Economic Regulation and Social Regulation

1
Economic Regulation and Social Regulation Novembe
r 26, 2007 Eric Rasmusen, Indiana
University, visitor, Nuffield College, Oxford
2007-08
2
When should the state use coercion?
Health, safety, morals, and the general
welfare'' are the traditional subjects of the
police power of the state. Health,
safety, and morals might be ends in themselves,
but they also might be means to the general
welfare. Economics adopts a particular
definition of general welfare called
efficiency, or, as I prefer it, surplus
maximization. We can use surplus
maximization as a test for what regulations are
desirable.
3

• The Economists MethodThe Rational Actor Model
• Analyze a situation in terms of players, possible
  actions, information available to each player.
• 2. Figure out each players objectives his
  payoff function usually a matter of trading off
  different goods.
• 3. Figure out the equilibrium--- what happens as
  a result of the interaction of the players.
• 4. See if different actions or rules to constrain
  actions would increase the equilibrium payoffs.
  

4

• Usefulness of the Rational-Actor Model
• Anonymous interactions in goods markets (supply
  and demand)
• 2. Strategic interactions in goods markets (game
  theory)
• 3. Sociological interactions (marriage, racial
  discrimination)
• 4. Political interactions (elections, committee
  agendas)

5
Why does morals regulation exist? Externalities
soft paternalism
6
(No Transcript)
7
Some Related Works
Feinberg, Joel (1988) Harm to Others, 3 more
volumes of The Moral Limits of the Criminal Law
Buckley, Frank, Just Exchange, 2005
Kaplow, Louis and Steven Shavell, Fairness versus
Welfare 2002 Eyal Zamir, The Efficiency of
Paternalism,'' Virginia Law Review, 1998
Eric Rasmusen, "The Economics of Desecration
Flag Burning and Related Activities." J. Legal
Studies 1998 Richard Zerbe, Econ. Eff. In Law
and Economics, 2001
8

• The Argument I Economic Regulation
• 1. Laissez faire generally maximizes surplus in
  market
• interactions (the Invisible Hand works)
• Government is useful to enforce property rights
  and
• contracts, a background function.
• 3. Market failures can make regulation helpful
  poor
• information, monopoly, real externalities,
  coordination.
• 4. Even then, government failure may make
• regulation worse than laissez faire. And often
  the market
• will cure market failure (e.g. ads).

9

• The Argument II Social Regulation
• 5. In social interactions, market failure is
  routine
• poor information, decisions with delayed
• results, mental externalities, behavior towards
  others.
• 6. It is hard for a market to profit from solving
  these
• failures (though free advice is easier to get
  than in
• market decisions, if desired, because of
  externalities)
• 7. Laws that are paternalistic or prevent selfish
  behavior
• can help. SOFT PATERNALISM, MENTAL
• EXTERNALITIES
• Often social norms are easier to enforce.

10

• The Argument III- Government
  Failure
• Government failure in the form of capture by
  special
• interests is less of a danger than in economic
  regulation
• because usually there is less profit
  opportunity.
• Government failure due to honest bad decisions
  is
• more of a danger than in economic regulation,
  since
• we understand social interactions less well
  (precisely
• because they are more complicated).
• 11. Hence, governments should be cautious either
  in
• changing traditional social regulation or
  imposing new
• regulation.

11
A Paradigmatic Example Buyer
approaches Seller and asks if Seller will sell a
bottle of whisky for 10. Seller agrees, and
the whisky changes hands. Is the transfer of
the bottle from Seller to Buyer a good thing?
Surplus maximization says that it is.
12
Surplus Maximization Is Consequentialist
It is not based on consent. We could have
Government force Seller to give the bottle to
Buyer, and force Buyer to leave 10 with Seller.
The result would be the same. Or, we could have
Buyer steal the bottle from Seller. The result
would be the same. Assumption we maintain the
high value of the Buyer and the low value of the
Seller, and ignore incentive effects and
transaction costs.
13
Market Background Governme
nt is useful to define property. This is a
necessary background to the regulation against
theft. Government is useful to enforce
contracts. Then the money and the bottle need
not change hands simultaneously.
14
Market Failure--
Information What if the bottle might be filled
with coloured water instead of whisky, and Buyer
cant tell in advance? --- regulations against
fraud are useful. --- even without them,
seller reputation, warranties, samples can
help, at some cost
15
Market Failure--Externalities Wha
t if we can predict Buyer will smash the
empty bottle on the sidewalk, something Third
Party would pay 2 to prevent? This is an
externality. 1. Give Third Party the property
right (or liability right) over bottle-smashing.
He must give permission or be paid. 2. Ban
whisky sales. (OK if Buyers value is 11,
Sellers is 9.50). 3. Tax the transaction 2.
16
Market Failure Information, Paternalistic
What if whisky is bad for Buyer, in the sense
that 10 years later he would be thankful for not
having bought it? What if whisky is bad
for Buyer in the sense that if he bought it now,
he would wish 10 years later that he had been
stopped? This is like the JS Mill
argument for higher pleasures. He seems to be
thinking of information-processing failure,
though, and he does not respect tastes.
17

• Market Failure-- Externalities
• What if Third Party would pay 2 to prevent
  Buyer from drinking? Possible reasons
• Buyer will be unpleasant or neutral to Third
  Party when drunk.
• Third Party cares about Buyers health, even
  though Buyer does not.
• Third Party thinks drinking whisky is an offense
  against God. (Is this in itself an information
  failure?)
• (n.b. the planner take tastes as
  given)

18
How Do We Measure Tastes? The
externality argument is based on Third Parties
caring more in aggregate than Buyer about his
behavior. How can we tell? -- The democratic
process is helpful. People must decide which
laws they care about they cannot get
everything they want. -- This is the same as the
problem of public-good spending. There must be
one level for everyone. -- In a dictatorship,
the dictator, even if benevolent, has trouble
knowing tastes. -- A court has the additional
problem that it cannot trade its power over laws
for money, so inefficiency can result.
19
Political Regulation What if
Smith would pay 10 to stop Jones from voting,
but Jones would only pay 7 to be able to vote?
(power) What if Smith would pay 5 to stop Jones
from arguing for legalization of homosexuality,
and Jones would only pay 2 to so argue? (public
good, binding future) What if Smith would pay
9 to stop Jones from burning a flag, and Jones
would only pay 3 to do it? (time and place
regulation)
20
Federalism Different Laws for Different
Places People care most about what happens
in their own neighborhoods. This argues for
local regulation. The Scotch Sabbath dry
counties in the U.S., red-light districts. Why
dont we see housing covenants that restrict
behavior? Would the courts allow it?
21
Asymmetric or Libertarian Paternalism
(pro, con Camerer, Issacharoff, Loewenstein,
ODonoghue, Rabin, Sunstein, Thaler,
Glaeser) Information disclosure is a relatively
harmless form of regulation. So are some
regulations aimed at poor decisionmaking. 1.
Choice of pension plan default rules. 2.
Cooling off periods for door-to-door sales
3. Mandatory disclosure of interest rates,
charges. 4. Deadlines to prevent
procrastination.
22
Federalism Different Laws for Different
Places People care most about what
happens in their own neighborhoods. This argues
for local regulation. The Scotch Sabbath dry
counties in the U.S., red-light districts. Why
dont we see housing covenants that restrict
behavior? Would the courts allow it?
23
Some Financial Regulations 1. Usury
laws (Glaeser and Scheinkman) 2.
Bankruptcy law (Elizabeth Warren cut off credit
to the poor) 3. Mandatory savings for old
age (social security, Deborah Weiss 1998)
4. Anti-discrimination laws (framing problem is
it unjust to charge a woman more than a man for a
lifetime annuity?) 5. Required
diversification in 401-K plans (Enron)
24
Some Other Topics 1.
Dynamic inconsistency in preferences. Akrasia,
self-control. 2. Discounting and future
selves. 3. When does a democracy generate
efficient laws?