Introduction
Regulation remains one of the fundamental functions of a state. The social theory faces a major challenge in explaining the government intervention in any market. Economic regulations refer to any form of tax, subsidies or administrative control by the government over the economic activities in a country’s setting. The two dominant theory advanced to explains economic regulation are the public interest theory and the economic group interest theory otherwise referred to as the capture theory. While the former theory has its roots in the political scientists, the latter owes to the work of economists. The essay aims at providing a succinct analysis of the two theories and their relevance in explaining and analyzing economic regulations.
The public interest theory of regulation
The theory has its roots in the sedulous work of Arthur Cecil Pigou, who held that almost all regulations are enacted to correct market inefficiencies. However, as argued by Posner (1974), not even one specific author has ever claimed any form of intellectual ascendancy to the public interest theory. In general terms, the theory argues that any regulation should seek (seeks) to protect and benefit the public at large.
The theory encompasses two main acceptable concepts. One of its concepts is as embraced by Stingler (1971) as summarized by Posner (1971) and explains that the main aim of any regulation is the protection and benefit of the public interest at large. The second concept is as embraced by the resulting academics which explain the theory proposes that the government should impose economic regulation in the event of market failures so as to maximize the social welfare of the general public. The theory holds one central assumption that economic markets are arguably highly fragile and often operate inefficiently should they be left to run on their own.
The public interest embraced by the public interest theory is the best possible way of allocation of the scarce resources in an economy for both the individual and collective goods in a society. Also, worth an explanation for a better understanding of the theory is the market failure. The term refers to a condition where the market fails to employ scarce resources for their optimum valued resources reflected in the market prices.
Ideally, in any efficient market setting, a firm should expand its production up to the point where the marginal cost of employing an additional unit in the production equals the market price of the added unit otherwise known as its marginal benefit.
Given the fact that the market rarely achieves this efficiency in resource allocation, the government has to intervene mainly through regulation for the sake of public interest. However, critics argue that the theory incorrectly assumes that theoretically efficient institution can correct an inefficient in the real world setting. However, even after development to the theory, elites still concluded that the main way through which the government should regulate the market for the sake of public interest is through regulations to correct market inefficiency. The diagram below illustrates a situation of market inefficiency/failure for a better understanding of the concept.
1.1.1. Limitations of the public interest theory of regulation
The main criticism is that government usually enact regulation for purposes of market control even in the absence of market failures. Besides, the theory is incomplete in explaining how other interest groups often affect the regulatory outcome. More interestingly, the theory overlooks the regulator’s interest and the interest of the other affected parties. William (1972) further argues that the theory is not without a severe deficiency in explaining how the regulators translate public perception into the legislative actions.
Capture theory of regulation
George Stigler is arguably the most prominent contributor to the capture theory in a path-breaking article. Owing to the failure of the public interest theory to consider the self-interest of both the regulators and other affected groups in the regulation process; the capture theory came to the fore. The theory is, however, not without different versions. However, a salient feature characterizes the theory; that is, it negates the public interests and holds that economic regulations act a way/process through which some interest group seeks to advance their private interest. The interest group often include the regulators themselves and any other groups affected by the government regulations. A more interesting version of the economic interest group theory is as advanced by political scientists. They claim that interest groups play a crucial role in the formulation of regulations (Posner 1974, pp. 341).
Political scientists in support of the capture theory argue that, over time, regulated industries often dominated the regulatory agencies. As such, the regulation usually reflects the interest of the dominating group in the regulatory body. Marxists on the other hand (in support of the capture theory) argues that the capitalists (bug businesses) control most of the society’s institutions. It is undeniable that among the institution in the society are regulatory institutions. As such, the capitalist usually controls the regulations. However, the argument fails to reflect the reality given that most regulations are in the interests of the small enterprises such as barbers and dairy farmers. The small businesses are entirely foreign in the Marxists arguments. Self-interest maximization characterizes most political actors according to the capture theory.
In summary, the capture theory holds that any regulation can benefit a firm if the firm captures the related regulatory body which could be officers or legislators to act in the firm’s interests (Becker, 1976).
The relevance of the capture theory over the public interest theory.
The former better explains the purpose of economic regulation. The reason being, it singles out some distinct interest groups such as the regulated firms which the theory argues that they influence the regulation. Even more important, it is the theory’s ability to predict a regular sequence in which the efforts of particular interest groups usually thwart the initial objectives of the regulatory program. However, the capture theory is not without unsatisfactory elements. It happens to embed indistinguishable versions of the former theory. Secondly, analysts have argued that the theory lacks a theoretical foundation. However, though unsatisfactory, the capture theory ranks above the public interest theory.
Practical Application of Accounting Theory
The economic interest group theory
In a nutshell, the theory postulates that the government enacts regulations to reflect the need for the regulation industry. The facts simply mean that the industry captures the regulators/lawmen. As such, at the end of the analysis, it is the industry which controls the regulatory institutions. Industries hate regulations as they depict them as an adverse contributor to the profitability of the firm. As such, the industries try their best to capture the regulatory bodies to act on their interests. That is, they try to control the regulatory bodies. Once they (industries) succeed in controlling them (regulatory institutions), they take over the regulation role or exercise significant influence in the control process. At the end of the analysis, the regulators will enact decision which favors the industries.
A vast list of empirical evidence exists to back the economic interest group theory. For instance, the accounting professions in Australia captured the ARSB. As postulated by the capture theory, economic regulators are unable to maintain their independence at the end of the analysis, and the regulation often loses its initial aim to regulate.
of the Capture Theory in the Setting of accounting standards in Australia: Empirical evidence
Before 1984, the accounting professional owned the responsibility of setting accounting standards. In 1984, the government established the ASRB (Australia Accounting Standards Review Board) owing to the inefficiency of the accounting professionals to regulate the accounting sector. However, AASB later replaced the ASRB.
AASB came to the fore as a result of the constant reduction in public confidence owing to the “capturing” of the ASRB in exercising control in the sector. The professionals not only acted on the goals of the regulation they were setting but also on the regulator. As such, only members of the profession were sanctioned for noncompliance. William (1976) provides a set of evidence of the “capturing” of the AASB in setting accounting standards.
During the initial discussions on the establishment of the ASRB, the accounting professionals worked to ensure that the legislative body lacked an independent capacity and was deficient in intellectual capacity by denying it an academic chairperson. They further ensured that, rather than receiving a research director, ASRB would receive an administrative officer. Even more interesting, it is the fact that majority of the ASRB’s members were professional accountants and financial directors (Sam, 2006). As such, it became evident that the regulators lacked professional independence in setting the accounting regulations.
Conditions appeared to change for the better when ASRB decided to enact its regulations only after reasonable consultations with the AARF. Ridiculously, accounting professionals controlled the AARF. Surprisingly, ASRB later changed and only considered submissions from AARF against its initial position of considering the submissions from all sectors of the economy. From this argument, it is evident that the accounting professionals captured the accounting regulatory authorities who had to act on their interest. The phenomenon serves to portray the practical application of the capture theory in the real world setting to support the theory’s theoretical approach.
In China, it is evident that the Tobacco industry has captured the regulation setting authorities in the country. According to a report by WHO (World Health Organization), cigarettes are among the leading causes of death. More interestingly, China agreed on the need to ban cigarette smoking. Surprisingly, a substantial part of China’s government revenue comes from the Tobacco industry. Even more surprising, it is the Administration of the China National Tobacco Corporation (a monopoly) that exercises administrative control over the tobacco sector. Moreover, the tobacco industry and the government are intertwined. As such, no regulatory policy against the industry can prosper. In simple terms, the tobacco industry has captured the tobacco regulators.
The theory, however, is deficient in explaining why the customers (the neglected party) would fail to capture the regulatory bodies to protect their interests.
The public interest theory
Relevance of the government to public interest
An analysis of the government activities which are in public interests proves inevitable in understanding the practical applicability of the public interest theory of economic regulation. The main activities include the provision of public goods, economic regulations, and social/environmental regulation. Among the public goods, national defense remains the most crucial activity of any government. Other public goods include legal institution, infrastructure, education, and social services. Social regulations encompass regulations on social activities such as child labor and safety of working condition. Similar to the public goods, social regulation encompass public interest which the government must protect, More important to the purpose of this paper is economic regulations. In the interest of the public economic regulations entails regulations of the markets to avoid exploitation of the general public. Regulations in such a setting include antitrust laws and price controls all of which aim at acting for the benefit of the public. According to Posner (1974), in a natural monopoly, the government must intervene mainly by fixing prices.
What would be the consequences of a natural monopoly conducting the supply of public utility services? Undeniably, the firms would make supernormal profits, charge high prices, and sometimes offer low-quality services. All the features characterize all monopolies. Economists argue that in such a situation, a market failure would occur; that is, inefficient allocation of resources. Through government intervention, welfare cost declines to the benefit of the public interest. In such a circumstance, the public interest theory would employ the ‘fair rate of return’ concept in explaining regulation in the presence of a monopoly (Michael, 2003).
In a nutshell, the public interest theory of regulation advocates for a comparative analysis of all sectors/institutions in achieving an effective allocation of resources. An equivalent reasoning would apply in social regulations. In an event that unsafe working condition results in work disability of an employee, the costs involved may include medical costs and loss of working ability which in extension would result in more costs. The government should act for public interest and enact health work condition regulations. The diagrams below illustrate the inefficiencies in a failed market setting which warrants government intervention as advocated by the public interest theory.
Accessed from: www.economicshelp.org [January 24, 2015)
Accessed from <www.triplealearning.com/files/developers/a_z/page_14.htm> [January 24, 2015]
In summary, public interest theory departs from three main assumptions. One, the prevalence of market failures. Two, the ‘benevolent regulator’ assumption; and three, choosing of efficient working regulatory bodies. To promote efficiency and protect the public interest the government must either put the national monopolies under the State’s control or highly regulate them. The fact is as it applies to several European countries.
Public interest theory and its relevance to the Resource Super Profit Tax (RSPT)
Of the 138 recommendations presented by Henry’s tax review, a resource tax was among the recommendation that the government accepted. The government, therefore, announced, in 2010, of its decision to introduce the RSPT. The tax aimed at taxing the supernormal profit made by the mining companies in Australia. RSPT rate is at 40% with capital allowances for expenses and losses. The government decision to introduce RSPT owes to many reasons.
The mining activity has created a resource boom in some parts of the country; however, a majority of the regions have suffered a lot. Even more interesting, the Australian dollar have gained value as a result of the high demand for the mineral resources. The fact comes with a huge setback to the farmers and manufacturers who usually export their products. It is undeniable that a high exchange rate for local currency leads to the exports becoming expensive in foreign markets, hence a decrease in demand. Besides, the high dollar rate in Australian has served to impact adversely on the tourism industry in the country. As such, an ‘inefficiency’ exists in the market with some parties benefiting at the expense of the others. In such a situation, public interest theory would advocate for regulations to protect the public interest.
Posner (1971) advocated for taxation as a form of correcting a market failure and protecting the interests of the affected party. Though, the mining activity does not necessarily result in a market failure; it results in undesirable effect for the larger part of the population. As such, the tax charged would help the government redress the imbalance in the economy as advocated by the public interest theory. Moreover, the tax works to ensure that Australians retain the benefit of their natural resources.
The Mineral Resource Rent Tax (MRRT)
The dawn of July 1, 2012, saw the enacted of an arguably controversial tax on the profit from mining activities. Initially, the tax aimed at taxing the excess profit the mining firms usually get from the sale of the mining activities. The government introduced the tax in replacement of the confusing royalties that the mining firms initially paid to the government. MRRT provides for the taxation, at a rate of 40%, of any profit made by the mining firms that was over 6% of the capital investment of such firms. Besides, the Act further provides for a rebate of the royalties the mining companies initially paid. According to Harrison et al. (2010), the world has witnessed a constant increase in the resource prices owing to the deficiency in the global capacity to produce. As such, there exist a huge difference between the cost involved in extracting minerals and the market price of the extracted minerals. As such, the mining companies make huge profits (supernormal profits).
The worrying fact, however, is that a majority of the mining firms are foreign-owned. Therefore, the firms receive a substantial amount of profit at the expense of the taxpayers. A notable fact as argued by the government is that mineral resources are a finite resource which when depleted the government loses an important source of revenue. The government further argue that the current tax rate paid by the mining firms do not reflect the skyrocketing market price of the minerals. For instance, the government charged a tax at a rate of 40% in 2001. Currently, the firms pay taxes at a rate of 20%, thus the need for the mining tax. As argued in above (RSTP case), the public interest theory would best explain the government decision to impose MRRT on the mining industry since the tax works for the benefit of the general public.
Repeal of the minerals resources rents tax law and the relevance of the capture theory
The eve of October 24, 2013, paved the way for the government intention to repeal the MRRT. However, it was not until September 5, that the repeal decision received a royal assent which saw the end of MRRT obligations owed by the mining firms to the government as from September 30, 2014. The capture theory would suitably explain the repeal of the Mining Act. Arguably, the mining companies constituted a substantial part of the government revenue. Moreover, we cannot overlook the political influence of the mining firms in the country owing to their large revenue bases. As such, it is arguable that the mining companies captured the regulatory institution leading to a favorable regulation in their favor (repeal of the Mining Act). The government acted in the interest of the mining companies owing to their significance in the country; they captured the government.
Regulation as a political process and the potential impact of the “mining tax.”
In most nations the legislature happens to be the main regulatory institution. As such almost all regulation result from the political process given the fact that the legislature is a political institution. As such, the political institutions plays an indispensable role in the formulation of regulations in any country. They constantly interact with the social groups and public opinions in the formulation of the formulation of administrative policies. As such, it is conclusive that regulations are an output of a political process.
According to an economic modeling by the department of national treasury in Australia (as stated by Harrison et al. (2010)), the ‘mining’ tax will result in an average gain by the ordinary worker of approximately $ 450 a year. Consequently, the government will reduce the corporate taxes for the local companies and the small business enterprises in the country. To add on to the benefits, the overall social welfare of the country will improve as a result of a decline in food prices (0.9%), housing (1.1%), and transport and communication (1.7% and 1.4% respectively) (Harrison et al., 2010). Furthermore, the mining tax will see a reduction in interest rate by 1.1%. Consequently, the interest rates will decline not to forget to mention the rise of the country’s GDP by 0.7%. The fact proves the indispensable role of the mining tax. Should the tax fail to work, analysts argue that Australia will continue enriching other nations to its detriment.
Conclusion
Regulation of any industry arises to protect the interest of two distinct groups which the regulation cannot serve together at the same time. That is the benefit of the public or the benefit of a subclass of the public. The perspectives are as attenuated by the public interest theory and the capture theory respectively. However, it is notable that an industry can actively seek a regulation or else it may thrust upon the regulation. It is the use of the public resource that usually provide a scheme of regulations. It’s the government’s role to protect the interest of the public. However, owing to the influence of the subclasses of the public in the regulation process, the government should approach the process in a diligent and alert manner to achieve its objectives.
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