Sunday, October 6, 2013

Do we really need to regulate that?

Why is it illegal to smoke on domestic flights in the U.S.? Whatever benefit there is of prohibiting smoking on a flight accrues to those who are actually on the plane. If this benefit is large enough, then it is in the interest of the airline itself to prohibit smoking, because the benefit to passengers translates directly into greater willingness to pay for airfare and greater profits for the airline. Is it somehow easier to enforce a smoking ban if the force of law is behind it? Did the government pass the law to insulate airlines from the ire of those passengers who would prefer to smoke in flight? Maybe, but I would also note that some airlines had their own smoking ban before the law took effect in 1998. Is the purpose of the law to level the playing field, because there is some negative consequence of allowing airlines to compete through their policies regarding smoking? Again, maybe. I wouldn't suggest that anyone should be able to smoke on airplanes, either as an economist or as an air traveler; but it is clearly incorrect to assume that the only way to achieve this outcome is by passing a law. This seems to be a fairly common belief: that if the government doesn't make something happen, it won't happen.

Here's another example. Referring to the movie industry’s rating system, filmmaker Kirby Dick said,
It’s astonishing that an industry would be allowed to regulate itself. It’d be like the pharmaceutical companies saying, ‘Hey, we’ll take over the FDA.’
No, it would not. The similarity between the MPAA (the industry association that provides movie ratings) and the FDA (the government agency that approves pharmaceuticals) is that they both provide information to consumers. There are two very big differences. One is that the consequences of misleading information are much lower for movie ratings than for pharmaceuticals: offense at viewing an unexpected level of sex and violence vs. threat to health or life. The other is that the information that ratings are meant to convey is definitively revealed to the consumer upon viewing the movie, whereas a consumer can never be sure to what degree any health-related outcome is attributable to a specific drug. A movie studio and a pharmaceutical firm both have an interest in providing information about their product to consumers. There may be a problem if the firm is not able to communicate information credibly, and regulation may be able to alleviate this problem.

In "Public versus Private Information Provision," I argue that government should only intervene to provide information when the two factors above--the severity of the consequences of misinformation and the lack of eventual information revelation to the consumer--are sufficiently strong. Otherwise market mechanisms for information provision are preferable. I'll leave the details of the argument to the paper. It's entirely non-mathematical, for reasons I also give in the paper itself. [Update: The final version of the paper, to which the link above now points, omits the rationale for the non-mathematical argument. I discuss this rationale in this post.]

There seems to be a lot of mistrust of markets that generates public support for regulation where it is unnecessary or counter-productive. Economists often criticize such examples of regulation, such as professional licensing requirements that serve primarily to convey rents to members of a profession. I agree with many of these criticisms, but there are also plenty of cases where regulation is beneficial. E.g., based on the two factors above, I would argue that there is no need for a legal requirement for licensing of hairdressers, but that there is such a need for doctors (and in the paper I offer a defense of this distinction in the face of evidence that physician licensing is a result of regulatory capture).

I can see why an economist might choose simply to criticize bad regulations, based on the observation that there is simply too much regulation and too little understanding of how markets can accomplish the same goals. But I think we can do a better job by focusing on the distinction between circumstances where regulation is or isn't necessary or useful. As in many contexts, I find either extreme (pro- or anti-market) untenable and reject dogmatic approaches out of hand. Still, on the whole, I think that there is too much market intervention in the U.S. and that we would be better off if we could achieve a meaningful change in regulatory activity itself as well as the public attitude toward regulation. A significant obstacle, I think, is that consumers are so accustomed to government oversight of firms' activities. Consider health codes for restaurants. In the absence of these regulations, restaurants could still have incentive to maintain healthy standards. Some market mechanisms serving this goal require effort from consumers, such as reporting to a public forum when one sees any indications of health risks from a specific restaurant, and consulting this forum before patronizing a restaurant. Significant reduction in regulatory restrictions would necessitate consumers' use of market signals, rather than assuming that the government is always watching out.

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