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ECONOMICS AND REGULATION By JOHN W. SNOW DEPUTY UNDER SECRETARY OF TRANSPORTATION It is a pleasure to be here and to address this Panel on Economics and Regulation -- a subject in which I have been heavily involved for the last several years. As a keynote speaker, I think my role should be to be brief and to the point. I will try to do that. There is a great movement afoot across the land these days. It goes under the rubric of regulatory reform. Regulatory reform means lots of differ- ent things to lots of different people, but to us in the Administration and to many in the Congress with whom I am in close contact on these issues, it covers two separate but related matters. First, government is involved in areas, such as truck regulations, which are more appropriately left to competitive market forces; second, government regulatory actions are being taken too often without adequate cost-benefit justification. There appear to be significant segments of the American economy that we have regulated as if they were monopolistic, or public utilities, or somehow unable to function appropriately under normal market constraints. It has been assumed that the government should influence the way these markets work by controlling entry into them, by controlling prices, by not allowing the com- petitive system to operate the way it normally does -- in short, by interfering with the market process. Nowhere in the American economy is an industry more heavily regulated than transportation. Transportation regulation goes back to 1887 and the Interstate Commerce Act to regulate railroads. Rails were then regulated on the basis that they were monopolists. In 1935 we regulated motor carriers on the basis that they did not perform satisfactorily in the marketplace and required regulation to improve their performance. Then, we regulated airlines under the Federal Aviation Act of 1938 and set up what is today the Civil Aeronautics Board. And finally, in 1940, we regulated water carriers and pipelines. The transportation industry in this country today is heavily regulated, although many doubts exist about the wisdom of such a regulatory system. We in the Administration, particularly those working in the Department of Trans- portation, have been trying for the last few years to analyze the effects of 14
economic regulation on the performance of the transportation industries. We have been asking ourselves the questions: Do we need the kind of regulation we now have? What are the consequences of this kind of regulation? How are prices, costs, and service affected? What would be the consequences of moderating the regulatory system to allow freer operation of competitive market forces? In this exercise we have drawn heavily on the work done in academic circles -- work done by many of you in this room. One of the principal pieces of domestic legislation that the Ford Administration submitted to Congress last year was the Railroad Revitaliza- tion Act. This bill was designed to allow wider scope and sway to the operation of competitive market forces in the railroad business. It allowed railroads to price their products competitively, and removed the antitrust immunity that attended the collective ratemaking activities of the railroads. As you may well know, railroads set rates through a collective mechanism which would be a violation per se of the antitrust laws if engaged in by industries outside of transportation. But the history of that legislation is really the history of people in the Administration drawing on work done in academic circles regarding the effects of economic regulation of railroads. It reflects the work of John R. Meyer, done back in the early 1960's, the work of Ann F. Friedlaender done in the 1960's, the studies of Thomas G. Moore, George W. Hilton, and the work of many other economists. These analyses came to essentially the same conclusion: By not letting competitive market forces work in the railroad business, we interfered with the efficient allocation of transportation resources and hurt the long-term prospects for the efficiency of the railroad industry. The resulting wastefulness and inefficiencies in the economy were costly. At the heart of the problem, these studies showed, was the absence of competitive pricing. We responded to these studies by producing legislation targeted on the problem of railroad pricing, removed the antitrust immunity, and letting rail- roads price competitively. Our legislative response met with success. So we are really, in the case of the railroads, the beneficiary of a rich academic tradition that we drew and built upon. We have two other major pieces of legislation in the Congress now, similar in outlook and underlying philosophy to the Railroad Revitalization and Regulatory Reform Act-the Motor Carrier Reform Act and the Aviation Act of 1975. We have over-regulated motor carriers and airlines. As a conse- quence, neither industry is performing as efficiently and as responsibly as they could and should. Neither industry has a public utility structure. There is little justification for not allowing competitive market forces to operate. Changes should be made. And again, in both cases, although more in aviation than in motor carriers, we are drawing upon an excellent academic tradition that has produced 15
a wealth of information. Thus, we owe you in the universities a great debt. My own criticism of the academic work that has been done is that it has attached too little importance to the kinds of questions congressmen raise. It has tended to focus too much on the long-run, on determining the aggregate losses associated with the present interference with market forces. The fact that the estimates vary widely in some cases is not particularly disturbing to me. After all, they are all in the same direction and the data, methodology, and research scope have varied. What is disturbing is the failure to look more closely at the short- run. The studies point out the inefficiencies in terms of long-term misalloca- tion of resources. They tell us that if we move to a less regulated environ- ment, the aviation industry will have dollar savings of about $1 billion a year. In the motor carrier industry the estimates range from $2 billion to $5 billion a year. In the railroad industry the estimate was even higher. Those are long-run estimates, assuming a long-run competitive equilib- rium. My criticisms, and I do not mean to be too argumentative, are twofold. One, we haven't had enough work on the short-term consequences of modifying the present regulatory systems-the effect of income redistribution, for instance. We know that there will be some short-term adverse consequences. After all, some beneficiaries of the present regulatory system exist. Otherwise, we would get the change fairly easily. It is desirable to make the changes despite the losses, because the long-term benefits offset the short-term con- sequences. There is very little quantification or even careful analysis, however, of those short-term consequences. And if we knew more about short- term consequences, we would be better prepared to come up with the kind of antidotes to the harmful short-term consequences that scare the interest groups and cause them to run to Congress to try and prevent achieving the long-term objectives. We could temper the transition to mitigate those effects. Often, in talking with airline or truck company managements, the point is made that they do not really disagree with our long-term objectives and that, in fact, the present regulatory system does have a lot of inefficiencies built into it. But their concern is how we get from here to there without causing enormous short-term consequences. They have an obligation to their employees and stockholders to avoid the adverse consequences if they can. So they are naturally arrayed against us. If we had a better feel for the kinds of short-term losses which are bound to occur as a consequence of changing the rules of the competitive game, we would be in a much better position to fashion short-term phasing of the regulatory reform proposals that would mitigate those consequences. I think this would enhance our ability to achieve the long-term objective. A second criticism is that the analytical work I have seen (and I have read, I think, a good bit of it) invariably makes the comparison between the present world and the fully competitive world that would result from 16
deregulation or allowing competitive market forces to operate. But this is no more valid than comparing market imperfections with a perfect government solution. In our analyses of the consequences of reduced regulation and more competition we need to deal with the kind of market structure that is likely to result. Rarely, if ever, will the regulatory reform changes produce fully competitive transportation markets. I doubt that we will get the full effi- ciencies of pricing flexibility with marginal pricing cost in every market as a result of even total deregulation. But I have seen little effort on the part of the analysts to take into account the market imperfections that would remain after we decontrol by removing the present controls on entry and pricing which produce the current inefficiencies. Having stated my criticism, however, I must also say that I do not know of any other field of public policy in which the academic community has played a larger role in influencing governmental policy and Congressional action. The rail, aviation, and motor carrier bills are testimony to the wealth of work you have done on the issue of transportation regulation. It is not just that we read the books and articles and then sought to fashion legislation to meet the identified problems. Economists played a major role in the drafting of the legislation. For instance, Jim Miller of the Council on Wage and Price Stability, who, with George Douglas, wrote the leading book on the economics of the air- line industry, was in the drafting sessions on the air bill. So were George Eads, Steve Sobotka, and a number of others. Clearly, the economics profession, both in and out of academic circles, has played an enormous role in analyzing the present problems with transport regulation and in fashioning the Administration's legislative response. My concern is that this tradition needs to continue and that the analytical work begins to deal with the more discrete, micro-type issues. We have looked now at the broad question -- the global question of what are the aggregate inefficiencies associated with regulatory systems. We need to have more detailed knowledge about individual markets. We have tended to treat the rail industry, the aviation industry, the motor carrier industry, and the barge line industry as if they constitute one market. And, of course, they are not. So, my plea would be for more attention to the discrete analysis, to the short-run, to the question of how we can fashion rules to achieve the long-run benefits of better regulation, minimizing the short-term disruptive effects. I should say, finally, that there is a broad effort going on, both in the Administration and in the Congress, to look closely at the question: How much sense does regulation make, be it economic, safety, environmental, noise, and so on? Some of the best work going on in the area of regulatory research right now is focused on the questions of safety. An important issue involves analyzing to what extent we can rely on the market process to produce an optimal amount of safety. What alternatives to the market are there? That is a very fruitful area for further review. It is an area that has not received 17
as much attention as economic regulation, but it is an area which, as I read the literature now coming out, is attracting increasing attention. We need more information and analysis about the economics of safety and the economics of environment. We need more precise answers to another question: When and under what circumstances do markets fail to provide proper incentives to produce safety? And if the market does not produce proper incentives, how can we influence the incentive process into a closer harmony with the produc- tion of an optimal amount of safety? This is a very difficult and complex question. It is going to require economists to dig into some very murky, detailed, specialized kinds of ques- tions, because safety regulation is highly technical, and not susceptible to the kind of broad generalizations that often characterize our usual approach. The economist is always going to remain the generalist, and he is going to have to work with the technologist and the scientist and other disciplines in order to understand the universe he is examining. I can only say in conclusion that I look forward very much to reading the proceedings of this conference and to future academic work on the effects of regulation. We will earnestly apply what you learn to the work that we are doing in the Administration. We are partners in a major public policy endeavor. 18
