Courts Fail. Use Regulators
Andrei Shleifer examines why regulation might emerge.
The Pigouvian theory is undermined because market failures or information asymmetries do not seem to be necessary for regulation, yet those are seen by the theory as the prerequisites for government intervention. The Coasian position is undermined because free contracts are expected to remedy market failures and eliminate the need for regulation, yet regulation often intervenes in and restricts contracts themselves, including contracts with no third party effects. The puzzle of ubiquitous regulation remains.
when litigation is expensive, unpredictable, or biased, the efficiency case for regulation opens up. Contracts accomplish less when their interpretation is unpredictable and their enforcement is expensive. Liability rules would not address market failures if compensation of the victims is vulnerable to the vagaries of courts. In short, the case for efficient regulation rests on the failures of courts.
…Competition without courts and contracts does not do much.
Thanks to John Alcorn for the email pointer.
The question that occurs to me is why regulation is supplied by government rather than by the private sector. If workplace safety regulation is more efficient than a system that relies on competition and contracts enforced by courts, then an entrepreneur could offer to set up a workplace safety standards body and earn fees from market participants for certifying compliance.
An example that I refer to in Unchecked and Unbalanced is kosher certification. There are 600 different certification bodies around the world, none of them affiliated with the U.S. government.
Underwriters’ Laboratories, which certifies electrical equipment, is another example of a private regulatory body. What Shleifer’s paper fails to explain is what determines the choice between private and government regulation.
What I suspect is that government regulation emerges when some firms want to restrict entry from other firms. Regulations that restrict entry are likely to be harder to enforce when they come from the private sector, because the unwanted entrant has little incentive to comply. Only with government coercion can entry-restricting regulations be enforced.
To induce taxpayers to fund any sort of regulation, a broad public interest must be asserted. However, of the universe of regulations that might be given a public interest justification, the ones that will be enacted will be those that serve to protect incumbent firms from new entrants.
[UPDATE: a reader emails me to suggest many Masonomics thoughts on this topic:
The point about regulation compensating for defects in the court system was also made by a “Masonomist”, though on opposite day, here.
You can see Alex (not Axel!) make those criticisms of the court system on the videos for the AEI event for his book.
In his paper, Schleifer points out that while contracts should provide solutions to the same problems regulation is supposed to solve, regulation often restricts contracts themselves. Robin Hanson argues that we should be able to contract out of regulation.]