Economics and Financial Regulation Will the SEC's New Embrace of Cost-Benefit Analysis Be a Watershed Moment?

By Manne, Henry G. | Regulation, Summer 2012 | Go to article overview

Economics and Financial Regulation Will the SEC's New Embrace of Cost-Benefit Analysis Be a Watershed Moment?


Manne, Henry G., Regulation


The modern history of the use of economic analysis in the development of legal policies, especially those relating to corporate and financial laws, can be dated to the New Deal. There was then a ferocious fight in the legal community over the establishment of what we have come to call the "administrative state," but which is more clearly seen as a mere variant of central economic planning. This was not central planning or resource allocation on the scale associated with the Soviet Union and advocated by a variety of 20th century socialist economists. Rather the U.S. variety was--and remains today--planning or resource allocation on a very detailed micro scale, but it is central economic planning and non-market resource allocation nonetheless. The regulatory agencies were each given enormous authority to make rules for the regulation of various private endeavors. The main fight in the 1930s, however, was not about the economic value or correctness of the ensuing decisions. Rather it was about Congress's constitutional power to delegate this much rulemaking authority to non-elected agencies.

Eventually that issue was put to rest with the arguments (largely pursuant to the "necessary-and-proper" clause of the Constitution) that society had become so complex that Congress had to rely on experts to do the detailed work of regulating, which Congress, by virtue of its expertise limitations, could not do; that the delegation had to have some semblance of reasonableness; and that due process, usually in the form of a right to appeal to the courts, be available. None of these justifications were premised on economic concerns. This issue was thought to be exclusively the province of lawyers and political theorists, not economists--though who was to exercise the needed expertise was never made clear.

Public Choice Theory

The next major phase in the debate over administrative powers came unexpectedly from the then-new field of Public Choice theory. Public Choice uses economics to analyze political phenomena, and the field is generally considered to have opened with the publication of James Buchanan and Gordon Tullock's book The Calculus of Consent in 1962.

Public Choice offers two main criticisms of the regulatory agencies. The first is that the behavior of bureaucrats is more accurately seen as self-serving rather than being motivated by the public interest. This would frequently manifest itself, not simply in the older idea that bureaucrats are slothful, but in agencies' push for ever greater budgets to fund expanded powers, first described by William Niskanen in his 1971 book Bureaucracy and Representative Government. The second criticism, in two parts, is that agencies could and very often are co-opted by the very interests that they are supposed to regulate, and that these combined interests are used for so-called "rent-seeking" purposes.

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Each of these criticisms of regulatory agencies has become standard fare in political theory. To a large extent, these ideas have permeated all levels of serious discussion about the administrative state. But "permeating the discussion" is a long way from having a real political influence, and on that score Public Choice seems to have only affected intellectual and academic understanding of regulation. There has been no serious legislative check on the possibility of regulatory abuse since the federal Administrative Procedure Act of 1946. But perhaps, often with considerable lag, intellectual discussion is the source of all good government reform.

Austrian Economics

Economic criticism of central planning has a long history. A now classic debate about free markets versus central economic planning raged in the late 1920s and the 1930s in reference to ideas of "scientific socialism" being advanced by apologists for the Soviet Union's extreme form of socialist planning. The principal criticism of this kind of planning probably originates with Ludwig von Mises, a founder of the Austrian School of Economics. …

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