Regulatory Intervention Beyond Fixing Market Failures

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Although regulation offers economic solutions, it can also safeguard the public interest and individual rights.

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Since the 2008 financial crisis, it has been widely accepted that regulation is necessary for the functioning of a market economy. But there is still a view—particularly found in political discussions and neoclassical economic schools of thought—that regulation’s only valid rationale is to fix market failures.

This view, however, is questionable. Even healthy and well-functioning markets sometimes generate undesirable outcomes. Moreover, citizens’ rights—an essential consideration in making public policy decisions—cannot be treated under the same logic as consumers’ rights or tradable goods, which are often more easily explained using the market failure theory. As a result, there exist other rationales for regulation. Governments use regulatory interventions to achieve public policy objectives that go beyond fixing market failures.

After all, even healthy and well-functioning markets will sometimes generate outcomes not desired by the community or will fail to offer feasible solutions to certain problems. When problems cannot be solved by a market failure regulatory approach, governments can justify regulatory intervention for other reasons.

One such reason involves the protection of individual rights. A regulation concerning health and safety in the workplace is a clear example in which well-functioning markets cannot generate a desired outcome—that is, workplace health and safety. Because the outcome of a free market approach often favors wealth maximization over collective benefits such as health and safety, communities rightfully demand a different regulatory strategy than a free market one.

Restricting regulatory intervention to market failures is related to an understanding of what is considered good quality regulation. If the standard of quality for regulation were the maximization of wealth, then the role for regulation would be weakened merely to fixing market failures since wealth maximization is the natural outcome of letting a well-functioning market work on its own, and regulation simply serves as “second best.”

Questions of justice, however, cannot be answered by economic appeals to efficiency alone. Issues that involve individual rights are often impossible to quantify in economic terms. Moreover, rights are not goods that free markets can allocate. Indeed, governments should intervene to protect individual rights—even if it is not efficient on economic grounds. The following example provided by Robert Baldwin, Martin Cave, and Martin Lodge illustrates this point:

A further moral objection to wealth maximization relates to its implication that it is right to allow B to interfere with A’s rights (by polluting their river or exposing them to a hazardous substance) if B generates enough wealth to compensate A for the harm done. Human beings, the objection runs, have certain basic rights that it would be morally objectionable to put up for sale. Certain risks, it might similarly be said, should not be imposed on individuals’ lives no matter what the price, compensation, or wealth gain on offer.

Another important distinction between a pure market failure rationale for regulation and a rights-based approach to regulation is the way in which the regulator is involved with citizens. Tony Prosser of the University of Bristol Law School explains that the efficiency and consumer choice rationale, which is related to the pure market failure approach, views citizens only as consumers. Under this consumerist view, individuals do not come to the market as equals. Instead, they exercise their rights in the market solely based on their individual purchasing power—which will be different for every person participating in the market. In that sense, when targeting market failures, the regulators’ relationship with citizens is indirect. That is, the regulator is not concerned with specific problems of the consumer, but rather in correcting the market problem since the proper functioning of the market is the main objective under a market failure theory.

In contrast, rights of citizens are—ideally—universal and make us all equal under the law. Rights will be relevant to the regulator in two ways. First, the regulator will protect rights directly by, for example, developing standards that safeguard rights and enforcing compliance with these standards. Second, the regulator will consider individual rights as a boundary that cannot be crossed, an idea that is not considered under the market failure approach. In this case, the relationship between the regulator and citizens is direct unlike under a market failure approach.

Mike Feintuck of the University of Hull Law School argues that in some instances—such as the regulation of media mergers, which aims to guarantee plurality of information to all citizens—regulators’ pursuit of a public interest agenda can contribute to a common understanding and value of achieving equality among citizens, even when, in doing so, regulatory decisions conflict with dominant values of the free market.

Fixing market failures is far from the only rationale for regulation, and indeed, legal scholars propose several different rationales for regulation. Among them, Feintuck suggests public interest, while Prosser suggests individual rights, social solidarity, and regulatory participation and deliberation. What all of them have in common, though, is that the objectives that each strives to achieve cannot be subsumed entirely into a market failure.

The market failure approach cannot be the only rationale for regulation since even well-functioning markets are unable to solve problems concerning the community or might even make them worse. We must consider different rationales for regulation.

Bruno Adriano Delgado Taboada

Bruno Adriano Delgado Taboada is a legal specialist at Sunedu, the office of the superintendent of universities in Peru.