Knowledge And Decisions

Insofar as the public is interested in, and able to monitor, the results of the regulatory process, it is usually in terms of product prices or the profit rate of the industry. Almost by definition, they have nothing to compare the prices with — there being no unregulated firm producing the same good or service, in most cases. This leaves the profit rate of a regulated firm as their criterion. The regulatory agency therefore appeases the public by keeping this profit rate “low” in comparison with unregulated firms. That is wholly different from keeping the prices low. A low profit rate on a truck delivery that costs twice as much as necessary, because the truck returns empty for lack of legal authority to do business the other way, may still mean almost double what the price would have been under unregulated competition. Passenger fares may also be double what they would be without regulation when commercial airlines fly half empty — which is the rule. In the latter case, there is some comparison possible, because large states like Texas and California have purely intrastate airlines which thereby escape federal regulation. Pacific Southwest Airlines, for example, flies between Los Angeles and San Francisco at far lower fares — and higher profits — than federally-regulated airlines flying between Washington and Boston, which is the same distance.³⁷ They simply fly with more of the seats filled,³⁸ partly because there is no CAB to stop them from charging low fares. In the words of economists studying prices of airlines, the “subtantial traffic gains of the intrastate carriers have more than offset the lower revenue yields per passenger...”³⁹ Indeed low markups and high volume have been the secret of many profitable businesses in many fields.

Although pious words about the “public interest” may abound in regulatory legislation and regulatory rulings, there is no institutional mechanism to compel, induce, or reward commissions for weighing the costs and benefits to the public when they make their decisions. In particular, there are no incentives to keep costs down — and costs make up a far higher percentage of the price of most goods than does profit. A small inefficiency can raise the price of a good by much more than the doubling of the profit rate would. The average profit rate in the United States is about 10 percent, and a 20 percent rate for any firm is considered enormous. Yet if Firm A has only 10 percent higher costs than Firm B, its price would tend to rise as much as if its profit rate had doubled. The political visibility of profit rates results in much regulatory time, energy, and controversy when going into determining whether a “reasonable” rate of return is 6 percent, 7 percent, or 8 percent — differences which may mean very little to the average consumer in dollars and cents. Much less effort goes into determining whether costs of production are higher than they need be, even though production costs may have far more effect on prices. This is partly because of both legal and common sense limits on how far a regulatory agency can go into the actual management of a firm.

Regulated firms whose explicit financial profit rate is restricted have every incentive to allow costs to rise, taking various benefits in nonpecuniary forms, such as fringe benefits (especially for management) more relaxed (inefficient) management, less innovative activity and the headaches it brings, less unpleasantness such as firing people or hiring associates who are offensive in manner, race or sex.⁴⁰ In addition, the more costs the regulated firm can accumulate — and get the regulatory agency to accept as valid — the higher its total profits at a given rate of profit.⁴¹ In short, there is little incentive for regulated firms to keep down costs, and much incentive to let them rise, especially in ways that make the management of such firms easier. For example, high wage demands by unions in regulated industries need not be resisted (and strikes risked) as strongly as in unregulated industries, because wage increases become part of the cost on which the regulatory agency sets prices. Some of the highest paid workers in America are railroad workers and municipal transit workers, despite the dire conditions of both industries and the frequent transfusions of taxpayers’ money they require.