JARG ONALERT Regulatory Capture BY BETTY JOYCE NASH n the early days of flight, airlines couldn’t provide air railroads had competed for business through price wars, service profitably so the government stepped in with secret rebates, and price concessions. The ICC is now Isupport. Airlines began to carry mail, paid for by regarded as a classic example of regulatory capture, in which airmail contracts. By 1933, four carriers collected 94 percent regulators enact rules in favor of the regulated industry. For of airmail service subsidies. Later, the Civil Aeronautics example, in the Transportation Act of 1920, Congress Board (CAB) set fares, subsidies, and mail rates. Airlines allowed the ICC to regulate minimum, not just maximum, were permitted profits, based on reported operating ratios. shipping rates. The Act also controlled entry into and exit That provided an incentive for airlines to overinvest and from the industry. Stigler also cited the regulation of long- generate higher operating costs. Profitable routes also distance trucking as an example of capture. As roads and subsidized unprofitable ones, justified by the CAB, which vehicles improved, by 1930 trucks posed competition for contended small cities would otherwise lose air service. By railroads in long-distance hauling. The railroads then sought 1978, airlines were largely deregulated, but for decades gov- state-imposed weight limits on trucks. Soon all states regu- ernment intervention was exploited to serve the interests lated truck weight and dimensions. Stigler noted that Texas of various stakeholders — including the regulated firms. and Louisiana limited trucks serving (in competition with) This is an example of regulatory capture. two or more railroad stations to 7,000 pounds. But trucks Capture can take various forms: subsidies, control of that served (did not compete with) one station were allowed entry by competitors, and price-setting, among twice the weight, 14,000 pounds. In 1935 the others. Economist George Stigler, who did Motor Carrier Act gave the ICC the power to much to develop the theory of regulatory control permits, approve routes, and set tariffs. capture and to identify prominent cases, That discouraged new entrants. Ultimately, concluded that “as a general rule, regulation is Congress deregulated the industry over indus- acquired by the industry and is designed and try and union opposition, but it took a long operated for its benefit.” Stigler’s work built on time, until 1980. earlier research on political utility maximiza- Regulatory capture also can become institu- tion. He applied those theories to regulation, tionalized. For example, local and state citizen and helped pave the way for the deregulation boards may be comprised of those who work in wave that began in the late 1970s. a profession or industry, creating a potential Regulation is typically a response to a per- conflict of interest. In some states practi- ceived market failure, ostensibly to serve the tioners of law, medicine, dentistry, cosmetol- public interest. But as the airline industry ogy and others may draft laws that determine example demonstrates, regulatory capture can the qualifications of those eligible to enter pose problems for policymakers who want their occupation. to implement regulation that improves the The extent of regulatory capture depends to general welfare. Last spring, people questioned some degree on the intensity of interest among the conduct of the government regulator over- those affected. Regulated firms may have much seeing offshore drilling. But it’s unclear, until the case is at stake in regulatory activity. Consumers, though, will have unraveled, whether regulatory capture or simple ineptitude a small or diffused stake in the outcome. Environmental contributed to the accident. regulation is a classic case where regulated firms have A significant insight emerging from capture theory is concentrated interests, but individual interest is diffuse. that a regulator may act, either intentionally or unintention- Environmental organizations act as intermediaries, osten- ally, in a way that results in personal or institutional gain. sibly promoting the public interest through lobbying and This can be fostered through a close relationship between other efforts. industries and regulatory agencies. Regulating agencies may An essential insight of Stigler and other economists who have incentive to hire from regulated firms to acquire exper- followed his lead was that all players in the regulatory regime tise, and firms may rely on industry-supplied knowledge. — firms, bureaucrats, interest groups, and legislators — act An early federal regulatory effort was the Interstate as economic agents who have the interest and opportunity OOK Commerce Act of 1887. Railroads supported the creation to advance strategic actions. Although public service may THY C of the Interstate Commerce Commission (ICC) because motivate players, Stigler pointed out that these are not the TION: TIMO its rules would strengthen the existing cartel. Previously, only incentives at work. RF TRA ILLUS 12 Region Focus | Third Quarter | 2010 .