Regulation, competition, and the social control of business

Originally published in Public Choice

In George Stigler’s (1971) economic theory of regulation, the primary motive of regulatory intervention is the promotion of private interests, not the promotion of the general welfare or efficiency as suggested by the public interest theory of regulation (Pigou 1932). More recently, Andrei Shleifer (2010, 2012) along with some coauthors (Glaeser & Shleifer 2003; Djankov et al. 2003) has proposed an alternative to Stigler’s theory, which he calls the enforcement theory of regulation. Shleifer’s new theory of regulation holds that the rise of regulatory institutions over the course of the twentieth century is in fact efficient and providing the requisite social control of business, largely because the alternative judicial mechanism is so inefficient and costly. Contrary to Shleifer, we argue here that because both courts and regulation are subject to ex-post defection, individual bias, and subversion, neither is categorically preferable. Whether or not courts or regulation are more efficient at providing social control of business ultimately depends on the features of the specific regulatory or judicial institutions as well as the economic problem addressed. Institutional environments differ with respect to the severity of knowledge and incentive problems and mechanisms for overcoming them that are built into them. The comparative efficiency of an institutional solution depends more on its institutional features (centralized/decentralized, contested/uncontested) than its form (regulation, courts, or private orderings). Stigler’s (1971) contribution acknowledges that concern implicitly by incorporating competition between different interest groups as the essential mechanisms driving regulatory outcomes.

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