Oct 29, 2018

Government Privilege: Regulation

Matthew D. Mitchell Senior Research Fellow , Tad DeHaven Research Analyst

[This is the sixth in a series of short commentaries on The Bridge that discusses the various types of privileges that governments bestow on particular businesses or industries.]

At a recent rally in Iowa, President Trump warned the crowd that “The Dems will end ethanol … They will take it away … you better go out there and vote for Republicans.” The president was referring to the Renewable Fuel Standard (RFS), which is a federal regulation mandating that petroleum refiners incorporate increasing amounts of biofuels in our fuel. Contrary to Trump’s claim, congressional support for the RFS is based more on geography than political party. Iowa grows more corn than any other state and corn-based ethanol is the primary biofuel additive. So, it doesn’t take a PhD in political science to see that the president’s motive here is to procure Iowa votes for Republicans ahead of the November mid-term elections and, perhaps, his own reelection in 2020.

All forms of government privilege, including regulatory privilege, come with a price tag. Although there may be differences with respect to who bears the burden (taxpayers, borrowers, consumers, etc), regulatory policies like the RFS act like a subsidy by redistributing wealth from the many to the privileged few. In this case, corn farmers are made financially better off at the expense of consumers and other industries.

Consumers pay higher prices for commodities because the RFS induces farmers to grow corn for ethanol, which reduces the supply of corn and other crops that would otherwise be grown for human consumption. Livestock farmers face higher prices for corn-based feed for their animals, which also puts upward pressure on the price of meat and dairy products. The RFS also raises costs for refineries, and the increased use of fertilizers and pesticides in growing corn causes costly environmental damage.

How does such a regulatory privilege come about when it’s clear to everyone except the beneficiaries that such policies are a net loss for society?

The oldest–and empirically weakest–theory of regulation is that governments regulate in order to serve the public interest by correcting market imperfections and preventing unjust activities. It could be called the “wishful thinking” theory of regulation because, while it sounds nice, governments aren’t benign, impartial referees. Even if well-intentioned, policymakers face strong incentives to serve narrow interests rather than the public interest. For instance, the RFS was originally sold to the public as being good for consumers and the environment. That hasn’t turned out to be the case, but it still exists because of its political value to politicians and the financial value to the benefiting interest.

The value of the regulatory privilege to the benefiting interest is the key. It takes time, money, and effort to demand a change in regulatory policy. And if others take on these costs, those who benefit from the change have an incentive to free ride on the efforts of the organizers. This “collective action problem” makes it difficult for any group to organize for political change. But it makes it especially difficult for large and diffuse groups such as consumers and ideologically motivated individuals.

On the other hand, commercial interests have a distinct advantage over consumers and ideological groups. Smaller groups are also easier to organize than larger groups (e.g., the number of corn farmers is considerably smaller than the number of corn consumers). They possess the time, money, and incentive to undertake a sustained campaign to influence policymakers to support their regulatory privilege. Whereas an individual consumer might not recognize that his or her grocery bill was higher, the corn farmer will certainly see the direct financial benefit.

The process of gaining benefits by lobbying policymakers, known as rent-seeking, hurts all of society by diverting resources to unproductive uses. Excessive corn-ethanol production is a perfect example. These resources would normally be spent on efforts to deliver value to customers, but the financial gains from regulatory privilege incentivize farmers to grow corn for gas tanks instead. Society would be better off if farmers focused more on developing new and better products (or finding ways to increase efficiency), and less on petitioning the government to sustain and expand an artificial market for corn. The same can be said for any industry that relies on the federal government’s power to regulate to enhance their bottom line.

Learn more: In The Pathology of Privilege: The Economic Consequences of Government Favoritism, Matthew D. Mitchell identifies multiple forms of government granted privilege (including tax privileges, contracting abuses, trade privileges, bailouts, and loan guarantees), and explains their consequences. The full special report is free of charge via pdf, and is available as an ebook and paperback for purchase at Amazon.com and CreateSpace.com.

Support Mercatus

Your support allows us to continue bridging the gap between academic ideas and real-world policy solutions.Donate