Deregulation Pros, Cons, and Examples
Why Airline Travel Is So Miserable, and Other Effects of Deregulation
Deregulation is when the government reduces or eliminates restrictions on industries, often with the goal of making it easier to do business. It removes a regulation that interferes with firms' ability to compete, especially overseas.
Consumer groups can also prompt deregulation, if they feel the regulation is not serving their interests. They may also seek to remove regulations if they find that 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.
- In certain industries, the barriers to entry are decreased to small or new companies, fostering innovation, competition, and increased consumer choice.
- The free market sets prices, which some believe promotes growth.
- It improves corporate efficiency, lowering costs for consumers.
- Companies have greater freedom to create monopolies, which in turn have their own pros and cons.
- 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.
- Asset bubbles are more likely to build and burst, creating crises and recessions.
- Industries with initial infrastructure costs need government support to get started. Examples include the electricity and cable industries.
- Customers are more exposed to fraud and excessive risk-taking by companies.
- Social concerns are lost. For example, businesses ignore damage to the environment.
- 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 The Gramm-Leach-Bliley Act repealed Glass-Steagall.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, leaders at the G-20 summit asked the United States to increase regulation of hedge funds and other financial firms. The Bush administration did not do so, allowing that reforms were needed but asserting that regulation would hobble U.S. companies' competitive advantage.
In 2010, 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 –– such as American International Group Inc., which required a government bailout –– from becoming too big to fail. 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 significant capital 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. California famously encountered a crisis after its attempt to deregulate. Eventually, the deregulation push ended after financial misconduct was revealed at energy company Enron, which had aggressively pursued the removal of regulations. 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 of these and other controls, airline travel was prohibitively expensive. According to the Airlines for America trade association, by 1977, only 63 percent of Americans had ever 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: American, Delta, United, and Southwest. Deregulation has created a near-monopoly.
Deregulation has 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.