11.4 The Great Deregulation Experiment
2 min read•june 25, 2024
Government regulation aims to correct market failures and protect consumers, but it can also stifle competition and innovation. Regulations can address issues like pollution and public health, but may create barriers to entry and increase costs for businesses and consumers.
, on the other hand, can lead to increased competition and lower prices. Examples like the airline and telecom industries show how removing regulations can spark innovation and new services, but may also result in market concentration and quality issues.
Government Regulation and Deregulation
Impact on Competition and Efficiency
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- Positive and negative effects of government regulations on market competition and efficiency
- Address market failures and externalities (environmental regulations reduce pollution, protect public health)
- Create barriers to entry, reducing competition (licensing requirements, quotas limit number of firms)
- Higher costs for firms passed on to consumers through increased prices
- Stifle innovation and limit flexibility of firms to respond to changing market conditions
Regulatory Capture
- Regulatory agency influenced or controlled by industry it is supposed to regulate
- Industry representatives influence appointment of regulators or regulators have close industry ties
- Regulations benefit industry at expense of consumers and public interest
- Protect incumbent firms from competition or allow higher prices
- Lax enforcement of regulations and lack of accountability for industry misconduct
Deregulation Effects
- Removal or reduction of government regulations in a particular industry
- Airline industry in the United States deregulated in 1978
- Increased competition, lower fares, entry of new airlines
- Also led to increased consolidation and emergence of a few dominant carriers
- Telecommunications industry partially deregulated in the United States in 1996
- Greater competition in local telephone markets and entry of new providers
- Growth of new services (broadband internet, mobile phones)
- Lower prices and increased innovation, but also potential concentration of market power and reduced service quality in some cases
Key Terms to Review (24)
Adjustable-Rate Mortgages: An adjustable-rate mortgage (ARM) is a type of mortgage loan where the interest rate is periodically adjusted based on a benchmark index. This allows the monthly payments to fluctuate over the life of the loan, unlike a fixed-rate mortgage where the interest rate remains constant.
Airline Deregulation Act: The Airline Deregulation Act was a landmark legislation passed in 1978 that removed government control over fares, routes, and market entry in the airline industry. This act marked a significant shift towards a more free-market approach in the aviation sector, ending decades of federal regulation.
Collateralized Debt Obligations: Collateralized Debt Obligations (CDOs) are complex financial instruments that are created by bundling together various types of debt, such as mortgages, loans, and bonds, and then selling them as securities to investors. These securities are structured to offer different levels of risk and return, allowing investors to choose the level of risk they are willing to take on.
Competitive Pricing: Competitive pricing is the strategy of setting prices for goods or services based on the prices charged by competitors in the same market. The goal is to offer products at a comparable or slightly lower price point to attract and retain customers.
Credit Default Swaps: A credit default swap (CDS) is a financial derivative contract that allows one party to transfer the credit risk of a bond or loan to another party. It functions as a form of insurance against the risk of default on a debt instrument.
Depository Institutions Deregulation and Monetary Control Act: The Depository Institutions Deregulation and Monetary Control Act (DIDMCA) was a landmark piece of legislation passed in 1980 that significantly deregulated the financial industry and gave the Federal Reserve greater control over monetary policy. This act was a key part of the 'Great Deregulation Experiment' that transformed the financial landscape in the United States during the 1980s.
Deregulation: Deregulation refers to the process of removing or reducing government regulations and restrictions on businesses and industries, with the goal of promoting competition, efficiency, and economic growth. It involves the relaxation or elimination of rules and regulations that previously governed specific sectors or markets.
Dodd-Frank Wall Street Reform and Consumer Protection Act: The Dodd-Frank Wall Street Reform and Consumer Protection Act is a comprehensive financial reform legislation passed in 2010 in response to the 2008 financial crisis. It aimed to regulate the financial industry and protect consumers from abusive practices that contributed to the crisis.
Eastern Airlines: Eastern Airlines was a major American airline that operated from 1926 to 1991. It played a significant role in the context of the Great Deregulation Experiment, which was a period of significant changes in the airline industry in the United States during the late 1970s and 1980s.
Economic Efficiency: Economic efficiency refers to the optimal use of resources to maximize the production and distribution of goods and services. It involves achieving the highest possible output from a given set of inputs or minimizing the inputs required to produce a desired level of output.
Financial Globalization: Financial globalization refers to the increased integration and interconnectedness of global financial markets and institutions, enabling the free flow of capital, investments, and financial services across national borders. It is a key aspect of the broader process of economic globalization.
Financial Innovation: Financial innovation refers to the development and introduction of new financial instruments, products, and services that aim to improve the efficiency, accessibility, and functionality of the financial system. It involves the creation of novel financial tools and the adaptation of existing ones to better meet the evolving needs of individuals, businesses, and the broader economy.
Garn-St. Germain Depository Institutions Act: The Garn-St. Germain Depository Institutions Act was a landmark piece of legislation passed in 1982 that significantly deregulated the banking industry in the United States. This act was a key component of the 'Great Deregulation Experiment' that sought to reduce government oversight and intervention in various economic sectors.
JetBlue: JetBlue is a major American low-cost airline that has played a significant role in the context of the Great Deregulation Experiment. It was founded in 1998 and has since become one of the leading carriers in the United States, known for its innovative approach to customer service and its focus on providing affordable air travel options.
The Great Deregulation Experiment refers to the series of policy changes in the airline industry that occurred in the late 1970s, which led to the removal of government regulations and the introduction of increased competition. This shift has had a profound impact on the industry, including the emergence of airlines like JetBlue that have capitalized on the new market dynamics.
Lehman Brothers: Lehman Brothers was a global financial services firm that was one of the largest investment banks in the world before it filed for bankruptcy in 2008, triggering the Great Recession. Its collapse was a pivotal event that highlighted the risks of financial deregulation and the interconnectedness of the global financial system.
Market Liberalization: Market liberalization refers to the process of reducing or eliminating government intervention and regulations in a market, allowing for greater competition, free trade, and private enterprise. This approach aims to promote economic efficiency, innovation, and consumer choice by minimizing state control over the market.
Money Market Accounts: A money market account is a type of savings account that typically offers a higher interest rate than a regular savings account. It is a deposit account that invests in short-term, low-risk securities, providing a balance between safety, liquidity, and modest returns.
Mortgage-Backed Securities: Mortgage-backed securities are financial instruments backed by a pool of residential or commercial mortgages. They are created by government agencies, government-sponsored enterprises, or private institutions to provide liquidity in the mortgage market and transfer risk from lenders to investors.
Pan Am: Pan Am, short for Pan American World Airways, was a major American airline that played a significant role in the history of commercial aviation. It was one of the first and largest international airlines, known for pioneering long-distance flights and establishing global air travel networks.
Regulatory Capture: Regulatory capture is a situation where a regulatory agency, created to act in the public interest, instead advances the commercial or political concerns of special interest groups that dominate the industry or sector it is charged with regulating. This phenomenon can have significant implications for the effectiveness and fairness of government regulation across various economic and political contexts.
Southwest Airlines: Southwest Airlines is a major American airline that has been a pioneer in the low-cost carrier business model. It is known for its innovative approach to air travel, which has transformed the industry and made air travel more accessible to the general public.
Staggers Rail Act: The Staggers Rail Act was a major piece of legislation passed in 1980 that deregulated the railroad industry in the United States. It marked a significant shift towards greater market-based competition and reduced government control over the rail sector.
Subprime Mortgages: Subprime mortgages are home loans granted to borrowers with poor credit histories or low incomes, who typically do not qualify for conventional mortgage products. These high-risk loans often feature adjustable interest rates, low or no down payments, and less stringent underwriting standards compared to prime mortgages.
Systemic Risk: Systemic risk refers to the risk of a catastrophic failure or collapse within a financial system or market, which can have far-reaching consequences for the broader economy. It arises from the interconnectedness and interdependence of various financial institutions, markets, and instruments, where the failure or distress of one entity can trigger a domino effect, leading to widespread instability and potential system-wide failure.