Regulatory Failure by the Numbers

Article excerpt

Between the current financial mess and the debate over carbon dioxide emissions controls, there is a lot of talk about regulation these days. We are told, for example, that the recession would have been prevented if proper regulations had been in place. While it is true that (by definition) the "right" regulations would have prevented bad and ensured good, it is also true that had an omniscient, omnipotent, omnibenevolent dictator been in charge, the recession would have been avoided as well. The problem, of course, is that God didn't run for president during the last election.

Enacting the right regulations is somewhat simpler than electing an omni-everything being to run the world - but not by much. As evidence, consider all the bad regulations that sot us into this mess in the first place. Also consider the oft-heard argument that financial regulators needed to "get out ahead of the innovators." Clearly, a job for the omniscient. There is, after all, a reason why the Wright Brothers' flight at Kitty Hawk preceded the establishment of the Federal Aviation Administration.

Any time government regulators try to do much more than lay out the basic rules of the game, unintended consequences and moral hazards rear their ugly heads. The following list of pitfalls, adapted from our book Energy: The Master Resource, is offered as a caution to regulatory enthusiasts.

1. Laws and regulations may institutionalize the tragedy of the commons.The rule of capture (which stated that oil belonged to whoever pumped it out of the ground) and related regulations led petroleum companies to drill as many wells as possible in order to get the oil before their competitors could. By encouraging companies to drill otherwise unnecessary wells, the rule led to wasted resources and sometimes to reservoir damage.

Groundwater in the United States is still a commonproperty resource. Because no one owns it, no one has an incentive to conserve it. Farmers in California, enjoying subsidized water prices, have been growing water-intensive crops such as rice and cotton in desert areas despite endemic water shortages.

2. Special interests lobby the government to get their products or services mandated by regulation. The mandated use of ethanol in automotive fuel is an example. In the United States most ethanol is made from corn. Farmers who grow corn and companies that make ethanol from it have heavily pressured Congress to require its use. As a further subsidy the government has banned imported ethanol even though it can be purchased from other countries for less than it costs to make it here. One unintended consequence has been an increase in food prices. As the price of corn has risen, so has corn-based animal feed and with it the price of beef, milk, chicken, and eggs.

3. Regulations can create (or destroy) entire industries overnight. The use of such power adds uncertainty and risk to the market. If risk reaches unacceptable levels, investors put their money elsewhere. The concentration of political power in Washington forces companies to lobby Congress and the White House for protection against its arbitrary use. Corporate lobbying, in turn, increases people's distrust of the system.

4. Regulations are often the result of compromise. After concessions have been made to this powerful representative or that influential senator, the resulting law or regulation may be very different from the original proposal and have far different consequences. Politics may be "the art of the possible," but what is politically possible may be neither practical nor environmentally friendly.

Compromise can also result in laws so vaguely worded that they can be interpreted in any number of ways. In the end it is left up to regulatory agencies and the courts to decide what a bill actually means. Their interpretations may be very different from the original intentions of the bill's proponents.

The Clean Air Act Amendments of 1977, for example, stated that only new factories and power plants would have to meet the tighter emissions standards imposed by the act. …