We’ve never understood why regulation has such a bad name in America. Yes, there are all kinds of terrible specific implementations of the concept “regulation.” But the difficulty of getting it right doesn’t mean the concept should be rejected out of hand, since it turns out the alternative of “no regulation” isn’t so hot. And per an article in today’s New York Times, businessmen are increasingly coming around to that view.
The problem is too many people posit a bizarre concept of “free markets” which stands in contrast to an evil antipode of “bureaucratic control.” Now in the days of the Cold War, when the Communism meant central planing, and that stood in contrast to actions largely in the hands of private agents, that dichotomy made some sense. But as America moved, right, “free markets” morphed into a Libertarian fantasy of no government rule-setting, while any government interference came to be characterized as a liberal (read watered-down Communist) conspiracy.
A seminal and widely overlooked 1994 Harvard Business School article, “Efficient Markets, Deficient Governance,” by Professor Amar Bhide argues that regulations are necessary for markets to function well. He notes that the market that most people like to uphold as a shining example of an efficient market, the US stock exchanges, are the creation of regulations. Unlike bonds or commodity contracts, stocks are a very promise to investors, and historically had been traded only among people who knew the business and the principals well and often played at least an advisory role. In the absence of extensive disclosures and stringent accounting requirements, no one would trade equities on an anonymous, arm’s length basis.
More recently, Mark Thoma, in “Markets are Not Magic,” reminded readers that a quite a few conditions have to be satisfied for markets to be efficient:
n order to work their magical efficiency, markets need very special conditions to be present. There must be full information available to all participants. Product quality, locations and prices of alternative suppliers, every relevant piece of information must be known. Not quite sure if the wine is good or not? That’s an information problem. Not sure if the used car has problems? Don’t know where any gas stations are except the ones beside the freeway in a strange town? No way to monitor the quality of the building built in Iraq with U.S. aid? No way to be sure if consultants are worth the amount they are being paid? Information problems are common and they can cause substantial departures from the perfectly competitive, ideal outcome.
There also must be numerous buyers and sellers, enough so that no single buyer or seller’s decisions can affect the market price. For example, if a firm can affect the market price by threatening to limit supply, the market does not satisfy this condition. If, as some claim, CEOs are in such short supply that they can individually negotiate their compensation, then the market is not producing an efficient outcome. Whenever there are a small number of participants on either side of the market – suppliers or demanders – this is potentially problematic.
In order for markets to work their magic, the product must be homogeneous. That is, the product or input to production sold by all firms in the market must be perfectly substitutable so that as far as the buyer is concerned, one is as good as the other. If some buyers favor one brand over another, if CEOs are perceived to have different and unique talents, if government favors one contractor over another due to political contributions, this condition does not hold. In many cases the variety may be worth the inefficiency, not many of us would want just one style and color of shirt to be available in stores, but the inefficiency is there nonetheless.
In order for markets to work their magic there must be free entry and exit. Most people understand free entry, but free exit is sometimes less evident….Whenever barriers exist in markets that prevent free movement into and out of the marketplace or between firms within a market (on either side – there are sometimes barriers to purchasing as well), markets will underperform.
The list goes on and on. In order for markets to work their magic, there can be no externalities, no public goods, no false market signals, no moral hazard, no principle agent problems, and, importantly, property rights must be well-defined (and I probably missed a few). In general, the incentives that the market provides must be consistent with perfect competition, or nearly so in practical applications. When the incentives present in the marketplace are inconsistent with a competitive outcome, there is no reason to expect the private sector to be efficient.
If such a market existed, no business would want to be involved in it. It would be impossible to make money. It’s market inefficiencies that create profit opportunities.
But as the New York Times tells us, companies are coming to realize that the sort of safety and product quality standards that many of them once thought were annoying, costly, and unnecessary actually serve them as much as they help consumers. In economic terms, regulation solves an information problem. If consumers are uncertain about product quality, and have to incur too much in the way of costs to get enough information, they wont’ make a purchase. And corporations are learning that to their horror as consumers abandon their products out of fear that they might contain Chinese components that could be dangerous.
Admittedly, this effort is completely self-interested. Not only are companies losing sales, but they are also worried that it they do not take the lead in proposing solutions, legislators may impose standards that they find unduly stringent. It’s tantamount to trying to get in front of a mob and call it a parade. And one of the reasons that many industries are pushing hard now is that the Bush administration has been willing to include provisions that bar lawsuits, which means that a consumer’s only recourse is to a regulator. And as we have noted before, regulators are often co-opted by their charges.
From the New York Times:
For toys and cars, antifreeze and fireworks, popcorn and produce and cigarettes and light bulbs, among other products, industry groups or major manufacturers are calling for federal health, safety and environmental mandates. Some of those industries are abandoning years of efforts to block such measures, often in alliance with the Bush administration, which pledged to ease what it views as costly, unnecessary rules.
The consequences for consumers, though, are not yet clear. The tactical shift by industry groups is motivated by a confluence of self-interests: growing competition from inexpensive imports that do not meet voluntary standards, and a desire to head off liability lawsuits and pre-empt tough state laws or legal actions that were a response to laissez-faire Bush administration policies. Concerns that Democrats could soon expand their control in Washington have also prompted manufacturers or producers to seek regulations that they consider the least burdensome, regulatory experts say….
Some industries and consumer groups are aligned in seeking the same regulations, though perhaps for different reasons. “It’s definitely a strange-bedfellow situation,” said Sarah Klein, a lawyer at the Center for Science in the Public Interest…. “The voluntary system is not working from a food-safety perspective, and it’s creating real problems for the industry.”
Other industries, though, are endorsing mandated government standards that fall well short of what consumer advocates want or what tougher state rules require. Trade groups representing makers of antifreeze, upholstered furniture and all-terrain vehicles, for example, had long opposed federal regulations, but are now pushing the Bush administration for rules that consumer advocates say inadequately address safety or environmental concerns.
“I am worried about industry lobbyists bearing gifts,” said Edmund Mierzwinski, consumer program director at the U.S. Public Interest Research Group in Washington. “I don’t trust them. Their ultimate goal is regulation that protects them, not the public.”
Federal agencies and the White House have responded to these regulatory proposals in varying ways, with some agencies quickly endorsing them and others deferring action or moving to block them. Susan E. Dudley, the head of the White House Office of Management and Budget division that oversees administration regulatory policy, said she was not sure if the number of requests for federal regulations from industry groups was rising. The administration must evaluate each of these proposals, she said, “to understand the full consequences of regulations on all citizens.”
The practice of industry groups turning to regulators or legislators in Washington for a national standard or mandate is not new, of course. While businesses often oppose requirements by saying they are unnecessary as it is already in their interest to produce safe products, at other times they have asked for them to avoid a patchwork of state regulations, to ensure that competitors must meet the same standard or to provide legal protection.
Warning labels on cigarettes, certain workplace safety laws and even nutritional labels on food packaging can be attributed, in part, to actions by industries over the last four decades to push for a federal standard, industry lawyers and lobbyists said.
But industry officials, consumer groups and regulatory experts all agree there has been a recent surge of requests for new regulations, and one reason they give is the Bush administration’s willingness to include provisions that would block consumer lawsuits in state and federal courts.
Such pre-emption clauses were included, for example, in a drug label rule issued by the Food and Drug Administration in 2006 and in a new fire-prevention standard for mattresses imposed by the Consumer Product Safety Commission in July, said David C. Vladeck, a professor at the Georgetown University Law Center.
The pre-emptions bar consumers from filing liability claims in courts and supersede any tougher state regulations, extremely valuable protections for a major manufacturer, Mr. Vladeck said. “This is Christmas,” he said of industry, “this is their wish list.” A number of businesses are seeking such pre-emptions, though the clauses are being challenged in many courts.
Concerns about competition have led to other proposals. As imports from China have grown in recent years, low-priced Chinese products that do not meet voluntary industry standards have motivated trade groups to seek new safety mandates….
The slow response by the Bush administration to several of these proposals has been a source of frustration to some industry groups.
“We have had a very, very uphill battle trying to get regulation,” said David H. Baker, a lawyer for the Lighter Association. The organization, representing cigarette lighter manufacturers, has been seeking a mandatory standard because unsafe, inexpensive Chinese imports were flooding the market, but staff members at the Consumer Product Safety Commission recommended against such a rule, saying the number of deaths and injuries did not justify it.
Similarly, the Bush administration is opposing legislative efforts, endorsed by popcorn makers and health and labor groups, that would impose strict limits on the levels of fake butter that can be found in the air in microwave popcorns plants. An ingredient in synthetic butter can cause deadly lung damage in workers, but the administration says the science on the issue is not conclusive.
Last year, almost all of the nation’s spinach crop was destroyed after contaminated spinach from one 50-acre California farm sickened nearly 200 people in 26 states, killing a Wisconsin woman. It was the last straw for large growers, who now support mandatory safety standards. But the Department of Health and Human Services has been slow to endorse them, leading some proponents to conclude that the agency has objections.
“It’s a little unique when both consumer groups and industry associations are out there saying that we need new regulations, and the government doesn’t agree,” said Jenny Scott, vice president for food safety programs of the Grocery Manufacturers Association….
Robert Shull, deputy director for auto safety and regulatory policy at Public Citizen, a consumer advocacy group based in Washington, said his organization and other consumer watchdogs would be keeping close tabs to see if these different proposals amounted to more than simply “opportunistic attempts to avoid real regulation.” But Mr. Shull said he was encouraged that at least some companies appeared to be coming forward with meaningful ideas.
“It can give American companies a leading edge,” Mr. Shull said, “especially if the safety or environmental standard is in the vanguard of what is going to happen worldwide.”