The erosion or abandonment of formal regulations by legislative means is known as deregulation. Formerly regulated industries—transportation, electric utilities, gas utilities, telecommunications, and financial markets—share certain characteristics that made them candidates for regulation, and in transitioning to deregulation they share a common set of problems.
Wherever they have appeared around the world, regulatory systems were not the result of strategic planning, but represented a reaction to financial, economic, and political crises. The airline industry, the steel industry, and every other industry have been subject to direct and indirect regulation. Indirect regulation dealing with the environment, work safety, product quality, truth in advertising, and similar issues affects all firms. The fundamental reasons for regulating the banking industry lie in the key role banks play in the efficient functioning of the economic system and in the conduct of an effective monetary policy, as well as protection for depositors and monetary stability.
In a Brookings Institution study, Martha Derthick and Paul Quirk acknowledge that government regulation had long been rationalized as a way of guaranteeing service to the public by industries having the character of public utilities and as a means of protecting the public from monopoly pricing practices, including the destructive competition that was said to lead to the creation of monopolies. However, the regulatory agencies had instead sheltered the regulated industries from competition and fostered very costly inefficiencies. Long a target of experts in administrative law, public administration, and political science, who found much fault with their structure and procedures, by the 1960s the regulatory commissions had become a target also of economists, who attacked their purposes by undertaking to show that the social costs of regulation far outweigh the benefits.
The notion of government regulation as a profit seeking enterprise in which self-interested groups and individuals seek to gain competitive advantage and in which the regulator is captured by the regulated is the basic argument of Chicago School economists George Stigler and Sam Peltzman. Deregulation suddenly changes the game of market competition, threatening the long-held advantage of dominant large firms and opening the way for new entrants.
The United States
Deregulation has been the global trend since the late 1970s and early 1980s. In the United States, the energy, airline, trucking, and telephone industries were deregulated in 1978, 1980, and 1982. Under strict federal regulation since 1954, the natural-gas industry began to exhibit shortages in the late 1960s. By the 1970s, producers were unable or unwilling to supply as much gas as customers wanted to buy at the regulated price. In 1978 Congress set a timetable for deregulation of most natural-gas prices. By 1985, when all gas discovered after 1976 was freed from federal price regulations, gas prices began a steep plunge. After that, federal regulators began to transform natural-gas pipelines into “open access” transporters of gas from various producers. Deregulation not only lowered prices for consumers, but also improved the quality of service by removing the threat of artificially created shortages.
Before 1978, both the maximum and minimum fares for air travel were set by the Civil Aeronautics Board (CAB). The CAB began to loosen its regulations in the mid-1970s. In 1978, Congress passed legislation to abolish the CAB within six years, open up the industry to new competitors, and eliminate government-set fares. Under regulation, intercity airline routes were served by one, two, or three carriers, all charging the same fare; after deregulation both the number of carriers and their prices became highly competitive, including such practices as restricted discounts, promotional fares, reduced off-peak fares, and premium services.
Federal regulation of interstate trucking began in 1935. Throughout the 1960s and early 1970s, economic research showed that trucking rates would be far lower in a competitive marketplace. In response to the growing opposition to interstate regulation, Congress passed legislation in 1980 that virtually deregulated the trucking industry. Deregulation meant shipping rates could be negotiated by individual shippers and carriers, with prices and services tailored to the shippers’ needs. While big shippers were in the strongest bargaining position, smaller shippers often needed to consolidate shipments to get a good rate.
The collapse of the merged Penn Central rail line in the mid-1970s prompted a major push to deregulate and transform the railroad sector. Congress passed a bill in 1976 that allowed railroads to merge and to abandon unprofitable routes; in 1980, Congress deregulated rates for some commodities. Gradually, rate deregulation extended to about 90 percent of rail traffic. Rail deregulation led to improved service, improving delivery time by 30 percent.
The first movement toward competitive long-distance telephone service came not from Washington policymakers but from the entrepreneurial efforts of Microwave Communications, Inc. (MCI). In 1969 MCI won federal permission to begin competing with the AT&T monopoly to provide “private-line” long-distance to companies, but did not receive the go-ahead to enter the ordinary long-distance market for businesses or residences. MCI clandestinely began to offer standard long-distance to businesses in 1974 without authorization by the Federal Communications Commission (FCC). The FCC tried to stop MCI, but lost in federal court. The FCC did authorize competition in telephone equipment, a move ratified by the courts in 1977.
As the pressure for competition in the long-distance and telephone-equipment industries began to heat up, the federal government challenged AT&T’s use of its monopoly on local telephone service to compete unfairly. Its legal actions finally led to a consent decree in 1982 that split “Ma Bell” into seven local telephone companies and a separate long-distance and equipment business that retained the AT&T name. Equipment prices fell by 6 to 7 percent a year between 1972 and 1987. Competition has also improved quality dramatically and led to the introduction of many new devices and services. Deregulation meant telephone users found that they could shop for bargains in long distance service. Whereas American Telephone and Telegraph (AT&T) and the affiliates and “independents” in its network were at one time the sole suppliers of long distance service, competitors now offered service at rates substantially below AT&T’s.
While the history of U.S. financial deregulation began in 1973, the period 1982–90 saw the disintegration of the savings and loan insurance fund and a sizable portion of the thrift industry and regulator-sponsored deregulation that provided increased earning opportunities, and risk, for surviving thrifts and commercial banks.
Japan, Russia, And China
By the early 1980s many capitalist governments reduced government interference in the marketplace, prompting increased competition. Japan’s telecommunications monopoly, NT&T, was deregulated in 1985, and European deregulation followed in the mid-1990s.
Before the collapse of communism, governments in most command economies exercised tight control over prices and output through state planning, prohibiting private enterprises from operating in most sectors of the economy, severely restricting foreign direct investment, and limiting international trade. Deregulation involved removing price controls, thereby allowing market forces to set prices. Laws regulating the establishment and operation of private enterprises were abolished, and restrictions on foreign direct investment and trade were relaxed or removed.
In Russia deregulation of prices was imposed through a presidential decree of December 3, 1991, “Measures to Liberalize Prices,” which solemnly declared that “on January 2, 1992, [the Russian Federation would undertake] the basic transition to free (market) prices and tariffs, formed under the influence of demand and supply” on producer goods, consumer goods, services, and labor. By the end of 1993, only two sectors, energy and agriculture, were regulated. The state monopoly on foreign trade had effectively been abolished in late 1986, when various branch ministries were given the right to pursue foreign trade independently.
Deregulation in China went through two phases. From 1980 until 1993, government began the partial or total deregulation of public sector enterprises, increasing the autonomy of state-owned enterprises under the “contract responsibility system,” under which state-owned assets were leased out. By 1987 over 27,000 state-owned enterprises had been leased out.
The second stage in China’s deregulation began in 1993 when the Central Committee of the Chinese Communist Party issued the so-called Resolution on Several Issues Concerning the Establishment of a Socialist Market Economy, which established a 50 point agenda for bold economic reform, including placing the assets of 1,000 large state-owned enterprises under the supervision of new asset management companies; transferring control of 100 large and medium-sized state-owned enterprises to shareholding companies, among other reforms. The plan was stalled by the 1997 East Asia financial crisis, but has resumed.
India
In mixed economies, the role of the state was more limited, but in certain sectors the state set prices, owned businesses, limited private enterprise, restricted investment by foreigners and restricted international trade—alongside an active, growing private sector. India is a good example of a mixed economy that is currently deregulating a large portion of its economy. Deregulation in India has involved reforming the industrial licensing system that made it difficult to establish private enterprises, opening areas that were once closed to the private sector, removing limits on foreign ownership of Indian assets, and lowering barriers to international trade.
Like China, India has also followed a sequenced deregulation pattern since the mid-1970s, when the central government proposed a reduction in the number of industries reserved exclusively for the public sector. India’s public sector undertakings are the equivalent of state-owned enterprises, often state monopolies in core or strategic industries, which are the sole suppliers of steel, coal, and oil to industry. A significant percentage (over 70 percent) of the total employment in the industrial sector is in these enterprises; other public sector undertakings exist in noncore or nonstrategic areas, such as hotels and tourism.
Major institutional reforms in the public sector were announced in July 1991 with the passage of the New Industrial Policy, which gradually reduced India’s extensive industrial licensing regime. The New Industrial Policy also encouraged reforms of public enterprises in order to make them better performers and more competitive. Beginning August 7, 1996, the Ministry of Industry moved quickly and aggressively to select public sector enterprises for disinvestment. India’s economic reforms have continued despite an apparent trend in minority governing coalitions at the center.
Latin America
During the 1980s, many developing countries entered upon a process of deregulation in which government controls over market operations, resource allocation, and capital flows were removed or loosened, a consequence of the oil price shock and the ensuing economic crisis, which forced fundamental reorientation of development strategies across countries and thrust the issue of financial reform onto the policy agenda. Coupled with the economic crisis was a cross-national ideological crusade against state interventionism supported by the World Bank, the International Monetary Fund (IMF), and major industrial powers to expand the role of market forces. In Argentina, Chile, and Uruguay, deregulation included steps to privatize state-owned banks, free interest rates, and eliminate restrictions on capital flows. Contrary to what had been expected by proponents of financial liberalization, reform efforts in the Southern Cone ended in chaotic financial markets, massive inflation, and worsening external imbalances, leading to the reversal of the liberalization process.
The disastrous outcomes raised the question about the appropriate economic and institutional conditions under which financial reform strategies should be designed and implemented.
Unlike their Latin American counterparts, however, the East Asian newly industrializing economies (NIEs) took a cautious and gradual line of action, until the second half of 1997, when many of the East Asian NIEs were struck by the worst-ever financial crisis in the postwar economic history of the region.
Indonesia, Korea, And Thailand
Farrukh Iqbal and William James note that until the mid-1980s, Indonesia lagged behind its East Asian neighbors in deregulating or liberalizing trade and investment policy, due in part to reliable primary sector (mostly oil) revenues. During the latter half of the 1980s, Indonesia made substantial reforms in its trade, investment, and financial regimes: Tariffs were cut, nontariff barriers were reduced, a duty-drawback system was introduced for export activities, a complex investment licensing system was replaced by a much simpler and relatively short “negative list,” foreign investment regulations were significantly eased, credit ceilings and interest rate controls were abolished, and entry into the banking system was made substantially easier.
Like many of their neighboring economies, Korea and Thailand opted for a gradual pattern of policy responses, particularly in the initial stages of financial reform. Korea adopted a gradual and piecemeal approach to the liberalization of interest rates and credit controls, but gave greater freedom to nonbank financial institutions, such as finance companies, merchant banking corporations, and securities firms, to mobilize savings and develop the financial system.
In Thailand, the authorities placed more emphasis on expanding the role of the banking system in service diversification and financial development. Thailand, which had maintained relatively relaxed controls over its external financial transactions, further deregulated the remaining controls while liberalizing the domestic financial market.
Effects
Sarkis Khoury sees the deregulated international financial environment as having been developed partially by design, but largely as a result of the dynamic market forces that produced more competitive markets all over the world and “leaner and meaner” financial institutions, with consolidation through mergers and acquisitions reducing the number of firms and increasing competition among the larger, remaining institutions. Khoury predicts that competition will only continue to increase as markets become more global and as new, aggressive entities come into the market. The Japanese firms which were once nowhere on the list of prominent financial institutions are now dominant in the world of finance. The Koreans and the Chinese have become major players. European financial institutions have streamlined their operations, and improved their product mix and their resource base in order to better compete more successfully in a united Europe.
While governments have taken a proactive strategy to deregulate their industries and financial markets, to open trade and foreign direct investment in order to stimulate sluggish economies, the permanency of the changes is still in doubt. A severe worldwide economic setback could prove a real test. Again, it must be emphasized that regulation is cyclical and potentially reversible. As Barbara Emadi-Coffin argues in her study of deregulation and governance, while deregulation implies the roll-back of the state, in fact, deregulation and the establishment of free trade zones have necessitated extensive government regulation and subsidy.
A financial crisis in 2008 had its roots in the GrammLeach-Bliley Act (1999), a bank deregulation bill, that swept away a Depression-era law known as Glass-Steagall. Gramm-Leach-Bliley tore down the separation of banks doing risky investments from those doing basic lending. In addition, some investment banking houses make risky bets that went awry in 2008. American policy makers and regulators let Wall Street recklessly invest in the context of extremely inflated housing prices (a bubble). Also to blame was the Commodity Futures Modernization Act, which freed the derivatives market and enabled banks to become more aggressive in their mortgage investments.
Bibliography:
- Anders Aslund, How Russia Became a Market Economy (Brookings Institution, 1995);
- Sean Barrett, Deregulation and the Airline Business in Europe (Routledge, 2009);
- Martha Derthick and Paul J. Quirk, The Politics of Deregulation (Brookings Institution, 1985);
- Barbara Emadi-Coffin, Rethinking International Organization: Deregulation and Global Governance (Routledge, 2002);
- John Hood, “Dividends of Deregulation,” Policy Review (v.84, 1997);
- Farrukh Iqbal and William E. James, Deregulation and Development in Indonesia (Praeger, 2002);
- Sarkis J. Khoury, The Deregulation of the World Financial Markets: Myths, Realities, and Impact (Quorum Books, 1990);
- David Leonhardt, “Washington’s Invisible Hand,” New York Times (September 26, 2008);
- Paul W. MacAvoy, The Unsustainable Costs of Partial Deregulation (Yale University Press, 2007);
- John R. Meyer et al., The Transition to Deregulation: Developing Economic Standards for Public Policies (Quorum Books, 1991);
- Tom W. Norwood, Deregulation Knockouts. Round Two (Airways International Inc., 2006);
- Jeffrey Worsham, Other People’s Money: Policy Change, Congress, and Bank Regulation (Westview Press, 1997);
- Xiaoke Zhang, The Changing Politics of Finance in Korea and Thailand: From Deregulation to Debacle (Routledge, 2002).
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