Peltzman: Toward a more general theory of regulation

Peltzman. 1976. Toward a more general theory of regulation. Journal of Law and Economics 19: 211-240.

In Brief

Stigler's model of regulation gave a demand-side explanation of regulatory politics--that is, an explanation based on Olson's logic of collective action, showing that the largest firms will lobby most effectively, resulting in regulation that almost always favors producers over consumers.

Peltzman seeks to update Stigler's theory to give it equal attention to supply-side factors--that is, factors that might motivate regulators to produce regulations that benefit consumers even though producers lobby better. Peltzman's primary motivation is to replace Stigler's vague concept of a "regulator" with the more concrete idea of a "legislator," with all the electoral motivations that implies.

Peltzman's theory, then, presents a balanced theory of both supply and demand of regulation. This theory specifies a political equilibrium for a regulator (i.e. how much he should bend to producers' demands).

Main Argument

Stigler's theory had problems. It would not explain why Congress passes regulations that hurt big businesses, or why protectionism is sometimes reduced. To obtain more realistic conclusions, Peltzman modifies the theory. He begins with three main premises:

1. Regulation redistributes wealth;
2. Regulators (legislators) desire to remain in office--so legislation will always be written to maximize political support (see Mayhew);
3. Interest groups compete by offering political support in exchange for favorable legislation.

Note that "political support" might mean either money or votes. So if a proposed regulation would increase prices, it has two effects on political support. Producers (at least those affected by the regulation) would gain profits, so the legislators gain interest group support. And consumers would have to pay more, so the legislators lose voter support. Winning takes both money and votes, so legislators will balance these two types of support at an equilibrium point that maximizes their chances of reelection.

Equilibrium

To say the same thing in more economic language, consider this process in terms of marginal gains and marginal costs. Regulators want to be reelected. They base their decision about a proposed regulation on marginal political costs and marginal political gains.

• Marginal gains: Each additional amount of protection provided to an industry brings the sorts of benefits Stigler talked about (campaign contributions from the big firms, etc.). Marginal gains are weighted by the probability that beneficiaries will actually support the regulator in the future.
• Marginal costs: Increasing protection reduces consumers' surplus. In effect, it creates an implicit tax (based on the size of the benefit transferred to producers and the number of nonbeneficiaries in the population, among other things). (The implicit tax is similar to a per-capita decline in consumer surplus). Marginal costs are weighted by the probability that this implicit tax is large enough that consumers will vote against the regulator in the future.

When marginal gains equal marginal costs, the regulator is at political equilibrium.

Deciding Whether to Lobby

In addition to the potential per-firm wealth transfer that the beneficiaries can enjoy, they also consider the total costs of getting these regulations (costs of politically supporting the regulator, costs of organizing to lobby). These firms may incur lobbying expenses for "voter education" programs (to persuade voters to support their tariff or whatnot). An interest group lobbies when the benefits exceed the costs.

Deciding Whether to Counter-Mobilize

Consumers rarely have an incentive to take action against the regulator (legislator); see Olson.

Comments and Criticism

Stigler left the "regulator" in a black box. Peltzman improves on this by thinking of the regulator as a legislator. But most regulation is done by executive agencies, not Congress. Later research has emphasized the importance of legislative-bureaucratic interactions in actually producing regulations--and this relationship might be just as important as the relationships Stigler emphasizes.