Why Regulation?

    Robert Baldwin and Martin Cave, London School of Economics and Political science

    Motives for regulation can be distinguished from technical justifications for regulating. Governments may regulate for a number of motives, for example they may be influenced by the economically powerful and may act in the interests of the regulated industry or they may see a particular regulatory stance as a means to re-election. Different commentators may analyze such motives in different ways. We consider the technical justifications for regulating that may be given by a government that is assumed to be acting in pursuit of the public interests.

    Many of the rationales for regulating can be described as instances of ‘market failure’. Regulation in such cases is argued to be justified because the uncontrolled market place will, for some reason, fail to produce behavior or result in accordance whit the public interests. In some sectors or circumstances there may also be ‘market absence’.

    There are a number of well recognized reasons commonly given for regulating. It should be stressed, however, that in any one sector or industry the case for regulating may well be based not on a single, but on a combination of rationales. Health and safety regulation, for example, can be justified with reference to a number of rationales like externalities, information defects, unequal bargaining and paternalism.

    A second point, to be born in mind in considering whether to regulate, is that the market and all its failings should be compared with regulation and all its failings. Any analysis of the need to regulate will be skewed if it is assumed that regulatory techniques will operate perfectly.


    Table 1. Rationales for regulation


    Main aims of regulation


    Monopolies and natural monopolies

    Counter tendency to raise prices and lower output.


    Harness benefits of scale economies.

    Identify areas genuinely monopolistic.

    Windfall profits

    Transfer benefits of windfalls from firms to consumers or taxpayers.

    Firm discovers unusually cheap source of supply.


    Compel producer or consumer to bear full costs of production rather than pass on to third parties or society.

    Pollution of river by factory.

    Information inadequacies

    Inform consumers to allow market to operate.


    Continuity and availability of service

    Ensure socially desired level of essential service

    Transport service to remote region.

    Anti-competitive and behavior predatory pricing

    Prevent anti-competitive behavior.

    Below-cost pricing in transport

    Public goods and moral hazard

    Share costs where benefits of activity are shared but free-rider problems exist.

    Defense and security service.

    Unequal bargaining power

    Protect vulnerable interests where market fails to do so.

    Health and safety at work.

    Scarcity and rationing

    Public interest allocation of scare commodities.

    Petrol shortage.

    Distribution justice and social policy

    Distribute according to public interest.

    Victim protection.

    Prevent undesirable behavior or results.


    Rationalization and coordination

    Secure efficient production where transaction costs prevent market from obtaining network gains or efficiencies of scale.

    Disparate production in agriculture and fisheries.



    Protect interests of future generations.


    Coordinate altruistic intentions.