or suffer the penalty of acting unlawfully.

This differs from regulation in any voluntary sphere of activity, but can be compared with it in some respects. For example, when a broker purchases a seat on the New York Stock Exchange, there are explicit rules of conduct the broker must conform to as contractual and agreed-upon conditions that govern participation. The coercive regulations of the U.S. Securities and Exchange Commission, for example, are imposed without regard for any individual's consent or dissent as to that particular trade. However, in a democracy, there is still collective agreement on the constraint - the body politic as a whole agrees, through its representatives, and imposes the agreement on the subset of entities participating in the regulated activity [3].

Other examples of voluntary compliance in structured settings include the activities of Major League Baseball, FIFA (the international governing body for professional soccer), and the Royal Yachting Association (the UK's recognized national association for sailing). Regulation in this sense approaches the ideal of an accepted standard of ethics for a given activity, to promote the best interests of the people participating as well as the acceptable continuation of the activity itself within specified limits.

In America, throughout the 18th and 19th centuries, the government engaged in substantial regulation of the economy. In the 18th century, the production and distribution of goods were regulated by British government ministries over the American Colonies (see mercantilism). Subsidies were granted to agriculture and tariffs were imposed, sparking the American Revolution. The United States government maintained a high tariff throughout the 19th century and into the 20th century until the Reciprocal Tariff Act was passed in 1934 under the Franklin D. Roosevelt administration. However, regulation and deregulation came in waves, with the deregulation of big business in the Gilded Age leading to President Theodore Roosevelt's trust busting from 1901 to 1909, and deregulation and Laissez-Faire economics once again in the roaring 1920s leading to the Great Depression and intense governmental regulation and Keynesian economics under Franklin Roosevelt's New Deal plan. President Ronald Reagan deregulated business in the 1980s with his Reaganomics plan.

In 1946, the U.S. Congress enacted the Administrative Procedure Act (APA), which formalized means of assuring the regularity of government administrative activity, and its conformance with authorizing legislation. The APA established uniform procedures for a federal agency's promulgation of regulations, and adjudication of claims. The APA also sets forth the process for judicial review of agency action

The development and techniques of regulations have long been the subject of academic research, particularly in the utilities sector. Two basic schools of thought have emerged on regulatory policy, namely, positive theories of regulation and normative theories of regulation.

Positive theories of regulation examine why regulation occurs. These theories of regulation include theories of market power, interest group theories that describe stakeholders' interests in regulation, and theories of government opportunism that describe why restrictions on government discretion may be necessary for the sector to provide efficient services for customers. In general, the conclusions of these theories are that regulation occurs because [4]:

  1. the government is interested in overcoming information asymmetries with the operator and in aligning the operator's interest with the government's interest,
  2. customers desire protection from market power when competition is non-existent or ineffective,
  3. operators desire protection from rivals, or
  4. operators desire protection from government opportunism.

Normative economic theories of regulation generally conclude that regulators should

  1. encourage competition where feasible,
  2. minimize the costs of information asymmetries by obtaining information and providing operators with incentives to improve their performance,
  3. provide for price structures that improve economic efficiency, and
  4. establish regulatory processes that provide for regulation under the law and independence, transparency, predictability, legitimacy, and credibility for the regulatory system.

The Worldwide Governance Indicators project at the World Bank recognizes that regulations have a significant impact in the quality of governance of a country. The Regulatory Quality of a country, defined as "the ability of the government to formulate and implement sound policies and regulations that permit and promote private sector development is one of the six dimensions of governance that the Worldwide Governance Indicators measure for more than 200 countries.

Bibliography and references
1. Gary Adams, Sharon Hayes, Stuart Weierter and John Boyd, "Regulatory Capture: Managing the Risk" ICE Australia. 2015. 2. Helmet, Andeson. Body of Knowledge on Infrastructure regulation Theories of Regulation. 2016. 3. Lenon, Almort. "A Decade of Measuring the Quality of Governance". 2016. 4. Scott, Green. "Effects of corporate social responsibility and irresponsibility policies".Journal of Business Research. 2015.

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