DEPARTMENTS:
Blessings of Liberty

By John Hood

John Hood on the dividends of deregulation

Washington, D.C., in the mid-1970s must have felt like heaven on earth to federal regulators and those who favor government control over the nation's economic activity.

From 1970 to 1975, federal spending on regulation grew by 77 percent (in inflation-adjusted dollars) and regulatory staffs grew by 46 percent. President Nixon had created new federal oversight agencies such as the Environmental Protection Agency and the Occupational Safety and Health Administration. It was the heyday of lobbying groups and self-styled consumer watchdogs that prodded, cajoled, protested, litigated, and otherwise drove regulatory policymaking in many areas of economic and social life that previously had been the domain of state governments or the private sector.

In the two decades since, however, politicians of both parties have voted to deregulate major industries and dismantle some of the bureaucracies that oversaw them. In that time, deregulation has improved the lives of every American by raising the quality of service and shaving billions of dollars off the cost of telephone service, natural gas, and air travel, as well as the groceries, clothes, and other goods transported by truck or rail (see table).

This early wave of deregulation in the mid- and late 1970s slightly predated the supply-side revolution on taxes. Thus it can be viewed as the first major milestone of the emerging movement toward free-market economics. A new report by Robert Crandall of the Brookings Institution and Jerry Ellig of George Mason University's Center for Market Processes examines five deregulation efforts undertaken since the mid-1970s:

Natural Gas. Under strict federal regulation since 1954, the natural-gas industry began to exhibit shortages in the late 1960s. By the 1970s, producers were unable or unwilling to supply as much gas as customers wanted to buy at the regulated price.

In 1978, Congress set a timetable for deregulation of most natural-gas prices. By 1985, when all gas discovered after 1976 was freed from federal price regulations, gas prices began a steep plunge. After that, federal regulators began to transform natural-gas pipelines into "open access" transporters of gas from various producers. Deregulation not only lowered prices for consumers, Crandall and Ellig state, but also improved the quality of service by removing the threat of artificially created shortages.

Airlines. Before 1978, both the maximum and minimum fares for air travel were set by the Civil Aeronautics Board (CAB). The CAB began to loosen its regulations in the mid-1970s. In 1978, Congress passed legislation to abolish the CAB within six years, open up the industry to new competitors, and eliminate government-set fares.

"Virtually all observers, including airline commissions established by both President Clinton and President Bush, agree that deregulation dramatically lowered air fares," Crandall and Ellig write. They conclude that when adjustments are made for other factors that could explain fare reduction, deregulation still emerges as a major cause of the savings. One study found that deregulation had saved passengers $12.4 billion annually. Also, deregulation improved the quality of air travel by increasing frequency of flights in many areas and reducing transfers.

Trucking. Federal regulation of interstate trucking began in 1935. Throughout the 1960s and early 1970s, economic research showed that trucking rates would be far lower in a competitive marketplace. In response to the growing opposition to interstate regulation, Congress passed legislation in 1980 that virtually deregulated the trucking industry.

Within six years, the number of licensed motor carriers had doubled. As Crandall and Ellig note, many of these new carriers were small owner-operators who had previously worked for the large licensed companies. Even as the total number of carriers increased, however, portions of the industry such as the "less than truckload" (L.T.L.) market began to concentrate. By 1993, the four largest carriers accounted for nearly half of all L.T.L. revenues.

Still, rates fell and have stayed low after deregulation. According to several studies, even L.T.L. rates seem to have fallen by about 17 percent from 1980 to 1985, and afterward by about 2.1 percent a year. Competition also gave birth to many quality enhancements, such as innovative tracking and monitoring services to ensure prompt and safe delivery.

Railroads. The collapse of the merged Penn Central rail line in the mid-1970s prompted a major push to deregulate and transform the railroad sector. Congress passed a bill in 1976 that allowed railroads to merge and to abandon unprofitable routes; in 1980, Congress deregulated rates for some commodities. Gradually, rate deregulation extended to about 90 percent of rail traffic. Crandall and Ellig conclude that price declines after deregulation were significant, though smaller than those in trucking.

Perhaps more importantly, rail deregulation led to improved service. "Prior to deregulation, many shippers considered the term 'rail service' an oxymoron," Crandall and Ellig write. "The main reason was that regulation rendered railroads so unprofitable that they failed to invest in maintenance and improvement." During the first five years after deregulation, railroad delivery time improved by 30 percent.

Telecommunications. The first movement toward competitive long-distance telephone service came not from Washington policymakers but from the entrepreneurial efforts of Microwave Communications Inc. (MCI). In 1969, MCI won federal permission to begin competing with the AT&T monopoly to provide "private-line" long-distance to companies, but did not receive the go-ahead to enter the ordinary long-distance market for businesses or residences.

MCI clandestinely began to offer standard long-distance to businesses in 1974 without authorization by the Federal Communications Commission (FCC). The FCC tried to stop MCI, but lost in federal court. The FCC did authorize competition in telephone equipment, a move ratified by the courts in 1977.

As the pressure for competition in the long-distance and telephone-equipment industries began to heat up, the federal government challenged AT&T's use of its monopoly on local telephone service to compete unfairly. Its legal actions finally led to a consent degree in 1982 that split Ma Bell into seven local telephone companies and a separate long-distance and equipment business that retained the AT&T name.

Crandall and Ellig estimate that equipment prices fell by 6 to 7 percent a year between 1972 and 1987. Long-distance rates have fallen after deregulation, as well, though there is some disagreement about the magnitude and causes of the decline. Competition has also improved quality dramatically and led to the introduction of many new devices and services.

Critics of deregulation like to claim that this massive wave of deregulation was instigated by the regulated industries themselves, out of gross self-interest. Businesses, they say, naturally oppose rules placed on them by government, and will always work to reduce or eliminate them.

In fact, many businesses welcome regulation. In industries such as trucking, natural gas, and airlines, existing firms often benefited by federal regulations on price and entry that served to restrict competition and thus inflate their profit margins. Before the deregulation of interstate trucking, for example, there were some 20,000 trucking firms in the United States. Today there are more than 300,000, mostly small businesses operating in niche markets such as the transport of high-value goods like pharmaceuticals or service to out-of-the-way markets.

This increase in competitors did not please existing common carriers that owned expensive operating certificates from the federal Interstate Commerce Commission (ICC). Before regulation, when entry into trucking was carefully restricted, an ICC operating license was worth billions of dollars. This constituted an investment in regulation that the existing firms did not want to see devalued.

In the case of trucking, as in many others, the ammunition for reform efforts was supplied by academic research and public-policy think tanks. The 1960s may have heralded the beginning of the modern federal regulatory state, but they also ushered in a truly remarkable period of careful research into the history and economic effects of regulation. The University of Chicago, through the Journal of Law and Economics, was one source of this work, as was the American Enterprise Institute, the first Washington-based free-market think tank. Its older and more liberal counterpart, the Brookings Institution, also began to publish empirical research questioning the basis for federal regulation in many areas.

Business journalist Susan Lee points out in her invaluable book Hands Off that the change in expert opinion about regulation began to show itself in Washington in the mid-1970s. Nixon had often talked about getting government off the back of business, but actually moved in the opposite direction. His successor, Gerald Ford, however, lamented the cost that regulation imposed on private economic decisions, and pushed for deregulation in the transportation sector. President Carter continued this campaign, while promoting deregulation in financial markets, telecommunications, and energy as well. In 1978, Congress passed and Carter signed landmark legislation to deregulate natural-gas production and airlines.

Today's hot regulatory issues involve communications, electrical power, and financial services. Deregulation of these industries promises to be a much more complicated task than the previous generation of regulatory reform. In all three cases, for example, states play a sizable or dominant role in regulating rates and condition of entry.

Still, the good news is that deregulation-minded policymakers in Washington are embracing the challenge. They know that consumers spend a lot more on local telephone service, electrical power, and insurance premiums than they ever will on long-distance or natural gas. There are, in other words, even more potential benefits for consumers from the new round of deregulation than the old-and lot more to lose if the process runs aground.