ChainWhat it assumes · how to break it
Start
The government limits a harmful activity by law, for example emissions standards for new cars or the ban on smoking in enclosed public places in England from 2007.
1
As a result, the government must write the rules, inspect firms and punish breaches, which takes information and administrative resources.
administrative costs
administrative costs
Assumes: Enforcement is costly.
But: Some rules largely enforce themselves, such as smoking bans that the public helps to enforce.
2
This means the regulator depends on the industry for technical information and expertise, and may come to act in the firms' interests.
regulatory capture
regulatory capture
Best link to attack
Assumes: The regulator relies on the industry it regulates.
Assumes: The regulator relies on the industry it regulates.
But: Regulators that do their own testing, publish their decisions and limit staff moving into the industry are harder to capture.
3
Consequently, rules may be set too loosely or enforced weakly, as when laboratory tests of car emissions failed to reflect emissions in real driving.
information gaps · enforcement
information gaps · enforcement
Assumes: Weak rules go unchallenged.
But: Independent testing and media scrutiny can expose weak rules, as happened with diesel car emissions.
4
Therefore, the externality persists while firms and taxpayers bear the costs of compliance and enforcement, a net welfare loss: government failure.
government failure · net welfare loss
government failure · net welfare loss
Assumes: The costs exceed the reduction in harm.
But: Even weak regulation may reduce harm by more than it costs.
End
Capture and weak enforcement can leave the externality in place at a cost, which is government failure.
Evaluation chain
- E1However, regulatory capture depends on how closely the regulator relies on the firms it regulates.
- E2When the regulator carries out its own testing, publishes its decisions and has staff who do not move to jobs in the industry,
- E3then firms have less influence over the rules, and breaches are more likely to be found.
- E4So regulation causes government failure through capture mainly where regulators are weak and dependent on industry; strong independent regulators reduce the risk.
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Questions this answers
- Explain what is meant by regulatory capture and how it can lead to government failure.
- Assess the problems of using regulation to correct market failure.
- Evaluate whether regulation is likely to lead to government failure.
Diagram
MPC, MSC and demand: draw the legal limit set well above Q* (too loose), so most of the welfare loss triangle remains; add that enforcement costs are an extra cost not shown on the diagram.
Reverse and related
Stronger, independent regulation → less capture and better enforcement, though at a higher administrative cost.