All capitalist economies require a certain amount of legal as well as physical infrastructure to operate. Citizens and companies must know that the property they currently own or hope to own in the future is legally and physically secure. Likewise, consumers and businesses must have faith that their agreements will be adhered to by parties on the other side of transactions (counterparties) and, if not, that the agreements will be enforced by a well-functioning judicial system.
There are other aspects of the legal infrastructure that are helpful to business formation and growth. Ideally, licenses and fees to launch a business are kept to a minimum, but those that remain should be obtained as quickly as possible. The World Bank’s Doing Business report annually ranks all countries around the world on the ease of launching a legal business.
Not as well recognized, but also equally important, are bankruptcy laws that enable failing firms to reorganize and not necessarily go completely out of business and strand customers and suppliers. Liability laws that assign responsibility for compensating injured parties to those whose negligence causes harm not only seem just, but also provide incentives to others to be careful. At the same time, corporate laws that limit the liability of shareholders for the losses of companies to the amounts shareholders invest are essential to encourage investment in new and existing enterprises in the first place.
This book assumes that these basic elements of an effective legal infrastructure are in place, although not necessarily in an ideal fashion in every location in the country. Indeed, there has long been and will continue to be tension between those who want more government regulation to protect against harms that business activity may cause and many in the business community who believe that regulatory burdens are already too high and need to be curtailed.
Although I will not attempt to resolve this particular debate, which likely has no end, the chapters in this second part of the book focus on industries where government has eliminated or significantly cut back what economists call economic regulation, which limits the prices of what firms in particular industries may charge and determines which firms may even enter an industry. Economic regulation is to be distinguished from what economists call social regulation, aimed at correcting market failures, such as pollution, or unequal information between buyers and sellers.
Although many businesses have been formed as a direct result of social regulation—think of those who make scrubbers that reduce emissions from electric power plants or airbag manufacturers that enable automakers to meet auto safety rules—I focus on economic deregulation and the economic arguments for it for two reasons.
First, as you will learn in the chapters that follow, economists have been arguing for years that the case for economic regulation for most industries has been weak or nonexistent, and thus most of it should be eliminated. This is not the case with social regulation in general, which is widely accepted in principle, but is argued over in its details (specifically whether certain rules have benefits that exceed their costs, and even if they do, whether the rules are the least restrictive alternatives available).
Second, when policy makers finally responded to the economists’ critiques and cut back or eliminated economic deregulation, it opened vast new horizons for many new businesses or business models to launch and flourish. In effect, economic deregulation has become a policy platform on which many new businesses have been formed and innovations developed. In the process, the U.S. economy has been changed forever, for the good, or so I argue.
Much of this change was brought about by the urgings, research, and writing of economists, demonstrating how economists in these instances indirectly contributed to the success of many businesses, an outcome of which the founders, executives, and employees of these firms may only be dimly aware. The stories you will read in this part are important for people in all walks of life to understand and strengthen the central theme of this book: that economists and their ideas are really important, much more so than many people may realize.
The chapters share another common thread: Each deals with an industry that either helps define what it is to be a modern economy, or is an essential part of what makes that economy—the U.S. economy in particular—tick. Thus Chapter 9 deals with mass transportation; Chapter 10 is devoted to energy; Chapter 11 discusses telecommunications; and, finally, Chapter 12 deals with finance. It is difficult to imagine how a modern economy would work without advanced technologies and practices in each of these industries. That they exist now, although imperfect and constantly evolving, is due in significant part to the rules and institutions that govern prices and entry into these industries. Broadly speaking, economists have argued for decades that these industries are fundamentally competitive (if not when economic regulation was adopted then certainly now) and should not be subject to regulatory regimes more suitable for natural monopolies. It has taken policy makers time to catch up and act on this insight, and I believe this would not have happened, or would have occurred much later, had economists not first laid the intellectual groundwork for it all.
To be sure, financial deregulation has been somewhat an exception, essentially a mixed bag. As I argue in Chapter 12, certain ideas urged by economists were taken too far by the unscrupulous and the reckless that later contributed to disastrous results, including the misuse of stock options (discussed earlier in Chapter 8) and the failure to police the development of certain mortgage securities. But the origins of the 2007 to 2008 financial crisis, which among other things helped give the economics profession the bad reputation that I discussed at the outset of this book, are complicated and many. There were many policy mistakes along the way that economists did not support or of which they were largely unaware. At the same time, a number of financial deregulatory measures had desirable social impacts and led to the creation of businesses that have helped investors. They deserve to be highlighted and credited for their contributions.
Finally, if so much deregulation outside of finance was such an unqualified success, what took policy makers so long to make the necessary changes? This, too, is a complicated story that is outside the scope of this book, although it deserves a brief discussion before I get into the details of each deregulatory measure.
Briefly, there are two broad schools of thought about regulation and deregulation. One posits that regulation or deregulation is adopted to advance the public interest. It is as if legislators and regulators read and follow the basic economic textbooks and only regulate to correct market failures in the most cost-effective manner possible.
For example, the public interest view is broadly consistent with the introduction and elaboration over time of various forms of social regulation, which are aimed at protecting the safety of our air, water, food, and, in a financial sense, our financial institutions. In addition, the initial economic regulation of a number of industries that were characterized by natural monopolies—railroads, electric utilities, and telecommunications—also seems consistent with the public interest. But the extension and maintenance of economic regulation in these and other industries as technology weakened or eliminated natural monopolies does not sit well with the public interest view. Instead, the public interest was rescued only when policy makers finally listened to those economists who had pointed this out and began, in the late 1970s, to deregulate prices and entry in many sectors where it was no longer economically justified.
The alternative view of regulation is called public choice theory and is premised on the notion that, as a general rule, the industries subject to regulation, both social and economic, generally want it, even if some industry members protest that regulation is unnecessary or has gone too far. The reasons why firms would want regulation vary, but at bottom they boil down to making it too costly or impossible for competitors to enter their industry (economic regulation), or to give them some advantages over competitors that might not have the resources to comply with certain regulatory requirements (social regulation).
For decades, developers and supporters of the public choice model were in the distinct minority of economists, but the view gained respectability when one of its founders, James Buchanan, won the Nobel Prize for his work in the field. Other prominent economists who have developed this theory or aspects related to it include Buchanan’s sometime collaborator, Gordon Tullock, Chicago’s Sam Peltzman and George Stigler, and my colleague at Brookings for many years, Anthony Downs (whose book Economic Theory of Democracy, written as his PhD thesis under the supervision of another Nobel winner, Kenneth Arrow, helped lay the foundations for public choice economics).
Like its counterpart—public interest theory—public choice has its limits, too. Industry generally did not back the major legislation that authorized most social regulation—such as the Food and Drug Act, the National Highway Traffic Safety Act, the Clean Air Act, the Clean Water Act, and the Occupational Safety and Health Act—which were pushed by consumer and environmental groups and labor unions. Nor was industry universally behind much economic deregulation, though in some cases they were, as various chapters in this part will show.
In sum, there is no grand universal theory of regulation and deregulation that can explain each and every regulatory statute or major regulation. Rather, elements of both major theories, public interest and public choice, have played important but different roles at different times.
What I want to emphasize in this part of the book, however, is the important roles that economists played in the economic deregulation of many key industries in the U.S. economy, which in turn has had profound impacts on many firms. Many economists over the years have joined in this effort and deserve credit for building the intellectual case for deregulation where it has proved especially beneficial. I have profiled a number of these individuals in this part.
I want to conclude this introduction to Part II, however, by singling out two particular economists who have had a major impact on the field and on my own thinking about regulation and the role of government during my own career, and yet who do not fall neatly within any one of the topic-specific chapters that follow. Readers who are interested can easily find their substantial body of work through any standard Internet search engine.
Roger Noll, now a professor emeritus at Stanford University where he taught economics for over two decades (and at this writing is still teaching a seminar for advanced undergraduate economics majors), is one of those rare polymaths, who is always fun to talk with, and who constantly comes up with stimulating ideas that make the listener want to explore further (no wonder he is such a great teacher). Blessed with a loud and infectious laugh, Noll has written on a wide variety of microeconomic subjects, including the regulation or deregulation of just about everything that matters, as well as topics relating to antitrust law and economics. Noll also taught at the California Institute of Technology and for a time was a senior fellow at the Brookings Institution. You might not see Roger’s name attached to any specific sentence in the chapters in this part, or in earlier chapters, but he’s there between many lines. I owe special thanks for his useful suggestions for topics in Chapter 11, in particular.
Lawrence “Larry” White, another longtime friend, has been a professor of economics at the Stern School of Business at New York University for most of his career. White is one of the leading specialists on what economists call industrial organization, the economics of antitrust law, and on the economics and regulation of the financial industry. White has held a number of government positions that have informed his views: as a senior staff economist for President Carter’s Council of Economic Advisers (where I first met him), as chief economist for the Antitrust Division at the Department of Justice, and as a member of the Federal Home Loan Bank Board (which used to oversee the savings and loan industry). White’s chapter on the influence of economists in antitrust enforcement in John Siegfried’s edited volume Better Living through Economics, cited in Chapter 9, is not only must reading for specialists in this field, but also makes clear how economists have taken over the thinking about how the nation’s antitrust laws should be enforced. This has had and will continue to have important effects on how businesses with significant presence in particular markets are allowed to behave, and when it is most likely that mergers between firms will be challenged.
Noll and White are just two of the many economists who have influenced my own thinking through the years, and from whom I have learned, in conversation and through their written works. I also thank them for their friendship.