Despite its flaws and limitations, Stigler’s seminal article on the theory of economic regulation offers important lessons.
George Stigler’s article “The Theory of Economic Regulation”—which celebrates its 50th anniversary this year—is one of the most influential political economy accounts of regulation. More than perhaps any other article, it shifted the prevailing explanation for regulation from a public interest model to a rational choice model. That is, it shifted regulatory scholars’ thinking from a model that once viewed regulation as emerging almost naturally from the mere existence of market failures to a model that instead sees regulation as a response to influence by businesses seeking to erect barriers against potential competitors.
Although decades old, “The Theory of Economic Regulation” still repays reading. Today’s readers, though, might well wonder at first why the article has received so much praise. Its weaknesses are not hard to spot. In fact, these weaknesses may be so readily apparent that they can easily obscure the article’s contributions. To appreciate Stigler’s article, then, one need not deny its limitations. By acknowledging forthrightly these limitations, we may even better see past them to understand its major contributions.
So let me first clear away some of the underbrush and flag five core weaknesses in “The Theory of Economic Regulation” before turning to a consideration of its virtues.
First, and perhaps most notably, Stigler overclaims. His article’s most famous line constitutes Exhibit A: “as a rule, regulation is acquired by the industry and is designed and operated primarily for its benefit.” This wording immediately prompts the reader to ask, Really? “As a rule”? Some readers can quickly dismiss Stigler for just these three words. By saying “as a rule,” Stigler sounds as if he is asserting an iron law that regulation only serves industry. Yet it is easy enough to point to selected examples where businesses have almost certainly not benefited from regulatory policies.
Second, Stigler leaves key concepts poorly defined or treated in simplistic terms. At times, for example, he refers to businesses in monolithic terms—“the industry”—even though regulatory conflict frequently exists across different businesses. Stigler further treats business influence over regulation in binary terms, with regulators either being subservient to business interests or not affected by them at all. He also treats the state—or the regulator—as a monolith, with the impetus for legislation left undifferentiated from the impetus for agency-created rules. In the years that followed Stigler’s article, the relationship between agencies and other parts of the state, especially the legislature, garnered much attention by political economy scholars.
Third, Stigler’s main observation—that businesses seek regulation to disadvantage their competitors—was hardly novel at the time he published “The Theory of Economic Regulation.” Years before, political scientists and historians such as Marver Bernstein, Samuel Huntington, Gabriel Kolko, and Theodore Lowi separately provided accounts of much the same kind of regulatory phenomena. And in economics, Mancur Olson and others had already worked out the basic political economy logic underlying almost all of Stigler’s analysis.
Fourth, Stigler’s empirical analysis is crude, and his findings are far from compelling. He provides two brief case studies of state trucking regulation and state occupational licensing laws—hardly a comprehensive account of regulation in general. He offers some statistical analysis in each of his cases, but that analysis comprises the most basic regressions with no robustness checks. Stigler himself acknowledges the limits of his empirical analysis. He admits that the empirical support for his theory rests on only a “modicum” of evidence. He describes his analysis as “illustrative” and acknowledges the “crudity of the data” on which he relies.
Finally, from the vantage point of history, Stigler’s theoretical claims seem to have been quickly overtaken by events on the ground. Notwithstanding his claim that business influence leads to economic regulation—that is, regulation of market entry, prices, and outputs—major swaths of such economic regulation disappeared in the United States during the 1970s and early 1980s in sectors such as trucking, airlines, natural gas, and telecommunications. It is far from clear how a political economy theory that emphasizes incumbent firms using regulation to restrict entry to new competitors can also explain the repeal of the very regulations that had supposedly advantaged incumbent firms. Nor does Stigler’s theory necessarily explain the emergence of extensive consumer and environmental regulation in the 1970s.
And yet, here we are, 50 years after Stigler published his theory, still celebrating the article. The University of Chicago Booth School of Business’s Stigler Center for the Study of the Economy and the State has even convened a virtual gathering of leading regulatory scholars to reflect on, and extol, the virtues and lasting legacy of “The Theory of Economic Regulation.” That kind of attention is indeed deserved. Despite its flaws and limitations, Stigler’s article remains an important piece of scholarship worthy of continued engagement decades after its publication.
Stigler’s extensive influence on regulatory scholarship probably helps explain why a graduate student reading his article today could be forgiven for not immediately appreciating its significance. This is because, in important respects, we are all Stiglerians now. The political economy approach to regulation has won over the field and it is now common sensical to look for how business interests influence the regulatory process for their own benefit. It seems naïve to explain patterns of regulation simply in terms of the public interest. But that was far from the prevailing view in the years before Stigler.
Stigler’s approach to regulation came to fit with the work of other economists and political scientists in a burgeoning rational choice approach to the analysis of political behavior. His article’s influence, though, extended well beyond an audience of other social scientists. Over the last 50 years, legislators and judges have responded to the Stiglerian account of regulation by seeking to apply its insights to the design of regulatory institutions. Lawyers and legal scholars now seek to use administrative law to combat the tendencies toward regulatory capture that Stigler revealed, such as by requiring governmental transparency, imposing limitations on interest group meetings with agency officials, and demanding that courts take a hard look at the justifications for government regulations.
Concerns about regulatory capture took off in the field of administrative law in the years following the publication of Stigler’s article. As one measure of the impact Stigler has had, consider the frequency with which his article has been cited in the nation’s leading law journals compared with citations to the major works of his predecessors Bernstein, Huntington, Kolko, and Lowi. Stigler’s article has been cited three times as often as the works of all four of these other scholars combined.
What might account for the prominence and staying power of Stigler’s article despite its flaws? I see three principal reasons:
Drama. Stigler’s article presents a dramatic story. Its drama comes from turning what most people had accepted as the hero into the villain. Under the public interest theory of regulation, regulation derives from efforts to promote public welfare; it amounts to a savior in the face of market failure. But then along comes Stigler who reveals that reality can be quite different. What appear to be regulatory policies grounded in the public interest are actually policies that protect the private interests of industry, to the detriment of consumers and the broader public.
In this way, Stigler’s article is like a mystery novel in which the unsuspecting character turns out to be the murderer. Or, to offer a simile from the panoply of contemporary Disney movies, Stigler’s dramatic element works a lot like the major plot twist in the animated film, Frozen. In the film, the seemingly charming Prince Hans appears to have fallen earnestly in love with Princess Anna, but is later revealed only to be manipulating her to marry him as part of an evil scheme to take control of her kingdom. This same dramatic element that works in fiction and popular entertainment has undoubtedly captivated regulatory scholars too.
Verisimilitude. Stigler’s account was more than just a compelling dramatic story. It also captured an important part of the reality of the regulatory process: business interests do exert a lot of influence over the existence and design of regulation. The public interest theory that held sway in the 1950s and 1960s was indeed too pollyannaish and naïve.
Of course, this is not to say that business always wins. Counterexamples to business dominance can be found, such as in the economic deregulation of the 1970s and the rise of consumer and environmental regulation. But there is also no denying the power of industry. Even though the 1970s saw the passage of much environmental legislation, for example, very little such legislation has passed since. Serious and prominent calls for addressing climate change have existed for at least the last three decades but still no federal climate legislation exists, and the climate policies adopted by the U.S. Environmental Protection Agency have been both limited and resisted. In other domains, too, business power is quite evident. Stigler’s concerns about occupational licensing, for instance, still ring true to this day. As a long line of political scientists from E.E. Schattschneider to Paul Pierson and Jacob Hacker have documented, the policy process often sings with a business bias.
Stigler was also clearly right to have noted, at the end of his article, that the way to protect the integrity of institutions is not just to preach goodness and fairmindedness to government officials, but to think also about how to shape their incentives. If those who serve as regulators—whether as legislators or agency officials—have little incentive to serve the public interest, it will be hard to expect that they will do so to a sufficient degree. The design of regulatory institutions can shape these incentives, and it is certainly worth considering how to create procedures and processes that might help foster better regulatory policies.
Fertile soil. The influence of Stigler’s article was surely affected by the fact that he published it at a time when academics and the rest of society were ready for his ideas. Overall public trust in the federal government peaked in 1964, when 77 percent of the public reported that they could trust Washington to do what is right at least most of the time. Within a decade, that trust had dropped by more than a half, to 36 percent. Vietnam, the Civil Rights Movement, and Watergate all added to the broader milieu that fit well with what Stigler was saying right in the middle of this period—namely, that the public cannot necessarily trust the government to be working on behalf of its overall interest.
At that time, skepticism about regulation was shared by both the left and the right. The left saw the government as in the pockets of the corporations, while the right saw government as interfering with positive market forces. Even today, with even more extreme partisan polarization, politicians on both ends of the ideological spectrum can agree to deplore regulatory capture—even though they approach it through different lenses.
In the end, Stigler’s article is important for bringing to light a crucial mechanism underlying much regulatory policy—namely, self-interest—and for pointing toward the need for thinking harder about how to design institutions with self-interest in mind.
His article ultimately offers not just a theory of economic regulation—as its title reads—but an economic theory of regulation. It was influential in foreshadowing and inspiring an extensive body of rational choice scholarship on regulation in the decades that followed. Even regulatory procedures and institutional designs have now been fruitfully studied from a rational choice framework and it has become well understood (if frustratingly so) that procedures and institutions can themselves be manipulated, contested, and influenced for political gain and the advancement of self-interest.
Nevertheless, if we are to make the world a better place through better regulatory institutions and policies, we must do what Stigler did so well: separate the empirical from the normative; think hard about the underlying causes of both market and government failures; and strive to apply a realistic understanding of the world as it does operate, so as to keep working to make the world closer to what it should be.
An earlier version of this essay appeared in ProMarket, a publication of the Stigler Center for the Study of the Economy and the State at the University of Chicago.