The Price of Reregulation

I know from personal involvement in the deregulatory movement of the 1980s and ’90s that what happens in America helps determine the agenda in other countries. So it should be of concern to believers in free markets in many countries that the interest groups in America that opposed the wave of deregulation that started in the airline industry, and then swept across the natural gas, electric, and telecom industries, are having an I-told-you-so field day. Their strategy is to blame the several disasters in once-regulated industries on the decision to expose those industries to market forces.

Major airlines are drowning in red ink. The natural gas and electric companies that cheered their freedom from the heavy hand of regulation are reeling from the consequences of phony trades in the energy markets, alleged manipulation of prices in California, and bookkeeping alchemy that turned loans into income.

Companies in the telecom industry have stopped convening staff meetings to figure out how to match the handsome profit margins WorldCom was reporting. Now they know: record ordinary expenses as if they are capital items, and treat a couple of billion dollars transferred from reserve accounts as operating income. Fun while it lasts, but not so much fun when the house of cards collapses, and the marshals appear with handcuffs to take executives on “the perp [for perpetrator] walk” before television cameras.

All of this gives opponents of deregulation gloating rights. But it is important not to confuse regulation that casts the government in the role of umpire, and regulation that makes government the player that determines prices and the management of business enterprises.

Start with those who favor regulation, and are right to do so. They have more than a few reasons for saying that poorly conceived rules and lax umpires contributed to the “infectious greed” that Federal Reserve Board chairman Alan Greenspan says led to crooked practices and cooked books. President Clinton’s chairman of the Securities and Exchange Commission, Arthur Levitt Jr., tried to persuade Congress to forbid accountants from accepting lucrative consulting contracts from their audit clients. A barrage of protests from the accountants’ lobbyists, backed by generous campaign contributions to members of both the Republican and Democratic parties, shot him down. Just as the lobbying of the Silicon Valley dot-coms and venture capitalists prevented the accounting regulators from heeding Greenspan’s (and my) suggestion that share options be treated as the expenses they most certainly are.

Clearer rules and more vigorous umpires, although probably unable to prevent determined book-cookers from plying their trade, would have kept more executives and auditors on the straight and narrow. But setting and enforcing rules are quite different from government replacement of market forces.

In the case of airlines, deregulation has produced an enormous transfer of wealth from airline shareholders to consumers. In the good old days of regulation, granny couldn’t afford to visit the grandchildren at Christmas, and students couldn’t afford the transatlantic trips that they now regularly take at deeply discounted fares in furtherance of, er, their educations. Now they can, with disastrous consequences for airline profits. The result is now clear: the value of airline assets has declined as the old days in which regulators set fares to cover whatever costs airlines incurred, including exorbitant labor costs, have given way to an era in which customers tell carriers what they are willing to pay. That may make thousands of shareholders and union workers dream of reregulation, but for millions of consumers that would be a nightmare.

The same is true in the electric industry, only a segment of which was partially deregulated. The monopoly wires business remains closely regulated, both here and in the U.K. But the generation sector now consists of competitors vying for customers, and competing so vigorously that prices for electricity have been driven down as consumers flit from supplier to supplier. Then along came California, where a flawed deregulation program combined with the absurdity of allowing wholesale prices to fluctuate freely while capping retail prices, to produce serious short-term shortages and add fuel to the re-regulation fire.

What consumers need, however, is not the re-entry of government into the business of setting prices, but a clear set of rules that prevent market manipulation. Any doubt that that is the case should have been dispelled by the benefits that have flowed to customers since Callum McCarthy, Britain’s electric regulator, pried that industry’s markets open to competition.

Telecom is another case where proper accounting rules rather than re-reregulation is the course most likely to produce an efficient, reasonably priced service. No one doubts that the industry is suffering from the financial shenanigans of some companies, and from the massive excess capacity constructed when booming stock markets made capital cheap (or in some cases free) and wild projections made it seem that the demand for communications capacity would be unlimited. But those problems are hardly the result of deregulation. Indeed, in the good old days most of the costs of such management errors— but far from all, in jurisdictions blessed with competent regulators—were borne by consumers, rather than, as now, by the investors who are supposed to bear such costs of failure.

Americans remember the days when telephone prices were so high that they berated teenagers for making too many calls. Now, we give them mobiles. We remember when monopolies such as AT&T would not allow “foreign devices” such as answering machines to be attached to the telephone system. Now, we use the telephone network in more ways than any monopolist could imagine. We remember when long-distance calls were so expensive that calling across state lines was virtually on an emergency-only basis. Now, international, direct-dialled calls are uncommon events.

This may be bad news for investors who forgot that competition drives profits down to the bare minimum necessary to attract capital. Any wider margins are quickly competed away. But it is good news for consumers. So think hard before harking to the siren call of interest groups that mourn for the day when regulators made sure that costs, including high labor costs, were borne by consumers. Their loss has been your gain.

This article appeared in London’s Sunday Times on August 25, 2002, and is reprinted with permission.