Breaking the Shackles
Deregulating Canadian Industry

by

edited by Walter Block and George Lermer

The Fraser Institute, Vancouver, British Columbia, Canada



Copyright (c) 1991 by The Fraser Institute. All rights reserved. No part of this book may be reproduced in any manner whatsoever without written permission except in the case of brief quotations embodied in critical articles and reviews.

The authors of this book have worked independently and opinions expressed by them, therefore, are their own, and do not necessarily reflect the opinions of the members or the trustees of The Fraser Institute.



Preface

The papers presented herein were commissioned for presentation at a conference held at the University of Lethbridge between September 20 and 22, 1989. The editors, Walter Block on behalf of the Fraser Institute and George Lermer on behalf of the Faculty of Management of the University of Lethbridge, designed the conference to be an opportunity for several leading analysts of regulation in those traditionally heavily regulated sectors of the Canadian economy to assess the success of the Mulroney government's deregulatory program. That program is outlined here in an essay by Anthony Campbell who as the senior civil servant first with the Nielson Task Force (which between 1983(?) and examined and reported on the scope of federal regulatory activities) and later as head of the Office of Deregulation was well placed to review the aims and objectives of the Federal Government.

The authors of the conference papers, critiques and discussions applaud the incomplete yet significant deregulation achieved especially in the transportation, communication and energy fields. Yet in transportation and communication, Canadian deregulation continues to lag American experience; and the record is bleaker elsewhere. The massive apparatus of agricultural regulation, much of it installed as recently as the late nineteen seventies (two hundred years after Adam Smith's publication of the Wealth of Nations) remains unreformed. Also, the process of reforming the regulatory system governing the financial sector strikes some as becoming a long running farce with little prospect for addressing the fundamental problems of the regulatory regime presently in place. Finally, rent control, a massive political intrusion into the market allocation system, has in the eighties become deeply rooted in Ontario. Because of the scope and significance of rent control, the editors commissioned a paper on the subject despite the fact that it falls outside federal jurisdiction.

We asked each author to provide a capsule review of the nature of, and with special emphasis on recent changes in, the applicable regulatory regime in their field and to contrast those developments with the U.S experience. Thus this volume provides a timely and convenient summary of regulatory regimes in telecommunications, agriculture, energy, finance, housing, and in rail, truck and airline transportation modes. In addition, each author was asked to evaluate the extent to which the economic benefits expected of deregulation have been realized, especially in the United States where the experience after deregulation is greater. Finally, the authors were expected to map the interest group politics that helps explain the shifting regulatory environment in each field. In other words, the authors were asked to explain the process of deregulation, if any, and if possible to link those changes to one of several positive theories of regulation and by implication re-regulation or de-regulation.

We planned the conference out of a belief in the importance of encouraging politicians to maintain and intensify a deregulatory program and to resist the special pleading of those groups that had lost from deregulation, especially in the United States but also in Canada. Such groups have been actively presenting alleged negative evidence of the impacts of deregulation, most vociferously in the airline industry. In our opinion the possibility of a political counter reaction to the feeble deregulatory initiatives of the past decade ought not to be dismissed, and that given how little has been achieved, such a counter reaction might reverse policies in some sectors and stall the deregulatory initiatives being considered in others. We wanted to set the record straight both about the comparatively slow pace of change and about the benefits that have followed from deregulation where it has occurred.

Moreover, we realized that conventional rhetoric about the downsizing of government masks enormous expansion of government in the allocation of resources in the social, environmental and health portfolios of government. But in the latter fields it was apparent from the outset of our planning that no group of economists could agree on where government responsibility starts and where it finishes. Because in the latter sectors poorly defined property rights and consequent externalities are recognizable, an economic case for some types of governmental interference has merit. When property rights are poorly defined, analysts may continue to disagree about what constitutes efficient government interference. That disagreement might turn on technical questions about how government should establish and enforce property rights where problems of appropriability, information asymmetry and contract enforcement seem to eliminate the possibility for private means of specifying property rights sufficiently clearly. Or, the disagreement might turn at a deeper level on the degree to which analysts differ on the extent to which it is legitimate for governments to attenuate individuals' freedoms even when there exists a bona fide economic efficiency rationale for intervention. Finally, many analysts would argue that failure is endemic if not characteristic in the political process that leads to the assignment by governments and regulatory authorities of property rights.

For the above reasons we decided to focus the conference's attention on the traditional areas of economic regulation in which it is difficult to maintain that regulation today corrects a "market failure". Market failure is said to result from the existence of a natural monopoly, inadequately specified property rights, information asymmetry and the associated excessive transactions costs of contract enforcement. In some of the sectors examined, a market failure rationale due to natural monopoly might once have had some initial plausibility, though as Herb Grubel points out market failure is not a sufficient condition for introducing regulation which itself might be prone to the broader problem of government failure. Whatever the merits of that dispute, the fact is that technological change has since undermined the "market failure" rationale, so that for all the areas examined herein few economists claim that a market failure can rationalize the continuation of current levels of regulation. In most areas, no "market failure" argument had any credibility at the time that regulation was first introduced. Before the conference began therefore, we expected after the conference to be able to write an introduction to this book that would list the gains from recent deregulation, bemoan the slow pace of deregulation and help strengthen the resolve of government to stand firm behind the deregulation that has been achieved and to speed the deregulatory process up where it has bogged down. We would have liked that this book, like the conference from which it is derived, to produce a simple to read scorecard rating the degree of success or failure achieved by the authorities in extracting government regulation from the morass of costly and unnecessary regulation.

In general, the conference's aim has been achieved and is recorded in this book. Like virtually all previous serious examinations of the morass of regulation in these traditional economic sectors, these studies cannot find economic benefits that outweigh the economic costs of regulation. Examined on a sector by sector basis, the deadweight losses in the form of reduced social wealth is in each case considerable, and United States experience since deregulation is in line with prior economic predictions about the merits of deregulation. Moreover, the efficiency losses reported do not generally include quantitative estimates of the resource cost associated with the "special interest groups" rent seeking efforts in the course of organizing to bring pressure on politicians and regulators.

At the same time, the essays and commentaries in this volume show just how difficult it is with our present state of knowledge to sort out all the issues involved in trying to rate the performance of governments on effective regulatory policy. The editors would stand accused by many of holding a naively simplistic belief that political forces can be directed in favour of economically efficient policies through presentation of data on economic cost-benefits of regulation. From this point of view, economists' ideas about, and evaluations of, regulation matter only as propaganda that can be used by a rent seeking or rent defending lobby on behalf of a special interest group. Because politicians did not initially introduce regulation in response to demonstrated market failures, they will not deregulate in response to demonstrations that the market is robust. According to this view, politicians supplied regulation under pressure from, and in a form of exchange with, "special interests" and they will alter regulations only in response to a shift in "special interests" relative effectiveness in outflanking their adversaries.

But this is the least serious of the attacks on the endeavour by academic economists with no apparent "special interest" to grind to enlist in the debate and present data on regulation and deregulation. At least the adversaries on the regulatory playing field may be forced to confront the economists' analysis, and that analysis might carry some additional weight with certain of the politicians' and regulators' constituencies because it comes from an independent source. A more serious attack is mounted on the partial equilibrium cost-benefit analyses of regulatory regimes reported in this volume by those who argue that the economist often may misspecify the alternative to regulation. Implicit in many of the studies presented here is the notion that deregulation, in the form of less onerous controls on entry, exit, price, service level and profit rate, will not be replaced by explicit subsidies and benefits previously delivered implicitly through regulation. But, as is most evident in the agriculture case, tariff protection, non-tariff barriers, and various forms of subsidies may often be as effective a means of conferring a benefit to a special interest group as is a regulatory instrument, in which category is included only those instruments that directly control entry, price, service level and the profit rate.

A still possibly more important criticism of the "cost-benefit" approach is that the administrative process surrounding much industrial regulation has emerged as an efficient alternative to direct regulation by legislative fiat. Since legislatures cannot be bound in advance to avoid introducing regulatory policies when circumstances change, for instance as in the case of the National Energy Policy, administrative regulation provides some measure of protection for private investors from expropriation by legislatures. In a similar vein, it is argued that politicians have opted for administrative means of regulation as a means of educating "special interest" groups and the public about the limits of government power with the purpose of diffusing intense political pressure to provide benefits. From the latter point of view, whatever may be the level of regulation we observe at any moment of time, it may well be an equilibrium in the political market place, even if economists observe only disequilibrium and waste in the economic domain. Moreover, a threat to an existing regulatory regime may in turn invite later legislative reaction and the expropriation of all those who invested on the anticipation that government would stay out of the field.

It is beyond the scope of this volume to evaluate the force of these criticisms. For those that warn that special interest groups might seek benefits from government outside the umbrella of economic regulation, we respond that at least those benefits might have more immediate and transparent implications for governments' budgets and might therefore be more costly for politicians to rationalize to taxpayers. It is more difficult to counter the argument that the regulatory process has emerged as a means of channelling special interest group pressures for governmental interference in the economy in order to protect both private investors and politicians from the ex post opportunism demanded from politicians by a short sighted and myopic electorate. We find it difficult to respond because the status of the argument is untested. Baldwin shows how regulation emerged in several U.S. industries as a response to legislative opportunism and how similar circumstances in Canada led instead to Crown Corporations replacing private investors. By contrast, the rent control case examined by Smith suggests that the regulatory mechanism of rent control is a means of implementing the ex post opportunistic behaviour and does not divert demand for rent control into an economically less damaging political channel. Nor, as Stanbury stresses does the rent control mechanism seem to educate any of the players in the drama to the economic and social deterioration it causes. Moreover, it is well within the scope of the position we advance that deregulation proceed without causing governments to eliminate the responsibilities for regulatory authorities to provide administrative machinery for restraining demands for new and more onerous regulatory regimes. As Campbell points out, government has moved in this direction by establishing a regulatory budgeting procedure. Alternatively, the government might choose to make increased use of its inquiry powers to inform the public of the costs and consequences of regulatory processes for allocating resources. The government has acted this way in the cases of textiles, footwear and corn by referrals to the Canadian Import Tribunal (known today as the Canadian International Trade Tribunal). It may be said to have acted similarly by establishing the Royal Commission on Corporate Concentration in response to pressure for merger legislation following the Power Corporation's threat to acquire the Argus Corporation. Regardless of the outcome of this comparatively new debate over the merits of regulatory procedures, all participants in and students of public affairs should find interesting the economic responses to deregulation where it has occurred, recorded herein, as well as the economic consequences in those sectors in which deregulation has been stalled.

THEORIES OF REGULATION

Not surprisingly many non-specialists may be unfamiliar with the debate over the value of cost-benefit analyses of regulatory regimes because the debate hinges on competing theories that economists and political scientists have offered to help explain the often bewildering array of regulatory interventions in the economy. Accordingly, Don McFetridge was asked to write an introductory level survey article about how recent deregulatory experience fits into the cosmology of theories of regulation. As a by product of his main assignment, Don has also succeeded in writing an exceptionally fine, non-specialist friendly, summary of the important theories of regulation, and he evaluates how competing regulatory theories have fared as models for recent deregulatory incidents in both Canada and the United States.

Don emphasizes that both the public interest and special interest group models of regulation are incomplete because they fail to model convincingly the political decision making process. This situation permits advocates of various models to interpret the fragmentary deregulatory record in favour of their own preferred model and makes it difficult to choose empirically between models. Don cannot identify any obvious shift during the nineteen seventies and eighties in "special interest group" structure or power that might explain the moves towards deregulation. Instead, the disappearance of a regulatory surplus to be shared between the regulatees and other politically favoured constituents does have some explanatory power. But the absence of a taxable regulatory surplus may have been present on other occasions without having led to deregulation, so evidence of the absence of a surplus cannot be used to argue conclusively that in the absence of a surplus the public and special interest group models will always agree that regulation is superfluous. Nevertheless, from the point of view of the public interest model, there is no further political capital in regulation when cross subsidies are impossible, and from the point of view of the special interest group model the "special interests" might well seek a return to their political capital through a policy other than regulation.

After canvassing the literature on the efficacy of cost-benefit analysis for evaluation of regulation and deregulation, McFetridge concludes that "the effect of deregulation has been salutary in the sense that it has resulted in welfare gains from both the restoration of cost-based pricing and from real savings". More importantly, McFetridge concludes that "ideas matter and that there is political opportunity in introducing new ones or repackaging old ones." In other words, books like this one that report on the economic cost benefits of regulation contribute to the political process through which regulatory and deregulatory policies are forged because the parties to the process may otherwise fail to identify all the relevant consequences of regulatory policies.

The authors, and other participants in the conference, have worked in the spirit that McFetridge recommends and we are confident that both the specialist and the informed lay person will learn something valuable from the essays and commentaries that follow. In the remainder of this introductory essay, we offer a condensed review of each paper in an executive summary style, and end with a brief editorial that acts as a summary of the papers and seeks to draw conclusions for the totality of deregulatory policy from these separate and distinct studies.

TELECOMMUNICATIONS

The pace of deregulation of telecommunications in Canada lags U.S., Japanese and U.K. experiences. In Canada, regulation has been relaxed only on the subscriber freedom to privately own telephone equipment that is connected to the network. Otherwise, regulations continue to govern conditions of entry, tariffs, rates of return and new service offerings. Competition is totally excluded from the provision of the switched voice telephone service which accounts for 90 percent of telephone traffic. The largest burden imposed by Canadian regulators today is the cross subsidy of local telephone service by long distance users. Globerman estimates that the deadweight loss of this policy stands at $2 billion (in 1984 dollars) per annum. Those who do not use long distance service enjoy low local monthly flat rates that fail to ration local telephone usage. Demand for this service is highly inelastic, whereas the demand for long distance services is elastic. Rules for efficient pricing under natural monopoly (Ramsey prices) requires that local prices should be high and long distance rates low, which conforms also with the relative marginal costs of providing the two types of service. Therefore, even if the combined long distance and local services were a natural monopoly, the present regulatory scheme creates large inefficiencies. Globerman examines the natural monopoly argument and finds that it likely has some transient credibility only for the local exchange networks. In the near future, the cable television systems and cellular telephone networks threaten entry into the local telephone network market.

The persistence of a cross subsidy for local telephone users at the expense of business users who make greater use of long distance services challenges the "interest group" model of regulation. On its face, local users are diffuse and disorganized, whereas business users are well organized. Globerman speculates that the "interest group" model may not be contradicted. The model's forecast, that concentrated special interests always win at the expense of widely scattered special users for whom the consequences of even a doubling of local rates would hardly be noticed as a percentage of income, may not describe the reality of the telephone industry. Politicians face immediate pressures from local users who have no difficulty observing the immediate benefit from lower local telephone rates but are ignorant of the higher prices they pay for goods and services because long distance telephone charges are incorporated in the price of virtually every good and service they buy. At the same time, the largest telephone users who would be well placed to pressure politicians make use of specialized services to avoid high rates. Medium and small business, and government service organizations are left to pay the burden, and some of these groups may be able to pass part of the additional cost on to consumers. Moreover, the latter groups are diverse and not particularly well organized.

Rate rebalancing between local and long distance services is slowly occurring and might be largely achieved under the auspices of the regulator since the regulator is aware of the speciousness of the arguments for maintaining the present cross-subsidy. Globerman would welcome that action, but rate rebalancing would not win for society all the efficiency gains that competition has to offer. After careful cross section analysis of telephone industry performance in various countries, and time series investigations of performance before and after regulation in several countries, Globerman concludes that, "competition has played an important role in stimulating producers to take advantage of available technology and to pass a large portion of available benefits on to consumers". In addition it, " encouraged a greater convergence between prices and costs, ie allocative efficiency, a proliferation of new products and services, and a faster adaptation of new cost-saving technologies, ie dynamic efficiencies".

TRUCK AND RAIL

Deregulation of railway tariffs, while allowing the two railways to quote jointly determined fares, occurred in 1967 in order to permit the railroads to earn a sufficient surplus to compensate for the burden of the Crow Rate tariff on grain transportation from the prairies. But intermodal competition between trucking and rail, despite the coalition of the two trunk railways, did not permit a sufficient surplus to be generated for the purpose. In the eighties, the Crow Rate was finally dismantled by transferring the burden of the subsidy to prairie land owning grain producers from the railways to the general taxpayer. In 1987, railway deregulation proceeded in light of the absence of a surplus available for the public finance of prairie grain producers, the effects of intermodal competition and, the demonstration effect of, and competition from, lower tariffs on the deregulated US rail network. Under the recent legislation, railways are unable to avoid negotiating confidential contracts, captive shippers have access to negotiating for access to the closest transfer point to another railway though there is some uncertainty about how that provision is operating in practice, and railway route abandonment is easier than it once was.

Data does not permit the calculation of the effects or gains from Canadian railway deregulation. US data does indicate that rates have fallen on those routes where intermodal competition was previously not binding. Also, Canadian railways seem to be concentrating more heavily on long distance hauling and offering a larger variety of specialized services.

Truck deregulation is partial because intraprovincial trucking is under provincial control. In 1967, the Federal Government reasserted its regulatory authority over interprovincial trucking that it had previously ceded to provincial authorities. On its face, the restrictive truck regulation should be relatively easy to avoid through "pseudo-leasing arrangements, freight forwarding, and private trucking", but control over tariff setting and entry to the public trucking industry continued to provide some measure of protection. The evidence for this conclusion is the higher rates charged in provinces with more onerous protection and the price commanded by operating authorities. As a result, provincial authorities encountered the well known regulatory trap by which it becomes difficult to eliminate regulation without first buying up operating authorities.

On balance, it seems that the partial deregulation in the railway and truck industries has brought much of the gains that might be expected from deregulation. Since the value added in this sector is about 2 percent of GDP the potential gains may be considerable and like telecommunications may be an important potential source of cost reduction for other industries.

In Canada railway regulation was a means of financing the Crow Rate subsidy and regulation disappeared with the disappearance of the opportunity for off budget financing. The special interest group served was the prairie land owner. In the United States, as Richard Schwindt emphasizes, the Interstate Commerce Commission regulated both trucking and the railways. Railway rate control was justified as a means of controlling a natural monopoly, and trucking regulation was necessary in order to protect the railway from competition. This ludicrous tale taught to all undergraduates in countless economics courses according to Schwindt lost credibility, and the misregulation became unsustainable. Palmer is less sanguine about the influence of rational analysis and he notes that deregulation coincided with the fact that "rapidly changing fuel prices in the 1970s made rate regulation a dog's breakfast". He suggests that bureaucrats in the Interstate Commerce Commission just could not cope with the situation and slowly permitted deregulation to emerge. Another interpretation is that heightened political awareness of high fuel costs, sensitivity to the environmental impact of extra fuel burning sending empty trucks around on circuitous routes and the drive to fight inflation all raised the political costs of continued regulation and strengthened the political position of shippers relative to truck owners.

Possibly the most controversial point that Palmer makes is that it is possible that safety might be compromised somewhat by the emergence of competitive trucking, but he speculates that safety must be paid for like anything else and there is no evidence that the level of safety is below the optimal level. If US experience is to be followed in Canada, competition is usually accompanied by an increase in the average size of trucking firms which makes attention to safety more likely because bankruptcy is less likely and the firm remains liable for losses attributable to unsafe operation of its trucks.

AIRLINES

Airline deregulation is examined separately from rail and truck. Based on its contribution to GNP this might indicate that the editors have misallocated space in this book. The rationale for this choice is that airline deregulation has received much media and scholarly attention possibly because airlines are so often used by academics, media people, lawyers and politicians. For whatever reason, Canada's recent steps towards deregulation of its airline industry is incomplete and is far from secure from a political reaction.

Though reduced labour costs accompanied US deregulation and explains also the opposition of Canadian airline personnel to deregulation, the main gains from deregulation are stimulated by improved route planning and the better matching of plane sizes and types to the passenger volume available. Though the gains experienced in the United States from the "hub and spoke" route systems may be less prevalent in Canada because of the linear nature of Canada's main traffic routes, Canada's regulatory system created a great deal of waste in the form of large jets being diverted to smaller communities. Just two short years since deregulation in Canada, any traveller can observe for herself the huge expansion in the fleets of various size turbo-prop and small jet liners that link smaller communities to major airports.

Grubel reports that "non-fuel" operating costs per passenger seat mile flown dropped in the United States by 43 percent in 1985 from their 1981 peak, and 21 percent below the pre-deregulation level in 1978. By contrast, the same index in Canada was 10 percent higher in 1985 than in 1978. Clearly, this is strong evidence that deregulation in the United States has caused performance there to improve faster than in Canada. As a result, fares in the United States fell by 14 percent and traffic skyrocketed. In Canada, fares fell by just 4 percent and traffic stagnated.

Grubel also addresses the safety, the quality and the concentration issues. On safety, he notes that in theory because of the possibility of bankruptcy a risk prone entrepreneur might skimp on safety and walk away from the firm's liabilities should safety experience be poor, but pocket additional revenues should safety experience turn out to be positive. Grubel points out however that safety and maintenance remains a regulated activity. Any airline operator would be aware of the rapid loss of clientele that follows a government report of any systematic effort to avoid safety procedures. Grubel examines the rate of accidents before and after deregulation in the United States and observes a continued trend towards improved safety performance despite the far greater congestion in the skies and the effects of the air traffic controllers strike. He also notes that the increased use of the airlines has reduced intercity automobile travel with a subsequent savings in accident costs of $1.9 billion per year and reduced deaths of 1,700 per year. He dismisses the quality and product differentiation issue as being a red herring. Regulation diverted competition from price to quality to the satisfaction especially of business travellers whose fares were paid by their employers. Post regulation, competition is forcing airlines to search for the mix of differentiated services and price premia that best serve the variety that significant groups of travellers prefer. Insofar as travellers are suffering from increased congestion and the lagged organizational response to rapid traffic growth, Grubel suggests that the fault lies with the absence of deregulation in the operations of airports and runways. He recommends increased use in the short run of pricing mechanisms to ration access to airports at peak periods, and in the long run for private ownership or franchise operation of airports. Grubel accepts that concentration may be an emerging problem despite the observation by many that there are few sunk costs in airline operations because an airliner is the classic example of a capital item that is not a sunk cost and can be transferred easily to better uses. It may be that much of the cost in establishing a hub and spoke system is in the nature of a sunk cost which creates protection for incumbents already established at a particular hub. But Grubel is sceptical about the potential application of competition policy to the airline concentration issue and he recommends instead that competition in Canada can be strengthened by allowing foreign airlines to operate between two points in Canada.

FINANCE

The traditional four pillars of financial regulation have been crumbling for several decades, but Federal efforts to reform financial regulation in recognition of those changes is stalled. Past regulation separated institutions into banking, trust, insurance,and securities; it also limited the ownership of a major domestic bank to 10 percent for a single owner and prevented a real sector firm from acquiring control of a bank. The old order has been battered by the internationalization of the financial services industry, the absence of ownership restrictions and separation rules on foreign institutions, including some that are operating in Canada, the shift of corporate financing away from banks towards securities markets, and competition between federal and provincial regulators with overlapping jurisdictions over the financial sector.

The effort to reform financial regulation in an orderly way seems to have been outpaced by events. Internationalization of financial markets is proceeding quickly and the international legal structure is expanding to cover trade in services taking the form of the Canada U.S. Free Trade agreement and discussions at GATT concerning services including financial services. For example, Courchene documents how Canada's international commitments places it presently in the uncomfortable position of disallowing the acquisition of a Canadian financial institution by a major Canadian conglomerate firm, while being forced to authorize the acquisition of the same target by a subsidiary of a similar foreign owned conglomerate.

The complexity of financial market regulation rules out a summary of Courchene's paper that does justice to the range of his rich ideas, especially as he has essentially written three different papers. The first outlines the reasons why the four pillar model of regulation is dead. The second paper reviews the several federal proposals for reform that have floundered after publication. That review is less concerned with the detail of the proposals than with the politics that has stymied reform. The last paper considers the link between financial structure and ownership and government industrial policy. In particular, Courchene demonstrates that Quebec has proceeded quite far towards subordinating regulatory concerns of a traditional nature in favour of building protected domestically owned institutions to be permanently headquartered in Quebec. Courchene believes that the federal authorities will like Quebec be forced into using financial regulation as an instrument of nationalism and industrial policy.

Lermer agrees that financial regulation is being caught up in the politics of geopolitical strategies and nationalism. He thinks this is unfortunate because there is only one rationale for financial sector regulation and that is protection of the deposit insurer. Lermer, Chant and Courchene would all prefer that the deposit insurance scheme be reformed directly so that financial regulation would become of secondary concern. Unfortunately, recent large bank failures makes it more likely that the deposit insurance system will be expanded rather than contracted. This makes it imperative that the financial system reform proceed in a way that will reduce the potential for moral hazard behaviour (taking the form of the financial institution holding a risky portfolio of assets in relation to the type of liabilities that they have issued in order to finance the assets) by managers and owners of insured institutions. In this connection, Chant suggests that one way to proceed is to insure only the deposits of certain institutions that are also required to hold safe assets. This proposal has much in common with Milton Friedman's and James Tobin's recommendations for a 100 percent reserve banking system. Chant further proposes that no other financial institution would receive a government guarantee, and therefore all non-insured institutions would be free to operate outside the control of government administered financial regulation.

Block points out in connection with his radical proposal for privatization of all roads, that government regulation and ownership prevents the market from searching out alternative methods of providing safety and otherwise better managing assets. However radical that idea may appear in the case of the public road system, or for environmental concerns, it certainly deserves attention for the financial sector. In the financial industry, there are no "market failure" concerns that give government, even in principle if not in practice, an advantage in the regulation of financial institutions.

OIL AND GAS

Watkins summarizes the events of 1985 that dismantled the National Energy Policy (NEP). The NEP and earlier policies allowed the federal government between 1974 and 1985 to appropriate a large part of the wealth of the owners of oil and gas reserves, including the province of Alberta (some estimates run as high as $50 billion dollars (1980???). Those policies diverted revenues from domestic crude oil production to subsidize imported oil in order to bring the average price of crude oil and refined petroleum products in Canada well below the world market price. The high tax on domestic crude oil was a disincentive to further exploration which led the government to expand the role of Petro-Canada and to subsidize up to 100 percent of exploration costs on Canada lands but not on provincial territory. The federal government's power to regulate so oppressively to the interests of Alberta was derived from its ability to tax and control the export of Alberta's oil and gas from Alberta and from Canada. The National Energy Board was able to disallow exports for a variety of reasons having to do with alleged future Canadian requirements or for insufficient price.

Unfortunately for the owners of oil and gas reserves, the Western Accord of March 1985 which "emasculated the NEP", coincided with a rapid drop in the price of oil and gas. Though some might ask questions about the fairness of expropriating the value of oil and gas reserves in the boom and deregulating in the trough of the cycle, the main legacy of the NEP, as Watkins points out is the Alberta government's fear that despite the apparent protection in the U.S Canada Free Trade Agreement the federal government may again behave opportunistically should energy prices once more rise. Another legacy is the existence of long term take or pay gas contracts between Trans Canada Pipeline limited and several natural gas producers that Trans Canada has been unable to live up to in the post regulation world.

Watkins emphasizes that we observe different rates of adjustment to deregulation in the oil and gas markets with the consequence that there has been continued provincial and federal interventions in the natural gas markets but the crude oil market is free of intervention. This difference can be traced to the differences in the downstream market structures for both products. Upstream, at the exploration and production levels there are many oil and gas producers in Canada and gas reserve ownership is less highly concentrated than oil reserves. Both oil and gas must move through pipeline systems to markets in the United States and Eastern Canada. Large sunk cost investments are needed in pipeline and production facilities, and when these assets are owned by distinct parties the threat of opportunistic behaviour exists. The regulation of pipelines is one response to the natural monopoly of the pipeline and the small numbers bargaining problem associated with a single pipeline serving a small number of producers. However, the regulation of pipelines does not eliminate the problem as can be seen by the dispute between natural gas producers and Canadian gas distributors and users about the toll to be applied in order to permit the expansion of the pipeline largely for the purpose of expanding sales to the United States.

Further downstream the markets for oil and gas differ fundamentally. Canadian crude oil refined in Ontario and Quebec must meet the price of imported crude oil and imported refined petroleum. Because the world market for crude oil and refined products is highly competitive there are active spot and futures markets from which price information can be freely and openly acquired. It is therefore impossible for Alberta crude oil to sell in Edmonton at a price other than the net back price calculated as the price of foreign crude landed in Eastern Canada minus the cost of delivery from Edmonton to the East. Watkins demonstrates that this is in fact the case under present market conditions.

In one significant segment of the natural gas market there is a rent that can be earned from the fact that the next best alternative fuel to natural gas is generally far more expensive and because in response to a price increase buyers would take some time to shift from burning natural gas to burning an alternative fuel like heating oil or propane. That segment of the market is the household user of natural gas that is served by a local distributor by pipeline. The pipeline is a natural monopoly and is regulated. If the local distributing company (LDC) can access alternative sources of natural gas, it would of course have the best poker hand and could negotiate the lowest possible price and hope its regulator would allow it to hold on to the higher profit stream. (Because the LDCs are regulated, the consumer provinces like Ontario and Manitoba have themselves become embroiled in negotiations with Alberta over the pricing of natural gas.) In Eastern Canada however the LDCs are highly dependent upon shipments from Alberta via the Trans Canada pipeline. This is largely because natural gas was until recently heavily regulated in the United States so that American sources of supply were not reasonably priced in Canada and a pipeline infrastructure linking the US sources of supply and Southern Ontario does not exist. Moreover, pipeline links will only be built when the investor can be assured that there will be sufficient flow of gas to warrant construction. Under these circumstances, natural gas distributors and pipeline companies seek assurances through contract, and sometimes with the assistance of a regulator, that long term supplies will be available and at reasonable prices. Much of the gas is therefore committed under long term contracts with a range of different prices applying to different sales. Watkins reports that recent sales to the "core" Ontario markets by Alberta producers through Trans Canada Pipeline is at a substantial premium price only part of which can be explained as compensation for the long term commitment of reserves for sales to Ontario. The remainder of the premium reflects some leverage retained by Trans Canada Pipeline and the Government of Alberta. This market power will assuredly disappear as new pipeline construction will make it possible to sell more natural gas in the United States and Alberta's producers compete for Ontario's business.

In a nutshell, there are no characteristics of the oil and gas business that invite government regulation except possibly at the level of ensuring that pipelines remain common carriers. In the oil business, the March 1985 deregulation is complete and the market is operating as would be expected. In the natural gas market, deregulation has not gone quite as smoothly because of the role of provincial regulators and the role of sales under long term contracts. Nonetheless, the natural gas industry has responded rapidly to deregulation, many spot and new contract sales are at marginal cost and the role of regulation is likely to disappear with the development of new sales opportunities for Western Canadian gas in the United States.

AGRICULTURE

Loyns and Carter indicate that in agriculture there is so high a degree of substitutability between tax, subsidy and regulatory policies that it becomes more convenient for analytic purposes to group these together and to measure the degree of government intervention in several different ways. One such way, used extensively by trade negotiators, is a single numerical measure to capture the degree of government interference. That measure is called the "producer subsidy equivalent", and it measures the rise in price that would be needed to leave farm income unchanged despite the removal of all applicable farm programs. For thirteen agricultural commodities, that producer subsidy equivalent for Canada averaged 31 percent between 1982 and 1986. Though there are numerous problems with measuring the extent of intervention, and of separating regulatory interventions from subsidies and taxes, this figure does convey the extent to which Canadian agriculture has become a government dependent.

Loyns and Carter describe the pro-interventionist environment of the 70s, review the Economic Council of Canada's extensive recommendations for reform published in 1981, and document for each product the limited progress made to step back from intervention during the 80s. Put plainly, there is no significant deregulatory experience to report with the exception of the moves made to deregulate grain transportation. Loyns and Carter see some signs that the 90s may be the period of deregulation for agriculture in Canada.

Not having deregulatory experience to examine, the authors ambitiously attempt a cross sectional analysis over 12 crops pooled with time series data for the period 1965-87. Their study is designed to test the validity of the Peltzman-Becker formulation of the "interest group" model of political influence. The results are ambiguous, and do not seem to support the notion that agricultural support conforms to an "efficient redistribution" through regulation hypothesis. For example, elasticity measures and production concentration measures, do not seem to have a significant impact on the extent of public support, whereas the retail/farm price ratio and production variability index both are highly significant. There is therefore some support for the "interest group" model but not the model in the form proposed by Becker. The retail farm price ratio result indicates that the lower is the farm share of the retail price, the lower is the degree of subsidy presumably because downstream processors and distributors have insufficient political power to resist producer initiatives. The production variability index indicates that the more regions of the country in which a crop is produced, the larger is the level of subsidy it will enjoy, presumably reflecting the greater ease with which a political coalition around a new program proposal can be formed within the agricultural community.

The joint influence of GATT and the Canada-US Free Trade Agreement may bring reform to Canadian agricultural support in its regulatory and subsidy modes. There is no indication that domestic political forces will provoke change, though Canadian consumers are aware of the disparity between Canadian and American food prices, especially for dairy and feathered product prices, and the heavy budgetary burden of agricultural programs on the taxpayer. At the same time, it must be acknowledged that agricultural regulation is in part a product of international conflict and negotiation strategies, and that unilateral retreat from agricultural support may be strategically and politically difficult. Still, agriculture is a clear case in which the consumer and taxpayer is generally poorer than those producers earning the largest share of the government support. This is an occasion on which subsidy programs can be attacked both for the deadweight losses they generate but also for the distributional consequences of the programs that transfer income from poorer to richer households.

RENT CONTROL

Rent control, more than any other form of regulation, demonstrates a flaw in the argument that regulation somehow responds to inherent weaknesses in the market allocation system. Rent control attenuates the property rights of landlords and creates property rights for tenants by expropriating the landlord. Setting aside the unfairness attached to the ex post opportunism that expropriates the wealth of those unfortunate enough to have invested in rental housing rather than something else, the impact of rent control is to destroy incentives for maintaining the existing housing stock and adding to that stock. Larry Smith documents how Ontario's experience has followed down the slope that destroyed the rental housing stock of so many other cities. Though rent control causes the rental housing stock to corrode, it is the corrosion of the social contract that does the most harm. First, potential investors lose all confidence in government that continually changes the rules in order first to entice new construction and then expropriates the investor through a later change in rules. Second, thousands of persons violate and evade the law with impunity a behaviour which allows rent control programs to operate without immediate catastrophic damage but which hardly entrenches respect for civic responsibilities.

Rent control is a negative sum game. The short term winners gain at the expense of others, but the costs of administering the rent control system and the costly long term incentive effects cause virtually everyone to lose in the long run. Larry Smith documents just the costs imposed by the rent control system on the Ontario taxpayer which totalled about $300 million in 1988. But this is just the tip of the iceberg and overlooks the legal costs of private parties, the dispute costs between landlords and tenants, the deterioration of the rental housing stock, the rise in the price of close substitutes, search costs and the loss in respect for law and government.

Despite these demonstrated problems many communities introduce rent control and others avoid it. Stanbury examines the politics of rent control, and with pessimistic implications for the possible triumph of long term economic and social rationality over the power of the political appeal to transferring wealth from an allegedly undeserving minority of landlords to a deserving majority of tenants. Denton Marks is more diffident, with more confidence than Stanbury and Smith that the market continues to work surreptitiously and thus mitigates the worst consequences of rent control, and that a flexible rent control system may be a reasonable substitute for a rental subsidy system or a negative income tax. But Larry Smith reports several studies that show that a comprehensive shelter allowance program in Ontario could be funded at far less cost than the administrative and tax cost of the rent control program and without the negative incentive effects on the rental housing stock.

The puzzle therefore is why an expensive and corrosive rent control system emerges and a comprehensive shelter subsidy system does not. Why has a better mechanism not emerged for controlling the tendency for legislative ex post opportunism in the rental housing market? Evidently, rent control is not a form of contract that protects landlords from expropriation, it is the vehicle for giving some semblance of order to the process of expropriation. Possibly it is inevitable that the Crown Corporation will emerge as the mechanism for building, owning and maintaining rental housing in Toronto. The record of public housing programs around the world demonstrates that government failure should be a greater concern than any alleged market failure, but ironically the only failure in the rental housing market is our inability to bind government from politically opportunistic behaviour in the form of rent control legislation.

SUMMARY

Is it accurate to describe the past decade as the decade of deregulation? Has Canada embraced the traditional liberal or today's neo-conservative program for reliance on market solutions in the traditional industries examined here?

Our review identifies progress in rail and truck transportation, incomplete but valuable deregulation of the airline industry, modest improvements in telecommunications, substantial progress in the oil and gas industry, and a confused and potentially damaging situation in the finance industry. The deregulatory process has barely begun in agriculture, but there are signs that international trade negotiations will force Canada to move away from the extensive regulatory system currently in place. Finally, the news is all bad regarding Ontario's rental housing market which seems to have entered a rigid and permanent regulatory regime.

One approach for selling deregulation might be for the government to publish a regulatory budget in the form of the billions of consumer dollars that would be released through deregulation. Deregulation would release resources that might be applied to the reduction of the budget without damaging the standard of living of more than a few Canadians. We cannot place a precise figure on the savings available, but it is certainly in the range of tens of billions of dollars each year. Globerman's estimate of the savings from rebalancing long and local telephone rates accounts for a substantial chunk of the total and many more gains are potentially available especially as the sector is poised to expand. Agricultural deregulation would bring a saving of many more billions of dollars since over 32 percent of farm income presently comes through government programs. Rent control in Ontario cost $300 million per year in tax losses and administrative costs and many more millions in private costs that have not been measured. In transportation deregulation has proceeded sufficiently to have generated the majority of the gains we are likely to see. We do not have an estimate of the costs of misregulation in the finance sector but the contingent liabilities of the government as deposit insurer are enormous, and as we have seen in the Savings and Loan crisis in the United States, these potential losses can be enormous.

The benefits from deregulation are difficult to measure with precision because they are cumulative and accrue through the speed of innovation, the effective management of resources as prices reflect costs and as management intensifies its search to package goods and services that respond to the requirements of consumers.

Walter Block
George Lermer


Chapter 1: Taming The Regulatory Tiger :
Revealing the Best Kept Secret in Ottawa

Anthony Campbell

The public policy of regulation richly deserves thorough and informed public debate at this time. Having been involved in the efforts to control regulation since late 1983, I am glad to have this opportunity to reflect on what has and has not been accomplished over those six years. This essay therefore is an informal "insider's" report on government efforts to "tame the regulatory tiger."

Perhaps you are like me. I often prepare a speech or essay by going to a dictionary or a book of quotations to crank up my thinking process by looking up the key words of the theme I have been assigned. This is almost always a mistake. First, because I usually get totally absorbed in reference books and waste a lot of time. And second, because I often try to fit my comments around whatever I find in the reference book and this usually produces an awkward and distorted draft which eventually has to be discarded.

Ignoring the experience of years, I began preparing this presentation by looking up the word "tiger." I found that it is a most appropriate symbol for regulation. A tiger is, with the lion, the most powerful of carnivorous animals, it can be majestic in appearance, but at other times is quite ugly and frightening, it weighs about 200 kilos (exactly the total weight of the Revised Consolidation of Regulations of 1978 and the Revised Statutes of Canada 1985) its productive life is about 20 years, and it is conceived and usually operates in the dark.

The major difference between a regulatory program and a tiger is that tigers always die when they are no longer useful!

By the time this essay will appear, I will have left the field (should I say jungle?) of regulatory reform. After six sometimes frustrating, sometimes satisfying, but nearly always fascinating years in the business of trying to tame the regulatory tiger, this is (to change the metaphor) my "swan song."

Even if I were not about to move on, this would be a good time to look backward at what has been accomplished in economic regulatory policy in recent years and then peer into the present and future challenges in this area. It is timely to put emphasis on the future - the question of where do we go from here - because there are many who consider regulatory reform to be a political fad, something akin to the Charleston or the hula hoop, whose time has come and gone.

I think that it is very important to take issue with that view. The single biggest message that I can discern since the regulatory reform movement emerged some twenty years ago is that the nature and exercise of regulatory authority in the post-Guttenberg, post-industrial age must be subjected to intensive rethinking and redirection, not just on a one-time basis, but continuously, if we are to keep this most important of the governing instruments relevant and in harmony with Canada's ongoing economic and political needs.

Ongoing regulatory reform, revitalization and adaptation is not a matter of choice, it is a matter of necessity. It is certainly not a matter of ideology, but rather a reality of public administration which all governments, from Albania to Zimbabwe, must face up to.

If this is correct and if, as I believe, the emergence of regulatory affairs is the most important recent development in the field of public administration, then it follows that we are nowhere close to the end of its useful life cycle. If anything, we are only at the beginning and it is important regularly to reinvigorate the ongoing pursuit of what we in Ottawa call "smarter regulation."

Here, then, is a view from inside the tiger cage of the past, present and future of regulatory reform in Canada. Although I estimate the regulatory reform movement to have begun in about 1968/69, it did not have a noticeable impact as far as Canada was concerned until the mid-70s. Even then, its impact was limited to only a few thinkers - in contrast to the U.S. where it had already resulted in far reaching major decisions and, more important, a very fundamental shift in the way people viewed government's use of its coercive legal powers.

One of the interesting questions for historians of this movement should be to explore why the Americans grappled with the issues so much ahead of Canadians. Why were we so slow to pick up the new intellectual currents? Had we by the '70s become mere "branch plant thinkers"? And, why generally speaking were our institutions comparatively resistant to the winds of adaptation and change? Are we still slow adapters or have we learned anything from our experience? Are Canadian "interest groups" more strongly entrenched than their American counterparts?

In short, why was i possible for the excellent work of the Economic Council of Canada, that detailed the social and economic costs of so much of Canada's ill conceived economic and social regulation, to be totally ignored for so long and why did it take until 1984 for Canada's federal government to get down to serious regulatory reform? Why for that matter have most provinces and municipalities not got down to it even yet - a case in point is the disappointing progress in ongoing negotiations to reduce interprovincial barriers to trade.

In low moments, my response is to mutter those opening words of our national anthem - "Oh Canada"!

Whatever the answer to these questions, the fact is the federal government took a dramatic change of direction in 1984, first under the Turner and then more decisively under the Mulroney administrations and since then has quietly but steadily turned in one of the more impressive regulatory reform performances in the world. Indeed, Canada has since outpaced even the U.S. in many important respects, and it is no exaggeration to suggest that the Bush administration's regulatory policy actually adheres quite closely to Canada's own pragmatic regulatory policy. Similarly, recent policy announcements by the UK, New Zealand and other governments seem to have copied from Canada's innovative work in this area.

Before looking a bit more closely at what has happened in the federal tiger's cage since 1984, let me explain that, if there is a touch of braggadocio in what follows, I hope you will understand that we have a lot of difficulty transmitting the message of Ottawa's regulatory reform accomplishments to the public. This is partly because of the media's resistance to undramatic news. But it may also have been that our good old Canadian penchant for "aw shucks" modesty muffled our message so much that even experts in academia seem not to have heard about it. For example, a recent book put out by Oxford Clarendon Press called "The Age Of Regulatory Reform" scanning developments around the globe contained not one but two articles on Canada's experience by two of our most knowledgeable experts and neither mentioned a word about most of what I am about to tell you.

There are many ways to measure accomplishment - for example, one can measure against an absolute ideal, or by relative progress from a defined starting point. Using these two standards, Ottawa's accomplishments would probably rate a C and a B, respectively in its regulatory reform performance since 1984. In government, however, we usually measure our success against what was possible. By that measure, I think the federal government is entitled to an A+.

By the way, to avoid any impression of partisanship by this professional public servant, who believes strongly in a non-partisan public service, I would like to emphasize that the A+ grade for the federal government's performance would include some of the preliminary experiments and analysis done by the Trudeau/Turner governments as well as the pivotal leadership provided by Lloyd Axworthy while Minister of Transport in early 1984. The bottom line, however, is that while the Mulroney government came to power in the fall of 1984 with only a few cautious words about regulatory reform or deregulation in its campaign platform, yet it proceeded to launch the most comprehensive and coherent regulatory reform initiative of any government anywhere else in Canada or the world. The Government coming second on my list would be the Jimmy Carter Administration (1976-80), followed until the last few months by New Zealand. The Reagan Administration, contrary to public image, was more like most governments over the years - long on rhetoric and short on action. As for Margaret Thatcher, her intentions have no doubt been good. But the British have had very little experience with some types of economic regulation because of their traditions and their penchant for crown monopolies. Thus, as their privatization policies result in many new untried and, in my view, unstable regulatory regimes, the ironical possibility is that Margaret Thatcher could go down as having introduced more new and unworkable regulation than any other Prime Minister in British history!

Rather than going over every detail of Canada's gold medal performance, I would like to summarize the case by listing a whole series of "firsts" - 16 of them - that individually and cumulatively illustrate the innovative and far-reaching importance of the federal regulatory reform record since 1984.

1.The first government to establish and publish a formal list of all of its regulatory programs as distinct from the traditional lumping of regulatory activities under expenditure programs. Only in 1984 did we learn that the federal government runs 145 regulatory related programs.

2.The first government to initiate a top to bottom review of all its regulatory programs to identify needed reforms. This was conducted by the Ministerial Task Force on Program Review in 1985 against 11 criteria (including economic criteria). The review involved a joint private-public sector team, itself an innovative regulatory reform technique, and it generated suggested reforms to 2/3 of the federal programs.

3.The first government in the world to adopt a meaningful and comprehensive Regulatory Reform Strategy calling for change in every dimension of government regulatory activity.

4.The first government to promise (and actually carry out the promise) to report to the public on its performance against the goals of the strategy.

5.The first government to define and enunciate a formal regulatory policy that departed from knee-jerk deregulatory rhetoric by emphasizing the principles of "smarter regulation." These pragmatic but meaningful principles have since been adopted by other government including the present Bush Administration.

6.The first government to establish performance standards for regulators. The Citizens Code of Regulatory Fairness issues in 1986 gave ministers and the public a unique set of criteria for holding regulators accountable not only for the substances but also the Management of their regulatory responsibilities. The significance of this "first" is illustrated by the fact that the Scowen Commission in Quebec and committees in the Ontario and, I am told, Manitoba legislatures have all recommended that the federal Code be adopted by their provincial governments. So far, none have done so.

7.The first government to appoint a minister with explicit generic responsibility for regulatory affairs at the Cabinet table.

8.The first government to recognize formally the critical role of sound regulatory management in achieving regulatory objectives. No matter how good a regulatory program design may be, its value is zero if it is not properly managed.

9.The first government to introduce compulsory approved annual regulatory planning. The U.S. and Canada introduced regulatory "agendas" in the early '80s but these covered indeterminate periods of time and in Canada's case were voluntary and therefore incomplete. The U.S. has since copied Canada's annual plan.

10.The first Parliamentary government to require full regulatory impact analysis for decision-making by Ministers.

11.The first parliamentary government to establish positive cost-benefit criteria for all regulatory decision-making.

12.The first and still the only government to publish the regulatory impact analysis underlying Cabinet's regulatory decisions.

13.The first government to establish a Cabinet committee with explicit responsibility for regulatory policy and thus to extend normal Cabinet approval procedures used for "big" policy decision-making to cover all subordinate legislation decisions. This replaced the traditional rubber stamp procedures typically used (and still used) by most governments in the world based on the mistaken belief that new regulations and amendments are "routine" decisions.

14.The first government to establish a central agency function for the overall management of the regulation development process as well as for coordination, research and review concerning generic or "horizontal" regulatory policy issues.

15.The first government to recognize "regulatory affairs" as a distinct public policy sector and to establish administrative structures and allocate resources to upgrade public service management expertise in this area. As educators you may be interested to know that there has been a flowering of training and development activities in the federal administration directed towards the goal of "smarter regulation." These include activities in the Canadian Centre for Management Development, the Department of Justice (Compliance and Regulatory Remedies Project), the Solicitor General's Department (Federal Law Enforcement Under Review or FLEUR Project), as well as experimental training programs developed in the Office of Privatization and Regulatory Affairs.

16.The first parliamentary government (the Americans were first) to adopt the principle of prepublishing regulatory initiatives to encourage public access to and direct participation in the regulatory process. It is quite fascinating to look at a copy of the weekly Canada Gazette, Part I to see the results of this innovation. In addition to the exact words of each proposed regulatory change, you will find a "RIAS" - a Regulatory Impact Analysis Statement - which explains what the change is intended to do, why it is being proposed and with what expected impact.

All of these innovations were directed at taming the regulatory tiger. They were not the stuff of headlines and heated public debate. But they were peaceful and orderly public management improvements that were intended to and have succeeded in fostering better government - and, dare we say it, even "good" government at the federal level.


Chapter 2: Is There a Theory of Deregulation?

Donald G. McFetridge and Ashish Lall

Introduction

The purpose of this paper is to examine the implications of some recent examples of deregulation in the United States and Canada for the theory of regulation. Specifically, the question is whether either the traditional public interest theory of regulation or the more recent interest group theories would have predicted either the occurrence or the outcome of deregulation in transportation, energy, telecommunications and financial services sectors.

The paper begins with a brief description of the major examples of deregulation, taken here to involve the virtual elimination of price, entry and exit controls, which have occurred in Canada. More detailed descriptions appear in the other papers in this volume. The description is followed by an analysis of the respective assumptions and predictions of the alternative theories of economic regulation. Finally, we explore whether the major examples of deregulation are consistent with either of the two contending theories.

Deregulation in Canada

Energy

The Western Accord of 1985 eliminated federal regulation of the price of natural gas sold in interprovincial trade. About 80 per cent of all reserves in the producing provinces are under long-term contract primarily to Trans Canada Pipelines. The remaining gas can be sold directly to users at a negotiated price. The number of contracts between gas producers and gas consumers has increased from 24 in 1986 to 354 in May 1988. These direct sales compete with and displace gas provided under long-term contract (system gas).

The Alberta government has attempted to discourage direct sales by refusing to issue removal permits in some cases and by changing its royalty calculations in others. The National Energy board has also limited direct sales by forbidding self-displacement (replacing system purchases with direct purchases) by gas distributors. This restriction was removed in November 1989.

Finance

As of July 1988 all restrictions on the ownership of securities dealers have been eliminated. Legislation which will grant chartered banks fiduciary powers has been proposed. It is also proposed that chartered banks be allowed to own insurance companies although restrictions would remain on their ability to act as insurance agents.

Telecommunications

In this industry regulatory change has occurred through decisions of the CRTC rather than by legislation. CNCP Telecommunications was allowed to interconnect with Bell in 1979 and BC Tel in 1981 in order to provide competing private line and data transmission services. The ability of the CRTC to order interconnection with Alberta Government Telephones which was challenged by the province of Alberta in 1982, was upheld by the Supreme Court in August 1989.

The ability of the CRTC to exempt certain competitors from price regulation has been challenged successfully in the courts. In September 1986, CNCP applied to CRTC for exemption from price regulation since CNCP had a small segment of the tele- communications market and did not have a monopoly in any individual sub-market. The application was supported by the Consumers Association of Canada and the Bureau of Competition Policy. On September 27th, 1987, the CRTC lifted the regulatory burden on CNCP since it was convinced that there was sufficient competition to ensure a loss in business if prices were raised by CNCP. On October 13th, 1988, in Telecommunications Workers Union v. CRTC and CNCP, the Federal Court of Appeal set aside the CRTC decision and referred it back for reconsideration. The court ruled that the CRTC's jurisdiction did not include the authority to relieve a firm from the requirement to file for toll approval. CNCP intends to take this issue before the Supreme Court.

Transportation

The federal law deregulating interprovincial trucking, the Motor Vehicle Transportation Act, 1987, came into effect on January 1st, 1988. The "public necessity and convenience" test that had been used to restrict entry was replaced by a "fitness" test which directed authorities to grant a license to any applicant who satisfied basic insurance and safety requirements. Public hearings were no longer required unless there was evidence of public detriment. The new law reversed the onus under the old one in that those opposing the license are now required to how detriment whereas before the applicant was responsible to show that the new service was required and would not damage incumbents.

In Ontario the Minister of Transport and the Ontario Highway Transport Board both sought the ultimate authority to issue licenses. The Minister had advocated a more liberal entry policy than the Board (requiring opponents of entry to show serious detriment). Judicial decisions in 1988 gave ultimate authority to the Board and rejected the Minister's interpretation of entry requirements.

The National Transportation Act also came into effect in January 1988. It increased competition among railways by providing for confidential contracts with shippers, by increasing the scope for interswitching (ie., increasing the number of consumers with access to a competing railway) and by eliminating provisions of the Railway Act which encouraged rate-making.

With respect to airlines, the National Transportation Act eliminated entry restrictions (except in Northern Canada) and he regulation of fares, flight schedules and equipment. Exit restrictions were liberalized (120 days notice is required). Confidential contracts with shippers were allowed. Only fare increases on "monopoly" routes can still be appealed.

The Public Interest Theory of Regulation

The public interest theory holds that regulation exists to correct market failures. Regulation thus increases societal wealth. The sources of market failure which regulation is said to remedy include natural monopoly, asymmetric information and externalities.

The regulation of natural monopoly was historically thought to allow the realization of the economies of large scale production while avoiding the "deadweight" loss associated with simple monopoly pricing. Critics of the natural monopoly rationale have pointed out first, that the "deadweight" loss associated with simple monopoly pricing can and presumably would be avoided without regulation by a regime of multipart tariffs (non-linear pricing). Second, as Demsetz (1968) argued, distributive concerns can be satisfied by auctioning off the monopoly right.

Goldberg (1976) salvaged a role for regulation with the argument that even with franchise bidding for monopoly rights the contract between the franchisee and consumers (or state) would bear a close resemblance to existing regulatory regimes. Regulatory control over pricing, entry and exit is seen by both Goldberg and Williamson (1976) as a means by which the government, acting on behalf consumers, can induce producers to make long-lived investments in specialized assets. Baldwin (1989) has examined cases in which this "regulatory contract" fails because parliamentary governments, acting as both contractors and adjudicators, cannot constrain their opportunism. The result is the replacement of regulation with government enterprise.

With respect to other forms of market failure it is generally accepted that there are potential efficiency gains to be derived from setting entry-restricting minimum quality standards in market characterized by asymmetric information (Leland, 1979) and from restricting the number of users of common property resources. Entry standards or restrictions need not be imposed by the government but the latter is likely to have scale and/or credibility advantages.

The Special Interest Theory of Regulation

In the special interest theory regulation is a means by which special interest groups use the political process to extract wealth from other groups in society. Apart from the redistribution itself, these transfers involve a "deadweight" loss and are therefore collectively wealth-reducing.

Stigler (1971) formalized the special interest theory as an economic theory of regulation. He argued that particular industries or occupational groups can use the coercive power of the state to facilitate and sustain an increase in their prices or fees thus increasing their wealth at the expense of their customers.

Since these transfers involve a deadweight loss, they would be rejected in a direct vote by an informed electorate unless the beneficiaries constituted a majority and no less burdensome means of transfer were available. In a representative democracy, however, voting is an expression of preferences on a variety of issues. Voters choose rationally to remain uninformed on issues not perceived as material to them. As a consequence, policies benefitting a minority at a small cost to individual members of the majority may not evoke substantial opposition.

Political parties fashion a majority coalition of interest groups each seeking to extract wealth via regulatory or other means from the public at large. Political parties thus serve the entrepreneurial function of promising regulatory benefits in the form of entry control, restrictions on the supply of substitutes and facilitation of joint price determination in return for the interest group's votes and financial support. The industries which obtain regulatory benefits are those which can deliver votes and financial support and whose customers cannot.

Peltzman (1976) elaborated Stigler's theory. Political parties again "sell" regulatory benefits in the form of higher prices and profits, to industry and occupational groups in return for votes and campaign contributions. As the price set by a regulated industry increases, however, it pays more consumers to inform themselves and to campaign and/or vote against the proponents of the regulatory regime in question. As a consequence, the regulatory benefits an industry or occupational group is able to extract fall short of full monopolization.

Peltzman's model implies that regulation of either otherwise monopolistic or otherwise competitive industries will command greater political support than will regulation of oligopolies. Regulation of the polar cases promises either a big increase in profits or a big decrease in prices while regulation of oligopoly promises only marginal changes in prices and profits.

The model also has the comparative static implications that regulators will require increased profits resulting from either demand increases or cost decreases to be "shared" with consumers in the form of price reductions. Regulated industries will, according to the model, also be allowed to buffer the effects of cost increases or demand decreases on profits by raising prices. Taken together, these propositions imply that regulation amplifies the effect of cost changes and attenuates the effect of demand changes on prices.

A refinement to the special interest theory was suggested by Posner (1971) who observed that regulation often serves to benefit one group of customers at the expense of another. The regulated industry becomes a conduit, though not necessarily a disinterested one, through which resources are transferred from the "taxed" group to the "subsidized" group. Regulation is thus an alternative to direct taxation and subsidization. Regulation as public finance is further considered in Section 5.

Becker (1983, 1985) embedded the special interest theory of regulation in a general theory of ret-seeking. For Becker wealth transfers are the result of political interplay of contending interest groups. The groups which are more efficient at producing political pressure benefit at the expense of the less efficient. Interest group efficiency depends on the ability to organize to deliver political support and to influence public opinion.

In Becker's model regulation is but one of the means by which wealth may be transferred. Moreover a regulated industry may be the beneficiary or the source of a wealth transfer or merely a conduit.

Becker's key insight is that the greater is the deadweight loss associated with a wealth transfer the less likely it is to occur. This limits the size and nature of transfers and implies that regulatory regimes may contain the seeds of their own destruction.

Becker obtains his insight by recognizing that an interest group will spend up to its anticipated wealth loss to forestall taxation and up to its anticipated wealth gain to secure subsidization. The wealth loss of the taxed group is equal to the tax revenue derived from it plus the deadweight loss resulting from tax-induced changes in behaviour. The wealth gain to the subsidized group is the tax revenue transferred less the deadweight loss resulting from subsidy-induced changes in behaviour. Thus, given equal political effectiveness, the taxed group will prevail over the group seeking subsidization. Put another way, groups seeking subsidization must be more politically effective than tax paying groups if they are to succeed.

By the same reasoning wealth transfers which either increase allocative efficiency (correct market failures) or entail small deadweight losses (inelastic supplies and/or demands) are more likely to occur than are transfers which induce large deadweight losses. Moreover, holding political effectiveness constant, there is a mutual interest in choosing the efficient method of taxation. That is, the more efficient the taxation method the smaller is the wealth loss of the taxed group for any given subsidy. The same may be (but is not always) true of efficient subsidization. The implication is that if regulation is used to transfer wealth then it must be the most efficient (smallest deadweight loss) method of making the transfer.

Becker concedes that the most efficient mode of transfer may not be adopted if political effectiveness depends on the mode of transfer. "Hidden" regulatory taxes (in the form of above-cost prices) may evoke less opposition from the taxed group than more visible taxes. A subsidy-seeking group may prefer a "hidden" tax which requires less lobbying to obtain over a more visible tax even though the latter has a smaller excess burden.

While existing regulatory regimes need not be efficient in the narrow sense of minimizing the deadweight loss associated with a given redistribution, efficiency of a broader sort is implied. Existing regulatory regimes must be regarded as efficient in the sense of maximizing political support. As Trebilcock et. al. (1982) argue, the support-maximizing redistributive instrument will have the characteristic of providing highly concentrated benefits to marginal voters while imposing costs on infra-marginal voters or dispersed costs on other marginal voters. The preferred instrument will also be one which allows for the exploitation of the poorly informed by exaggerating its benefits and understating its costs.

Given instruments which are equivalent in these respects, political competition militates in favour of the instrument with the lower deadweight loss.

A problem with the special interest theory and with the public interest theory as well is their vagueness about what political support is and how it is maximized. Indeed, these theories leave the political sector virtually unspecified (Posner, 1974; Romer and Rosenthal, 1987). Political parties, legislatures and regulatory agencies are treated as interchangeable. They are assumed to maximize support but the means by which this occurs remain unstated. What might constitute support or contribute to political effectiveness is not discussed. Although the special interest theory turns on coalition formation and political entrepreneurship neither is modelled. Similarly, the public interest theory does not indicate how the political system determines the public interest. As the discussion in Section 8 will indicate, the failure to model a political sector reduces the ability of these models to explain the incidence and timing of deregulation.

Regulation as Public Finance

The public finance approach draws from both the public interest and the special interest theories of regulation. The public finance approach recognizes that regulation is one of a number of policy instruments available to governments for taxation and subsidization. As such, regulation may benefit any or all of workers, owners of other factors or a group of customers at the expense of another group of customers. Public finance regulation may serve the special (minority) interest or the general (majority) interest. It may increase or reduce deadweight losses.

Examples of regulatory tax-subsidy systems include the subsidization of rail passenger and grain movement with freight profits (McManus, 1976), the subsidization of local telephone service with long-distance profits (Breslau and Smith, 1982; Globerman and Stanbury, 1986) and the subsidization of the maritime and prairie air services with transcontinental profits (Baldwin, 1975). Legislation governing intercity bus transportation in Quebec explicitly requires that the ability of existing carriers to cross-subsidize low density routes be taken into account when the licensing of new carriers is considered.

Posner (1971) argues that regulatory cross-subsidization is most likely to prevail in industries providing infrastructure services such as utilities and common carriers. Such services have the useful property of being difficult to resell thus allowing government to restrict the benefits of cross-subsidization to a target group of users. Posner also suggests that infrastucture industries are subject to regulatory cross-subsidization because of "political" decisions that their services should be widely available.

Globerman (1986) describes the web of cross-subsidization that exists in the telecommunications industry in Canada. As noted above, long distance revenues are used to subsidize local rates. In addition, local business subscribers subsidize local residential subscribers and intra-provincial long distance callers subsidize rural subscribers (at least in Saskatchewan and Manitoba).

The situation in telecommunications illustrates that the system of regulatory transfers can be complex and the ultimate beneficiaries are not always readily identifiable. Where, for example, is the ultimate incidence of the higher rates paid by local business subscribers? The problems likely to be encountered in identifying the ultimate beneficiaries of regulatory transfers also make it difficult to test the special interest theory of regulation.

Regulatory cross-subsidization ha also been used as an industrial and regional development tool. One example of this is Canada's National Oil Policy. Baldwin (1982) shows that this policy was motivated fundamentally by a desire of the federal government to increase exports of western Canadian crude oil to the United States. In return for access to the U.S., Canada was obliged to commit itself not to replace exported crude with (cheaper) imported foreign crude in domestic use. As a consequence, Ontario refineries were required to run domestic crude. Competition from offshore product which continued to "leak" into Ontario reduced refining and distribution margins in Ontario. The major petroleum refiners benefitted from the NOP to the extent that it raised the price at which they could sell their western Canadian crude and were hurt by the NOP to the extent that it reduced their Ontario refining and distribution margins. Baldwin calculates that Imperial and Gulf were net beneficiaries of the policy while the benefit for Shell was marginal (pp. 1-2).

The NOP increased royalty income and drilling and related activity in Western Canada. The cost was borne by Ontario consumers. The industry served as a conduit receiving benefits just sufficient to induce the marginal national major to participate in the scheme.

A second example is due to Acheson (1989) who analyzes the terms and conditions of the Canada-United States auto pact. The pact restricted the right to import U.S.-built cars into Canada duty free to bona fide Canadian producers who met Canadian content provisions. The U.S., in contrast, allowed duty-free importation of Canadian-built cars by any U.S. resident. The producers used their exclusive right to duty-free importation to maintain higher prices for cars in Canada than in the U.S. for the first ten years of the pact. The pact also provided for an expansion of vehicle assembly operations in Canada. The emphasis on a relatively low wage and labour-intensive component of automobile production reflected a Canadian concern with jobs an job creation as opposed to income per capita.

The automobile producers were induced to enter the auto pact by the guarantee of higher profits on Canadian production. The producers, in turn, induced U.S. labour to agree to the expansion of employment in Canada by increasing the wage rates of their U.S. workers relative to their Canadian employees. Thus the apparent Canadian desire for a bigger automobile industry was realized in return for higher profits to the (U.S.) companies and higher wages to U.S. labour.

These examples serve to emphasize that the raising and spending of revenue by governments can involve a variety of policy instruments of which the type of economic regulation being discussed here is just one. Moreover the incidence of benefits is not necessarily confined to one group ("big oil" or "big labour") and dispersed interests (such as potential auto workers) can be and probably often are among the beneficiaries.

Examples of the use of regulation for industrial policy purposes continue to arise. A recent example involves the amendments to the Patent Act. The amendments effectively lengthen the patent term on pharmaceuticals for patentees performing R&D in Canada. In this case the subsidy is the additional profit earned over the longer period of monopoly. The tax is the excess of the monopoly price over the more competitive price which would have prevailed had the period of exclusivity not been extended.

Provinces as Interest Groups

The type of interest groups contemplated in the theories discussed in the preceding sections are occupations or industries. Acheson (1989) concludes that the principal Canadian beneficiaries of the auto pact were potential auto workers rather than existing union members. The cross-subsidy in this case was to increase employment rather than real wages. It is difficult to envisage either existing union members choosing more employment over higher real wages or potential auto workers as an effective interest group.

Acheson sees the auto pact as yet another example of public regulatory and other policies designed to reduce real wages at the margin so as to increase employment. This "taste for employment" continues to motivate both federal and provincial regulatory policies. Provincial economic interests have also accelerated the pace of deregulation in some cases (airlines, finance and energy) and retarded it in others (telecommunication).

With respect to airlines, Schultz and Alexandroff (1985) conclude:

It would be inaccurate to claim that the intergovernmental conflicts over air policy that emerged in the last decade were the sole cause of the decision to de-regulate the Canadian airline industry significantly. Other factors clearly played a role, especially the U.S. de-regulation beginning in 1978 and the subsequent "haemorrhaging" of Canadian traffic to U.S. border points such as Burlington, Vermont; Buffalo, New York; and Bellingham, Washington. In addition, partisan and personal motives on the part of then Minister of Transport Lloyd Axworthy were doubtless instrumental. It is our contention, however, that no other single reason played as important a role as that of intergovernmental conflict. To the extent that airline de-regulation represented "an idea whose time has come" the decade of conflicts and the numerous setbacks for the federal government, as well as many stalemates, were crucial to federal acceptance, and willingness to act, on that fact (p. 60).

For these authors the end came for airline regulation when provinces began to see air service as an instrument of economic development policy and their respective interests came into conflict both with other provinces and with the federal government.

Provincial economic development interests are also the driving force behind financial deregulation in Canada. Much of the impetus for deregulation came from Quebec which was, in turn, attempting to slow the relative decline of both the Montreal Stock Exchange and Montreal as a financial centre (McNish, 1989). Further pressure against federal restrictions on concentrated and cross-ownership of financial institutions has also come from Quebec which is attempting to insulate major Quebec-based companies from ownership changes and possible exit from the province (Courchene, 1990).

The opposite situation prevails in telecommunications where the three prairie provinces have successfully resisted attempts to increase competition in long distance services (Globerman and Stanbury, 1986). While it could be the case that the provinces are merely fronts for local special interest groups, it is also possible that they reflect the general interest in their respective jurisdictions.

Theories of Regulation as Theories of Deregulation

Predictions Regarding the Incidence of Deregulation

The public interest theory predicts that deregulation would occur if the market imperfection which necessitated regulation in the first place were to disappear. An example would be a change in technology which eliminated a natural monopoly.

The public interest theory would also predict that deregulation would occur if it were discovered that a regulatory regime which had been perceived to be in the public interest either never had been or no longer was. It may turn out that, in the light of experience, the cost of the regulatory apparatus is or has become greater than the loss resulting from the market imperfection it was designed to correct (Posner, 1974). Thus, it may become apparent only with experience that entry restrictions are a relatively costly way to enforce airline safety standards. A variant of this explanation is that assertions by various parties regarding the public interest in regulation are revealed to be self-serving only with experience.

Another possibility which touches on the special interest theory is that the regulatory process may be co-opted (captured) over time by the industry or occupational group it was designed to control so that regulation which was initially in the public interest is no longer so.

New information plays a crucial role in the public interest theory of deregulation. Deregulation occurs because of information that the market no longer requires it or that the regulatory process is more costly than anticipated or that the regulators are pursuing objectives at variance with those which had been intended.

The Stigler-Peltzman version of the special interest theory suggests a number of factors which may give rise to deregulation. These include, first, a reduction in the cost consumers must incur in order to inform themselves regarding the effect of regulation on them. For example, price comparisons between regulated and non-regulated jurisdictions can assist consumers in estimating the effect of regulation on the prices they pay.

Second, increasing substitutability between regulated and non-regulated products should reduce the profitability of hence the incentive to lobby for regulation-induced price increases. Substitution may occur between regulated and unregulated industries or between regulated and unregulated jurisdictions.

Third, a change in industry structure can reduce either the incentive on the ability to lobby for regulation. An increase in the number of firms in an industry or a convergence of their respective interests may increase the incentive to free ride and make it more costly to organize in support of politicians promising regulatory benefits (Sigler, 1974).

Becker's generalization of the special interest theory predicts that the incidence of rent-seeking, of which regulation is but one form, is reduced if: (a) the taxed group becomes politically more effective, or (b) the subsidized group becomes politically less effective or; (c) the deadweight loss associated with the transfer increases.

Political effectiveness again depends on interest group size and composition and on the cost of gathering information regarding the consequences of regulation. The deadweight loss associated with a wealth transfer increases with the ability of individuals to substitute in favour of the subsidized activity or away from the taxed activity. The extent of substitution may increase over time either because investment horizons are long (involving long-lived, specialized assets) or because the invention of substitutes which either escape tax or qualify for (more) subsidy is encouraged. Substitution may be discouraged by further regulation. This too is costly.

Increased substitutability erodes the tax base and/or dissipates the subsidy thereby discouraging regulatory and other forms of wealth transfer. If substitutability increases over time regulation will become increasingly difficult to sustain and deregulation may follow.

Is there a Bias Against Deregulation?

A number of authors maintain that the tendency of regulated industries is not toward deregulation but toward the entrenchment of regulation. There are two types of arguments. The first is that regulation increases the political constituency in favour of continued regulation. The second is that, given the political influence of contending interest groups, the incentive is greater to seek regulation than deregulation.

Noll and Owen (1983) argue that, over time, the beneficiaries of regulation will grow, hence in political influence while groups that lose will contract. In other words, ,persons exit the taxed activity and others enter the subsidized activity. The community with a vested interest in regulation is further expanded if there are unintended beneficiaries from regulation.

This argument is not compelling for a number of reasons. First, while exit from the taxed activity implies that there are fewer voters engaged in it, it also erodes the tax base. Similarly, entry into the subsidized activity implies more voters with an interest in it but with a reduced interest per voter.

Second, exit from the taxed activity and entry into the subsidized activity need not change the political balance. The lobby for subsidy includes both current and potential beneficiaries while the lobby against taxation would not derive strength from current marginal (low rent or no rent) participants in the taxed activity. Potential entry and exit are thus already reflected in the pre-exit and pre-entry political effectiveness of the contending interest groups. There will, of course, be unintended beneficiaries from regulation. There will also be unintended losers. There is no reason to believe that the unintended effects of regulation should increase the effectiveness of the subsidized relative to the taxed interest group.

Noll and Owen also argue that once regulation is in place its characteristics and consequences are known while the consequences of deregulation are a matter of conjecture. While the assertions of all contending interest groups are likely to be discounted by the average voter or legislator as self-interested, the assertions of regulated firms being, in a sense, "on the inside" may be more plausible and more persuasive than the arguments of outsiders (ie., those without industry expertise). Of course, those groups seeking new regulation must als overcome an imperfect information problem. It is quite possible that imperfect information burdens any attempt to change the status quo whether this involves either regulation or deregulation.

McCormick et. al. (1984) offer two reasons why, given interest group structure, substitutability and information, the incentive to regulate is greater than the incentive to deregulate. The first is that the cost of seeking regulation may be as much as the present value of the anticipated wealth transfer involved and if this cost is sunk it is not recoverable in the event of deregulation. These authors reason that because the amount of the transfer has effectively been lost to the economy there are no gainers from deregulation and thus little political support for it. This argument is false. As Cherkes et. al. (1986) point out, the gain to consumers from eliminating monopoly power is the same whether the cost of obtaining the monopoly is sunk or not. More generally, the incentive of the taxed group to oppose the continuation of a tax is the same whether the initial cost of seeking or opposing the tax is sunk or not.

The second argument of McCormick et. al. is that if regulation increases the marginal cost of production both the increase in consumers surplus and the increase in total surplus resulting from deregulation (i.e. expanding output) are smaller than the initial losses in consumers and total surplus due to regulation. Under these circumstances consumers have less incentive to lobby for deregulation than to oppose regulation when it is proposed. If they fail to stop the introduction of regulation they are even less likely to obtain its removal. Lott and Reynolds (1989) point out that this argument is false if deregulation results in the decline of marginal cost to its initial value. The latter scenario appears the more probable (see Section 9).

Evidence Regarding Factors Contributing to Deregulation

The theories of regulation discussed in Sections 3-5 suggest that deregulation should be associated with the presence of the following factors:

•New Information

•Increased Substitutability

•Changes in Interest Group Characteristics

New information plays a role in all theories. For the public interest theory information that regulation no longer serves the public interest or never has is decisive. For the special interest theory new information changes relative political effectiveness. In particular the emergence of a comparable unregulated market may provide the taxed group with better information regarding the magnitude of the regulatory tax burden it is bearing. Armed with this new information members of the taxed group may find it less costly to organize their opposition.

The demonstration effect of unregulated markets has been cited as playing an important role in a number of instances. Bailey et. al. (1985) cite the importance of the unregulated intrastate air carriers in California and Texas in demonstrating the costs of interstate air transport regulation in the United States. Robyn (188) notes that the fare reductions resulting from airline deregulation helped to convince opponents of interstate trucking regulation in the U.S. that efforts to eliminate it would be worthwhile. The demonstration effect of the U.S. experience has played a role in Canadian deregulation of air transportation and trucking (Schultz and Alexandrof 1985; Ludwick and Associates, 1987). Note, however, that deregulation of financial services in Canada has led not followed the U.S., and the regulation of long distance telecommunications in Canada seems not much influenced by the spectacular deregulation which has occurred in the U.S.

The role of new information is also stressed by political scientists studying deregulation. In their examination of the factors leading to the deregulation of the U.S. airline, trucking and telecommunications industries, Derthick and Quirk (1985), Robyn (1987) and Quirk (1988) emphasize the change in the intellectual climate and political entrepreneurship in both the legislative and executive branches.

The implication of the view that "ideas matter" is that regulation is intended to serve the general interest rather than special interests. The problem is that politicians and voters are often mistaken as to what policies serve the general interest. It follows that economic studies demonstrating that regulation has benefitted the few at the expense of the many and that it has resulted in large deadweight losses along the way constitute new information which may lead to a change in government policy.

There is no question that the intellectual climate of opinion regarding regulation has changed. In his 1964 Presidential Address to the American Economics Association, George Stigler (1965) characterized the approach of the economics profession to regulation as one of simply assuming that regulation reduced the inefficiencies endemic in markets. Stigler's admonition to demonstrate rather than assume the consequences of regulation is somewhat ironic for it implies that at least some regulation is the result of a mistaken attempt to serve the public interest rather than knowingly serving special interests as his later theory (Stigler, 1971) suggests.

Increased substitutability should act to discourage special interest and public finance regulation by eroding the regulatory tax base, increasing the deadweight loss associated with a given wealth transfer and the incentive of the taxed group to oppose the transfer. It may also contribute to the dissipation of the subsidy reducing the initial incentive to seek it.

Increased substitutability has figured in a number of recent incidents of deregulation in Canada and the United States. McManus (1976) argues that truck competition eliminated the tax base available for the cross-subsidization of rail passenger service and grain movement ultimately leading to the deregulation of railways in Canada. Peltzman (1989) makes a similar argument with respect to U.S. railways. Others point out, however, that railway deregulation in the U.S. lagged the exhaustion of the regulatory tax base by many years (Noll, 1989).

Schultz and Alexandroff (1985) and Ludwick and Associates (1987) find that the loss of passengers to U.S. carriers contributed to the deregulation of Canadian airlines. Substitution of this nature was not a factor in U.S. airline deregulation. While the regulatory tax base appears to have remained intact, some argue that attempts by the airlines to engross a larger portion of the excess profits made possible by regulation dissipated these profits and eliminated the incentive to lobby for continued regulation (Becker, 1985; Peltzman, 1989). Others dispute the assertion that significant dissipation occurred or that support for regulation waned within the airline industry (Levine, 1989).

Substitution away from the regulated product also contributed to the deregulation of brokerage commissions on the New York Stock Exchange (Jarrel, 1982) and to the elimination of regulatory ceilings on bank deposit rates in the U.S. (Hammond and Knott, 1988; Petzman, 1989).

The absence of significant cross-border substitution may have been one of the factors retarding deregulation of telecommunications in Canada in the face of a massive U.S. deregulation. Globerman (1988) reports that diversion of Canadian traffic to lower cost U.S. long distance carriers has been minimal.

Little evidence is available on the role played by changes in the structure of interest groups in bringing about deregulation. The deregulation or, more properly, the elimination of regulatory sanctions for collective commission setting by brokers on the New York Stock Exchange (NYSE) was, according to Jarrel (1982), due, in part, to the emergence of a strong contending interest group in the form of institutional traders. The institutional traders changed the political balance and increased the elasticity of demand for the NYSE's services by trading on other exchanges. These actions also split the ranks of the NYSE members on the basis of willingness to compete for institutional business nd reduced their political effectiveness.

Changes in interest group structure are not cited in other cases of deregulation. Indeed, in some cases commentators have noted explicitly that deregulation has occurred without any change in the structure of the contending interest groups. For instance, trucking deregulation occurred in the U.S. without any erosion of the regulatory tax base and any measurable change in the ability of the trucking lobby to deliver votes and financial support. Robyn's account emphasizes the role of ideas, to wit, the idea that deregulation could reduce trucking costs and the role of political and bureaucratic entrepreneurship, specifically the determination of the Carter administration to be seen to be doing something about inflation.

To summarize this highly impressionistic survey, new information and demonstration effects have contributed to deregulation in some cases. The erosion of the regulatory tax base as a result of substitution away from the regulated product has frequently played a role as has the dissipation of surplus by the regulated industry. Changes in interest group structure have not been important.

While this is not a remotely definitive test of the special interest group theory, it must nevertheless be concluded that the theory does not do particularly well in explaining the major incidents of deregulation which have occurred in the U.S. These have generally occurred without a discernible change in interest group structure. New information and demonstration effects have mattered but these are consistent with either a public interest or a special interest explanation.

Increased substitutability, the erosion of the regulatory tax base and the dissipation of surplus have been important and this is consistent with a special interest explanation. Peltzman (1989) concludes that these factors were present in five of the seven incidents of deregulation he examined. He regards this as confirming the importance of the special interest theory.

Others have pointe out that, while these factors may have been present at the time of deregulation, they had also been present for various lengths of time prior to deregulation. The theory does not do well with respect to timing. Indeed, the concentration of the major U.S. deregulations in the 'seventies' suggests that both common as well as industry-specific factors were at work. Among those common factors that have been suggested are the increased complexity of regulation due to the volatility of interest rates and of energy and other prices. This volatility was, in part, a consequence of the inflation experienced during the 'seventies'. This, together with the political opportunity presented by being seen to "solve" the inflation problem, may explain the timing of the major U.S. deregulations.

It is also important to note that while the erosion of the regulatory tax base eliminates the opportunity for regulatory wealth transfers, it does not reflect one way or the other on whether these transfers served the general interest or special interests. When the opportunity for cross-subsidization disappears so, ultimately, does cross-subsidization.

The Theories of Regulation and the Consequences of Deregulation

Another source of evidence on the balance of general and special interests underlying a regulatory regime is the price, profit and product quality consequences of its elimination. Who has gained from deregulation? The best evidence on the consequences of deregulation comes from the U.S. airline, motor carrier, brokerage and telecommunications industries. The consequences of U.S. airline deregulation are assessed by Moore (1986) as "mainly beneficial" with some fare rebalancing (relative fares rising on low density routes) and some losses to airline employees. Morris and Winston (1986) conclude that "...deregulation has led to a yearly welfare gain to travellers and carriers of roughly $8 billion 1977 dollars without generating any substantial losses to specific groups in society" (p. 51). The magnitude of this gain and the apparent absence of large losses to any particular group lends some support to the view expressed by Levine (1987, 1989) that airline regulation was simply a mistake, a failure to understand where the general interest lay rather than a result of capture by special interests.

With respect to motor carrier deregulation, the evidence is that over $5 billion dollars worth of operating authorities (licenses) were rendered almost valueless (Felton and Anderson, 1989). In addition, average length of haul and average load size increased and unit costs fell (McMullen and Stanley, 1988). Rose (1985) provides further evidence that the loosening of regulatory restriction by the Interstate Commerce Commission (ICC) prior to the passage of the Motor Carrier Act reduced trucking company monopoly profits. The effects of deregulation on trucking company share prices were fully capitalized prior to passage of the Motor Carrier Act (Rose, 1985; Schipper, Thompson and Weil, 1987).

The evidence here is fairly clear. Regulation involved a large transfer to trucking companies and significant deadweight losses. It would be an excellent illustration of the special interest theory were it not for the truckers' inability to restrain either the ICC or the Congress from deregulating.

Deregulation of brokerage fees on the New York Stock Exchange resulted in a reduction in the value of NYSE seats and a decline in aggregate broker profits. The anticipated profitability of national publicly traded brokerage firms increased. This case is characterized by the emergence of a contending interest group (large fund managers), a divergence of interest within the brokerage community (national versus New York brokers) and an increased ability to substitute (trade at other exchanges). Of the examples of deregulation which have been examined in detail this is the most compatible with the special interest theory.

MacDonald (1989) provides a comprehensive analysis of the consequences of railway deregulation for agricultural shippers in the United States. The general decline in freight rates on grain and the rapid spread of unit-train and multiple-car shipments lead him to reject the hypothesis that regulation benefitted all agricultural shippers in favour of the hypothesis that regulation benefitted small agricultural shippers at the expense of the large in areas where the railways were sheltered from intermodal (barge) competition. It is not clear from MacDonald's discussion whether regulation also served to increase railway profits.

Other studies of railway deregulation in the U.S. (Grimm and Smith, 1986) and in Canada (Tansz, 1988) conclude that railway deregulation has resulted in lower rates and better service. MacDonald concludes, these lower rates are probably a result of efficiency improvements rather than reductions in monopoly profit.

With respect to telecommunications, Perl (1990) concludes that deregulation facilitated a rebalancing of long distance and local telephone rates resulting in annual welfare gains in the amount of$3.8-$4.2 billion while maintaining the universality of the service.

This cursory review of the evidence yields the following tentative conclusions. First, the effect of deregulation has been salutary in the sense that it has resulted in welfare gains from both the restoration of cost-based pricing and from real cost savings.

Second, deregulation has resulted in wealth transfers among producers, among consumers and between producers and consumers. Cross-subsidization appears to have been a prominent feature of telecommunications regulation and perhaps railway regulation. The other regimes do not appear to have been serving any public interest or public finance purpose at the time of deregulation. Whether they had ever been intended to do so can not be determined from this evidence.

Conclusion: Is there a Canadian Theory of Deregulation?

The public and special interest theories of regulation have rightly been criticized for their vagueness regarding transactions in political markets. In the simplest terms the political decision process is still a black box. Moreover, as Noll (1987) and others have concluded, empirical work in this area lags the theory.

As it stands, the evidence on deregulation supports an eclectic theory of deregulation embracing both the public and special interest theories. The two are part of a continuum. Regulation is used to effect wealth transfers. These transfers may benefit highly concentrated special interest groups such as taxicab owners. They may also benefit larger groups such as residential telephone subscribers, potential auto workers or the residents of Alberta. Some regulatory regimes would be approved by a majority in a direct vote. Others would not. Some are difficult to categorize.

In seeking regulatory benefits special interests cloak their arguments in the public interest. A consequence of this is that ideas matter and that there is political opportunity in introducing new ones or repackaging old ones. This may account for the problem both the public special interest theories have in explaining the timing of deregulation. It is not only necessary for the regulatory tax base to be eroded, for example, but also for this to be seen to be the case. The two events may be widely separated in time.

In a Canadian context future deregulation is likely to be associated with several factors. These include, first, demonstration and, more importantly, diversion effects principally from less regulated U.S. industries.

Second, the erosion of the regulatory tax base through domestic interindustry substitution and the dissipation of subsidies together with the complexity of the additional regulation necessary to prevent this will continue to be factors.

Finally, the industrial development aspirations of provincial governments and the extent to which they are compatible with existing regulatory regimes will also play a role.

References

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Bailey, E., D. Graham and D. Kaplan (1985), Deregulating the Airlines (Cambridge, The MIT Press).

Baldwin, J. (1975), The Regulatory Agency and the Public Corporation (Cambridge, Ballinger).

Baldwin, J. (1982), "Federal Regulation and Public Policy in the Canadian Petroleum Industry: 1958-1975", Journal of Business Administration, V. 13, No. 1-2, pp. 57-98.

Baldwin, J. (1989), Regulatory Failure and Renewal: The Evolution of the Natural Monopoly Contract (Ottawa, Economic Council of Canada).

Becker, G. (1983), "A Theory of Competition Among Pressure Groups for Political Influence", The Quarterly Journal of Economics, 98 (August), pp. 371-400.

Becker, G. (1985). "Public Policies, Pressure Groups and Deadweight Costs", Journal of Public Economics, 28, pp. 329-47.

Blais, A., J.M. Cousineau and K. McRoberts (1989), "The Determinants of Minimum Wage Rates", Public Choice, 62, pp. 15-24.

Breslau, J. and J. Smith (1982), "Efficiency, Equity and Regulation: An Optimal Pricing Model for Bell Canada", Canadian Journal of Economics, 15 (Nov.), pp. 634-48.

Cherkes, M., J. Friedman and A. Spivak (1986) "The Disinterest in Deregulation: A Comment" American Economic Review, 76 (June), pp. 55