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

Definition: 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, an agency can remove the regulation, usually under an executive order. Third, the federal agency can stop enforcing the law.

Pros

  1. Allows more innovation from small, niche players.
  2. Allows the free market to set 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 often create monopolies.

Cons

  1. Allows asset bubbles to build and burst, creating crises and recessions.
  2. Prevents industries with huge initial infrastructure costs from getting started. Examples include the electricity and cable industries. 
  3. Exposes people to fraud and excessive risk-taking by companies.
  4. Social concerns are lost. For example, businesses ignore damage to the environment.
  5. Rural and other unprofitable populations are underserved.

Example: Banking Deregulation

 

Financial regulations protect investors from financial risk and fraud.

In the 1930s, the Glass-Steagall Act prohibited retail banks from using deposits to fund risky stock market purchases.

In the 1980s, banks sought deregulation to allow them to compete globally with more profitable financial firms. In 1999, they got their wish. The Gramm-Leach-Bliley Act repealed Glass-Steagall.

The banks promised to invest only in low-risk securities. These would diversify their portfolios and reduce the risk for their customers. Instead, traditional banks invested in risky derivatives to increase profit and shareholder value.

Foreign countries blame these lax U.S. banking regulations 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 United States refused, saying deregulation was needed for companies to compete globally.

Two years later, the G-20 got several things it had asked for when 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.

As a result, deregulation led to some problems. First, small and even midsized cities, such as Pittsburgh and Cincinnati, are underserved. 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. (Source: "Is Airline Deregulation Bad?" The Economist, August 20, 2013. "Airline Deregulation," Huffington Post, December 13, 2013.)