What Is the Theory of Economic Regulation?

The theory of economic regulation is an economic theory developed by George Stigler. It is intended to explain the "supply," "demand," and practical use of government regulatory power over the economy. In particular, Stigler examines the various ways in which disparate interest groups are able to influence and use government power to advance their economic needs. The theory also examines the connection between the demand for regulation from large firms and from consumers. The theory of economic regulation states that, when conflict arises between these two groups, large firms almost always win because, for various reasons, they have much more political power.

Stigler's theory of economic regulation treats government regulation as a commodity in itself, subject to its own laws of "supply" and "demand." Many different interest groups, ranging from large oil companies to small environmental organizations to consumers in general, often seek government regulation. Such regulation is generally aimed at either providing some benefit to or correcting some detriment against the concerned interest group. Groups with greater organizational power and resources are, in general, able to secure greater government regulation in their favor.

According to the theory of economic regulation, large firms are almost always able to secure beneficial regulation over smaller organizations and consumers. Large firms have more resources to work with and are more able to organize effective collective movements. Smaller organizations and consumers tend not to organize collective actions as much because of the expense of doing so and the relatively small potential benefits.

Some of the possible methods of governmental regulation are also examined in the theory of economic regulation. Two primary methods are direct subsidy and protectionist regulation. Direct subsidy provides short-term benefits, but it also encourages new firms to enter into a given industry, thereby creating more competition. Protectionism, on the other hand, is deliberately crafted to create obstacles to entry to a given industry. This protects firms from potentially costly competition.

Criticism against the theory of economic regulation mostly involves its relative disregard for the supply of regulation. The theory of economic regulation focuses largely on the motivations and methods of those who demand economic regulation. Regulators, however, have their own motivations that may prompt them to act in a manner different from that predicted by large-firm influence. In general, regulators seek political support and desire reelection, campaign funding, and other benefits. In some cases, supporting smaller organizations or consumers can provide these benefits when helping large firms cannot.