Thursday, January 21, 2016

Did Deregulation Fail?

Often when discussing the 1980s and 1990s we hear the allegation that some incident, often the S&L crisis, but sometimes others  -- the deregulation of public utilities, especially electricity, being the second most popular example -- that deregulation failed, leaving us in much worse shape than we had been in under the "mild" regulatory environment of the 1960s and 1970s. And, of course, this is quickly followed by the argument that what is needed to cure our current economic woes, is not just a restoration of all those old regulations, but similar regulation of other areas of our economy.

Memories of such arguments came to me several times while I was writing my last essay "A Passing Thought on Cell Phones". Obviously, the topic -- how the breakup of the AT&T monopoly lead to the spread of cell phones -- was part of that, but that was not all there was to it. You see, the phone industry is one of those examples sometimes offered as proof of the failure of deregulation. Of course, it depends on the economic climate. When rates are low, and phone companies are stable, we hear little, but when some big telecom company crashes (this was an especially common argument during the dot com bubble's demise), or when phone rates rise, or service quality declines1, suddenly we are deluged with claims that the state of telecommunications is all due to sinister Republicans pushing their ideological agenda by deregulating the phone company.

Obviously, I am not convinced by such arguments, as I have made clear in other posts2. But since it does come up so often, I figure it is worth examining the various types of deregulation we experienced, especially through the 1980s and 1990s, to ask what were the positive and negative effects, and, more important, to ask what caused the problems we experienced, if any.

Actually, it is something of a mistake to imagine deregulation began in the 1980s. Carter actually began removing extensive Nixon era price controls during his presidency, leaving in place only a handful of controls, many on oil3. Of course, this had a mix of good and bad outcomes, though overall it was positive. Nixon had implemented the controls in an effort to prevent massive inflation when he took the dollar off the gold standard completely. However, though people could not exchange dollars for gold, the fact that gold could still be purchased for various uses meant there still was a spot price for gold, and people could see that from 1971 to 1981 there was a 600% rise in prices relative to gold. Thus, rather than creating an economic boon, as the closing of the gold window was supposed to, it created recurring shortages, beginning with the early 70s oil crisis. Of course, when these price controls were removed the result was massive "inflation" at least in terms of dollars4, but it was a necessary fix, as the only other alternative was to keep prices artificially depressed, with ever increasing shortages. This is not an attempt to exonerate Carter for "stagflation", as he met the inflation brought about by his removal of controls with still more "pump priming" inflation, exacerbating the situation, and setting the stage for the S&L collapse as we shall see later. But I can say the blame is not entirely Carter's, Nixon5 is to blame as well.

But that was a single incident in a decade otherwise known for increasing regulation and centralization -- such as the creation of the Nuclear Regulatory Commission, the Department of Education, Housing and Urban Development and a host of other massive, national-level agencies. So, let us ignore for the now the one case of deregulation in the 1970s and look at the 1980s and 1990s.

This era was unusual in that the trend toward deregulation was not consistent, and was not even found in a single level of government. In much of the 1980s, deregulation was the official policy of the federal government, and most efforts were centered there, especially in reducing and removing the powers granted to new Carter-era creations (a topic we will not discuss much in this essay6). But, in the late 1980s, and early 1990s, the impetus behind deregulation seemed to die, with the Bush administration giving no indication it would expend its limited political capital on efforts to deregulation. It was only with the beginning of the Clinton era that we see deregulation begin to reappear, but initially not at the federal level, but rather in the states. Granted, by 1994, with the change in congressional makeup, deregulation became a federal concern once again, but even then, it was quite a different world from the 1980s, with many efforts originating in the states, before moving to the federal level, or, in a few cases, remaining purely state efforts without any federal involvement7. And then, sometime in the late 90s, around the time of the dot com crash, the more vocal public support for reducing government seemed to fade away. And with it, most of the political influence required at the federal or state level to make such changes. But, for that period of somewhat less than two decades, there were a number of changes made that substantially reduced government power, and gave us a real end to many types of regulation.

So, what particular deregulatory efforts should we examine? Given that there were quite a few, it would be foolish to cover every deregulatory effort, so, perhaps it would be best to cover the most well known, and, among those, pay special attention to those which have been, at one time or another, been put forth as failures of deregulation.

Obviously, the first of these would have to be the deregulation of banks, especially the FLSIC. As this was involved in the subsequent crash of the S&L industry, it makes a great candidate. Second, let us look at the deregulation of power and other utilities. Though a much later effort, and mostly done at the state level8, it too is often held forth as evidence of the ways deregulation harms customers. After that, we will need to look at some less obvious candidates. Airline deregulation, for example, did not bring any massive failures such as the S&Ls did, but many point to continuing issue with over crowding, inadequate flight paths, poor service, bankrupt airlines and so on as evidence that deregulation was a failure. And the same is sometimes said of phone deregulation. Though more popular than airline deregulation -- and largely forgotten in today's world -- at one time phone deregulation garnered quite a few complaints. Turning to another state project, or one where the states had much more of a role than the federal government, let us look at school voucher programs. While not a traditional deregulation, it achieves similar results, and has the same aims, and, most important, produces the same complaints, so it is another good subject for our essay.

I could probably come up with another dozen examples if I wanted, but for now, let us stick with this list, if only to keep our essay to a reasonable length9.

So, let us start with the Savings and Loan crisis. This is the argument most often offered to show how deregulation failed. According to the standard argument, greedy bankers managed to manipulate friendly politicians into removing various regulatory reserve requirements, as well as eliminate oversight of investments. Once this was done, these bankers, without a thought about their depositors, undertook horribly risky investments in order to get high returns. In the end, these investments failed, and the S&L industry collapsed. But it all could have been prevented simply by leaving in place the original regulations.

In this case, the story is actually not too far from the facts, though it is wrong as to motivations, and forgets the real forces driving the fiasco, but in the facts alone, it is not too far off. And, unlike other cases where I will argue the supposed failure of deregulation conceals significant benefits, in this case, there truly was a problem, though, in the long run, it was a problem that would have materialized eventually in any case, so it has nothing to do with deregulation.

To make this argument easier to follow, let me lay out the main issues involved in the collapse. First, quite simply, the S&L industry, as created by statute, was of such a nature that massive inflation would inevitably cause its collapse. So whether deregulated or not, the S&Ls were doomed by the actions of Nixon and Carter. Second, the deregulation itself was not complete, restrictions were removed, but deposit insurance was left in place, making it easy for bankers to take excessive risks. Some may have done this out of greed, but as mentioned in our first point, inflation was also ruining the bottom line of S&Ls, making high return investments the only hope of staying afloat. Third, the entire capital market was suffering as well, thanks to massive inflation, gas crises and economic stagnation. Conventional banks were somewhat supported for a time by the ability to add an inflation premium to interest rates, as well as borrow at a prime rate set far too low to cover inflation. But S&:s were largely stuck with long term mortgages with pre-1970s interest rates, which no one wanted to buy and which had negative real returns thanks to inflation. Couple that with the failure of many of the risky investments attempted to stave off collapse, and there was no way the S&L industry could have survived.

Which brings me to my main argument, nothing could have saved the S&Ls. With their reserves made up largely of low rate, long term instruments such as mortgages, their revenue was negative, and was only going to get worse as inflation continued to rise. The deregulation was simply an attempt to hold off this collapse, though an ill-advised one. Not because deregulation is a bad idea, but because nothing could have saved them, they were going to crash from their very design. And, to make things worse, by only partially deregulating, leaving insurance in place, the stage was set for the pressures on bankers to inspire them to make risky investment which would eventually make that crash much worse.

Or, to put it more plainly, the S&L deregulation was not a true case study of deregulation. It is akin to taking a terminal cancer patient and putting him on an exercise regiment and then arguing his inevitable death proves the uselessness of exercise.

Electrical utilities are a bit more difficult to discuss, as there are so many individual cases. I wrote before about the case of Maryland10, where the state paid our previous monopoly firm a stipend to compensate for taking over the lines,a stipend which the statue predicated upon them continuing to charge set prices, prices far below what the remaining firms could charge. Thus, for almost 10 years, competitors were closed out of the market, and, when the stipend finally ran out, and prices rose to market prices, it was argued as a failure of deregulation11.

I don't recall the problems of many other states, though I do recall California had tremendous problems with brownouts, and the need to buy expensive power from the grid well outside of the state. Then again, given California's environmental regulations, and opposition to building new infrastructure, both before and after regulation, these problems were unavoidable, and were taking place before regulation. In short, they were hardly the fault of deregulation, they were the fault of excessive regulation.

And, in truth that is the problem with many schemes to deregulate utilities, in most cases, the deregulation is partial at best, with the government still playing a considerable role, from environmental regulation, to sometimes still setting rates. Obviously, the transition from a monopoly utility to a truly competitive market in electricity or gas or water would take some work, and may not occur all at once, but still, in most cases I have examined, the amount of remaining regulation is still quite large, making claims that deregulation has failed rather amusing.

The deregulation of airlines is a bit harder to discuss, since the complaints about the supposed failure of deregulation are not as frequent any longer. But still, when there were a number of airlines merging or going bankrupt, there were any number of pundits who argued that deregulation had destroyed the airlines. Similarly, today, from time to time, when someone discusses the shortage of new airline routes, the maxed out capacity of air traffic control systems12, and so on, we will sometimes hear once more that the problem is deregulation.

To answer these objections, we need to make two observations, or rather to deal with each objection separately. The first argument, that airline failures was due to deregulation was absurd, as airlines failed prior to deregulation as well, and, comparing airlines to other low-return, very high capital industries of the same time show that they had no more failures than other companies of a similar nature. Then again, even if they had, for a time, suffered from more closures following deregulation, that would have been neither surprising nor upsetting. In many cases, cartels and monopolies created by regulation allow companies to stay in business even when they should be closed due to relative inefficiency13. So, when regulation ends, there is often a period when inefficient firms are liquidated or bought out, and either new competitors enter the market or existing firms expand. Thus, seeing an increase of bankruptcies would not have been upsetting had it occurred.

The second argument is more interesting, as it suggests that the free market, far from being more efficient, is actually less efficient than regulation. Why else would we suffer from such shortcomings after deregulation?

But, as with the case of utilities -- but even more so -- the reason for the inefficiency, the lack of resources and the inability to meet new demands, is not that the free market is failing, but rather that the airline industry is far from deregulated. Just think about it. The FAA oversees almost all aspects of aviation. Airports are generally publicly owned, or, if not, then highly regulated. Air traffic controllers are overseen by the government. TSA is a government agency. Flight paths are assigned by the FAA. New airports are approved or denied by the FAA. And so on and so on.

Does this sound like an industry that has been deregulated? Yes, some of the most onerous regulations were removed from airlines in the two decades we are examining (and a few years earlier as well), but there remain ever so many more. Not to mention a host of others imposed in the aftermath of September 11, 2001. All of which makes it meaningless to examine airlines as an example of the failure or success of deregulation.

Phone deregulation is one of the few areas where we see deregulation which comes close to actual deregulation. Granted, the government still exercises a lot of control over broadcast bands14, and there is still regulation of some aspects of phone service -- such as the requirement phone numbers be portable, disabled cell phones can dial 911 and so on -- but for the most part, phone companies are a true case of deregulation, and, for the most part, quite successful.

I admit, during the earlier days of phone deregulation, we heard complaints about phone service sales calls, bout the failure of a number of phone carriers and so on, but these are trivial complaints. Sales calls are hardly a real cause for worry. And the failures of a number of phone carriers came, as anyone could have predicted, from the inexperience of new companies attempting to exploit a new market. It would be surprising had there not be some bankruptcies.

Which brings us to the final topic, school vouchers. This is an oddity, as most specific programs were claimed as successes, even often by those who opposed them. Yet, time and again, school systems will argue that voucher programs "as a whole" have failed15.

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1. This is similar to the arguments we hear about global warming whenever there is a particularly long or hot heat wave, or a particularly severe storm. (A practice I parodied in "Mandatory Global Warming Post", "Global Warming Revisited", "Oh That Global Warming", "Global Warming Watch", "Odds and Ends", "Global Warming Watch, Again", and discussed a bit more seriously in "The World's Most Stupid Bureaucrat".) Not that it is unique to either those promoting theories of anthropogenic global warming or advocates of regulation, it seems every group I could name is susceptible to the simplistic argument founded upon one current and highly publicized example. (See "The Plural of Anecdote is Not Data".) But these two groups do seem to be particularly frequent promoters of such arguments.

2. See "How To Blame The Free Market", "Those Greedy Bankers", "Greed and the Price of Oil" and "Killing the Railroads".

3. The outcome of leaving the oil price controls in place, which mostly made "old" wells more profitable than "new", was to prevent exploration for new reserves, and cause an ever increasing dependence on foreign imports, setting the stage for the late 70s oil crisis.

4. Dollar figures often mislead. People knew that there were goods they had to sell at a loss, thanks to the price controls. And so we had shortages, even though there was no official inflation, as prices were pegged at set points. Removing those pegs did not create the problem, it just allowed people to adjust prices to reflect market realities. See "The Rubber Yardstick".

5. And the same can be said of FDR for beginning the process which made it illegal to hold monetary gold, eventually allowing us to divorce money from gold. And, even earlier, Wilson can be blamed for creating the Federal Reserve, which made the whole fiasco of fiat currency possible. See "Monetary Issues Made Simple Part I", "Monetary Issues Made Simple Part II", "Inflation and Uncertainty", "Bad Economics Part 7", "Bad Economics Part 8", "What Is Money? ", "What Is A Dollar?", "The Gold Question, Not "Why?" But "When?"", "Bad Economics Part 19","Fiscal Discipline", "Putting the Bull in Bull Market", "Why Gold?", "The Free Market Solution" and "Misunderstanding Money".

6. Well, to a degree. I will obviously touch on some of these topics, as efforts such as education vouchers relate to reducing the influence of the Department of Education. But for now I will not look at efforts which had an explicit goal of reducing the scope of these departments.

7. In a way, I suppose I should be optimistic about this, as it indicates a more federalist approach to government, with the states bearing the burden of government reform. (See "Reforms, Ideal and Real", "The Benefits of Federalism", "Conservatism, Incremental Change and Federalism", "Power and Disorder", "Redundancy as a Protective Measure", "Adaptability and Government", "Inflexibility and Bureaucracy" and "Why Freedom is Essential") But I am not so sure that is the truth behind these changes. Having lived through the era, it seems far more probable that those local politicians who won their way into federal office gradually gave up their commitment to deregulation, leaving the states on their own. Of course, since there was, for a time, strong public support for such reforms, many times federal politicians would step in and claim credit for state successes, but in many cases it is very clear who truly pushed a project through.

8. Obviously, to some degree the Department of Energy was involved in these efforts, but for the most part, specific details were decided by the states themselves, which is why outcomes were so varied.

9. The list of other possibilities is quite long, though some stretch beyond our time limits. The death of the ICC, the side lining of the NLRB, the weakening of the FCC (though that was a joint effort by both parties, with each removing elements it found objectionable), the break of Conrail and overall deregulation of rail freight, and so on. If you have a particular topic you want me to examine, let me know and I may write a follow up on those new subjects.

10 See "How Did the Press Miss This?" and "How To Blame The Free Market".

11. This was a particularly clever political move as well, since most of those who passed the bill, and especially the governor who signed it, no longer held office when the bill came due and prices rose. In fact, to the joy of the Democrats, the price hike hit during an almost unheard of Republican governorship in Maryland, causing blame to fall on a governor, and a party, which played no role in the deregulation. But, as deregulation is seen as a Republican issue, the smear stuck.

12. I recently attended the ACSAC conference in LA, and this topic was discussed in one of the LAWS sessions. It was interesting to hear the requirements imposed on developers of air traffic control and collision detection and prevention systems.

13. See "Anti-Business Businesses", "Bad Economics Part 11" and "Bad Economics Part 19".

14. Personally I oppose vouchers, for reason I explain in "Never Ascribe To Evil, A Discussion of Education", "Why Vouchers are not the Answer" and "You Don't Drown in a Glass of Water - Vouchers Revisited".

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POSTSCRIPT

When I started this, I forgot that the airline deregulation act was enacted in 1978, and thus a Carter era measure. On the other hand, I am hardly alone, as most people seem to think it was part of the 1980s era of deregulation and blame any shortcomings on Republicans. It doesn't really change anything in my essay whether it was a measure from the 1970s or 1980s, as my premise is not predicated upon the party responsible, but simply whether or not deregulation is advantageous. Had Carter enacted every measure mentioned, or Clinton truly been responsible for those parts of the Contract with America he tried to claim as his own, it would not change my basic premise. Thus, I did not feel a need to go back and correct my initial version, though I did want to add this note to point out my small mistake as to date.



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