Martha OHagan
Junior Sophister

In an era of high budget deficits and high tax rates, regulation as a cost-efficient means of government intervention is both advisable and necessary. In many ways as effective as other means of intervention, such as government expenditure, its advantages are being praised at a time when there are many calls for cuts in public spending. òGovernments need not and should not be idle. Choosing the right policies is a matter of cost-effectiveness. Do what costs little and is sure to work well, avoid what costs a lot and probably will not work at all [1]. Le Grand et al describe regulation as follows; òGovernment regulation is an alternative to provision to the problems caused by the market of social care by imperfect information and irrationality. Instead of replacing the market providers by government ones, the market providers could be strictly controlled by a system of monitoring undertaken by field social workers and by inspectors[2]. Irelandõs integration into Europe affects the role of regulators. With free movement of goods, services, capital and people between member states of the EC, foreign ownership and pollution on an international scale, European co-operation is needed, to fulfil the role that previously the Irish government regulators fulfilled on a national scale.

This essay firstly analyses why the need for regulation arises. Secondly, regulation is analysed in relation to market failures and primary policy objectives of the government; economic growth and equality. In conclusion I will evaluate regulation as a means of intervention in Ireland in the 1990s, in light especially of European integration.

Why intervention?

The market price mechanism operates on two principles. (i) A consumer reveals preferences for a good or service by buying it. (ii) The benefits of a good or service are incurred by its consumer or producer only. The existence of externalities, public goods and imperfect information leads to market failures. The market also assumes perfectly competitive behaviour which operates on two assumptions. Firms are profit maximisers and consumers are utility maximisers and both have perfect information. This should ensure an efficient outcome and is referred to as Adam Smithõs ôinvisible handõ. Non-competitive behaviour such as monopolies or oligopolies cause the assumption of an efficient outcome to fail and government intervention is needed. Where market failures or an inefficient outcome occurs, consumer welfare may not be maximised. The ideal aim of a government is to maximise its peopleõs welfare, therefore intervention is justified. Apart from efficiency, income redistribution is also an objective. The government can regulate the price or quantity of a good or service and entry into markets. Regulation in Ireland is used to regulate monopolies (to ensure competitive behaviour for allocative efficiency), to ensure equality (a primary policy objective), to correct externalities, to provide information and to stop ôexcessiveõ competition.

Correcting market failures

Examples of market failures are the existence of externalities and imperfect information. The costs and benefits of goods and services are often not restricted to the consumer or producer. In an unregulated market negative externalities such as pollution tend to be produced. Although some pollution cannot be avoided if we want economic growth, regulation is necessary to control the amount. The optimal level of pollution is difficult to determine. Usually it is reached by setting uniform standards across firms, which may not be the cheapest way of reaching the given level. Firms who find it cheaper to abate pollution will have no incentive to reduce pollution below the level set by the standard. The two main problems concerning the regulation of pollution are lack of information and regulator ôcaptureõ (bias in favour of other objectives). Regulator capture expresses the idea that, if companies are publicly owned, politicians are also responsible for the performance of the firm and may therefore be more concerned with keeping down costs rather than increasing them to maintain environmental standards. If the firm is privatised, regulators will only be concerned with quality control. However, the information regarding the firmõs activities may be imperfect, posing problems for regulators.

Information is like a public good: supplying an extra person costs next to nothing, yet its acquisition by a single person would cost a huge amount. Regulations for health and safety are needed due to imperfect information about the possible consequences of consuming a good. Health warnings on cigarettes and safety belts in cars are due to regulation. Regulation also ensures that drugs are stringently tested before being marketed. However, this may push up the price of drugs (increasing costs of the producing firm), making them inaccessible to those on lower incomes. Overregulation may discourage firms from research which could potentially be very beneficial to society. Also, regulating what people consume impinges on their personal freedom to make decisions concerning their welfare. Some argue that information concerning the potential consequences of certain drugs be provided but the drugs be made available. òThe urgency of AIDS has changed the ways in which drugs are tried and approved....For those with fatal illnesses, a succession of inconclusive trials and the associated delays in approval may mean that drugs which could help are not available. Moreover, tight controls on those enrolled for trials means that many who want to try the drug often cannot[3]. Because of illnesses such as AIDS, the role of regulators must be revised. Those who contract the disease are not likely to thank the government for regulating a potentially beneficial drug because it has not been tested over a five-year period. Its urgency changes the argument for government regulation.

Policy Objectives :

(i) Growth

Being a small open economy with few natural resources to speak of, we rely heavily on trade. Without imported inputs no output can be produced and without output to export no foreign exchange can be earned in order to pay for imports for domestic consumption. Therefore Irelandõs economic activity relies heavily on the traded sector. The output of an economy depends on productivity, human capital, natural resources and technology. In order to grow, an economy must experience an increase in any of these. The key to this is gross investment, which is therefore also the key to growth. Thus in order to evaluate the determinants of growth, it is necessary to investigate what determines investment in a small open economy. Whereas in a closed economy, domestic savings determine domestic investment, there is no such relationship in Ireland given the integration of our capital markets into the world markets. Investment in Ireland is a function of world investment and of the k-variable, our attractiveness to foreign investors relative to other countries. World investment is exogenously determined, therefore the k-variable is the means by which we can influence our growth rate. Because the k-variable depends largely on factors in the non-traded sector, inefficiencies there are of great relevance to the Irish economy.

The importance of the non-traded sector, rests on the determination of the k-variable (infrastructure, legal costs, telephone costs etc.), input costs for the traded sector (with given prices and wages, lower costs increase the profits and the competitive position of the traded sector) and the percentage of GNP spent in the non-traded sector. As prices of traded goods are given exogenously, lowering the prices of non-traded goods can directly affect living standards. In 1992, 60% of GNP was spent on non-traded goods and services. Because the non-traded sector is not open to international competition, monopoly power causes inefficiency and high prices. Therefore regulating the non-traded sector will be of great relevance to the growth of the economy and to consumer welfare.

Two types of monopoly exist in the non-traded sector. Firstly, economies of scale and natural monopolies have led to the provision of public utilities such as water, gas, telephones to be undertaken by monopolies. Secondly, in order to protect the public from inadequate services, for which information would be difficult to obtain, barriers such as length of training or qualification licenses have restricted competition in services, banking and insurance. In order to ensure competitive quantity and price these monopolies must be regulated. òIt has been argued that the medical professionõs power over the length of training has been used to limit the supply of doctors (and hence raise their income) rather than to protect the public from poor quality treatment[4]. Thus, further regulation is needed to reduce doctorsõ fees and to increase the supply of doctors.

Furthermore, other non-competitive behaviour may include ôexcessiveõ competition, where large firms operate below cost price in order to push smaller firms out of the market, creating their own monopoly. Hence, improving efficiency of the non-traded sector is essential for the competitive position of the traded sector, for living standards, for the attractiveness of Ireland as a location for investment and thus for the growth of the economy. òThose who call for an industrial policy to help manufacturing are missing the point. If services account for over half the sales price of the good, then improving efficiency there will help to trim the cost of the final product and thus become more competitive, rather than tinkering with the production process [5] However, regulation has costs and can cause inefficiencies which I will discuss later.

(ii) Equality

There are two definitions of equality, equality of opportunity, where everyone has equal access to all markets, and equality of outcome, where everyone has an equal level of utility. Using income as a crude measure of utility, equality of outcome will be measured by the extent to which income is evenly distributed among the population. A combination of the two is desirable. Where one exists without the other, inequality still occurs, e.g. equality of opportunity may result in gross inequality of outcome and vice versa. Equality, being a social issue, often conflicts with economic issues.

Equality of opportunity ensures equal access for everyone to all markets. In the labour market regulation ensures equal pay for equal work and makes discrimination illegal. Firms may be required to hire a certain quota from specified minorities. However an article in The Economist entitled Discrimination and the market[6] points out the costs and problems of regulating market access. In the case of banks, insurance companies and other financial institutions, problems arise. In England a bank charging unmarried couples higher mortgage rates than married couples, because the former were likelier to default, provoked outrage. Similarly, banks are reluctant to lend to inner city areas because of the risk involved. Should health insurance companies offer the same cover to those whose families have a history of a hereditary disease or to homosexuals (because of the risk of AIDS) as to everyone else? Apparently so. However covering the costs of these risks cripples some financial institutions. Often the government must support financially troubled banks who offer equality in lending. Therefore equality of opportunity imposes a cost on the taxpayer, a cost that they should know about. Other costs of regulation include the expenses of the regulatory body and its staff.

The two main regulatory means for improving equality of outcome are the minimum wage law and rent control. In the labour market, supply and demand equate at the equilibrium wage. Imposing a minimum wage may have distortionary effects. If, however, the minimum wage exceeds the equilibrium wage, workers may be priced out of a job. Costs accruing to the employer arise. These costs may be passed on to the consumer by increasing prices but unless there is inelastic demand for the good, quantity demanded will fall. Producers may cut back on output or employment or replace labour with machinery. Those who keep their jobs gain at the expense of those who lose jobs. If wage differentials within employment are maintained, then equality within employment will not increase. Therefore minimum wage laws are an imperfect method of achieving equality. Some argue, however, that those on lowest wages are teenagers on a part-time temporary basis. Therefore unskilled, manual workers may gain at their expense (assuming they are not priced out of the labour market).

Rent control, or the imposition of a rent ceiling, transfers money from landlords to tenants. If demand for housing increases, rent may rise to what the government may consider an unacceptable level. Imposing a rent ceiling will reduce the number of houses rented, so that those lucky enough to obtain accommodation will gain at the expense of those who are not. Lower rents, however will make investment in housing a less profitable venture and supply may decrease, reducing the supply of housing at the rent ceiling even further. Therefore, more tenants will be worse off than before. In addition, it is not always the case that landlords are among the wealthy in society. Surveys have shown that often low earners or manual workers own property, and reducing their income does not reduce inequality.

Regulation on grounds of equality is sometimes ineffective and costly. Uninformed regulation such as imposing an excessive minimum wage or imposing laws which cripple insurance companies can have serious consequences.

The effect of Europe on regulation

Many believe that a large service sector means slower growth in an economy, because of its flagging productivity. European integration has opened up trade possibilities, making many goods and services tradable which were previously non-tradable (i.e. opening them to international competition). This is of great relevance in Ireland as services will be forced to become more efficient, in particular banks and insurance companies. òCocooned for years by restrictive practices, liberalisation and deregulation have opened services to competition. Privatisation is having a much bigger effect on services than on manufacturing, forcing airlines, banks and telecom firms to become more efficient[7]. By deregulating some services, they will be forced to act more competitively. These services are not only vital for the k-variable and for the traded sector, but they themselves are becoming tradable. Therefore there is less of a role for regulation, as monopolies will be forced to act as competitive firms Indeed some deregulation may be beneficial.

Externalities, especially pollution, are no longer simply on a national scale. The English nuclear plant, Sellafield, pollutes the Irish sea and environment, yet we are powerless to regulate its emissions. A European central regulatory board is however needed to regulate on a European level. Undertaking measures concerning the ozone layer would be useless without international co-operation. However, problems will be faced: European authorities will not have adequate information or be perfectly impartial in regulating pollution levels. Also, setting international standards will mean inefficiencies on a large scale. However, with international externalities, since we are useless in regulation alone, Europe must take over the role to some extent.

Since January 1993, customs barriers have been removed. Free movement of goods and services means that safety and health standards are an international issue. The rule at the moment is, however, that if an international standard has not been set for a good, the standard set by the country in which the good is produced is the one used throughout Europe. Ultimately standards for all goods will be set at a European level. Imported cars will have to be concurrent with Irish safety regulations. Similarly, laws against drugs are useless if they can be purchased abroad and brought here. Therefore regulations which are set to protect individuals from the potentially harmful consequences of goods due to imperfect information must be set through government co-operation and agreement.

Finally, the European social charter will influence equality measures. Minimum wages and rent ceilings will be surveyed by European boards. The European Commission accepts complaints of unfair discrimination, ensuring equality of opportunity in all countries. Therefore equality regulation will be very much affected by European set standards. òInternational trade barriers have been pushed forward by three main things: falling regulatory barriers to overseas investment, tumbling telecommunication and transport costs and increased mobility in domestic and international capital markets[8].

Deregulation and closer ties with Europe, which in many cases will assume the role of regulator, given the international nature of many factors, is beneficial to Ireland for growth, control of pollution, safety and health standards and for equality. Regulation exclusively on a national level is in some cases no longer effective.


In the 1980s deregulation was all the rage. In the 1990s re-regulators are getting to work throughout the world. However, because of our closer ties with Europe the role of regulator will be increasingly centralised. Regulation may impose costs such as regulation-caused inefficiencies (x-inefficiency). This is particularly evident in Ireland in the professions. Restrictive practices have given professions the position of monopolist, increasing the price and decreasing the supply of their services. Opening services to competition may overcome some of the regulation-caused inefficiencies. General laws, for example concerning nuclear plants throughout Europe will cause large scale inefficiencies, but will also provide a means for countries affected by pollution from other countries to control that pollution.

With changing times and changing situations, the role of regulation changes. Although a potentially very useful and effective means of intervention, its adverse effects can be very serious and costly. When needed, deregulation must be as readily implemented as regulation. European integration will also change the role of regulators in Ireland, to which they must be quick and willing to respond, in order to maximise the welfare of the individuals in the economy. Regulation, however, is particularly relevant in Ireland because of the constraints placed on government spending because of the national debt. One of the preconditions set by the Maastricht Treaty is the reduction of our debt and no monetary financing of budget deficits. Therefore, to comply with this we must reduce the debt, which reduces expenditure available for government intervention. Although there is still a role for government intervention in Ireland, in the context of Europe it is changing.


Di Cagno, D (1990) Regulation and Banks behaviour towards risk.

Le Grand, Propper & Robinson (1992) The Economics of Social Problems

OHagan, J (ed. 1991) The Economy of Ireland

Spulber, D (1989) Regulation and Markets

The Economist - relevant articles as quoted in footnotes