Conceptualizing Regulation

How should we think about regulation? What basic stories should we tell to frame the phenomenon? My friend Carl Danner has an intriguing new candidate, the “Commandeering Theory” of regulation. He explains in a nice article at the CATO review. In Carl’s words,

In a nutshell, this new theory holds that government can use its regulatory authority to pressure or require a firm to exercise its influence to fund desired projects or shape customer behavior.

First, let’s back up. What do I mean by a “theory of regulation?”

If you’ve been subjected to a standard Econ 101 course, you know one such theory: A “market imperfection” such as monopoly, externality, or asymmetric information means that free markets are not ideal. A benevolent technocratic regulator steps in to remedy the market failure.

Public choice economists looked out the window, and noticed that this theory had next to zero explanatory power for the regulations we actually see. Many regulations, like rent control and many labor regulations, serve to try to transfer wealth from one group to another more favored group.

The public choice economists noticed frequent “regulatory capture.” Regulators were “captured” by industry. The regulators enforced (rather than fought) monopolies and oligopolies, to keep up industry profits. After all, who talks to the regulators day in and day out, but the affected industries? Regulators not only have a natural desire to please their day to day pals, but get a revolving door of benefits when they step down from regulatory posts. That story still describes a lot of regulation today. Much banking and securities regulation looks that way to me.

I wrote an earlier post on two-way capture. As I look out the window, I see a lot of reverse capture. Regulators use the threat of enforcement to get industries to support them politically or do take actions that support their political party. The twitter files revelations are a classic example.

Carl lists a few other such theories — basic parables — of regulation

• Public Interest Theory: Regulation addresses monopolies, externalities, public goods, and other problematic circumstances that market forces may fail to correct.

• Special Interest Capture: An industry gains control of its regulator, to act for the industry’s advantage.

• Public Choice Theory: People in regulatory agencies steer the agency’s actions to benefit themselves.

• Bounded Rationality: Regulation corrects for information asymmetries, biases, short-termism, or flawed reasoning by firms or the public.

• Momentum of Institutions: Entrenched procedures and rules lead agencies and courts to act as they always do.

• Bootleggers and Baptists Theory: Political coalitions enact rules to advance their ideologies and economic interests.

• Taxation by Regulation: Regulators have some customers pay more so others can pay less for a service or product.

Carl’s theory of “Commandeering” is a better articulated version of two-way capture, with a lot of detail. Regulators force industries to do their political bidding, not just partisan support.

Carl knows a lot about electricity, so his prime example comes from California’s electricity market. Here the Econ 101 parable states that electricity is a natural monopoly because of network economies of scale. So it must be allowed a monopoly, but regulators will step in to keep it from charging too high profits to consumers.

Like public choice, Carl looks out the window, or at his electricity bill. Does this theory explain what we see, especially in California?

Source: Carl Danner

So, compared to a national average of 16.4 cents per kWh, Californians pay 33-50 cents. Clearly, “keeping prices down” on a super-efficient natural monopoly does not explain California.

Where is the money going? (Especially given California’s commitment to solar and windmills, in a sunny windy state, and with the constant claim that these are now cheaper than fossil and nuclear.)

These prices are elevated because of three types of California government initiatives—that is, three types of state commandeering of the utilities’ monopoly power. The first is mandated programs, funded through utility bills, whose costs fall on customers. The second is an assignment of liability to these utilities for wildfire damages they may not have caused. The third is mandated transfers between customers for an environmental initiative, where some pay higher utility bills so that others can more easily purchase rooftop solar systems.

Source: Carl Danner

Carl is remarkably even-handed about the benefits of these kinds of policies. His point: If they are beneficial, why are they funded by forcing electric utilities to provide them? For example,

Cross subsidies California mandates two major types of cross subsidies for consumers: those that fund low-income support programs and those that fund environmental programs.

California’s CARE program funds discounts to low-income beneficiaries, including enrollment and eligibility verification done in-house by the utilities. Monopoly electricity customers were charged program benefits and administrative costs of $1.76 billion in 2023. In this way, the majority of customers pay higher utility bills so their neighbors of lesser means can pay less.

Numerous public programs help low-income people afford the necessities of life, a key role for government. Yet, providing these benefits is not a typical part of doing business for the companies that deliver such necessities, and it seems more appropriate for an on-budget tax-and-transfer government program funded through progressive taxation.

The twitter/Facebook censorship is Carl’s second, and excellent, example of the “Commandeering” theory of regulation.

In recent years, high-level federal officials commandeered social media market power when they asked, persuaded, and threatened companies like Twitter, Facebook, Google, and LinkedIn to shut down user accounts, remove disfavored posts, and reduce the availability of other information on topics such as the origins of the COVID virus, the effectiveness of vaccines, the reasonableness of vaccine mandates, the integrity of elections, climate change, gender debates, abortion, economic policy, and even a parody making fun of President Joe Biden’s family. Among the agencies involved were the White House, the Federal Bureau of Investigation, the Surgeon General, the Centers for Disease Control and Prevention, and the Cybersecurity and Infrastructure Security Agency. …

As examples of pressures that were brought both privately and publicly, President Biden’s press secretary threatened a “robust anti-trust program” as a potential consequence for social media platforms failing to cooperate with administration demands. The White House communications director also threatened adverse amendments to Section 230 of the Communications Decency Act, which gives online media companies immunity, as platforms, for the contents of third-party posts. Either of these actions could greatly harm social media firms (Missouri v. Biden 2023a, Missouri v. Biden 2023b).

Nice business you have there. Too bad you’re allowing people to spread “misinformation” contrary to the Administration’s Daily Spin. It really would be a shame if we had to send the SEC, FTC, NLRB, OSHA, EEOC, CFTC, IRS, and so forth to have a look at what’s going on there….

Two final reflections.

Economics has a veneer of equations and models, and those are indeed how we express ourselves in order that are parables are internally consistent. But we are creating parables, simplified stories, that people use to understand causal mechanisms in a complex world.

Econ 101 seems awfully stuck in a rut. A week of market perfection, with eyes rolled. Nine weeks of theoretical “market failures” remediable by the all seeing benevolent regulator. No time on the experience of actual government policies, evaluating how well the parable explains them, or alternative parables of government failures.

Update:

A correspondent reminded me of the brilliant recent plan to charge for electricity by income

A year ago, California’s three big investor-owned electric power utilities – Pacific Gas & Electric, Southern California Edison and San Diego Gas & Electric – proposed new fixed charges on their residential customers that would vary by income.

Households making less than $69,000 a year would pay $20 to $34 a month, while those earning $69,000 to $180,000 would be charged $51 to $73. The charge would be $85 to $128 on customers with incomes over $180,000.

So the power companies would be directly involved in income redistribution. How “income” would be defined and measured is a good question. An economist sees an interesting marginal tax rate at $69,001 and $180,001 income. Even in California, this was too much. And per the article, this wasn’t even a regulatory idea. The utilities came up with it on their own!