Deregulation gains are not free of pain

By James P. Miller
Tribune staff reporter

May 11, 2003

Times change.

The loudest voices these days are calling to have the federal government free industries, including the media, from the burden of regulation. But there was a time when regulation was considered the progressive idea, and business the dangerous force to be reined in.

In fact, most of the regulatory agencies now under fire for allegedly thwarting market efficiencies and stifling corporate innovation were created specifically to protect the public from being ripped off.

Most economists have come to believe that the government should try to minimize its interference in marketplace activities. Behind their "less is more" perspective lies some pretty solid evidence: The nation's commercial aviation, railroad and trucking industries have been revitalized since being deregulated--to the benefit of consumers and the overall economy.

Still, efforts to relax rules for other industries have generated decidedly mixed results. And because it is an inherently disruptive act, deregulation of any industry routinely generates a class of financial losers along with the winners.

Truck drivers earn less money since trucking was deregulated.

Under deregulation, Chicago-area residents can fly to San Francisco for an astonishingly cheap $79, but people who live in rural areas must pay through the nose to fly anywhere.

Airline deregulation gave us low-cost airlines, which brought air travel to the masses. But growing Wal-Mart-ification of the airline business has contributed to the financial distress that threatens the very existence of full-service carriers such as United Airlines and American Airlines.

"I'm not going to tell you the path to deregulation is smooth," said economist Robert Crandall, a senior fellow at the Washington-based Brookings Institution. "Are there winners and losers? I can't imagine a change to any economic system where there isn't. The point is, the amount of gain to the winners far outweighs the cost to the losers."

Regulation came in waves; not through careful design but in response to assorted scandals, changes in the political environment and the introduction of marketplace-altering new technology.

Responding to public outcry

The first wave arrived in the late 1800s, when railroads wielded almost unchecked power over farmers who needed to ship their grain to market. In all but the biggest cities, there was only one rail line, and its owners often weren't shy about squeezing their captive customers for all they were worth.

In response to howls from farm interests, the federal government created the first regulatory agency, the Interstate Commerce Commission, and granted it power to impose rail rates.

Later, the Food and Drug Administration was created, after Americans read about the grotesquely unsanitary practices of the nation's meatpackers. And after the stock market crash of 1929 touched off a series of bank failures, lawmakers barred interstate banking and restricted banks' activities in the securities market. Those restrictions remained in effect, and kept the industry highly fragmented, until the late 1980s.

During the New Deal era of the 1930s, when public mistrust of business was running high, the U.S. government created a host of regulatory watchdogs. The Federal Communications Commission began overseeing the radio industry, under the theory that the airwaves belonged to the public and should be regulated on the public's behalf.

When commercial aviation began to take off in that era, the Civil Aviation Board was created to govern air carriers' fares and routes. As trucking became a viable industry, the Interstate Commerce Commission extended its rate-setting power to include trucking and, later, interstate bus transport.

Public outcry following business financial failures also brought the government into other areas.

Long before Kenneth Lay gave us the imploding energy company known as Enron Corp., there was Samuel Insull. A onetime lieutenant of Thomas Edison, Insull created Commonwealth Edison Co. in Chicago. As a utility, Insull's operation was a big success. But in a development that eerily presaged Enron's travails, the interlocking holding companies that Insull had established around Commonwealth Edison collapsed during the 1929 crash. The failure of Insull's empire helped spur the federal government's move to regulate the electric utility industry.

The Federal Power Commission, created in 1935, oversaw New Deal programs such as rural electrification and the Tennessee Valley Authority. It also laid down federal rules governing electric utilities. Regulation helped ensure that utilities didn't use their natural monopoly power to soak consumers and pushed electric companies to extend service to rural areas that had been avoided because the potential revenue didn't justify the capital outlay.

Rules became oppressive

However well-intentioned the thinking behind the creation of the nation's regulatory agencies, the regulators grew increasingly powerful. Over time, their grip on many industries became oppressive, critics contend.

In the airline industry, the Civil Aviation Board restricted new entrants, effectively making the existing handful of carriers a cartel. And because the board dictated maximum and minimum fares, airlines competed mainly on the basis of frequent flights, fancy in-flight dinners and other amenities, said Daniel Alger, a deregulation expert and an associate professor of economics at Lawrence University in Appleton, Wis.

The board made airlines provide below-cost service to tiny cities in rural markets. But the carriers didn't care because the government set prices on more desirable routes high enough to offset those losses. In fact, rates were so high that few Americans could afford to fly, except on business. Southwest Airlines started operations in 1973, but in the regulated era, the no-frills pioneer could only operate inside the state of Texas.

In the railroad industry, a new term, the "standing derailment," made its appearance during the 1970s. The phrase was coined to describe a previously unheard-of mishap, in which stationary freight trains occasionally toppled onto the ground in rail yards when the badly maintained track beneath their wheels suddenly collapsed sideways.

Throughout the 1960s and '70s, the rail industry steadily lost market share to the trucking industry. There was little it could do to counter the trend: Although the industry was no longer a transportation monopoly, the government still was setting the fees railroads could charge for hauling freight, forcing rail owners to provide service on unprofitable spur lines and blocking many proposed mergers. Those strictures ensured that railroads' return on investment was inadequate; in response, many cut corners on equipment and track upkeep.

A drag on the economy

By the late 1970s, sentiment in favor of government oversight had turned. Although regulators such as the FDA had become key elements in the government's effort to protect its citizens, the overseers of many other industries were seen as an economic drag. Within a short time the Civil Aviation Board dissolved itself and let the market decide where airlines would fly and how much they would charge.

The Interstate Commerce Commission stopped controlling routes and rates for train and truck service. Those changes introduced competition--an economic version of the law of the jungle--to industries that had grown slack and inefficient.

Airlines learned how use the more efficient hub-and-spoke system. They introduced frequent-flier promotions. Southwest was freed to fly across state lines and soon began its revolutionary advance into once-inviolate high-volume routes.

Railroad companies went through a series of mergers, then began spending heavily, not just on improved track but on efficiency-enhancing gear such as room-size supercomputers to optimize network routing.

Hundreds, perhaps thousands, of small trucking lines went out of business because they weren't efficient enough to handle the new competition. But the surviving companies began providing superior service.

Deregulation of those transportation industries "has been very close to an unqualified success," said Lawrence University's Alger. But in sectors that have historically been "natural monopolies"--that is, where the expense of establishing a competing system is so great that it deters new entrants--it has been less successful.

Efforts to deregulate natural gas pipelines and electricity markets have produced "a mixed bag," Alger said. Although the successful deregulation of long-distance telephone service has cut consumers' costs by half, he said, the related effort to deregulate local phone service has been "a complete failure."

Copyright © 2003, Chicago Tribune

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