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Regulation Magazine

The Cato Review of Business & Government

Regulation After Reagan

Roger G. Noll

Roger G. Noll is director of the public policy program
and professor of economics and political science at Stanford University,
and Sunderland Visiting Professor of Law at the
University of Michigan

Ronald Reagan's departure from the presidency invites conjecture about whether the policies of his administration will endure. Among the policies most clearly identified with the Reagan administration are those relaxing government regulation of business. Although nearly all recent regulatory reforms had their origins in earlier administrations, many were implemented and had their first visible consequences during the Reagan era. For example, the Reagan administration dismantled the Civil Aeronautics Board (CAB), implemented the near-deregulation of surface freight transportation, and broke up the nation's largest public utility, the American Telephone and Telegraph Company (AT&T), in order to enhance the prospects for competition and deregulation in communications. It also undertook the task of designing workable market processes for interstate transactions in natural gas and electricity, and adopted lotteries rather than comparative fitness investigations to award licenses for new television stations and mobile telephone services.

This article examines whether the regulatory reforms of the Reagan presidency are likely to be retained or even extended in the 1990s or, alternatively, whether regulatory reform reached its apex under Reagan and is likely to be reversed in the next few years. Recent congress enacted very little legislation pertaining to regulation, numerous bills were introduced to undo previous reforms. Among these were bills that would reregulate the airlines, tighten the regulation of railroads and trucks, and declare a moratorium on further deregulation in telecommunications. In the environmental area legislation was introduced to control acid rain that would require across-the-board retrofitting of the largest sources of air pollution with technological fixes such as scrubbers. Such proposals implicitly reject eh use of economic analysis for identifying least-cost solutions to achieving environmental policy objectives, and explicitly reject the use of emissions trading and other market mechanisms These proposals constitute an even more inflexible approach to environmental regulation than that embodied in the Clean Air Act amendments of 1977.

Congressional dissatisfaction with regulatory reform reflects a broader public criticism that has emerged in national media. Airline deregulation has been widely blamed for flight delays and airline crashes, and pundits have observed that divestiture and deregulation in telecommunications have left consumers confused if not abused. The failure to make significant progress in achieving environmental, health, and safety goals is often attributed to the increased reliance of regulatory decision makers on economic analysis and market processes.

Critics of regulatory reform offer two reasons why the Reagan policies may not long survive his presidency. One is ideological: the reforms of the Reagan era and before reflected a generally conservative national mood. According to this argument, market processes and economic analysis are intrinsically conservative policy tools. Hence, the life of the regulatory reform movement should coincide roughly with the swing of an ideological pendulum. If the pendulum is returning toward a more progressive ideology, the reforms of the Reagan era are likely to be swept away in its path.

The second reason cited for the likely demise of regulatory reform is consequentialist: regulatory reforms have not delivered their promised benefits, and have made the nation worse off. The reimposition of economic controls in infrastructure industries and the strict regulation of environmental quality, health, and safety will arise because administrative regulation is a superior means of protecting citizens from an array of market failures. Regulatory reform will be swept away because it has been tried and found wanting.

The history of regulatory reform provides ample evidence that both of these explanations are false. One burden of this article is to explain the basis for this assertion. But if the fate of regulatory reform is not tied closely to ideology or performance, it does not necessarily follow that recent reforms are safe from reversal. Instead, it means that the political dissatisfaction with these policies has other causes. The second burden of this article is to identify the roots of dissatisfaction, and to suggest measures that could be taken to preserve the benefits of regulatory reform.

The Ideological Explanation

The intellectual foundation of regulatory reform is microeconomic analysis, which is certainly not free of ideological content. Nonetheless, within the spectrum of contemporary American politics the ideological content of microeconomics, and thus the rationale for regulatory reform, is not the cause of controversy.

The wellspring of modern microeconomics is eighteenth century rationalist liberal philosophy. Its core assumptions are that economic institutions should be evaluated solely on the basis of their effects on the welfare of individuals, and that the best available measure of individual welfare, on average and in the long run, is derived from the choices people actually make. From these simple assumptions economists have derived some arguments that are emphasized by conservative politicians, such as the benefits of competitive markets and freedom of contract, and some other arguments that are emphasized by liberals, such as the theory of market failure and the rationale for corrective measures such as antitrust and environmental policies.

Both proponents and opponents of traditional methods of regulation have used the basic tools of microeconomics to build theoretical cases supporting their positions. That the opponents eventually gained the upper hand may have been largely an accident. The development of computers in the l98Os permitted economists for the first time to engage in serious empirical studies of the economy. While macroeconomists were busy developing the first generation of econometric forecasting models, microeconomists were diligently measuring the efficiency of specific industries. Regulated industries were an obvious early target for study because of the rich vein of data stored in regulatory agencies, most of it freely available to the public. Obtaining relevant data about prices, output, and inputs in regulated industries was far easier than coaxing recalcitrant competitors in unregulated businesses to provide the same information.

Economists generally entered the study of regulation with the naive view that regulatory institutions were set up for the purpose of rectifying market failures. Unfortunately, and almost without exception, the early empirical studies--those commencing in the late 1950s and continuing into the 1970s-found that the effects of regulation correlated poorly with the stated goals of regulation. By the early 1970s the overwhelming majority of economists had reached consensus on two points. First, economic regulation did not succeed in protecting consumers against monopolies, and indeed often served to create monopolies out of workably competitive industries or to protect monopolies against new firms seeking to challenge their position. Second, in circumstances where market failures were of enduring importance (such as environmental protection), traditional standard-setting regulation was usually a far less effective remedy than the use of markets and incentives (such as emissions taxes or tradable emissions permits).

The essentially nonideological character of these conclusions is illustrated by two examples. First, in the mid-1960s two quite similar books were published on the origins of the Act to Regulate Interstate Commerce, which established economic regulation of railroads by the federal government. Both books were detailed and extensively researched, and both concluded that railroad regulation was set up essentially for the purpose of forming a more effective railroad cartel. One was written by Marxist historian Gabriel Kolko; the other was written by economist Paul W. MacAvoy, who later served as economic adviser to both President Gerald Ford and Vice President George Bush.

Second, during the late l960s and l970s a significant fraction of the new books on regulation were published by either the Brookings Institution or the American Enterprise Institute. The first was noted for its liberalism and its ties to the Democratic Party, while the latter was more known as a conservative think tank with ties to the Republican Party. Yet on regulatory policy issues, it was difficult to tell the institutions apart. Both were busy publishing books and articles by the same set of authors. For example, MacAvoy was the coauthor of a Brookings book on the Federal Power Commission and an AFT series on regulatory policy analysis in the Ford administration. James C. Miller 111 was the coauthor of a Brookings book on airlines, before joining AEI as a resident scholar and then going on to head the Federal Trade Commission and the Office of Management and Budget during the Reagan administration.

The outpouring of critical research on regulatory policies need not have led automatically to significant changes in public policy. Indeed, on other issues, such as the design of the welfare system, educational institutions, and medical care, economic research seems to have played a less important role in policy development. That research became important in regulatory policy may have been simply a matter of fortuitous timing. The stagflation and other economic difficulties of the 1970s led political leaders to pay greater attention to proposals for improving the performance of the economy, including proposals for regulatory reform. Although the economic logic was tortured, the political logic was straightforward: If the nation suffered from rising prices and low productivity growth, and if regulation caused prices and costs to be higher in regulated industries, regulatory reform was a sensible program for attacking stagflation.

The group that jumped on the reform bandwagon was bipartisan. In the case of airline deregulation Senator Edward M. Kennedy convened the first hearings in which a series of academics excoriated the CAB for creating an airline cartel, and Nixon and Ford appointees to the CAB began the process of introducing competition. In the case of telecommunications the key events were the decisions by the Federal Communications Commission in the late 1960s and early 1970s to permit competition in long-distance and customer-equipment markets, and the decision by the Antitrust Division of the U.S. Department of Justice to pursue a restructuring of AT&T. The FCC actions required a coalition between liberal Democrats and conservative Republicans on the commission. The AT&T breakup had its roots in the last years of the Johnson administration when, as participants in the Rostow task force on telecommunications policy, Justice Department officials became convinced of the desirability of competition and initiated internal studies of the industry. The case was filed during the Ford presidency; it continued through the Carter administration, and was settled early in the Reagan era. A case grounded only in partisan ideology could not have survived five presidents and even more assistant attorneys general for antitrust.

In environmental, health, and safety regulation the ideological argument must be taken more seriously than in economic regulation. In part this is because there is still a rich intellectual debate about the normative value of economic analysis in this area; hence, the precise boundary of valid uses of economic principles remains controversial. And in part it is because the political debate over the use of economic methods has taken on a more partisan and ideological character. These two factors are not necessarily connected. The scholarly debate about the validity of "commodifying" human life or threatened wilderness is not the source of political controversy. The political debate is about the aggressiveness with which policy goals should be pursued and about the redistribution of wealth that regulation engenders.

My purpose here is not to defend the philosophical foundations of economic policy analysis, so I will not recap the academic debate about commodification, inalienability, and the ethics of the transactions metaphor. Instead I will state my reasons for believing that this debate is largely irrelevant for understanding the core issues in these policy areas.

First, as many radical analysts have already concluded, the philosophical arguments against the extensive use of economics in environmental regulation apply with equal force to most, if not all, of the economy. For example, Barry Commoner, director of the Center for the Biology of Natural Systems at Queens College, has chastised fellow environmentalists for failing to realize this point and thereby isolating themselves from radical social movements that would eliminate both capitalism and markets. Legal scholar Margaret Jane Radin makes a similar but more detailed argument in analyzing the ethics of markets for prostitution, surrogate parenthood, and adoption. Her conclusion is that, in the absence of transition effects, the complete replacement of markets as a means of allocation is ethically preferable. These conclusions are so obviously at odds with the spectrum of political views held by government officials that it is implausible to argue that this philosophical position motivates their views about regulation.

Second, the use of economic analysis and market mechanisms does not preclude any realistic degree of stringency of regulatory standards. As actually practiced in government policy processes, the core parameters of benefit-cost analysis (such as valuations of life and morbidity and the choice of a discount rate) are determined politically, either by legislation or by officials appointed by the president, rather than derived from economic models using market information. Regulatory standards can be made far weaker, or far stronger, by making relatively minor changes in these parameters. The import of economic analysis is not, therefore, in the stringency of regulatory standards; it is in the choice of regulatory strategies for achieving these standards. Specifically, if emissions standards are under consideration, economic analysis will suggest the least-cost standards. Because the information available to regulators is sure to be incomplete and out of date, however, economic analysis will also suggest that a market-like solution-emissions taxes or tradable emissions permits-is almost always preferable. Hence, the objection to the use of economic analysis in environmental, health, and safety regulation is in reality a rejection of the most efficient methods for achieving policy objectives and of the allocation of burdens implicit in those methods.

Third, even some ardent environmentalists have embraced economic analysis and market based reforms; this is perhaps the most convincing argument that the controversy is not ideological. In fact, many of the most important contributions to the development of economic methods for environmental policy have been made by economists who are both strong environmentalists and political liberals. More significantly, several environmental organizations have come to advocate more, not less, reliance on economic approaches.

The real threat is that the use of economic methods in policy analysis exposes the conflicts that so many political officials face with their constituents. Public opinion polls reveal that, regardless of partisanship, a large majority of citizens favor relatively strong environmental, health, and safety programs, and at the same time oppose government actions that threaten businesses and jobs in their local communities. Politicians can respond to both preferences by stridently advocating tough policy objectives, while pursuing an implementation strategy that rarely forces businesses to close. Economic methods will tolerate, under some circumstances, highly visible pollution, and under other circumstances, highly visible economic dislocation. While economically (and environmentally) efficient, these arc politically unpopular outcomes.

In short, the growing dissatisfaction with regulatory reforms based on economic efficiency is not, at base, ideological. Individual political actors have different ideologies and give different reasons for their policy positions, but the ideological differences that are significant in the mainstream of American politics do not explain the debate over the regulatory reforms of the past 20 years.

The real threat is that the use of economic methods in policy analysis exposes the conflicts that so many political officials face with their constituents.

The Performance Explanation

The essence of the performance explanation for the rise and fall in the ardor for regulatory reform is that the policy changes of the past 20 years have not delivered on their promises. A non-ideological American pragmatist might conclude from the information available in 1970 that regulation led to inefficiency and that regulatory reform held significant promise, but then conclude in the late 1980s that the cure had been worse than the disease. Based on experience, imperfect government might well do better than imperfect markets.

Other articles in this issue deal with the actual effects of regulatory reform in some important cases, so I will not go into detail here. Instead I will offer some key generalizations that reflect the consensus of the research literature on the effects of recent regulatory reforms.

The key issue is the extent to which economic approaches to regulatory reform are responsible for the successes and the failures of the Reagan era. Obviously the answer is very different in the ease of economic regulation than in the case of social regulation.

With respect to economic regulation, increased competition had predictable effects, including the adverse effects on unions and the rising relative prices facing rural consumers. Also predictable was the dependence of the performance of deregulation on the response of other government policies such as antitrust, infrastructure construction, and state regulation. Neither category of consequences can he considered a failure of economic deregulation; indeed, the overall effects of economic deregulation should lead advocates of unionized labor and rural constituencies to realize that regulation was a weak, inefficient means to obtain their objectives. The magnitude of the economic benefits to these groups was small compared to the efficiency gains from deregulation.

For other forms of regulation the principal lesson is that when economic reforms are highly limited, so are the resulting benefits. The Reagan administration adopted two policy reforms advocated by economists: institutionalizing economic analysis in the regulatory process, and permitting a very limited use of emissions taxes and trading as an adjunct to traditional environmental standards. Economic analysis has made some small headway in undermining a handful of excessively stringent standards. Judging from the array of standards across industries and sources of hazard, much less headway has been made in affecting regulatory priorities and in rationalizing the distribution of the costs of achieving regulatory objectives. The absence of significant progress, or the presence of substantial costs, is hardly a consequence of the application of economic approaches.

Although performance shortcomings take a different form in economic and social regulation, the ultimate conclusions are the same. First, experimentation with economic approaches has provided convincing evidence that regulation is an exceedingly expensive way to protect jobs, companies, and specific communities. Second, economic policy reforms have not led to the maximum possible increase in efficiency primarily because they have been applied in too limited -a form. Some anticompetitive regulation persists L in nearly all cases; procompetitive actions to facilitate economic deregulation have not been--pursued with Full vigor; and economic approaches to social regulation are but a small tail on the very large dog of traditional standard setting.

The Real Explanation: Politics as Usual

Two decades ago scholars of regulation were skeptical of the prospects for regulatory reform. The infirmities of regulatory policy making seemed to he deeply ingrained in the American political system, which led both liberal and conservative government officials to be excessively responsive to the demands of well-organized, homogeneous pressure groups. Regulatory agencies were used to protect and to enhance the economic positions of politically influential industries. Economic approaches to regulatory reform were regarded skeptically because of the threat they posed to established economic interests. Initially even the most ardent advocates of effective regulation, such as consumerists and environmentalists, sought primarily to be given a seat at the bargaining table so that they, too, could be cut in on the distribution of benefits from administrative processes.

Despite these obstacles extensive economic deregulation has taken place and there has been a noteworthy expansion of economic approaches to social regulation. With the single exception of the CAB, however, all of the regulatory institutions in existence in 1970 still exist today. The same economic interests still participate in the administrative processes of regulatory agencies and still lobby the members of Congress who sit on the relevant oversight committees. Even the airlines have the U.S. Department of Transportation, the House Energy and Commerce Committee, and the Senate Commerce, Science and Transportation Committee, all of which still play important roles in shaping the industry. Consequently, all of the political forces that gave rise to regulation are still in place, leaving industries, unions, and favored communities the same forum for pleading their cases. The real test of regulatory reform now and in the years ahead is whether these interests will be able to undo what has been done thus far.

Opponents of regulatory reform ought to be weaker now than they were a decade or two ago. For one thing, the entrenched economic interests that unanimously favored the use of regulation to protect themselves are more divided. The firms and employees that have fared best under regulatory reform are stronger, and protected firms and unions are weaker. In no major industry can a consensus be formed in favor of reversing the policy changes of the past decade. In addition, to the extent that the force of argument and evidence matters in policy debates, the case for regulatory reform is stronger. Numerous dire predictions- airline, truck, and rail accidents, loss of service to smaller cities, rampant increases in pollution- have not come to pass, where as the economic benefits of lower costs and prices did take place as predicted.

Of course, the incomplete nature of each major example of regulatory reform poses real questions about the durability of reform. Obviously political officials have been only partially committed to reform. Perhaps this is because of political risk aversion: by undertaking partial and gradual reform, political officials could monitor progress and quickly reverse course if performance deteriorated. Since performance in fact has improved, we should expect politicians to be willing to try further reforms in the future. These might include elimination of the ICC, further movement toward deregulation of telecommunications, and expansion of the bubble and offset concepts in air pollution control in the direction of a market for emissions permits.

Unfortunately the history of regulatory reform of the 1980s does not appear to fit this view. Little has been accomplished during the second term of the Reagan administration, undercutting the argument that past success should breed further reform. So perhaps the explanation is that regulatory reform was a happenstance, made possible by a decade of unusually poor performance by the American economy. As the economy recovered in the 1980s, the underpinning for regulatory reform disappeared, and "business as usual" in regulation, with its susceptibility to special-interest politics, gradually returned.

Fortunately a more optimistic view is also consistent with the facts. It is the regulatory reform ran out of steam in the Reagan administration for reasons peculiar to the policy agenda of the president and his key advisers. For example, right form the beginning the Reagan administration held a commitment to a version of federalism that has not held sway in the White House since the nineteenth century. In essence it sought to devolve to state and local government as much policy authority as possible-even if that meant stepping aside to let state and local regulatory officials substitute highly inefficient forms of traditional regulation for federal regulatory reforms.

In addition the Reagan administration has appeared to be more oriented toward eliminating government constraints on businesses than toward promoting efficiency. The early Reagan appointees at many regulatory agencies sought not to introduce efficiency criteria for setting priorities and changing regulations, but simply to relieve industry of what it regarded as the most expensive requirements. Numerous aspects of a durable reform were simply overlooked, such as a complementary antitrust policy and the use of market-based incentives in social regulations. The result was that regulatory reform produced less economic benefit than was possible, and lost momentum once some of the most odious regulatory policies were reversed.

Finally, the Reagan administration has had a relatively poor relationship with Congress especially since the 1982 congressional elections. Historically, effective regulatory reform has been achieved through cooperative ventures between the president and Congress and has depended on alliances across party lines. Even the Carter administration, also regarded as less than adept in its relations with Congress, worked closely with the legislature in getting regulation relaxed in transportation and energy. But for the most part the Reagan administration has not consulted with Congress about regulatory r3eform and, in some cases, such as the FCC's actions in telecommunications and broadcasting, has been openly confrontational. It is noteworthy that the most important economic policy reform of Reagan's second term- the tax bill of 1986-was the outcome of a process in which both the executive and legislative branches played major roles, and in which leaders of both parties were in a positions to claim some of the credit. In regulatory policy there were no parallel attempts at serious collaboration and compromise.

If these observations explain the snail's pace of reform during Reagan's second term, new faces in Washington ought to be in a position to resume progress. The fundamental arguments in favor of further economic deregulation and economic approaches to more efficient social regulation are stronger now than a decade ago, for intervening events have provided confirmation of their value. Moreover, the political case for regulatory reform does not appear to be much weaker than before. Indeed, past reforms have created new interests that have a stake in the improved performance that resulted; these can be mobilized against the interests favoring the use of regulation to protect themselves. But further success will require that the next administration adopt a holistic approach to regulatory reform: actively pursuing policies to ease the transition to a less regulated economy, working with a bipartisan congressional coalition for regulatory reform, and taking effective actions to make certain that inefficient federal policies are not simply replaced by equally undesirable state regulations. All of this will require that the new administration adopt a coherent, broadly consistent approach to regulation, regarding it as something more than a group of discrete and unrelated specific problems to be solved by writing a better regulation.

Selected Readings

Commoner, Barry. "A Reporter at Large: The Environment," The New Yorker (June 15, 1987).
Liroff, Richard A. Air Pollution Regulation. The Conservation Foundation, 1986.
Noll, Roger G. and Bruce M. Owen. The Political Economy of Deregulation: Interest Groups     in the Regulatory Process. The American Enterprise Institute, 1983.
Radin, Margaret Jane. "Market-Inalienablility," Harvard Law Review, Vol. 100, No. 8 (June     1987).

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