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Regulation, competition, and the social control of business

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Abstract

In George Stigler’s (1971) economic theory of regulation, the primary motive of regulatory intervention is the promotion of private interests, not the promotion of the general welfare or efficiency as suggested by the public interest theory of regulation (Pigou 1932). More recently, Andrei Shleifer (2010, 2012) along with some coauthors (Glaeser & Shleifer 2003; Djankov et al. 2003) has proposed an alternative to Stigler’s theory, which he calls the enforcement theory of regulation. Shleifer’s new theory of regulation holds that the rise of regulatory institutions over the course of the twentieth century is in fact efficient and providing the requisite social control of business, largely because the alternative judicial mechanism is so inefficient and costly. Contrary to Shleifer, we argue here that because both courts and regulation are subject to ex-post defection, individual bias, and subversion, neither is categorically preferable. Whether or not courts or regulation are more efficient at providing social control of business ultimately depends on the features of the specific regulatory or judicial institutions as well as the economic problem addressed. Institutional environments differ with respect to the severity of knowledge and incentive problems and mechanisms for overcoming them that are built into them. The comparative efficiency of an institutional solution depends more on its institutional features (centralized/decentralized, contested/uncontested) than its form (regulation, courts, or private orderings). Stigler’s (1971) contribution acknowledges that concern implicitly by incorporating competition between different interest groups as the essential mechanisms driving regulatory outcomes.

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Notes

  1. Shleifer (2012, p. 40): “the case for efficient regulation rests on that against efficient courts.”.

  2. Elinor Ostrom’s (1990) work has distilled the importance of eight institutional design principles for the proper functioning of self-governing institutions to overcome common pool resource problems. Her work highlights the importance of the specific features of institutions for their success or failure.

  3. In the context of his discussion of Tullock’s case against the common law, Shughart (2018, p. 222) suggests that “although the origins and evolutions of common-law and civil-law traditions differ considerably, especially with respect to norms of judicial discretion, judges are part of the political process (Tullock 1997, p. 15) and are perhaps subservient to it in both legal regimes.” While he does not elaborate on this point, the observation that all judges (in both civil and common law systems) are subject to political pressure is related to the argument we are advancing here, i.e., all institutions are subject to attempts at rent-seeking and ex-post subversion; it thus is not the institutional form but particular institutional features that will make institutional frameworks more robust and resilient to politicization.

  4. Note that Medema (2014) suggests that Pigou himself had an account of government failure that in many ways anticipated the public choice revolution.

  5. This part of Shleifer’s argument is somewhat surprising considering some of his other work with Djankov et al., (2002, p. 1), which finds that more heavily regulated countries also tend to be more corrupt, featuring large unofficial economies without “better quality of public or private goods.”.

  6. Maybe surprisingly, one of the founders of the public choice perspective, Gordon Tullock, is famous for arguing against the common law and in favor of a legal system based on a civil code. His preference rests on the idea that common law courts are rife with error (Tullock 1980, 1987, 1997). Recently, Shughart (2018) suggests, however, that Tullock’s argument against the common law is based on limited empirical evidence and ignores some of Tullock’s own insights regarding the operation of bureaucratic agencies.

  7. One important contribution to the literature on courts accounting for the public choice perspective is Fuller (1978). Fuller argues that courts are likely to produce inefficient outcomes because they are, by nature, limited in the number of perspectives that can be represented in any particular case. For issues that are polycentric in nature, markets or legislation therefore will provide more robust solutions, because they can accommodate a wider variety of interests that may not otherwise be represented in courts.

  8. In the same vein, Aghion et al. (2021) show that regulation stifles innovation.

  9. Piano (2019) makes a related contribution to the literature on state capacity. He points out that an important missing element in the state capacity literature is competition. In short, the literature suggests that economic development is the result of a state with sufficient fiscal capacity to finance public goods production (Besley and Persson 2009; Johnson and Koyama 2017). The overarching insight of the state capacity literature is that states with high levels of capacity also tend to be economically wealthy (i.e., high taxes and regulation are complements to economic development). Piano (2019) set up a dichotomy between those institutions that develop to provide more attractive environments for capital investment on the one hand and those that specialize in capturing rents on the other. He suggests that competition between states is an effective check on the tendency of states with greater fiscal capacity to abuse their power for the purposes of rent extraction. That line or reasoning is like the argument we are making here, which is that competition between jurisdictions (extramural) or between groups inside a jurisdiction (intramural) can curb rent seeking.

  10. Several other contributions build on Ekelund and Tollison (1982) by incorporating and elaborating on the insight that competition between jurisdictions or internal to a jurisdiction can keep the rent-seeking society at bay. See, for example, Nye (1997, 2007, 2009) and Moberg & Tarko (2021).

  11. Koppl (1992, p. 307) uses the term “extramural” in his discussion of type-two invisible hand explanations and specifically Hayek’s contribution to the literature on institutional evolution: “Says Hayek [1967, p. 71], ‘the selection process of evolution will operate on the system as a whole’. The rules that generate the overall pattern are enforced by an external discipline and not by an internal profit motive.” That description of externally enforced discipline constraining institutional evolution overlaps neatly with our understanding of competition between jurisdictions constraining special interests within a jurisdiction, which is why we adopt the term “extramural” here.

  12. Note that the conclusion is true only if regulatory agencies are either managing a commons or are producing a pure public good. If they are restricting access in an anti-commons type manner or if they are producing a public bad, the more efficient institution is monopoly (see Buchanan & Yoon 2000; Buchanan 1973). Apolte (2001) shows that competition between governments in the provision of public goods can serve as a substitute for constitutional constraints on government. Similarly, Ashworth et al. (2013) illustrate how decentralization functions as a constraint on the size of government.

  13. The example presented in this subsection is taken in large part from Thomas & Thomas (2018).

  14. The story of Cologne’s brewers is based on Diana W. Thomas (2009).

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Acknowledgements

We would like to thank two anonymous referees for extremely helpful comments and suggestions.

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    Diana W. Thomas & Michael D. Thomas

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Thomas, D.W., Thomas, M.D. Regulation, competition, and the social control of business. Public Choice 193, 109–125 (2022). https://doi.org/10.1007/s11127-022-00989-z

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