Document Type

Article

Comments

Forthcoming in M. Landy, M. Levin and M. Shapiro, ed. Creating Competitive Markets: The Politics and Economics of Market Design (Brookings, 2007)

Abstract

Since airlines were deregulated, shareholders, management and workers, already well organized, have suffered severe, sometimes catastrophic losses, while the benefits have been spread among unorganized consumers and the investors and managers of new entrant airlines, which themselves have had a high failure rate. While the gains greatly outweigh the losses, their incidence violates traditional versions of the economic theory of regulation. Organized subgroups should be able to protect their rents against less-organized subgroups, especially when the organized subgroups experience concentrated effects while the impact on the less organized subgroups is much more dispersed. Under the circumstances, it is reasonable to ask why the airlines were not reregulated once the incidence of deregulation became clear. I hypothesize that there are two principal reasons, one requiring a refinement of the theory. The first is that under regulation the incentives of both regulators and their regulated population face incentives to make the firms and the interests connected with them more alike and that deregulation very rapidly allows the development of firms and other organized interests with different incentives. Political cohesion, and hence changes, become more difficult to achieve. The second reason and theory refinement is that rent creation and wealth transfer through regulation requires both political unity and “slack”, that is, protection from public scrutiny. Slack is the normal state of affairs in a world of information costs and lack of incentive for the electorate to overcome them. Deregulation often occurs when a dramatic event or an issue entrepreneur manages to get the regulatory arrangement on the public agenda. Then slack disappears, leaving the rent-creation and wealth transfer mechanism transparent to the general public.

Date of Authorship for this Version

November 2006