George Stigler and regulatory capture
The Theory of Economic Regulation
George J. Stigler
The Bell Journal of Economics and Management Science
Vol. 2, No. 1 (Spring, 1971), pp. 3-21 (19 pages)
This article is fifty years old. I am not sure I’ve ever read the original, but the ideas it contains, as popularized by academics such as Luigi Zingales and Russ Roberts have been hugely influential on me, and have been very influential in forming my political outlook. The idea is simple: that regulation to protect the public can be structured in such a way as to protect incumbent suppliers of the regulated good or (usually) service.
An episode of Capitalismisn’t was devoted to this article, which has some excellent illustrations of what can happen. Probably the most egregious example of how the theory predicts what will happen in the banking industry is what happened with Dodd Frank, and in particular the Volker Rule, which is exquisitely crafted to protect the incumbents and create the illusion of protection to the public. Quite obviously, the banks which were “too big to fail” in 2007 are much bigger and more dominant now.
Stigler was in favour of breaking up monopolies and using structural means of protecting the public, over complex rule books written by legions of lawyers who would be later able to make money by explaining how to skirt these rules.
There are not many ways of preventing the dysfunctional outcomes that Stigler’s theory predicts. One is to create permanent incorruptible civil servants. As far as I know, the only state to have tried this seriously is Singapore. More generally, in the USA, and increasingly in the UK, the regulators of finance and judges (who interpret the law itself) are paid a tiny fraction of what practitioners are paid. As Zingales says, it might be possible to persuade a judge to forego a career as a partner in a top law firm if he was expected to sacrifice only 20% of his possible salary, but if he is expected to forego 90% of it, we are doomed to have practitioners who are hugely more talented than regulators.
Another issue is the sheer complexity of modern regulation. Dodd Frank is estimated to have introduced over 27,000 new restrictions on business activity. It is simply inconceivable that anyone has the time to read and understand this other than people paid as lobbyists to ensure that the regulation is ineffective in terms of limiting the power of large financial institutions.
I like to think about how a situation like this comes about. This is easy: the economic incentives are extremely large. And I like to think about how it might end or change. This is much more difficult to do. I suppose that, eventually, the deadweight costs of economic inefficiency resulting from the misallocation of resources will allow some other form of economic organization to overtake societies which allow Stiglerian regulatory capture. We might have to wait a long time.
Wrap
Today almost literally nothing happened. 10Y yields hardly budged, and equity markets remained stalled. The Ponzi sector mean reverted a bit, oil dragged many non-monetary commodities upwards, by a little. The GSCI index was up 1.2%, with CL1 up 3%. Gold was flat. Coal miners were down a lot. The see-saw between the rise of alternative fuels and the recovery of fossil fuel prices is likely to continue for the rest of this year, at least.
This is a fantastic thread about what the appropriate size of the state must be in order to carry out its proper function of protecting citizens against external or otherwise organized threats, and about how that size must change as a function of the size of these threats. I think that the threat level is in some sense determined by the size of the state that can be plundered: seizing the reins of power in the US would take a big power (China, presumably), but the reward, in terms of the US state’s reach both in it’s control of its domestic economy and it’s global influence are so great it might actually be worth that power attempting the job. Beefing up the army is not the best solution to the problem.
So, I don’t agree with the solution, but I agree that there is a problem and anarchy is not a solution. Although David Friedman has some ideas which make some much reduced size of the state sound feasible.
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