Tuesday, 9 September 2014

A "pretense of knowledge" problem? 2

In the comments section to my previous post on this topic Donal Curtin makes the point that
However, unfortunately but unavoidably, it is the job of regulators to set some prices in situations where important markets aren't functioning competitively. I'd prefer if it wasn't, and personally I'd fire the price regulation gun only as a last resort if all other more market-friendly options were exhausted. But that said, even generally pro-market governments find themselves setting some prices. I agree that the process is imperfect, and there are multiple methodology and other choices to make along the way each of which introduces room for error. But sometimes it has to be done, and as well as you can manage, and preferably (as ComCom tends to do) with investment-friendly "err on the high side" numbers, to keep investment flowing into the regulated sector. The opportunity cost point is fine, but I wonder if in practice it's addressed (albeit in some rough and ready fashion) when regulators set a rate of return equal to that earned by "similar" sorts of activity, given that they're likely to be the sorts of activities the regulated company would otherwise have pursued?
My point here would be, and let me go all Coaseian for a moment, that comparative institutional analysis is needed. The first thing the regulators have to show is that their "wrong solution" is likely to be better than the market "wrong solution". It is possible that the regulated outcome is worse that the unregulated one. As Coase said in an interview with Reason magazine in 1997:
Reason: You said you're not a libertarian. What do you consider your politics to be?

Coase: I really don't know. I don't reject any policy without considering what its results are. If someone says there's going to be regulation, I don't say that regulation will be bad. Let's see. What we discover is that most regulation does produce, or has produced in recent times, a worse result. But I wouldn't like to say that all regulation would have this effect because one can think of circumstances in which it doesn't.

Reason: Can you give us an example of what you consider to be a good regulation and then an example of what you consider to be a not-so-good regulation?

Coase: This is a very interesting question because one can't give an answer to it. When I was editor of The Journal of Law and Economics, we published a whole series of studies of regulation and its effects. Almost all the studies--perhaps all the studies--suggested that the results of regulation had been bad, that the prices were higher, that the product was worse adapted to the needs of consumers, than it otherwise would have been. I was not willing to accept the view that all regulation was bound to produce these results. Therefore, what was my explanation for the results we had? I argued that the most probable explanation was that the government now operates on such a massive scale that it had reached the stage of what economists call negative marginal returns. Anything additional it does, it messes up. But that doesn't mean that if we reduce the size of government considerably, we wouldn't find then that there were some activities it did well. Until we reduce the size of government, we won't know what they are.
My issue is that regulators don't seem to think like this, they just seem to assume that whatever they do will be better than what it occurring without their intervention. And I just want them to show that their regulated outcome is likely to be better than the current, albeit imperfect, market situation.

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