Friday, January 27, 2017

How To Think About Government Regulation

Suppose a customer wants some kind of safety feature or quality assurance on a product they are buying. Say it’s a warning tone in an automobile, or a quality inspection on apples, or whatever else you can imagine. Suppose the customer is willing to pay up to $5 extra to add this feature. If the feature costs less than $5 to produce, the company will obviously add it to the product. If I can spend $2 on added quality and charge the customers an extra $5 per unit, that’s an extra $3 per unit I can pocket. (Or, more likely you’ll charge somewhere between $2 and $5 and share some of the surplus with the consumer. Anyway, re-write the example with whatever numbers you prefer.) On the other hand, if it costs more than $5 to produce the feature, the customers don’t really want it. They aren’t willing to pay the cost of production.

If you think this through, you start to realize that government regulation is gratuitous. If a regulation “forces” a company to produce something that the customer is already willing to pay for, that regulation is completely redundant. A free market will already supply that particular “regulation.” If a regulation forces a company to produce something that the customer is not willing to pay for, it’s actually doing harm. What this regulation is really doing is forcing the consumer to bear the cost of something they don’t actually want. If you impose an extra, say, $10 in production costs on something by adding a feature that the customer only values at $5, you’ve destroyed $5 in value per unit. You’ve harmed the consumer by $5 for each unit purchased.

This ignores “externalities,” or costs to third parties. The consumer might not want to purchase a $20 pollution-mitigating mechanism on their car even though the benefit to society is, say, $50, because the consumer only gets a tiny fraction of that benefit. Regulation of such "externalities" can in theory be justified because everyone wants everyone to have the pollution-mitigating device even though everyone is tempted to cheat by not buying his own. But my above discussion certainly applies to regulation that is meant to benefit the consumer directly. A safety inspection on the meat that I purchase directly benefits me; I don’t benefit third parties by assuring the safety of the food that I eat. There is no “pollution” effect on most of these kinds of safety/quality regulations. 

The above argument also applies to various labor regulations. If the cost of a safety practice (or safety equipment, or a comfortable amenity like climate control) is less than the value the worker places on it, then the employer will buy it for his workers. If your workers each value the additional safety at $100 per week and it only costs you $50 per worker-week to provide the safety, you would have to pay your workers an additional $100 to endure risks that you could mitigate for $50. Even if there is "market power" or something else going on here, there is clearly a deal to make and a surplus to share. (Here is a good treatment at Econlib.)

The point isn't to say that "no regulation is good" or "all regulation is pointless." That is close to my own position, but I won't try to sell that here. The point is rather that you should think more critically about some proposed piece of at-first-blush reasonable regulation. What is the cost? Why aren't consumers already demanding it ("demanding" implicitly meaning "being willing to pay the production costs")? Is there an obvious externality or market failure here? Is there really asymmetric information (in which a sophisticated company bamboozles low-information customers), or are customers actually indifferent to the information and thus ignore readily-obtainable information? Think about it. You might not get all the way to "There should be no government regulation at all." But plainly the stereotype of greedy corporations looking to slash safety and quality costs to earn a quick buck is a mistake. Slashing quality costs a corporation more than the cost savings if you think for a moment about the customer's willingness to pay. (I'm assuming here that actual fraud, selling something other than what you say you are selling, is illegal under any regulatory framework. Just as theft and murder are illegal under any regulatory framework. There are common law doctrines that exist basically everywhere and aren't a function of the regulatory state.)

No comments:

Post a Comment