The Rise of the Regulatory State: Institutional Entrepreneurship and the Decline of Markets for Blood.

• Author: Thomas, Michael D.

Regulation is ubiquitous in wealthy nations around the world today. No aspect of life in a modern Western economy remains unregulated, and although regulation of product safety, for example, often goes unnoticed, it is not costless (Thomas 2012; Chambers and Collins 2016; Coffey, McLaughlin, and Peretto 2016; McLaughlin and Stanley 2016). Research on the economic cost of red tape abounds, and yet the flood of new rules that enter the federal code of regulation each year seems unstoppable.

Edward Glaeser and Andrei Shleifer (2003) argue that this rise of the regulatory state is an efficient response to the court system's failure to resolve property-rights disputes effectively (see also Shleifer 2010). In their model, courts and regulation are alternative institutional structures designed to achieve the social control of business. When businesses seek to avoid legal damages, courts can be the most efficient institutional mechanism for the facilitation of exchange. However, as businesses grow larger, they influence the courts more frequently in their favor, property rights become less secure, and regulation becomes relatively more efficient as a means of social control of business.

We argue here that Glaeser and Shleifer (2003) are too optimistic about the potential for regulation to alleviate court-system failure. Our discussion suggests instead that institutional entrepreneurs often use regulation to undermine the court system when it successfully constrains business to socially useful activities. We suggest that the economic theory of regulation paired with a theory of institutional entrepreneurship is the more plausible explanation for the rise of the regulatory state. Lobbyists actively seek out regulation and provide the impetus for intervention in order to undermine the legal institutions that constrain the industries they represent.

Blood markets in the United States are a case in point. Prior to state and federal regulation of markets for blood in the 1970s, blood supply in the United States was sourced from both volunteer and nonvolunteer or paid donors. Since 1978, nonvolunteer or commercial blood has essentially been banned. This ban was initially justified as an effort to combat hepatitis transmission. As we show, however, regulation of blood markets, despite its otherwise noble aim, effectively undermined a more efficient legal regime governing blood markets at the time and was ultimately merely the result of successful lobbying by a coalition of blood donor agencies and hospitals that benefited from the intervention.

The first section of this paper discusses Glaeser and Shleifer's (2003) explanation for the rise of the regulatory state in the context of the existing literature on regulation versus litigation. Then in the second section we summarize the history of the legal institutions governing markets for blood before intervention. In the third section, we recount the rise of regulatory institutions governing markets for blood. We close by describing problems in the market for blood today and drawing conclusions from our inquiry.

Theories of Regulation versus Litigation

The earliest justification for regulatory intervention (Pigou 1920) famously suggests that government intervention is needed to address negative-spillover effects of market activities. This public-interest theory of regulation was first questioned by Ronald Coase in his article "The Problem of Social Cost" (1960). Coase famously argued that litigation will solve problems of negative externalities as long as property rights are well defined and transactions costs low. Following Coase, much of the literature in law and economics has discussed the trade-off between regulation and litigation in terms of transaction costs and more specifically in terms of potential information and incentive problems with either method of social control of business. Richard Posner argues, for example, that the choice between the two methods of public control, regulation or litigation, should "depend upon a weighing of their strengths and weaknesses in particular contexts" (1977,271). He goes on to discuss several specific examples. In the case of consumer fraud (272), consumers will have a lack of incentive to complain to the respective agency tasked with the enforcement of regulation because the agency, in this case the Federal Trade Commission, cannot award any damages or penalty to the defrauded consumers. In the case of mandated disclosure laws, consumers will already know about product defects or side effects by the time the respective agency has sufficient evidence to justify a disclosure mandate. And a tort action is not sufficient to remedy health and safety concerns associated with a particular product if the hazard cannot be linked clearly to the product. The case for health and safety regulation is strong wherever the costs of accident or illness are difficult to measure. The case for regulation is weakened when the cost of safety regulation is also safety itself, as may be the case when the drug-approval process for pharmaceuticals mandated by the Food and Drug Administration (FDA) delays the arrival of a drug on the market. Dale Gieringer (1985) estimates the cost of this sort of drug delay at between twenty-one thousand and fifty-one thousand lives lost per decade. Finally, in the example of regulation to mitigate environmental pollution, Posner (1977) argues that, on the one hand, the cost of the injury to the individual may be too small to warrant legal action but that, on the other, there is the significant potential problem of getting locked into an inferior technological equilibrium once regulation has mandated certain methods of pollution control.

Steven Shavell (1984) similarly discusses the efficiency implications of regulation versus litigation. He proposes four determinants that may make either regulation or litigation more advantageous in different situations (359). The first determinant is the difference in knowledge about risky activities on the part of the private parties involved as compared to the regulator. Shavell argues that when private parties have the information advantage, as they often do, litigation is the more appropriate means of social control of business activities. The second determinant is that private parties may be unable to pay for the full magnitude of the harm done, in which case regulation is usually the more appropriate response unless private parties can be incentivized to purchase liability insurance. The third determinant is that private parties might not face the threat of a suit for harm done, in which case regulation would again be the more appropriate response when externalities are present. The fourth and final determinant is the magnitude of the administrative costs incurred from regulation as compared to litigation. Shavell suggests that the advantage here will usually be with the tort system because administrative costs will be incurred only in the case of actual harm, and the administrative costs of regulation are independent of actual harm. Shavell's analysis suggests that, depending on the case, either regulation or litigation will be the more appropriate response to negative-spillover effects.

Like Shavell (1984) and Posner (1977), Glaeser and Shleifer (2003) develop a theory of law enforcement that distinguishes between private litigation and government regulation as alternative institutional arrangements that secure property rights. Unlike Shavell's and Posner's views, however, Glaeser and Shleifer's model of the relative efficiency of either method of social control of business is not based on informational and incentive considerations. They propose instead that firm size may be the relevant margin of analysis. Using evidence from the Progressive Era, they show that with increasing firm size, private litigation becomes less effective at securing property rights because larger firms have an increasing ability to pay to avoid legal damages.

Glaeser and Shleifer (2003) suggest that regulation arose during this period because of a question surrounding the courts' ability to adjudicate fairly between large powerful corporations and private individuals. They argue that during the Progressive Era the court system became widely used to privilege corporations who faced a constant cost structure of influencing justice (see also Shleifer 2010). In light of this critique, corporations came under scrutiny, and regulation became more prevalent. This story emphasizes an efficient institutional response when the court system breaks down: more regulation. Shleifer and Glaeser suggest that ultimately as corporations grow in size and the relative cost of undermining the court system decreases, regulatory oversight grows, which is efficient.

We argue here that although this explanation may account for intervention during the Progressive Era, it cannot explain the more recent expansion of the regulatory state, which has come at a great cost: lower economic growth in the most heavily regulated economies. A growing literature describes the costs of regulatory accumulation: Simeon Djankov and his colleagues (2002) show that countries with better formal institutions tend to have fewer barriers to entry and, as a result, greater economic growth. James Bailey and Diana Thomas (2017) show that more-regulated industries experienced fewer new firm births and slower employment growth between 1998 and 2011. Bentley Coffey, Patrick McLaughlin, and Pietro Peretto (2016) estimate the cumulative cost of federal regulation over a thirty-five-year period in the United States. They find that economic growth has been dampened by approximately 0.8 percent per year since 1980, which equates to a total cost of $4 trillion or about $13,000 per capita (8). (1)

This evidence suggests at least that the recent rise of the regulatory state has come with more-negative implications for economic efficiency than what...