How Well Does the Economic Theory of Politics Explain Deregulation?

July 2nd, 2014 by Gary McDonnell

The theory of economic regulation developed by Stigler and expanded by others is sometimes referred to as the Chicago theory of politics. Politicians broker resources, typically transferring them from large, unorganized groups whose individual members have a small stake in the outcome, to well-organized groups whose individual members have a large stake in a political outcome. Voter ignorance and apathy help this process along. There is a tendency for government regulatory bodies to be captured by the interest groups they oversee. Regulation is either enacted to address a market failure and then the regulated industry captures the regulators, or regulation is established in the first place to benefit interest groups. (Chapter 4 of Madmen discusses Stigler along with other key figures in public choice such as James Buchanan and Gordon Tullock).

But then, as Ed and Wayne point out on p. 106 of Madmen, deregulation occurred in a number of industries, a surprise to public choice economists. In my earlier post I discussed some of the reasons why there has been less confidence in the economic theory with respect to the exit of regulation from the political marketplace.

In this 1989 Brookings paper, Sam Peltzman, Micheal Levine, and Roger Noll survey the literature and debate some of the key issues regarding the economic theory of politics and how well it explains deregulation. In what he calls Arrow I (after Kenneth Arrow) Roger Noll challenges some of the key assumptions of the Chicago theory of politics, and explains why the Chicago theory of politics may be incomplete.  The most salient criticism by Noll in my view is that while political systems are inherently stable—that is, there are institutional constraints that generate “structure-induced equilibrium” such as separation of powers, bicameral legislatures, etc. –a more encompassing economic theory of politics includes not just interest groups but also a role for the political entrepreneur:

“A political entrepreneur is a person who invents a way to undo structure induced stability. He or she discovers how to take advantage of the fundamental instability of majority rule within the constraints imposed by the institutional arrangements designed to induce stability” (p. 51).

Politicians do not act as mere brokers between competing interests.  They can creatively pursue their own interests. The concept of the political entrepreneur is key to understanding how ideas fit into an economic framework of political change; the political entrepreneur is a major protagonist in Madmen.  A political entrepreneur with the right idea, at the right time, can overcome vested interests and benefit themselves in terms of votes, notoriety, and prestige. This insight helps in understanding how ideas and the incentives to use them must be compatible. Otherwise, ideas have no “efficacy in human affairs.”

In future posts I will discuss more of the literature on deregulation and discuss how the ideas put forth in Madmen contributed to my own work on deregulation.