What is regulatory role of the government? What are the rationales for regulation? Why regulation is considered necessary in a free market economy?
The direct and indirect measures used by the government from time to time to control and regulate the private sector are included under the regulatory role. It means, the regulatory roles include all direct and indirect policy measures which the government employs from time to time to control and regulate private business to prevent the growth of socially undesirable business activities, to prevent concentration of economic power and to direct private activities, to prevent concentration of economic prosperity, employment and social justice.
The promotional roles, on the other hand, include all the activities that are undertaken and all the policies that are adopted to build the development infrastructure (i.e., the economic and social overhead capital) necessary for industrial growth; to enhance the resource potential of both mean and materials to enlarge the production capacity of economy and to create all other facilities deemed to be necessary for the overall growth of the economy. In a mixed economy like ours, the government through a comprehensive program of development carries out the development activities.
The regulatory roles of the government are as follows, which has been dealt in detail under government response to market failure:
- To provide patent and subsidy, which provide direct benefit to the business firms.
- To make operating control or levy specific tax. These measures obstruct both the nature of the goods and services produced by the firms and the production processes used in the production of these goods and services.
- Direct regulation on monopoly to ensure enough output and restricts monopoly profit.
- Make provision of antitrust act to maintain the level of workable competition in the economy.
Rationale for Regulation
The decision-making regarding where to regulate and how to regulate are affected by political and economic considerations. The economic consideration is related to the cost and efficiency implications of various regulatory methods. From the viewpoint of efficiency, a particular regulation method or change is better to that extent till benefit exceeds cost. On the other hand, if political consideration will have to be taken into account in regulatory decision-making, equity or fairness should be given more attention than efficiency criteria. In political consideration, one should look at the incidence or placement of regulation or the cost and benefit of regulation decision. There are economic and political reasons as to why the society should regulate.
a) Economic Consideration
The economic reason has an important role in formulating regulatory policy. In fact, it is due to the market imperfection that the need of regulation in production and marketing activities is realized. If unregulated, the market activity itself creates inefficiency or waste or market failure. Market failures are of following types:
- Failure by market structure: The first type of market failure is the failure by market structure. There should be enough sellers and buyers in the market to get the beneficial effect of competition or there should be at least the possibility of the easy entry of new firms. Such conditions is not fulfilled in some markets. The market for water, telephone, electricity comes under this category. If a single firm, which is called natural monopoly, can serve a particular market efficiently, it has market power. It can earn economic profit by limiting the output and by charging high price. Due to this reason, the price and output of public utilities are being regulated.
- Failure by incentive: The second type of market failure is the failure by incentive. In the production and consumption of goods and services, social price and cost is different from private price and cost of producers and consumers. In this way, since market imperfection or market failure does not give the signal of appropriate cost and benefit. The government should play an active role in the economy.
b) Political Considerations
The political consideration has also great effect on the formulation of the regulatory policy. From political viewpoint there are two reasons for regulation:
- Preservation of consumer sovereignty: To protect the choice of consumers or consumer sovereignty is an important characteristic of competitive market. The competition by providing incentive to produce the type and quantity of goods according to the desire of the consumers promotes efficiency. The competition by rewarding private initiative promotes individual freedom to the greater extent. The firms with market power may set higher price by limiting the output to earn economic profit, whereas the competitive firms determine optimal quantity of output according to market price. Therefore, price and output of monopoly can be controlled by regulatory policy.
- Limit concentration of economic and political power: The second objective of regulation is to limit the concentration of economic and political power. In a democratic society, it is not desirable to have economic and political power concentrated in limited persons or groups. It is regarded that the economic and political power remains linked with one another. There are examples of economically active person interfering in politics as well. Therefore, the development of large structures is prevented through regulatory policy.
