Theories of Regulation

Lesson 5

Outline

Definition of Regulation

Process of Regulations

Regulatory Agency Employees

Theories of Regulation

Definition

Definition of Regulation “A government imposed limitation on the

behavior of individuals or organizations.”

President and legislature create regulations and the regulatory agencies

Regulatory agency enforces the limitation

Definition

Regulatory agencies are influenced by• Politicians

• Regulatory agency employees

• Firms

• Interest groups

Process of Regulation

Various groups in society strive for control or influence over regulatory agencies • Consumer groups – want lower prices

• Incumbent firms – want high stable profits • Also restrict international trade

• Also restrict labor unions

• Competitors – want more liberalized markets

Regulatory Agency Employees Careerist

• Wants agency to exist and grow • Careerist wants simple rules to avoid problems

Politician • Will leave agency for other office • Politician wants to please interest groups

Professional • Will move on to other work • Professionals want more complex rules

• Complex rules create demand for smarter professionals • Professionals are paid more

Theories of Regulation

Different theories explain the relationship between the public and regulatory agencies

Public Interest Theory Capture Theory Principal Agent View Parkinson’s Law

Public Interest Theory

Government creates a regulatory agency. • Government wants to correct a problem in a

market Example 1 - One firm, a monopoly,

controls a market, preventing market competition• Unregulated monopoly increases prices and

reduces output

• Gov. regulates monopoly 

Public Interest Theory

Example 2 - Firms producing contaminated foods• Gov. regulates food, reducing food

contamination

Regulation increases “social welfare”• Improves society

Capture Theory

First variation• Firms in an industry has a demand for

regulation.

• Firms are friends with the regulatory agencies

• Regulatory agencies strongly influence the President and legislature

• Industry “captures” the government

Capture Theory

The industry controls the regulatory agencies. • Industry wants high prices and low output

• Industry wants to capture consumer surplus

Capture Theory

Second variation• Firms or an interest group capture the

regulatory agencies

United States• Politicians want to be re-elected to office

• Political campaigns costs millions of dollars

• Firms and interest groups contribute campaign funds

Capture Theory

Politicians write favorable laws for firms or interest groups

Regulatory agencies follow and enforce the laws

Principal Agent View

Government bureaucracies do not serve the purpose that they were created for

Regulatory agencies are concerned about maximizing their power, influence, and prestige

Agencies could be:• Dysfunctional

• Corrupt

Parkinson’s Law

C. Northcote Parkinson, British economist Noticed as the British Empire became

smaller, the number of employees in the Colonial Office increased• Less work means more workers???

• Note – Colonial Office administered the British Empire

Parkinson’s Law

Law - Government agencies expand over time• The expansion has no relationship to the amount of

work that needs to be done

• Regulatory agencies expand approximately 5% per year

A private firm expands a business to expand sales, services, or new products.• Expansion is profit driven

• Expansion means more work

Parkinson’s Law

Parkinson’s Law applies to many gov. agencies

Why? 1. “Expenditures rise to meet income”

• No matter the amount of government funding for a regulatory agency, the agency always spends the money.

• Gov. agencies want more and more funding!

Parkinson’s Law

2. “Work expands so as to fill the time available for its completion” • If a bureaucrat needs 4 hours to complete a

task and has an 8-hour work day, the bureaucrat will expand the task into 8 hours

Parkinson’s Law

3. Bureaucrats like “to multiply subordinates, not rivals” • A bureaucrat can elevate himself as manager

by hiring subordinates

• To hire subordinates, bureaucrats “create work for each other” • Expand paperwork and broaden regulations

• If bureaucrat hires a rival, then that rival also competes for a promotion

Parkinson’s Law

Thus, the size, scope, and mission of gov. increases each year

U.S. government agencies increase 5 to 10% per year

Conclusion

My opinion

Public Interest View dominates for new or re-structured regulatory agencies

Capture Theory, Principal Agent View, and Parkinson Law start to dominate over time as regulatory agency matures

References

I have the Economist article

1. Parkinson, C. Northcote. 1957. Parkinson's Law. Cambridge and Massachusetts: The Riverside Press

2. Parkinson, C. Northcote. November 1955. "Parkinson's Law." The Economist