Regulatory Failure: Time for a New Policy Paradigm

Regulation is presumed to be designed to avoid (potential) market failures,usually because of firms' market power, the consequence of which leads to a decrease in economic welfare. However, the cost of regulation may outweigh any effects policy makers have on the firm due to administrative costs, regulatory capture and other effects that have been addressed by others. More importantly, policy makers have been using the wrong models to guide their decisions, with a major impact on the investment incentives of firms, a misallocation of resources and a lowering of social welfare. As policy makers misread economic theory, they produce results worse than those they are attempting to correct. Thus, these distorting effects are equally as bad, or worse than, the market failure regulators hoped to ameliorate. However, this need not be the case. By concentration on dynamic models, rather than the simple static models on which policy makers have focused, it is possible to improve economics welfare and obtain results that at least are better than the costs associated with current regulatory practices. Ofcom appears to be moving in this direction. Will other policy makers learn from Ofcom? This paper shows some of the failures of the current model and sets forth some of the necessary steps to make improvements. However, it is unclear whether the institutional structures will allow for such a departure from the current paradigm.