Of regulatory capture and regulatory timidity
My recent piece on “Dangers of regulatory timidity” appears to have excited many of our readers. While some of the reactions were quite strong and based on a misunderstanding of the concept of regulatory timidity, they present an opportunity for us to elevate and advance the discussion on regulation and other derivative issues naturally germane to regulation. Some of those derivative issues that grow wherever regulation is planted include regulatory capture, political influence, regulatory corruption and the concept of special interest; all of which mean completely different things with different implications for the economy.
The dominant normative argument for regulation stems from the view that natural monopoly requires a single firm to provide the goods or services entailed. Of course, the conditions that lead to natural monopolies have been identified by economists to include industries facing declining long run average costs or economies of scale. Natural monopolies occur in industries where the minimum efficient scale of production is not reached until the firm has become very large in relation to the total size of the market. They arise when there are very high fixed costs, as may exist when large-scale infrastructure is required to ensure supply.
Examples of natural monopoly situations include the cables and grids infrastructure for electricity supply, and pipelines for gas and water distribution. The investment on these items is generally known as sunk cost, which helps to prevent free entry and exit to the industry because many can’t afford it. Monopolies, like the then PHCN that had sole control of power supply in Nigeria, come to mind. Regulation is therefore needed to prevent exploitation of the masses by these monopolies. Accordingly, early literature on regulatory capture focused on the economics of natural monopolies, and the potential for them to negatively exploit their market powers.
A highly charitable view of the normative argument for regulating public utilities is that regulators are motivated strictly by the desire to protect consumers. This view, known as the public interest view, has long been attacked and defeated. It is now open secret that regulation sometimes ends up serving the needs of the regulated than those of the public. It has been found in many cases, in developing countries, that regulation is not always in the interest of the consumers of the regulated firm’s products or services. The regulated institution often ends up as the main beneficiary of regulation. We shall use this stand point to elaborate on the differences among the concepts of regulatory capture and timidity.
The concept of regulatory capture was initially articulated by Professor Stigler, the University of Chicago Nobel Prize winner, in his 1971 masterful article on the theory of economic regulation. Stigler therein explained that sometimes regulation, which was set up to prevent monopolistic abuse, ends up being “captured” by the monopolist or firms in the industry it sought to control. Of course, regulation is not only directed at the control of public utilities, for which we have seen a supportive normative argument. It equally applies to other activities and may come in the form of price controls and minimum entry requirements that limit participation, tariffs and policy instruments, among others. In industries such as banking and finance, regulation could be in the form of a minimum capital or spatial requirements.
An exposition of the elements of the two regulatory phenomena- capture and timidity – may be useful in explaining the difference between them. Regulatory capture bears both wide and narrow meanings. In its wide meaning, regulatory capture is the process by which special interest affects the power of government to regulate or intervene by any method, including setting of taxes, tariffs, choice of monetary policy and even choice of policy instruments. However, its narrow meaning relates to intervention in a particular industry. In this sense, it means the process by which regulated industries, especially monopolies, end up manipulating and controlling public institutions or government agencies meant to regulate and control them.
The original view of regulation was the “public interest view”, which assumed that regulators were motivated solely by the desire to protect the interest of the public. This view has long since been discarded as political and special interests have been known to take priority over the public interest in many instances of regulation. Regulatory capture is a mark of failure of government. It is a product of corruption foisted on the regulator by one form of inducement or the other, orchestrated by the regulated. It is an involuntary and corrupt act.
On the other hand, regulatory timidity, a concept I am developing and advancing, is the failure of the regulator to exercise its powers for reasons not traceable to any act of the regulated. It is not induced by the operators in the regulated industry and is not a result of bribery or any kind of corruption. Regulatory timidity happens when the regulator voluntarily restrains itself from doing its job because it believes doing so may set off reactions that might have serious negative implications for the economy. It is the failure of regulators to effect a regulatory action, not because they have been captured but because they are afraid that the effective and legitimate discharge of their duties may lead to greater damage to the regulated industry.
Regulatory timidity is not an act or product of corruption. Nor is it induced by the regulated. It is rather the free choice of the regulator to exercise fear (and this is different from caution), not necessarily of the regulated but of the possible unintended consequences of a regulatory action. Unlike regulatory capture, regulatory timidity is voluntary and not a corrupt act. It is more an act of cowardice. In the banking industry it may manifest in the regulator failing to wield the sword at a technically failed institution because it is “too big to fail”. In the telecoms sector it may come in the form of overlooking the terrible act of unwarranted charges to consumers now the rampant in Nigeria.
I think it is important to make this clarification because some readers, particularly among operators in the microfinance subsector, seem to misunderstand the phenomenon that could exist in any sector. They mistake it for regulatory capture, which is the control of a regulator by those it was set up to control. The two concepts are miles apart both in meaning and genealogy. In the literature on the economics of regulation, regulatory capture is discussed alongside political influence and corruption, which are at the root of it. Regulatory timidity is a budding concept of mine, the full ramifications of which are still under research.
While a timid regulator is not necessarily corrupt, it is equally dangerous. It fails to do its duties not for any form of inducement by the regulated but out of sheer cowardice, because it fails to anticipate and handle the consequences of regulation. The telecommunication companies are posting unsolicited adverts into our phones, making and renewing subscriptions to information we did not demand, and harvesting the meagre incomes of poor Nigerians. This is a sector where regulatory capture has not been ruled out. If we add timidity to it then the masses are lost. We continually receive notices that our membership to music clubs we never heard of had expired and was renewed at a cost, and the opt out option never works. It is time to know what is at play here – regulatory capture or timidity.
Emeka Osuji