As embodied in administrative rules, public regulation is any attempt by the executive branch of government to implement statutory law controlling the behavior of citizens, business and nonprofit enterprises, and subunits of national or state/regional/ provincial governments. In effect, public regulation is the government’s attempt to limit the choices available to the regulated entity. The focus here, however, will be on the government’s regulation of business enterprises and achievement of policy goals. In industrialized nations with democratic forms of government, the legislative branch enacts statutes that codify public policy. These statutes, or laws, are then executed by the executive branch or, in some cases by independent agencies, which implement the law through the development and codification process of administrative rule making. These administrative rules are used to guide agency oversight activities and to assess penalties against the regulated party for noncompliance. The judicial branch is responsible for ruling on the constitutionality of administrative rules or legislative intent in the law. It does not have to be an “all-or-nothing” judicial decision, as sections of a regulation may be judicially upheld or struck down.
There are two approaches to analyzing business regulation: positive and normative analysis. Positive analysis examines when and what type of business regulation will occur, while normative analysis asks when government agencies should intervene in private markets. It is normative analysis that presumes government intervention is required in cases where competitive markets do not exist to an optimal level, resulting in “market failure” allocating resources inefficiently. In the public interest, political leaders will subsequently intervene to correct this market failure by enacting laws and codifying and implementing public regulations.
Market failure conditions exist when (1) negative externalities occur, a condition when business transactions create uncompensated costs for third parties, including abuses of “public goods” such as common natural resources, or negative internalities, where the regulation of product quality or workplace safety, for example, are not reflected in market exchanges; (2) there are natural monopolies, such as public utilities, when economies of scale are of such a magnitude (also referred to as an “entry barrier”) that a market can be serviced at the lowest cost only if production is limited to a single product; and (3) when market participants have inadequate information for markets to allocate resources efficiently. There is also a moral rationale for instituting business regulation. Elected representatives may put forth utilitarian fairness and justice ethical rationales to establish health and safety standards of behavior to protect employees, consumers, and other stakeholders.
“Public choice” economics provides another perspective on the normative analysis of public regulation. According to the public choice perspective, government officials, elected officials, and those in the executive branch and interest groups (including the business community) pursue their private interests in the regulatory arena with the same enthusiasm they individually display in the private market arena. Therefore, the pursuit of public regulation should be recognized as nothing more than an effort by government officials and interest groups to use public authority to redistribute income from one interest group to another, maximizing private gain at the expense of others. According to the public interest perspective, any benefits accruing to private groups from lobbying efforts to obtain these regulatory rents should not be considered as a subversion of the democratic process, but only as a reflection of the nature of the regulatory process.
From a positive analysis perspective, public regulation comes in essentially two forms: economic or social. Economic, or competitive, regulation is the oldest form of regulation and is most often industry specific (although industry wide as pertaining to, for example, labor issues) with public agencies concerned about the overall economic performance of the industry, while seeking to compensate for market failure by mimicking market conditions through administrative rule-making procedures. This form of regulation uses economic controls on prices, interest rates, and wages (using price ceilings or floors); places restrictions on the quantity of goods; establishes service territories; limits the number of participating firms; and allocates public resources. While some scholars view antitrust as a form of economic regulation, a stronger case can be made for the promulgation of antitrust, or competition, laws as an effective tool for avoiding public regulation, thus leaving resource allocation to competitive market forces rather than public regulators. The absence of competition in the marketplace is more likely to result in direct public regulation of price and profits or direct public regulation of a good or service. When antitrust policy fails to prevent the creation or maintenance of private monopoly power through the use of unfair business practices, direct public regulation is the usual response by government officials in a democratic market society.
The normative public interest justification for most economic regulation is to control prices established by so-called natural monopolies. While economic regulation has as its intention to protect consumers by adjusting prices so that they are equal to the competitive market price, there is no guarantee this will occur when decided by a public regulatory authority. There are five major reasons for this regulatory outcome not to occur: (1) regulatory established prices that are below competitive market levels can create shortages, deterioration in the quality of service, or other problems diminishing consumer welfare; (2) regulation can hold prices above costs, thus increasing prices and reducing consumption; (3) regulation and monopoly inflate costs, thus firms fail to operate at minimum cost; (4) regulation stifles innovation and entrepreneurial incentives to lower costs, improve quality, and develop new products and services; and (5) expenditures by business firms or groups to retain monopoly profits, or to protect themselves from below-competitive prices that expropriate assets, is considered wasteful and may even exceed the size of the wealth transfer (“regulatory rent”).
Social, or protective, regulation is a more recent form of public regulation—emerging in the 1960s and 1970s—and tends to be industry wide in coverage (although industry-specific as it pertains to, for example, the consumer safety of a specific pharmaceutical). The purpose of social regulation is to improve the quality of life or social conditions by protecting individual members of society from mainly noneconomic public policy issues concerning the adverse effects of discrimination or serious risks to public health, safety, or the natural environment. As commerce has become increasingly global in nature, the public health and safety of imported products has become a serious regulatory concern, especially from developing countries importing their products into developed countries’ economies. Social regulation may directly affect the conditions and physical characteristics under which products are manufactured (see command-and-control approach below). The normative public interest justification for most social regulation, particularly those addressing health, safety, and environmental concerns, is due to “externalities” or “information asymmetry.”
Social regulations can be designed by agencies using a number of compliance approaches. A command-and-control approach to regulation specifies in the administrative rule the technologies which a business enterprise must adopt in its operations to be in compliance. An output approach to public regulation specifies a performance level, but not the production methods, which a company must meet to be in compliance with the administrative rule. An incentive approach to regulation offers economic benefits to companies—which exceed a technical performance standard—by allowing these companies to sell their unused credits to other companies not meeting the technical performance standard in the administrative rule. Lastly, a disclosure approach to regulation allows consumers to make informed purchasing decisions on products or services by providing accurate information on their attributes to the potential buyers. In a descending order of magnitude following command-and-control public regulation, these respective regulatory approaches each represent a declining level of direct government intervention in business operations and consequently, an increasing emphasis on market-based solutions.
Because social regulation so often concerns people’s health and safety, risk assessment analysis is often applied to this form of administrative rule. Risk management analysis employs the science of risk assessment (which attempts to find out how much risk is presented by a certain factor “X”), as well as other pertinent information, and to find out how much risk is too much for society to accept. To acquire these answers, public regulators must balance the risk with the costs and benefits of reducing it. The evaluative methodologies applied to risk assessment include (1) risk-risk analysis, which compares the risks associated with regulating with the risks associated with not regulating; (2) cost-effectiveness analysis, which compares the cost of different approaches to meet the legislative charge underpinning the administrative rule against a quantitative metric—such as life-years saved or tons of pollutants removed from the atmosphere; and (3) cost-benefit analysis, which attempts to quantify and assign dollar values to the benefits and costs of different policy approaches. Economic regulation can also be evaluated using the above-cited methodologies of cost-effectiveness and cost-benefit analyses.
While public regulation receives the most attention, there is also a growing interest in private regulation, also referred to as self-regulation. Self-regulation, in its broadest sense, involves planning and policy making regarding issues and activities not covered by public regulation. Self-regulation exists when a firm, an industry (or profession), or the business community establishes its own standards of behavior, through a code of conduct or ethics, either self-established or adopted, or technical specifications where no such statutory or regulatory requirements exist, or when such standards assist in complying with or exceeding existing statutory or regulatory requirements. In general, self-regulation is a voluntary activity that involves behavior or activities (such as abiding by social, political, environmental, or economic principles) of a discretionary nature.
Industry self-regulation standards or business practices may eventually be referenced in administrative rules regulating business activities, thus giving these standards or business practice legal compliance requirements. Self-regulation standards or business practices also may include specified forms of inspection and certification of compliance with the established standards or business practices. Self-regulation standards or business practices may be certified by the firm (first-party certification), industry trade association (second-party certification), an independent third-party auditor, such as a nongovernmental organization (third-party certification), or by an international quasi-governmental or nonprofit assessment organization (fourth-party certification), such as the United Nations, with its business practice–oriented Global Compact, or the ISO, the international technical standards–setting body, respectively.
Trends In Public Regulation
In democratic, market-based economies, the trend throughout most of the 20th century has been to increase public regulation of the private sector. Beginning in the late 1970s and continuing through the 1990s, an international regulatory reform movement emerged that predominantly emphasized economic deregulation of industry—but not exclusively. For example, regulatory reform efforts in the United States and Great Britain have generally reduced public regulation of industry, but recent changes in Germany and Japan have reinforced national regulatory agency control (largely because of the movement from public ownership to “privatization” of major industries). There have also been some deregulation efforts occurring in European countries, especially directed at social regulation. During the early 2000s, there was reregulation of the U.S. securities industry, a result of corporate scandals typified by the demise of energy giant Enron Corporation, focusing on developing administrative rules strengthening financial reporting practices.
In the mid-to-late 1970s, many economists argued that the administrative rules that had been adopted to regulate “price and entry” by business were sometimes ineffective and could actually block the effective attainment of the original policy objectives, that is, to compensate for market failure, by failing to provide economic incentives for industry innovation. In contrast to the criticisms of economic regulation, critics of social regulation attacked the regulatory procedures, objectives, and goals of administrative rule making. Citing legislation specifying rigid industry standards (and thus, only one approach) and precise deadlines to attain compliance, these “technology forcing” administrative rules were often impossible to meet, as the technology was not, or did not, become available. Other critics of social regulation believed that the health, safety, environmental, and equity legislative objectives embodied in administrative rules were simply not worth the increased role (and cost) of government in society, as society would be better off relying on the values and choices of individual citizens.
The increase in, and costs of, economic and social regulation in the United States can be illustrated through the longitudinal data analyses conducted by the Center for the Study of American Business at the University of Washington. For example, between 1960 and 1980, the staffing requirements of national regulatory agencies rose from fewer than 40,000 federal employees to approximately 100,000 federal employees—or a 150 percent increase in the number of federal employees. For the same range of years (1960 to 1980), the costs (unadjusted for inflation) of federal regulation rose from just under $20 billion (1960) to approximately $80 billion (1980)—an average annual increase in regulatory costs of $3 billion, or 15 percent on the base year 1960, borne by industry and consumers. While economic regulation costs modestly exceeded the costs of social regulation in 1960, the cost of social regulation was nearly two-and-a-half times that expended on economic regulation in 1980.
In spite of these rapidly rising public regulatory costs, defenders of increased public regulation, particularly of the social form, argued that the benefits still outweighed the costs (although benefits are more difficult to monetize). Since 1980, regulatory reform efforts in the United States have stanched the increase in national regulatory agency staffing, as the level of employment has increased modestly to approximately 110,000 employees by the middle of the first decade of the 21st century. However, the costs of federal regulation (unadjusted for inflation) has continued to rise to more than $170 billion (2005) over the ensuing 25 years, although reflecting a decreasing rate of growth in the cost of public regulation over the 1960–80 period.
As global commerce has expanded, so has the international regulation of business practices. In 1994, the World Trade Organization was established to define the rules under which international trade is conducted and to resolve disputes among member nations. The World Health Organization (WHO), an agency of the United Nations, has partnered with the global pharmaceutical industry to establish quality standards and resolve potentially harmful marketing and manufacturing practices. WHO had previously worked with infant formula manufacturers to develop an international marketing code, which would later be adopted as national policy by governments. The development of bilateral or multilateral regulatory agreements between or among nations is a process by which numerous stakeholders, representing business, government, and nongovernmental organizations (the latter representing labor, consumer, or environmental interests), engage in lengthy consultation. The list of multilateral agreements regulating business practices pertain to ocean fishing, chemical emissions affecting the earth’s ozone layer, and the dumping of hazardous chemicals in oceans, to name a few.
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