1. Public Regulatory Policy: An Economic Perspective Public Regulatory Policy: An Economic Perspective urban @ prf.cuni.cz room 341, Thursday, 10-12 a.m.

2. First things first  What is „Public regulatory policy ?  Why „An Economic Perspective“ ?

3. What is public regulatory policy ?  Government decisions and actions (or inactions) intended to address a perceived public issue/problem

4. What are public issues?  Situations or issues where personal choices may (positively, or negatively) affect other people or the public as a whole (rather than only private individuals)

5. What are public issues?  Decision whether to buy or sell a car is a private problem because it affects you as a private individual.  Deciding what the speed limit should be on a street or a highway is a public problem because how fast a person drives can affect the safety of other persons.

6. What are public issues?  Public issues (usually) occur in public settings, such as communities, rather than in private settings, such as homes

7. What is public policy problems?  Public intervention aimed at regulating a public issue is called public (regulatory) policy

8. What are public problems ?  Public issues usually involve both facts and values

9. What are public issues?  People may know facts about public issues, but they solve them on the basis of their values  When they argue about how best to solve a public problem, they are likely to select the facts that support their values

10. Public values  Public issues usually involve four principal values: - freedom (choice, individuality, etc.), - fairness (equity, justice, etc.) - safety (security, social order, etc.) - prosperity (efficiency, productivity, etc.)

11. Public policy infrastructure  Public policy is associated with formally approved policy goals as well as policy measures (tools), usually embedded in laws  It may be executed/implemented by state agencies  Broader policy areas can be called policy programs

12. Typical broader public policy areas:  Health care protection  Consumer protection  Environmental policy  Social security policy  Employment (labor market) policy  Energy policy  Education policy  Public transportation policy etc.

13. Some specific public policy issues:  Workplace safety  Immigration  Housing policy  Automobile safety  Smoking  Renewable energy  Gambling  Hospitals privatization  Public subsidies to low cost carriers  Policy of disposable drinks packaging deposit

14. More questionable public policy issues:  Bankers bonuses  Tax on financial transactions  Subsidizing corn-based ethanol production  Protecting domestic producers  Obesity (tax on fat consumption) 

15. Why „An economic Perspective“?  Public policy often includes two economic aspects - prosperity (it usually aims at increasing public welfare expressed in economic terms) - efficiency (cost/benefit ratio).

16. Why „An economic Perspective“?  Public policy tries to change economic behavior of subject (individuals, firms), e.g. consumer habits, production methods etc.  Public policy tools often use economic incentives (taxes, tax reliefs, subsidies etc)

17. Public policy and Regulation  When applied to economic subjects/matters public policy is often also called „regulation“, „regulatory measures“ or „regulatory policy“

18. Some regulation examples:  Financial markets regulation  Competition policy and merger regulation  Opening of energy markets to competition  Policy of investment incentives  Ecological taxes, pollution permits (Introduction of Emissions trading scheme)

19. The focus of the course  The course focuses on policy analysis and evaluation based on economic criteria  Therefore, it looks mainly at public policy areas having a law-economics interface

20. Why study public policy ?  The purpose of public policy, among other things, is to regulate society in such a way as to provide higher welfare or economic benefits

21. Why study public policy ?  The best way how to accomplish this is, however, often debatable (as is the questions who actually benefits from the policy)

22. Policy analysis  Policy analysis is an evaluation of public policy programs and alternatives in terms of their actual impact, i.e. how successfully they comply with their objectives

23. Scope and method of public policy analysis  The main criteria of a specific public policy analysis comprise its goals, effectiveness, efficiency (economic feasibility), its tools, impact on equity and freedom, its political feasibility etc.

24. Initial policy analysis question  Do we need public policy (public policy intervention)?  Should specific issues be considered public problems?  Do they deserve regulation ?

25. Further policy analysis issues  Public policy effectiveness - its ability to reach its stated goals  Public policy tools - possibilities of alternative tools  Public policy efficiency - its costs, side-effects etc.  Public policy comparisons - in terms of its goals, tools, effectiveness and efficiency

26. Examples of policy analysis results: broader conclusions  why policymakers sometimes fail to pursue socially desirable policies or policy reforms

27. Examples of policy analysis results: specific conclusions  which policy tools have been successful and which have not

28. The Main Economic Question  From the economic perspective, the main question analyzed by the theory of public policy is: - when is it best to let market forces take their natural course and when should government intervene in or regulate market activity

29. Policy Distinctions two main policy cathegories  The economic approach to public policy analysis distinguishes two main policy cathegories - distributive policies - distributive policies - regulatory policies - regulatory policies

30. Distributive policies  The objective of distributive public policies (or social policies) is to solve social problems and/or to pursue a social goal through redistributing income from one group of citizens for the benefit of another group of citizens.

31. Distributive policy goals  Typical distributive policy goals include reducing poverty, ensuring higher fairness (e.g. in labor markets), and providing public or merit goods—that is, goods and services that a society believes every citizen is entitled to regardless of whether he or she can afford them.

32. Regulatory policy  Regulatory public policies can be considered as legal restrictions imposed on economic behavior

33. Regulatory policy goals  Regulation attempts to produce behavior, which might not otherwise occur, or prevent behavior than would otherwise occur.

34. Regulatory policy: Examples  Common examples of regulation include attempts to control market entries, market prices, wages, pollution effects of production or consumption, employment for certain people or in certain industries, standards of production for certain goods and services etc.

35. Regulatory policy can have five major legal forms (either Command-and-Control or Market- Based) Regulatory policy can have five major legal forms (either Command-and-Control or Market- Based) Command-and-Control) 1. Public standards or statements of expectations (Command-and-Control)

36. Regulatory policy can have five major legal forms Command-and-Control) 2. A process of registration or licensing to approve and to permit an operation, usually by a named organisation or person (Command-and-Control)

37. Regulatory policy can have five major legal forms Command- and-Control) 3. A process of inspection or other form of ensuring standard compliance, including reporting and management of non- compliance with these standards (Command- and-Control)

38. Regulatory policy can have five major legal forms Command-and-Control) 4. A process of de-licensing whereby organisation or person is judged to be operating unsafely, and is ordered to stop operating at the expense of acting unlawfully (Command-and-Control).

39. Regulatory policy can have five major legal forms 5. Taxes and subsidies levied on production or consumption motivating economic subject to increase or decrease their activities in certain areas (Market based)

40. Regulatory policy examples  Regulations imposed on the selling of (financial) products to individuals have been introduced as a protection against unscrupulous (financial) firms with better information than their customers (problem of „information asymmetry“).

41. Regulatory policy example (market based policy) Taxes and/or subsidies can motivate to substitute current production method polluting the environment by ecologically less harmful technologies etc.).

42. Some regulation has been motivated by politics rather than economics  For instance, restrictions on the number of hours people can work or the circumstances in which an employer can dismiss employees.

43. Regulation vs. deregulation  The second half of the 20th century saw a wave of attempts to remove, reduce, or simplify restrictions on business and individuals with the intent of encouraging the efficient operation of markets.

44. Regulation vs. deregulation  The stated rationale for deregulation is often that fewer and simpler regulations will lead to lower costs, therefore higher productivity and competitiveness and lower prices und higher employment overall.

45. Regulation vs. deregulation: Example  For example, deregulation of the air industry in Europe in 1992 gave carriers from one EU country the right to operate scheduled services between other EU states.

46. Regulation vs. deregulation  In addition, there have been regulatory innovations, usually suggested by economists, such as emissions trading scheme

47. Main Economic Reasons for Government Interventions  Market failures: situations when markets fail to be „efficient“  There are five main cathegories of such situations

48. Market failures: situations when markets fail to be efficient  The existence of monopolies, or excessive market power  „Externalities“  Provision of public (collective, merit) goods  Information failures (information asymmetry)  „Moral hazard“

49. Economic reasons for government interventions  Analyses of public policy/ government intervention in the economy should be looking at whether or not have market failures occured.

50. Economic reasons for government interventions  The occurrence of market failure usually legitimizes government intervention

51.  In contrast to a competitive firm, the monopoly charges a higher price.  From the standpoint of consumers, this high price makes monopoly undesirable. Monopoly: Problem of Welfare Loss

52.  Legislation designed to encourage competition and discourage/ban the use of monopoly practices can curb the inefficiencies resulting from market power in general and monopoly in particular Competition/Anti-trust Law

53.  Government may regulate the prices that the monopoly charges.  This is often the case with natural monopolies. Price regulation Price regulation

54.  Practical problem associated with price regulation: regulators often depend on information obtained from monopolies Price regulation Price regulation

55. The actions of an economic subject can have externalities  An externality is an impact or „spill-over“ (positive or negative) on any party not directly involved in an economic decision/activity

56. Externalities: both positive and negative  A negative externality occurs when an economic decision (concerning production or consumption) creates undeserved costs to a third party  A positive externality means undeserved benefits to a third party.

57.  In other words, the producers or consumers in a market suffering from externalities either do not bear all of the costs or do not reap all of the benefits of their economic activity. Externalities: both positive and negative

58.  For example, manufacturing that causes polution imposes costs on others, while planting forests (rather than other agricultural activities) would improve water quality. Externalities: Examples

59. Why market failure ?  Because costs and benefits are not fully included in prices, they do not form part of the calculations of the people deciding whether to go ahead with the economic activity

60. Why market failure ?  The existence of externalities means that either too much or too little of the good is produced and consumed in terms of overall cost and benefit to society

61. Why market failure ?  If there are external costs (negative externalities) such as pollution, the good will be overproduced by a market, as the producer does not take into account the external costs when producing the good.

62. Many negative externalities are related to the environmental consequences of production and use  Air and water pollution,  Industrial farm animal production, overfishing  Overconsumption of health care caused by smoking and drinking  When car owners use roads, they impose congestion costs on other users  Consumption of energy increases the nation’s dependence on foreign oil

63. Positive externalities: Examples  Education creates a positive externality because, among other reasons, more educated people are less likely to engage in violent crime, which makes everyone in the community better off.  Home ownership creates a positive externality in that homeowners are more likely than renters to become actively involved in the local community.

64. Positive externalities: Examples  Inventions and information - once an invention (or other form of practical information) is discovered or made accessible, others benefit by exploiting the invention or information.  An individual buying a product that is interconnected in a network increases the value of the same product owned by others.

65. u One potential solution of externalities is a policy of command-and-control (bans, requirements etc) u For instance, specific technologies are banned to eliminate an externality, requirement that every car be fit with a catalytic convertor, that all citizens be immunized etc. Policies correcting externalities

66. u Government can fight externalities also by quantity policies (specific limits are set for a particular externality such as air pollution) Policies correcting externalities

67. u The liability system administered by the courts also seeks to reduce the cost of externalities by encouraging firms and consumers to behave in a more socially efficient manner. Policies correcting externalities

68. u Market based policy dealing with externalities, when the externality is negative, is a tax on the activity or, if the externality is positive, a subsidy. u Taxes and subsidies make consumers and firms account for („internalize“) the social costs or enable them to accrue the social benefits of their actions. Policies correcting externalities

69. Externalities and public goods u Extensive positive externalities connected with providing certain goods may cause problems for the production of such goods.

70. Externalities and public goods u Markets, therefore, maybe be unable to provide these goods in desired quantities because their producers would be unable to collect revenue from their sales. u These issues are known as public goods problems.

71. u Public goods are regarded as a very important example of market failure, and in most countries they are provided at least in part by government and paid for through compulsory taxation Provision of public goods

72. u Public safety u National Defense u Basic Research u Fighting Poverty Some Important Public Goods

73. u Government may decide to provide a public good if the total benefits exceed the costs. Provision of public goods: An Economic Perspective

74. u Cost benefit analysis refers to a study that compares the costs and benefits to society of providing a public good. u In order to decide whether to provide a public good or not, the total benefits of all those who use the good must be compared to the costs of providing and maintaining the public good. The Difficult Job of Cost- Benefit Analysis

75. u Government may decide to provide public good by public production or to subsidize production of a public good in the private sector u Unlike public production (direct government provision of public goods), subsidies may result in some form of a competitive market. Provision of public goods

76. u Informational asymmetry arises when one party to a transaction has more or better information than the other party. Market failures due to nature of exchange

77. u If consumers are uninformed or misinformed about the quality of a product, they may derive less utility from it than they expected. u Consumers’ choices could be distorted by false advertising, by firms’ failures to disclose relevant information about their products and services, and by a lack of information to assess accurately the safety of potentially risky products. Why market failure ?

78. u Similarly, workers may become injured or ill because they lack information about the health risks they may encounter in their workplace. u Another example of information asymmetry is adverse selection when people who are high risk are more likely to buy insurance Why market failure ?

79. u Governments attempt to minimize the welfare losses caused by imperfect information by empowering regulatory agencies to - direct firms to provide complete and accurate information about their products and workplaces - ensure that consumer products and workplaces meet reasonable safety standards. Policies to imperfect information

80. u Policies aimed at improving information asymmetries entail measures in - advertising regulation, - disclosure rules, - labelling, - product standards, - occupational licensing etc. Policies to imperfect information

81. u Moral hazard arises because an individual or an institution does not bear the full risk of its actions because it can shift at least some consequences of its risky behavior on others. u Therefore, it has a tendency to act less carefully than it otherwise would Market failures due to nature of exchange

82. u For instance, an individual with insurance against automobile theft may be less vigilant about locking his car, because the negative consequences of automobile theft are (partially) borne by the insurance company. Market failures due to nature of exchange

83. u Financial bail-outs of banks by governments, central banks or other institutions can encourage risky lending in the future, if those that take the risks come to believe that they will not have to carry the full burden of losses. Moral hazard in financial industry

84. u A special case of moral hazard/asymmetric information is the principal-agent problem, where one party, called agent, acts on behalf of another party, called principal. Principal-agent problem

85. u The agent usually has more information about his actions or intentions than the principal does, because the principal usually cannot perfectly monitor the agent. Principal-agent problem

86. u The agent may have an incentive to act inappropriately (from the view of the principal) if the interests of the agent and the principal are not aligned. Principal-agent problem

87. u There are some types of policy issues where economists believe strongly in a policy that may or may not appeal to the general public. Some Policy Recommendations

88. u For example, economists believe that we benefit from free trade, even though the public sometimes resents foreign imports. Some Policy Recommendations: Free Trade

89. u The principle of substitution says that individuals will respond to incentives by substituting low-cost methods for high-cost methods. u Example: applying taxes directly to the activity that is to be discouraged Some Policy Recommendations: Substitution

90. u The most ineffective policies are those that will be undermined by the principle of substitution. The principle of substitution

91. u Example: when a minimum wage is imposed, businesses will substitute low- skilled workers. The principle of substitution

92. u Lack of Information u Special Interest Effect (Lobbying, Corruption) u Rent-Seeking Behavior u Short sightness Effect: Clear Benefits, Hidden u Costs The opposite of Market Failures: Government Failures

93. Special Interest Effect u One that generates substantial personal benefits for a small number of subjects while imposing a small individual cost on a large number of other persons

94. Special Interest Effect (cont.) u T he voters bearing the cost of special- interest legislation will often be uninformed on such an issue because it exerts only a small impact on their personal welfare and because they are unable to avoid the cost by becoming better informed.

95. Interest Groups and Public Policy u Politicians are likely to offer policies where the costs are widely diffused, but where the benefits are more significant for a particular interest group u Public policy makers may, therefore, have a strong incentive to favor special interests even if the corresponding action is inefficient (higher social costs than benefits).

96. Interest Groups and Politics u Therefore there may be bias in political decisions towards public intervention u

97. Economics of the Transfer Society u A large and growing part of government is devoted to transferring income.

98. Economics of the Transfer Society u There are two major reasons why large- scale redistribution will reduce the „size of the economic pie“:

99. Economics of the Transfer Society uAs public policy redistributes a larger share of income, more resources will flow into wasteful rent seeking activities. uHigher taxes to finance income redistribution and an expansion in rent-seeking will induce taxpayers to focus less on income-producing activities, and more on actions to protect their income.

100. Four Factors that Weaken the Case for Market forces u Lack of competition u External costs and benefits u Public goods u Poor information

101. Four Factors that Weaken the Case for Public Solutions u The power of special interests u Rent seeking/corruption u The shortsightedness effect u Redistribution