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Readings

Sins of Commission

Public Choice & Regulation: A View from Inside
the Federal Trade Commission,

Robert J. Mackay, James C. Miller III, and Bruce Yandle,
eds. (Hoover Institution Press, 1987), 363 pp.

Reviewed by Daniel Oliver
Daniel Oliver is chairman of the Federal Trade Commission.

I was among the noneconomists who cheered when a Nobel prize was awarded to James Buchanan. His pioneering work in the field of public choice helped dispel the myth that government is a black box automatically programmed to advance the public interest. His theoretical analysis provided an explanation for the conclusion that I and many others had reached through casual empiricism: government programs often fail to achieve their stated objectives.

Economists are not, of course, satisfied with casual empiricism. Give economists a little data and a computer and they will construct models with testable hypotheses, run regression analyses, and predict future behavior. Many of them seek to measure and to predict what often appears immeasurable and unpredictable to laymen. In large part, this is what the contributors to Public Choice & Regulation: A View from Inside the Federal Trade Commission have done. This volume, edited by Robert J. Mackay (an economist formerly with the FTC), James C. Miller III (former chairman of the FTC), and Bruce Yandle (former executive director of the FTC), contains 16 chapters, most of which use public choice theory to analyze the behavior of the Federal Trade Commission.

I approached my reading of Public Choice & Regulation with great interest. As chairman of the FTC I welcome any new insight into the workings of the agency, and this volume promised to be particularly helpful. It offers a positive analysis explaining what the FTC has actually done, rather than just a normative analysis explaining what the commission is supposed to do. In addition, 14 of the 16 chapters are authored by individuals who have worked at the FTC (many in senior positions). Here was an opportunity to see what would be revealed through the prism of public choice analysis.

The analytical chapters of Public Choice & Regulation fall into three major parts. Part I analyzes the relationship between Congress and the commission and explores the extent of congressional control over the commission. Part II examines the economic and political determinants of program activities at the FTC. Part III deals with internal management and budgeting-topics that will mainly interest FTC insiders and public choice scholars.

The first part of Public Choice & Regulation provides two statistical insights regarding congressional control over the FTC. We learn that the FTC regulatory agenda has conformed to be predilections of its overseers. The commission undertook activist regulatory programs when senators who received high ratings by the Americans for Democratic Action were on the Subcommittee on Consumer Affairs of the Senate Commerce Committee, and reduced its activism in 1979 and 1980 when the ADA ratings of those senators fell. We also learn that between 1961 and 1979 the commission systematically dismissed complaints brought against corporations headquartered in states represented by congressmen on certain committees and subcommittees overseeing the FTC (not, however, the Senate Commerce Committee).

In Part II we are told still more about the economic and political determinants of program activities at the FTC. During the period 1937 to 1981 the FTC adjusted the number of Robinson-Patman cases it brought according to the business cycle: during recessions it rescued businesses by bringing cases to stamp out price discounting; during expansions it reduced the number of such cases. From 1948 to 1981 the FTC and the Department of Justice colluded to eliminate competition between the two enforcement agencies-eliciting higher budgets from Congress for approximately the same number of cases. During the period 1970 to 1972 the commission established, maintained, and enforced its ad substantiation program to confer a comparative advantage on large firms. (By targeting industries where market shares and reputations vary widely, ad substantiation imposed a greater relative burden on smaller firms.) From 1968 to 1981 the commission subverted consumer welfare by settling cases against firms in concentrated industries while litigating against firms in more competitive industries. From 1968 to 1982 the ETC operated its merger enforcement program to maximize the welfare of staff attorneys. It brought challenges in industries already familiar to staff; weak suits were initiated, allowing staff to show output and increase their perceived value to future employers; most cases were then settled without effective relief because the staff did not want to litigate weak cases. The unevenness of civil penalties imposed by the FTC between 1972 and 1981 revealed that the commission's constituency was large rather than small business: civil penalties imposed on smaller firms constituted a higher percentage of annual sales.

What assessment should one make of this collection of information? In a final chapter, Gordon Tullock reaches modest conclusions: the market does not work well when there are large externalities; government does not work well anywhere but where externalities are large; the FTC's ostensible effort to control monopolies is a sensible solution to a number of problems but we should not expect a great deal of good to come out of a regulatory board. Government agencies justify their actions in terms of the larger public interest, but much of their activity is "devoted to generating particular benefits for small groups of people." In the case of the FTC, the identifiable interest groups that predictably affect the FTC, by their private actions or through intervention by Congress, are big industry, the FTC staff, and the FTC bar.

What would Tullock have us do? First, expect less. Second, use careful thought and a good deal of further research to design a set of public institutions that can produce an outcome truly to the public's advantage.

What conclusions do I, as chairman of the FTC, draw from reading Public Choice & Regulation? My initial conclusion is that the authors must be describing a commission from the distant past. After all, most of the data relates to the 1960s and 1970s. What other conclusion can I draw? Despite its warts, the FTC I see in operation looks somewhat better than the composite picture portrayed by the authors.

Yet sober second thoughts intrude. Economic incentives outside the agency have not changed: rent-seeking is still in style and congressmen still seek reelection. Within the agency, the economic incentives faced by the staff depend in part on guidance from the top. And while the Reagan appointees may have been good, they certainly have not created a new homo bureaucraticus. Therefore I may be deluding myself. Distasteful as the thought may be, I must entertain the hypothesis that I, an ardent deregulator, have been captured by the bureaucracy and the regulated industries and that I unwittingly further the pecuniary interests of large businesses and the career plans of staff attorneys.

If I accept all the chapters in Public Choice & Regulation at face value and assume that the patterns described are accurate and remain true today, I conclude that stronger medicine is needed than is prescribed by Gordon Tullock. Given the unflattering positive analysis, the appropriate normative prescription is abolition of the agency. What justification can there be for an agency that has created jobs for a specialized bar, colluded with its sister enforcement agency to acquire a larger budget, enriched large advertisers at the expense of the small, and challenged mergers that are not anticompetitive just so trial lawyers can enhance their human capital? Further, if the theory of one chapter is given credence, we should impeach or indict any commissioners and congressmen implicated in the systematic dismissal of cases against respondents headquartered in states represented by members of oversight committees. What justification can be given for granting immunity to firms, after their cases have been heard by an administrative law judge, simply on the basis of the political jurisdictions in which they operate? Though the authors of this particular chapter do not suggest corruption, their theory can hardly be understood on any other basis.

My legal training necessarily cools my ardor for reform and my righteous indignation at corruption. How, I ask, would a prosecutor prove the corruption implied by the systematic dismissal of cases? Can we put three economists on the witness stand to testify that the dismissal rates are statistically significant and cannot be explained by chance, leaving corruption as the only explanation? The thought of proving a criminal violation by means of statistical correlation forces a reassessment of Public Choice & Regulation. Economists and noneconomists alike understand that statistical correlation does not prove anything. Statistical evidence is only as good as the underlying theory, the relevant data, and the fit between them.

The FTC's performance during the past seven years belies certain predictions in Public Choice & Regulation, suggesting problems with either the underlying theories or the data used. Consider, for example, the accuracy of two of the book's predictions in light of evidence from recent history. Robinson-Patman antidiscrimination complaints are predicted to rise during a recession. Why did the number of such complaints not jump in 1982 and 1983? FTC enforcement patterns are predicted to follow the preferences of members of oversight committees. Why have the number of predatory pricing and resale price maintenance suits not risen since the oversight committees began requiring the commission to explain its disposition of every complaint regarding such alleged conduct?

Public choice is a powerful idea expounded by articulate individuals. But unless the concepts of public choice are used carefully, they trivialize the power of ideas and the importance of individuals. Ideas matter. Legal and economic thinking has changed regarding predatory pricing, resale price maintenance, and price discrimination. Knowledge of this fact permits better predictions of FTC performance than is afforded merely by statistical trends.

Individuals also matter. I am confident that a comprehensive history of the FTC written two decades from now will demonstrate that the commission performance served the interests of consumers better when economists such as James C. Miller III, Bruce Yandle, and Robert J. Mackay were manning the FTC. Was it their knowledge of public choice theory that made a difference?

Ironically the only article in Public Choice & Regulation written by a noneconomist- William Kovacic-provides evidence that the FTC's historical record cannot be understood without an appreciation of the evolution of and interaction among competing ideas. Kovacic's article is well worth reading first. Explicitly or implicitly, it raises basic questions about the FTC. Do President Wilson's ideas of the role of the FTC in 1914 meet the needs of the present? Does the concept of administrative expertise have any content? Is administrative law enforcement, subject to legislative rather than executive oversight, consistent with our Constitution? Which inflicts the greater harm on consumers: the market failures the FTC addresses or the FTC's remedies for these market failures? Is there a legitimate role for two federal antitrust enforcement agencies? Are there activities by the federal government that would predictably protect consumers?

Understandably these partly normative questions are left unanswered by Public Choice & Regulation. Some elements of an entirely convincing positive evaluation of the performance of the FTC are also missing. These weaknesses preclude any confident conclusion that the FTC's performance is governed by public choice, not the public interest. Although it is not totally convincing, the book provides numerous insights into past mistakes made by the FTC, mistakes that are consistent with public choice theory. Left for others is the normative task of evaluating whether the FTC should continue to exist. So long as it does exist, books like this provide some help for people like me to avoid the mistakes of the past.


Sharing Shortages
Responding to International Oil Crises, edited by
George Horwich and David Leo Weimer (American
Enterprise Institute, 1987), 313 pp.

Reviewed by David R. Henderson
David R. Henderson is associate professor of economics at the Naval Postgraduate School in Monterey.

In 1974, shortly after the Organization of Arab Petroleum Exporting Countries (OAPEC) imposed an embargo on the United States and on Holland, Secretary of State Henry Kissinger created the International Energy Agency, recruiting virtually all of the Western industrialized countries as members. One of the IEA's main purposes was to ensure that an embargo like OAPEC's could not happen again.

This was ironic, since the OAPEC oil embargo, like all selective embargoes of fungible commodities, was ineffective. If Saudi Arabia and Iran refuse to sell to the United States but still maintain production, then they have to sell more oil to, say, West Germany. But then buyers in West Germany will buy less oil from Venezuela and sellers in Venezuela will sell more to the United States. Suppliers and demanders are simply reshuffled. The net result is that everyone pays a slightly higher price reflecting higher transport costs, but no differential cost is imposed on the target of the embargo. The only way a selective embargo can hurt badly is if production is cut. But then all consuming countries pay more for oil. Again, the targeted country is not differentially harmed. The "oil weapon," selectively used, is a dud.

Whether Henry Kissinger understood this is not clear. What is clear is that the IEA members worked out a plan and even an explicit formula for sharing the oil in the event of a 7 percent or greater cut in world output, a so-called supply disruption. Under the Emergency Sharing System (ESS), countries with allocation obligations must offer to sell oil-at vaguely specified prices-to countries with allocation rights.

Meanwhile, the U.S. government unilaterally began to fill the Strategic Petroleum Reserve (SPR), a large reservoir of oil stored in salt mines in Texas and Louisiana to be used if world supplies fall by an unspecified magnitude for an unspecified duration.

How should the US government respond to a large drop in oil supplies caused by a revitalized OPEC or by internal strife in Mideast oil-producing countries? Should it keep its commitment to the IEA's oil-sharing agreement? Should it draw down its stocks of oil in the SPR, either unilaterally or in concert with other nations that hold stocks? Should it try to act like a buyers' cartel, and if so should it do so by imposing import quotas? These and other questions are addressed in Responding to International Oil Crises, a collection of essays edited by George Horwich, professor of economics at Purdue University's Krannert School of Management, and David Leo Weimer, professor and deputy director of the University of Rochester's Public Policy and Analysis Program.

In his comprehensive analysis of IEA policy, one contributor, Rodney T. Smith, shows that the IEA's Emergency Sharing System would either be ineffective or harmful. Smith points out that if world oil supplies were suddenly cut, the world price would rise until markets cleared. The higher price would bring forth additional supplies from oil wells and from stockpiles, and would cause oil users to reduce their consumption. In his argument Smith assumes that the Emergency Sharing System is activated after the market has already adjusted to the disruption in supply. This assumption is controversial, and is disputed in a chapter in this book by Richard N. Cooper, former undersecretary of state for economic affairs under President Carter
.
However, if the sharing is triggered by a recorded 7 percent or greater drop in oil supplies, then Smith's assumption has to be correct, because in order to share oil, you have to know how much is available. That is, you need data on current supply. But although the concept of supply in economics is well understood, supply itself can not be directly measured. What can be measured is consumption, which (assuming no change in stocks) will equal supply. This means that to know current supply, you have to know current consumption. I conclude that the sharing agreement can be triggered only after each country has already adjusted its consumption.

Smith, who shares this conclusion, proceeds to calculate the gains and losses from the ESS. He points out-as do Horwich, Hank Jenkins-Smith, and Weimer-that buyers of oil in countries with allocation rights will not exercise these rights except at prices below the world price.

Therefore, for the ESS to have any effect, it must give buyers the right to purchase oil at below-market prices. But this presents a problem. For the IEA to get such supplies, a member government with an allocation obligation would have to buy oil from its residents. Such a purchase would drive the domestic price above the world price. Domestic oil users in a country with an allocation obligation would then buy more oil at the lower world oil price. The only way to stop them would be to restrict imports. Similarly oil prices in countries with purchase rights would be below world levels, causing residents of those countries to sell oil to users in other countries. The only way to stop them would be with export controls. The net result is inefficiency, because oil would be prevented from going where it is valued more and would instead be used where it is valued less. For a 7 percent reduction in supply, Smith estimates the aggregate loss in efficiency for the IEA members to be about $1.1 billion annually.

This estimate is surprisingly small. On the other hand, the estimate by Horwich, Jenkins-Smith, and Weimer-$ 116 billion-is surprisingly large. No attempt is made in the book to reconcile the two. The difference could be due to differences in the models. But then surely we should be skeptical about at least one of the models. Another possible reason for the difference is that in the model of Horwich, et al., oil-sharing (mysteriously) increases consumption by LEA countries and drives up the world price. Yet the increase in consumption is slight-O.8 percent. Would this drive up the price enough to cause an extra $ 100-plus billion in losses?

Horwich, Jenkins-Smith, and Weimer, contrary to Smith, believe that the IEA could implement oil-sharing before the market has had time to adjust to an oil supply disruption. But the only way to do so, it would seem, is if the IEA bureaucrats are responding to an anticipated disruption, not to one that has already occurred. Otherwise, by the time the IEA gets together to implement oil-sharing, the world oil market already will have adjusted. How long after the Persian Gulf shutdown would oil traders in Tokyo be on their telex machines buying non-Persian Gulf oil? Not weeks, maybe not even days, but hours. That is what happened in 1979, when the Iranian revolution reduced production in Iran and temporarily reduced supplies to Japan. According to Department of Energy veterans, the Japanese government contacted the US government for help in getting oil. The White House quickly held interagency meetings to discuss the situation. Forty-eight hours later, the White House contacted the Japanese, only to be told that there was no problem-the Japanese had already lined up alternate supplies.

Horwich, et al. do point out one potential offsetting benefit from the ESS. If each country's allowed consumption is treated only as an enforceable ceiling with no requirement that those with allocation rights exercise them-they call this "partial implementation"-then, they argue, IEA consumption will decline. The ESS will turn the IEA into a buyers' cartel and will drive the world price of oil down. The gains from cheaper oil, they find, can more than offset the loss from inefficient allocation of oil. The net result is a gain to the IEA members of about $21 billion per year.

Interestingly, Horwich, et al. do not then conclude that the ESS should be partially implemented. Indeed they show that if the IEA begins with partial implementation, then pressure on member governments by special interests could quickly lead to full implementation with all its associated losses. Therefore Horwich and Weimer advocate that the United States withdraw from the ESS.

A better policy than partial implementation of the ESS, they argue, would be a "disruption tariff," that is, a tariff imposed on oil by all the IEA members during an oil supply disruption. Such a tariff, if imposed by all IEA members, would have the salutary effect of forcing down the world price without causing inefficient allocation of oil among IEA countries.

Not all of the book's authors are as confident as Smith or as Horwich, Jenkins-Smith, and Weimer that the world oil market would function so well during a disruption without mandatory oil-sharing. Dissenting from their view are authors Daniel B. Badger, Jr., a former IEA employee, and Richard N. Cooper. Badger claims that if the government did not intervene to allocate oil during a supply disruption, shortages and lineups would be inevitable. Oil companies would be "unwilling to assume the responsibility" of raising prices to eliminate shortages.

The truth is precisely the opposite. Shortages and lineups are inevitable when the government intervenes to control prices below market-clearing levels. That is the main energy lesson of the 1970s. When governments refrain from imposing price controls-as did the West German and Swiss governments during the 1970s, for example-oil companies are quite willing to "assume the responsibility" of raising prices to make millions of dollars in added profits.

Cooper's case for the ESS is more sophisticated. He argues not that prices will fail to clear the market quickly, but that the spot market will clear at an artificially high level. Why? Because most oil, according to Cooper, is purchased at contract prices rather than at spot prices. These prices, he claims, are "sticky"; they do not increase quickly when supplies fall. This stickiness, Cooper argues, puts a disproportionate burden of adjustment on spot prices. Invoking the ESS would allow oil users to avoid buying on the spot market and bidding the price so high.

Close scrutiny reveals two flaws in Cooper's argument. First, as Horwich and Weimer point out in their concluding chapter, contract prices are quite flexible: virtually all contracts provide for price changes every three months. Also, they point out, on 30 days' notice, sellers may terminate contracts or offer discounts. Second, and more important, even if contract prices were sticky, buyers who paid these low prices could simply turn around and sell the oil on the spot market, thus preventing spot prices from rising unreasonably.

Should governments stockpile oil for use during an oil supply disruption, not just for their own uses, but also for their residents'? Rodney Smith points out that if governments are expected to refrain from imposing price controls during a supply disruption-admittedly a big if- the anticipated high price is a strong incentive for companies and individuals to hold oil reserves.

Will they hold enough reserves? That depends, writes Smith, on two offsetting factors. On the one hand, when private storers sell off reserves during a disruption, they will benefit buyers by driving down the price. Because no individual storer will sell enough to have a perceptible effect on the price by himself, however, private storers will not take account of this beneficial effect (a positive externality) when storing oil in the first place. The result is an understocking of oil. On the other hand, notes Smith, neither will private stockpilers take account of the increased price (a negative externality) caused when they add to their stockpiles. The result is an overstocking of oil. On net, as Smith concludes, one cannot say whether private stockpilers who do not fear price controls will build too few or too many stocks.

Given that governments have built large stocks, should they coordinate their draw downs? John Weyant believes they should. Coordination, writes Weyant, "may be required to ensure large aggregate draw downs" If this is so, might it not be because some governments want to maintain their stocks on the expectation that the disruption will last long and keep prices high? Surely this expectation could be correct. If so, are governments wise to risk exhausting all their stocks? A safer policy than Weyant's seems to be to let each storer, private or government, act on his expectations.

The authors, who address the issue of import quotas, unanimously agree on the perversity of import quotas. A whole chapter, written by Horwich and Bradley Miller, is devoted to showing the great harm that can be inflicted on the country that imposes quotas. Unlike a tariff, an import quota can cause a supplier with some monopoly power to raise the world price of oil. How? Imagine that the United States currently imports seven million barrels of oil per day and announces that henceforth it will limit imports to six million. OPEC can help accomplish this by raising the price until only six million barrels per day are demanded. Horwich and Miller show that such a price increase will occur even when OPEC is not a perfectly functioning monopoly.

In the final analysis, though some of the authors disagree, Responding to International Oil Crises makes a strong case against IEA-mandated oil-sharing during a supply disruption. The book is an important addition to the stock of knowledge available to policy makers.


City to City

Deregulation and the Future of Intercity Passenger Travel,
John R. Meyer and Clinton V. Oster, Jr. (MIT Press, 1987), 312 pp.

Reviewed by James Voytko
James Voytko is a research analyst at Paine Webber, Incorporated.

Like a rather disjointed movie sprinkled with excellent individual performances, Deregulation and the Future of Intercity Passenger Travel presents some good analysis and important conclusions for transportation policy makers combined in a frustrating structure. This structure is an easy target for criticism. Indeed, there are two small books here joined in the middle. The first is a lengthy and detailed recounting of the nation's experience with airline deregulation through 1985. The second, only loosely connected to the first and overshadowed by its length and level of detail, deals largely with competition between passenger modes-air carrier, bus, automobile, and rail-and the ways in which exogenous variables, such as income growth and public policy, influence the struggle for market share in intercity travel. Any transition between the two sections, from historical data on airlines to forecasts of multi-modal markets, is largely missing.

Within each "book within a book," however, there is much of value for the reader. The summary of the beneficial effects of airline deregulation will thoroughly impress all but the most closed-minded reader. The analysis of deregulation's positive effects on airline fares, productivity, and employment displays both clear objectivity and an impressive level of detail. It is the third in a series of reports generated by the Harvard Airline Deregulation Study begun in 1979.

The second "book," however, is the more intriguing of the two. Here the authors' conclusions are more relevant to regulatory policies now under discussion at the federal level. For instance, a common refrain during the annual debate over the Amtrak subsidies has been "Why can't the United States have fast, well-patronized passenger train service like Europe and Japan?" The authors argue quite convincingly that the well-utilized train systems in these countries result far more frequently from the regulatory impediments their governments place on competing modes than from some inherently better idea of how to provide passenger rail service. The message their analysis send to policy makers seeking to "save" passenger rail service in the United States is straightforward: Be prepared to restrict the public's access to other transport modes (such as airplanes and automobiles) whose cost and service quality is determined by a largely deregulated market, and be prepared to continue the current level of rail passenger subsidies-a thoroughly unappetizing prescription, one would think.

The most disturbing aspect of this part of the book is the authors' enumeration of the "dangers" of deregulation. They believe that there is the potential for transport monopolies, for chronic financial instability in the transport industries, and for extreme differences in access to intercity transport by various segments of society that could threaten reliance on the market for intercity passenger transport. As they correctly note, however, there is little evidence that any of these possibilities pose real economic problems. A different sort of analysis-one focused more on the political economy of deregulation-would likely reveal that the "danger" is not so much that the market will fail, but that the public's concerns may provide entry points for reregulation and the reestablishment of the special interest benefits that accompany it.



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