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George Stigler’s theory of economic regulation opened our eyes to the rent-seeking that undermines the public interest. Yet many in positions to influence policy today do not appreciate the beneficial innovation and increased consumer choice that economic deregulation and competition brought.
This essay is part of the Stigler Center at the University of Chicago's series commemorating the 50-year anniversary of George Stigler's "The Theory of Economic Regulation."
Fifty years ago, most of the administrative agencies in the US issued “economic regulations,” constraining economic activities of particular industries using controls such as price ceilings or floors, quantity restrictions, or service conditions. While the “public interest theory” of regulation suggested that legislators and regulators took regulatory action to protect consumers from the exercise of producers’ market power and other market failures, it was becoming increasingly evident that the economic regulation of the time tended to keep prices higher than necessary, to the benefit of regulated industries, and at the expense of consumers.
George Stigler’s 1971 article offered a clear, testable theory that explained the type of economic regulation observed in different industries. It also raised awareness of the incentives and wealth-redistribution consequences of economic regulation. Stigler started with the basic premise that the government’s main “resource” is the “power to coerce.” Thus, a rational, utility-maximizing interest group will seek to convince the government to use its coercive power to the group’s own benefit.
Stigler’s work—generalized by Sam Peltzman, Gordon Tullock, James Buchanan, and others—hypothesized that regulation is supplied in response to the demands of well-organized interest groups acting to maximize their own well-being at the expense of diffuse interests. It explained why air travel between states, regulated by the Civil Aeronautics Board (CAB), was much more expensive per passenger-mile than intrastate air travel not subject to the same regulation. CAB regulation controlled which airlines could fly which routes, protecting incumbent airlines by keeping prices higher than necessary. Similarly, it explained why the Interstate Commerce Commission’s (ICC’s) trucking regulations, supported by railroads that viewed trucking as an emerging competitor, led to inefficiencies and high costs.
Policy entrepreneurs at think tanks championed these insights and policy makers followed suit. Senator Ted Kennedy, staffed by the then-young law professor (now Supreme Court Justice) Stephen Breyer, held a series of hearings investigating airline and then trucking regulation and its impact on consumers. In his first State of the Union address, President Jimmy Carter committed to “do a better job of reducing Government regulation that drives up costs and drives up prices.” Thus, bipartisan efforts across all three branches of government eventually led to the removal of unnecessary regulation in several previously-regulated industries, and the eventual abolition of agencies such as the CAB and the ICC.
Within a decade or two, the deregulation of trucking, railroads, airlines, and telecommunications had brought about efficiency improvements equivalent to a 7-9 percent increase in GDP, with consumers receiving most of the benefits. Competitive markets have not just reallocated resources but generated tens of billions of dollars per year in benefits for consumers and society as a whole, and markets have evolved in beneficial ways unanticipated prior to deregulation. (For example, the hub-and-spoke system for air travel emerged to address pre-deregulation concerns that a competitive market would underserve remote areas.)
Despite this enormous success, many in positions to influence policy today seem to have forgotten the lessons from Stigler’s landmark work and do not appreciate the beneficial innovation and increased consumer choice that economic deregulation and competition brought. In sharp contrast to the bipartisan support for deregulation 50 years ago, we now see efforts across the political spectrum to apply the economic regulation tools that so harmed competition and consumers just a few decades ago. For example, Senators Elizabeth Warren and Josh Hawley are both calling for breaking up Big Tech and ensuring fair practices, harkening the golden era of the ICC’s railroad regulation. Like supporters of economic regulation before them, they assume regulators will have the information, skills, and incentives to rein in behavior they dislike, and that consumers will somehow benefit—hope again triumphs over experience.
Stigler’s theory does not always predict when regulations will be issued, as Sam Peltzman observes in this series, but it does often shed light on the form regulations take. Once regulation is inevitable, industry works to ensure that it is implemented in a way that best serves its interests. This may explain why Facebook now supports politicians’ calls for new regulations related to privacy, security, and content moderation—regulations with which potential competitors may be less able to comply. It may also explain why, in 2009, the auto manufacturers joined President Obama on the White House lawn to endorse tighter fuel-economy standards (fending off varying state-level regulations and foreign competitors).
As Bruce Yandle observed, industries often hide behind public interest arguments when supporting regulation, as did the bootleggers of the early 20th century south who quietly supported laws—publicly championed by Baptists—to ban liquor sales on Sundays. They can influence the design of regulations to protect vested interests, while allowing politicians to claim public-spirited goals. This may explain why Amazon and other large companies support an increase in the federal minimum wage; it would disproportionately harm their smaller competitors.
However, it isn’t always organized businesses who capture regulators, as Stigler originally hypothesized in his seminal article. Peltzman and others generalized the theory to show that other interests can also “organize, articulate, and deliver political pressure.” Social media makes it easier now for other politically-connected groups to capture agencies’ agendas. For example, in 2015, EPA administrator Gina McCarthy defended a water quality rule to a Senate committee saying that, of the millions of comments the agency had received on its proposal, almost 90 percent supported the changes.
In 2014, television comedian John Oliver aired a segment critical of the Federal Communications Commission’s (FCC’s) proposed approach to regulating broadband. His episode sparked almost 80,000 nearly-identical comments (compared to just 3,000 comments submitted the previous week). The FCC responded by reclassifying the internet as a “common carrier” service, paving the way for pre-Stigler style economic regulation of rates and service. When, two years later, the FCC proposed to repeal the 2015 classification, another mass comment campaign ensued (now the subject of a high-profile New York Attorney General investigation). In these rulemakings, businesses lined up on both sides of the debate, as Stigler would have predicted. Internet service providers (ISPs) generally oppose being regulated as public utilities, while internet content providers (Amazon, Netflix, Facebook), who ride on the ISP networks, support such regulation of the ISPs (though not for themselves).
George Stigler’s theory of economic regulation opened our eyes to the rent-seeking that undermines the public interest. His insights contributed to the economic deregulation of the 1970s and 1980s that enjoyed bipartisan support from all branches of government and created lasting positive impacts by increasing competition, encouraging innovation, and lowering consumer prices. We should not let today’s legislators and regulators ignore those lessons.