The evolution of regulation: twentieth century lessons and twenty-first century opportunities.

• Author: Mayo, John W.

TABLE OF CONTENTS I. INTRODUCTION AND OVERVIEW II. BACKGROUND: THE EVOLUTION OF REGULATION A. The Rise of the Regulation B. Stability of the Early Years C. Ideological and Intellectual Underpinnings of Deregulation. D. The Inklings and Promise of Results-Based Regulation III. RESULTS-BASED REGULATION: A NEW FRAMEWORK FOR TWENTY-FIRST CENTURY POLICYMAKING IV. RESULTS-BASED REGULATORY POLICY: THE CASE OF TELECOMMUNICATIONS V. CONCLUSIONS AND CAVEATS What these rules should be is the principal question in human affairs; but if we except a few of the most obvious cases, it is one of those which least progress has been made in resolving. (1)

John Stuart Mill On Liberty, 1859

1. INTRODUCTION AND OVERVIEW

   During the second presidential debate of the 2008 election, then candidate Barack Obama opined, with respect to financial markets, that "[t]he problem is we still have a[n] archaic, 20th-century regulatory system for 21st-century ... markets." (2) While the focus on regulatory reform in financial markets has subsequently been pronounced, an important set of questions remain regarding the applicability of this phrase to other traditionally regulated industries such as telecommunications. In this paper, I explore this issue by focusing on lessons that may be learned from both the evolution of economic analysis and regulatory experiences during the past half-century.

   I find, inter alia, that while the trend toward deregulatory policies over the past half-century was nominally motivated by a push toward economic efficiency, policymakers were also attracted to deregulatory policies by deep-seated ideological desires to protect individual freedoms deemed to be infringed by regulation. (3) With the emergence of the 2008 financial crisis in the United States, that simple ideology has receded, giving way to another equally crude ideology that calls for more government regulation and controls. (4) This shift in ideological passions, however, is unlikely to provide proper guidance for any regulatory system that takes seriously the goal of promoting economic welfare.

   Aside from ideological predispositions as guideposts for regulatory policy, the question remains whether there is an alternative, fundamentally sound foundation for guiding regulatory and deregulatory policies. In that regard, careful reflection on the evolution of regulation since the early 1960s reveals a subtle but potentially substantive and meritorious basis for calibrating regulatory and deregulatory policymaking in the twenty-first century. In particular, when stripped of the ideological drivers, the most successful dimensions of regulatory and deregulatory policymaking in the past half-century can be seen as decidedly "results-based." (5) In this paper, I describe and document this set of more subtle regulatory developments and explain how they have provided for the soundest regulatory decisions over the past fifty years. Drawing on these developments, I then propose a set of principles that hold the potential to underlie a new results-based regulatory framework. Results-based regulation ("RBR") draws upon the most successful aspects of both regulatory and economic analysis over the past fifty years with the aim of establishing principles that can guide policymakers as they pursue regulatory and deregulatory policies in the twenty-first century.

   The potential for, and the urgency to establish, a twenty-first century results-based regulatory paradigm is significant. And, while the significance of a results-based regulatory framework is relevant to a wide swath of industries, it is particularly important in the case of the telecommunications industry. Specifically, the twentieth century regulatory infrastructure for telecommunications was designed for a monopoly, and while legislative reforms enacted in 1996 embraced competition, the regulatory infrastructure has remained fully entrenched. (6) Even though the regulatory structure has remained intact, the industry has evolved very rapidly, by the confluence of dramatic technological change, the easing of regulatory constraints on entry, and the significant broadening of telecommunications services from voice-only to voice, video, and data. (7) As a result, it is widely believed that with an appropriate twenty-first century policy framework in place, the industry has the potential to significantly and substantively enable economic growth and enhance the quality of virtually all Americans' lives beyond what it has already achieved. (8)

   This rapid evolution of the telecommunications industry, together with the infrequent changes to the governing regulatory structure, creates the profound risk of a policy incongruity in which economic welfare is harmed by inert regulation. In this case, legislative policy reforms are likely to offer the most promising path forward. In an industry as complex as telecommunications, however, legislation is often years in the making. (9) Accordingly, in the short run, economic welfare can be enhanced to the extent that regulators are willing to adopt rigorous analysis steeped in the principles of RBR. A core element of such a regulatory approach is addressing the question of whether proposed, or extant, regulations affirmatively can be shown to benefit economic welfare relative to the alternative of resource allocation that relies more heavily on market-based transactions.

   Importantly, the foundation of RBR analysis is not built on speculative theorizing about potential dangers of alternative regulatory governance structures, but rather upon serious empirical analysis that seeks, in counterfactual fashion, to establish how economic metrics of the industry in question compare with those that would prevail in alternative states of the world. In some instances, such counterfactual benchmarks are difficult to come by, but in other often overlooked circumstances, benchmarks may readily arise within the industry over time. To highlight both the promise and challenge of the applicability of this approach, the paper closes with a "proof of concept" examination of the implications of RBR in the provision of modern telecommunications services.

2. BACKGROUND: THE EVOLUTION OF REGULATION

   Today, regulatory policy is at an inflection point, complicated by financial market regulatory failures and a backlash against the prevailing ideology that has trended the United States toward less intrusive regulation of industries such as telecommunications, electricity, rail, airlines, and trucking over the past half-century. (10) In the face of these complications, now is an ideal moment to pause and reflect on the basic lessons that can be culled from the practice of regulation and economic science once the clouds of ideology are stripped away. I begin this exercise by reflecting on the simple lessons that emerged from the past half-century of economic regulation. (11)

   1. The Rise of the Regulation

      There is a continuum of alternative governance mechanisms for allocating society's scarce resources. (12) These mechanisms may be extreme forms of fiat imposed by authoritarian rule, rely on free markets, or involve combinations of both market-based and rule-based governance mechanism. (13)

      From the outset of the Republic, the United States' economy has been market-oriented. (14) This affinity with market-based, rather than governmentally-imposed, decision making is deeply rooted in both a political philosophy that treasures individual freedom and compelling economic theory dating back to famed economist Adam Smith, who opined on the general superiority of market-based resource allocation. (15) Against this backdrop, regulation of "public utilities" first arose during the 1800s in the form of municipal regulation and evolved into state and federal regulation during the twentieth century. (16) This rise of a regulatory superstructure at the state and federal levels supplanted the more traditional reliance on private litigation as the mechanism for ensuring and promoting trade between economic entities. (17)

      In their analysis of the rise of the regulatory state, Glaeser and Schleifer develop a model in which the merits of a deeper reliance on private litigation, rather than regulation, rely upon the underlying strengths of the legal institutions, which in turn are vital to ensuring the integrity of the litigation process. (18) They demonstrate that, in general, the stronger legal institutions are, the more society may efficiently rely upon litigation rather than regulation as its governance mechanism. (19) Their review of both private litigation and regulation in the United States in the years preceding the onset of the twentieth century "regulatory state" points toward the vulnerability of the legal foundations of litigation as a governance mechanism during this period." Thus, they see the rise of the regulatory state as an efficient response to the state of legal institutions during the late nineteenth century. (21) An important implication of Glaeser and Schleifer's interpretation of the rise of regulation is that governance structures that arise efficiently in one period may be overtaken by the efficacy of alternative structures in a different period. (22) For example, as competition policy and consumer protection agencies arose and matured in the course of the twentieth century, the relative merits of full-blown regulatory superstructures may reasonably be thought to fade relative to private litigation. (23)

   2. Stability of the Early Years

      Between the 1880s, with its introduction of federal railroad regulation, and the beginning of WWII, a number of federal regulatory agencies were created to regulate the transportation, telecommunications, financial, and energy industries. (24) What emerged during this period was a remarkably stable set of regulatory institutions and industries.

      For example, following the creation of the Civil Aeronautical Board in 1938, regulators quickly established...