Government Regulation: Enemy of Individualism
by Dr. Edward Younkins
Professor of Accountancy and Business Administration at Wheeling Jesuit University in West Virginia and author of Capitalism and Commerce.
America was founded on the basis of an explicit philosophy of individual rights. The Founding Fathers held the view that government, while deriving from the consent of the governed, must be limited by the rights of the individual. The purpose of government was to maintain a framework within which individuals can pursue their own self-interest, controlled by the competitive marketplace. Until the early 1900s, the U.S. had a very limited government; however, since the Great Depression, both attitudes toward government and the interpretation of the Constitution changed, resulting in an increasingly large government that has spread its functions to now include: maintaining national defense and internal law and order; protecting property rights; enforcing contracts and adjudicating disputes; promoting exchange by providing a stable monetary system; handling market defects and promoting competition by regulating the American product, labor, and financial markets; providing public goods; maintaining transportation and postal systems; using fiscal and monetary policy to promote a high level of employment, economic growth, and price stability; protecting people from unintended by-products of business activities including the degradation of the environment, unsafe products and work places, and the exclusion of minorities; and redistributing income through the impact of taxes, inheritance laws, and transfer payments (i. e., social security, aid to families with dependent children, and unemployment compensation). A substantial proportion of the above functions deals with the area of government regulation.
An Overview of Regulation
The Constitution provides for certain government interventions. However, it stresses minimum intervention. Regulation, a mechanism for implementing social choices, is based on the following constitutional powers: (1) the power to regulate interstate and foreign commerce, (2) the power to tax and spend, (3) the power to borrow, and (4) the power to promote the general welfare.
Regulations are promulgated by agencies in response to laws passed by Congress to remedy a perceived "market failure" or to attain a social goal. When the government regulates business it sets legally enforceable standards for conducting what are considered to be legitimate business activities. Within their range of jurisdiction, federal, state, or municipal agencies set standards by which goods and services must be produced, marketed, transported, financed, sold, or disposed of.
By legally requiring that people behave in certain ways not in their best interests in carrying out their professional tasks, regulation can distort firms' behavior and choices. By forcing the terms of exchange, regulation requires people to transfer value directly to other people. Since the terms of a regulated exchange are coerced, they are against the judgment of at least one of the participants in the transaction. The purpose of regulation is to have government intervene in order to force an exchange that would not be agreed upon in free market.
Government regulation occurs when: (1) undesirable market structures are said to exist (i.e., fewness of firms); (2) there is a perceived need to conserve and efficiently use a natural resource; (3) significant negative economic externalities (e.g., pollution) are associated with a firm's activities; (4) the market or other conduct of a firm is judged to be socially undesirable (e.g., price discrimination); and (5) there is a desire to control or dilute large power blocks in the economy (e.g., the strategic position of utility companies). These reasons primarily involve perceived or actual "market failures."
The term, market failure, implies that the market is a means to certain desired ends. If these ends are not attained, a deficiency is said to exist in the market system. Many proponents of market failure theory argue that certain public goods such as electricity or water would be provided inefficiently in a market setting. Others take the market failure concept even further by calling for government to correct the inability or unwillingness of private firms to provide certain values. The idea of a market failure has been extended to include the failure of a free market to produce specific goods and services at a cost or in quantities judged to be desirable or reasonable. The political process is thus used to lobby the government to interfere and correct the market failure by requiring firms to produce certain goods or services or at a given price. This revised and expanded concept of economist's idea of market failure not only claims that what is produced should be produced efficiently, but also that the market should supply additional goods and services in quantities and prices not in the firm's own perceived best interests.
The enhanced version of market failure theory can be traced to the ideas of democracy and positive rights. According to democratic theory, a demand by the majority ought to be met even if that means government intervention into the economic sector. However, a law can still be a violation of natural rights, no matter how popular it may be. In addition, people do not possess positive rights and are not owed involuntary servitude by their fellow men. Examples of recent claims to positive rights include: the right to a job, the right to job safety, the right to education, and the right not be discriminated against.
Many types of perceived market failures turn out to be caused by non-market institutions or political failures such as the influence or capture of the regulatory process by vested interests and industry experts. The idea of political failure includes the notion that there is a tendency for government to do more harm then good when it intervenes in economic activities. Even in cases of true market failure there is no compelling reason to believe that the situation will not worsen through government intervention. The costs of market failure versus the cost of government failure need to be compared. Regarding the values that the market system does not provide, it is wrong to assume that government can bring about their supply in the right amounts, efficiently, and without great costs elsewhere.
A new type of regulation, social regulation, gained in importance during the post-World War II period. Unlike economic regulation (which focuses on market or economic variables, entry to or exit from markets, and types of services that can be offered), social regulation focuses on firms' impacts on people as employees, consumers, and citizens. Social regulations attempt: to provide protection from discrimination in employment practices; to assure safe and healthful workplaces; to protect consumers against risks from unsafe products; and to protect citizens from environmental pollution. In contrast to economic regulations, social regulations are usually rather lengthy and specific and are normally aimed at business practices affecting all industries – only occasionally are there social regulations that are industry specific. The Environmental Protection Agency, for example, sets precise pollution reduction goals and timetables for all firms and, as a result, is less likely to identify with, and have sympathy for, those regulated than an agency like the Federal Communications Commission, which is related to a specific industry. The growth in social regulation has signaled an increasing role for government in the affairs of businesses of all sizes. This power shift from managers to government regulators has led to a blurring of the distinction between private power and public power.
While economic regulation has decreased over the last few decades, social regulation has been on the rise. The inspectors, reviewers, etc. of social regulatory agencies outnumber the staffs of federal economic regulatory agencies. The government uses regulatory power to attain all types of "socially desirable" ends in areas such as: the reduction of pollution, improved areas for the handicapped, workplace safety, product safety, etc. The function of social regulation has not been to control entry, exit, prices, or profit, but to address such "market failures" as externalities and information inadequacies.
Costs and Consequences of Regulation
Government intervention into private markets produces costs and unintended consequences more harmful than the targeted problem itself. Government actions create obstacles to prosperity and economic growth. Initially, the impacts of government regulation are to increase firms' costs, slow down their decision making processes, and reduce the resources available to produce goods and services. Ultimately, it is the consumer who is at the receiving end of the repercussions generated by regulation. It is imperative to look at the effects on all groups and in the long run.
One adverse effect of regulation is the administrative, on-budget costs to taxpayers for running and maintaining federal regulatory agencies. Bureaucrats have vested interests in creating increased demands for their own regulatory skills (and for more resources) by producing a broad, complex, maze of rules through which firms and individuals must pass. Businessmen and other citizens, in turn, seek to expand the scope of the regulatory process because each envisions a way of gaining from it – people are motivated to create ways of also qualifying for the benefits to those favored by various regulations.
Direct compliance expenditures include the costs of processing paperwork, accountant and attorney fees, staff time needed to understand and comply with the web of federal regulations, specific equipment requirements, the time lost waiting in lines for permits and inspections, etc. Not only are such costs passed on to customers in the form of higher prices, compliance costs also produce a lag in the introduction of new products since firms must get permission from an array of agencies at each level of government and oftentimes from the courts.
Opportunity costs, hidden or indirect costs of regulation, are the benefits that would have occurred if resources had not been devoted to some regulatory activity. By focusing on what opportunity is foregone by spending the money on particular regulations, we can estimate the lost benefits of alternative public or private uses of taxpayers' wealth. Those foregone benefits can be viewed as deadweight losses.
When regulators ask if people are in favor of safer products, they are asking for a comparison between something and its absence. The benefits gained through regulation should be compared with what could be obtained with the same resources in the absence of regulation. The benefits of government regulation can only be produced by employing resources which citizens may prefer to use in other ways. While the effects of government regulation can be pointed to, the costs of the preferred choices of individuals are unseen.
Many regulations increase the cost of employing workers and thus act like a hidden tax on job creation. The minimum wage law and federal labor laws increase the cost of employing workers and decrease wages and/or employment. Government-mandated costs such as unemployment and disability insurance, retirement benefits, child care, government paperwork requirements, and the cost of lawyers and accountants raise the cost to employers above the rewards received by the worker. This can lead to layoffs, or at a minimum, to a slowdown in the creation of new jobs.
The intended purpose of minimum wage laws is to help the lowest wage earners at the expense of the of their employers. The actual result is to increase unemployment among the poor and unskilled. Such a law does not increase the worth of any employee, it merely makes unemployable any worker whose service potential is worth less than the minimum wage. If such a restriction did not exist everyone looking for employment would find some type of job.
Federal labor laws restrict the flexibility of companies to hire and dismiss workers. Such laws also require the firm to engage in costly and time-consuming negotiations with labor unions. In addition, compulsory union dues reduce the net benefit received by workers thereby decreasing the supply of labor.
Proponents of government regulation make the case that while regulations may cut jobs in some companies, it increases them in other firms. While it is true that jobs are created in companies that help firms to comply with rules (e.g., with Treasury or environmental regulations), the truth is that regulation diverts employment from productive (i.e., value-added) to unproductive (i.e., non-value-added) activities.
Costs of regulation to the economy and society include the loss of enterprises that cannot afford to meet the hundreds of government regulations; the reduced flow of new and improved products; and a less rapid rise in the standard of living. Some firms are forced to close their businesses or to carry them overseas. For surviving domestic firms, regulatory costs are a hidden tax reducing the competitiveness of domestic companies in a global marketplace.
Not only do rent controls violate the rights of both landlords and tenants to freely and jointly decide the price of a rental unit, rent controls create shortages and decrease the quality of housing. Tenants desire the best apartment for lowest possible rent and landlords want the highest rent they can get. Rent controls have produced notorious housing shortages and have encouraged the wasteful use of space. There is no incentive to build new housing under rent control. Landlords have no incentive and little capital to invest in new construction or to keep low-income housing in good repair. In turn, tenants are encouraged to use space wastefully because of low fixed rents and legal protection against rent increases.
Duties, import quotas, and other restrictions on free trade can only benefit any domestic industry at the expense of consumers who must buy higher priced (or lower quality) goods. Tariffs, like price supports, shift higher costs and inferior quality goods onto consumers.
The nature of price controls (i.e., maximum or minimum prices) is to control and force people to do what the government wants them to do. In a free society, a government does not have the right to interfere with the choices of people to do business with each other at terms mutually agreed upon.
Without the benefit of feedback market signals, regulators have no basis of knowing which actions are "correct" and which are mistaken. Prices maintained by artificial mechanisms necessarily contain misinformation. Regulatory measures such as price-fixing obscure the true cost of one course of action compared to its alternatives, inhibit the feedback that permits transactors to communicate, and create market distortions that ultimately harm consumers.
Prices are mechanisms for carrying out the rationing function and are fast, efficient conveyors of information through a society in which fragmented knowledge must be coordinated. Accurate prices resulting from voluntary exchanges allow the economy to achieve optimal performance in terms of satisfying each person as much as possible by his own standards without sacrificing others' rights to act according to their own standards.
Regulation impairs economic growth, retards the innovation process, and delays the adoption of new technologies. For example, Americans are frequently deprived of superior medicines because the U.S. is one of the last countries to allow the introduction of new and better pharmaceutical products. Slowness in drug approval prevents Americans from obtaining drugs that might save their lives and/or increase the quality of their lives.
Automobile safety requirements for seat belts, air bags, auto inspections, etc. may not necessarily reduce highway accidents, injuries, and fatalities. Drivers may be willing to accept a certain level of risk and therefore might compensate for "safer" vehicles through reckless driving.
Regulated firms whose profit is limited to a stipulated percentage multiplied by the sum of the allowable expenses and assets in its "rate base" have every incentive to permit costs to rise and to become too capital intensive, given that the regulatory agency accepts these expenditures as valid for inclusion in the rate base. There is little incentive for regulated firms to keep costs down, and great incentive to see them rise.
Traditional economic theory postulates the following reasons for excluding competitors: (1) external effects (e.g., broadcast interference which renders unrestricted competition infeasible) and: (2) industries (usually natural monopolies such as electricity, gas, or telephone) that require huge investments in fixed costs in which cost per unit of output is constantly declining and, therefore, in which one producer can supply the market more cheaply than multiple producers. Regulatory agencies have thus been assigned the valuable legal right to exclude firms from entering the industry they regulate. Although inconsistent with the "public interest", a rational response of members of regulatory commissions is to protect and favor incumbents who can possibly reward them in the future (e.g., by employing them in firms they currently regulate).
Similarly, the government can restrict entry into a given market by requiring occupational licenses, certifications, and business permits. Here there is also a strong bias towards incumbents. Existing practitioners in a licensed occupation are almost always exempted from escalating qualification standards such as educational requirements, apprenticeship requirements, and tougher qualifying examinations. The change in qualification standards is often accompanied by rules forbidding either price undercutting or price advertising. A good case may be made that the espoused "public interest" benefit of weeding out unqualified practitioners may be less than the related costs.
Deregulation is based on an ethical base that recognizes the primacy of conscious and informed individual choice and responsibility for one's actions. Since the 1970s, there have been major efforts to lessen or eliminate economic regulations where competition sufficiently serves the "public interest." During the last few decades, the U.S. has deregulated airlines, trucking, taxi fleets, utility rates, interest rates, broker rates, etc.
Before 1978, for nearly 50 years, the airlines had been run as a highly regulated quasi-utility, with each carrier allowed to fly only those routes, and charge only those prices, approved by the Civil Aeronautics Board (CAB). The CAB began to deregulate in 1977 by granting increased freedom in pricing and easier admittance to routes not previously served. As a result, fares were lowered, passenger load factors were improved, the cost per seat was decreased, profits soared, and better service was received by customers. Then, in 1978 Congress passed laws that phased out the CAB, abolishing its authority to control prices and entry. Lawmakers began to recognize that airline regulation tended to increase risk and decrease safety – not only did such regulation increase carrier costs, it made routing more circuitous, required people to spend more time in the air, and caused planes to make more take-offs and landings.
An unanticipated benefit from airline deregulation was a decrease in auto accidents. Lower air fares shifted more travelers to airlines from other modes of transportation such as the automobile. The deregulation of airlines thus saved lives since travel by automobile is riskier and more likely to result in injuries and fatalities.
Congress passed the Motor Carriers Act of 1980 that permitted more pricing freedom to individual carriers, made entrance to the market less burdensome, and removed many costly Interstate Commerce Commission (ICC) restrictions. Before such deregulation, the ICC created inefficiencies and artificial demand for trucking services through regulations such as: (1) forcing many trucks to come back empty instead of returning home carrying another load, and (2) forbidding a truck carrying one product or a product in a specified stage of completion to haul another product or the same product in a different completion phase. Deregulation in the trucking industry resulted in lower prices per truck-load shipment, fewer complaints, and better service.
Also, in 1980, Congress allowed railroads more flexibility in rate setting and in 1986 the ICC was abolished. The results were similar to those attained in the trucking industry. There was a reduction in the cost per mile of freight shipped, lower rates for customers, and more money available to spend on deferred maintenance and on better equipment.
Deregulation in the petroleum industry has reduced gas prices. Furthermore, beneficial, but less complete patterns of deregulation have taken place in telecommunications, banking, and other financial services.
Instead of Government Regulation
Proponents of a free society uphold individual freedom as the primary principle for the state to protect and therefore do not recognize the moral legitimacy of government regulation. Individuals have natural rights to be free from having others interfere with their lives, liberty, and property. Governments are much too willing to formulate and adopt "solutions" to problems which would be better left for the free market to deal with.
Many regulations involve men voluntarily dealing with other men. It is through the regulatory process that the state forces the terms of exchange in such transactions. Protection is the purported reason for many regulations. However, the government often fails to recognize that any transaction is voluntary in the absence of coercion and that, therefore, protection is only appropriate when force is involved.
Some paternalistic defenders of regulation contend that regulation is necessary to protect people from their own faulty judgments and wrong decisions. Essentially, this is an argument for safeguarding people from their own rational minds. Most people do not have to be forced to do what they believe to be in their own best interest. Certainly, some individuals are less able than others at discerning what is to their own best advantage. That is no legitimate reason for others to be denied their rights, through regulation, to act according to their own judgments.
Anti-individualism underlies the tendency of government to regulate behavior. This concept includes the notion that selfish men must be forced to serve a higher purpose such as the "common good," others' needs, the majority's desires, or the goals of political authorities which ostensibly are in the "public interest."
The "public interest" viewpoint mistakenly assumes that government officials have both sufficient knowledge and the proper incentives necessary to rationally affect private markets. In a democracy, government bestows benefits in anticipation of receiving votes. Regulators react to payoffs and pressures from special interest groups. As government intervention increases, so does the motivation for private individuals and firms to invest less in the quest for profits and more into the pursuit of government protection and favors. Whenever a new law is passed, citizens wonder if it applies to their own situations. They seek to expand the applicability of the law because each envisions a way of prospering from it. People have the incentive to find ways of also qualifying for the benefits. Whenever the government has special benefits to give, there will be companies and individuals lobbying for handouts.
Certainly, markets are the best means for achieving the most efficient distribution of goods and services. When a business abides by the rules of the free market, it has not been granted any special privileges by the government and therefore has no legislative advantages over its competitors and is unable to charge artificially high prices to customers.
Much of what government regulation attempts to do can be dealt with by the courts. Judicial means can be utilized to remedy many injustices. The law of torts may be able to cope with much of what is now handled through government regulation.
In addition, regulation does not necessarily have to include the government. A great deal of regulation is currently privately produced and administered by trade associations and other independent bodies. These private associations oversee members' actions through monitoring, standard-setting, product testing, inspection, warranty approval, certification, arbitration, etc. The federal government should seriously look into transferring most (if not all) regulatory functions to independent, private third parties. Including these private associations in the regulatory process will downsize and perhaps ultimately eliminate the current command-and-control system and replace it with a more responsive and adaptable process.