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Makale:
Analytical Survey on Regulation Theories
Arş. Gör. Dr. Murat Aslan*
Özet: Regulasyon Teorileri Uzerine Analitik İnceleme
Bu calışmanın amacı regulasyon teorileri üzerine bir inceleme yapmaktır. Konunun kapsamının genişliği düşünülerek, calısmamızda sadece genel kabul görmüş teoriler üzerinde durulmaktadır. Regülasyon alanının genis olmasının yaninda ustelik komplike ve girift mahiyeti sebebi ile, bu konunun çoklu-disiplinsel bir çercevede incelenmesinin gerekliliğine inanmaktayız. Bu kanaate varmamızdaki en temel sebep: mevcut teorilerin, regülasyon konusunda karşılaşılan somut sorunlarda ve teorik acmazlarda yetersiz kalmalarıdır. İncelenen teorilerin, pek çok konuda aydınlatıcı ve ikna edici olmalarina rağmen, cevaplanamayan sorunlar ve birçok guncel konuda uygulama sorunları bulunmaktadır. Bu yetersizlikleri gidermede ekonomi bilimi ile siyaset, sosyoloji ve hukuk bilimi arasinda coklu-disiplinsel bir alisveris ve yardimlasma yonunde egilim tasimaktayiz.
Anahtar Kelimeler: Regülasyon teorileri, siyasi-rant, piyasa aksaklıkları, doğal tekeller
Abstract
The objective of this essay is to narrate regulation theories. Since the topic, regulation theories, are too diverse, the essay limits its focus on some of the general mainstream regulation theories. The study concludes that regulation is a very complex issue which calls for multi-discipline approach in addressing some of the major problems that these theories encountered. Another conclusion that this research brings about is that there is no single theory which can address all the problems arising from this complexity. Although the valuable insights have been provided, this essay suggests that the theories have some shortcomings in explaining pragmatic problems in regulatory frameworks.
Key Words: Regulation theories, rent-seeking, market failures, natural monopolies
I-) Introduction
Parg. 1. In basic economic sense, the regulation consists of government actions to supervise and control the economic activities of economic actors with the aim of preventing private decision making that would take inadequate account of the public interest understood as economic efficiency, fairness, health and safety (Dolermo, 2001). Haid (2001) argues that one of the objectives of the positive regulation theory is to answer the question why regulation is needed? In this characteristic, if a model addresses the question: “when regulation should occur?”, then it is a normative analysis of regulation. The positive theory, on the other hand, answers the question:” when regulation does occur?” Therefore, the positive theories hypothesize conceptual relationships that are potentially verifiable or refutable [[1]].
Parg. 2. The merits of general equilibrium and corresponding Pareto optimum in achieving
Parg. 3. allocative efficiency depend on the validity of the assumptions employed in the theorem.
Parg. 4. Some of the assumptions of the theorem are invalid due to so called “market failures”. In a state of no market failures, it would be nonsense to study on the government intervention and regulation issues. There are four important issues in analyzing the regulation theories:
1) What are the major types of market failures?
2) Is government action the only solution for correcting those failures? Put it differently, despite of these failures, is market mechanism capable of generating at least some solutions that might compensate for the costs associated with these failures?
3) What are the mechanisms that induce legislators or regulatory authorities to search for proper actions in designing, implementing and enforcing essential regulations?
4) What are the costs and benefits of government regulation? In any case, do the benefits of regulation necessarily exceed the costs? Who are the potential winners and loser according to alternative regulatory policieis?
Parg. 5. There are four major market failures in the literature: (1) imperfect competition, (2) externalities, (3) public goods, (4) asymmetric information [[2]]. In social point of view, in addition to these factors, the distributional and social issues are frequently brought into the picture as a disturbance (disturbance to societal harmony) created by market economy. In Pareto optimality, the distribution issues are left outside of the model coverage, and therefore, it is assumed that distributional issues are independent from economic efficiency and the distribution, taken as ex-post outcome, should not affect resource allocation problem [[3]]. The social dimension of regulation issue (due to the belief that competitive market’s inability in solving social justice) has been strongly supported by some of the theoretical models explored in this research [[4]].
Parg. 6. The main objective of theories in regulation is to make comparison between market and political process as a mean of carrying a system on to a higher social indifference curve since the price mechanism -the only coordination method in the pure capitalist system- would be considered inferior to that of political (and bureaucratic) mechanism in some part of economy where market failures are prevalent. As Wolf (1993) states there is rarely a first best solution, and the problem is to choose among second or third best coordinating mechanisms. If the pure competitive market is inadequate in tackling market failures, the regulation theories, then, may be considered as one of the tools in disposal of government in coordinating (or carrying) the economy on to the higher social indifference curve, and therefore, one of the objectives of the “positive” regulation theories should focus the process of regulation i.e. it should include legislative and enforcement dimensions. According to Joskow and Noll (1981, p.36), general theories of regulation are either legislative or bureaucratic , in that they select either the electoral process and the incentives operating on politicians or bureaucratic process and the incentives operating on regulators as the focus of analysis.
Parg. 7. The essay consists of three sections. In the first section, the essay will concentrate on the school of thoughts favoring government regulation. In this part, the study will analyze public-interest view and French regulation approach. Both approaches, in general, agree that due to market “failures” (particularly for former) and sociological reasons (particularly for latter), there is a room for government intervention (and regulation) in order to institute the orders without which (capitalist) economic system might be unstable particularly in the long run. In the second section of the essay, the study will focus on schools defending minimal government intervention. In this part, the study investigates Chicago School, Virginia School of Political Economy (or Public-Choice approach) and Austrian School of Market Process. In the final section of the essay, we will give brief summary about the regulation theories.
II) Pro-Regulation Theories
II-1) Public Interest View of Regulation
Parg. 8. Although there is no explicit public-interest theory or view, economists use the term “public-interest view” in order to distinguish it from private-interest view [[5]]. Supporters of the public-interest view assert that the existence of “failures” (alone) in the market economy is believed to call for government interventions in order to allocate resources properly. That is, according to them, firstly, the existence of market “failures” encompasses necessary and sufficient conditions for government to initiate regulatory actions, and secondly, the economic efficiency is presupposed to be improved after the regulation. In Paretoian sense, if the regulation issue is analyzed from the perspective of public-interest view, one can conclude that existence of market “failures” would lead to deviation from social optimum where the relative prices would not reflect social costs and non-regulation environment might cause under or over supply. The existence of such failures, according to adherents of this view, can justify government action.
Parg. 9. The public interest theory is criticized on both theoretical and empirical grounds. One of the theoretical criticisms is due to incompleteness of the approach in explaining the starting point of regulatory demand. Public interest view proposes that regulation occurs when it should occur because regulation will necessarily increase economic efficiency – this is also considered demand side of regulation. Therefore, existence of the market failures is necessary and sufficient requirement for regulatory authorities to carry out necessary measures in implementing regulation. The statement proposes a strong implication stating the sole objective of regulation is to improve economic efficiency. However, the history shows that regulatory authorities frequently seek other objectives such as procedural fairness or redistribution (social aspects) in regulation designs. That is the public-interest view is silent about actual regulatory design by government which do not always target solving market failures. Another important observation also indicates that contrary the predictions of the public-interest view, the regulations did not necessarily target market failures. Posner, a Chicago economist, underlines this as:
Some fifteen years of theoretical and empirical research conducted mainly by economists, have demonstrated that regulation is not positively correlated with the presence of external economies or diseconomies or with monopolistic market structure. (Posner, 1974, p. 336).
Parg. 10. Another theoretical criticism, on the supply side, is given by Posner (1974) stating the approach is silent about the mechanism in which public interest for regulation is translated into legislative action. That is, using the deduction method, the view formulizes the regulation by just assuming; “it should”. This point is also connected with the assumption of the view proposing existence of some social welfare function. The theoretical criteria in definition of social welfare function (or social efficiency) relative to economic efficiency (e.g. Pareto and Kaldor- Hicks) is weak. Due to subjective formulization of the reasoning and the assumption over social welfare function, the public interest view is regarded as a “normative” theory.
Parg. 11. The other major shortcoming of the public interest theory is due to belief that government has the super ability to both identify and correct market failures. The claim does not reflect the governmental capacity in introducing and enforcing the regulatory acts as well as it ignores the possibility that the costs associated with introduction and enforcement of these regulations might outweigh the social gains from regulations.
Parg. 12. The belief that the market mechanism can not compensate (solve) some of the seemingly failures is criticized by Austrian school. Austrian school strongly believes that the (competitive) market mechanism may compensate any inefficiency without the intervention.
Parg. 13. The empirical findings also challenge the public-interest view. On the benefit side of the regulation, the empirical studies did not find evidences reflecting significant gains from regulation. Stigler and Friedland, (1962), for instance, show that electricity regulation in the US (a natural monopoly) did not correct the inefficiencies due to natural monopoly. On the cost side, Rose-Ackerman (1992) for the US demonstrates that the costs associated with regulation e.g. transaction costs and administrative costs, sometimes, produce more burdens to society than the costs of market failures. The regulation practice for the natural monopolies in the US showed that the competing industries –relative to natural monopolies- tended to increase their prices after the regulations was enacted which resulted in reduction in social welfare.
II-2) French Régulation School
Parg. 14. The French “régulation approach” is a research agenda and a methodology rather than a unified theory (Broomhill, 2001) and mainly focusing on macroeconomic issues such as capitalist accumulation, growth and crisis. The French “régulation” approach, built critically upon the Marxian legacy, Keynes and Kalecki breakthroughs, aims at a providing precise analysis of the current stage of modern capitalism, the transformations of its basic institutions, the changing pattern of structural crises (Boyer,2001).The research agenda of the approach is to construct an explicit theoretical framework elucidating the institutional underpinnings (which can change through time and through space) of the economic development for the market economy.
Parg. 15. The approach refuses the neoclassical automatic equilibrium mechanism and also expresses disbelief over use of mathematics (in a deterministic way) in the social science. Moreover, including the social dimension of regulation i.e. mode of social regulation, the approach emphasizes the importance of the cultural and social elements [[6]] in stabilizing the capital accumulation process of the market economic system. In other words, the approach firmly believes that there exist a strong link between social justice and allocative efficiency which is absent in the neoclassical framework.
Parg. 16. The theory is built on three guiding principles: 1) different from Marxist’s hypothesis, the regime of capital accumulation means more than simple capital-labor relation indicating there exists several accumulation regimes: 2) institutional forms matter in capitalist system: 3) mode of regulation.
Parg. 17. The regime of accumulation describes the constellation of regularities ensuring the continued existing of mode of production, by describing relationship between production relations, consumption and income distribution necessary ensure (temporary) stability (Boyer, 1990, Dolermo, 2001). Being the coercive feature of capitalist system (Boyer, 2001, p. 70, and Dolermo, 2001, p. 5), the accumulation regime that characterized each particular phase of capitalist development was defined by a number of processes including : the relationship between the forces and relations of production; the forms of market organization; the pattern of distribution; the composition of demand; and division of labor (Moulaert and Swyngedouw, 1989, p. 330).
Parg. 18. There are at least five key institutional forms which make up the mode of regulation: the monetary credit relations; the wage-labor nexus; the forms of competition which tend to be different from perfect competition; the configuration of the state and; international regime i.e. connection of an economy with rest of world. Can the first three institutions be self-implementing? Most economists (close to neoclassical thinking) would say “yes”, but scientists from other social disciplines (and some economists) would believe that without political and legal orders, these forms would have not been implemented (Boyer, 2001).
Parg. 19. A mode of regulation is a set of rules and individual and collective behaviors which fulfill three requirements: they render potentially conflicting decentralized decisions mutually compatible without the need for decision units gathering the information necessary to understand the working of the entire system ; in the sense, they regulate the regime of accumulation ; and “They reproduce the basic social relationship through a system of historically determined institutional forms” (Boyer, 1988). Another definition of the ‘mode of regulation’ is that it is the construction of institutional forms, networks and explicit or implicit norms which assures compatibility of market behavior within a regime of accumulation, in keeping with the actual patterns of social relations among economic agents and social groups (Lipietz, 1987). According to French school, the successful growth period from 2nd World War to early 1970s is interpreted as the Fordist mode of development, where the institutional structure and mode of regulation were compatible in generating high growth rates. That is, the school argues that during this period, high real wages led to mass consumption, and this in turn, created intensive capital accumulation associated with significant growth records. The mode of regulation associated with increased place of credit-based money supply, high real wages (describing wage-labor nexus), and strong technological advances played important role for this success (Dolermo, 2001, pp 8).
Parg. 20. Since economic and social institutions are neglected in neoclassical models, the French school illustrates two stylized facts which are observed after the 1960s as evidences showing the weaknesses of the theoretical models. Firstly, the shortcomings of Keynesian orthodoxy, surfaced after the1960s, and inadequacy of other macro models in addressing the economic and social problems after the early 1970s. The shortcomings of those models call for new models which aim at addressing these problems as well as establishing links between institutions and economic success[[7]]. Secondly, history shows that liberal economy is not self implementing. The first evidence in this direction comes from the relative failures of the liberalization experience of developing countries after the 1980s. After the 1980s, although some countries introduced structural measures in liberalizing their economy (e.g. liberalization of financial system, liberalization of trade and capital account, privatization etc), the expected (or promised) gains from these measures were not realized, yet. Secondly, the transformation of Russia and of the East European countries into the market economic system was relatively ineffective. These countries still face significant problems.
Parg. 21. These two stylized facts, according to proponents of New Institutional and French Régulation schools, challenge the neoclassical paradigm indicating a successful market economy calls for rules (or institutions) and a form of public authority in order to edict and enforce them. They further argue that these rules are not universal and can not be implemented from above by law or decrees. In other words, it is naive to think that capitalism is self implementing, since quite on the contrary it requires strong and coherent interventions from political authorities and a stable legal system (Boyer, 2001). That is, the pure adaptation of the norms and organization of a successful country with a market economy to another would be a false recommendation.
Parg. 22. The French theory makes a distinction between small crisis i.e. contraction period of business cycles and structural crisis (Dolermo, 2001). The main focus of the research of this school is the structural crisis because, according to Dolermo (2001), the small crisis will not lead to full scale shifts in the character of regulation and institutional forms.
Parg. 23. In the structural crisis, on the other hand, self correcting mechanism (particularly emphasized in various neoclassic-oriented macro models) become ineffective and economic development and thus the accumulation process become incompatible with the existing institutional forms sustained by the regulations. Ultimately, the whole combination of the mode of regulation form and regime of accumulation, which constitute of development, becomes questioned renders necessary that strategic choices, both socio-economic and political, be made by firms, the government and unions in order to favor restructuring the economy (Delorme, 2001).
Parg. 24. Although capitalist systems are crisis prone due to market failures, according to the school, capitalist systems are not that chaotic and usually function, rather well which means that some key institutions are playing the role of diffusing information and allocating goods and resources according to some rather effective rules (Boyer, 2001).
Parg. 25. Broomhill (2001) argues that the form of any regulatory regime is not predetermined or predictable but is arrived at through political struggles, negotiations, and compromises. Periods of relative stability only arise from political and economic compromises which have been struck between conflicting interests between societies (Broomhill,2001).The French theory postulate that the result –success or failure- of mode of regulation can be known only once it has settled (or ex-post).
Parg. 26. The school has three important conclusions. The first conclusion of French régulation theory is, then, that institutional structure (and thus mode of regulation) matters for the success of capitalist system and the structure is not static but changes in response to structural crisis. That is, the particular form of economic, political and social regulation is never static but continually evolving through ongoing political interactions and conflicts [[8]] (Broomhill, 2001, p. 119). Second, the success of new mode of regulation is realized only after it is implemented i.e. ex-post. The direction of the regulation mode is dynamically determined by the compromises of the conflicting groups, and therefore, mode of regulation or institutional structure imported from another society would produce different (or disappointing) outcomes. Finally, showing evidences from contemporary growth theories, the approach firmly believes that since there exist positive link between social variables and economic growth, social demands are needed to be undertaken in democratic process so as to create societal harmony [[9]].
Parg. 27. Treuren (1999) argue that the criticism over French approach arises on two perspectives: (i) a rejection of the methodology; and (ii) rejection of outcomes of the applications of the methodology. Being very eclectic, the French theory’s mythology is too broad and vague in addressing specific problems. That is, the methodology promises too much, and explains too little (Treuren, 1999). Specifically, the appearent structural-functionalist approach not only ignores human agency, the role of social classes in shaping the mode of production, but also leaves out important details, such as formation, composition and evolution of mode of regulation and regime of accumulation (Branner and Glick, 1991; Clarke, 1988). Another critism is that approach emphasizes the content and nature of the regimes of accumulation but is largely silent on the issue of the transition between the regimes (Hay, 1995, pp.387). Moreover, in the current usage the approach is of limited relevance to micro-economics, regional or industry analysis, or small States; with an emphasize on macro-economic modeling and global analysis (Johnson, 1993). In any case, the approach is also silent about defining the actors of the game (Treuren, 1997).
III) Schools Defending Minimal Government Role
Parg. 28. This part focuses on three schools defending minimal government role are Chicago, Public Choice and Austrian Market Process. The Austrian approach is slightly different from Chicago and Public choice school. The main focuses of Chicago and Public choice schools, also known as “private interest views of regulation”, are on the one hand, to explain the mechanism in which regulation is translated into the legal action, on the other, to compare the costs and benefits of the regulation. While all three schools are mainly concentrated on economic regulation (i.e. microeconomic dimension of the regulation) in their theoretical models, the social regulation (e.g. the regulation in the area of safety, environment and health), and the link between “regulation mode” (as in the French regulation school) and institutional structure and between economic crisis, seem to be outside of the research questions [[10]]. While Austrian approach shares minimal government intervention with Chicago and Virginia models, the model is differentiated from these two approaches due to its dynamic treatment of regulation issues and claims that “failures” created by government regulation would be more costly to society than the costs implied by the Chicago and Public- Choice models.
III-1) Private Interest Views of Regulation: Chicago and Public Choice Schools
Parg. 29. The Chicago school’s theoretical model is launched by the seminal work Stigler (1971) and is followed by Posner (1971), Peltzman (1976) and by Backer (1983). The main tasks of the Chicago models are “to explain who will receive the benefits or burdens of regulation, what form of regulation will take, and the effects of regulation upon the allocation of resources” (Stigler, 1971, p.3). The school characterizes the regulation as a device for transferring income from less organized to well-organized groups if the groups will return the favor with votes and contributions to politicians (Joskow and Noll, 1981, p.36, Haid, 2001, p. 76-77).
Parg. 30. The government regulation is seen as an end point of supply and demand process. The interest groups and political parties (and may be representatives) are positioned on the demand and supply side of the regulation process, respectively. Stigler (1971) and Peltzman (1976) also known as Stigler-Peltzman model (Haid, 2001, p.77) assume that; i) regulatory process involves wealth transfers; ii) political actor’s (or legislator’s) main objective is to remain on the power and ;iii) whoever gives the most political support, regulation will be favoring them. Becker (1983) redefined the third assumption of the previous models stating that the “political support” is a rather vague concept, and therefore, he replaced it with “efforts of interest groups”. According to Becker, political support is organized through foundation of interest groups who are willing compete with each other for favorable outcome by means of offering monetary and or electoral returns to political actors. In general sense, the Becker’s model envisages that more efficient groups in exertion of political pressure will be successful in design of regulatory actions (Hertog, 2000) . The main objective of Posner’s paper “Taxation by Regulation” is to shed some lights over the cross-subsidization issue where cross-subsidization is explained as the result of competition among ‘different interest groups’ (Haid, 2001, Viscusi, Vernon, and Harrington, 1996).
Parg. 31. According to Peltzman (1976), regulation tends to take place in two cases: 1) on monopolistic markets where few organized firms can have impressive effects over regulatory acts of policy makers so that the benefit from regulation is realized by these few organized firms (rail roads, telecommunication) :2) highly competitive market where political regulation decision is benefiting society at large (agriculture, independent professions, cab companies). In both case, political support i.e. monetary favors in the first and populist regulation for votes for the second. The welfare loss due to monopolistic market is equal to Harberger’s triangle according to Chicago model indicating a monopolist is willing to devote the resources up to the area determined by Harberger’s triangle in securing his monopoly rights. Once these rights are granted to a monopolist, according to Chicago models, the case would be closed.
Parg. 32. Similar to treatment of public-interest view, regulation is more likely to take place in sectors exhibiting market failures (Hertog,2000, p.236 ) and therefore market failures is seen as necessary condition, but not sufficient condition. Sufficient condition in Chicago models depend on the relative efficiency of pressure groups in exerting political pressure (Hertog, 2000, p.236-238).
Parg. 33. While the Public-Choice and Chicago approaches have much in common (Tollison 1982), there are also some important differences [[11]]. The conceptual differences between Chicago and Public-Choice approach are regarded as the main starting point of the Public-Choice approach in criticizing Chicago models. The most important conceptual criticism (perhaps the main difference) is that the Public-Choice approach stresses government failure including the inefficient "waste" of resources consumed in the rent seeking process. The Chicago models propose that the political process in solving market “failures” through regulation is an efficiency improving mechanism. Quoting from Posner;
A corollary of the economic theory of regulation is that the regulatory process can be expected to operate with reasonable efficiency to achieve its ends. The ends are the product of a struggle between interest groups, but . . . it would be contrary to the usual assumptions of economics to argue that wasteful or inappropriate means would be chosen to achieve those ends. Posner (1974, p. 217).
Parg. 34. So, the Chicago version of interest group theory of government implies that legislators attempt to efficiently transfer wealth i.e. minimize the deadweight losses arising with transfers (Becker 1983). Given the objective of politicians to win the next election, the rent-seeking activities are efficient in the sense that it can facilitate reducing transaction costs [[12]].
Parg. 35. The welfare loss due to monopoly, according to Public-Choice School, is more than that of Chicago approach. Tullock (1967) emphasizes the true calculation of monopoly and thus rent seeking activities. According to Hertog (2000), Tullock’s ideas over true calculation of costs due to monopoly and thus rent seeking can be summarized as:
Firstly, some individuals and groups expend resources (e.g., time to organize interest groups, lobbyists, invest in political campaigns to exchange support for those who have the discretionary power to create or change regulations) in an effort to gain wealth in the form of artificial rents created by government actions (e.g., monopoly franchises, licenses, quotas, tariffs). Secondly, others expend resources in an effort to defend against such transfers. Thirdly, for the same rents, there may be more than one group or single individual who seeks to capture this rent. Finally, monopoly rights can cause x-inefficiencies: the monopolist will not produce at minimum cost of production (Hertog, 2000, p.243-245).
Parg. 36. In other words, since the resources devoted for rents (in the rent-seeking process) have born with the opportunity costs [[13]] i.e. the resources could have been used in productive areas, the monopoly (and thus rent seeking activities) can prevent an economy to operate on its production possibility frontier in Paretorian sense [[14]]. In sum, Public-Choice scholars criticize the Chicago theoreticians for their disregards of the inefficiencies of rent seeking. Tullock (1967) emphasizes that the inefficiencies in monopoly consists not only the of the welfare losses known as Harberger triangle (according to Chicago school, it is the only cost due to monopoly), but also of the resources costs stemming from competition among potential monopolists to acquire monopoly rights and this additional costs is also known as Tullock’s rectangle [[15]].
Parg. 37. In general, the regulation tasks, before bringing to legislation step, are delegated to commissions and bureaucrats, and the interests of these agents are ignored in Chicago models indicating legislators have perfect knowledge about the regulation subject and these agents do not depart from the wishes of the ministers. The Public-Choice school introduces principal-agent problem indicates that “if there were no constraint on legislator’s time and resources and they have sufficient knowledge, they would force politically efficient behavior, but constraints do exist (Tullock, 1965, p. 72).
Parg. 38. The Chicago approach is also challenged on the empirical grounds. Although the model setting indicates that the regulation efforts tend to be pro-producers (since it is expected that few producers can be more organized and more efficient in exertion of political pressure), the empirical works show that workers tend to capture most of the benefits from regulation rather than producers (Hertog,2000).
Parg. 39. In terms of instrument selection among alternatives i.e. through regulation, taxation or subsidy, Chicago and Public-Choice models have different implications. Regarding monopoly issue, the efficiency loss implied by Chicago school due to existence of monopoly would see all these instruments to be equivalent [[16]]. Public-Choice scholars, on the other hand, argue that since regulation gives more room to politicians and bureaucrats to put their own objectives into effect, the inefficiency measured by Tullock rectangle is larger for taxation than for regulation (Hertog, 2000).
Parg. 40. The rent seeking literature of Public-Choice school is also criticized. Varian (1989), for example, argues that it is not likely for monopolists to use entire Tullock’s rectangle in order to acquire their monopoly rights, and furthermore, rent-seeking outgoings also have positive effects on welfare. Since the Public-Choice models are normative analysis, it will be too selective to serve as a basis for policy (Hertog, 2000).
III-2) Austrian Theory of Market Process
Parg. 41. Economics in neoclassical sense establishes a link between human wants and scarcity of resources (human and non-human) by using constraint optimization as an analytical tool borrowed from mathematics [[17]]. On the other hand, the economics in the Austrian perspective includes “time dimension” and “limited information “usage of human beings. The definition of economics according to Austrian view is given by Vaughn (2002):
Whereas neoclassical economics views the human predicament as attempting to maximize satisfaction of unlimited wants in the face of limited resources, Austrians add to that description the observation that human beings pursue their projects and plans in the face of scarcity of resources, the forward progress of time and limited information about the world around them (Vaughn, 2002, p.119) .
Parg. 42. Firstly, the Austrian tradition refuses the state of world where information is fully known by economic actors and does not see asymmetric information as market “failure” but see it as fundamental aspect of human life. In a state world where complete information is not given to anyone with totality, Austrians believe that markets are the only institutions that permit individuals to act upon their limited information in ways that both to learning and to the spread of knowledge in society [[18]]. In other words, existence of limited information is one of the most important reasons that market transaction is important (Vaughn,2002). Based on limited information, any government’s effort on regulating economy would not necessarily solve market “failures” once for all, and therefore, Austrian school see regulation as a dynamic process ,which in turn, suggests that those models treating regulation issue in a static framework would (at best) be incomplete.
Parg. 43. Misses (1963) argue that any government intervention would be followed by others because since regulators can not predict the economic actors’ responses , the regulation designed with limited information would create other problems and these problems would call for new regulations which in turn creating new problems and so on and so forth [[19]]. That is at the time of regulation, since regulators can not know -ex ante- how would economic actors respond in the new environment created by the new regulation, even the political optimum which satisfy second best equilibrium argued by Chicago and Public Choice models might not be possible.
Parg. 44. The other critical aspect of Austrian thought is the idea of “dynamic market process” which refuses the static equilibrium indicated by the neoclassical framework. In the public-interest view as well as Chicago and Public Choice literature, the regulation and associated costs and benefits are defined in a static framework where through regulation, economy is moving away from disorder (failure) to an order (in particular by Public-Interest and Chicago views). Hayek’s ideas over regulation outlined in Benson (2002) where Hayek argues that [[20]]:
…the evolution of regulation and regulatory institutions clearly involves deliberate human design, for instance, and significantly, designed rules can disrupt spontaneous orders, but the result is not likely to be a designed order [[21]] .
Parg. 45. In order to distinguish between Austrian view and other views i.e. public interest, Chicago and Public Choice, Benson (2002) defines them as “static” views of regulation. In the static views of regulation, the models implicitly assume that any regulation proposal is intended to solve the market “failures” once and for all. To clarify, for example, Vaughn (2001) argue “… the on-going, time-consuming nature of market competition requires that regulation itself be a process rather than a once and for all solution to a perceived market failure. (Vaughn, 2001, p.125) “
Parg. 46. The theoretical backgrounds provided above reveals some important outcomes about the position of Austrian scholars in pragmatic issues on regulation. Although the regulation of natural monopoly, for instance, have strong theoretical supporters i.e. public interest view and Chicago view, on the pragmatic grounds [[22]] i.e. the costs associated with regulation might be more than the costs without regulation [[23]], Austrian scholars defend “no regulation” on the grounds of “dynamic process”. Menger (1981) argues that if the stage(s) of economic growth (development) requires the existence of some monopolies in this process, a monopoly should be seen a necessary stage of development and not as a market “failure”. According to Menger (1981); economic development is a process of moving from more and more monopoly to competitive markets as the extent of market expanded and knowledge grow [[24]].
Parg. 47. The Austrian theory argues that regulation also distorts the discovery process which is neglected by other theories. The regulation creates a “wholly superfluous” discovery process as “entirely new and not necessarily desirable [either from perspective of the interest groups involved or from an efficiency perspective] opportunities for entrepreneur discovery” (Kirzner 1985, p.144). According to Kirzner (1997, p.62), the discovery process make entrepreneurs to move forward in findings ways to reduce the costs, and increase both the quantity and the quality of output. When a market is subject to regulation, the potential for entrepreneurial discover may actually be enhanced, although importantly, it is also redirected (Kirzner, 1985, p. 141-145). Knowing the well-being of an entrepreneur on the stake due to regulation (or the well-being would be enhanced through regulation), the entrepreneur, as a rational person, would find the ways to circumvent the impact of regulation implying the part of discovery efforts is directed to capture political rents. In a dynamic setting, then, the valuable sources would have been devoted market discoveries are redirected to discoveries in exerting political favors. In sum, regulation can have significant adverse effects on the discovery process (Benson, 2002, p. 235).
Parg. 48. The subject “information problem” is also described in other perspective. Austrian school distinguishes two types of information problem: 1) asymmetric information between producer and consumer and; 2) sheer ignorance i.e. information that no one possesses or recognizes that they posses. According to Austrian scholars, competitive markets (if allowed to work without intervention by government) can capable of solving the asymmetric information problems in at least two ways: 1) competition by entrepreneurs who can both create alternative commodities with different features and create options for costumers over features-quality-price matrix i.e. if an entrepreneur understands the importance of a specific feature(s) of a product, they can exploit this profit opportunity through competing over price-quality matrix : 2) creation of institutions ; the history shows that market mechanism and free societies can generate their own institutions in correcting market failures; i.e. independent auditing firms, consumer advocacy groups , independent certification firms, free-media etc.
Parg. 49. In sum, Austrian theory believes that the regulation is a dynamic process. Second, since decisions and plans by economic actors and government are always based on limited information, the regulation by distorting price signals would lead to miscalculation of the costs and would harm the resource allocation decisions. That is Austrian scholars have tended to focus on the knowledge problem in their challenges to regulation (e.g. Kirzner 1985, p. 119-149, Ikeda, 1997, Benson, 2000, p. 232). Thirdly, regulation can have significant adverse effects on the entrepreneurial discovery process. Finally, the theory believes that if left alone, market economic system is capable of building its own institutions through which (at least some of) the costs associated market “failures” would be compensated.
IV) Conclusion
Parg. 50. The liberalization efforts surfaced after the 1980s by the developing nations and the collapse of Communist system in the same period encourage deregulation and privatization policies in many countries. In the early 1970s, the public-interest view (which is in favor of strong government involvement in economic activities) was challenged by the scholars with strong market-oriented backgrounds. The following models e.g. Chicago, Public Choice and Austrian Market Process Approach challenge any ideas which assume the benevolent government assumption. These models generally neglect the institutional factors which are the very part of economic reality that is confronted by economic actors in their everyday lives when they make decisions. French approach seems to include the institutional factors in the macroeconomic perspective, but their methodology is very eclectic and does not address microeconomic issues.
Parg. 51. The research concludes that the regulation issue is much broader and deeper than a single social science (i.e. economics) can handle. Each model on regulation focuses on very narrow part of regulation issue and leaves several economic, social, political and cultural issues outside of the model. Therefore, we believe that the regulation issue calls for multi-discipline approach for the hope that the multi-discipline approach can overcome the problems arising from narrow-focused modeling effort.
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