In order to rationally treat deregulation, we must therefore
first examine other examples of deregulation and their consequences. We’ve touched on examples in Germany and
Poland, both of which produced outstanding results. A more complex foreign example would be the
rolling back of democratic socialism in India, which helped end the exceedingly
corrupt, monumentally inefficient “permit raj” approach to licensing private
industry. China, too, has instituted
market reforms, allowing for some measure of private ownership and
investment. It still maintains a
stranglehold over society in a legal / social sense, but the Chinese people are
unarguably freer today than they were 30 or even 20 years ago. And it is no coincidence that China and India
are both becoming major economic powerhouses in their respective quarters of
Asia. Regulation and central planning
shackled their economies for decades; privatization and deregulation have
brought prosperity and increased liberty.
And this is of course precisely
what Hayek and Friedman predicted. As
Daniel Yergin recounts in The Commanding
Heights, it took a great deal of courage for the social democrats in India
to swallow their pride and reverse their position. Prime Minister Monmohan Singh states, in the
PBS video documentary of the book, that it was difficult to admit fault,
especially given the reverence that many Indian politicians and bureaucrats
felt for their first prime minister, Jawaharlal Nehru, who was the chief architect
of the post-colonial economy. The
contrition expressed by the politicians, and the discomfort with which
bureaucrats accepted the new rules of the game, comprised part of what Yergin
terms “the agony of reform.” However,
once committed to that path, they found it only became easier, because the
positive results were so encouraging.
One lesson we can take from this is to expect some chaos in the wake of
deregulation; what matters most in any given instance isn’t the short-term pain
but the long-term gain. I would agree
that if the latter is of less significant magnitude than the former, then that
instance wasn’t worth the effort. But we
are only in a position to make this determination at some much later date, not
while we’re still in the throes of that agony (to which an entire third of the
PBS video documentary of Commanding Heights is devoted). Unfortunately,
another lesson from India is that corruption, once entrenched, becomes
difficult if not impossible to eradicate. Prevention seems to be more
desirable than cure in this regard.
But to drive the point home to my American readers, I’ll
focus on examples from our own country, preferably those examples that are
recent enough to be within memory or the newspaper archives. Probably the most well-known such example is
that of the airline industry. Yergin
provides a great deal of detail about how the airline industry grew up under
the aegis of federal regulation. In
keeping with Robbins’ theory on cartelization, Pan Am benefited substantially
from federal regulations, becoming one of a handful of national carriers
dominating the industry by preventing newcomers from getting a toehold.
High-tech, low-margin industries present formidable barriers to entry, and
those firms that can most rapidly exploit economies of scale become
predominant. Before federal regulations come to bear on any new sector,
market entrepreneurs with a profound economy-of-scale advantage can eventually
become monopolies; Standard Oil’s history is one example. Once the sector
becomes regulated, the advantage shifts to those firms that can best exploit
the regulations. Firms can leverage any such pre-existing advantage via
political patronage; firms that haven’t grown sizeable enough to thusly benefit
can appeal to anti-trust sentiment, or to whatever other political expedient
presents itself, such as a politician’s favor toward companies in his home
state. Where feedback loops present themselves (as through lobbying and
political action), this process—the shift from market capitalism to political
capitalism—is reinforced, and it accelerates. At its culmination, there
is no longer a free market (although pretense at such may remain for decades);
there is only corporatism. And this environment does not favor market entrepreneurs;
it favors those who can wield the government’s force on their own behalf.
Once political power has been coopted by corporate will, it no longer serves
the people. This is the source of the military-industrial complex and the
prison-industrial complex. At its extreme, this tendency results in
fascism. In moderation, it results merely in loss of freedom of choice.
As previously discussed, during the 1970s, Stagflation held
the American economy in an iron grip. There was no measure available to
policymakers, at least in a Keynesian context, that could improve either
inflation or unemployment without simultaneously exacerbating the other.
There were economists of the Chicago school arguing that the government’s price
controls were the leading cause of inflation, and that competition would prove
to be the necessary palliative, but opening up competition would in turn
require deregulation, and this was absolute anathema to the Keynesian orthodoxy
of the day. It was simply not given due consideration under the Nixon
administration (as demonstrated by his infamous statement “We’re all Keynesians
now”). “What is the effect of regulating the airlines?” asks Chicago
economics professor Sam Peltzman in the PBS documentary. “What is the
effect of regulating the trucking industry? What is the effect of
regulating the railroad industry? Very often it raises
prices. Instead of allowing competition, it suppresses
competition.” Alas, Peltzman was not on Nixon’s staff.
Supreme Court Justice Steven Breyer was not a Chicago
economist in the early 1970s; he was a member of the competing, liberal Harvard
school. He supported a liberal Democratic administration, and was an
acquaintance of liberal Democratic legislator Ted Kennedy. Kennedy asked
Breyer to head a Senate investigation studying the impact of federal
deregulation of the airline industry. What they found was that the
leading firms of 1938—the time at which New Deal-era regulation had been
applied to the airline industry—were still the leading firms in 1974.
Competition had had no effect on the dominant carriers, a telltale sign of
their having benefited from the regulatory climate. Members of the Civil
Aeronautics Board were called to testify before the Senate panel. The
figures that emerged from testimony were troubling: approximately 5% of
the regulators’ time was spent controlling prices deemed too high, and the
remaining 95% of their time was spent controlling prices they deemed too low.
The main thrust of regulatory effort was to ensure that prices
remained artificially high. And of course this was precisely how the
leading airlines wanted it. Contrast this with the “monopolist” practices
of Standard Oil, who while dominating the US market, always labored to lower
prices. Monopoly itself doesn’t provide a useful distinction between
market and political entrepreneurs; what matters, ultimately, is the presence
or absence of the firm’s willingness to coerce the consumer using state force.
Englishman Freddie Laker, owner of the cut-rate airline
Laker Airlines, pleaded his case with American federal regulators. The
system appeared, at least to him as an outsider, to be set up deliberately to
favor Pan Am. He was trying to get the market opened up to his firm,
Laker Airlines, as well as to other competitors that had been shut out of
participation. The Transportation Department listened to Laker’s
complaints, and then ruled that lowering prices (and thereby lowering barriers
to third-party entry) would hurt Pan Am. “The cause of all this is
Panamania,” he replied: the idea that “everybody should do everything for
Pan Am.” Nonetheless, Laker had patrons in government, such as Cornell
economist Fred Kahn, named chairman of the Civil Aeronautics Board in 1977 by
Jimmy Carter. Kahn championed the idea of a much leaner, weaker
regulatory structure. At the time, the largest division of the Board was
the Enforcement Department, which spent its budget by sending hundreds of
agents into airports to seek out companies offering discounts…for which the Department
fined them. Because airlines couldn’t compete on the basis of fares, they
competed in other ways, such as on the sumptuousness of their in-flight
meals. The Enforcement Department, in turn, issued fines to companies who
charged less than the commanded rates for meals. By the time Kahn was
done with the deregulation of the airline industry, the Board was left with
essentially no function, and so was decommissioned. A free-for-all of
competition ensued, with dozens of smaller and regional carriers coming into
and going out of existence. Some employees lost jobs, but were often able
to rejoin other carriers (or, eventually, the same carrier), albeit sometimes
at reduced salary. This is the kind of course correction, “agony of
reform,” that could have been avoided altogether had the market simply been
left competitive in the first place. But it’s to be expected that
progressives will blame the job loss on deregulation, rather than on
inefficiency in the market. It falls to you, the reader, to determine on
the basis of the above evidence whether the blame for job loss falls to the
market or to government. The net result for consumers today is
unquestionably more competition. Firms compete on the basis of fares and
amenities, and prices have on average gone down considerably. As happened
during the era of steamboat travel, the price war in air travel has brought
about an age of world travel, opening up flight to the masses. Many
competitors have lost, but the consumer has nonetheless won.
And while this is a major triumph for Chicago-school
economics and conservative policymakers, it must not be forgotten that this
triumph comes at the hands of liberal Democrats. Jimmy Carter and Ted
Kennedy are among the nation’s foremost practitioners of deregulatory economic
improvement, giving the lie to Democratic claims that such measures are, always
and everywhere, a bad idea for the economy and for the consumer. Similar
stories played out in the trucking and railroad industries. While these
are but a tiny subset of all economic activity, they in sum represent the bulk
of the transport sector, and their mutual deregulation has arguably contributed
to the massive, rapid growth of technology that began in the late 70s and
continues to this day. It could reasonably be argued, in other words,
that the personal computer revolution and the rise of the Internet have, among
their roots, the deregulation of domestic transportation. Even the Wiki
on Reaganomics acknowledges:
One controversial issue concerning Reaganomics is the issue
of how much of deregulation which took place during the 1980s the Reagan
administration was responsible for. Economists Raghuram Rajan and Luigi
Zingales point out that many of the major deregulation efforts had either taken
place or begun before Reagan (note the deregulation of airlines and trucking
under Carter, and the beginning of deregulatory reform in railroads,
telephones, natural gas, and banking).
Carter and Reagan, therefore, both deserve credit for the
win, but the theory itself long predated both. Nonetheless, the results
were positive, meaning that if we ignore the name and party of the individual
occupying the Oval Office and focus just on the policies, the policies are
fully-vindicated. Carter was a successful deregulator, but he was
unsuccessful at stimulating the economy or taming inflation, and that was
because although he could be talked into deregulation of specific sectors, he
could not abandon the strict Keynesian assumptions of the Democratic Party with
respect to unemployment.
The agony of reform nonetheless rears its head in most if
not all cases of deregulation. History presents us with one clear
maxim: there are unintended consequences for all rapid changes.
Another Democrat, William Clinton, oversaw the Executive branch during most of
the 1990s, replacing President George H. W. Bush largely on the basis of the
latter’s inability to keep his “no new taxes” campaign pledge. Bush had
achieved the Oval Office on the strength of the performance of his direct
predecessor, Ronald Reagan. Reagan is of course the Right’s shining
example of deregulatory, supply-side economics. The 1980s were one long
economic expansion, providing some of the best proof available of the validity
of the Austrian (and related) schools. At the end of that decade, another
phenomenal proof was revealed: the ability of capitalist prosperity to
outcompete economic planning. The Soviet Union, drawn increasingly into
competition with the West on such fronts as defense spending and outer space,
found itself unable to sustain its competitive participation while still
operating a functional economy. At its height, the USSR spent more than
60% of its GDP on national defense, an entirely unsustainable amount (and one
that the government carefully hid from outsiders as well as its own people); in
the early 80s, it froze domestic industrial output at 1980 levels, in effect
creating a deliberate recession. The constant focus on defense spending
and economic planning left little in the way of economic resources to grow the
economy or promote social development. Slow economic growth was
compounded by a burgeoning trade deficit with the West, itself the result of
the inherent superiority of capitalism. And the Reagan Doctrine—the
supplying of arms to governments fighting against Soviet-backed revolutionaries
or invaders—was compelling the Soviets to expend ever-greater amounts of men
and materiel in their various military entanglements.
After the United States announced its Strategic Defense
Initiative, the Soviets had little choice but to counter with an initiative of
their own…one which eventually broke the national budget. And although
the SDI program turned out to be practically infeasible, given the state of
technology at the time, it met its objective by effectively ending the Soviet
nuclear threat. Faced with the inability to keep government operating
without funds, and with communism under increasing attack elsewhere in the
Soviet bloc, General Secretary (and later President) Mikhail Gorbachev began
instituting substantial economic and social reforms in the late 80s,
culminating with the adoption of a fully-democratic political system supporting
an unplanned market economy. The result for the United States was an end
to the Cold War, and a commensurate reduction in the need for expanding defense
spending. Through the first of his two terms, Reagan had adhered largely
to the campaign platform of reduced taxes and lowered government
spending. And this combination, in concert with Volcker’s contractionary
monetary policy, helped tame inflation and bring about what was at the time the
longest peacetime expansion in the nation’s history. Democratic critics
are fond of pointing out that although Reagan met many of his policy objectives
during that first term, he nonetheless expanded government spending and raised
taxes during the second term. If we regard each term as a predominantly
one-issue administration (taming the economy and ending the Cold War,
respectively), then the pattern is explicable in terms of changing policy
objectives. Trickle-down economics worked, and once it was working, the
President’s emphasis shifted toward defense.
Another factor to consider is the degree of support Reagan
had from the predominantly Democratic congress. They were willing to work
with him on some measures, but the longer he was in office, the greater the
resistance they offered. By the start of his second term, he could no
longer count on any great degree of cooperation. As was the case with the
Mellon’s Treasury policies, the pendulum swung against him, and he ceased
making substantial economic progress. The difference between his degree
of success during his first term and that of his second comes down largely to
the differing degree of indulgence granted him by a hostile Congress.
That was not a problem faced by Clinton. Congress was
still heavily Democratic during his first term, and he didn’t face the
legislative resistance that Reagan faced. He was generally more
successful overall in getting his policies enacted, a fact which Democrats
point to with deserved pride. One fact that goes overlooked by Democrats
is that most of his policies were far more in line with Reagan’s supply-side
economic theory than with Roosevelt’s or Carter’s demand-side policies.
As previously discussed, Reagan’s tenure can be logically divided into two
terms, each with a different focus (and therefore each with a different degree
of observance of fiscal restraint). Early in his presidency, Reagan cut
taxes and cut government spending; later, he raised taxes and increased
spending. Clinton’s tenure offers a neat mirror-image of this
approach. During his first term, he raised taxes and increased
spending. Later, he lowered taxes and cut spending, continuing the
former’s deregulatory streak. The boom of the 1990s is frequently
attributed to this tax cut and decrease in government spending. It in
fact is but another example of the success of the Mellon Doctrine. And
this is attested to by Clinton’s own policy wonks. In February 1995, 18
months after the tax increase took effect, his Office of Management and Budget
issued projections of deficits for the next five years, assuming the
continuation of existing policies. As shown in the following graph, the
projection was an admission of defeat; the tax hike would not stave off deficit
spending, and in fact deficits would increase well beyond $200 billion over the
next five years.
So why didn’t government spending exceed that limit during
his tenure? In part, because Clinton was faced by an adversarial
Republican legislature during his second term, and this imposed strict fiscal
restraint on the government. Indeed, spending increased by only about
2.9% over the next four years. This encouraged the institution of the
1997 tax cut, with the result that the economy expanded considerably. In
this result, Clinton’s presidency extended and continued Reagan’s
results.
However, Clinton was a Democrat, and as such was less
committed to the idea of smaller government than had been Reagan. While
he was in office, Clinton oversaw some substantial increases to the size of
government. Regulatory structures such as FMLA, OSHA and NAFTA were
either enacted or greatly expanded, with the net result that employers began
seeking external labor markets. In effect, it had become much more
expensive and complicated to hire American workers, so corporations sought offshore
labor. While the offshoring phenomenon is decades old in the
manufacturing sector, it had never touched on white-collar work before.
An interesting collusion of competing principles resulted: India, having
substantially deregulated and privatized its economy, and with a growing
cultural emphasis on technology and education, suddenly became attractive as a
vast pool of cheap labor. It is now a growing economic powerhouse in the
tech sector; a substantial majority of the world’s programming firms reside
there today. And while this is no doubt a considerable boon to the
developing world, it presents another of those market-tilting distortions to
those of us living in the United States who earn a living by programming
computers. Now we have to compete on the basis of wages against
application developers who can survive at a much lower cost of living than we
can. The unintended consequences of regulation, once again, have unleveled
the playing field in a fundamental way. Clinton, as much as any one technology
firm, is responsible for the trend in offshoring. As such, he bears some
responsibility for the intractability of the 2008 recession, by diminishing the
number of domestic programming jobs available to unemployed programmers.
So Clinton, like Carter, produced wins and losses, achieving
an overall mixed record. Of all the presidents so far discussed, only
Reagan appears to come off without any major losses. Although he failed
to accomplish all of his policy objectives, resulting in the eventual increase
in marginal tax rates and the accompanying increase in government spending,
there is at least no mismanaged recession, nor any major damage to any economic
sector on the order of, say, offshoring. Volcker’s contractionary Fed
induced a sharp recession that the market nonetheless quickly recovered from;
had the tax cuts and spending cuts not already been in place, that recession
might have proven much more extensive and severe.
There is another example I can bring to bear here:
Vladimir Putin’s tax reforms. When he took over the office of President
of Russia, market reforms were well underway, and private industry was starting
to take the reins of the commanding heights. Like Reagan, he is often
credited with successes that were already underway before he stepped into
them. And he actually halted and reversed some reforms, starting a wave
of business nationalizations while satisfying personal agendas against
politically-irritating entrepreneurs. But among the first achievements of
his tenure was to restore pension payments to retirees, and shortly thereafter
got ordinary workers’ payrolls rolling again. The biggest problem he
initially faced was the budget shortfall. The Russian tax structure was a
horrific revenant of the Soviet era, with labyrinthine regulations, punitive
marginal tax rates and an exceedingly bloated, inefficient bureaucracy.
Tax evasion was, quite simply, the norm all across Russia, and the sheer number
of creaky bureaucratic moving parts made enforcement all but impossible.
The Russian tax agency recorded essentially $0 in collections the year he took
over. Putin’s reforms slashed the size and budget of the agency,
dramatically reduced marginal tax rates, and lowered the incentive to evade
payment. And, as had taken place under Andrew Mellon in the United
States, collections reflected the reasonability of the new rates, and revenue
burgeoned overnight.
The writing team of Daniel Yergin and Joseph Stanislaw wrote
in detail of the differences in technique and results between the American and
European regulatory models. Whereas many western nations adopted a
welfare state and a socialistic, nationalizing governance structure, the United
States opted to maintain industry and government in separate sandboxes, albeit
connected via regulation. Because the models are so different, it’s not
possible to obtain one-to-one comparisons between features and results.
But it is possible to evaluate each model’s successes and failures in the
context of the predictions of Keynesian and Austrian economic theories.
The Berlin of 1947, the Poland of 1989, and the Russia of 1991 are not the
United States of the Stagflation era. But in each of these cases, some
form of Chicago-style shock therapy was employed, and in each case, the economy
markedly improved immediately. There is no feature of Keynesianism, short
of sheer bloody coincidence, that can account for this, yet it is predicted
exactly by the Austrian and Chicago schools’ theories. Contrary to the
ever-lovin claims of Paul Krugman, there is substantial empirical
evidence in favor of their views, and against the view of his
hero. The most convincing argument he’s managed to bring to bear on the
success of Reaganomics is that the economy had been in decline for so long that
it was due for an expansive correction.
(This disregards the rather phenomenal coincidence of Britain’s Margaret
Thatcher enjoying similar success after having employed similar methods.)
Meanwhile, the successes of airline / trucking / railroad deregulation, and the
connection between Clinton-era regulations and tech offshoring, appear to have
pretty much sealed Keynes’ coffin…it might perhaps be hoped, with Krugman
trapped inside, lips extended in perpetual gesture of kissing the fossilized
posterior of his progenitor.
So far, the results of regulation appear vastly
underwhelming. We will hear frequently that abuses or “market failures”
have resulted from this act of deregulation or another; we will be told that
every natural disaster to occur in the next decade is the fault of corporations
who’ve bought government and successfully sought deregulation of their
sectors. I myself have heard that the BP Deepwater Horizon
disaster was the result of deregulation of the oil industry. Deregulation
of the single most heavily regulated sector in our entire economy (and not
coincidentally, people, the sector with the heaviest representation in the
Washington lobby) caused the disaster! Never mind that the National
Committee report of the EPA’s findings in the incident argue exactly the
opposite: that it was regulatory failure—the ineffectiveness of 13
existing regulations—that allowed the incident to take place. The report
specifically blames the ineffectiveness of the EPA and the failure of its
regulations to keep pace with technological changes in the energy sector.
It also makes no mention of any deliberate malfeasance on the part of the
corporation. The disaster took place as the perfectly innocent, yet
perfectly lethal and destructive, confluence of many individual acts of
negligence and unconcern, not as the result of any deliberate attempt to
improve the bottom line at the expense of safety. Among the Key
Commission Findings: “The Commission found that the Deepwater Horizon
disaster was foreseeable and preventable. Errors and misjudgments by
three major oil drilling companies—BP, Halliburton, and Transocean—played key
roles in the disaster. Government regulation was ineffective, and
failed to keep pace with technology advancements in offshore drilling.”
To be forewarned is to be forearmed. If you know that
the BP disaster was brought about not by deregulation, but by regulatory
failure, you can avoid falling prey to the same assumptions that pathological
ideologues cannot avoid. If you know that the Great Depression was caused
by government intervention, that the Obama stimulus plan is causing the Great
Recession to drag on endlessly, and that the Reagan tax cuts provoked the
precipitous expansion of the 80s, then you are heir to enough reason to be able
to shrug off the progressives’ propaganda. But in that case, you also
undoubtedly harbor enough reason to be able to grant the occasional
exception. There are some few regulatory efforts that appear to achieve
their desired ends without inflicting substantial damage on the economy.
The best measures are those that rely on the market itself, of course; this
keeps spurious signals out of the feedback loops, and permits the market a
modicum of self-regulation. The category of regulation to which this
model best applies is environmental regulation. The technique which has
produced the best results so far is “cap and trade.”
To understand how this works, we must first familiarize
ourselves with externalities. An externality is an activity
performed by one actor that impacts one or more other actors outside of the
market’s own mechanisms. Pollution is an example; it has no economic
value, and is essentially a byproduct of all economic activity (including that
of ordinary individual households), but its accumulation poses hazards to
everybody. The cap-and-trade system was set up in order to treat this
kind of externality as part of the market, and therefore as subject to economic
activity. In the case of atmospheric pollutants that contribute to acid
rain, polluters are permitted to trade portions of the maximum allowable level
of a pollutant. The maximum, or “cap,” is the limit mandated by the
regulatory body (in this case, the EPA); firms whose activity results in their
exceeding their portion of the limit are compelled to purchase additional
portions from other firms whose activity puts them below their own
limits. This brings pollution into the fold, so to speak, allowing market
mechanisms to allocate it in much the same manner as those same mechanisms
allocate resources. Although there is still enforcement envolved—the
“cap”—it isn’t more intrusive or oppressive than ordinary laws against
pollution, which impact private citizens to the same degree. The upshot
is that firms are generally willing to work within this framework, as it
permits a modicum of normal market activity. And it has proven
effective: cap-and-trade regulation of nitrous and sulfurous oxide
emissions from factories has reduced acid rain and brought about a return to
health in many previously-ravaged ecosystems, while not excessively impacting
either the operation or the profitability of the regulated firms.
So with all this in mind, we can now revisit the question of
whether electrical deregulation has on balance proven to be beneficial or
harmful to consumers. As before, the answer is necessarily “time will
tell,” but with the given that the agony of reform is temporary, and that
market mechanisms have a way of correcting problems over time. And, once
aware of the pros and cons of regulation and deregulation in any specific
context, consumers do still have the option of reinstating regulations, as
Virginia has done in the electrical market. And this brings me to the
last of my caveats and warnings about the impact of regulation: the fact
that most regulation is written by unelected officials, behind closed doors,
away from public oversight. The democratic process is supposed to require
constant interplay between the representatives and their constituencies.
As I’ve previously pointed out, our modern lobbying structure circumvents this
interplay, shifting the relationship from constituency to lobbyist. A
more sinister aspect of this syndrome is the fact that the people we elect to
craft our regulation don’t actually do the crafting. Much regulation is
written by organizations such as SEIU, the Service Employees International
Union, who had a major hand in the drafting of the Obama health care
bill. This may be a perfectly acceptable situation to many liberals, who
trust government implicitly. It is absolutely horrifying to conservatives
and libertarians and pretty much everyone else who regards his vote as going to
a specific individual and not to entities who neither campaigned for votes nor
face voter repercussions. The same people who regard the encroachment of
corporatism should find this situation onerous and threatening, but they are
incredibly accepting of it, considering how unaccepting they are of corporate
malfeasance. There is an incredible disconnect here, one that I’m at
pains to explain. The best I can offer is that people seem remarkably
susceptible to propaganda that fits into their worldview.
Still, while electrical rates have risen more than 21%
across the board, rates in deregulated states have risen an additional 15% on
average. Electrical deregulation may well prove to be unsustainable and a
bad idea for the consumer. If this turns out to be the case, however, it
does not bode ill for deregulation in general; it only demonstrates that sectors
involving natural monopolies should remain regulated. And this is a
point that Milton Friedman, et al, have made in their own arguments…and one
that Krugman seems perpetually poised to ignore utterly.
Choose your ideological authorities with care.
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