Part of an interview with Kenneth Arrow:
“There Is Regulatory Capture, But It Is By No Means Complete”: ... Q: George Stigler and the public choice school predicted that regulation will inevitably be captured by special interests, and used as a tool to prevent competition. Some people see that as a reason for deregulation, or even no regulation. Perhaps we need to construct different market structures, so that regulation won’t be captured?
There’s a famous Churchill quote: “democracy is the worst form of government, except for all the others.” That applies to regulation as well. In the late 1800s, we had a natural monopoly: railroads. The government created a regulatory enterprise – the Interstate Commerce Commission – and of course it was captured. But it still made a difference.
I think we just have to accept that capture does occur, but it’s limited. The Federal Trade Commission, for example, is a pretty active body. Monopolies have been broken up. The AT&T telephone monopoly was broken up in 1982 – Stigler was still writing about regulatory capture then. AT&T was a classic monopoly, but a pretty benevolent one. ...
So there is regulatory capture, but it is by no means complete. Regulations do play a role.
One example of non-regulatory capture fighting against effective regulation was during the run-up to the 2008 crash, when several officials argued for CDOs to be regulated, which means they would have had to meet certain requirements of transparency. This was not accepted. I’m not saying the crash could have been avoided if that happened, but that would have made a big difference.
Q: Regarding the financial industry, in recent years Luigi Zingales and other scholars have questioned its size. Some argue that most of its business today is in fact rent-seeking, while only half or a third of it is allocating resources efficiently. Do you agree with this sentiment?
I don’t consider myself an expert on the financial industry, but the fact that the financial industry is responsible for something like 30 percent of all profits seems rather remarkable. I am startled by the size of the financial industry and what it means. I can’t believe this is really needed for the allocation of resources. A lot of it is going to be rent-seeking. It creates a diversion of resources, especially human capital, and not only does it create problems for the legitimacy of income distribution, but that also means resources diverted for this purpose [rent-seeking] can’t be used elsewhere. ...
Q: A large number of industries in the U.S. today are highly concentrated. Does concentration lead to declines in innovation?
Monopolies don’t feel a need to innovate, because they’re already making money off their existing products. However, there’s an argument to be made that the incentive for innovation is the prospect for monopoly. The award for innovation is that, at least for a period of time, you have a first-mover advantage until other people catch on. Existing monopolies are bad for innovation, but the prospect of monopolies is good for innovation. That’s the paradox. ...
He also talks quite a bit about health care at the beginning of the interview.