Public interest theory

The Public Interest Theory of regulation explains in general terms, that regulation seeks the protection and benefit of the public at large;[1] public interest can be further described as the best possible allocation of scarce resources for individual and collective goods. Regulation means the employment of legal instruments for the implementation of socio-economic policy objectives, for example the government can establish economic and social regulations in order to realize goals like allocative efficiency, stabilization, or fair and just income distribution

In modern economies, the allocation of scarce resources is mainly coordinated by the market. In theory, this allocation of resources is optimal, but these conditions are frequently not complied in practice. The allocation of resources is not optimal and there is need for methods for improving the allocation. One of the methods for achieving efficiency in the allocation of resources is government regulation.[2]

According to public interest theory, government regulation is the instrument for overcoming the disadvantages of imperfect competition, unbalanced market operation, missing markets and undesirable market results. Regulation can improve the allocation by facilitating, maintaining, or imitating market operation. The exchange of goods and production factors in markets assumes the definition, allocation and assertion of individual property rights and freedom to contract.[2]

Public Interest Theory is a part of welfare economics and emphasizes that regulation should maximize social welfare and that regulation is the result of a cost/benefit analysis done to determine if the cost to improve the operation of the market outweighs the amount of increased social welfare.

The following costs can be distinguished in this:

1. The costs of formulating and implementing regulation;

2. The costs of maintaining regulation;

3. The costs of compliance with the rules for industry;

4. The dead weight costs resulting from distortive changes in connection with 1-3.

Public interest theory is developed from classical conceptions of representative democracy and the role of government,[3] and it has considerable confidence in the civil service, according to Max Weber civil servants are office carriers dedicated to carry out the duties that constitute their particular role or task within a strictly ordered and specialized hierarchy. The combination of merit and tenure with unambiguous norms of impartiality support rational decision making based on administrative decision making where individual decisions are attributed to either the subsumption under norms or the balancing of means and ends.

In this conception, regulatory administration neither adds to nor subtracts from the policy decided by lawmakers. The public interest may be served, but it is served exactly as interpreted by lawmakers. Bureaucracy does not usurp the public interest, nor does it protect against its usurpation by particularistic interests seeing regulation as a vehicle for their own concerns.[4] Contrary to the capture theory, it states that the ultimate goal of regulation is to pursue some conception of the general good

History

The theory of public interest regulation prevailed up to the 1960s until public choice theory launched its critical attack on established theory. While there is no pointed origin or categorical articulation of this theory, its notions can be traced back to works of Arthur Cecil Pigou;[5] related to his analysis of externalities and welfare economics. This theory was prevalent, especially during the New Deal progressive era, as stated above, starting the 1960s, economists of the Chicago school began critiquing the assumption of benevolent regulators, proposing counter theories, like the Public choice theory, which is based on personal-interests of agents.

Regulation, according to Public interest theory however, is assumed initially to benefit society as a whole rather than particular vested interests.[6] The regulatory body is considered to represent the interest of the society in which it operates rather than the private interests of the regulators.[7]

Public Interest Theory in the Practice

One example of the application of Public Interest Theory can be seen in an investigation in Sweden and the energy market:

We test the public interest and regulatory capture hypotheses, in the context of the Swedish electricity market, by studying the factors influencing the Swedish Energy Agency’s decision to replace decision-makers it employs to hear customer complaints against utilities.

We test if the regulator’s decision to retain, or replace, the decision-maker, following a sequence of decisions, can be explained by whether the customer or utility is being favored by the civil servant. Based on whether the regulator replaces the decision maker that it has the power to appoint, we draw inferences about what theory can best explain the behavior of the regulator. The regulator can choose to favor the customer. To do so would be consistent with the fact that the primary objective of the electricity market reform in 1996 was to put the onus on the Swedish Energy Agency to provide stronger consumer protection against market abuse by the electricity utilities. On the other hand, the regulator might be captured because the utilities have more financial and legal resources and they have a well-established lobby organization which the customers do not have. It is not clear, therefore, whether customers or utilities have benefited most during the post-reform regulation.[8]

Criticism and other theories

The most critiqued aspects of Public Interest Theory, are its ambiguity, and inability to determine when and if public interest has progressed.

Two problems with public interest theory are:

  1. Different theories arise regarding how much regulation is optimal, and
  2. It is difficult for the legislature to ensure the regulator is acting in the public’s best interest and not its own

When the regulatory agency is established, during a period of regulatory reform, the agency is subject to close scrutiny from the government and the public alike and the regulatory agency faces strong pressure to protect consumers from market abuse. However, over time, the focus of government and public attention turn to other issues, removing the spotlight from the activities of the regulator. With this development, the regulator becomes more susceptible to regulatory capture.[8]

The competing hypothesis is that even when a regulatory body is established to protect consumers from monopolistic abuse, it will be captured by the firms that it is established to discipline.

References
  1. Hantke-Domas, Michael (March 2003). "The Public Interest Theory of Regulation: Non-Existence or Misinterpretation?". European Journal of Law and Economics. 15 (2): 165–194. doi:10.1023/a:1021814416688. ISSN 0929-1261.
  2. Hertog, Johan den (2012). "Economic Theories of Regulation". Cite journal requires |journal= (help)
  3. Grønnegaard Christensen, Jørgen. "Public Interest regulation reconsidered" (PDF).
  4. Dialnet, Universidad de La Rioja (2002-06-30). "Dialnet (Servicio de Difusión de Alertas en la Red)". Contextos Educativos. Revista de Educación. 0 (5): 276. doi:10.18172/con.519. ISSN 1695-5714.
  5. Pigou, A. C. (1932) The Economics of Welfare. London: Macmillan and Co.
  6. Deegan, C., Unerman, J. (2011) Financial Accounting Theory. Maidenhead: McGraw-Hill Education.
  7. Richard A. Posner, Theories of Economic Regulation, The Bell Journal of Economics and Management Science, Vol. 5, No. 2 (Autumn, 1974), pp. 335-358
  8. Smyth, Russell; Söderberg, Magnus (December 2010). "Public interest versus regulatory capture in the Swedish electricity market". Journal of Regulatory Economics. 38 (3): 292–312. doi:10.1007/s11149-010-9129-9. ISSN 0922-680X.
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