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Regulation In Theory Vs. Practice

Regulation is traditionally justified in three ways. One is the presence of externalities, such as a factory that pollutes a stream and affects its neighbors. Another is information asymmetry; think of a used car dealer who knows more about his wares than his customers do. Third is monopoly, where a firm can jack up its prices and lower its output without fear of competitors swooping in.

That's the theory, anyway. Robert Litan and William Nordhaus know that the reality is very different. On page 34 or their 1983 classic Reforming Federal Regulation, they write:

In theory, regulation should arise as a response to market failures. In practice, regulation is more accurately characterized as a government tool for redistributing society's resources toward those groups that have successfully enlisted the support of the government on their behalf.

Indeed. This public choice-influenced view is a far more useful tool than the traditional theory if the goal is to understand how regulators and regulated actually behave.

For example, the 50 biggest-spending lobbying groups spent $176 million on lobbying from July through September this year. If agencies weren't cranking out 3,800 new rules per year, and if the Code of Federal Regulations wasn't 169,000 pages long, it is unlikely that so much money would flow into Washington.

Externalities, asymmetric information, and monopolies are useful concepts for understanding how regulators perhaps should behave. But the important thing is how they do behave.