Tag Archives: behavioral economics

Why Do We Get So Much Regulation?

Over the past 60 or 70 years, levels of regulation in the United States have been on the rise by almost any measure. As evidence, in the year 1950 there were only 9,745 pages in the US Code of Federal Regulations. Today that number is over 178,000 pages. There is less information about regulation at the state level, but anecdotal evidence suggests regulation is on the rise there too. For example, the Commonwealth of Kentucky publishes its regulatory code each year in a series of volumes known as the Kentucky Administrative Regulations Service (KARS). These volumes consist of books, each roughly 400 or 500 pages or so in length. In 1975, there were 4 books in the KARS. By 2015, that number had risen to 14 books. There are many different theories as to why so much regulation gets produced, so it makes sense to review some of those theories in order to explain the phenomenon of regulatory accumulation.

Perhaps the most popular theory of regulation is that it exists to advance the public interest. According to this view, well-intended regulators intervene in the marketplace due to “market failures”, which are situations where the market fails to allocate resources optimally. Some common examples of market failures include externalities (cases where third parties are impacted by the transactions involving others), asymmetric information (cases where buyers and sellers possess different levels of information about products being sold), public goods problems (whereby certain items are under-provided or not provided at all by the market), and concentration of industry in the form of monopoly power. When market failure occurs, the idea is that regulators intervene in order to make imperfect markets behave more like theoretically perfect markets.

Other theories of regulation are less optimistic about the motivations of the different participants in the rulemaking process. One popular theory suggests regulators work primarily to help powerful special interest groups, a phenomenon known as regulatory capture. Under this view—commonly associated with the writings of University of Chicago economist George Stigler—regulators fix prices and limit entry into an industry because it benefits the industry being regulated. An example would be how regulators, up until the late 1970s, fixed airline prices above what they would have been in a competitive market.

The interest groups that “capture” regulatory agencies are most often thought to be businesses, but it’s important to remember that agencies can also be captured by other groups. The revolving door between the government and the private sector doesn’t end with large banks. It also extends to nonprofit groups, labor unions, and activist groups of various kinds that also wield significant resources and power.

The “public choice theory” of regulation posits that public officials are primarily self-interested, rather than being focused on advancing the public interest. Under this view, regulators may be most concerned with increasing their own salaries or budgets. Or, they may be focused primarily on concentrating their own power.

It’s also possible that regulators are not nearly so calculating and rational as this. The behavioral public choice theory of regulation suggests regulators behave irrationally in many cases, due to the cognitive limitations inherent in all human beings. A case in point is how regulatory agencies routinely overestimate risks, or try to regulate already very low risks down to zero. There is significant evidence that people, including regulators, tend to overestimate small probability risks, leading to responses that are disproportionate to the expected harm. For example, the Environmental Protection Agency’s evaluations of sites related to the Superfund clean-up project routinely overestimated risks by orders of magnitude. Such overreactions might also be a response to public perceptions, for example in response to high-profile media events, such as following acts of terrorism. If the public’s reactions carry over into the voting booth, then legislation and regulation may be enacted soon after.

One of the more interesting and novel theories as to why we see regulation relates to public trust in institutions. A 2010 paper in the Quarterly Journal of Economics noted that there is a strong correlation between trust in various social institutions and some measures of regulation. The figure below is an example of this relationship, found in the paper.

QJE trust

Trust can relate to public institutions, such as the government, but it also extends to trust in corporations and in our fellow citizens. Interestingly, the authors of the QJE article argue that an environment of low trust and high regulation can be a self-fulfilling prophecy. Low levels of trust, ironically, can lead to more demand for regulation, even when there is little trust in the government. One reason for this might be that people think that giving an untrustworthy government control over private affairs is still superior to allowing unscrupulous businesses to have free rein.

The flip-side of this situation is that in high-trust countries, such as Sweden, the public demands lower levels of regulation and this can breed more trust. So an environment of free-market policies combined with trustworthy businesses can produce good market outcomes, more trust, and this too can be a self-fulfilling, allowing some countries to maintain a “good” equilibrium.

This is concerning for the United States because trust has been on the decline in a whole host of areas. A Gallop survey has been asking questions related to trust in public institutions for several decades. There is a long-term secular decline in Gallup’s broad measure of trust, as evidenced by the figure below, although periodically there are upswings in the measure.

gallup trust

Pew has a similar survey that looks at public trust in the government. Here the decline is even more evident.

pew trust

Given that regulation has been on the rise for decades, a decline in trust in the government, in corporations, and in each other, may be a key reason this is occurring. Of course, it’s possible that these groups are simply dishonest and do not merit public trust. Nonetheless, the US might find itself stuck in a self-fulfilling situation, whereby distrust breeds more government intervention in the economy, worse market outcomes, and even more distrust in the future. Getting out of that kind of situation is not easy. One way might be through education about the institutions that lead to free and prosperous societies, as well as to create a culture whereby corruption and unscrupulous behavior are discouraged.

There are a number of theories that seek to explain why regulation comes about. No theory is perfect, and some theories explain certain situations better than others. Nonetheless, the theories presented here go a long way towards laying out the forces that lead to regulation, even if no one theory can explain all regulation at all times.

Nudges or Shoves?

David Brooks writes in the New York Times:

I’d say the anti-paternalists win the debate in theory but the libertarian paternalists win it empirically. In theory, it is possible that gentle nudges will turn into intrusive diktats and the nanny state will drain individual responsibility.

But, in practice, it is hard to feel that my decision-making powers have been weakened because when I got my driver’s license enrolling in organ donation was the default option. It’s hard to feel that a cafeteria is insulting my liberty if it puts the healthy fruit in a prominent place and the unhealthy junk food in some faraway corner. It’s hard to feel manipulated if I sign up for a program in which I can make commitments today that automatically increase my charitable giving next year. The concrete benefits of these programs, which are empirically verifiable, should trump abstract theoretical objections.

I agree with Brooks that arguments over nudges should be based on empirical evidence rather than a purely theoretical discussion. So let’s examine the evidence.

As I pointed out in a recent op-ed:

On the federal level, energy efficiency regulations costing billions of dollars are justified by claiming to correct consumers’ irrational choices. Regulators claim that given the lifetime energy savings, rational consumers would demand more efficient vehicles and appliances voluntarily. They take the fact that many consumers are willing to forego efficiency in favor of other attributes, such as style, safety or lower upfront costs, as a clear proof that consumers are irrational. Hence, regulators force consumers to save by reducing their choices.

Below is a list of recent major federal regulations that use behavioral economics arguments to justify government intervention in markets. While far from exhaustive, it should give you some idea as to the magnitude of “intrusive diktats” that are justified using the nudge philosophy. Note that these regulations are not nudges. This is hard paternalism. Federal regulations do not gently push you towards better choices or give you a chance to opt-out. Contrary to Brooks’ assertion, it is not only in theory that “gentle nudges turn into intrusive diktats.”

For comparison, I can think of no major federal policy that actually nudges. When one looks at the evidence, federal regulators give consumers few nudges but plenty of shoves.

Agency Rule Cost (millions)
EPA/DOT Control of Greenhouse Gases from Light-Duty Vehicles

$176,995

EPA/DOT Greenhouse Gas & Fuel Efficiency for Medium/Heavy Duty Vehicles

$9,600

DOE Energy Conservation Program: Small Electric Motors

$514

DOE Energy Efficiency Standards for Pool Heaters and Direct Heating Equipment and Water Heaters

$1,012

DOE Energy Efficiency Standards for Commercial Clothes Washers

$23

DOE Energy Efficiency Standards for Residential Refrigerators and Freezers

$1,849

DOE Energy Efficiency Standards for Microwave Ovens

$1,341

DOE Energy Conservation Program: Energy Conservation Standards for Fluorescent Lamp Ballasts

$425

DOE Energy Conservation Program: Energy Conservation Standards for Distribution Transformers

$289-$351

DOE Energy Conservation Program: Energy Conservation Standards for Battery Chargers and External Power Supplies

$247

DOE Energy Conservation Standards for General Service Fluorescent Lamps and Incandescent Reflector Lamps

$77-$139

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Addendum: Some of these costs are annualized; some are total. There is no consistency in the way they are reported. Agencies report one or the other but not both. In addition, in an earlier version of this post, two figures were transposed. I have now corrected this.