No Free Lunch: Economics for a Fallen World: Third Edition, Revised

Chapter Eight: Market Structure: From competition to monopoly 191 Because of this potential inefficiency, many critics suggest that government needs to regulate oligopoly industries to ensure optimal efficiency. There are several problems with this idea that are worth reviewing. First, there is an assumption that a regulated industry would necessarily lead to the competitive result. Experience with regulated industries does not necessarily lead us to agree with that conclusion—as theorized by Nobel Laureate George Stigler, the industry may “capture” the regulator and not lead to the intended result. The regulator may serve the interests of the industry more than the general public. Interestingly, many of the major problems the U.S. has faced recently (from the subprime mortgage mess t o the BP gulf oil spill) have, in part, been blamed on poor regulation. While somewhat biased, examples of regulatory capture can be found here. Nevertheless, proponents of regulation are ever optimistic that further regulation may yet succeed. A second consideration is that a cartel that colludes in oligopoly industries is very difficult to maintain (beyond the fact that it is illegal). The reason why is that although it is in every firm’s interest to reduce market production as a whole (to gain the monopoly profits), it is also in their individual interest to cheat in order to expand their own production. At the overall monopolist quantity, an individual firm can still produce at costs lower than the consumers are willing to pay. So if they can get everyone else to restrict production to raise prices, they can secretly increase production and gain additional profit. The most effective cartels actually must have the government to enforce the agreement, since 1) the government is often better able to monitor compliance, and 2) the only leverage other firms can exercise to punish a member caught cheating is to expand production themselves. Government regulators are often the primary source of barriers to entry. Consider the safety regulations that new cars must meet. However beneficial safety regulations are to consumers (which is debatable when you consider both costs and benefits), they certainly increase the costs of compliance and production of the good. These regulatory costs are much more burdensome for new competitors trying to enter the market. And not surprisingly, large corporations in oligopolistic industries are often in the vanguard of those asking for additional regulation! Since the major problem associated with monopoly and oligopoly is the presence of high barriers to entry, it seems that the best approach for government action would be to concentrate on removing barriers to entry, especially those imposed by government. This will allow competitive forces to bring about the desired social outcome (production at quantities approaching the perfectly competitive outcome). ARE SAFETY REGULATIONS BENEFICIAL? If consumers understand the costs and benefits, economics suggests they are able to make the determination of the benefits of safety features without government regulation. If the consumers clearly benefit, they will pay for safety features without a government mandate. Many manufacturers do compete according to safety, offering additional safety features without any mandate (such as Volvo). But the mandatory aspect of regulations ensures that even customers that do not value the safety features as much as their cost will nevertheless be forced to pay.