The Weekly Standard, March 12, 2001
WITH ALL EYES focused on the president's efforts to push his tax cuts through Congress, little attention is being paid to what we economists call microeconomic policy -- more (un)popularly known as regulation. That lack of interest in a coherent underpinning for policy proposals is already evident in the defense of their boss's tax cuts being mounted by the president's men. These advocates are abandoning the solid supply-side basis for the reductions – that reducing marginal rates and the overall tax burden will encourage harder work
and more entrepreneurial risk-taking -- in favor of Keynesian tax cuts-as-economic-stimulus arguments that will lose their potency if the economy begins to recover.
Although it is fashionable to believe that policy is made by a series of ad hoc deals with congressional barons, and by opportunistic appeals to shortsighted voters, no policy worthy of that name can actually succeed without a consistent, coherent underpinning. Franklin Roosevelt may have lurched from one expedient to another, but he succeeded in weaving a social safety net because he believed firmly that capitalism could not survive without one. Lyndon Johnson may not have created a "great" society, but he certainly refashioned the old one in his own image because he knew what he wanted: a redistributionist welfare state with an activist government. And Ronald Reagan succeeded in unleashing a record-breaking period of economic prosperity
because he aimed his several domestic programs at unleashing individual initiative and freeing markets to do their job of allocating capital to its highest and best use. The vision thing matters.
Contrast this with the failure of Richard Nixon in the domestic arena, as he lurched from speeches supporting free-market capitalism to the imposition of wage and price controls. Or the dismal record of George Bush the elder, who loaded costly regulations and an increasing tax burden on American business, all the while thinking that his was a pro-business, pro-enterprise administration.
Which is why George W. Bush and his able team of economic advisers must do some hard thinking about what sort of regulatory policy they want to promote. It does no good to say merely that one opposes "regulation," or any initiative to which one can affix that label. No good, either, to allow the rules-writing bureaucrats who are ever with us to go their merry, regulation-crafting way. And no good to adopt an ad hoc approach, signing off almost at random on this or that regulation, while frowning on others.
So we start with first principles: The market does a better job of allocating the nation's output and its capital in an efficient manner than do regulators, even the best-intentioned and most able ones. Unfortunately for opponents of "regulation," that simple principle calls for more than a hands-off policy: It demands an active policy to preserve competition. Last week's argument before the appeals court in the Microsoft case was not, as many conservatives see it, a battle between evil regulators who would stifle a successful company out of envy of the wealth of its founders, and, on the other side, defenders of the capitalist faith. Rather, it is a battle between two views of how to maximize competition. The government argues that the competitive system is best served by preventing a dominant firm from engaging in a variety of practices that the lower courts found will stifle new competitors; the Microsoft team contends that competition is better served by recognizing that in a high-tech world all monopoly power is transient, and that consumers are best served by letting Microsoft go about its business of creating software that makes the lives of computer users easier and easier.
Whatever one's views on this particular case, it is difficult to argue with the following two propositions. First, the competitive system is worth preserving, both because it increases economic efficiency and because it contributes to the preservation of an open society in which fledgling entrepreneurs can challenge incumbent firms on a relatively level playing field. Second, firms with dominant positions will at times find it in their interests to erect barriers to the entry of newcomers, relying on tactics that have no relation to superior efficiency. Bigness is certainly not bad, which is why fairly won monopoly power is beyond the reach of the law. But use of exclusionary or predatory tactics to obtain monopoly status is, and should be, a felony. Bush's new antitrust chief, Charles James, although he may differ slightly from his predecessor on some details of antitrust enforcement, knows that, and should be left to pursue a vigorous enforcement policy without interference from those Bushies who really would like to see the antitrust laws repealed.
These truths lead to a conclusion that some conservative economists will find unpleasant: One informing principle of regulatory policy must be that all policy initiatives should be aimed at preventing incumbent businesses from barring entry by price-cutters and innovators. Translated into specific terms: Maintain a vigorous and well-funded antitrust division of the Justice Department, and do the same for the Federal Trade Commission. Recognize that the best way to avoid the need for regulating the prices and practices of America's corporations is to maintain a competitive marketplace, and leave it to consumer preference, reflected in the forces of supply and demand, to do the job of constraining business behavior.
Unfortunately, competition is not always feasible. Not so long ago we thought that to be the case in airlines, trucking, and a host of industries in which competition has, indeed, proved possible -- and infinitely superior to the old regulatory regimes in producing reasonable prices and a wide variety of services. Not so long ago, we thought that all regulators were in the business of balancing the interests of consumers and investors to produce what we called "just and reasonable prices." We now know better: Many regulators, even the most able and least venal, tend to protect the firms they are supposed to control, and to see potential competition as a threat to the health of their charges.
But the narrowing of the areas requiring regulation because competition is not effective does not mean that no such areas remain. It is not possible, for example, for newcomers to threaten the market power of many incumbents in a variety of so-called wires businesses -- transmitting electrical energy over long distances; moving that energy from distribution points into the home; getting a telephone call to travel the so-called "last mile" over the local loop into each residential customer's home.
That leaves the Bush folk, who approach this issue with an admirable bias against government intervention in business affairs, with two options. One was best stated by Michael Powell, the new chairman of the Federal
Communications Commission, an agency that under Clinton-Gore cast its regulatory net widely enough to cover the content of children's programs and the ethnic composition of firms bidding for spectrum. Powell, quite properly, says that he intends to put a stop to such mindless intervention. Regulatory barriers to entry in the form of restrictions on media cross-ownership clearly have no place in a world in which the sources of news and entertainment have proliferated. Nowadays, every viewpoint and everything that passes for entertainment can be found in some newspaper, magazine, or on some television station or on the Web.
But Powell may have gone one step too far when he told reporters, "I do not believe that deregulation is like a dessert that you serve after people have fed on their vegetables, as a reward for competition. I believe instead it's a critical ingredient to facilitating competition." The chairman is certainly right in believing that there are instances in which the public interest is best served if regulators simply get out of the way, even at the risk of perpetuating a transient monopoly, in the hope that new entry will soon increase competition and consumer choice. But he and his colleagues in the regulatory agencies must also recognize that there are instances in which the regulated monopolist is too entrenched, the cost of building an entirely new competitive infrastructure too great, simply to remove all regulatory constraints and hope for the best. It is the job of the regulator to distinguish those instances in which deregulation reduces barriers to entry from those instances in which those barriers are so high that he cannot withdraw from the game.
If independent generators of electricity are to have access to customers, they must be able to use the only path that exists to get to them: the transmission systems and wires that are often owned by the utilities with which they are competing. Similarly, if phone companies struggling to compete with the Bells cannot have reasonable access to Bell-controlled local telephone networks, they cannot compete for customers.
Unless fealty to ideology compels Bush's microeconomic policymakers to remain passive in the face of such monopoly power, they must do one of two things: assure that in those instances where it is effectively uneconomic to build a competitive infrastructure (an empirical not an ideological question), access is granted on reasonable, non-discriminatory terms (again, an empirical question); or separate the monopoly elements of the electric and telephone businesses from the vertical levels in which competition is feasible.
I don't know just what careful empirical analyses of the various regulated industries would show. I do know that regulated companies are skilled at presenting evidence that favors the status quo, and that they often outgun the agencies that are supposed to regulate them, although not necessarily their adversaries, potential competitors with a stake in breaking down barriers to entry. But I also know that the answer to the difficult policy questions surrounding these industries is not to be found in a creed that holds that all government intervention in markets is likely to harm consumers. It is the hard work of the regulator to learn the facts, and then decide whether the public interest is best served by intervening in the hope of simulating, or better still creating, a competitive market where none exists, or by washing his hands of the controversy and letting the players fight it out in the marketplace. There is no one-size-fits-all answer to the myriad questions regulators face. But there is one pair of principles that fits all: competition where possible, regulation where necessary.
Which brings us to the other area that the Bush team will find difficult: environmental policy. It is not enough to say that we have abundant supplies of coal, so the government will subsidize the development of clean coal technologies, as it has announced it plans to do. Or that we have a shortage of oil and gas (at prices that politicians find acceptable, there being no physical shortage of these resources) and therefore should drill offshore or in wilderness areas. Here, as with other aspects of regulatory policy, lurching from ad hoc solution to ad hoc solution is not policymaking: It is the equivalent of sailing without a compass.
What Christie Todd Whitman's Environmental Protection Agency and Spencer Abraham's Department of Energy must do is shed the ad hocism that will leave them defenseless against energy producers when they uphold some restrictions on development, and under siege by environmentalists when they approve drilling, or mining, or expanded fossil fuel use.
Again, policy must have a basis in principle, and the principle here is that the benefits of any proposed policy must exceed its costs, which means making a best-faith effort to measure both costs and benefits. To be sure, there is some truth in historian Eric Hobsbawm's observation that "from time to time history catches economists at their brilliant gymnastics and walks off with their overcoats." But careful analysis supplemented with a dollop of humility should enable the new rulers of EPA and DOE to decide whether the value of lost environmental amenities exceeds or is exceeded by the value of the oil and gas to be retrieved from offshore fields, and whether the expenditure of public funds on subsidies to various new technologies has a significant public payback. One thing seems certain: The recent rise in the prices of oil and gas should increase the benefits of developing new reserves, without increasing the social costs associated with their development.
All of this may seem excessively prissy to those who prefer to be free to develop policies on the basis of what strikes them as practical in each separate case. But in the failure to impose coherence and a vision on microeconomic policymaking lies chaos.