Thoughts on Regulation

James K. Galbraith made an interesting point regarding government regulations of business in his book The Predator State. While government regulations are usually posed as impediments to progress and a general nuisance, he points out that regulation can be the friend of both business and consumer.

"Regulation emerged, reached its high point in the Nixon administration, and survived thereafter because a large part of the business community was prepared to support it. And this was so because while regulation is a burden for some businesses, it is a competitive blessing for others. A functioning structure of regulation is the competitive instrument of the more progressive part of the business community, which wishes—for its own advantage—to force everyone to play by a common set of rules."

Playing by a common set of rules is the critical issue. Say you are a manufacturer of a product that is safe and robustly designed to be reliable and long-lived. These attributes do not come for free; they add to the cost. If there are no rules defining safety standards, then it is relatively easy for another company to come in with an inferior product that is less safe and less reliable, but at a much lower price. The lower cost item will take away some of the business and put pressure on the first business to cut costs to compete, and in the process also put out an inferior product. This competition could easily lead to a situation where the only product available is cheap junk and neither the business nor the consumer is happy. With regulation in place, the companies would have to compete on a basis that does not diminish the quality of the product. It would be more likely that the consumer would get a good product at a good price and that the most efficient company would be able to make a decent profit.

This idea of regulation providing a common set of rules that can benefit everyone comes up in the current debate about financial reform as well as the health care debate. Consider a financial outfit that is trying to be conservative in limiting its exposure to risky by maintaining a reasonable amount of capital to fall back on and cover any losses. It has to compete with an outfit that does not share those concerns, one whose debt-to-capital ratio can be enormous. When times are good that has been shown to be a way to make a lot of money. The conservative firm now has to explain to its shareholders why it is making less money. So it will come under pressure to leverage its transactions more heavily also. The lack of regulation then has pushed all the players into a risky situation. As we have seen when times turn bad they can turn very bad when this is the case.

Similar situations arise in health care. Many states have minimum coverage regulations which define what can and what need not be contained in a medical insurance plan. These are intended to protect the consumer from spending money on a plan that is essentially worthless. A lot has been said about allowing people to purchase out-of-state plans. The reason for doing this is to allow people to shop in states that have the least protection for the consumer. Once again you will have a rush to the bottom in terms of coverage if that is allowed to occur. Federal, nationwide coverage rules would eliminate this downward competition.

Regulation, thoughtfully applied, can be to everyone’s benefit.