The Regulation of Regulation
The controversy over the level and nature of regulatory activities in the economy is shaped by both the methodology of analysis and its perspective. Most of the tools used to evaluate specific portions of the regulatory system are embedded in neoclassical economic theory. Further, these tools are applied from the perspective of questioning only the efficiency aspects of the regulations. These neoclassical tools and perspectives constrain the analysis to an evaluation limited to government activities in the regulatory matrix. The analysis compares the effects of regulation to equilibrium in a competitive market system. The criteria of evaluation are based on efficiency, while equity considerations may have been the impetus for creating the regulation. This process limits the range of conscious alternatives that policy makers have. If the neoclassical concepts of Pareto optimality and the theory of second best are applied in a strict sense, the conclusion will usually be for the status quo. Pareto optimality tends to prevent the development and evolution of new policies in two ways. First, in the political sphere there is nearly always some interest group or person that will insist that their welfare will be reduced by any change in the existing rule structure. Secondly, it can be shown that when any new policy is evaluated using "efficient" prices and values generated by an existing set of policies, there is a bias in favor of the existing policy. This bias has been called "conservative reinforcement."' The theory of second best holds that the correction of one defect