Effect of Regulation:

It is difficult to comment whether regulation is good or bad. The studies on the effect of regulation have mostly been on a case-to-case basis. The fact that government regulation in has declined over the years points to the limitations of regulation. We have mentioned earlier about the problem of red-tape and corruption in economies pursuing command and control policies. The liberalization measures in China appear to have yielded results and- the Chinese economy is growing at a very high rate for several years now. The disintegration erstwhile USSR also points to the deficiencies in controlled economies.

Averch and Johnson (1962) attacked the public interest theory by putting forth the view that there is an incentive on the part of the regulated firms to distort their input choices. Their results gave rise to the famous Averch- Johnson effect, according to which if there is a rate of return regulation then firms adopt capital-intensive production technology even though labor is available in abundant supply. Empirical study on the Averch-Johnson effect by Joskow and Noll (1 98 1) was inconclusive regarding the presence of such behaviour. Some other studies, however. lend support to the Averch-Johnson effect thereby challenging the public interest theory.

The government usually functions through a regulatory body to regulate monopoly prices. Often the regulatory serves the interest of the industry group as members of the body have affiliation or some bias towards the industry. Often pressure groups such as industries associations or political interference help in fulfilling the interest of the industry. Such a situation is termed 'regulatory capture' as decision-making authority is captured by others.

It is often argued that regulation has adverse consequences and thus should be minimal. In line with the classical economists it is suggested that the role of the government should be limited to protection of life, liberty and property of individuals. Government should not diminish individual autonomy and responsibilities in order to rectify market failure.

Second, regulation is seen as a problem itself. According to this line of thought, regulation tends to bring in more regulation. In the Indian industries context. as we mentioned earlier, the government of India imposed restrictions on imports of several commodities during the 1970s to conserve foreign exchange. The Indian producers were not in a position to compete globally. Thus exports were minimal. The restrictions on the import of capital goods adversely affected productivity of industrial sector.

Thirdly, in the process of regulation, there are some negative consequences in addition to the originally intended objectives. Thus a regulation brought in to cure a problem of 'market failure' could give rise to a problem of 'policy failure'. Let us take certain examples from the Indian scenario. In order to increase agricultural production the government provided subsidized inputs such as HYV seeds, chemical fertilizers and pesticides. In order to bring in mechanization of agriculture there was subsidies on inputs such as tube wells and electricity. As output increased in certain pockets of the country, the government purchased food grains at higher prices so that farmers get remunerative prices. In the process two problems came up. First. there were severe environmental problems: tube wells dried up due to excess drawing up of ground water. water table got depleted, and fertility of land declined.

Second, due to provision of excessive subsidies, adequate funds for capital formation in agriculture were not available. This hampered growth rate of agriculture in the long run.