Appropriate Regulatory Technology: The Interplay of Economic and Institutional Conditions

Abstract

Appropriate regulation means maximizing the benefits from removing market failures in relation to the costs of government intervention. Monopoly markets fail because of both allocative and cost inefficiencies. The former are measured by Harberger's little triangles and the latter by big rectangles. Regulation that mitigates allocative inefficiency while exacerbating cost inefficiency is inappropriate because the costs of intervention outweigh the benefits. In developing and formerly socialist countries the potential benefits from intervention are larger because the realm of market failure is greater, but the costs of intervention are also larger because government failures are more likely. The marginal benefits of regulation decline linearly as intervention increases, while costs rise exponentially. Therefore intervention should only attempt to control egregious allocative inefficiencies through low-cost mechanisms. The Chilean and New Zealand methods represent quite different ways of doing this and thus provide appropriate modelsfor developing and formerly socialist countries.