Regulatory Capture

What Is Regulatory Capture?

Regulatory capture is an economic theory that says regulatory agencies may come to be dominated by the industries or interests they are charged with regulating. The result is that an agency, charged with acting in the public interest, instead acts in ways that benefit incumbent firms in the industry it is supposed to be regulating.

Understanding Regulatory Capture

Regulatory capture, also known as “the economic theory of regulation” or simply “capture theory,” was introduced to the world in the 1970s by the late George Stigler, a Nobel laureate economist at the University of Chicago. Stigler noted that regulated industries maintain a keen and immediate interest in influencing regulators, whereas ordinary citizens are less motivated. As a result, even though the rules in question, such as pollution standards, often affect citizens in the aggregate, individuals are unlikely to lobby regulators to the degree that regulated industries do.

Regulated industries devote large budgets to influencing regulators at federal, state, and local levels. By contrast, individual citizens spend only limited resources to advocate for their own rights. This is an extension of the concept of concentrated benefits and dispersed costs of regulation, public policy, and collective action in general, described by economist Mancur Olsen.

In many cases, the regulators themselves come from the pool of industry experts and employees, in part due to the complex and specialized knowledge needed to regulate an industry, and may also then return to work in the industry after their government service. This is known as the revolving door between government and special interests. In some cases, industry leaders trade the promise of future jobs for regulatory consideration, making revolving doors criminally corrupt.

Regulatory agencies that come to be controlled by the industries they are charged with regulating are known as captured agencies, and agency capture occurs when that governmental body operates essentially as an advocate for the industries it regulates. Such cases may not be directly corrupt, as there is no quid pro quo; rather, the regulators simply begin thinking like the industries they regulate, due to heavy lobbying.

Even well-organized groups in favor of tougher regulations — such as the Sierra Club, a well-known environmental advocate — have only modest resources relative to industry interests.

Examples of Regulatory Capture

Regulatory capture is common across the economy and throughout history. Many argue that it is a ubiquitous tendency whenever any industry is regulated because even regulation that harms or imposes costs on existing firms also tends to create barriers to entry to new firms.

Regulation inherently tends to raise the cost of entry into a regulated market because new entrants have to bear not just the costs of entering the market but also of complying with the regulations. Oftentimes regulations explicitly impose barriers to entry, such as licenses, permits, and certificates of need, without which one may not legally operate in a market or industry. Incumbent firms may even receive legacy consideration by regulators, meaning that only new entrants are subject to certain regulations.

Regulatory capture can, in some cases, even result in deregulation of the behavior of the supposed subjects of the regulation themselves, while maintaining regulations that benefit them, such as barriers to entry, subsidies, and taxpayer bailout guarantees.

Transportation

The transportation industry in the U.S. can be considered a classic example of regulatory capture. In the late 19th century, as the industrial revolution created vast new wealth, government trade regulators openly advocated for the industries they oversaw, including railroads. Large railroad companies themselves advocated for regulation by the Interstate Commerce Commission (ICC) under the Interstate Commerce Act of 1887, and the ICC allowed the railroad industry to function as an effective cartel.

Finance

Modern financial regulatory bodies, likewise, tend to consist largely of industry insiders, have overlapping interests with industry, and act primarily in the interests of those whom they regulate. Financial market deregulation, at the behest of the industry, in the run-up to the financial crisis, combined with the retention of taxpayers guarantees for banks and the dramatic series of monetary and fiscal bailouts, are widely believed to have contributed greatly to the U.S. housing bubble and ensuing Great Recession of the late 2000s.

Criticism of Regulatory Capture

Some economists discount the significance of regulatory capture. They point out that many large industries that lobby regulators, such as industries in the fossil fuel sector, have experienced lower profits due to regulation. In other words, these economists argue that the lobbying efforts have failed to capture agencies.