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The Regulatory State
Wayne State University Law School
Hofmeister, Brandon J.

The Regulatory State
Prof. Hofmeister
Spring 2011
Theoretical Justifications for Regulation/Non-Regulation
I. Economic Analysis of Regulation
1. When adding up costs, think about ALL kinds of costs
a. Primary costs AND transaction costs
– An insurance system might reduce transaction costs, but might be worse at reducing primary costs because the costs are distributed around to other people – risky individuals may have less of an incentive to act safer
– A regulatory mandate may OVER-regulate; may have high transaction costs on government  making a determination and enforcing it
b. Keep Distribution in mind
– Can spread costs broadly to everyone (tax, insurance)
– Make the wealthy pay since they can afford it (tax)
– Make those who are risky pay (insurance)
c. Argue about incentives of actors
– The rule should result in people acting in ways that maximize utility
– Market: let people decide; or, Regulate: sometimes more efficient because “market failures” (externalities) make   market less efficient (mostly looked at in a negative way in CBA)
– Positive externalities – ex: someone plants roses in their yard you can look at it from your backyard
d. Use data/evidence to make arguments about what is more                      cost-effective
2. Economist – when & how to regulate
a. Free markets can be very effective at allocating risks efficiently;            use markets whenever possible. They are more efficient than direct controls
b. Regulate only when the market fails to efficiently allocate risks – when the market isn’t maximizing social utility; When there is an externality, regulation can help the market work better
c. How to regulate:
i. internalize the cost of externalities
ii. educate people better so they can make more informed choices
iii. be wary about regulating in ways that have large transaction costs – can decrease overall utility
            1. Problems with market approach
– The balancing of lives against money is not purely monetary
– Monetizing costs is difficult (ex: valuing a human life)
– Especially in a complex system, it is difficult to determine what is the cost of what, and where to regulate
– If a rule is created based on CBA, who should pay extra cost? (consumers, manufacturers, taxpayers)
– Can be insightful in creating an objective standard for making policy determinations: weigh benefits and costs; (ex: Rule against bikes in the park)
            2. Don’t have to just place costs on victims
– Can put costs on manufacturers, victims, taxpayers (society as a whole), place it on risky people, or the rich who can afford it
            3. Many actors can potentially decide where to place the costs
– Government regulators, judges/juries, consumers, companies
4. Using the market to address problems
a. Reduce the number and severity of accidents
– Forbid certain acts (criminal law)
– Make certain acts more expensive and less attractive (market)
b. Address distributional impacts of accidents – social costs
– Spread the costs widely – insurance or general taxes
– Require wealthier (more able) persons to pay
c. Reduce transaction costs
– The costs imposed by instituting a system of regulation and administering the system
d. Put liability on the cheapest cost avoider (CCA)
– Reduce transaction/administrative costs at a system-wide level (Ex: make young male drivers pay more for insurance)
– Avoid externalization of costs to third parties in the initial allocation; try to initially line up the costs with the parities who cause the most of the costs.
– Put costs on the party with the best knowledge of the risks of the activity & best ways to reduce costs.
Finding the CCA
“Best briber” – put the costs on the party who can     best transact in the market to spread costs to the real cost causer; put the loss on the person who can find the best decision maker; put costs on party       that is best suited to analyze the risks and find proper distribution – will lead to less transaction costs
5. Use of Markets
– Incentivize – encourage/discourage activities (don’t want a complete ban on all risk);
– Benefit of using market: all individual choice to set the level of accidents; good at allocating things efficiently; not as good at taking “justice” into account
– Assumptions of market approach:
a. individuals are the best judge of their own welfare: so long as one is adequately informed about his alternatives,     each individual  is best suited to make a choice about what he wants, including how much risk he is willing to take
b. prices adequately represent all of the costs of a particular good or activity. Costs should include: materials, labor, accident costs coming from product. If true the market will be  an efficient way to allocate; Individuals can spend their money on other things – there is an opportunity cost in giving up one thing to purchase another; As a whole society will reach an efficient equilibrium point that             maximizes overall welfare.
c. In a world of perfect information with no transaction costs, it doesn’t matter who has

risk of clothing a policy decision in CAB, making it seem more scientific and neutral, when actually, it is full of assumptions, and not as value-neutral as one may think
II. Liberty/Freedom
Roosevelt v. Friedman
The Role of Government
FR: gov. is meant to serve individual interests; limit gov. intervention to those instances where the free market is inadequate; government should set the ground rules for the free market to function
RO: equalizing opportunities across the board
Conceptions of liberty
FR: thinking about freedom in a negative sense (I have freedom from something); Restriction on freedom is minute
RO: thinking about freedom in a positive sense ( I have freedom to do something; you are able to take advantage of something); the freedom to do something means that others have to be regulated; Restriction on freedom is larger
Worker's safety
FR: if a worker doesn't like his job, he can find another job
RO: Business will act in its interest, which is not necessarily in worker's interests; need regulation
Environmental regulations
FR: could be against: would restrict the free market's ability to delegate materials amongst individuals; could be in favor: maybe the free market would not do a good job of protecting the resources; is an exception
RO: would be in favor of regulation, otherwise a few individuals might purchase & exploit the materials and future generations would not be able to benefit from them
Centralizing / Decentralizing government power
FR: the system is better off dispersing gov. power
RO: more concerned about concentrations of power in big business
Ex: Gov. regulating airbags
FR: if people were educated on how airbags worked, people could choose whether to have them or not; if we have regulation might increase costs
RO: the economy at large would benefit from the introduction of airbag regulation by the lives saved from airbags; business may not push for the regulation on its own
While Friedman distrusts government, Roosevelt distrusts big business