Authors: Adam Smith
It may seem counterintuitive, or at least ironic, that those who pursue government favors can find themselves suffering from a kind of buyer’s remorse, but this phenomenon has long been recognized in public choice scholarship. In another insightful article, Gordon Tullock dubbed this apparent paradox the “transitional gains trap” (Tullock 1975). His story describes a multistage process in which special interest groups first gain a profitable advantage but then must keep spending to hold their favored position. With profits seemingly assured, owners and managers of politically favored enterprises tend to spend more on fancier digs for themselves and share some of the wealth with their employees. As operating costs head skyward, producers of substitute goods—including novel types of goods that may fall outside the bounds of the monopolizing regulation—cheerfully expand to serve price-sensitive consumers. The market enjoyed temporarily by the favored interest groups contracts, profits fall, and the federal rules that protected the interest group—now with higher built-in costs—become handcuffs that won’t let go.
Tullock uses the example of the U.S. Postal Service to illustrate the point. By maintaining its status as a monopolist in the delivery of first-class mail, the Postal Service garnered plush revenues for decades. With this income came generous pay and fringe benefits for postal workers. Prospective employees flocked to obtain the cushy positions on offer, and with more bright people looking to sign on, hiring standards rose—as did wages, benefits, and of course, postal rates. Costs then were locked in at a permanently higher level. The attendant higher prices attracted more efficient competitors who took advantage of technological change and new forms of communication. With the advent of e-mail and online billing services, the Postal Service discovered that its legal monopoly no longer guaranteed it a captive audience. Captured by an old technology and a labor force spawned by it, the Postal Service held on to its disappearing first-class mail delivery system while caught in a transitional trap.
The essence of Tullock’s lesson is that a regulatory advantage is not necessarily a goose that perpetually lays golden eggs or, indeed, any eggs at all. Successful government favor seekers enjoy only temporary gains that are soon eaten away as windfall profits translate into locked-in costs. If earnings should then be driven to competitive levels—whether by technological innovation, changing consumer preferences, or a shift in the political winds—the organization will find itself desperate to meet its inflated costs, as we’ve seen in the case of the Postal Service. Having been reared in a regulatory hot house, the “lucky” Bootlegger discovers it cannot sustain itself with mere competitive returns.
We find a similar dynamic at work in the surface and air transportation sectors. In both cases, regulation purposefully set up monopoly arrangements, to the benefit of owners and workers. As the regulated industries prospered, their competitiveness languished. Substitute services emerged, often based on new technologies. Some who had favored more regulation called for reform, until eventually, the regulatory structures came crashing down. The ICC, which had regulated trucking and rail transportation for decades, was eliminated in 1995. Trucking was deregulated; rail passenger transportation was nationalized. The Civil Aeronautics Board, which regulated airline pricing and service, was dissolved in 1984. Even the U.S. Postal Commission loosened its grip on the sale of stamps beyond the confines of post offices, cut hours of service, and allowed competitors such as FedEx to place receiving boxes on Post Office property. Deregulation is not complete, but the days of golden eggs for these industries are over.
To sum up, Bootlegger/Baptist theory rests on several key public choice insights. First, each of us tends to be naive about a vast number of subjects but intensely informed about matters that have an immediate and direct bearing on our own well-being. As a result, large benefits can be provided to well-informed special interest groups (Bootleggers) through government transfers without the majority of the population being aware that anything is going on—or having much incentive to find out.
Second, smaller Bootlegger groups have lower organizing costs than larger groups, and average gains per member are higher for smaller coalitions, given a fixed payoff. Startup costs are associated with organizing a lobbying effort. Once that initial investment is made, however, a lobbying group will be ready to go for the pork when another political opportunity surfaces.
As politicians redistribute pork to Bootleggers, the number of organized groups expands. At the upper limit, a rational Bootlegger will be prepared to spend the expected value of a political prize in pursuit of that prize. Once obtained, political restraints on competition or other benefits can improve profits for a time. But higher profits tend to feed higher costs in Bootlegger organizations.
The costly political machinery that provides all this must be maintained. Meanwhile producers of substitute goods and services are attracted by Bootlegger profits. With costs rising and profits falling, Bootleggers find themselves caught in a regulatory trap. The process has limits. Redistribution cannot continue indefinitely without killing the goose that laid the golden eggs or chasing off the pigs that provide the pork.
Four Explanations for “Why So Much Regulation?”
Having laid a public choice foundation, we now consider several accounts of why regulation flourishes and how the Bootlegger/Baptist theory explains the workings of the regulatory world. We review four theories of regulation and trace their appearance in successive editions of the
Economic Report of the President
spanning 1965 through 2010. We examine which theories White House officials used to explain their regulatory policies and when the various theories seemed to be important. Though the goal of theory is to describe political action, how politicians and the public understand regulation can also have an enormous impact on how political outcomes unfold. That underlies our interest in discovering when the essence of Bootlegger/Baptist theory shows up in the reports.
Serving Everyman (and Everywoman)
The first and oldest theory of regulation—so old it has no clear inventor—is the public interest theory. This theory holds that when they take office, politicians and their appointees also take on a new life, putting aside their personal interests to serve the common good. Once ensconced in Washington, representatives lie awake at night trying to find better ways to provide broadly appreciated public benefits, their thoughts unsullied by any narrower interests.
Whether the problem to be addressed is pollution, unhealthy working conditions, or teenage smoking, a public interest legislator seeks to achieve as much improvement as possible given realistic budget constraints. He is constantly searching for lower-cost ways of achieving public interest goals. The legislator works to build institutions that strengthen (and in some cases repair) beneficial market forces so that markets will be robust. The public interest theory recognizes that politicians are, alas, human—meaning errors and even deliberate acts of chicanery will occur. But these failings are the exception, not the rule.
English economist Arthur Cecil Pigou (1920) is often (mistakenly) seen as the godfather of the public interest theory. Pigou famously argued that governments could take steps to correct all kinds of problems that plague unregulated private markets. Leaders could address the uncompensated harm done when sparks from railway engines set woods aflame, when land management practices caused rabbits to invade neighboring property, or even when construction practices tended “to spoil the lighting of the houses opposite.”
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Pigou worried about automobiles that wore out the surfaces of roads, the sale of intoxicants that then required additional expenditures on law enforcement and prisons, and in his own words “[p]erhaps the crowning illustration of . . . the work done by women in factories . . . for it carries with it, besides the earnings of women themselves, grave injury to the health of their children” (Pigou [1932] 2009, 134, 186–87, 196–203).
The remedy? Pigou called on enlightened leaders to address these problems by taxing unwanted activity, subsidizing desirable activities that tended to be underproduced, and imposing regulations on producers who disregard the social costs of their behavior.
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Now, let’s take a peek at President Lyndon Johnson’s
Economic Report of the President
(1965
,
135–36), in which we get more than a hint of Pigou and the public interest theory:
In the vast majority of industries, competition is the most effective means of regulation. But in a few industries, technological and economic factors preclude the presence of more than one or a few firms in each market. When these industries provide an important service to the public, direct control is substituted for competition. The independent federal regulatory commissions were established in the transportation, power, and communications industries because competition could not be expected to protect the public interest. In other areas, regulation is aimed at providing the public with reasonably full knowledge of the market. In particular, securities and certain commodity markets become so complex and technical that regulation is necessary to insure that buyers and sellers have access to accurate and reasonably comprehensive information.
The statement, prefiguring much of the recent rhetoric aimed at banks by the Consumer Financial Protection Bureau, makes a case for antitrust enforcement as well as regulation of certain consumer markets. Government, in President Johnson’s view, was there to protect and further public interests that would be jeopardized by unchecked private action.
We see a more detailed expression of market failure and public interest theory in President Johnson’s
Economic Report of the President
(1966). After describing the emerging problems of air and water pollution, the report claims that “in the case of pollution, however, those who contaminate the environment are not charged in accordance with the damage they do. . . . Public policies must be designed to reduce the discharge of wastes in ways and amounts that more nearly reflect the full cost of environmental contamination” (
Economic Report of the President
1966, 119–20). Without acknowledging the possibilities for enhancing common law and other private action-based remedies, Mr. Johnson’s economists took a cue from Professor Pigou. Their rhetoric expands the domain of public interest from antitrust regulation and consumer protection to dealing with external costs imposed by firms on their neighbors.
By 1978, the ever-ballooning domain of public interest had led to such extensive regulation that President Jimmy Carter’s
Economic Report of the President
(1978) began to address regulatory reform. Still, the report indicates the need for government intervention as a means of limiting the unfettered private pursuit of profit: “In a mixed market economy like that of the United States, government regulations of the marketplace sometimes play a vital role in meeting social goals, curbing abuses, or mitigating the hardships that would flow from the unconstrained play of economic forces” (
Economic Report of the President
1978, 206). Even as late as 1978, the
Economic Report of the President
did not recognize what historians and political scientists had known for decades: that the regulatory process can be captured by the regulated.
Capturing the Regulator
The second theory of regulation, called capture theory, builds on the public interest theory but recognizes that even politicians and regulators dedicated to serving the broad public interest face a fundamental information problem: they have no handbook that defines “the public interest.” What the dedicated legislator and regulator do have is an ample supply of private- and public-sector advisers eager to offer their own ideas—not to mention the lobbyists.
It is important to recognize that lobbyists do more than curry favor and plead for pork: they also often provide a high level of valuable technical expertise. That can make them important adjuncts to the politician’s office given the breadth and complexity of the myriad issues a modern government is expected to address. If fact, some lobbyists are so helpful that they get called on to assist in defining the public interest! Thus a thorny problem for elected officials becomes a golden opportunity for the lobbyist, a nascent Bootlegger. Increasingly dependent on the representatives of the very firms they are expected to regulate, politicians are effectively captured.
It is perfectly logical that a president’s report would not discuss this element of political action. Admitting that politicians can be captured would seem to suggest that public servants are not up to doing their jobs. But in the real world, even the most dedicated public servant must obtain detailed information about prospective law and regulations somewhere. Generally speaking, those with the most information are the parties who will be directly affected by regulatory action—and they are typically only too happy to share it, along with their recommendations on the best course of action.
The reason is simple: with the stroke of a pen, a politician can cause vast wealth to be transferred from taxpayers to the providers of all this valuable information. Capture theory helps explain how eastern high-sulfur coal interests influenced key members of Congress when the 1977 Clean Air Act Amendments were being developed. These amendments required the use of “scrubbers” to remove sulfur oxides from smokestacks. Massive machines that used as much as 10 percent of the power generated to operate, scrubbers were mandated even though cleaner low-sulfur western coal could have accomplished the same thing without scrubbers.
The cost of the rule was spread over an enormous number of electricity users; most consumers never knew that their power bills were slightly larger because of the rule. Meanwhile, the benefits were concentrated among a relatively small group of coal mine owners and operators, and coal workers. Additionally, eastern coal was produced by organized labor spread over several states, whereas cleaner western coal was produced by nonunion workers concentrated in lonely Wyoming. Because unionized labor is well organized, unions can far more easily speak with one voice to help influence the debate.