Deregulation Pros, Cons, and Examples

Why Airline Travel Is So Miserable, and Other Effects of Deregulation

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Deregulation of the airline industry resulted in fewer carriers, fewer routes and higher fees. Photo: Paul Chesley/Getty Images

Deregulation is when the government reduces or eliminates restrictions on industries. Its goal is to improve the ease of doing business. It removes a regulation that interferes with firms' ability to compete, especially overseas.

Consumer groups can also prompt deregulation. They point out how industry leaders are too cozy with their regulatory authorities.

Deregulation occurs in one of three ways. First, Congress can vote to repeal a law.

Second, the president can issue an executive order to remove the regulation. Third, a federal agency can stop enforcing the law.

Pros

  1. Small, niche players are free to create innovative new products and services.
  2. The free market sets prices. Often prices drop as a result.
  3. Large businesses in regulated industries often control their regulatory agencies. Over time, they amass power. They then create monopolies.
  4. Regulations cost $2 trillion in lost economic growth, according to the National Association of Manufacturers. Companies must use capital to comply with federal rules instead of investing in plant, equipment, and people.

Cons

  1. Asset bubbles are more likely to build and burst, creating crises and recessions.
  2. Industries with huge initial infrastructure costs need government support to get started. Examples include the electricity and cable industries. 
  3. Customers are more exposed to fraud and excessive risk-taking by companies.
  1. Social concerns are lost. For example, businesses ignore damage to the environment.
  2. Rural and other unprofitable populations are underserved.

Example: Banking Deregulation

In the 1980s, banks sought deregulation to allow them to compete globally with less regulated overseas financial firms. They wanted Congress to repeal the Glass-Steagall Act of 1933.

 It prohibited retail banks from using deposits to fund risky stock market purchases. Like other financial regulations, it protected investors from risk and fraud. 

In 1999, banks got their wish. The Gramm-Leach-Bliley Act repealed Glass-Steagall. In return, the banks promised to invest only in low-risk securities. They said these would diversify their portfolios and reduce the risk for their customers. Instead, financial firms invested in risky derivatives to increase profit and shareholder value.

Foreign countries blamed deregulation for the global financial crisis. In 2008, the G-20 asked the United States to increase regulation of hedge funds and other financial firms. The Bush administration refused, saying such regulation would hobble U.S. companies' competitive advantage.

Two years later, the G-20 got several things it had asked for. Congress passed the Dodd-Frank Wall Street Reform Act. First, the Act required banks to hold more capital to cushion against large losses. Second, it included strategies to keep companies from becoming too big to fail. The biggest was insurance giant American International Group Inc. Third, it required derivatives to move onto exchanges for better monitoring.

Example: Energy Deregulation

In the 1990s, state and federal agencies considered deregulating the electric utility industry. They thought competition would lower prices for consumers.

Most utilities fought it. They had spent a lot to build generating plants, power stations and transmission lines. They still needed to maintain them. They didn't want energy companies from other states to use their infrastructure to compete for their customers.

Many states deregulated. They were on the east and west coasts where there was the population density to support it. But fraud occurred with a company called Enron. That ended any further efforts to deregulate the industry. Enron's fraud also hurt investors' confidence in the stock market. That lead to the Sarbanes-Oxley Act of 2002.

Example: Airline Deregulation

In the 1960s and 1970s, the Civil Aeronautics Board set strict regulations for the airline industry.

It managed routes and set fares. In return, it guaranteed a 12 percent profit for any flight that was at least 50 percent full.

As a result, airline travel was so expensive that 80 percent of Americans had never flown. It also took a long time for the Board to approve new routes or any other changes.

On October 24, 1978, the Airline Deregulation Act solved this problem. Safety was the only part of the industry that remained regulated. Competition rose, fares dropped, and more people took to the skies. Over time, many companies could no longer compete. They either were merged, acquired or went bankrupt. As a result, just four airlines control 85 percent of the U.S. market. They are American, Delta, United, and Southwest. Ironically, deregulation has created a near-monopoly.

Deregulation created new problems. First, small and even mid-sized cities, such as Pittsburgh and Cincinnati, are under-served. It's just not cost-effective for the major airlines to keep a full schedule. Smaller carriers serve these cities, at a higher cost and less frequently. Second, airlines charge for things that used to be free, such as ticket changes, meals, and luggage. Third, flying itself has become a miserable experience. Customers suffer from cramped seating, crowded flights, and long waits.