Creating Competitive Markets: The Politics of Regulatory Reform / Edition 1

by Marc K. Landy, Martin A. Levin, Martin Shapiro

Overview

"Promoting competition has been a leading theme of public policy over the past 30 years. In the United States, the movement began in the 1970s with efforts to rewrite the rules for aviation, trucking, and telecommunications. Since then, many other industries have come in for similar treatment, with banking, securities, agriculture, and energy heading the list. This trend is often described as "deregulation," but "market design" is a better term. Promoting competition is not just about removing legal controls and then getting out of the way. It also requires that policymakers consciously design new markets, often with significant rules and regulations to promote efficiency. In Creating Competitive Markets: The Politics and Economics of Regulatory Reform, leading experts from academia, government, and the private sector evaluate more than a dozen efforts at market design. The contributors to this volume analyze a broad range of sectors, including airlines, electricity, education, and pensions. They examine developments in Canada, the United Kingdom, and Japan, as well as the United States. In each case, the authors ask three critical questions: Can markets be designed? How significant are the impediments to competition found in different sectors? And how do the politics of market design shape the policies that result? Taken together, these chapters help explain why few recent cases of market design have proven to be as unambiguously successful or as relatively uncontroversial as the deregulation of trucking, airlines, and telecommunications. They also provide valuable lessons for future participants in the never-ending process of market construction and redesign. Rich in analysis and detail, Creating Competitive Markets is essential reading for anyone interested in regulatory politics and policy. Contributors include John Cioffi (University of California-Riverside), Darius Gaskins (Norbridge, Inc.), Jacob Hacker (Yale University), Udi Helman (Federal Energy Regulatory Commission), Frederick Hess (American Enterprise Institute), Edward Iacobucci (University of Toronto), Alan Jacobs (University of British Columbia), Michael Levine (New York University), Jonathan Macey (Yale University), Richard O'Neill (Federal Energy Regulatory Commission), Eric Patashnik (University of Virginia), Andrew Rich (City College of New York), Peter Schuck (Yale University), Steven Teles (Yale University), Michael Trebilcock (University of Toronto), Steven Vogel (University of California-Berkeley), Graham Wilson (University of Wisconsin), and Ralph A. Winter (University of British Columbia).

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Product Details

ISBN-13:	9780815751151
Publisher:	Rowman & Littlefield Publishers, Inc.
Publication date:	03/22/2007
Edition description:	New Edition
Pages:	368
Product dimensions:	6.00(w) x 9.00(h) x (d)

About the Author

Marc K. Landy is professor of political science and faculty chair of the Irish Institute at Boston College. Martin A. Levin is professor of politics at Brandeis University. Martin Shapiro is James W. and Isabel Coffroth Professor of Law at the School of Law-Boalt Hall at the University of California-Berkeley.

Read an Excerpt

Creating Competitive Markets

The Politics of Regulatory Reform

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Brookings Institution Press

Copyright © 2007 Brookings Institution Press
All right reserved.
ISBN: 978-0-8157-5115-1

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Chapter One

Creating Competitive Markets: The Politics of Market Design

Marc K. Landy and Martin A. Levin

Creating Competitive Markets should be read, in part, as a cautionary tale. Although we strongly support the use of government to promote market competition, many market reforms we analyze have had checkered results. The privatization of British pension funds launched in 1986, for instance, failed entirely. The U.S. decision to end subsidies for major agricultural commodities under the Federal Agriculture Improvement and Reform (FAIR) Act of 1996 was rescinded after a few years. Changes in telecommunications policy also enacted in 1996 have had at best an ambiguous competitive impact. And the political momentum pushing for greater pro-competitive policy has weakened. The opening up of electricity markets to greater competition in the 1990s, once considered the wave of the future, also met with mixed results. This is in stark contrast to the earlier and highly successful wave of "deregulations" of trucking, airlines, railroads, and telecommunications that took place during the 1970s and early 1980s.

A cautionary tale need not be a pessimistic one, however. Despite the sobering lessons of the second wave of marketization policy reform that our book presents, greater success is possible-but only if policymakers fully appreciate and face up to both the political and analytical difficulties of creating competitive markets.

Deregulation and Market Design

For the first two-thirds of the twentieth century, it appeared that the nineteenth-century dream of free markets was being subjected to a rude awakening. Communism had rejected the market throughout much of Asia and Eastern Europe. Government ownership and public provision of goods and services had become a major force in the democratic nations of Western Europe as well-even in the birthplace of free enterprise, Great Britain. Although the United States was less affected by the anticapitalist turn, the dominant trend since the rise of Progressivism in the early 1900s had been toward stricter and more interventionist regulation and control of many economic sectors, including trucking, airlines, telecommunications, banking, power production, agriculture, health, and finance. In the early 1970s there was scant evidence that a worldwide pro-market counterrevolution was about to get under way. Yet by the dawn of the new millennium every alternative to markets-from communism to democratic socialism to command-and-control regulation-was on the retreat around the globe.

In the United States, pro-market public policy took the form of what is conventionally called "deregulation." A wave of deregulation hit aviation, trucking, and telecommunications in the mid-1970s, stimulated by an intellectually powerful and persuasive body of writings from experts in influential economics departments, law schools, and think tanks. In 1985 the Brookings Institution published a seminal account of this phenomenon, The Politics of Deregulation, by Martha Derthick and Paul Quirk. During the more than two decades that have elapsed since then, almost every heavily regulated sector of the economy-including banking, agriculture, telecommunications, and energy-has experienced serious reform aimed at improving economic performance by removing the dead hand of regulation and increasing competitive pressure.

Inspired by the pioneering work of Quirk and Derthick, this book takes up where they left off, just as public policy had begun questioning the previous era's rhetoric of disciplining and taming markets. This book examines what is now a thirty-year history of policy innovation dominated by a rhetoric of freeing up competitive forces and replacing flaccid and cumbersome government intervention with the flexibility and creativity that markets are supposed to stimulate.

Central Findings

This book contains seven central findings. First, policy affects market competition on two distinct levels: macro and micro. Second, efforts to create competitive markets do not deregulate; they redeploy regulation. Third, the track record of regulatory redeployments to date is highly uneven, with at least as many failures as successes. Fourth, success can best be fostered if policymakers abide by the following policy design principles: provide risk protection on a macro not a micro level, accept the constraints imposed by imperfect knowledge, and limit the ambition of the market design. Fifth, failure to produce more competitive markets is due to complex mixtures of cognitive and political constraints; indeed, the single greatest impediment to successful marketization policy is the sheer amount of political interference in the market design process. Sixth, increased market competition is greatly facilitated by Schumpeterian "creative destruction," which occurs when technological innovations destroy existing oligopolistic barriers and facilitate market entry or when intrusive regulatory agencies are abolished. Whatever the mechanism, creative destruction has positive effects by reconfiguring interest group dynamics to facilitate the formation of a powerful new political coalition that supports the new pro-competitive policy regime. Seventh, the way for policy designers to cope with political constraints and formulate successful policy design is to adopt a more self-consciously political understanding of their roles. To enable the "invisible hand" of the market to gain a foothold and to flourish despite the onslaughts of rent seekers, they need to apply a noninvisible hand-a political hand-that will help them anticipate and stave off political obstacles.

Macro Policy

The role of public policy in promoting competitiveness is by no means limited to intervening directly in the design of particular markets. As discussed in the first part of this book, macro policies that are not market specific may establish or fail to establish the necessary and complementary conditions for sustaining a competitive economic environment. Such macro policies include insurance and other forms of risk amelioration, welfare and health policies that affect labor mobility, corporate reform, and other government policies and programs aimed at creating sufficient levels of security and transparency to encourage individuals and firms to live by market outcomes.

We use the term "macro policy" to draw attention to the broad frameworks in which markets operate. It flags a key question of this discussion: how and why do actors in a particular market system accord it sufficient legitimacy to actually live by its outcomes rather than seek to undermine and destroy it. The term also encourages an appreciation of the relationship between a cultivation of the norms of trust, efficacy, and legitimacy, on one hand, and the design of a particular pro-competitive system, on the other. In this volume, John Cioffi explores that relationship by considering how changes in corporate governance under the Sarbanes Oxley Act of 2002 are likely to affect the public's trust in corporate behavior and thereby its willingness to continue to invest in corporations, whether the reform gives firms relatively free rein to control their own affairs, and to what extent it refrains from interfering in how they compete with one another.

Likewise, Martin Shapiro investigates the dangers that stem from undermining public faith in corporate good behavior. He looks at the relationship between governmental efforts to create greater economic competition and the resulting incentives to both the regulated and the regulator. Shapiro concludes that the doctrine of self-interest central to free market competition does not encourage playing by the rules. Hence a free market economy depends upon rigorous policing to prevent unfair practices. But recent salutary trends in regulatory reform designed to remove the "dead hand" of command and control undermine the government's ability to police the private sector, not to mention itself. Efforts to ease monitoring problems, encourage voluntary compliance, and negotiate settlements of regulatory violations rather than insist on immediate and complete remediation or punishment undoubtedly remove obstacles to greater competition and more efficient operations. By removing a whole series of blunt enforcement instruments, they also make it much easier for the regulated to evade the spirit of a reform. It then becomes easier to cheat, harder for the regulators to catch cheaters, and easier for reluctant regulators to avoid catching them. Further incentives to cheat are provided by the massive amounts of money funneled into corporations by today's highly efficient stock market, bending behavior far beyond the typical levels of corporate fraud. Shapiro's analysis of these dangers speaks to macro policy at the broadest conceivable level-at the interaction between economic efficiency, trust in government, and justice.

This book's discussion of macro policy has its roots in early discussions about the impact of risk protection on economic efficiency and innovation. A positive view, eloquently expressed by the renowned economic anthropologist Karl Polanyi, is that government is the crucial vehicle for tempering and softening the profound dislocations associated with a dynamic economy. In The Great Transformation, Polanyi explains how the advent of the welfare state enabled citizens to cope with the destabilizing effects of the Industrial Revolution and its aftermath. Absent government tempering and disciplining, Polanyi claims, the entire capitalist enterprise would have imploded.

Micro Policy

The second part of this book focuses on "micro policy," the specific policy designs created to address perceived inadequacies in the regulatory regimes governing specific economic sectors. The term "deregulatory" does not adequately convey the nature of the micro policies described in this book. A more appropriate term for policies that ostensibly aim to increase private competition in a specific market realm is "market design." This is not merely a semantic quibble. Market design initiatives, successful or not, embody rules and regulations that are often at least as numerous and complicated as those they displace. Indeed, our chapters show a striking interpenetration of politics and markets. The traditional distinctions between government and market and between public and private do not apply to the processes of market design and redesign that we found to be at the heart of creating competitive markets.

The absence of literal deregulation is evident in all of our case studies. Banking, securities, and telecommunications provide especially striking examples of how efforts to stimulate competition result in ever more complex and numerous government strictures. Even if these initiatives have stimulated competition, nothing resembling complete deregulation has in fact taken place. Instead, the government has changed the nature of its involvement in order to make use of laws and policy designs establishing a pro- rather than anticompetitive institutional framework. Rather than deregulating, public policy has been self-consciously fashioning-or as Eric Patashnik puts it, reconfiguring-markets so that they will exhibit particular and contingent features. One of the primary goals of our analysis is to determine the extent to which these frameworks and features promote the pro-competitive goals they were ostensibly designed to foster.

The regulatory redeployments described here come in many guises. Some are fundamental to any effort at market formation, beginning with clearly defined property rights. Likewise, sanctions must be imposed on those who violate the norms of honesty and transparency on which market systems depend. To discourage fraud and deception, measurement must be accurate; information provided by the buyer must be true, and the payment provided by the seller must be genuine and timely. To this end, Cioffi points out, the Sarbanes Oxley Act established new forms of liability for chief executive officers, chief financial officers, and corporate boards of directors. Regulation in the form of antitrust rules and mandated consumer information may also be necessary to cope with certain market imperfections that competition cannot cure and may even magnify. As Frederick Hess shows, state education departments are struggling to make sure parents are adequately informed about the charter schools licensed to compete with ordinary public schools.

Making a new market is a much more subtle and complex regulatory task than maintaining an existing one. More intrusive rules may be needed to stimulate competitive behavior where it did not previously exist-an idea that Steve Vogel captures with the term "asymmetric regulation," in reference to regulations designed to impose restraints on incumbents and give advantages to potential competitors. Alan Jacobs and Steven Teles illustrate this concept in pension privatization in Britain. When privatization began in 1986, there was no market of individualized retirement savings vehicles for workers. The few products that did exist were designed for a small group of the self-employed and wealthy. The government sought to stimulate the creation of a broader market by proposing that holders of personal pensions be given a rebate on their National Insurance contributions (which then flowed into their occupational scheme, if they had one), and that contributions to personal pensions be deferred, just like contributions to occupational schemes. In addition, the government boosted returns on privately purchased pensions above the actuarial baseline.

Any such changes in the rules of the competitive game, despite the fact that they are meant to improve efficiency, will inevitably punish some competitors or some consumers, or both. Therefore new rules are likely to include some form of direct compensation, grandfathering, or other means of benefiting those who have been harmed. If benefits are difficult to define, Darius Gaskins notes, market designers may face great political obstacles, as those in the electricity sector do because they cannot guarantee in advance that the changes they propose will always produce lower prices. In the airlines case discussed by Michael Levine and Eric Patashnik, Congress had to establish a program of side payments in the form of regional and other subsidies to those interests whose opposition had to be neutralized if the reform was to be adopted.

Technological Innovation, Government, and Competitive Success

Our studies focus largely on micro efforts to create competitive markets and macro efforts to undergird and sustain them. But we recognize that in some instances the most important influences on particular markets may not be those micro or macro policies, but rather an exogenous force such as technological innovation. Regulation has repeatedly proved unable to stifle innovation. For example, tight regulation of railroads by the Interstate Commerce Commission (ICC) may have slowed the growth of competition in the transport sector but did not prevent it. Technological innovation in the form of trucks, automobiles, and airplanes placed relentless pressure on railroads to lower rates and improve service.

The best example of the impact of technological change is in telecommunications, which has seen greater price declines over time than any other economic sector discussed in this book. As Andrew Rich explains, telecommunications competition increased despite the Telecommunications Act of 1996, as a result of a technological development ignored by the act-cellular telephony. This technology dates back to the 1970s, when new telecommunications entrants such as MCI and Sprint developed novel alternatives to AT&T's reliance on landlines.

Although such innovation is exogenous to the policies this book considers, its success was dependent on prior government action. Neither Sprint nor MCI could have entered the long-distance phone market if not for the successful suit brought by the Justice Department to end AT&T's monopoly. The settlement forced AT&T to allow competitors to purchase space on its landline facilities. Without this court-imposed toehold, these dynamic innovators would not have had the chance to explore the technological alternatives to landlines that proved to be the precursors to the cell phone industry.

(Continues...)

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Editorial Reviews

" Creating Competitive Markets contains a rich collection of case studies, all of which shed light on the promise and pitfalls of market-oriented reforms. The book is a fascinating collection of narratives that can serve as the foundation for courses on regulation and the politics of institutional design." —David Andrew Singer, Massachusetts Institute of Technology, Perspectives on Politics

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