More featuring David Sharp»

by David Sharp, Founding President of the Australian Adam Smith Club (Melbourne) and author of Economic Simplicities

Capture theory [aka Regulatory Capture] is a part of the economics of regulation. It purports to explain the reality and rationale of much present-day government economic regulation. In particular it seeks to examine and determine the identity and motives of those who are supportive of the introduction of new or increased regulation.

Government Economic Regulation
Government economic regulation, i.e. government intervention into the market, comprises taxes, subsidies and controls of all sorts, imposed by government, for the stated purpose of promoting and controlling the efficiency and/or equity and/or integrity of economic activity in general, and for achieving specific beneficial goals in such areas of the economy as desired by government.

There a number of theories that purport to explain the basis for government economic regulation. They include the following;

(1.) The government acts in response to demands from the public for action to overcome perceived shortcomings in otherwise unregulated economic activity [sometimes referred to as market failure] or otherwise in order to improve the results that the public receives from unregulated economic activity. This is a benevolent view and is probably the most widely propounded and perceived basis for government economic regulation.

(2.) A second and less benevolent view of the basis for government economic regulation is that it is initiated, not in response to demands from the public, but by government itself, for the purpose of expanding the size and control of government, and hence of increasing the power and influence of government and the bureaucracy.

(3.) Capture theory provides a third and perhaps even less benevolent view of the basis for the initiating [and maintaining] of government economic regulation. The theory postulates that much if not most economic regulation is initiated by existing participants in an industry or activity who are seeking the protection of government, the more easily to exploit the public and/or to shield existing participants from competition. In effect, such existing participants are thereby seeking to create a legally sanctioned cartel. Provided they have some say in the making of the regulations and of their content [which is usually the case] existing participants in such industry are happy to insist on government regulation.

Typically government regulation once put in place leads to the creation, or assignment of an existing, government agency or bureau to administer the operation of the regulations. Capture theory postulates that the existing industry or activity participants then seek to influence and ultimately effectively take over the running of such agency or bureau so that its activities are directed towards benefiting the members of the regulated industry or activity rather than the public. Moreover such capturing is ongoing so that even in the unlikely event that the regulations are initially totally unfavourable to the interests of the participants in the regulated industry or activity, they will on capturing such agency or bureau be able to turn the situation around so that henceforward it works for the benefit of the members of industry or activity rather than for the public.

How & Why it Happens
Those involved in a particular industry or activity have a significant stake in the controls and conditions that affect it. They are in a position and likely to expend time money and effort to achieve a favourable result for their own vested interests. Conversely, consumers, albeit likely to be much larger in number, are individually unlikely to have other than a minor interest in such controls and conditions, and are rationally unlikely to expend much time, money or effort opposing measures that are against their interest.

Moreover, because vested interests in a particular industry or activity have a major focused concern with the actions and activities of any relevant agency or bureau set up to regulate them, a close relationship is likely to develop between them. In so far as expertise and understanding of the particular industry or activity is required for its effective regulation, the agency or bureau can be obliged to look to the participants in the industry or activity to provide it. In what is sometimes referred to as the revolving door, members of the agency or bureau are often recruited from the relevant industry or activity, spend a few years in government service, and then return to their original industry or activity. Similarly long serving members of the agency or bureau often retire into the industry or activity they were responsible for regulating. In any event the industry or activity is thus able to exert considerable ongoing influence over the agency or bureau. Critics of economic regulation suggest that most major regulatory agencies and bureaus throughout the world have, to a greater or lesser extent, been captured by the industry or activity they have been set up to regulate. A particularly recent egregious example is the U S Securities & Exchange Commission which has been described by a leading American journalist Matt Taibbi as an agency that was set up to protect the public from Wall Street, but which now protects Wall Street from the public.

Examples of regulatory capture abound in Australia. For example, by any standard the quality of taxi service in Melbourne is abysmal. Operators are possessed of government licences worth in excess of half a million dollars. Following recent suggestions of minor reforms, a Victorian MP was assaulted on the steps of Parliament.

In Crikey, the internet blog, on 4 October 2005 consumer banking advocate Peter Mair wrote: “It is the foundation of the ‘capture theory’ of regulation that the regulated capture the regulators. One corollary of this is no regulation remains on the books that does not suit the regulated. My lifetime experience in the regulatory framework in Australia is that both these observations hold always … it is salutary to reflect on the sheer regulatory power wielded by some industries — by the racing industry in the different states, by the retail banking industry [particularly the payments system cartels] and by the superannuation industry.”