The State, Regulation and the Economy: An Historical Perspective

Published by EH.NET (July 2002)

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Lars Magnusson and Jan Ottosson, editors, The State, Regulation and the Economy: An Historical Perspective. Cheltenham, UK and Northampton, MA: Edward Elgar, 2002. x + 228 pp. $80 (hardback), ISBN: 1-84064-128-2

Reviewed for EH.NET by Mark Kanazawa, Department of Economics, Carleton College.

Economists have long been interested in the mutual relationship between government policy and the private economy. Government policies such as taxation and regulation can importantly affect private economic activity, while the latter influences what sorts of government policies are economically desirable and politically feasible. Historical studies of this relationship are quite numerous, and have provided many important insights into the origins of government programs, the form that they take, and their economic consequences. Often, however, studies examine an historical episode but are for all intents and purposes history-less. By this I mean that the analysis does not model the historical process in which one thing follows another, the nature of the latter determining, in any important way, the final equilibrium outcome, except in a history-less comparative static sense. As a result, one gains insights into the particular historical period, but one doesn’t gain a good sense for how the historical actors got there and where they would ultimately end up, or any sense that the final outcome was somehow inevitable, if indeed it was. Occasionally, however, studies come along that take seriously the charge that historians perform genuinely historical studies, in which early events can endure and have lasting impacts on future outcomes (so-called path dependence). The State, Regulation and the Economy is an ambitious foray into this area.

This edited volume is based upon several interesting premises, each of which has both strengths and weaknesses. First, the volume takes a determinedly multidisciplinary approach in examining the interaction between government and private business, which I applaud. The chapters are a varied collection of contributions from different social science disciplines: economic history, sociology, and political science. Novel to me was the approach of one chapter on early U.S. railroad regulation by two sociologists, Timothy Dowd and Frank Dobbin, which supplemented models of industrial organization with principles of ecological models to predict the founding of railroad lines. Toward explaining government policies such as regulation and taxation, many economists would probably agree that we are nowhere near the point of exhausting the potential for fruitful interactions among the traditional social science disciplines. However, such interactions can be tricky because practitioners of each discipline bring a different set of assumptions to the modeling exercise, and common ground is not always immediately evident or easily agreed-upon.

Second, because the core issues relate to institutions and institutional change, the temporal focus of the volume is the very long-term. This comes across clearly in most of its chapters, many of which span decades of events. This long-term focus is useful in permitting us to observe the broad currents of institutional change. Thus we can clearly see, for example, the temporal pattern of jurisdictional shifts in how courts and legislatures resolved early railroad disputes in the U.S., an important point made in a chapter by historian Colleen Dunlavy. The virtually inevitable downside of such a long-term focus is that it requires, to some extent, that we sacrifice depth for breadth. Consequently, while we observe the long-term trends clearly, questions can remain regarding which of several competing hypotheses are chiefly responsible for those trends.

Dunlavy’s interesting and useful chapter is only one example of this depth-for-breadth tradeoff, and clearly illustrates both the strengths and weaknesses of the very long-term focus. One of her main points is that early governmental attempts to regulate railroads encountered avoidance strategies as railroads attempted to move the locus of their disputes back and forth both between federal and state jurisdictions and between the courts and legislatures, in order to gain more favorable outcomes. The jurisdictional switching she has identified is unquestionably an interesting phenomenon, and the extent to which it occurs is only apparent when one observes the very long-term. Yet in covering seven decades of events in the nine pages she devotes to the nineteenth-century experience, serious questions will remain regarding exactly why the switching occurred. All economists will wonder exactly what it was that altered either the relative costs or the relative uncertainty experienced by the railroads associated with using one milieu to fight the good fight, rather than another. The answer is not entirely clear in Dunlavy’s narrative.

Finally, as mentioned earlier, the volume attempts to take a truly historical approach, by investigating the extent to which government policies have exhibited path dependence. Indeed, this is a fundamental premise of the volume, which the editors regard as of the “utmost importance” (p. 4). Many economists, including myself, take the notion of path dependence seriously enough that a careful, detailed attempt to document its presence in a particular instance is a welcome development. It should be recognized from the outset, however, that this is a formidable task, as convincing documentation of the phenomenon, at least in an economically interesting form, has proven to be difficult. I will return to this point shortly.

True to the singular preoccupation of many historians and economic historians, railroads occupy a major portion of the volume’s attention, with two chapters devoted to the American experience and two devoted to the Swedish experience. Not that this is a bad thing: given their unique position as the first major regulated industry in the United States, railroads are a worthy topic of study, and all sorts of lessons emerge from examining their regulatory experience. One interesting bottom line that emerges from these chapters is that the experiences of the two countries have been quite different, for reasons having to do with the differential way property rights to the rail lines have been defined. In describing the situation in Sweden, where the state has played a huge role as owner-operator, Lena Andersson-Skog’s entire narrative is dominated by politics, much of it the good old-fashioned pork-barrel kind. For example, intense lobbying by regional interests influenced early expansion of the Swedish national rail network to previously unserved areas. Thomas Pettersson supplements Andersson-Skog’s study in describing how transport subsidies, chiefly applying to rail freight, emerged from a coalition of mostly agricultural regional interest groups during the late 1800’s and early 1900’s. Though the identities of the chief beneficiaries have changed, this basic system of transport subsidies exists to this day.

In the United States, where private rail corporations dominated, we observe, over a period of decades, a complex progression of subsidies being supplanted by regulation, and local regulation giving way to state regulation, which gave way to federal regulation. This progression seems to predictably follow the life-cycle of the railroad industry, from infancy as a new and valuable technology for which localities competed vigorously, through to maturity as a dense network of rail lines serving both short- and long-haul destinations. The overall picture is clear and compelling. However, due in part to the long term focus which necessitates broad strokes on the historical canvas, a number of key questions remain unanswered about the little steps that comprise the process. For example, how and why the political dynamic in the United States changed in moving from a regime of railroad subsidies to rate regulation probably needs to be understood as a complex interplay of interest group stakes, transactions costs, and policy focal points. This is a dynamic that remains to be fully elucidated. Despite all of the ink spilled on the subject, there remain some important things that economic historians do not yet fully understand about the origins of railroad regulation, and how it evolved over time.

The other substantive chapter about the United States concerns the historical evolution of tax policy, by a political scientist, Sven Steinmo. Again, the perspective is the very long-term: U.S. tax policy over the course of the entire twentieth century. Steinmo’s narrative and interpretation will be useful to those who are not familiar with the long-term trends in U.S. tax policy, which has changed dramatically over time. Though seemingly unrelated to the issue of railroad regulation, there is an important common theme. While nineteenth-century state and local governments had to grapple with challenges by railroads to their jurisdiction in formulating effective regulatory policies, national governments nowadays must similarly consider the possibility that corporations and individuals will take advantage of increasing globalization to engage in tax avoidance. While obviously not a new idea, Steinmo does a nice job of placing this notion within its long-term historical context.

Two additional chapters about Sweden by Jan Ottosson and Carl Jeding examine other aspects of government policy regarding certain infrastructure industries — in particular, civil aviation and telecommunications. As with railroads, we observe industry life cycles and government policy to match, albeit with some interesting differences. Early Swedish civil aviation consisted of private companies that enjoyed some public promotion but apparently only modest subsidies, which were insufficient to keep many companies from going bankrupt after World War I. The government responded by expanding subsidies, and granting what was in effect a monopoly franchise to one company, ABA. However, ABA crashed and burned, so to speak, during the Depression, which led to state ownership. In sharp contrast to civil aviation, Swedish telecommunications was state-owned from the outset, apparently because it was considered of greater strategic importance to the economy. However, in the 1980’s, the desire to promote greater efficiency led the government to promote competition through licensing of independent operators. Though it is not always easy to see the precise lessons for understanding institutional path dependence, both of these chapters provide nice broad-scope overviews of the development of these industries, and how government policies changed over time.

Finally, I would be remiss if I did not mention one of the most noteworthy chapters in the volume: a study by Ron Johnson and Gary Libecap on the U.S. ethanol program. Johnson and Libecap argue that inefficient government programs can persist over time because politicians and interest groups have both incentive and opportunity to distort information in pushing forward their favored programs. Buying this story requires, of course, that one believe that reputations for dishonesty and institutional penalties for lying, dissembling, and other assorted behaviors will not have much deterrent effect. However, I for one can easily imagine Congress buying into a collusive dishonesty repeated game where everyone gets their turn at the goodies (though this might be fleshed out a bit more). It is telling that I found this chapter to be one of the most satisfying in the volume, as it takes a relatively short-term perspective of a couple of decades and is thus able to provide more supportive details. But the most important contribution of this chapter is not in the specifics of the ethanol program or even in how their argument applies but rather, in recognizing and avoiding the nirvana fallacy which is so easy for economists to fall in to. Basing institutional inefficiency not on transactions costs of change but rather, ex ante information sets, makes good sense and is consistent with the attempts of some economists to define path dependence in an economically meaningful way.

Which brings me back to a fundamental premise of the volume: the importance of path dependence in understanding the relationship between government and business. The notion that economic processes can be path-dependent has been around for some time, and few people question it in its most basic form. My bedroom is indeed a bit too far from my bathroom (especially late at night) because of some dunderheaded decision made by some builder decades ago. But really, it is no big deal, which is why I never do anything about it. However, the more difficult question of whether economic agents or indeed, entire economies, can get locked into significantly less efficient paths because of network externalities or whatever, remains controversial, in part because it has proven difficult to document convincingly. There is much in this volume that is suggestive of institutional path dependence, but much less that is going to convince a serious skeptic. In my view, the main difficulty is that there is insufficient specific detail to lead us to conclude with confidence that path dependence is really what was going on. In part, this is due to the volume’s very long-term perspective, which clearly shows the forest, but makes it hard to make out the trees. Perhaps the vehicle of an edited volume treating various policies concerning assorted industries is not quite right. Instead, a study of a single industry, or a single set of policies, over a long time period might enable us to see both the broad currents and enough of the details at key junctures to feel more comfortable concluding that yes indeed, the historical experience exhibited path dependence.

This reservation notwithstanding, The State, Regulation and the Economy is an excellent volume which I very much enjoyed reading. It is a productive collaboration of practitioners of different disciplines, and provides much useful information and interpretation of the long-term regulatory experiences of two quite different economies. The editors are to be commended for attempting to fill an important gap in the literature on comparative institutional change. I will look forward to other studies that fill in more of the details of these regulatory experiences, in ways that shed additional light on the presence of path dependence.

Mark Kanazawa is the author (with Roger G. Noll) of “The Origins of State Railroad Regulation: The Illinois Constitution of 1870,” in Claudia Goldin and Gary Libecap, editors, The Regulated Economy, Chicago: University of Chicago Press, 1994.