Saturday, April 13, 2013

Regulatory Capture and Deregulation

I decided to write this post after seeing a series of excellent Venn diagrams showing how common it is for politicians and their staff to overlap with the private sector they are regulating. For example, William Daley was Obama's White House Chief of Staff and Clinton's Secretary of Commerce, but he was also on the Boeing board of directors and the Executive Committee of JPMorgan Chase & Co.

This type of situation leads to something called regulatory capture, where regulatory agencies are used to advance the interests of the industries (or specific companies within an industry) that they are supposed to be regulating. Politicians can be hired after they held office (often for a considerable amount of money) or they can go from the company into a political position, or at worst they can hold both positions at the same time, but the corrupting influence is still there.

I suspect that most Democrats believe that this is a problem with Republicans and that Democrats will keep those regulatory agencies in line. Well, not really. If you look at those diagrams, you'll notice that the vast majority of people on them are given their positions by Democrats. Just look at all of those Goldman Sachs employees holding important positions under Obama. I don't know if there is some selection bias by the person who made the diagrams, so it's entirely possible that for every CEO, lobbyist, or "director of govt. relations" that a Democrat takes on board there are three more hired by Republicans. Ultimately, that just makes my point stronger: no matter who is in charge of regulations, regulatory agencies will be used to serve the interests of the industries they should be regulating. If you think that the Republicans will be even worse about this than the Democrats are, then that's all the more reason to dismantle the regulatory apparatus before the Republicans get their hands on it again.

Regulatory capture has more malign effects than just getting regulators to turn a blind eye. Regulations can allow the company with the most political influence to use those regulations to cripple its competitors. For example, tobacco companies know that with the ban on tobacco advertizing, they don't have to worry about new competition showing up to challenge them. Wal-Mart, as I mentioned in my post on the minimum wage, supports an increase in the minimum wage because they already pay more than that while many of their competitors do not. Regulations are a path to corporate hegemony, wherein powerful corporations offer their support to politicians in exchange for regulation that favors them over their competition, or which simply hits their competition harder.

In the absence of regulation, companies compete on the basis of their ability to make a good product, advertize it well, and sell it at a competitive price. The selective pressure of a market economy ensures that without being able to do those things, a company will fail and those resources will be allocated elsewhere, so companies that thrive will tend to be pretty good at what they do, and the rest of us benefit from this. With regulation, the company's political pull becomes relevant as well. As the power of regulatory agencies grows, political influence grows in importance. This means that in a highly regulated environment, political influence alone can determine whether a company succeeds or fails. The Holy Grail of this, for companies, is being deemed "too big to fail" whereupon bailouts and heavy regulations enshrine them as a permanent fixture in the economic and political landscape. The nature of the selective pressure in a highly regulated environment will ensure that companies are good at either getting regulation that favors them or getting around regulation that doesn't, but they won't necessarily be very good at making and selling good products at a competitive price because the relative importance of those things is diminished. Naturally, larger companies will find it easier to exercise political influence, so regulations will tend to favor them and the economic landscape will shift toward larger and larger companies.

The solution to this corrupt intermixing of companies and government is to limit the power of regulation. It's fine if you don't trust companies; I don't either. They are looking out for their own interests first and foremost, and nothing will change that. The important thing to realize is that regulation isn't going to make them more efficient or socially responsible or "green" or whatever it is that you care about; it's only going to replace economic criteria for success with political criteria. It gives them incentives to get heavily involved in the political process and make regulations that are worse than nothing. Regulation does not limit the power of companies because it is the most powerful companies that make the regulation in the first place, even under a president who loves to play up the notion of "Wall Street vs Main Street" and then take a populist position. Politicians who are heavily involved in this corrupt process will insist that regulation keeps companies in check, when in reality limiting the power of regulation limits the power of companies to use that regulation to their own benefit at the expense of everyone else.

This is not to say that companies should not be bound by the law. Rather, the law should arise directly from the legislative body itself rather than having that responsibility delegated to regulatory agencies or subcommittees. It's a lot harder to buy off enough Congressmen to enact favorable legislation (although certainly not impossible; Monsanto has given jobs to at least two former Congressmen, as have tobacco companies) than it is to swing a vote in a subcommittee someplace, many of which meet behind closed doors for even less transparency in their proceedings.

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