The X, Ys and Zs of regulation

For some time now we have been setting out the history of insurance regulation. We have also been trying to link this history to the economic theories of regulation.

This study now forms part of an honours course at the University of the Witwatersrand. However, there is a gap in this history.

Closing the gap

Academics do not like gaps because they should not exist. The academic ideal was captured by Sir Isaac Newton, one of the world’s greatest scientists when he said, “If I have seen further, it is by standing on the shoulders of giants.”

To make a contribution it is first necessary to discover what is already known. All academic research starts with a literature review section. When looking back, no gaps exist. Therefore, gaps are problems.

In the theory of regulation, we found a gap. The question is why do we have regulation at all? The original correct reason seems to have been forgotten.

Life, liberty and property

The answer for regulation is the same reason we have governments. Why then do we have governments? It is generally accepted that the answer to that question was famously given by John Locke when he wrote, “The great and chief end, therefore, of men's uniting into commonwealths, and putting themselves under government, is the preservation of their property.”

He considered life, liberty and property as property. The American’s called these unalienable rights. The Americans accepted Locke’s reason as is, clear from their Declaration of Independence. They went to war against their British government declaring that if a government threatens their unalienable rights they reserve the right to rise up and overthrow that government and that is what they did.

Therefore, one would think the only basis for regulation is to protect the rights of life, liberty and property. One would expect, when reading any fundamental text on regulation, to see this as the basis of regulation.

Indeed Locke himself said so, “Political power, I take it to be the right to make laws for regulating and preserving property only for the public good.” So laws are made to protect life, liberty and property where such laws are for the public good – or, as is more often said, laws in the public interest. Laws can only be in the public interest where they protect life, liberty and property.

Confusion in the transition phase

This is all very good and clear. However, there is a problem. When one reads more modern texts something different and very confusing appears.

Take for example a statement made by Mr Justice Richard Posner (1971), at the time a Professor at Chicago University, when he said “The Public interest theory holds that regulation is supplied in response to the demand of the public for the correction of inefficient or inequitable market practices.”
So regulation is not there to protect life, liberty or property but to correct inefficient or inequitable market practices!

We can all understand life, liberty and property laws; laws prohibiting murder, rape, kidnapping and assault and so on but what is an inefficient and inequitable market practice?

These things appear rather arbitrary and confusing and in our quest to fill the gap, we wondered where this came from and why, in the literature, is this not explained. It simply starts to appear in the early to mid-1950s.

If academics had done their job properly there would not have been a gap. The transition should be explained in the literature however, it is not. This gap comes from American history and so to American history we must go.

In the late 1800s allegations began to surface in America that Big Business was oppressing society via monopolies and so, in 1890 the Sherman Anti-Trust Act was passed. Matters become a bit clearer.

In theory, a free market results in competition and competition produces the lowest practical prices. Should the market fail to do so, then the new theory says market failure occurs and government intervention is justified. Regulation then exists because of some perceived market failure. The scope for government intervention now widens considerably. If the market is inefficient i.e. does not produce the lowest practical prices, regulation becomes justified. If the market price is too high, the market is inequitable and then regulation becomes justified. Regulation becomes totally arbitrary and always justifiable!

Existence of monopoly profits

When the Sherman Anti-Trust Act was passed in 1890, did monopoly profits exist? Allegations were made but what about reality?

George Stigler, who was awarded the Nobel Prize in Economics, in 1985 investigated the existence of monopoly profits during the 1890s. The complaints were directed against the railways and emanated from the agricultural sector.

He found agricultural expenditure on railway services had accounted for a mere 1 to 1.5 per cent. He concluded that regulating railway rates would have made a negligible addition to farm incomes and that farm expenditure costs on transport, had in any event declined with the introduction of railways. He pointed out that railways were not attacked because they were in fact the devil but because farmers believed they were the devil. Therefore, the belief that monopoly profits exists does not mean they do exist.

In 1991, Professor Thomas DiLorenzo, who has spent a life time studying the economics of competition and is the author of the leading textbook on the subject, concluded that there was never a golden age of monopolies. As a general rule, monopoly profits in a competitive market do not and never have existed. To the extent that this may be possible, it is a matter of timing.

Justifying regulation

To argue that regulation can be justified because of market inefficiencies is to base regulation on an arbitrary illusion and cannot be a solid basis for regulation. So the transition from Locke to market efficiencies can be explained but why does the transition take place?

Well it seems the new basis of regulation was introduced with little thought of the fundamental basis of legislation. At the time this was realised by at least one Senator, James George (1890). He opposed the Sherman Anti-Trust Act with “I have shown this bill is utterly unconstitutional, and, even if constitutional, utterly worthless. If we pass it we do not only a vain and useless thing; we do a wicked thing.”

Adopting competition legislation, as we have in South Africa, also demonstrates the foolishness of what is nowadays referred to as “Best International Practice”. When we import legislation from other countries we should understand the reason for that legislation or we may simply be importing unconstitutional and utterly worthless legislation.

It is odd however, to see leading economists justifying regulation on the basis of something as vague as market inefficiency. Clearly this can be of no practical value to justify regulation. On this basis, all regulations become arbitrary. More importantly if regulation is passed on market inefficiency grounds does it violate the original purpose to protect life liberty and property? The answer is yes.

So, if one has liberty, one is free to enter into exchange contracts. So a person who wishes to be employed can do so at a negotiated rate. Liberty gives him that right. However when the National Minimum Wage, for example, is introduced, he cannot do so even in those cases where the person who wishes to employ him will gain no profit at all.