1
Introduction: I
In the early 20th century the emergence of new technologies spawned a
multitude of innovative and revolutionary industries in the United States. In a select
group of industries that emerged during this time, including the trucking, airline,
telephone, cable, natural gas, electricity, and financial sectors, the government
created a system of regulations that granted the agency tasked with overseeing
these industries substantial control of their market operations. The designated
regulatory agency exerted its control primarily through the use of economic
regulation, which allowed it to determine, among other things, entrants into market,
prices, and competitors.
In the late twentieth century, beginning in the mid-1970’s, these industries
experienced a sudden and extreme shift towards a free-market model of operation.
Industries that had never operated in a competitive environment now saw the
regulations that had governed their market eliminated or severely scaled back. The
primary goal of this capstone is to denote the political, economic, and social forces
that drove this sudden shift in policy.
There has been a great deal of research centered around the study of
regulatory structures and the forces behind their genesis. In 1971 George Stigler
championed this discipline with the publishing of “The Theory of Economic
Regulation”, which generated groundbreaking theories relating to regulatory policy
in the United States. Since its publication this article has served as the foundation for
the majority of later studies on governmental regulation.
2
Stigler denoted the forces leading to regulation. At the center of his thesis
was the premise that industrial actors actually sought greater regulation in order to
limit free-market competition and create oligopolistic conditions served as the
foundation of his thesis. This assertion separated his work from previous
hypotheses, and explained patterns in regulatory policy within the markets
discussed in this paper, specifically those of which the government had kept under
regulatory control.
The revolutionary model that Stigler introduced applied economic theory to
the analysis of regulatory policy and the forces behind its implementation. This
analysis, like most economic models, applies the forces of supply and demand to
predict output. The model adapts the cost of obtaining influence to model supply
and the potential benefits to interested groups to model demand.
Using the model created by Stigler, this paper seeks to discover the forces
behind the deregulation of these markets in the latter half of the 20th century. To
accomplish this, it identifies and explains the shifts in demand and supply that
occurred with deregulation. The economic climate and rise in consumer prices
during the 1970s put political pressure on elected officials to reduce prices,
increasing the cost of implementing policies that negatively impacted consumers.
The resulting increase in the political capital needed to support these policies
represents the shift in the supply side of the model. The changing nature of interest
group relations created a new network of entangled interests that aligned various
groups that benefited from similar policies, causing a shift in the demand side of the
economic model.
3
The basis of Stigler’s original thesis, with adjustments to specific variables,
continues to function as an accurate indicator of patterns of de-regulation in the
twenty-first century. This paper will use Stigler’s fundamental conceptions to assert
that changes in the specific factors that created over-regulation in 1972 evolved and
were responsible for the extensive patterns of de-regulation in our society.
4
Part I: Background and Evidence of Deregulation
II: Setting The Stage: Interest Group Relations and Regulatory
Policy Study
The specific markets discussed in this paper followed a predictable
evolutionary model in the formation of their regulatory structure. The technological
advancements of the early 20th century created new industries that required more
complex government oversight. Understanding the process through which the
regulatory systems that emerged in these markets requires an understanding of the
intricacies of political decision-making in the United States.
In a complex democracy citizens contribute to the policy direction of their
government through two primary means: the election of officials and lobbying.
Groups that participate in collective action, dubbed interest groups, have played a
vital role in influencing the creation of policy in Washington. In the course of the
twentieth century political structures continually transformed and reacted to
developments outside their institutional boundaries. As these systems adapted to
the progression of technology and to social issues, so did the processes by which
interest groups influenced domestic policy outcomes. In the second half of the
century increasingly complex economic markets and societal entanglements
catalyzed significant changes in the structure of interest groups and the methods by
which they influenced policy.
This broader concept describes how political decisions are made and where
power is allocated. This field of study focuses on interest groups and the processes
5
by which they influence policy. Since the emergence of democratic regimes, political
scientists have attempted to identify and understand the processes and incentives
through which governmental decisions are made. As our system of government in
the United States has evolved, so have these theories that conceptualize its inner
workings.
The first section of this capstone recounts the development of theories about
interest group relations throughout the 20th century. The evolution of these theories
provides a more complete understanding of the workings of the specific markets
addressed in this paper.
Pluralism, Elitism, Agency Capture
Prior to the 1970’s and the emergence of Stigler, scholars often adhered to
the concept of pluralism when mapping the political decision process. Within the
works of prominent theorists such as Dahl and Lindblom rested a fundamental
understanding that political decisions in the American democracy represented the
interests of a multitude of groups and organizations.1
The pluralist argument lost much of its following the late 1960’s and early
1970’s. During that time the output of political decisions showed little signs of
representing less powerful interest groups, but rather resulted primarily from the
influence of small but powerful individuals and groups. Later works such as Olsen’s
Participatory Pluralism attributed the fall of pluralism to the disorganized nature of
1
McFarland, A. S. (1987). Interest groups and theories of power in America. British Journal of Political
Science, 17(2), 129-147.
6
some interest groups and their inability to garner dedicated support from all
members. 2
This time in the history of political science resembles a revolutionary coup as
figures in the discipline began to construct new theories of collectivization. Some
adhered to Marxist principles while others took a more elitist, non-pluralistic view.
These sprouting disciplines ultimately sought to identify the causal
mechanism behind the emergence of powerful interest groups in post WWII
America. The strong party model identifies disciplined parties as the major players
in interest group activities. Neo-Marxists, on the other hand, assert that classinterest plays a major role in determining political outcomes. By the early 1970’s
these theories had been dismissed by the majority and there existed a disjointed
consensus regarding the evolving political landscape. Andrew S. McFarland3
grouped these disciplines into a single identification which he aptly named “plural
elitism”; others refer to this as straightforward elitism:
Essentially this argument states that (1) many widely shared
interests cannot be effectively organized within the political process; (2)
politics tends to be fragmented into decision-making in various specific policy
areas, which are normally controlled by special-interest coalitions; (3) there
2
Olsen, M. (1982). Participatory pluralism: Political participation in the United States and Sweden.
Chicago: Nelson-Hall.
3
McFarland, A. S. (1987). Interest groups and theories of power in America. British Journal of Political
Science, 17(2), 129-147.
7
are a variety of specific processes whereby plural elitist rule is maintained; (4)
a wide-spread ideology conceals this truth about American politics. 4
Although there existed many differences within the group of “plural elitists”, these
general principles were widely adopted by political scientists. Lowi is seen as the
founder of this movement and classified policy into three distinct groups:
“distributive”, “regulatory”, and “redistributive”.5 His most heralded work focused
on distributive policy, such as pork-barrel awards, but the fundamental basis of
applying plural-elitist arguments to regulatory policy provided a foundation for the
work of George Stigler.
A central idea within the pluralist-elitist model is agency capture. The socalled capture theory details how large, powerful industrial firms use their political
influence to create advantageous policy. This capture is the driving force behind
regulatory plural-elitism as the industrial firm’s tool through which it manipulates
policy. In analyzing the progression of regulatory agencies, capture theorists
observed a pattern in which these agencies “age” out of pluralistic tendencies. In
their youth, these agencies serve the public interest they are designated to serve.
Over time, however, they experience increased bureaucratization and distance
themselves from their constituents. During this process the agency moves closer
4
Lowi, T. J. (1969). The end of liberalism: Ideology, policy, and the crisis of public authority. New York:
W.W. Norton.
5
Lowi, T. J. (1969). The end of liberalism: Ideology, policy, and the crisis of public authority. New York:
W.W. Norton.
8
towards their industry of designation and begins to value their needs over the
publics.6
The capture theory serves as the basis for most contemporary studies of
political decision-making. Although often recognized as overly simplistic as an
explanation for all policy decisions, evidence indicates that powerful industrial
interests are overrepresented in the United States. Variations of the theory often
explain occurrences it alone cannot decipher. Gilligan, Marshall, and Weingast found
that a multiple interest group perspective explains many regulatory decisions in
which competing interest groups had yet to compromise, preventing the capture of
the agency by a single entity.7 Teske found that business intervention occurs but
was only able to measure potential intervention.8 Although not direct capturetheorists, these works continuously refer back to the original capture-theory and
vicariously on Lowi and the plural-elitists in their assertions.
6
Etzioni, A. (2009). The capture theory of regulations-revisited. Society, 46(4), 319-323.
doi:http://dx.doi.org.libezproxy2.syr.edu/10.1007/s12115-009-9228-3
7
Gilligan, T. W., Marshall, W. J., & Weingast, B. R. (1989). Regulation and the theory of legislative choice:
The interstate commerce act of 1887. Journal of Law and Economics, 32(1), 35-61.
8
Teske, P., Mintrom, M., & Best, S. (1993). Federal preemption and state regulation of transportation and
telecommunications. Publius, 23(4, Federal Preemption), 71-85.
9
Economic Regulation Theories:
Within the broad context of political decision-making lie, numerous areas of
policy making that retain specific systems of formation. One of the most important
methods by which the US Government enacts influential policy is through economic
regulation. This policy area involves government control of the economic functions
of a market including entry into the industry, price controls, and allocation of
resources, among others. Although often viewed as one of the most insipid functions
of a government by the public, the implementation of regulatory economic policy
plays a vital role in shaping an economy and the society in which it operates.
Industrial interest groups take considerable interest in policies that affect
economic regulation. Their influence on this policy plays a vital role in the success of
an industry, which prompts interest groups that represent a particular industry to
invest considerable resources to enact advantageous regulatory policy. Through
implementation of regulatory policies, governmental institutions can effectively
control both the performance and structure of industries and economic markets.
Due to the powerful nature of these policies industrial firms take considerable
interest in their implementation. These firms represent a powerful interest group in
that diverts considerable resources towards influencing regulatory policies.9
As the previously mentioned theories regarding broader political decisions
evolved during the 20th century, so did theories that attempted to identify the forces
that guided the implementation of economic regulation. A review of this evolution
9
L Lowi, T. J. (1969). The end of liberalism: Ideology, policy, and the crisis of public authority. New York:
W.W. Norton.
10
allows for a more complete understanding of how the process has evolved into its
contemporary form.
Public Interest Theories:
Just as pluralism dominated the academic landscape during the first half of
the century in describing collective action, so did the public interest theory in
describing economic regulation. This theory, which originated during the industrial
revolution, holds that regulation is supplied in response to the demand of the public
for the correction of inefficient markets. Posner10 identifies two assumptions that
shaped views on economic policy during this time period:
One assumption was that economic markets are extremely fragile and apt to
operate very inefficiently (or inequitably) if left alone; the other was that
government regulation is virtually costless11
The purpose of government interference, by these standards, was to economically
swoop in, correct any inefficiency within the market, and return to the political
realm until the next correction. Thus, any act of regulation had tangible justification
in the form of market imperfection and the decision to enact such a regulation could
be traced back to that market inefficiency. The second assumption also counters
10
Posner, R. A. (1974). Theories of economic regulation. The Bell Journal of Economics and Management
Science, 5(2), 335-358.
11
Posner, R. A. (1974). Theories of economic regulation. The Bell Journal of Economics and Management
Science, 5(2), 335-358.
11
rational economic theory in asserting that regulating markets presented little to no
cost for either the government or actors in that specific market.
If these assumptions correctly identified the catalysts of regulatory policy,
then these agencies would only implement regulations in markets that were
susceptible to monopolistic tendencies and those which generated substantial
external costs or benefits.12 Eventually, scholars collected significant empirical
evidence that demonstrated that regulators had not exclusively enacted regulatory
policy in industries that required market correction. Markets that retained
extremely high levels of regulation created monopolistic or oligopolistic conditions
that limited efficiency and provided little benefit to the consumer. The public
interest theories fell short in explaining these regulatory structures, which tended to
benefit the industry being regulated and not its consumers.
As public interest theorists realized these shortcomings, they attempted to
develop alternative theories that better described the processes leading to
regulation. These adaptations took on many forms. Some of these theories stated
that the regulatory agency in its original form looks out for the interests of the
public, but then its leaders mismanage it leading to the implementation of policies
that opposed the public interest. Others claimed that regulators intend to protect
the public good, but the very nature of regulatory practices renders them ineffective
12
Peltzman, S. (1993). George stigler's contribution to the economic analysis of regulation. Journal of
Political Economy, 101(5), 818-832.
12
in doing so; Stigler refers to this assertion as the expert theory13. Ultimately, all
forms of the public interest theory fell short in explaining trends in regulatory
policy. Many theorists turned to capture theory to explain regulation.
Different variants of capture theory were proposed to explain the forces
behind economic regulation. Marxists asserted that the capitalists controlled the
institutions within our society and therefore controlled the regulatory agencies
within these institutions. The pluralist community, particularly Bentley and
Truman14, proposed a more rational theory that centers around interest groups and
their influence on the formation of public policy. Based on the increasingly popular
capture theory, this conception of economic regulation asserted that the regulated
firm pressured the agency that oversaw its market into deviating from its original
purpose to benefit the public and instead implement policies that primarily
benefited the regulated industry. These hypotheses laid the foundation for a more
precise theory but did not precisely model the process through which regulatory
economic policy emerged. At this point in the evolution of these theories George
Stigler adapted the conceptual model proposed by Bentley, Truman, and their
13
Stigler, G. J. (1971). The theory of economic regulation. The Bell Journal of Economics and Management
Science, 2(1), 3-21.
14
Bentley, A. F. (1957). The process of government. Cambridge Ma.: Belknap Press of Harvard University
Press.
Truman, D. (1981). The governmental process: Political interests and public opinion. Westport Conn.:
Greenwood Press.
13
followers and, through applying it to an economic model, created a testable precise
analysis of the process through which these regulations emerged.
Summary of Stigler’s Theory:
The emergence of these capture theories paralleled the rise of the “pluralelitist” movement lead by Lowi.15 George Stigler led efforts to apply this school of
thought to the processes behind economic regulation and, using quantitative
methods, prove the application of capture theories to this area of policy. His
contemporaries view him as the founder of the conservative economic division of
the plural-elitists. 16
The work in Stigler’s 1972 publication “The Theory of Economic Regulation”
“changed the way economists analyze government regulation.”17 This empirical
study provided one of the first tangible theses identifying industrial influence on the
policy process. Although it retained many characteristics of the capture theorem, it
ventured far beyond this overly simplistic approach to describe the processes
behind regulatory policy.
The success of this theory can be attributed to new approaches taken by
Stigler that corrected mistakes in the logic of the political scientists attributed to
capture theory to economic regulation. First, Stigler’s theory was based on the
15
Lowi, T. J. (1969). The end of liberalism: Ideology, policy, and the crisis of public authority. New York:
W.W. Norton.
16
Peltzman, S. (1993). George Stigler's contribution to the economic analysis of regulation. Journal of
Political Economy, 101(5), 818-832.
17
Peltzman, S. (1993). George Stigler's contribution to the economic analysis of regulation. Journal of
Political Economy, 101(5), 818-832.
14
fundamental principles of economics, specifically that actors in the marketplace
rationally seek self-interested outcomes. Posner identifies the distinction between
the economic and political perspectives:
A political scientist can argue that regulation is more likely to be imposed in a
declining industry because adversity is a greater spur to effort than
opportunity. The economist is reluctant to accept such an explanation. He does
not distinguish between a profit foregone and a loss incurred—the former is a
cost too, indeed the same kind of cost. 18
A second distinction Stigler made from the political scientists was regarding the
roles of regulatory institutions. Previous theories did not see regulators as rational
actors, and thus they were omitted from models. Stigler conceived these regulatory
agencies as rational and self-serving, and for this reason incorporated them into his
theory.
Unlike previous work in this area, “The Economic Theory of Regulation”
used economic reasoning to describe a market for regulation. Through an
integration of the economics of regulation and the economics of politics “in which
transactions between self-interested suppliers and demanders determine
18
Posner, R. A. (1974). Theories of economic regulation. The Bell Journal of Economics and Management
Science, 5(2), 335-358.
15
regulatory outcome”,19 Stigler mapped out a rational system through which these
outcomes could now be explained. This theory, unlike those before it, had a more
precise foundation and could be tested empirically. At its most basic level, the
theorem used the principles of supply and demand to explain the creation of
regulatory policy:
The potential uses of public resources and powers to improve the economic
status of economic groups (such as industries and occupations) are analyzed to
provide a scheme of the demand for regulation. The characteristics of the
political process which allow relatively small groups to obtain such regulation
is then sketched to provide elements of a theory of supply of regulation.20
By attributing the concepts of supply and demand to regulation Stigler also
acknowledges that regulation has value to some party, and that there is some cost to
obtaining regulation.
Demand for Regulation:
The demand side of this diagram illustrates the potential uses of the state in
an industrial market. Stigler entitles this section “What benefits can a state provide
19
Peltzman, S. (1993). George Stigler's contribution to the economic analysis of regulation. Journal of
Political Economy, 101(5), 826.
20
Stigler, G. J. (1971). The theory of economic regulation. The Bell Journal of Economics and Management
Science, 2(1), 3-21.
16
to an industry?” This section outlines the powers held by regulating agencies that
create demand for coercion over the state.
The most obvious, yet least common, of these powers are direct subsidies.
These policies provide the least benefit to the industry, as they must be divided
among numerous participants. The second regulatory power occurs when firms in
one industry attempt to suppress the government support for a substitute product
e.g. firms in the butter industry lobbying for a reduction in margarine subsidies. The
third involves the government’s ability to fix prices at rates higher than what the
market will allow. A firm will desire price fixing when it faces a moderately large
number of competitors that restrict its ability to set monopolistic prices. An example
of this is the prohibition of interest on demand deposits, which “is probably effective
in preventing interest payments to most non-business depositors”21
According to Stigler’s analysis, the three aforementioned functions of
government provide only a small percentage of the demand for industrial influence
in government. The fourth and most influential public resource sought by the
industrial firm is the government’s ability to control entry to markets. Theories that
preceded Stigler’s often underestimated the value of entry barriers to industrial
firms. This failure to adequately value entry barriers led to questions about why
agencies implemented these regulations when they did not appear to extensively
benefit a particular group. Stigler answers this query with one of the central theses
in his paper: “Only when the elasticity of supply of an industry is small will the
21
Stigler, G. J. (1971). The theory of economic regulation. The Bell Journal of Economics and Management
Science, 2(1), 6.
17
industry prefer cash to controls over entry or output.”22 The institution can exert
this influence through limiting prices, vertical integration, and most commonly the
use of certificates of convenience and necessity. The formulation of this concept
leads Stigler to perhaps the most important assertion of his groundbreaking work:
We propose the general hypothesis; every industry or occupation that has
enough political power to utilize the state will seek to control entry. In addition,
the regulatory policy will often be so fashioned as to retard the rate of growth
of new firms. 23
Powerful industrial actors will prefer regulations that restrict access to the market
to direct cash subsidies and other governmental provisions. This is due to the fact
that reducing regulations for subsidies will allow more firms into the market that
will take a percentage of the subsidies. Only if market conditions naturally limit the
number of firms entering the market (low supply elasticity) will industrial actors
seek cash subsidies over regulations.
This hypothesis serves not only as the central theme of Stigler’s paper, but
also as a foundational concept in the majority of studies performed on the subject
22
Stigler, G. J. (1971). The theory of economic regulation. The Bell Journal of Economics and Management
Science, 2(1), 4.
23
Stigler, G. J. (1971). The theory of economic regulation. The Bell Journal of Economics and Management
Science, 2(1), 5.
18
since. Stigler finds that the majority of demand for government influence stems from
the institution’s ability to crowd out competition and in doing so creating favorable
market conditions for the industrial actor.
In his work, Stigler provides several examples of policies that crowded out
competition to the benefit of the regulated industrial powers. He includes the
Interstate Commerce Commission, which, at the time, had not allowed a new truck
line to be created since 1938. Additionally the FDIC had reduced the rate of entry
into the commercial banking market by 60%. The most detailed and prevalent
example, the trucking industry, had seen a significant rise in the weight of its freight
hauled but a dramatic drop in the number of licenses given out to companies.
Before demonstrating the demand side of his theorem, Stigler demonstrates
three costs of obtaining political benefits. These allow for a more realistic
understanding of a firm’s desire for political influence and include:
1. The political decisions take account also of political strength of the firms, so
small firms have a larger influence than they would possess in an
unregulated industry. Thus, when quotas are given to firms, the small firms
will almost always receive larger quotas than cost-minimizing practices
would allow.
2. The procedural safeguards required of public processes are costly. The
delays which are dictated by both law and bureaucratic thoughts of selfsurvival can be large
19
3. The political process automatically admits the powerful outsiders to the
industry’s councils.24
Understanding these costs proves vital in mapping out the demand for political
influence, and creates a more realistic model of institutional power within the
government.
Stigler illustrates the factors that influence with an analysis of the trucking
industry and the motivations behind the creation of weight limits on trucks. Three
primary considerations influence the actors involved in the industry:
1. Heavy trucks would be allowed in states with a substantial number of
trucks on farms: the powerful agricultural interests would insist upon this.
a. Variable: trucks per 1000 of agricultural population
2. The railroads saw the trucking industry as competition only for shorter
hauls therefore the longer the average rail haul is the less the railroads will
be opposed to trucks
a. Variable: length of average railroad haul
3. The better the state highway system, the heavier the trucks that would be
permitted.
24
Stigler, G. J. (1971). The theory of economic regulation. The Bell Journal of Economics and Management
Science, 2(1), 8.
20
a. Variable: The percentage of each state’s highways that had a high
type surface25
These variables are the basis for the following regression equation: X1= a + bX3 +cX4
+dX5, where X1 is the weight limits for four wheel trucks, X3 is the amount of trucks
per 1000 agricultural labor force in 1930, X4 is the average length of the railroad
haul of freight in 1930, and X5 is the percentage of state roads with a high quality
surface in 1930. The following table contains the results of this demand regression:
Dependent
Variable
X1
N
Constant
X3
X4
X5
R²
48
12.28
0.0336
0.0287
0.2641
0.502
X2
46
10.34
0.0437
0.0788
0.2528
0.243
26
These results demonstrated that all three variables are statistically significant and
had considerable influence on the implementation of weight regulations. This model
revolutionized the study of regulatory forces by identifying and accurately
measuring the components of demand for governmental regulation by interested
parties.
25
Stigler, G. J. (1971). The theory of economic regulation. The Bell Journal of Economics and Management
Science, 2(1), 9.
26
Stigler, G. J. (1971). The theory of economic regulation. The Bell Journal of Economics and Management
Science, 2(1), 9.
21
Supply of Regulation:
Stigler’s theory also describes the supply side through observing the costs of
obtaining legislation. This section of Stigler’s work, labeled “The costs of obtaining
legislation”, identifies the nature of obtaining influence in government and how it is
limited based on certain characteristics of the interested party. In order to convey
the nature of this process, Stigler first identifies two distinctions between market
functions and political decisions. This distinction is vital to the study as many
political outcomes counter the fundamental free-market economic principles of
rational choice and effective allocation of resources:
1) The political process demands simultaneity of decision. This makes
voting on specific issues prohibitively expensive; as individuals must
participate at the moment the vote is called and cannot change their vote
with a change in preference.
2) The democratic decision process must involve “all” the community, not
simply those who are directly concerned with a decision…the political
process does not allow participation in proportion to interest and
knowledge. In a measure, this difficulty is moderated by other political
activities besides voting which do allow a more effective vote to interested
parties27
27
Stigler, G. J. (1971). The theory of economic regulation. The Bell Journal of Economics and Management
Science, 2(1), 10.
22
In order to correct these inefficiencies society employs full time political parties to
represent their interest on a daily basis. Members of these parties seek the political
desires of their constituency, which in turn rewards them with electoral victories.
Within these constituencies exist both citizen voters and industrial powers. To
achieve re-election the elected official will best represent the interests of the group
that has the power to win them re-election. For the representative to oppose
industry interests, the official must discover a coalition of voters with anti-industrial
interests whose political power exceeds that of the industry groups. . This system
functions around the strength to which a group or individual cares about a specific
policy outcome: “The system is calculated to implement all strongly felt preferences
of majorities and many strongly felt preferences of minorities but to disregard the
lesser preferences of majorities and minorities.”28
These characteristics of the political process create a system in which
information and accurate representation have significant costs to an individual. Just
as in the free market, the voter’s expenditure to learn about an individual policy or
political action is modeled by weighing the cost versus benefits of the potential
outcome. To study and comprehend each individual policy outcome a voter would
need to devote considerable resources to this pursuit and forgo other opportunities.
In order to avoid these costs, the voter allows political parties that they elect to
make individual policy decisions.
28
Stigler, G. J. (1971). The theory of economic regulation. The Bell Journal of Economics and Management
Science, 2(1), 12.
23
The industry’s costs exist within a more tangible monetary arena. Industry
actors must approach the political party in order to see their interests represented
in the public arena. In order to function and maintain power, these political parties
need both resources and votes. The industry can provide both of these to the party
in exchange for representation of their interests. Resources can be given through
campaign contributions, services, and other more indirect methods. Votes are
provided through programs that take advantage of the cost of information to the
voter; through use of educational movements and public relations campaigns these
industries can sway the minds of voters that could not afford the information
otherwise.
As the size of the industry influencing policy increases, so does the negative
effect of this policy on society and the associated costs of misinformation campaigns.
Additionally, the market for political influence has a fixed size and precludes the
majority of smaller firms from participating in the process unless they have a special
advantage or influence on public opinion. This concept serves as Stigler’s
fundamental basis for the supply model of political influence-- cost rises with the
amount of influence sought and therefore larger industries have the ability to exert
more influence on the political process.
The model for this supply side uses occupational licensing as an example to
prove its assertions. In order to measure why the government distributes a specific
number of licenses, Stigler uses four characteristics of the occupation in question:
1) Income of occupation
2) Size of the market
24
3) Stability of occupational membership
4) Size of group
5) Concentration of occupation in large cities
The analysis found the first three of these characteristics had an expected effect on
licensing while the effect of the last two was ambiguous. Licensed occupations had
higher incomes, the membership of the licensed occupation is more stable, and the
licensed occupations are less often employed by business enterprises. This model
correctly predicts and identifies the cost structure for influencing policy.
Occupational groups with higher incomes and more influence will invest to have
their occupation licensed, therefore allowing them to maintain a higher share of the
market and keep prices high.
III: Evidence of Deregulation: Policy Overhaul in
the Airline and Trucking Industries
Stigler formulated his theory around an evolved conceptualization of the
industrial use of policy influence-- that the regulated industry will seek to utilize its
political influence to control entry into its market. This system resulted in high
levels of government control and oversight over several distinct industrial markets
in the United States. Based on this model markets with powerful actors should
retain high amounts of regulatory oversight and limits on the number of entering
firms.
In the early to mid-1900s several distinct markets reflected this form of
regulatory control; these specific industries had few competitors and excessive
25
government oversight. The regulatory characteristics of these industries separated
them from others that had fewer restrictions on their market operations. This
allows us to characterize them collectively in an exclusive group. The airline,
trucking, energy, communications, railroad, and finance industries all maintained
membership to this exclusive group throughout the better part of the 20th century.
During the period of significant de-regulation in the late 20th century, these markets
experienced the most dramatic shift in regulatory policy.
Politics of Deregulation
In the study of US government regulation, the mid-to-late 1970s and early
80s serve as the most tumultuous and perplexing era of observation. Shortly after
the publishing of Stigler’s work, the US government began to significantly reduce the
regulatory burdens described in his groundbreaking piece. Areas of industry over
which the government had traditionally maintained strict oversight were converted
into free markets and lost a significant portion of their mandated regulations. The
agencies that regulated these industries had previously held powers that allowed
them to control market operations. The most common of these included the ability
to set prices, limit production, and most importantly control entry into the market.
During this period congress voted to strip the majority of these powers from the
regulating agency.
The government significantly reduced its oversight in specific sectors of the
transportation, communication, energy, and finance industries, over all of which it
26
had previously maintained significant control. 29 The pattern of de-regulation
started with the Railroad Revitalization and Regulatory Reform Act in 1976 and
continued with the Airline Deregulation Act of 1978, the Motor Carrier Act of 1980,
and the Staggers Rail Act of 1980. Each of these legislative acts moved the industry
in question towards a free-market model and supported the incoming waves of
legislation that further de-regulated the country. At the same time regulations in the
previously unregulated sectors of health, safety and environment inexplicably and
dramatically increased. 30 These acts of increased regulation reflected social issues
at the time and supported emerging public causes.
When President Reagan entered his first term in office in 1981, he sought to
continue to reduce the scope of the federal government and its oversight on
markets. More aggressively than any predecessor, President Reagan imposed his
philosophical and political views upon agencies under the purview of his
administration.31
His election marked the emergence of a second and more extreme era of deregulation in the United States. Under the guidance of the Reagan administration,
29
CRANDALL, R. W. (1983). Deregulation: The U.S. experience. Zeitschrift Für Die Gesamte
Staatswissenschaft / Journal of Institutional and Theoretical Economics, 139(3, Regulation: Analysis
and Experience in West Germany and the U.S.A.: A Symposium), 419-434.
30
CRANDALL, R. W. (1983). Deregulation: The U.S. experience. Zeitschrift Für Die Gesamte
Staatswissenschaft / Journal of Institutional and Theoretical Economics, 139(3, Regulation: Analysis
and Experience in West Germany and the U.S.A.: A Symposium), 419-434.
31
Durant, R. F. (1993). Hazardous waste, regulatory reform, and the Reagan revolution: The ironies of an
activist approach to deactivating bureaucracy. Public Administration Review, 53(6), 550.
27
regulatory agencies relieved numerous markets of many of the regulations and
oversight policies. This era was also marked by the emergence of “New Federalism”
which sought to distribute remaining oversight responsibilities to the state level.
It attempted to accomplish this through deregulating the labor market, reducing
welfare provisions, distributing more tax responsibilities to the states, and
encouraging the states to assume a greater role in promoting economic
development.32
The popularity of New Federalism and President Reagan’s agenda
popularized the practice of reducing federal oversight. Before President Reagan’s
first term, the deregulation of the airline and transportation industries were
perceived more as isolated incidences of industries that benefited from removal of
regulatory burdens. This new conservative agenda promoted the idea of reducing
the oversight capabilities of the federal government and increasing the scope of deregulatory practices. Over the course of the Reagan presidency, the administration
continued to deregulate the transportation and airline industries while at the same
time removing federal oversight in the areas of energy, finance, and
communications.33
This pattern of deregulating previously tightly controlled markets continued
from President George H.W. Bush’s term to the conclusion of the Clinton
32
Grant, D. S.,II. (1995). The political economy of business failures across the American States, 19701985: The impact of Reagan's new federalism. American Sociological Review, 60(6), 851.
33
Kahn, A. E. (May 1987). Transportation deregulation...and all that. Economic Development Quarterly, 1,
91. doi:10.1177/089124248700100201
28
administration. During the 1990’s the government continued to remove regulations
over industries, most notably in the electricity and financial sectors. President
Clinton’s de-regulation of the electricity industry is seen as one of the most
significant acts of deregulation in the 20th century and provides a clear example of
the widespread and bi-partisan support for deregulation.
During this perio d, numerous industrial sectors had their regulatory market
restrictions significantly reduced. Two industries in particular, the airline and
trucking industries, exemplify the process by which the government deregulated
these previously controlled markets. The following section will provide an overview
of the de-regulatory policies in each of these industries, the timeline of their
implementation, and their effect on the industry in question.
The Airline Industry:
The first industry to experience a large scale reduction of regulations was the
airline industry. The Airline Deregulation Act of 1978 reduced or annulled many of
the provisions in the Civil Aeronautics Act of 1938, which had previously
established the federal guidelines for control of the commercial air transportation
industry. The Act of 1938 created the Civil Aeronautics Authority34 which it
designated as the agency in charge of enacting its provisions. The legislation granted
the CAA control over route entry, the ability to regulate fares, the authority to
distribute subsidies, and control over mergers and inter-carrier agreements.35 In its
declaration of policy, the bill outlines its goals in implementing these regulations:
34
35
The Civil Aeronautics Authority was later recognized as the Civil Aeronautics Board
Goetz, A. R., & Vowles, T. M. (2009). The good, the bad, and the ugly: 30 years of US airline
deregulation. Journal of Transport Geography, 17(4), 251-263. doi:10.1016/j.jtrangeo.2009.02.012
29
(a)The encouragement and development of an air-transportation system
properly adapted to the present and future needs of the foreign and domestic
commerce of the United States
(b)The regulation of air transportation in such a manner as to recognize and
preserve the inherent advantages of, assure the highest degree of safety in, and
foster sound economic conditions…
(c)The promotion of adequate, economical, and efficient service by air carriers
at reasonable charges…
(d) Competition to the extent necessary to assure the sound development of an
air transportation system…
(e)The regulation of air commerce in such manner as to best promote its
development and a safety
(f) The encouragement and development of civil aeronautics…36
Based on these provisions, the regulatory structure put in place guided the new
industry into creating a safe and profitable industry. The legislation’s more specific
directives, however, granted the CAA almost complete authority in market
operations. It had the ability to direct the airlines where to fly and how much to
charge while at the same time controlling entry into the market through licensing.37
36
Civil aeronautics act of 1938, CH 600-601, 75th Congress. (1938). 2.1.
37
Robson, J. E. (1998). Airline deregulation. Regulation, 21(2), 17-22.
30
From 1938 to 1978, the government treated the airline industry as a
regulated utility. During this time the regulations reflected Stigler’s claims as the
CAA (later the CAB) maintained strict control over entry to the market and rarely
allowed new competitive airlines to emerge. The extensive and complex web of
regulations created a sluggish system that required significant effort for any change:
“The CAB would hold extensive and elaborately staged hearings on nearly every
single request regarding routes or prices, including requests by existing and new
carriers to start additional service between two given cities.”38 This process
significantly limited the number of firms in the market and allowed the government
to control the entrance of new airlines. Since the limited number of firms in the
industry required government approval for new routes and pricing, they competed
primarily through adding flights and improving in-flight amenities. In this scenario
it became extremely difficult for any single firm to gain a competitive advantage.39
In the 1970s support for deregulating the airline industry spread throughout
the US Government. This movement expanded and eventually garnered support
from key political actors such as Senator Edward Kennedy, who led Congressional
hearings questioning the benefits of regulatory policies in the United States. Shortly
after these hearings the airline industry emerged as the first industry that the
38
Robson, J. E. (1998). Airline deregulation. Regulation, 21(2), 17.
39
Fischer, J. (1980). Airline deregulation: An assessment. ( No. 80-139). Washington, DC: Congressional
Research Service. doi:August 5, 1980
31
government chose deregulate through the creation of the Airline Deregulation Act of
1978.
At its most basic level, this legislation stripped the CAB of the majority of its
regulatory powers in the airline market and rendered many of the provisions in the
Civil Aeronautics Act of 1938 completely inert. Its most essential provisions
included:
1. Reducing standards for new entrants into the market
2. Liberalizing the rules that stipulated what cities an airline could
service
3. Removing total price regulations while still maintaining some
oversight to ensure reasonable fares
4. Elimination of all fare and entry regulation and dissolution of the CAB
by 1984
5. Subsidies for small community air services40
The CAB’a ability to control market entry was nearly completely nullified and its
policy regarding new airlines shifted:
40
CRANDALL, R. W. (1983). Deregulation: The U.S. experience. Zeitschrift Für Die Gesamte
Staatswissenschaft / Journal of Institutional and Theoretical Economics, 139(3, Regulation: Analysis
and Experience in West Germany and the U.S.A.: A Symposium), 419-434.
32
(d)(1) The Board shall issue a certificate authorizing the whole or any part of
the transportation covered by the application, if it finds that the applicant is fit,
willing, and able to perform such transportation properly and conform to the
provisions of this Act…
(A) in the case of interstate or overseas air transportation, is consistent
with the public convenience and necessity; and
(B)in the case of foreign air transportation, is required by the public
convenience and necessity41
This section in the Airline Deregulation Act of 1978 reflects the previous regulations
in place in the Federal Aviation Act of 1958. The 1978 Act, however, drastically
reduced the requirements for being “consistent with the public convenience and
necessity” and the legislative language grants less power to the government in
determining these qualities:
(B)In any determination as to whether the air transportation specified in any
application for a certificate described in paragraph (1)(A), (2)(A), or (3)(A) of
this subsection is or is not consistent with the public convenience and necessity,
an opponent of this application shall have the burden of showing that such air
transportation is not consistent with the public convenience and necessity42
41
Airline deregulation act of 1978, Public Law U.S.C. 95-504 (1978).
42
Airline deregulation act of 1978, Public Law U.S.C. 95-504 (1978).
sec 401(b) p 1719
33
This section eased entry requirements by placing the burden on existing
participants to prove that entry of a new firm runs counter to the public interest.
These new amendments opened the licensing process and allowed more entrants
into the market by reducing the government’s ability to impose regulations without
cause. The rest of the amendments reflected these ideals and continued the process
of removing regulations and the CAB’s oversight capabilities.
The process of deregulating the airline industry exemplifies the increased
institutional focus on reducing regulations in the period from 1970 to 2000.
Overnight one of the most highly regulated industries in the United States was
transformed into a freely competitive market. The airline case served as the first in a
long pattern of industry deregulation and catalyzed the process in other industries.
Trucking Industry:
In Stigler’s empirical analysis of regulation he used the trucking industry to
demonstrate the demand for industries to crowd out competition. This sector of
transportation proved to be an ideal candidate for Stigler’s theory, as the
government had consistently maintained strict control over the industry without
clear justification. In its early years the industry had a diverse contingency of
regulated and unregulated carriers. In 1935 Congress enacted the Motor Carrier Act,
which established a strict regulatory infrastructure for the commercial trucking
industry. The Interstate Commerce Commission was tasked with implementing
these newly created regulations.
The Motor Carrier Act of 1935 created a strict regulatory system for the
commercial trucking industry. The Act granted the ICC numerous oversight powers,
34
all of which allowed it to strictly control the market and its entities. Perhaps the
most influential power granted was the ability to control licensing and through this
entry into the market. The ICC Commissioner justified this by claiming that the
ability to control licensing allowed the ICC to prevent an oversupply of trucks, which
could lead to diminishing profits for all:
The most important thing, I think, is the prevention of an oversupply of
transportation; in other words, an oversupply which will sap and weaken the
transportation system rather than strengthen it…The States have, I think, in all
cases found the necessity in their regulation of motor transportation to provide
for that prevention of oversupply. 43
The authors of the Motor Carrier Act of 1935 applied language similar to that of the
airline industry prior to 1978. The licensing powers granted to the ICC empowered
it to issue certificates based on the “public need and necessity” without expanding
on what defines these terms. This allowed the ICC to maintain control of licensure
throughout the better part of the 20th century.44 During this time the agency
continually supported the needs of the current license holders above applicants to
entry in order to protect them from free market competition.
43
Hearings on S. 1629, S. 1632, and S. 1635: Committee on Interstate Commerce, Senate, 74th
Congress. 1st Session. (1935).
44
Thoms, W. E. (1983). Rollin' on...to a free market motor carrier regulation 1935-1980. Transportation
Law Journal, 43(1), 13.
35
A second significant provision of the Motor Carrier Act granted the ICC
control of rates within the industry. It allowed the agency to meticulously control
any rate implementation or change within the market and held the following
provisions:
1. Publication of rates and fares is required and there must be strict
observance of tariffs
2. Rates and fares are to be reasonable and not unjustly discriminatory
3. Carrier practices and regulations relating to fares and charges are to be
just and reasonable
4. Notice of at least 30 days is required for changes in rates and fares
5. Proposed rates and fares may be suspended by the Commission for a period
not exceeding seven months
6. The Commission has power to prescribe the maximum, minimum, or actual
rate to be charged in lieu of a rate found unreasonable or otherwise
unlawful
7. The Commission has the power to hear complaints and institute
investigations pertinent tits Congressional mandate45
The legislation made little effort to set guidelines on what constitutes “fair and
reasonable” prices, leaving those refinements to the discretion of the ICC. This
45
Thoms, W. E. (1983). Rollin' on...to a free market motor carrier regulation 1935-1980. Transportation
Law Journal, 43(1), 13.
36
afforded the ICC almost complete control over the rates charged by firms. The third
important provision granted to the ICC allowed them to regulate the routes of
commercial trucks. Both general commodities carriers and bus lines were forced to
follow specific routes stipulated by the agency.
When deregulation emerged as a focal point of politics in the 1970s, the
trucking industry provided a telling example of the harmful effects of
overregulation. Like the airline industry, the trucking industry existed in an
institutional vacuum that allowed little competition or free market reform. In the
mid 1970s the ICC began to loosen its regulatory stranglehold on the industry and
allow elements of competition. Over several years the agency began to allow more
competition through the liberalization of licensing requirements and pricing
controls. In 1980 a legal ruling in Alamo Express v. Interstate Commerce Commission
forced the ICC to issue a license to Alamo Express while simultaneously setting a
precedent that the ICC could not issue its own interpretations of public need and
necessity:
Thus-having found that the applicant Yellow met the statutory criteria for
issuance to it of a permit as a motor contract carrier of property for it to enter
into a contractual relationship to provide transportation services for
forwarding-we do not find merit to the protestant Alamo's underlying
argument that the evidence was insufficient to grant the territorial authority
37
because insufficient data from representative points of origin and destination
were presented.46
After this precedent was set, the government reduced regulation even further with
The Motor Carrier Act of 1980. This law established new standards for the ICC in
performing its regulatory tasks. In terms of licensing, the burden of proving
necessity was shifted from the ICC to the applicant, providing applicants with a
greater say in whether their application was accepted or denied. Previously, the
applicant would simply submit their application and the ICC would determine the
licensing necessity. After these changes the applicant was allowed to prove their
necessity to an unbiased panel and plead their case. Through a number of separate
provisions this statute removed several restrictions on applicants, most notably by
eliminating the limitation on the number of shippers.47The legislation also required
the Commission to determine public convenience and necessity through a
rulemaking procedure. The bill eliminated the ICC’s authority to direct route
operations, and eased the restrictions on prices by broadening the parameters
limiting price adjustment:
(1) In general.—For purposes of this section, a rate or division of a motor
carrier for service in noncontiguous domestic trade or water carrier for portto-port service in that trade is reasonable if the aggregate of increases and
46
Alamo Express inc. v. Interstate Commerce Commission, 81-4112 673 F.2d 852 (Fifth Circuit 1982).
47
United States Code, 1994 edition, title 49 - TRANSPORTATION, Y 1.2/5:10923, (1994).
38
decreases in any such rate or division is not more than 7.5 percent above, or
more than 10 percent below, the rate or division in effect 1 year before the
effective date of the proposed rate or division48
This provision granted the trucking firms the ability to set their own prices through
a controlled system. Although the bill did not dissolve the ICC completely, it stripped
it of most of its regulatory powers.
The trucking industry, as with the airline industry, saw a major shift in its
regulatory oversight over a very short timeframe. Before the Motor Carriers Act of
1980 the ICC had almost complete control over most of the functions of the industry.
The ICC retained some oversight capabilities in terms of pricing and licensing, but
could no longer control the market without consequence. This industry provides
another clear example of the deregulation pattern during this era.
The airline and trucking industry each experienced drastic policy shifts in
terms of their level of government oversight in the late twentieth century. The
process through which these two industries deregulated provides the clearest and
most simplified model of the deregulation movement popularized during the late
twentieth century. During this same period a number of other industries
experienced a similar change in government policy.
The railroad industry, telephone companies, cable providers, electricity
providers, financial corporations, and natural gas companies, among others, each
48
Requirements for reasonable rates, classifications, through routes, rules, and practices for certain
transportation, 13701, 49Cong. (2003).
39
saw the governmental restrictions on their industry significantly reduced during
this period49. Although these groups vary in terms of the pace and extent of their
deregulation, they all share a common trait in that each had previously operated in a
market extensively restricted by the government and moved towards a free market
model during the same general period.
The next section of this paper will employ Stigler’s original model to identify
the shifting variables that catalyzed this unprecedented movement. The premise of
this analysis is that if Stigler’s original model correctly identified the motivations for
the creation of these regulations, then the same model should explain the reversal of
the regulatory trend.
49
Crandall, R. W. (1983). Deregulation: The U.S. experience. Zeitschrift Für Die Gesamte
Staatswissenschaft / Journal of Institutional and Theoretical Economics, 139(3, Regulation: Analysis
and Experience in West Germany and the U.S.A.: A Symposium), 419-434.
40
Part II: Forces Behind Deregulation
In the previous sections I describe the overregulation in the airline and
trucking industries, the model that explains how these conditions emerged, and the
eventual deregulation of these industries. In this section I will attempt to map out
the changing political and economic environment that catalyzed the deregulation
that occurred in the late twentieth century, again focusing on specific industries that
followed a similar path towards deregulation. The cases presented are industries
that existed under strict government control throughout the twentieth century then
proceeded to operate under free market conditions. Their path towards
deregulation provides the most simplified case study of deregulation in the late
1900’s and creates a foundation for a more general study of the phenomenon.
To the untrained eye the deregulation of these industries might seem to
nullify Stigler’s original assertions. At its most basic level his groundbreaking work
asserts that the regulated industry will seek government oversight in order to
crowd out competition. Logic suggest that, since Stigler asserted that regulations
were usually bad public policy and the markets that provided him with examples for
this theory suddenly deregulated and established policies that supported the public
good, then his model must have incorrectly outlined the causal system that created
these regulations. Perhaps the public interest theory had previously and correctly
identified the true motivations of regulatory policy and capture theory was a
relative fad. I contend that these assertions fail to dismiss Stigler’s model in the
41
analysis of regulation, and that modifications to variables within the model prove its
continued validity.
Stigler’s model incorporates an economic analysis of regulations and the
policy process behind their erection using fundamental principles of supply and
demand. In this model the potential benefits of the regulations to the industry
represent the demand for these policies while the cost of obtaining legislation
through the political process denotes the supply side:
The potential uses of public resources and powers to improve the economic
status of economic groups (such as industries and occupations) are analyzed to
provide a scheme of the demand for regulation. The characteristics of the
political process which allow relatively small groups to obtain such regulation
is then sketched to provide elements of a theory of supply of regulation.50
In order to correctly identify the causal factors in the deregulation of the discussed
industries, alterations both the supply and demand functions must be separately
analyzed. This section asks what changes in the political environment modified the
benefits of regulation and the cost of obtaining these policies.
IV: Graphical Representation: Graphically Deriving
Stigler’s Model
A graphical model provides a more and clear depiction of the shifting
variables in the policy process. In Stigler’s analysis the market incorporates the
50
Stigler, G. J. (1964). Public regulation of the securities markets. The Journal of Business, 37(2), 117142.
42
decision that political party faces in choosing which group to grant influence of a
particular policy to. This model reflects the characteristics of a monopoly market in
which there exists only one producer that retains considerable control over price
and production. The single producer, the political party or agency, faces no
production competition as no firm can provide the particular service sought by the
consumers.
The model for a monopolistic economic market provides a reasonable
starting point for modeling the regulatory policy market. As in perfect competition,
the monopolistic producer seeks to maximize its profits. In these configurations,
however, it sets the price at a level that achieves this goal; in perfect competition the
forces of supply and demand set the profit-maximizing levels. The graph below
depicts these forces:
43
Each factor in this diagram plays an important role in determining final output and
price. The demand curve represents the marginal benefit received by the consumers
in the market for each combination of price and output along the curve. It slopes
downward because as price falls, more consumers will demand the product and the
quantity demanded increases. The marginal revenue curve represents the additional
revenue the producer receives from producing one additional unit of the particular
good. Its downward slope results from the fact that the producer must charge a
lower price in order to sell an additional unit, which lowers the revenue for each
additional unit sold. The marginal revenue curve lies below the demand curve
because the additional revenue received from selling an additional unit cannot
exceed the price of that unit.
The marginal cost curve slopes upward because as the firm produces a
greater quantity of a good or service, the cost to produce each additional unit
increases. As the firm produces additional units of the good, its costs of handling,
storing, transporting and labor increase. This creates a higher production cost for
each additional unit of output. It also represents the supply curve for the producer;
each point along the line denotes the price a firm is willing to charge for that
particular unit of output. 51
To determine output, the producer will designate the quantity produced in
which the marginal cost and marginal revenue curve intersect. At every point before
this, the revenue for producing an additional unit exceeds the cost of producing that
51
Abel, Andrew B. Bernanke, Ben S. Croushore, Dean. (2008). Macroeconomics. New York:
Pearson/Adison Wesley.
44
unit. For each quantity after the two curves intersect, the cost for producing each
unit exceeds the revenue generated from selling it. Since profit equals revenue
minus the cost (P=R-C), the profits of the firm continually increase until this
intersection, and then decrease at every quantity after. Thus, the firm maximizes its
profit when producing the quantity where these two curves intersect. 52
To determine what price to charge consumers at this profit maximizing
quantity, the producer then looks to the demand curve. Each point on this curve
represents the price consumers are willing to pay for a certain quantity of goods. At
point Q1 in the above diagram, the price along the demand curve is represented by
P1, which denotes the price consumers are willing to pay for that specific quantity of
good. Pe represents the free market equilibrium price for this market, which occurs
at the intersection of the demand and supply (marginal cost) curves. The difference
between the free market equilibrium price and the price at Q1 along the demand
curve (P1) represents the monopoly profit for the firm. A monopoly profit reflects a
profit that can only be attained with some monopolistic conditions and is infrequent
in free markets. The individual firm cannot charge this price in a free market due to
price competition. The supply (or marginal cost) represents the price producers are
willing to sell the product for at a specific quantity, so if the firm charged the
monopoly price at this quantity in a free market other firms would undercut their
prices.
52
Abel, Andrew B. Bernanke, Ben S. Croushore, Dean. (2008). Macroeconomics. New York:
Pearson/Adison Wesley.
45
Regulatory Policy Market:
The graphical derivation of this market represents the forces that create the
profit maximizing level of exclusionary regulations the producer, the governmental
agency backed by a political party, imposes on a market. The final output of
regulation in this market occurs at this profit maximizing level. Just as in any
economic model, the determination of output relies on the forces of supply and
demand. In Stigler’s economic analysis of this market he provides the specific forces
that determine both the supply and demand in this market, therefore allowing a
graphical depiction of both.
Creating a graphical representation of this market first requires a
determination of the variables. The standard economic model uses price, meaning
the price the producer charges for one unit of the good, and quantity as its variables,
with price along the y-axis and quantity along the x-axis. This graphical
representation adapts price, meaning the amount of votes and financial resources
the political party requires an outside entity to supply for them to enact a specific
policy, as the variable along the y-axis. The variable along the x-axis, quantity of
regulation, refers to the amount of economic regulation that restricts entry into the
market. The greater the amount of this exclusionary regulation imposed on the
market, the more difficult it becomes for new firms to enter the industry. The
market for regulatory policy is a monopolistic market; it has a single producer, the
political party/regulating agency that faces no competition and therefore sets the
output at the profit maximizing level. Therefore, this model relies on the same forces
as the monopoly model, marginal revenue and marginal cost, in determining output.
46
Supply Side:
To derive the marginal cost curve in the model, this paper looks to the supply
side of Stigler’s model, which outlines the process through which the agency decides
which group will influence the policy output. This analysis uses the characteristics
of the political process to develop a systematic model that details the decision
making process of a political group when debating which groups will gain input into
the policy process. The groups that control the policy process, the political groups,
require funds to maintain their organization and votes to compete in elections.
Therefore, they seek funding and support from groups attempting to influence some
function of the government:
The industry which seeks regulation must be prepared to pay with two things a
party needs: votes and resources. The resources may be provided by campaign
contributions, contributed services (the businessman heads a fund-raising
committee), and more indirect methods such as the employment of party
workers. The votes in support of the measure are rallied, and the votes in
opposition are dispersed, by expensive programs to educate (or uneducated)
members of the industry and of other concerned industry. 53
In this system of thinking political influence is positively correlated with the
financial and civil resources of a firm. That is, the larger and more financially
influential an entity is, the more political influence it will have.
53
Stigler, G. J. (1971). The theory of economic regulation. The Bell Journal of Economics and Management
Science, 2(1), 3-21.
47
In a very large industry with extensive revenue dispersion and a large
number of firms, the political party undertakes an entrepreneurial role in providing
favorable legislation.54 In these markets interests are spread out and the political
parties must find the most profitable route of engagement. In more concentrated
industries, however, the limited number of firms generally have similar policy
preferences. Since these few entities share the majority of the profits and desire the
same policy outcomes, they can provide the party with more resources together:
We can go no further than the infirmities of oligopoly theory allow, which is to
say, we can only make plausible conjectures such as that the more concentrated
the industry, the more resources it can invest in the campaign for legislation.55
This concept proves essential in analyzing the overregulated industries discussed in
this paper. In their infancy these markets had relatively few firms competing; the
firms captured their regulating body early on and almost immediately began to limit
entry into the market. This created oligopolistic conditions in the industry in its
early years, which benefited both the political party, since they received more
contributions from markets with few competitors, and the competing firms, which
received more benefit from entry control than the influence cost them.
The cost of implementing regulations incorporates two distinct expenditures
for the political party in question. The more obvious of the two, the cost of
54
Stigler, G. J. (1971). The theory of economic regulation. The Bell Journal of Economics and Management
Science, 2(1), 3-21.
55
Stigler, G. J. (1971). The theory of economic regulation. The Bell Journal of Economics and Management
Science, 2(1), 13.
48
implementing the policies involves the standard operating costs of operation
including paying employees, renting office space, and all other expenses needed to
oversee the specific market. These expenditures are reasonably predictable and
increase at a steady rate with the amount of regulations imposed. For each
additional policy that increases regulation, the agency requires additional funding to
impose these regulations. The additional resources needed depend only on the
increase in regulations and does not vary with the amount already imposed;
therefore the marginal cost line has not slope and extends horizontally.
In order to implement a regulatory policy that crowds out competition, a
political party must also invest in a public relations campaign to obtain public
support for the effort. Thus, as Stigler’s analysis demonstrates, the marginal cost of
providing regulation increases with the size of the industry seeking regulation. This
is because larger industries desire regulatory policies that are more costly to society
more and draw more opposition from affected groups than do smaller industries.
Since, as previously discussed, larger firms will seek more barriers to entry in the
form of higher regulations, then the cost of providing the legislation for the
producer (political party or agency) will increase with the extent of legislation
sought (the variable along the x-axis). Thus, the total marginal cost curve for the
agency to provide the legislation combines both the operating costs involved with
implementing regulations with the cost of the public relations campaign to garner
voter support for the legislation:
49
The line MC1 reflects the marginal cost of operation for each additional regulation in
place. It extends horizontally representing the constant nature of these expenses-the additional expenditure for each additional regulation imposed the same costs
regardless of the regulations already in place. The curve MC2 symbolizes the cost to
garner public support for each additional regulation imposed once a specific level of
exclusionary regulation already exists in the market. It slopes upward at an
increasing rate because as the extent of regulation in the economic market
increases, so does the cost for each additional regulation. The greater the amount of
regulation already present in the market, the greater the potential opposition and
potential harm to society of each additional policy that increases the regulation. This
causes an increasingly steep marginal cost curve, reflecting the fact that the more
regulations already in place, the greater the cost for the implementing agency or
50
party to increase the regulation. The line MC combines these two cost line to denote
the overall marginal cost curve the agency faces in implementing these regulatory
policies.
Demand Side:
To derive the marginal revenue curve for the graphical model, I look to
Stigler’s analysis, which uses the potential benefits the state can provide to
industrial firms to denote their demand for these services or policies. The regulating
body can provide direct subsidies, undermine substitute products, support
complementary products, fix prices, and limit entry into markets through excessive
regulations. Above all other provisions, the large industrial entity seeks to use policy
influence to restrict entry into its market. The benefits the firm receives from the
restriction of competition, which creates monopolistic conditions and allows for
monopoly profits, greatly exceeds any benefit from other governmental support
such as direct subsidies.
The markets discussed in this paper, in particular airline and trucking
industries, had a small number of market participants that shared the majority of
the revenue.56 Thus, in this market, the demand for regulation reflects the demand
of a large industrial firm for exclusionary regulation to limit competition in the
market. Therefore, their marginal benefit increases consistently for each additional
regulation that crowds out competition. The demand curve in this model, in contrast
56
CRANDALL, R. W. (1983). Deregulation: The U.S. experience. Zeitschrift Für Die Gesamte
Staatswissenschaft / Journal of Institutional and Theoretical Economics, 139(3, Regulation: Analysis
and Experience in West Germany and the U.S.A.: A Symposium), 419-434.
51
to the normal monopoly model, slopes upward. Since the demand for specific levels
of exclusionary regulation for the few large firms in these markets is based on the
extent of regulation, and not price, demand increases with each increase in
regulatory policies that crowd out competition. In the monopoly model a lower
price attracts more demand for a product. In the regulatory economic model for
markets with limited competitors, the demand increases with the amount of
regulation and relies less on pricing.
52
Demand increases steadily as the amount of regulation increases a result of the
positive correlation between the amount of exclusionary regulation in the market
and the benefits the firms receive. For each additional policy that eliminates
competition, these firms are willing to pay a higher price and their overall demand
increases. Since the firms that do not have access to the market desire to have these
restrictions removed, the demand curve originates above the origin along the y-axis.
The marginal revenue curve derives from the demand curve of the firms
seeking policy influence. As with the monopoly model, the marginal revenue curve
lies below the demand curve and has a more horizontal slope due to the fact that the
additional revenue from each increase in price must be less than the price charged.
For example, if the consumers in the market demanded a price of $20 at Q1 and 30$
at Q2, the consumer receives a marginal revenue of 10$ at Q2 while the demand curve
lies at 30$ at this point.
Merging both the supply and demand models with the marginal revenue
curve the marginal cost curve creates a graphical representation of the market for
economic regulatory policy:
53
This model operates under the assumption that the regulating agencies enact policy
at the profit maximizing point along the regulation curve. The marginal revenue
potentially received from firms seeking to enter the market occurs when marginal
revenue intersects with the y-axis. The marginal cost of operations occurs at the
intersection of the marginal cost curve at the y-axis. The y-intercept of the marginal
revenue curve exceeds the y-intercept of the marginal cost curve through the logical
assumption that marginal costs of operation dictate a minimal percentage of overall
cost, and that the revenue the firms seeking to enter the market are willing to pay
exceeds this expenditure.
Qmax represents the maximum amount of entry barriers a government could
feasibly erect; at this point the regulations would restrict the market to one
54
producer. Q1 represents the output of the market in terms of the extent of
regulations that restrict entry. The agency controlling these regulations, the
producer in the market, imposes the level of regulation that maximizes its return
from firms willing to contribute to their controlling political party. This profit
maximization occurs at the specific quantity of regulation where the cost of
implementing any more of these policies in the market exceeds revenue the political
party receives from the interested firms, Q1.
V. Explaining Deregulation: Political and Economic Forces
Behind Deregulation
Supply Side:
What changes could potentially cause a reduction of market-restricting
regulations in these industries? In terms of the supply model, a theoretical shift in
the marginal cost curve that creates increased costs for the political party to
implement excessive levels of regulation could potentially cause such a change in
regulatory output. Evidence in changing political interactions and atmosphere
reflects such a change.
A causal analysis of this change in the marginal cost from its original
trajectory requires a return to Stigler’s original supply model. In deriving the overall
marginal cost curve for the policy-implementing agency this paper divides
necessary expenditures into two separate categories: operational costs and
resources dedicated to swaying public opinion. The marginal cost of operational
expenditure needed to function as an agency flows horizontally across the graph
55
representing the stable nature of these expenses; no matter the amount of
regulations already imposed, the operational cost of additional regulations remains
constant. Operational expenses, for all companies and government agencies, have
little fluctuation in their overall levels. A drastic increase in the overall marginal cost
caused by fluctuations in operational costs would need to involve a sharp rise in
employee salaries at the imposing agency, an increase in the cost of providing
licenses, or any other rise in cost that could dramatically inflate the funds needed to
conduct the day-to-day operations of the agency. Due to the unlikelihood of any of
these factors drastically rising over a short period, combined with the low
percentage the operational cost contributes to the overall marginal cost curve, I look
to the other side of the marginal cost to discover the variation in the supply. After
operational expenses, expenditure needed to sway public opinion in favor of the
imposed policy constitutes the remainder of the complete marginal cost curve.
The primary consequence of the entry-restricting policies implemented in
these markets was the creation of monopolistic (or oligopolistic) conditions in the
industry that denied consumers free-market pricing. The industries discussed in
this paper have high concentrations of large industrial firms that control the
majority of the market. Based on Stigler’s conception, these firms prefer policies
that have higher costs to society in the form of regulations that limit entry into their
market.57 These policies prohibit free-market pricing and create monopolistic or
oligopolistic conditions within the industry. In these market conditions the
57
Stigler, G. J. (1971). The theory of economic regulation. The Bell Journal of Economics and Management
Science, 2(1), 3-21.
56
producers charge a higher price for a lower output while gaining a monopoly profit.
The additional profit incurred by the firms is stripped from the consumer in the
form of a deadweight loss caused by a decline in the consumer surplus:
Figure 1
Figure 2
Figure 1 reflects the output decision the single producer faces in a monopoly
market; the bottom model represents the free market analog. As previously
asserted, in a monopoly market the producer fixes output at the quantity where the
marginal cost and marginal revenue curves intersect. The producer charges the
price that corresponds to this quantity along the demand curve. In a free market
57
economic forces would set the price at Pe where the supply and demand curves
intersect, this is reflected in Figure 2.
The consumer surplus in a market constitutes the overall benefit consumers
receive from a particular output. This benefit emerges from the number of
consumers in the economy who pay a lower price than what they were willing to
pay for one unit of the product or service. In both markets the blue shaded area
represents the consumer surplus in that market. The producer surplus constitutes
the benefits a producer receives from a specific level of output and is represented by
the green shading in both graphs. Producer surplus denotes the difference between
the price charged and the supply curve at each quantity; in other words, the price a
firm charges above what they were willing to sell the good for at each quantity.
When a market shifts from a freely competitive model to a monopolistic
model the producer surplus increases and the consumer surplus decreases, as seen
in the transition from Figure 1 to Figure 2 above. The producer surplus increases by
the square extending vertically from P1 to Pe and horizontally to from the y-axis to
Q1. This additional producer surplus is taken away from the consumer surplus,
which loses this rectangle in addition to the red shaded triangle above Pe. The red
shaded area represents a deadweight loss to all of society, or the loss in consumer
and producer surplus that neither can gain back. The increase in producer surplus
taken from the consumer surplus exceeds the small deadweight loss in producer
surplus.
The primary observation taken from this model revolves around who loses
when monopolistic conditions emerge and why producers invest to limit
58
competition. When monopolistic conditions develop, consumers lose surplus
demand and producers increase profits. In returning to the marginal cost model for
the policy market, industrial firms seek to limit entry into the market in order to
create these monopolistic conditions and increase profits. When these conditions
emerge, consumers lose a large portion of their surplus and pay higher prices for
lower quantities of the good or service. This also supports the overall shape of the
marginal cost curve; the more regulations limiting entry imposed on an industry the
higher the loss in consumer surplus and the more resources the political party
requires to convince consumers that the policy serves their best interest.
Neoclassical Economic theory supports the principle that competition
produces the best price for consumers, maximizing consumer surplus and
minimizing deadweight loss. Regulators restricting entry or fixing prices in markets
prevent the most efficient outcome and results in a deadweight loss for society and a
loss in surplus for consumers. Free market operations promote fair pricing.
Restricting these functions almost exclusively results in higher prices for
consumers:
As for the first, it is a general rule, nowhere more abundantly illustrated than
under regulation, that if you prevent competition from driving price down to
the cost of providing a service efficiently in a structurally competitive industry,
competition will instead take forms that drive cost up to price.58
58
Kahn, A. E. (1988). Surprises of airline deregulation. The American Economic Review, 78(2), 316.
59
In any case free-market forces produce the fairest pricing mechanism. Any
significant alteration of these functions, regardless of the intention, prevent efficient
pricing and hurts consumers.
When Stigler and his counterparts released their observations of these
markets, it brought light to the motivations behind the regulations in place and the
unfair pricing that resulted from their implementation. These works erected a
consensus among the policy community that these regulations opposed the general
public interest:
With few exceptions, there was a general consensus that economic
regulation— the control of rates and entry by government – did not serve the
public interest.59
The primary markets discussed in this paper, the airline and trucking industries,
reflected this unfair pricing during the period in which they retained high levels of
regulation and restriction of competition. In the airline industry the system of price
regulations and restrictions on competition created high costs for passengers:
The subsidy scheme relied on the CAB authority over fares. Fares generally
were revised upward based on average costs, thus allowing pass-through of
most cost increases to passengers. Even more importantly, the fare formulas
59
Crandall, R. W. (1983). Deregulation: The U.S. experience. Zeitschrift Für Die Gesamte
Staatswissenschaft / Journal of Institutional and Theoretical Economics, 139(3, Regulation: Analysis
and Experience in West Germany and the U.S.A.: A Symposium), 419-434.
60
were not consistent with cost behavior, with long-haul routes providing much
higher profit margins.60
Instead of free-market pricing, this industry relied on price formulas and corporate
determination of fare-rates. These rate adjustments resulted in inefficient
production and high pricing within the industry.
The trucking industry also reflected this pattern in its pricing system, which
too opposed the public good:
At the same time, there developed over the decades of the 1960’s and 1970’s
something close to a unanimous opinion among academic students that, most
obviously in the transportation but also elsewhere, regulation had suppressed
innovation; denied the public the variety of price and quality options that a
competitive market would have provided; sheltered inefficiency, both within
each transportation mode and in the distribution of business among them;
discouraged intermodalism, and, by repressing price competition,
systematically encouraged competition in wasteful, cost-inflating ways; and
encouraged the wage-price spiral that, in a broader context, might be
conceived of as the microeconomic component of our national stagflation
problem.61
60
Meyer, J. R., & Strong, J. S. (1992). From closed set to open set deregulation: An assessment of the
U.S. airline industry. Logistics and Transportation Review, 28(1), 1.
61
Kahn, A. E. (May 1987). Transportation deregulation...and all that. Economic Development Quarterly, 1,
91. doi:10.1177/089124248700100201
61
The resulting output of this highly regulated market fell well short of optimal
efficiency and pricing. Because most consumer goods were transported by truck,
and transportation constituted a material part of the price of those goods, the
increased prices caused by regulation had a direct effect on the prices of goods in
stores across the country.
The realization that regulation of these markets contravened the public
interest did not immediately force any action on behalf of public officials. The final
push for reform arose from an economic downturn and significant rise in inflation
beginning in the early 1970’s.
The economic conditions and political atmosphere during the 1970s into the
1980s brought the debate over consumer prices to the forefront of American
politics. During this period the American economy experienced one of its largest and
most prolonged slumps since the Great Depression, the most pronounced
characteristics of which were a dramatic rise in oil prices due to international
tensions, and runaway inflation. 62 From 1969 to 1985 the Consumer Price Index,
which measures the overall price for goods in an economy, rose by almost 200%,63
signifying a dramatic rise in the prices of consumer products in the American
economy. This rise in the CPI is represented by the following graph:
62
POLAK, R. G. (1983). Inflation in the U.S. during the 1970's: An analysis of sectoral and distributional
effects (united states). (Ph.D., Boston University Graduate School). ProQuest Dissertations and
Theses, (303287247).
63
Historical Statistics of the United States. (1948-2000). CPI index over time. Cambridge, Ma.: Cambridge
University Press.
62
64
In the years before this significant increase in price levels, inflation had remained
relatively stable.
The repercussions from these economic were felt throughout the economy,
as Americans faced continually rising prices and a reduced standard of living.
Consumers living on a fixed income such as retirees were particularly hard hit. The
situation demanded political action. In a Congressional hearing in 1973 Senator
John Tunney of California testified in front of the U.S. Senate Committee on
Commerce, Subcommittee for Consumers regarding the rise in the prices of goods
64
Historical Statistics of the United States. (1948-2000). CPI index over time. Cambridge, Ma.: Cambridge
University Press.
63
and its effect on the American consumer. In California during this year, the average
family grocery bill increased over 20%, lumber costs rose, gasoline prices increased,
and medical costs spiraled.65 During this inflationary period average Americans saw
the prices of the items they purchased everyday rise dramatically and demanded
political relief from these conditions.
In Stigler’s paper he begins his analysis of the cost of regulation by describing
the characteristics of the political process that support the system of regulation
implementation. One of these primary characteristics is the employment of political
parties to make decisions for individual voters due to the significant cost to the
voter to obtain information about individual policies. The condition of simultaneity
requires the political process to represent the needs of all voters on every issue
regardless of whether a particular issue affects every participant or not. The
majority of these decisions only affects or apply to a small percentage of the voters.
Therefore citizens employ political parties to handle the logistics of all political
decisions, including ones that affect the majority of people. In this process voters
will only put political pressure on these elected officials regarding policies that have
significant impact on their day-to-day lives.66
During the inflationary period of the 1970’s individuals that had previously
remained uninterested in regulatory policy became focused on it as a cause of
inflation. The rise in the CPI devastated the middle and lower classes, which then
65
Hearings before the Committee on Commerce United States: Subcommittee for Consumers, Senate, 1st
(1973).
66
Stigler, G. J. (1971). The theory of economic regulation. The Bell Journal of Economics and Management
Science, 2(1), 3-21.
64
turned to the government for relief.67 Consumers demanded lower prices across the
board and pressured elected officials to assist in reducing price burdens. This
brought attention to all parts of the market that had restricted low prices, including
over-regulations.
The political rhetoric during this time reflected this pressure for price
reduction. Numerous politicians crusaded for the average consumer and attempted
to garner the support of their constituencies by fighting rising costs of living. The
testimony of Senator Tulley in front of the Committee of Commerce in 1973 reflects
the increase in support for average consumers:
We will hear testimony on how inflation has robbed countless citizens not only
of their hard earned dollars, but of their health and their dignity. We will hear
testimony on how inflation has hit certain groups with special problems—the
elderly and minorities—as well as what one witness has called “the silent
majority among minorities, the poor and middle class white.”…And most
unconscionable of all, we will hear of Government agencies charged with
enforcing price controls and addressing consumer grievances, which have
responded with indifference 68
67
Polak, R. G. (1983). Inflation in the U.S. during the 1970's: An analysis of sectoral and distributional
effects (united states). (Ph.D., Boston University Graduate School). ProQuest Dissertations and
Theses, . (303287247).
68
Polak, R. G. (1983). Inflation in the u.s. during the 1970's: An analysis of sectoral and distributional
effects (united states). (Ph.D., Boston University Graduate School). ProQuest Dissertations and
Theses, . (303287247).
65
This testimony provided one of the first signs that elected officials intended to target
inefficient regulations as a cause of high prices. As the public pressure to drive down
prices mounted throughout the course of the 1970s, politicians sought out means to
reduce costs and protect the consumer. At this point more elected officials turned to
the regulations that Stigler and his associates established as detrimental to
consumers. Although these regulations did not directly contribute to the increased
inflation during this period, they had continuously created high prices in these
industries for the better part of the 20th century. These regulations represented a
policy area that contributed to higher pricing that elected officials had explicit
control of, as opposed to the other economic forces that had caused the increased
inflation during this period. Thus, politicians who wanted to show the public that
they were fighting high prices lobbied for the removal of these policies.
Those in the trucking industry that had been fighting for deregulation saw
this as an opportunity to garner public support for their cause through claiming that
the regulation in their industry drove up the prices that they transported:
If both farm-friendly congressmen and consumer-friendly Democrats could be
convinced that deregulating trucking would lower the price of food at the super
market without lowering farm prices, Parkhurst could attack the ICC as an
outmoded relic and the Teamsters as selfish brutes who contributed to
runaway inflation69.
69
Hamilton, S. (2009). The populist appeal of deregulation: Independent truckers and the politics of free
enterprise. Enterprise and Society, 10(1), 131.
66
The trucking union’s attachment to this movement signified recognition that price
deflation represented one of the most advantageous political stances of the time. In
the initial committee meeting on airline deregulation, Sen. Edward Kennedy also
implied that the ultimate goal of deregulation would be to lower prices and give
consumers more efficient output:
That will produce fuller planes, and fuller planes at lower prices. To take this
answer back where you started, fuller planes are in the public interest. But
fuller planes should mean lower fares to the people who actually fly them, not
subsidies to someone else.70
The overall rhetoric of the political landscape during this period reflected an
increased support for price deflation. This political movement targeted any
practices that had maintained high or inefficient pricing, including the regulations
that Stigler had ousted as against the public interest years earlier.
The political implementation of these ideas emerged as a predictable
reaction to a strong economy centered on the consumer:
The likelihood that a society will select competition is higher the less socially relevant
cost-reduction is and the stronger the political power of consumers is. This prediction
is consistent with U.S. power market data. During the 1990s, deregulation was
70
Oversight of civil aeronautics board practices and procedures hearings before the subcommittee on
administrative practice and procedure of the committee on the judiciary, united states senate, ninetyfourth congress, first session. (1976). Washington DC: United States Civil Aeronautics Board.
67
implemented where generation costs and inefficiencies of input usages were
historically lower and politicians were more pro- consumer. 71
Politicians react to a voter constituency that seeks price-reduction through meeting
these demands in all functions of governance. The regulation in these markets was a
casualty of this demand and politicians used deregulation as a strategy to garner
favor with a frustrated constituency.
These observations translated onto the derived marginal cost curve show an
increase the exponential nature of the curve:
This model reflects a theoretical shift in the marginal cost caused by an increase in
the cost of convincing the public that these regulations support their best interest.
71
Smith, V. L. (1988). Electric power deregulation: Background and prospects. Contemporary Policy
Issues, 6(3), 14.
68
The initial cost of regulation remains at the operational expense levels. Due to the
political pressure to lower prices combined with the realization that these
regulations supported high prices, the cost of convincing the public that these
regulations supported their best interest dramatically rises. This increase in
marginal cost results in a intersection of the revenue and cost curves at a
significantly lower level of regulation in these markets. The profit maximizing
intersection for the political party now occurs at Q2, which represents a market with
fewer entry restricting regulations.
Demand Side:
The significant rise in the cost of implementing these regulations represents
the greatest contribution to the deregulation of these markets. The marginal
revenue and demand for these policies, however, also changed during this period.
The demand, and in turn the marginal revenue, in this market represents the
political benefits to the industrial firms seeking regulation. During this period the
structure of interest groups and the nature of their formation changed. The new
structure of interests created a wider scope of policy benefit and spread out benefits
among multiple groups. The evolution of these subsystems within the American
political system provides a clear understanding of these changing interests.
The concept of subsystems plays a vital role in understanding the process by
which industries capture firms. The United States government has developed a
number of subsystems both within and outside of its institutional framework in
which policy influence takes place. Subsystems represent the movements and
entanglements of interest group activities. The original subsystem characterization,
69
iron triangles, revolutionized the idea of agency capture through meticulously
mapping out one of its most dominant forms of execution.
The triangle system produced a detailed empirical analysis for which Lowi
had laid the fundamental theoretical groundwork. This “triangle theory” created a
basic mapping of how interest groups assert their political capital to influence
government decisions through agency capture. These triangles represent the ideal
system through which industries that capture their regulatory agencies operate.
They allow concentrated interests to control a market with little interference from
outside political interests. The industries discussed in this paper that had controlled
the regulation of their industry operated in a similar manner. These concentrated
groups alone benefited from the implemented regulation and sought to control the
policies that affected their industry.
Although sometimes criticized as overly simplistic, the iron triangle theory
provides an accurate example of how some interest groups within a plural-elitist
system would exert their industrial power within the government. The triangle
(seen below) portrays the committees of Congress, interest groups, and executive
agencies as the primary actors in the policy process. 72
72
Fritschler, Lee and Rudder, Catherine. (2006). Smoking and politics (6th ed.) Prentice Hall.
70
Congressional Committee
Executive Agency
Interest Group
These iron triangles function discreetly and often deal with complex policy
initiatives. Each participant in the system benefits in some way, which creates a
sustainable routine until, interfered with from the outside. Within the system the
congressional committee provides appropriations to the executive agency, the
executive agency provides services to the interest groups, and the interest groups
provide electoral support to the politicians within the congressional committee.73
This system omits the executive branch, as lobbying directly to the executive branch
occurs behind closed doors and is often unseen.
These triangles do not consistently operate and adjust to outside factors.
Ripley and Franklin detail the four stages of triangles as (1) dominance, when the
triangle functions undisturbed by outside influence; (2) adaptation, in which the
triangle faces threats to which it adjusts (3) competing, which occurs when two iron
triangles vie for policy advantages: and (4) disintegration when the system fails.
73
Fritschler, Lee and Rudder, Catherine. (2006). Smoking and politics (6th ed.) Prentice Hall.
71
74Ultimately,
these iron triangles seek to maintain the status quo, in which the
influential industry maintains influence and increases profits, the politician
continues to attain re-election, and the executive agency receives its large budget:
The goal of the iron triangle is to promote policies that preserve the status quo.
Maintaining the status quo means promulgating policy alternatives that keep
or allow the iron triangle participants to control the policymaking process over
public policy which its members have a vested interest.75
These triangles provide us with a tangible example of agency capture and through
this popularized the idea among even more political scientists. In the late twentieth
century, however, scholars began to doubt the universality of these triangles as
instruments of policy making. The increasingly complex network of interest group
relations created a need for a more complex analysis of these systems.
In 1978 Heclo proposed a new definition of subgovernments that more
accurately described interest group networks and functions. In his opinion iron
triangles had accurately identified a small portion of subgovernmental systems, but
did not accurately depict the majority of interest group networks:
74
Ripley, Randall and Franklin, Grace. (1977). National government and policy in the United States (3rd
ed.). Itasca: F.E. Peacock.
75
Hanks, C. D. (2000). Reexamining the subsystem concept. (Ph.D., Texas A&M University). ProQuest
Dissertations and Theses, . (304669007). 124.
72
Based largely on early studies of agricultural, water, and public works policies,
the iron triangle concept is not so much wrong as it is disastrously incomplete.
And the conventional view is especially inappropriate for understanding
changes in politics and administration during recent years.76
Heclo asserted that the widening scope of the federal bureaucracy had exiled
all but the strong iron triangles with the most powerful industrial backing. The new
political landscape was characterized by the emergence of numerous new interest
groups. The increasingly large bureaucracy in Washington gave interest groups
access to influence smaller agencies, more policy decisions, and more regulations:
With more public policies, more groups are being mobilized and there are more
complex relationships among them. Since very few policies ever seem to drop
off the public agenda as more are added, congestion among those interested in
various issues grows, the chances for accidental collisions increase, and the
interaction tends to take on a distinctive group-life of its own in the
Washington community.77
76
Heclo, H. (1977). Issue networks and the executive establishment. The new american political
system (pp. 88) American Enterprise Institute.
77
Heclo, H. (1977). Issue networks and the executive establishment. The new american political
system (pp. 87) American Enterprise Institute. P 96.
73
This new, entangled system revealed a much more complex network of interests
that could not be categorized as triangles or any type of system resembling one.
Heclo’s theses gave rise to new theories on subsystems, issue networks, which
emerged as a popular subsystem context among scholars studying interest group
relations.
Issue networks formed as a reaction to the growing complexity of
Washington politics: “Policy networks are mechanisms of political resource
mobilization in situations where the capacity for decision making, program
formulation and implementation is widely distributed or dispersed among private
and public actors.”78 They are comprised of loosely associated participants who
share mutual interest in a particular policy field. The many participants in issue
networks are all involved in the policymaking process, many being policy experts.
Their complex structure and fluctuating membership make them difficult to define:
“clouds of issue networks . . . overlay the once stable political reference points with
new forces that complicate calculations, decrease predictability, and impose
considerable strains on those charged with government leadership”.79 Some of these
networks evolved from previous triangles and although they still resemble a similar
structure, the number of actors moves them away from previous definitions of iron
triangles.
78
Kenis, Patrick and Volker Schneider. (1991). Empirical evidence and theoretical considerations. In Bernd
Marin and Renate Mayntz (Ed.), Policy networks and policy analysis: Scrutinizing a new analytical
toolbox (pp. 25). Boulder, Co.: Campus Verlag/Westview Press.
79
Heclo, H. (1977). Issue networks and the executive establishment. The new american political
system (pp. 87) American Enterprise Institute.
74
These issue networks had begun to displace political parties, executives, and
other institutions they once existed within and were decentralizing power in the
government.80 This decentralization reduces the power of government officials and
gives more power to leaders of the particular network. They have given way to a
new path towards political prowess through an individual issue network instead of
the traditional institutional legislative path: “Thus, party influence, the primary
source of hierarchical leadership in our governing system, is eroding further and is
becoming displaced by the more decentralized leadership structures associated
with policy issue network”.81 These systems had a decentralized horizontal
structure as opposed to the hierarchical structure of institutions. The part of the
network within the public administration seeks to broker between the public and
private sector. Through narrowing information and displaying a preference on the
policy that the network prefers, they influence policy towards the needs of the
entire network and include more interest groups in the process.
Issue networks revealed a changing environment in the Washington system
of interest group relations and governance. The lines between institutions and
interests had blurred even more since the days of the iron triangle and had now
become almost indistinguishable:
80
Skok, J. E. (1995). Policy issue networks and the public policy cycle: A structural-functional framework
for public administration. Public Administration Review, 55(4), 325.
81
Skok, J. E. (1995). Policy issue networks and the public policy cycle: A structural-functional framework
for public administration. Public Administration Review, 55(4), 325.
75
More than ever, policy making is becoming an intramural activity among
expert issue-watchers, their networks, and their networks of networks. In this
situation any neat distinction between the governmental structure and its
environment tends to break down82
Since Heclo’s identification of issue networks several other interest group structures
have emerged which rest in a purgatorial state between the concise nature of iron
triangles and the entanglement of issue networks. One such subset, policy
communities, include policy experts or specialists which represent both the public
and private sector in a multitude of industries including transportation, energy,
technology, and manufacturing, among many others. These seemingly fragmented
participants relate through a common interest in a policy area and network through
this interest.83 Advocacy coalitions, another recognized network, refers to
considerably less complex subsystems in which two or more competing groups,
public or private, vie for specific policy initiatives. The oil industry and
environmental groups represent an obvious example of an advocacy coalition. Each
group has clearly opposing interests and each uses its considerable political
influence to alter environmental and energy policy.84
82
Heclo, H. (1977). Issue networks and the executive establishment. The new american political
system (pp. 87) American Enterprise Institute.
83
Hanks, C. D. (2000). Reexamining the subsystem concept. (Ph.D., Texas A&M University). ProQuest
Dissertations and Theses, . (304669007).
84
Weible, C. M. (2008). Expert-based information and policy subsystems: A review and synthesis. Policy
Studies Journal, 36(4), 615-635. doi:10.1111/j.1541-0072.2008.00287.x
76
The concept of issue networks and the increasing participation in
Washington revived the concept of pluralism after an era of plural-elitist sentiment.
This era, starting in the 1980s and essentially continuing today, was marked by a
lack of consensus and confusion with respect to the inner workings of interest
groups. The identification of issue networks had given some merit to the idea that
scholars comprehended this new system, but it failed to map out or define the
process like the iron triangle had previously. To this day, little consensus exists
among scholars as to whether we live in an era of pluralism, elite-pluralism, elitism,
or corporatism. Most agree that the current system exists as a hybrid of the group,
but its complexity and entanglements have formed an increasingly
incomprehensible system of interest group relations and policy procedure.
To apply this evolution of subsystems to the policy model, this paper
observes how these changing interest group structures changes the nature of policy
benefits originally discussed by Stigler. In the era of the iron triangle and similar
group structures interests took a more staggered formation. Groups, in this case
industrial firms, had interests and lobbied for them predominantly individually. This
allowed the groups with the most power to capture agencies as they had the most
political and financial resources to offer political parties. Smaller groups had little to
no collectivization methods and therefore had significantly fewer resources to offer
in exchange for policies. As the interest group structure evolved into more network
based systems, interest groups grew more interconnected and industrial firms
began to collaborate to vie for similar interests. As these industrial firms
77
collaborated on their interests, they combined their resources and emerged as
legitimate forces in the market:
This model estimates this change in demand, and in turn a change in the marginal
revenue. The origin point rises with the increase in collective resources for groups
that demand no regulation in the market, which according to Stigler’s model would
be the small firms that regulation crowds out. The slope of the revenue curve also
lessens as groups that demand moderate levels of regulation now also have more
collective power. Due to the concentrated nature of the industry, however, the
groups that demand the highest level of regulation will continue to have the most
collective resources to provide the political party.
Combining both the shift in marginal cost and marginal revenue shifts
produces the following model:
78
This graphical representation of the shifts in the regulatory policy market combines
all of the previous observations made. Both the change in the cost of implementing
the legislation and the alteration to the benefits specific firms can provide to the
political parties create a market in which the profit maximizing level of regulation is
at a much lower level. The intersection of the new marginal revenue curve (MR2)
and the marginal cost curve (MR1) now occurs at Q2 which represents a much lower
level of entry restricting regulation than Q1. This model is consistent with the
observations of deregulation seen beginning in the mid 1970’s.
Alternative Hypothesis:
An alternative thesis regarding the cause of this deregulation may claim that
firms demand deregulation after taking hold of a market, once they no longer
needed the benefits of the regulation in place. A potential cause of deregulation,
then, would be a change in the policies that influential firms demanded. In this
scenario the firms that had always maintained influence over policy in these
79
markets would continue to do so, but would instead demand allowance of free
market operations, primarily lowering entry restrictions, as opposed to the
restrictions that had been in place.
To dispute this theory I turn back to Stigler’s original analysis of the potential
benefits policies the state can provide to an industry. In this analysis he observes
the four primary benefits the state can provide to the industry and includes direct
subsidies, control of entry, suppression of alternative products, and price controls.
In the demand analysis Stigler asserts that industries with the ability to coerce the
state will seek to limit entry into the market above all the other benefits. This
assertion operates under the assumption that industrial firms seek to maximize
profits above all else, and that limiting entry into the market maximizes profits
above all other state powers in an industry.
If the alternative hypothesis proved true, then industrial firms demanded
regulation under the belief that removing restrictions on entry would increase
profits. The results from the deregulation of the airline and trucking industries,
however, cast doubt upon this assertion. In the airline industry the emergence of
new competition has distributed revenue among new entrants and greatly reduced
the profits for the firms that had previously controlled the market. In the initial
years of deregulation from 1978-1982, the airlines that had previously controlled
the market lost 11 percent of their market share and along with it the profits from
these consumers.85 In 1997 airlines that entered the market since the deregulation
85
From closed set to open set deregulation: An assessment of the airline industry. (1992). Logistics and
Transportation Review, 28(1), 1.
80
of the industry in 1978 held an all-time high 18 percent share of the overall
market.86 During the period from 1978-2000 the five larges airlines saw their
market share fall slightly from 73 percent to 68 percent while the next five largest
airlines increased their share from 20 percent to 23 percent. In the decades after
deregulation airlines that had previously held a strong portion of the market began
to fail. These included Eastern Airlines and Braniff, which shut down in 1989, and
Pan American, which shut down in 1990. 87
The results for the trucking industry’s major companies after deregulation
follow a similar pattern to the airline industry. After President Carter signed the
Motor Carrier Act of 1980, the industry greatly expanded and the revenue spread
among the new competitors. From 1980 to 1998 the number of ICC certified motor
carriers more than doubled, increasing from 17,721 to 39,602. 88 The newly
implemented price competition caused many firms that thrived before the
deregulation to go into bankruptcy and dissolve. 89
If the same firms that demanded over-regulation had altered their lobbying
efforts to demand deregulation of their industries, this change would be motivated
to increase profits. The results of the deregulation in the airline and trucking
industries show a reduction in the major firms’ revenue and market share. These
86
Robson, J. E. (1998). Airline deregulation. Regulation, 21(2), 17-22.
87
Robson, J. E. (1998). Airline deregulation. Regulation, 21(2), 17-22.
Kellerman, B. J. (1998). The impact of 1994's further deregulation of the trucking industry: The rural
88
shippers' view. Journal of Marketing Theory and Practice, 6(4), 92-103.
89
Kellerman, B. J. (1998). The impact of 1994's further deregulation of the trucking industry: The rural
shippers' view. Journal of Marketing Theory and Practice, 6(4), 92-103.
81
observations suggest that industrial firms with coercive power over the state do not
benefit from the reduction in regulations and would not lobby for these policies
with self-interested motivations.
Although this alternative hypothesis does not apply to the specific industries
discussed in this paper, it may be a reasonable explanation for other patterns of
deregulation in society. At its most basic level it provides a reasonable explanation
for patterns of deregulation and could be a useful thesis in the future.
VI: Conclusion
The causal analysis of the deregulation of the industries addressed in this
paper creates a broader understanding of the political decision-making process in
the United States. The supply shift analysis provides a somewhat demoralizing
insight into the relationship between the US Government and its constituencies. The
regulations previously in place had to some degree reduced the welfare of the
consumer and in turn the majority of voters for years. The agencies implementing
regulatory policies, which elected officials controlled, continued to enforce them
until voters placed sufficient political pressure on them for change. This conclusion
provides further support for the basis for George Stigler’s original analysis-- that
policy decisions follow an economic model in which welfare maximization for the
policy maker drives the final output. The elected officials and political parties that
had supported these policies placed their well being above the voters and only
shifted course when their political careers were threatened.
82
The analysis of the demand shift, however, does shed light on positive
changes within the political decision making process. The increasingly complex
nature of interest group relationships has allowed smaller groups to gain some
influence over the system and have their voices heard. The reduction of the gap in
political influence between large powerful corporations and smaller interest groups
gives more Americans a voice in the political process and in turn moves the country
closer towards a fair democracy.
The observations made in this Capstone provide a foundation for a broader
analysis of the study of regulation, particularly the widespread deregulation during
this period. The observed cases paint a black and white picture of policy shift; these
industries had previously been highly regulated and then saw a significant
reduction of governmental restrictions over a short timeline. The overall policy shift
during this period has a much more complex nature and requires more in depth
analysis. The analysis within this capstone creates a reasonable starting point for
this analysis in denoting a causal mechanism for the observed cases.
83
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Capstone Summary
In the early stages of my research, I focused on the deregulation of the
financial industry and its connection to the mortgage crisis of 2008. At this point,
however, my focus shifted to the broader pattern of deregulation that occurred
during the 1970s and 1980s. As I looked into this subject I discovered an absence of
a cohesive explanation t for the causes of this change in policy direction, and
decided to develop one. I also decided to design my analysis around a focused case
study on the specific industries that most clearly exemplified the policy shift
towards deregulation.
In researching these regulations and the theories that attempted to explain
them, I discovered that George Stigler’s theory was consistently respected among
scholars as the most accurate depiction of regulatory policy and the processes
behind its creation. His economic modeling of the regulatory policy decision
explained how some markets had become over-regulated against the public interest.
After a lengthy period of research, I decided to use Stigler’s model as the foundation
of my paper and adapt his theories to explain the deregulation that occurred shortly
after he released his theory. Since Stigler’s paper was based on economic theory and
modeled accurately, I believed its foundational assumptions would hold even with
the deregulation that occurred shortly after his theory’s release.
In choosing my example industries, I sought to choose the markets that most
clearly exemplified the transition from very high levels of regulation to very low
levels of regulation. In my search I discovered that the airline and trucking
92
industries best fit this mold. Once I decided to apply these industries I created a
detailed analysis of the transition from high to low regulation, which established my
thesis question that asked what caused these industries to deregulate.
The graphical derivation of Stigler’s model provided a starting point in the
search for the causes of deregulation in these industries:
This model applies Stigler’s fundamental assertions to a monopoly market model in
order to visually display the causes of over-regulation proposed in his paper. This
also provides a graphical representation of potential shifts that could potentially
lead to fewer regulations in these markets.
A potential shift in the marginal cost curve represented a higher cost for political
parties to convince the public that the level of regulation in place. The regulations in
place created oligopolistic conditions in these industries, which led to inefficient
market operations and in turn higher prices. In the period before and during the
deregulation of the airline and trucking industries, the United States experienced a
93
significant increase in inflation, creating higher prices for basic goods. This
ultimately led to political pressure from voters to lower prices by any means
necessary, which increased costs for political parties to implement and maintain
these regulatory policies that had maintained high price levels. The shift in the
marginal cost is represented on the graph:
On the other side of Stigler’s model is the demand for regulation, represented
by the potential benefits industrial firms can receive from the state. This paper
posits that the shift in the demand for these regulations was caused by a change in
subsystems, which describe the functional arena of interest groups. During this
period interest groups ceased to operate exclusively in iron triangles, which were
exclusive systems with concentrated interests. The new form of subsystems that
emerged, issue networks, instead allowed more participation from smaller interest
groups that now were able to pool their resources in order to collectively lobby for
their desired policy. The shift in the demand is represented in the graphical model:
94
By combining the shift in both the supply and demand variables in Stigler’s model, a
final output that represents the observed deregulation during the period is
produced: