What’s it: Deregulation refers to reducing or removing regulations to promote economic activities, competition, and free markets.
Deregulation trends gained popularity due to new trends in economic thinking, criticizing government regulations’ inefficiency. Critics consider regulation to be detrimental to consumers and the economy. The allocation of economic resources is inefficient due to low competition. As an alternative, they see deregulation to promote competition and improve efficiency in the economy.
However, on the other hand, critics argue, excessive deregulation actually raises various problems instead of solving them.
Examples of deregulation
Deregulation can take many spectrums and aspects of the economy. Examples of deregulation include:
- Removes price controls. Price control policies result in deadweight losses in the economy.
- Eliminate trade barriers such as import tariffs and quotas. That opens up more foreign competition.
- Reducing barriers to capital flow. Foreign direct investment is important to encourage competition, innovation, technology, and knowledge transfer in the economy.
- Shifting from the fixed exchange rate regime to a floating exchange rate. Under a fixed exchange rate, the government can devalue the domestic currency’s exchange rate to make export products cheaper. Such advantages disincentives domestic producers to be more efficient and reduce production costs.
- Cutting subsidies for companies. Subsidies sometimes benefit some firms and put others at a disadvantage. That results in unfair competition.
- Reducing regulatory, licensing requirements, and other barriers to doing business. The complexity of regulations and bureaucracy makes entrepreneurs reluctant to start new companies.
The four fundamental reasons for deregulation are:
- Promoting competition
- Reducing the costs of running a business
- Maximizing economic welfare
- Irrelevant reasons for regulatory
The government seeks to remove barriers to competition and create an environment of fair competition for the private sector. A competitive market contributes to innovation and productivity in the economy, thereby encouraging a more efficient allocation of economic resources.
Reducing the costs of running a business
The government removes regulations that interfere with the ability of entrepreneurs to set up businesses. Fewer and simpler regulations reduce the costs of running a business.
Regulatory and bureaucratic reforms attract more business people to enter the market, increasing competition. The tighter and fairer competition encourages higher productivity and efficiency. As a result, products are more diverse, and prices are lower.
Maximizing economic welfare
Regulations such as price controls give rise to deadweight losses; economic prosperity is lost due to markets not operating competitively. Therefore, to maximize welfare, the government should eliminate such interventions.
Initial reasons for regulations are no longer relevant.
The government allows monopolies in some industries to produce lower prices. Industries such as electricity have a very significant proportion of fixed costs. Therefore, to lower average costs, the industry needed a few players and even only one player. That way, monopolists can achieve higher economies of scale to lower costs and selling prices. The government then regulated several industries to limit the potential for market abuse by monopolists.
However, the market transformation makes such reasons irrelevant. For example, technological and technical advances lowered costs in some industries under natural monopolies such as power and telecommunications. Firms can achieve lower prices even with lower economies of scale than before. It renders the original excuse of natural monopoly no longer valid.
Advantages of deregulation
Deregulation is essential to promote competition and allocate economic resources more efficiently. Meanwhile, other advantages of deregulation are:
- Reducing the costs of running a business
- Reducing the corrupt behavior of officials
- Offer consumers more choices
- Improve long-term economic welfare
More efficient allocation of resources
Eliminating government intervention promotes healthier and fairer competition for companies. In general, competition is a driver of efficiency, product innovation, and lower prices.
Barriers to entry decrease, allowing new firms to enter the market and reducing monopoly power. The new competition lowers prices on consumers by forcing inefficient firms out of the market.
Some economists believe deregulation stimulates economic growth in the long run and promotes efficient allocation of economic resources. The market mechanism will guide them to produce the most profitable products and satisfy consumers.
Businesses will strive to produce goods and services to achieve a competitive advantage. They will produce as efficiently as possible to lower production costs and offer low prices.
They can also encourage innovation to create unique products. They can charge a premium price and sell it to more quality-conscious consumers.
On the other hand, the power of demand will select businesses. If companies are inefficient and unable to satisfy consumers, the market places them in a disadvantaged position. If they can’t transform their strategy, the market will force them out.
Reducing the costs of running a business
Deregulation makes it easier for entrepreneurs to run a business. They can more independently determine their operational processes and strategic interests. They can launch new products, set prices, expand markets, and acquire capital assets without getting involved in complicated licensing.
Government regulations often create high bureaucratic costs. Companies often pay a lot of money to comply with rules that are deemed unnecessary. For example, in the United States, regulatory compliance costs were more than $1.9 trillion a year in 2018. That’s the equivalent of 10% of the country’s gross domestic product.
Therefore, deregulation becomes a way to reduce such costs. Companies can use the money for capital investment instead of incurring unnecessary regulatory fees.
When investment increases, not only does production capacity become larger, firms also create more jobs. That then produces a ripple effect throughout the economy.
When the unemployment rate falls, households have more money. They then spend on products and services. The increase in demand encourages businesses to further increase production. And that means more jobs and income for the economy.
Reducing the corrupt behavior of officials
Regulations often lead to corrupt behavior among officials. Policy distortion has a strong correlation with corruption. Businesses with monopoly power try to secure their positions. They then bribe officials to launch policies to support their positions.
Also, officials often use regulations for their own benefit. For example, heads of state can take advantage of regulations to support their popularity ahead of general elections. They can take populist policies such as not raising the selling price of electricity or setting higher minimum wage increases.
Offering consumers more choices
As I mentioned earlier, deregulation promotes more competition in the market. Businesses develop competitive advantages to satisfy consumers. To do so, they can offer lower prices with standard quality. Alternatively, they can develop unique products, enabling them to charge higher prices and satisfy consumers.
Such competition will ultimately lead to the supply of higher quality, varied, and cheaper products. Consumers finally have more choices. Those who are budget conscious can choose an inexpensive product. Meanwhile, those who are a quality conscious can choose differentiated products.
Improve long-term economic welfare
Apart from increasing consumer choices, deregulation also restores economic prosperity that was lost due to government regulations. Take price controls, for example.
Such regulations reduce consumer and producer surpluses. However, the lost surplus was not captured by any economic actors, be it individuals, businesses, or governments. As a result, economic welfare is lost (in economics, we call it deadweight loss).
Disadvantages of deregulation
Critics argue that excessive deregulation has adverse effects, such as:
- Control of the economy by a few people
- A decrease in product quality
- Increase the systemic risk of the financial system
- Increase the cost of negative externalities
- Essential services to be exclusive
Control of economic resources by fewer people
Owners of capital control the economy. The competitive map is like the jungle, where the economically strong prey on the weak. Owners of capital control the market, have market power, and control the economy.
When they have mastered the economy, they act in their own interests. For example, when they dominate the market, they try to maximize profits by increasing prices or lowering product quality.
A decrease in product quality
The government issued several regulations to protect consumers, including health standards, product safety, and consumer privacy protection.
Deregulation can also result in lower service standards. As regulations have been relaxed, businesses are trying to cut costs and remove essential features to maximize profits. That is, of course, detrimental to consumers.
Increase the systemic risk of the financial system
Some institutions may tend not to care about risks while they are still profitable. They take excessive risks creating innovative financial instruments and practices.
They increase exposure to other unregulated financial instruments. For example, banks repackage loans and mortgages as securities or derivatives. Lack of effective regulation and speculation ultimately results in financial crises, as occurred during the great depression of 2007-2008.
Increase the cost of negative externalities
Regulation is essential for limiting negative externalities. Businesses compete with each other for profit. Due to weak regulation, they don’t really care about the negative externalities they produce, such as pollution and waste. Exploitative behavior towards natural resources also occurs when there is no regulation.
In the financial system, the systemic impact of financial institutions also resulted in a significant bailout. For example, the 2008 crisis forced the United States government to launch a $700 billion Troubled Asset Relief Program (TARP) to purchase banks’ toxic assets. Such bailouts come from taxpayers’ money, who may not enjoy the services of those banks.
Essential services to be exclusive.
Some essential services, such as health and utilities, become expensive. Although the government opens up competition in the sector, maybe only a few new companies are willing to enter. Apart from large capital investments, such sectors also pose a high risk. As a result, a few companies are willing to operate.
With only a few firms, the market is more likely to be an oligopoly. The players dominate the market. Since their main motive is profit, they take advantage of monopoly power to charge high prices for their services. In the end, only wealthy individuals can use the service.