Regulatory capture

An organization’s evasion of control by a regulatory body, often an anti-trust or takeover body.

Organizations will attempt to dilute the effectiveness of regulatory bodies through political control, and by developing superior information and more effective staff.

Theory

Interstate Commerce Commission (ICC) as Barrier-to-Competition: Applications-to-Operate vs In-Operation

For public choice theorists, regulatory capture occurs because groups or individuals with a high-stakes interest in the outcome of policy or regulatory decisions can be expected to focus their resources and energies in attempting to gain the policy outcomes they prefer, while members of the public, each with only a tiny individual stake in the outcome, will ignore it altogether.[4] Regulatory capture refers to the actions by interest groups when this imbalance of focused resources devoted to a particular policy outcome is successful at “capturing” influence with the staff or commission members of the regulatory agency, so that the preferred policy outcomes of the special interest groups are implemented.

… as a rule, regulation is acquired by the industry and is designed and operated primarily for its benefit… We propose the general hypothesis: every industry or occupation that has enough political power to utilize the state will seek to control entry. In addition, the regulatory policy will often be so fashioned as to retard the rate of growth of new firms.
— The Theory of Economic Regulation, George Stigler, 1971[5]

Regulatory capture theory is a core focus of the branch of public choice referred to as the economics of regulation; economists in this specialty are critical of conceptualizations of governmental regulatory intervention as being motivated to protect public good. Often cited articles include Bernstein (1955), Huntington (1952), Laffont & Tirole (1991), and Levine & Forrence (1990). The theory of regulatory capture is associated with Nobel laureate economist George Stigler,[6] one of its major developers.[7]

Likelihood of regulatory capture is a risk to which an agency is exposed by its very nature.[8] This suggests that a regulatory agency should be protected from outside influence as much as possible. Alternatively, it may be better to not create a given agency at all lest the agency become victim, in which case it may serve its regulated subjects rather than those whom the agency was designed to protect. A captured regulatory agency is often worse than no regulation, because it wields the authority of government. However, increased transparency of the agency may mitigate the effects of capture. Recent evidence suggests that, even in mature democracies with high levels of transparency and media freedom, more extensive and complex regulatory environments are associated with higher levels of corruption (including regulatory capture).[9]

Relationship with federalism

There is substantial academic literature suggesting that smaller government units are easier for small, concentrated industries to capture than large ones. For example, a group of states or provinces with a large timber industry might have their legislature and/or their delegation to the national legislature captured by lumber companies. These states or provinces then becomes the voice of the industry, even to the point of blocking national policies that would be preferred by the majority across the whole federation. Moore and Giovinazzo (2012) call this “distortion gap”.[10]

The opposite scenario is possible with very large industries, however. Very large and powerful industries (e.g. energy, banking, weapon system construction) can capture national governments, and then use that power to block policies at the federal, state or provincial level that the voters may want,[11] although even local interests can thwart national priorities.[12]

Economic rationale

The idea of regulatory capture has an economic basis: vested interests in an industry have the greatest financial stake in regulatory activity of any social agent and are thus more likely to be moved to influence the regulatory body than relatively dispersed individual consumers,[4] each of whom has little particular incentive to try to influence regulators. When regulators form expert bodies to examine policy, these invariably feature current or former industry members, or at the very least, individuals with lives and contacts in the industry to be reviewed. Capture is also facilitated in situations where consumers or taxpayers have a poor understanding of underlying issues and businesses enjoy a knowledge advantage.[13]

Some economists, such as Jon Hanson and his co-authors, argue that the phenomenon extends beyond just political agencies and organizations. Businesses have an incentive to control anything that has power over them, including institutions from the media, academia and popular culture, thus they will try to capture them as well. This phenomenon is called “deep capture”.[14]

Regulatory public interest is based on market failure and welfare economics. It holds that regulation is the response of the government to public needs. Its purpose is to make up for market failures, improve the efficiency of resource allocation, and maximize social welfare. Posner pointed out that the public interest theory contains the assumption that the market is fragile, and that if left unchecked, it will tend to be unfair and inefficient, and government regulation is a costless and effective way to meet the needs of social justice and efficiency. Mimik believes that government regulation is a public administration policy that focuses on private behavior. It is a rule drawn from the public interest. Irving and Brouhingan saw regulation as a way of obeying public needs and weakening the risk of market operations. It also expressed the view that regulation reflects the public interest.

Development

The review of the United States’ history of regulation at the end of the 19th century,[clarification needed] especially the regulation of railway tariffs by the Interstate Commerce Commission (ICC) in 1887, revealed that regulations and market failures are not co-relevant. At least until the 1960s, in terms of regulatory experience, regulation was developed in the direction of favoring producers, and regulation increased the profits of manufacturers within the industry. In potentially competitive industries such as the trucking industry and the taxi industry, regulations allow pricing to be higher than cost and prevent entrants. In the natural monopoly industries such as the electric power industry, there are facts that regulation has little effect on prices, so the industry can earn profits above normal profits. Empirical evidence proves that regulation is beneficial to producers.[citation needed]

These empirical observations have led to the emergence and development of regulatory capture theory. Contrary to regulatory public interest theory, regulation capture theory holds that the provision of regulation is adapting to the industry’s need for regulation, that is, the legislator is controlled and captured by the industry in regulation, and the regulation institution is gradually controlled by the industry. That is, the regulator is captured by the industry. The basic view of the regulatory capture theory is that no matter how the regulatory scheme is designed, the regulation of an industry by a regulatory agency is actually “captured” by the industry. The implication is that regulation increases the profits of the industry rather than social welfare.[citation needed]

The above-mentioned regulatory capture theory is essentially a purely capture theory in the early days, that is, the regulators and legislators were captured and controlled by the industry. The later regulatory models, such as those by Stigler, Pelzmann, or Becker, belong to the regulatory capture theory in the eyes of Posner (1974) and others. Because these models all reflect that regulators and legislators are not pursuing the maximization of public interests, but the maximization of private interests, that is, using “private interest” theory to explain the origin and purpose of regulation. Aton (1986) argues that Stigler’s theoretical logic is clear and more central than the previous “capture theory” hypothesis, but it is difficult to distinguish between the two.[citation needed]

Regulatory capture theory has a specific meaning, that is, an experience statement that regulations are beneficial for producers in real life. In fact, it is essentially not a true regulatory theory. Although the analysis results are similar to the Stigler model provide interpretation and support for the regulatory capture theory is beneficial for producers, however the analysis methods of the latter are completely different. Stigler used standard economic analysis methods to analyze the regulation behavior, then created a new regulatory theory—regulatory economic theory. Of course, different divisions depend on the criteria for division, and they essentially depend on the researchers’ different understanding of specific concepts.[citation needed]

Justice Douglas’ dissent in Sierra Club v. Morton (1972) describes concern that regulatory agencies become too favorable with their regulated industries.[citation needed]

Types

There are two basic types of regulatory capture:[15][16]

  • Materialist capture, also called financial capture, in which the captured regulator’s motive is based on its material self-interest. This can result from bribery, revolving doors, political donations, or the regulator’s desire to maintain its government funding. These forms of capture often amount to political corruption.
  • Non-materialist capture, also called cognitive capture or cultural capture, in which the regulator begins to think like the regulated industry. This can result from interest-groups lobbying by the industry. Highly specialized technical industries can be at risk of cultural capture, because the regulating agency typically needs to employ experts in the regulated area, and the pool of such experts typically consists largely of existing or former employees from the regulated industry.

Another distinction can be made between capture retained by big firms and by small firms.[17] While Stigler mainly referred, in his work,[18] to large firms capturing regulators by bartering their vast resources (materialist capture) – small firms are more prone to retain non-materialist capture via a special underdog rhetoric.

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