Government Regulations and Parkinson's Law
Lecture 3

Types of Regulatory Control

1. Gov. regulation
   1. Definition – gov. imposes a limitation on the behavior of individuals or businesses
   2. A regulatory agency is the institution that monitors and enforces the limitation
   3. President and Legislature create regulatory agencies
2. Types of regulatory control
   1. Gov. sets market price
   1. Retail price for electricity
   2. Gov. sets limit on market quantity
      1. New York City gov. sets the maximum number of taxicabs that can operate within the city
   3. Gov. mandates a quality standard.
      1. Drinking water has a maximum level of metals, toxic chemicals, and microorganisms
      2. Mandate – gov. tells market participants what to do
         1. May impose penalties for noncompliance
         2. Gov. does not pay for the cost of mandates
   4. Gov. restricts market entry
      1. Patents – an inventor designs a new product
      2. Patent gives exclusive control over his product for 17 years
         1. Encourages inventors to design new products
         2. Creates monopoly power
   5. Gov. bans the activity.
      1. Gov. imposes severe penalties for violators
      2. Gov. bans the sell and use of illegal drugs
3. Why does gov. regulate?
   1. Gov. intervenes in markets with little competition
      1. U.S. at the turn of the 20 ^th century
         1. U.S. Gov. started to regulate businesses
      2. Monopoly - one firm supplies the whole market
         1. Monopolist reduces its production level
         2. Market price to increase, earning large profits
      3. Example
         1. U.S. Gov. broke up Standard Oil into smaller companies at the turn of the 20 ^th century
         2. John Rockefeller founded Standard Oil
         3. Controlled over 90% of the petroleum market

   2. Gov. corrects an externality .

      1. An externality – a firm or person affects a third party without the third party’s consent.
         1. Imposts a cost or benefit on the third party
         2. Most externalities are negative
         3. Example – neighbor plays loud music
      2. Negative externalities - market prices are too low and market quantities are too high
      3. Positive externality – a market system may not supply it
      1. Market price is too high and market quantity is too low
      2. Research and technology – country, firm, or person can steal anther's scientific discovery
   3. Government provides a public good
      1. Public good requires two conditions
         1. Non-rival – one person consuming the good does not prevent other people from consuming the good
         2. Non-excludable – the good cannot be restricted to the customers who pay for it
      2. Free riders will consume public goods, but they have no incentive to pay for it
         1. Market undersupplies public goods
         2. Cannot restrict consumption to paying these goods
      3. Examples
         1. Clean air
         2. Flood control projects
         3. National defense (military)
         4. Public safety (police)
         5. Streetlights
      4. Quasi-public goods – market can supply these products and services
         1. Producers do not supply enough of them
         2. Gov. steps in and supplies them
            1. Postal service
            2. Highways
            3. Libraries
            4. Education
   4. Gov. correct asymmetric information – either the buyer or seller has more information than the other party
      1. Examples
         1. Person with heart trouble gets health insurance
         2. Tax payers and tax authority
         3. New workers and employers
      2. Some producers provide low-quality, defective, or even harmful goods
      3. Gov. regulates
         1. Some forms are illegal
         2. Establishes weights and measures
            1. Inspects gas pumps and supermarket scales
         3. Occupational license – the right to practice his specialty
            1. Ensures professionals have a high level of competency
               1. Doctors
               2. Lawyers
               3. Mechanics
               4. Hair stylist
      4. Market can minimize asymmetric information
         1. Brand names, franchises, and product warranties
         2. McDonald’s – Big Mac tastes the same everywhere in the world
   5. Social regulation – gov. sees a societal problem and regulates it
      1. Have exploded in last 35 years in the U.S.
         1. Cannot spank children
         2. Husbands cannot yell at wives

Theories of Regulations

1. Public Interest Theory – gov. corrects a problem in society or in a market
   1. Gov. creates a regulatory agency that corrects the problem
   2. Gov. establishes a health regulatory agency to reduce contaminated foods
2. Capture Theory – an industry “captures” the regulatory agency
   1. Industry wants a new regulation
      1. Industry controls the regulatory agencies
      2. Regulatory agencies influence the President and legislature
   2. Interest group – a political organization that influences government
      1. Form for any purpose or cause
      2. Political campaigns cost millions of dollars
      3. “Buy” influence through campaign contributions
      4. Pass favorable laws the interest group wants
3. Principal Agent View – gov. bureaucracies do not serve the purpose that government created them for
   1. More concerned about maximizing their power, influence, and prestige
   2. Can also be corrupt or dysfunctional
      1. Dysfunctional means a government agency is not performing its true function
      2. Example – police want high arrest numbers
      3. Officers “plant” drugs on innocent people to enhance arrest records
4. Parkinson’s Law – regulatory agencies expand in size each year without any relationship to amount of work the regulatory agency does
   1. Observation by C. Northcote Parkinson
   2. Noticed as the British Empire became smaller, the number of employees in the Colonial Office increased
      1. Administered the British Empire
   3. Bureaucracy increases in size by 5-7% per year irrespective of any variation in the amount of work (if any) to be done
   4. Why?
      1. Gov. agencies always spend their budgets
         1. Always requesting more funding and then spending it
      2. Bureaucracy always creating new work
         1. Expand size, scope, and mission
         2. Create new forms, permits, approvals, or other such documents
      3. Bureaucrats like “to multiply subordinates, not rivals”
         1. Rivals compete for the same promotions
5. Szulczyk – Public Interest View Theory holds when gov. creates a new government agency
   1. Over time, Parkinson's Law, Principal Agent View, and Capture Theory begin to dominate.

Cost of Government Regulations

1. Gov. diverts resources from the private sector
   1. Bureaucracies employ staff and pay salaries
2. Gov. finances regulatory agencies through taxes
   1. Expands the tax authorities
3. Taxes and regulations “destroy” the market
   1. Causes higher market prices and decreases market quantities
   2. Lowers economic activity
4. Taxes and regulations create violators
   1. Gov. consumes resources to enforce and punish violators
   2. Create new gov. agencies like courts and prison systems

Problems of Regulations

1. Gov. makes poor investment decisions
   1. Gov. spends $100,000 to fix a $50,000 house
   2. Financial problems – gov. can increase taxes to cover bad investment decisions
   3. No other institution can do this
2. Bureaucracies could be political
3. Bureaucrats have self-interest
   1. More concern with maintaining their jobs and importance
   2. Design programs that are long term
   3. Expand their size, scope, and mission
4. Regulatory agencies and their regulated companies may become “too friendly” over time
   1. Regulators may be too lenient on their regulated companies
   2. Extreme form is corruption
5. Regulations differ between countries and among levels of government
   undefined
   1. U.S. Department of Energy wanted electric power plants to use more coal
   2. Reduce reliance on petroleum
   3. U.S. Environmental Protection Agency was penalizing coal use, because it is a dirty fuel
6. Regulations become rigid and fixed
7. Gov. workers interpret the laws and regulations differently
   1. Internal Revenue Service (IRS) workers are known to give conflicting information to taxpayers
   2. U.S. tax laws are too complex
8. Regulations may do the opposite than intended
9. Regulators process documents slowly
10. People with agendas and hidden motives become leaders of government bureaucracies
    1. Environmentalist who hates corporations become director of an environmental agency
    2. Creates red tape and problems for businesses