The Next Phase of Regulatory Reform

James Broughel

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Not so long ago, free-market, right-leaning economists and legal scholars dominated the regulatory arena. Emanating from the "Chicago school," a generation of reformers — Milton Friedman, Richard Posner, and George Stigler among them — promised to bring evidence and rationality to policymaking.

Today, though, the Chicago school's influence has waned, and the once ascendant movement of conservative and libertarian thought in regulatory policy has lost steam. As it stands, the broad field of regulatory law and economics has come to be dominated by center-left technocrats who high-mindedly view themselves as following the science. While a body of right-leaning scholars does remain, it lacks the intellectual trailblazers that came to define the old Chicago school.

As the right has ossified, it has found itself relying on established ideas instead of offering new theories of regulation. This has led to two problems. First, it has caused reformers to be ineffective: Old theories remain helpful, but they struggle to explain many features of the administrative state as it currently exists and thus fail to shift the paradigm. Second, it has compromised contemporary reform efforts. As the heyday of the Chicago school becomes an increasingly distant memory, right-leaning scholars accept more and more of the core assumptions of the elite technocrats. The Overton window has shifted too far in the wrong direction.

The country needs a practical, empirically minded, free-market regulatory-reform movement that is not afraid to take on the sacred cows of regulatory scholarship. Yet right-leaning economists — libertarians in particular — remain insulated and detached from day-to-day debates about regulatory policy. To recover the momentum the right once had, the next generation of reformers will need to come to terms with its declining influence, reflect on what the old theories can and cannot explain, rethink some existing fundamentals, and offer updated ideas for the 21st century.

THE REGULATORY RIGHT

In 1971, the Chicago school was near the height of its influence. Stigler, the famed University of Chicago economics professor, wrote a classic essay titled "The Theory of Economic Regulation." His thesis was two-fold: On the one hand, he asserted that economists should think about regulation in terms of supply (provided by government officials) and demand (driven by the public and various interest groups motivated by a variety of factors); on the other, he argued that regulation is "acquired by [an] industry and...designed and operated primarily for its benefit," giving birth to the idea of regulatory capture.

Stigler's theory suggests that regulations, when supported or spurred by influential interests, can be used as impediments to competition, thus harming consumer welfare. This was a 180-degree turn from the theory associated with Cambridge economist Arthur Pigou — which was widely accepted at the time — positing that regulations are primarily enacted to promote the public interest and to correct market failures. Stigler's theory gained steam as the 1970s progressed, and over time, most economists reached a consensus in favor of it. The airline, rail, and trucking industries were deregulated as a result. The government relinquished control over prices, and they fell as competition increased. Routes were no longer prescribed by bureaucratic fiat, and several regulatory bodies — including the Civil Aeronautics Board (CAB) and the Interstate Commerce Commission — were eventually abolished altogether.

These successes were a sign of the power and influence of free-market theory in the regulatory-reform movement. Libertarian ideas had come to be accepted by the mainstream in both the academy and the policy community. Alfred Kahn, a one-time chair of the CAB who considered himself a "good liberal Democrat," was one of the greatest champions of regulatory reform at that time. Senator Ted Kennedy and consumer advocate Ralph Nader were also key allies of the deregulation movement.

Today, however, regulatory capture persists. The revolving door between Wall Street and financial regulatory agencies remains an ever-present problem. Presidents Joe Biden and Donald Trump both used executive fiats to raise or maintain import tariffs on items like solar panels and goods from China. The Jones Act, in place since 1920, continues to protect American shipping interests. Ethanol subsidies support the American corn industry but hurt the poor in developing countries. Even as the internet has started to democratize the public-comment process — which is the primary way the public can engage with proposed rules — it remains dominated by special-interest groups. As debates have grown ever more technical and arcane, the average man on the street has little chance of influencing regulatory policy.

Regulatory capture may be even worse at the state level. One 2017 study found that 85% of state occupational-licensing boards are required by law to consist of a majority of licensed professionals from the industry being regulated. Not surprisingly, these boards end up protecting incumbents and making it harder for would-be competitors — often blue-collar workers trying to get a leg up — to enter a profession. Regulatory capture has also morphed into new forms. Take "NIMBYism": When property owners lobby their local governments to establish zoning rules, historical-preservation laws, minimum lot-size requirements, parking restrictions, and similar regulations that limit building and development, they drive up property values. Just as with other forms of regulatory capture, these types of economic regulations restrict entry into the market so that a particular resource under special-interest control becomes increasingly scarce.

The persistence and evolution of regulatory capture reflects the fact that, despite its success, the influence of Stigler's work has waned, and the momentum of the free-market regulatory movement has stalled. Moreover, although Stigler's article has accumulated more than 15,000 citations in the half-century since it was published, it still struggles to explain much regulation that is enacted today. Meanwhile, Pigou's "public interest" theory continues to dominate regulatory scholarship. Reformers need to ask why.

BLURRED LINES

Now, as in the past, the most obvious examples of regulatory capture tend to come in the form of economic regulation: rules attempting to control prices, limit trade, or dictate private terms of service. While Stigler's theory remains a good explanation for such regulation, it has been less successful when it comes to explaining "social" regulation — that which relates to rules affecting health, safety, and environmental risks. Social regulation's recognizable character is perhaps most visible in the regulatory bodies themselves.

On the one hand, agencies like the Federal Communications Commission, the Securities and Exchange Commission (SEC), and the Department of Agriculture tend to work closely with business interests to establish industry-specific standards, sometimes even with an explicit goal of promoting an industry domestically or internationally. They also tend to enact economic regulations and appear more susceptible to regulatory capture. On the other hand, agencies like the Environmental Protection Agency (EPA) and the Occupational Safety and Health Administration — with their broad social missions to protect the environment and workplaces — often find themselves in heated battles with the industries they regulate. This makes them more difficult to understand through Stigler's theoretical framework. Of course, one could argue that food, pharmaceutical, and environmental activists are the new "capturers" of agencies like the Food and Drug Administration or the EPA, but it is difficult to believe that the EPA — with its often massive and expensive regulations — is "operated primarily for [the industry's] benefit" (emphasis added). In short, to recover its relevance, free-market regulatory scholarship needs a better explanation of social regulation.

Though never clear cut, the line distinguishing economic and social regulation has blurred over time, as bureaucrats have consistently co-opted economic regulation to serve specific social purposes. Health and environmental regulations serve as a case in point: Today, patents on pharmaceuticals, permits for new development projects, and terms-of-service requirements for health-insurance plans are all economic regulations in form, but because of what they aim to accomplish, they are social regulations in practice.

Even in industries that were once clearly the domain of economic regulation, technocrats have managed to insert social regulations. Restrictions on payday lending, while economic on their face, are implemented to protect low-income individuals from their own ostensibly short-sighted choices. Taxes on products like cigarettes or soda are imposed to advance public health. Calls to require companies to disclose carbon-dioxide emissions in SEC filings highlight how financial regulation can be used as an instrument of environmental policy.

Bruce Yandle, an economist whose "bootleggers and Baptists" theory of regulation posits that coalitions of activists and special interests form to advance regulations that both sets of interests benefit from, may be of help in explaining how social regulations come about. Regulations, he argues, are supported by both noble and selfish interests — much the way a bootlegger of yesteryear could undermine his legal competition by siding with small-town Baptists pushing to restrict the sale of alcohol.

Yandle's and Stigler's theories can be read as complementary to one another. Yandle's insight is, in some ways, an astute observation of something that should have been obvious: that regulations need coalitions of support behind them in order to become law. His theory offers a plausible explanation of how coalitions form to influence regulators, but it doesn't address the fact that the overall level of regulation in certain industries seems to rise unrelentingly year after year. This is where Stigler's capture theory is helpful. Firms typically resist new regulation attempts in order to avoid the corresponding compliance costs. However, once regulations are implemented, compliance costs are often sunk and cannot be recouped. Therefore, existing firms will often resist efforts to remove the very rules they initially fought against, since these regulations become barriers that stand between them and potential competitors who haven't yet paid the compliance costs. These dynamics all but ensure that there is no influential constituency to support removing regulations once they are enacted.

Yet Yandle's theory is better than Stigler's at explaining why the dominant form of regulation over the last 40 years has been social regulation. Capture theory would predict the opposite: that economic regulation would be dominant, as seemed to be the case in the 1970s. Experience since then, however, has shown that shamelessly self-interested economic regulation lacks a public-interest rationale, and therefore often fails to convince regulators and a skeptical public to favor the policy. Social regulations provide business interests with a useful public-interest cover.

Together, Yandle's and Stigler's theories form a useful analytical framework for helping conservatives and libertarians explain regulation. Yet this framework also raises further questions: When and why do coalitions form? Why are some coalitions successful at advancing their causes while others fail? Why does some messaging from well-meaning figurative Baptists find support from the public (and resonate with regulators) while other messages fall on deaf ears?

To fill in these gaps in understanding, other theories of regulation have emerged. Public-choice theory, for instance, posits that both regulators and agencies are self-interested and concerned with their own careers, budgets, and reputations. The enforcement theory of regulations sees agency rules as balancing societal disorder and hierarchical control. Studies have found that societies in which members trust each other less tend to regulate one another more, revealing the importance of social trust. While each of these theories can explain regulation in particular instances, none explain it perfectly as a general phenomenon. For this reason, the existing theories are in need of some refinement.

A META-THEORY OF REGULATION

Whatever their merits, public-choice and capture theories struggle to explain certain contemporary phenomena. For instance, anyone who picks up the newspaper on a given day is likely to read a story of some industry fighting attempts to be regulated — which poses a problem for Stigler's regulatory-capture theory. In addition, the regulators themselves have a complex set of motivations and incentives. While some are narrowly self-interested, many public servants genuinely believe in their agency's mission and have devoted their lives to the cause it is meant to advance. At the same time, the public is largely disengaged from the regulatory process (as public-choice theory might predict), but ordinary people can participate in rulemaking by submitting public comments on proposed regulations. And they have done so in large numbers at unexpected times, most notably during the net-neutrality debate.

As these examples indicate, context and circumstances always seem to matter. At times, regulatory capture seems to explain a set of circumstances well. But in many instances, public-interest theory might be a better fit. Given this reality, there is a need for a meta-theory that brings together existing theories to provide a more universal explanation of regulation in all its forms.

Any such meta-theory will have to begin with public-interest theory, which has historically found the most support among intellectuals. However, public-interest theory's central proposition — that regulators are primarily concerned with correcting for market failures — construes regulation through the lens of economics, and thus falls flat. In practice, neither the public nor regulators seem all that interested in correcting externalities, information asymmetries, public-goods problems, or other forms of market failure. This is confirmed empirically by the fact that regulators rarely discuss market failures in depth — even in their economic analyses, where one would expect to find such discussion.

But if one takes a broader view of the public interest, the theory becomes stronger. Consider, for example, what it means if the term "public interest" is used to refer to whatever regulators and intellectuals generally happen to believe is best for the public at any given moment. From this perspective, regulation might be driven by fads: events, salient risks, and crises real or imagined that, for whatever reason, happen to rise in status within the immediate public consciousness.

Rather than performing economic analyses and addressing market inefficiencies, then, regulators may simply want to address what they see as the most pressing issues of the day. Hence, the motivation to "do good," as the regulators see it, cannot be overlooked. There may be economic market failures that can be corrected while doing good, but few people get out of bed in the morning to correct market failures. Fighting inequality, advancing social justice, protecting animal rights, and saving the planet, on the other hand, are causes to devote one's life to. Free-market champions need to find similarly compelling causes that excite the passions of the public.

Whatever arguments the next generation of regulatory reformers bring to the table, it's important that they acknowledge how factors like ideology, sense of purpose, and sense of identity are often more important drivers of regulation than almost anything else. When one's sense of status and identity are wrapped up in a cause, no amount of proof will change that person's beliefs. This is why, regardless of whatever lip service might be paid to evidence-based regulation today, empirical analysis is often absent from actual decisions.

One example of such evidence-free regulation in recent years comes from the Department of Health and Human Services (HHS). In 2021, HHS repealed a rule enacted by the Trump administration that would have required the agency to periodically review its regulations for their impact on small businesses. The measure was known as the SUNSET rule because it would attach sunset provisions, or expiration dates, to department rules. If the agency failed to conduct a review, the regulation expired.

Ironically, in proposing to rescind the SUNSET rule, HHS argued that it would be too time consuming and burdensome for the agency to review all of its regulations. Citing almost no academic work in support of its proposed repeal — a reflection of the anti-consequentialism that animates so much contemporary regulatory policy — the agency effectively asserted that assessing the real-world consequences of its existing rules was far less pressing an issue than addressing the perceived problems of the day (by, of course, issuing more regulations).

Through its actions, HHS has rejected the very notion of having to review its own rules and assess whether they work. In fact, the suggestion that agencies review their regulations is an almost inexplicably divisive issue in Washington today. "Retrospective review" has become a dirty term, while cost-benefit analysis has morphed into a tool to judge intentions rather than predict real-world consequences. The shift highlights how far the modern administrative state has drifted from the rational, evidence-based system envisioned by the law-and-economics movement just a few decades ago.

In today's administrative state, intellectual fads appear to be in the driver's seat, while science and economics are simply along for the ride. Despite pronouncements to the contrary, few intellectuals seem genuinely interested in "following the science": Too many have their careers, social status, and sense of personal identity wrapped up in perpetuating the status quo.

A FEW CALLS TO ACTION

Free-market thinkers could play an important role reviving rationality in the regulatory process. However, many of the most impressive free-market economists today seem reluctant to engage with mainstream scholarship on the administrative state. Why is this the case?

For starters, some of them still reject various forms of empiricism. Famously data-averse economists from the Austrian school now accept statistical analysis to a much greater extent than they did in the past, but many still cling to backward rationales for rejecting empirical science. One example comes from those who claim that costs cannot be measured — an extreme, bastardized take on the subjectivist branch of economics, which posits that value is subjective because it is derived from individuals' preferences. While prices do derive from value judgments made by individuals, the costs of regulatory actions are objective in the sense that real productive resources and their returns are used up or forgone when a regulation is put in place. If the consensus among Austrian economists is that costs cannot be measured, they shouldn't be surprised when costs receive no weight in regulatory decision-making.

Additionally, conservatives and libertarians lack an elite academic perch from which to present their ideas. The University of Chicago once served this purpose, but it is no longer the center of conservative and libertarian thought in economics or policy. One public-policy scholar at the university recently observed that he could think of no conservatives in his department. Let that sink in: The university that was the center of the free-market movement a few decades ago has no conservatives in its public-policy school.

A sea change may have occurred in the span of a single generation. Today, the focal point of academic free-market scholarship has shifted to George Mason University (GMU) in Virginia (where I am also a scholar). That said, there are important differences between GMU and the old Chicago school. Whereas scholars at the latter spent more time publishing in top journals, GMU academics have focused much more on communicating ideas to the broader public and expanding the practical influence of economics in matters of public policy. This influence has been important, and GMU punches above its weight in both popular discourse and day-to-day policymaking. Yet GMU lacks the influence on elite opinion that the old Chicago school once wielded.

Those few right-leaning scholars who do still publish in the top journals tend to be older and more interested in preserving the victories of the past than pushing forward into the future. Although the successes they and their Reagan-era counterparts achieved — which include institutionalizing the use of cost-benefit analysis in federal rulemaking and creating the Office of Information and Regulatory Affairs to review regulations — are notable, the next generation of the regulatory-reform movement needs to move beyond them.

Young, up-and-coming scholars in the right-leaning policy and academic communities should prepare to step in to the breach and make their voices heard. To do so, they will need to take several steps.

First, they should get involved directly in regulatory agencies. At a time when elected representatives in Congress are unwilling to assert their authority, we are largely governed not by legislation, but by regulation. Progressives and socialists understand (and embrace) this development; conservatives and libertarians must understand it as well. This is not to say that young people on the right need to accept the regulatory state. But if they hope to fix it, they need to offer pragmatic solutions tailored to the situation on the ground.

Second, conservatives and libertarians should reject the counterproductive fringes of the free-market movement. The Covid-19 pandemic has brought out some of the worst elements of libertarianism. Paranoid obsessions over lockdowns and borderline (if not outright) vaccine denialism will not convince those on the fence that our policy proposals are superior to those offered by the left. There is no way to build legitimacy for our movement if these elements are central features. At the same time, we should not be afraid to offer sweeping proposals that challenge the core assumptions of the technocratic left. Economic theory in particular is an Achilles' heel of that intellectual outlook, yet no visible movement to criticize it has taken shape.

Finally, the cost-denialism alluded to above is a similarly destructive influence behind the scenes. Conservatives and libertarians cannot allow subjectivism to lead the right off a cliff of nihilism that renders their movement useless; instead, they need to be able to offer constructive, evidence-based insights on matters of policy.

Perhaps counterintuitively, the technocratic left should encourage this type of engagement from the right. Constructive challenges to their paradigm will improve the practice of policymaking — after all, if cost-benefit analysis comes to be perceived as a tool of the political left to justify regulatory interventions, then in the long run, it will lose all credibility. Those on the extreme left might prefer this development, but it should strike fear in the hearts of those of a more moderate persuasion who hope to build an evidence-based foundation for policymaking.

In many ways, a half-century after Stigler's seminal article was published, conservatives and libertarians are still no better at explaining regulation than Stigler was when he observed that there is a supply of and a demand for it. Today, a new generation of free-market thinkers needs a new research agenda. Any such agenda should be grounded in solid economic theory backed by evidence, be aware of the ideological factors that motivate much of the regulation crafted in today's agencies, and be guided by a pragmatic commitment to getting things done.

James Broughel is a senior research fellow with the Mercatus Center at George Mason University, where he specializes in regulatory institutions, cost-benefit analysis, and the impact of regulations on economic growth.


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