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Thursday, November 20, 2003

Dean and "Re-regulation"
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Regulatory policy peeked its head into the presidential race in the past couple of days. It will no doubt fade back into acronym-laced obscurity. But first, a comment.

Governor Dean called for "re-regulation" of industries, including telecom and electricity. Today, Senator Lieberman and General Clark shot back that Dean's calls for reregulation would be harmful.

Debates premised on a regulation/deregulation axis are rarely illuminating. But let's try.

The issue is one of consumer welfare and how that can best be maximized within the context of real institutions -- corporate and regulatory. In network industries--content, telecommunications, airlines, electricity--there are enormous economies of scale to be achieved through declining average costs, network effects, interoperability and the like. This means big businesses. And these big businesses are good for consumers because their scale allows them to offer low cost products to consumers. Furthermore, the diseconomies of big business -- bureaucracy, manifold agency problems and the like -- are swamped by the economies of scale in these high fixed cost, low marginal cost network industries.

Regulatory institutions, by contrast, have their own problems that we have learned through experience. There are huge information asymmetry problems between regulator and regulated entity. There are enormous incentives for the regulatee to capture the regulator. (Witness AT&T's relationship with the FCC 1934 through the 1970s.) Finally, the tools of regulation stifle and resist innovation and technological dynamism. (Again, witness the FCC's decade-plus delay in wireless phone rollout.) These problems and the dynamism brought out by the digital revolution made a transition to competitive markets possible. Notably, this was a consensus political position. The likes of Stephen Breyer and Alfred Kahn looked at regulation in the 1970s and concluded that consumers would be better off if these closely-regulated network industries were transitioned to competitive markets.

The proper regulation/deregulation policy mix is a prudential decision and thus tough to satisfy with neat, ideological answers. Experience teaches us that consumers benefit, often wildly, from ending administrative regulation of a given industry. That said, the transition is important, and perilous. Incentives for regulatory gaming -- by different parts of the industry and regulators themselves -- go through the roof during these transitions. An improper mix of regulatory and market mechanisms can mean disaster. Witness the California power experience, where the glaring problem was wholesale power worked on a market basis (sort of), while the retail level remained regulated and thus never signaled the wholesale prices of energy to consumers.

In the end, I remain convinced that consumers have much to gain from ending administrative regulation in network industries. But that has to be done at the right time and in the right way. These are the interesting questions. Nonetheless, it is encouraging to see that the Democratic party still has some spokesmen who believe markets serve consumers better than regulation.

posted by Ray Gifford @ 12:45 PM | General

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