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The theoryof economicregulation
GeorgeJ. Stigler
of Chicago
The University
1. Whatbenefitscan * The state has one basic resourcewhichin pure principleis not
a state provide sharedwitheven the mightiest of its citizens:the powerto coerce.
to an industry? The statecan seize moneyby the only methodwhichis permitted
by thelaws of a civilizedsociety,by taxation.The statecan ordain
the physicalmovementsof resourcesand the economicdecisionsof
householdsand firmswithouttheirconsent.These powersprovide
the possibilitiesforthe utilizationof the stateby an industry to in-
crease its profitability.The main policies which an industry(or
occupation)mayseek of the stateare four.
The most obvious contributionthat a group may seek of the
government is a directsubsidyof money.The domesticairlinesre-
ceived"air mail" subsidies(even iftheydid not carrymail) of $1.5
billionthrough1968.The merchant marinehas receivedconstruction
and operationsubsidiesreachingalmost$3 billionsinceWorldWar
II. The educationindustry has longshowna masterful skillin obtain-
ingpublicfunds:forexample,universities and collegeshavereceived
federalfundsexceeding$3 billionannuallyin recentyears,as wellas
subsidizedloans fordormitories and otherconstruction. The veterans
of warshave oftenreceiveddirectcash bonuses.
I The domestic producersof petroleum,who also benefit
fromthe import
quota,wouldfinda tariff or cashpayment equallyattrac-
to domesticproducers
tive.If theirinterests
alonewereconsulted,importquotaswouldbe auctionedoff
4 / GEORGE J. STIGLER insteadofbeinggivenaway.
We have alreadysketchedthe main explanationforthefactthat
an industry withpowerto obtaingovernmental favorsusuallydoes
not use thispowerto get money:unlessthelist of beneficiaries can
be limitedby an acceptabledevice,whateveramountofsubsidiesthe
industry can obtainwill be dissipatedamong a growingnumberof
rivals.The airlinesquicklymovedawayfromcompetitive biddingfor
air mail contractsto avoid this problem.2On the otherhand, the
premieruniversities have not deviseda methodof excludingother
claimantsforresearchfunds,and in the long run theywill receive
much-reduced sharesof federalresearchmonies.
The second major public resourcecommonlysoughtby an in-
dustryis controloverentryby newrivals.Thereis considerable,not
to say excessive,discussionin economicliteratureof the rise of
peculiarpricepolicies(limitprices),verticalintegration, and similar
devicesto retardtherate of entryof new firmsintooligopolisticin-
dustries.Such devicesare vastlyless efficacious (economical)than
thecertificate ofconvenienceand necessity (whichincludes,ofcourse,
theimportand productionquotas oftheoil and tobacco industries).
The diligencewithwhichthepowerof controloverentrywillbe
exercisedby a regulatorybody is alreadywell known.The Civil
AeronauticsBoard has not allowed a singlenew trunkline to be
launchedsinceitwas createdin 1938.The powerto insurenewbanks
has been used by the Federal Deposit InsuranceCorporationto
reducetherateofentryintocommercialbankingby 60 percent.3 The
interstatemotorcarrierhistory is in somerespectsevenmorestriking,
because no even ostensiblyrespectablecase forrestriction on entry
can be developedon groundsof scale economies(whichare in turn
adduced to limitentryfor safetyor economyof operation).The
numberof federally licensedcommoncarriersis shownin Figure1:
the immensegrowthof the freighthauled by truckingcommon
carriershas been associatedwitha steadyseculardeclineof numbers
of suchcarriers.The numberof applicationsfornew certificates has
beenin excessof 5000 annuallyin recentyears:a rigorousproofthat
hope springseternalin an aspiringtrucker'sbreast.
We proposethe generalhypothesis: everyindustry or occupation
thathas enoughpoliticalpowerto utilizethe statewill seek to con-
trolentry.In addition,theregulatory policywilloftenbe so fashioned
as to retardthe rate of growthof new firms.For example,no new
savingsand loan companymaypay a dividendratehigherthanthat
prevailing in thecommunity in itsendeavorsto attractdeposits.4The
powerto limitsellingexpensesof mutualfunds,whichis soon to be
conferred upon the Securitiesand ExchangeCommission,willserve
to limitthegrowthof smallmutualfundsand hencereducethesales
costsof largefunds.
One variantofthecontrolofentryis theprotective tariff(and the
corresponding barrierswhichhave been raised to interstate move-
mentsofgoodsand people).The benefits ofprotection to an industry,
one mightthink,will usuallybe dissipatedby the entryof new do-
mesticproducers,and the questionnaturallyarises: Whydoes the
industry not also seek domesticentrycontrols?In a fewindustries
2See [7],pp. 60 ff.
ISee [10}.
4The FederalHomeLoan BankBoardis theregulatory body.It also controls THEORY OF
theamountofadvertising and otherareasofcompetition. REGULATION / 5
FIGURE 1
CERTIFICATES FOR INTERSTATE MOTOR CARRIERS
200
0~~~~~~~~~~~~~~~~~~~~~~~~~~~~~00
0j 150
< '_CUM ULATIVE
O APPLICATIONS
0
z
C E9 :
80 10
15
0-10 11.4
10-20 10.4
20-30 9.5
30-60 8.5
60-100 7.6
100-150 6.6
150-200 5.7
200-300 4.7
Li An illustrative
analysis.The recourseto the regulatory
processis
of coursemorespecificand morecomplexthanthe foregoing sketch
5 The largest wererestricted
refineries quota
oftheirhistorical
to 75.7percent THEORY OF
importquota plan.
undertheearliervoluntary REGULATION / 7
suggests.The defensivepowerof variousotherindustrieswhichare
affected bytheproposedregulationmustalso be takenintoaccount.
An analysisof one aspect of the regulationof motortruckingwill
illustratethesecomplications.At this stage we are concernedonly
withthecorrespondence betweenregulations and economicinterests;
laterwe shall considerthe politicalprocessby whichregulationis
achieved.
The motortruckingindustry operatedalmostexclusivelywithin
citiesbefore1925,in good partbecause neitherpowerfultrucksnor
good roads wereavailable forlong-distance movements.As
freight
these deficiencieswere graduallyremedied,the share of trucksin
intercityfreightmovementsbegan to rise,and by 1930 it was esti-
matedto be 4 percentof ton-milesof intercity The railroad
freight.
industry took earlycognizanceofthisemerging competitor,and one
ofthemethodsbywhichtrucking was combattedwas stateregulation.
By theearly1930'sall statesregulatedthedimensionsand weight
oftrucks.The weightlimitations werea muchmorepervasivecontrol
overtrucking thanthelicensingofcommoncarriersbecauseeventhe
trucksexemptfromentryregulationare subjectto thelimitations on
dimensionsand capacity.The weightregulationsin the early1930's
are reproducedin the appendix(Table 6). Sometimesthe participa-
tion of railroads in the regulatoryprocess was incontrovertible:
Texas and Louisiana placed a 7000-poundpayload limiton trucks
serving(and hence competingwith)two or morerailroadstations,
and a 14,000-pound limiton trucksservingonlyone station(hence,
not competingwithit).
We seekto determine thepatternof weightlimitson trucksthat
wouldemergein responseto theeconomicinterests oftheconcerned
parties.The mainconsiderations appear to be thefollowing:
(1) Heavytruckswouldbe allowedin stateswitha substantialnum-
ber of truckson farms:the powerfulagriculturalinterestswould
insistupon this.The 1930 Censusreportsnearlyone milliontrucks
on farms.One variablein our studywillbe, foreach state,trucksper
1000of agricultural
population.6
(2) Railroads foundthe truckan effective and rapidlytriumphing
competitor in theshorterhauls and hauls of less thancarloadtraffic,
in the carload and longer-haultraffic.
but much less effective Our
secondvariableforeach stateis,therefore, lengthof averagerailroad
haul.7The longerthe averagerail haul is, theless the railroadswill
be opposedto trucks.
(3) The publicat largewould be concernedby thepotentialdamage
done to the highwaysystemby heavytrucks.The betterthe state
highwaysystem,theheavierthetrucksthatwouldbe permitted. The
percentageofeach state'shighways thathad a hightypesurfaceis the
thirdvariable.Ofcoursegood highways are morelikelyto existwhere
the potentialcontributionof trucksto a state'seconomyis greater,
so thecausationmaybe looked at fromeitherdirection.
wouldmeasuretheproductof (1)
6 The ratioof trucksto totalpopulation
theimportance and (2) theimportance
of trucksto farmers, in the
of farmers
state.For reasonsgivenlater,we prefer
to emphasize (1).
7This is knownforeach railroad,and we assumethat(1) theaverageholds
within eachstate,and(2) twoormorerailroadsina statemaybe combined on the
8 / GEORGE J. STIGLER basisof mileage.Obviouslybothassumptions are at bestfairapproximations.
We havetwomeasuresofweightlimitson trucks,one for4-wheel
trucks(X1) and one for6-wheeltrucks(X2). We maythencalculate
two equations,
Xi (or X2) = a + bX3+ cX4+ dX5,
where
X3 = trucksper 1000 agricultural
labor force,1930,
X = averagelengthof railroadhaul of freight traffic,
1930,
X5 = percentageof stateroads withhigh-qualitysurface,1930.
(All variablesare fullydefinedand theirstatevalues givenin Table
7 on page 20.)
The threeexplanatoryvariablesare statistically and
significant,
each worksin theexpecteddirection.The regulationson weightwere
less onerous; the largerthe truckpopulationin farming,the less
competitivethe truckswere to railroads(i.e., the longerthe rail
hauls),and thebetterthehighwaysystem(see Table 2).
TABLE 2
REGRESSION ANALYSIS OF STATE WEIGHT LIMITS ON TRUCKS
(T VALUES UNDER REGRESSION COEFFICIENTS)
DEPENDENT N CONSTANT X5 R2
VARIABLE N OSAT X3 X
SOURCES: XI AND X2: THE MOTOR TRUCK RED BOOK AND DIRECTORY [11],
1934 EDITION, P. 85-102, AND U.S. DEPT. OF AGRIC., BUR.
OF PUBLIC ROADS, DEC. 1932 [13].
EMBALMERS
EMBALMERS 37
37 1910
1910 l
~~~~~3.32
(0.36)
-4.24007
(0.44)
0
| | |
T
| DENTISTS l 48 | 190C0 l 2.51 -22.94 103
DENTISTS 1900
~~~~~~
~~~(0.44) ~ (2.19)0.3
We expectthesevariablesto be negativelyassociatedwithyear of
licensure,and each of the ninestatistically regressionco-
significant
is of theexpectedsign.
efficients
The resultsare not robust,however:the multiplecorrelation
coefficientsare small,and overhalfof theregressioncoefficients are
not significant(and in these cases often of inappropriatesign).
Urbanizationis more stronglyassociatedthan size of occupation
withlicensure."3 Thecrudityofthedata maybe a largesourceofthese
disappointments: we measure,forexample,thecharacteristics ofthe
in
barbersin each state 1930, but 14 stateswere licensingbarbers by
1910.Ifthestateswhichlicensedbarbering before1910had relatively
more barbers,or more highlyurbanizedbarbers,the predictions
13 We maypooltheoccupationsandassigndummy variablesforeachoccupa-
thenare:
coefficients
tion;theregression
relative
sizeofoccupation to laborforce: -0.450 (t = 0.59)
urbanization . -12.133 (t = 4.00). THEORY OF
is highly
Thusurbanization significant, is notsignificant.
whilesize ofoccupation REGULATION / 15
wouldbe improved.The absenceof data foryearsbetweencensuses
and before1890led us to make onlythecruderanalysis."4
In general,thelargeroccupationswerelicensedin earlieryears.15
Veterinarians are theonlyoccupationin thissamplewho havea well-
definedsetofcustomers, namelylivestockfarmers,and licensingwas
laterin thosestateswithlargenumbersof livestockrelativeto rural
population.The within-occupation analysesoffersome supportfor
theeconomictheoryof the supplyof legislation.
A comparisonof different occupationsallows us to examine
severalothervariables.The firstis income,alreadydiscussedabove.
The secondis thesize ofthemarket.Justas it is impossibleto organ-
ize an effectivelabor unionin onlyone partof an integratedmarket,
so it is impossibleto regulateonlyone partof themarket.Consider
an occupation-junior business executiveswill do which has a
nationalmarketwithhighmobilityof labor and significant mobility
of employers.If the executivesof one statewereto organize,their
scope for effective influencewould be verysmall. If salarieswere
raised above the competitivelevel, employerswould oftenrecruit
elsewhereso the demandelasticitywould be veryhigh.16The third
variable is stabilityof occupationalmembership:the longer the
membersare in the occupation,the greatertheirfinancialgain from
controlof entry.Our regrettably crude measureof this variableis
based upon thenumberof membersaged 35-44in 1950and aged45-
54 in 1960:thecloserthesenumbersare,themorestablethemember-
shipoftheoccupation.The data forthevariousoccupationsare given
in Table 4.
The comparisonof licensedand unlicensedoccupationsis con-
sistently in keepingwithour expectations:
OCCUPATION |
Z< < < c < o z oJ
m i ? <
ui(
LU <
i u
LU
Lu <cL
L9
0
1-~
LL U ~ LU
WO0
L1 uj~
LuZ> WIu-LO
LICENSED:
ARCHITECTS 41.7 16.8 $ 9,090 0.012 57.8% 44.1% 0.045%
CHI ROPRACTORS 46.5 16.4 6,360 0.053 5.8 30.8 0.020
DENTISTS 45.9 17.3 12,200 0.016 9.4 34.5 0.128
EMBALMERS 43.5 13.4 5,990 0.130 52.8 30.2 0.055
LAWYERS 45.3 17.4 10,800 0.041 35.8 43.1 0.308
PROF. NURSES 39.1 13.2 3,850 0.291 91.0 40.6 0.868
OPTOMETRISTS 41.6 17.0 8,480 0.249 17.5 34.5 0.024
PHARMACISTS 44.9 16.2 7,230 0.119 62.3 40.0 0.136
PHYSICIANS 42.8 17.5 14,200 0.015 35.0 44.7 0.339
VETERINARIANS 39.2 17.4 9,210 0.169 29.5 14.4 0.023
AVERAGE 43.0 16.3. 8,741 0.109 39.7 35.7 0.195
PARTIALLY LICENSED:
ACCOUNTANTS 40.4 14.9 6,450 0.052 88.1 43.5 0.698
ENGINEERS 38.3 16.2 8,490 0.023 96.8 31.6 1.279
ELEM. SCHOOL TEACHERS 43.1 16.5 4,710 (a) 99.1 18.8 1.482
AVERAGE 40.6 15.9 6,550 0.117(b) 94.7 34.6 1.153
UNLICENSED:
ARTISTS 38.0 14.2 5,920 0.103 77.3 45.7 0.154
CLERGYMEN 43.3 17.0 4,120 0.039 89.0 27.2 0.295
COLLEGE TEACHERS 40.3 17.4 7,500 0.085 99.2 36.0 0.261
DRAFTSMEN 31.2 12.9 5,990 0.098 98.6 40.8 0.322
REPORTERS & EDITORS 39.4 15.5 6,120 0.138 93.9 43.3 0.151
MUSICIANS 40.2 14.8 3,240 0.081 65.5 37.7 0.289
NATURAL SC IENTISTS 35.9 16.8 7,490 0.264 96.3 32.7 0.221
AVERAGE 38.3 15.5 5,768 0.115 88.5 37.6 0.242
(a) NOT AVAILABLE SEPARATELY; TEACHERS N.E.C. (INCL. SECONDARY SCHOOL AND OTHER) = 0.276
Appendix
TABLE 5
CUMULATIVE OPERATING
APPLICATIONS CARRIERS
YEAR
ENDING NME
GRAND- NEW TOTAL APPROVED INUME
FATHER APPLICATIONS 3 OPE ION
3 ESTIMATED.
* RED BOOK [11] FIGURES ARE REPORTED (P.89) AS "BASED ON THE STATE'S INTERPRETATIONS OF
THEIR LAWS [19331 AND ON PHYSICAL LIMITATIONS OF VEHICLE DESIGN AND TIRE CAPACITY." PUBLIC
ROADS [13] FIGURES ARE REPORTED (P.167) AS "AN ABSTRACT OF STATE LAWS, INCLUDING LEGISLA-
TION PASSED IN 1932."
(B) MAXIMUM AXLE WEIGHT (AS GIVEN IN RED BOOK, P.90-91), MULTIPLIED BY 1.5 (SEE RED
BOOK, P. 89).
2.6-WHEEL: MAXIMUM GROSS WEIGHT AS GIVEN IN PUBLIC ROADS, P. 167. THESE FIGURES AGREE IN
MOST CASES WITH THOSE SHOWN IN RED BOOK, P. 93, AND WITH PUBLIC ROADS MAXIMUM
AXLE WEIGHTS MULTIPLIED BY 2.5 (SEE RED BOOK, P.93). TEXAS AND LOUISIANA ARE EX-
CLUDED AS DATA ARE NOT AVAILABLE TO CONVERT FROM PAYLOAD TO GROSS WEIGHT
LIMITS.
THEORY OF
REGULATION / 19
TABLE 7
INDEPENDENT VARIABLES
(BASIC DATA FOR TABLE 2 - CONT'D)
(1) AVERAGE LENGTH OF RR HAUL OF (REVENUE) FREIGHT =AVERAGE DISTANCE IN MILES EACH TON IS
CARRIED = RATIO OF NUMBER OF TON-MILES TO NUMBER OF TONS CARRIED. FOR EACH STATE, AVERAGE
LENGTH OF HAUL WAS OBTAINED BY WEIGHTING AVERAGE LENGTH OF HAUL OF EACH COMPANY BY THE
NUMBER OF MILES OF LINE OPERATED BY THAT COMPANY IN THE STATE (ALL FOR CLASSI RR'S).
(2) PERCENTAGE OF STATE ROADS WITH HIGH-QUALITY SURFACE: WHERE HIGH-QUALITY (HIGH-TYPE)
SURFACE CONSISTS OF BITUMINOUS MACADAM, BITUMINOUS CONCRETE, SHEET ASPHALT, PORTLAND
CEMENT CONCRETE, AND BLOCK PAVEMENTS. ALL STATE RURAL ROADS, BOTH LOCAL AND STATE
HIGHWAYS SYSTEMS, ARE INCLUDED.
20 / GEORGE J. STIGLER
References
1. ASSOCIATION OF AMERICAN RAILROADS, BUREAU OF RAILWAY ECONOMICS.
Railway Mileage by States. Washington,D. C.: December 31, 1930.
2. BECKER, G. S. "Competitionand Democracy." Jolurnlal
ofLaw anldEconomics,
October1958.
3. THE COUNCIL OF STATE GOVERNMENTS."OccupationalLicensingLegislation
in theStates."1952.
4. DEMSETZ, H., "Why Regulate Utilities?" Jouirnlal
of Law and Econlomics,
April1968.
5. GERWIG, R. W. "NaturalGas Production: A StudyofCostsofRegulation."
Journ-lal
of Law and Economics,October 1962, pp. 69-92.
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Cambridge,
Mass.: HarvardUniversity Press,1951.
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xversity
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THEORY OF
REGULATION / 21