8
Government Regulation
McGraw-Hill/Irwin
©2007 by the McGraw-Hill Companies, Inc. All rights reserved.
Chapter
8
Government Regulation
of Business
Key Points
• Reasons for government regulation
• Primary constitutional foundation of
regulation of foreign, interstate and intrastate
commerce
• Understanding the “fourth branch” of
government
• Duties of and constraints on agencies
•Pros and cons of regulation and deregulation
Fundamental Questions
Throughout Course
What is the proper role of business in society?
Has business abused the public trust?
Is government the answer to the problem?
Might we rely on self regulation (ethics and social
responsibility) and market “regulation”?
What is the proper blend of these “control” devices
as well as others left unexplored (e.g., social
customs)?
Market Failure—Part I
Imperfect Information:
An efficient free market presumes reasoned decisions. Reasoned
decisions require adequate information. Because we cannot have
perfect information and often will not have adequate information, the
government may impose regulations either to improve the available
information or to diminish the unfavorable effect of inadequate
information.
Monopoly:
Natural monopolies exist where a single large firm is more efficient
then several smaller ones. In such situations, the government has
commonly intervened to preserve the efficiencies of the large firm
while preventing that firm from taking unfair advantage of the
consumer.
Market Failure—Part II
Externalities:
When all the costs of a good or service are not fully internalized or
absorbed, those costs or benefits fall elsewhere as what economists
have labeled externalities, neighborhood effects, or spillovers.
Government regulation is sometimes considered necessary to place full
cost on those who generated it, which in turn is expected to result in
less wasteful use of resources.
Public Goods:
Some goods and services cannot be provided through the pricing
system because we have no method for excluding those who choose
not to pay. For such public goods, the added cost of benefiting one
person is zero or nearly so. Thus, in the absence of government
regulations, public goods would not be produced in adequate quantities.
Regulatory Life Cycle?
Stage One: The free market itself—the period when government regulation is
absent from the market in question
Stage Two: A market failure is identified suggesting the need for government
intervention
Stage Three: Government regulation is imposed in the form of a rule
Stage Four: Regulatory failure occurs because, in brief, the benefits of the
rule in question no longer exceed its costs
Stage Five: The government may respond with regulatory reform to correct
the failure
Stage Six: The regulation in question is simply eliminated. The market, thus
fully deregulated, has returned to Stage One and the regulatory life
cycle is complete
Source: Joseph P. Toumain, “American Regulatory Policy: Have We Found The ‘Third Way’?”
Kansas Law Review 48 (May 2000), p. 829.
Philosophy and Politics
An explanation for government regulation may also lie in the political
process:
• One view is that regulation is considered necessary for the
protection and general welfare of the public: To achieve a
more equitable distribution of income and wealth; or to
stabilize the economy, thus curbing the problems of recession,
inflation and unemployment
• Another view is that regulation is developed at the request of
industry and is operated primarily for the benefit of the
industry, illustrated by the various subsidies and tax
advantages afforded to business
• Bureaucrats who perform government regulation are themselves a
powerful force in maintaining and expanding that regulation
The Constitutional Foundation of
Business Regulation
Commerce Clause, Article I, Section 8:
“The Congress shall have the power … To regulate Commerce
with foreign Nations, and among the several states …”
Supremacy Clause, Article VI, Section 2:
“This Constitution and the Laws of the United States … shall be
the Supreme Law of the land.”
Police Power:
State authority to regulate commerce resides in the police power
specified by the Constitution; police power refers to the right of
state governments to promote public health, safety, morals and
general welfare by regulating persons and property within each
state’s jurisdiction
Interstate Commerce
Heart of Atlanta Motel v. U.S. (S. Ct. 1964) (public
accommodation provisions under the Civil Rights
Act of 1964 found constitutional)
U.S. v. Lopez (S. Ct. 1995) (Gun-Free School Zones Act
held unconstitutional)
Brzonkala v. Morrison (S. Ct. 2001) (Violence Against
Women Act held unconstitutional)
Gonzalez v. Raich (S. Ct. 2005) (federal government can
regulate use of medical marijuana, even where
state law permits such use)
Regulation of Commerce
Foreign Commerce: The federal government has
exclusive regulatory authority over foreign
commerce
Interstate Commerce: Regulation by the federal
government or state governments or both may be
permissible
Intrastate Commerce: Purely intrastate commerce, having
no significant effect on interstate commerce, is within
exclusive regulatory jurisdiction of the states; of
course, commerce purely intrastate in nature is
uncommon
State and Local Regulation of
Interstate Commerce
Such regulation is unconstitutional if:
• It expressly discriminates against interstate commerce
• It unduly burdens interstate commerce
• It imposes only an “incidental” burden on interstate commerce,
but that burden is clearly excessive in relation to local
benefits
• Legitimate local purposes could be adequately served by
reasonable non-discriminatory alternatives
Example: Granholm v. Heald (S. Ct. 2005)
State and Local Regulation of
Business
Categories:
• Controlling entry into business
• Regulating competition
• Preventing consumer fraud
Example:
• Voyeur Dorm v. City of Tampa (11th Cir. 2001)
History of Federal
Independent Agencies
1887: First federal regulatory agency established
(for the purpose of regulating railroad
routes and rates)
1930s: Federal regulation became pervasive in
response to the Great Depression
1960s-’70s: New agencies created directed to
social, as opposed to economic, reform
1980s and after: Strong deregulation movement
Agency Duties
Control of Supply: Some agencies control entry into certain
economic activities, by granting licenses, for example
Control of Rates: Historically, those federal agencies
charged with regulating utilities and carriers set the
prices to be charged for the services; there has been a
general decline in agency rate-setting, such as over the
price of airline tickets, cable TV rates and long-distance
telephone rates
Control of Conduct: A major element of government
regulation is through requiring information, establishing
minimum performance standards and banning certain
products
Operating the Agencies
Executive Functions: Agencies implement the
policy provided for in enabling legislation and
in the agencies’ own rules and regulations
Legislative Functions: Agencies create rules and
regulation that are, in effect, laws
Judicial Functions: Adjudicatory administrative
hearings are used to enforce the agency’s
rules and regulations
Legislative Function: Rules
Procedural rules: Delineate the agency’s internal
operating structure and methods
Interpretive rules: Offer the agency’s view of the
meaning of those statutes for which the agency
has administrative responsibility; they are
important expressions of opinion as to what the
governing legislation requires
Legislative rules: Are policy expressions having the
effect of law; the agency is exercising the lawmaking function delegated to it by the legislature
Legislative Function:
The Rule-Making Process
Informal rule making:
• Publication of a Notice of Proposed Rule Making in the Federal Register
• Written comments on the proposal submitted by the public
• Agency may hold open hearings
• Agency either discontinues the process or prepares the final rule
• Final rules are published in the Federal Register and later compiled in the Code of Federal
Regulations
Formal rule making:
• Publication of a Notice of Proposed Rule Making in the Federal Register
• Agency must hold public hearing conducted with most procedural safeguards of a trial,
where all interested parties may call witnesses, challenge agency evidence, etc.
• Agency decision based only on the formal record
• Final rules are published in the Federal Register and later compiled in the Code of Federal
Regulations
Judicial Function:
Administrative Hearings
• After investigation, a violation of a statute and/or rule may be
alleged
• Affected parties notified
• Effort is made to reach settlement via a consent order
• Failing settlement, case is heard by an administrative law judge
(ALJ)
• ALJ decides all questions of law and fact and then issues a
decision
• Order may be appealed to the agency or commission
• After exhausting opportunities for review within the agency,
appeal may be taken to the federal court system
Controlling the Agencies
Executive Constraints: President appoints the top
administrators and has great influence in the budget
process
Congressional Constraints: Congress creates and can
dissolve agencies and controls agency budgets; it can
directly intervene by amending the enabling legislation
or by passing laws that require agencies to take
specific directions
Judicial Review: Agency rules and orders may be challenged
in court; however, historically, courts have taken a
rather narrow approach to judicial review, giving
deference to the presumed expertise of the
administrative agencies
Insufficient Regulation?
•
We have many regulatory success stories: Cleaner air,
child labor laws, etc.
• Our reliance on government intervention is restrained
by worldwide standards
• Reduced regulation may just result in increased
litigation
Excessive Regulation?
• From 2002 to 2003, number of federal government
employees increased by 12.1 million
• Regulatory agencies have been “captured” by the
industries they regulate, which use regulation to reduce
new competitors
• Industry has too much power, through the agencies, in
the political process, leaving the public voice unheard
• Agencies are criticized for inefficiency, incompetence
and arbitrariness
Deregulation Assessed
Good news:
• Deregulation has brought lower prices, more
innovation and consumer benefits in some
areas
Bad news:
• Deregulation has created mega-firms, loss of
service to smaller markets and new
opportunities for abuse in financial services