Regulatory capture

Regulatory capture is what happens when regulated industries are able to gain influence over their regulator, so that regulation that ostensibly serves the public interest actually supports the interest of the industry concerned.

Some economists argue that regulatory capture is inevitable, most that it is a significant risk. It occurs because those who are regulated have a high stake in influencing regulation to favour them, whereas those the benefits of regulation are more diffusely spread: consider a typical regulated industries, such as most utilities, where a small number of large firms are regulated to benefit a large number of consumers. Each firm's profits are heavily influenced by regulation, so they will each put a lot of effort into influencing the regulator, whereas few individual consumers will have a sufficiently large stake to expend much effort.

Another advantage that the regulated industry has over consumers, and often over the regulator, is expert knowledge of the industry. This allows the industry to marshal the facts and arguments needed to influence the regulator, far more easily than consumers, and often more easily than regulators.

Conflicts of interest among individuals who run the regulator may also lead to regulatory capture. It is not uncommon for people to move between working for the regulator and working for the industry: for example working for a financial regulator and then in a compliance role in a bank.

Regulated industries may also be able to lobby legislators to restrict the level or form of regulation, or the duties and aims of the regulator. Even where there is no industry regulator as such, most industries are affected by a variety of regulation that they can influence. Once again, focus, funding, expert knowledge, and conflicts of interests enable this.

Regulation may even evolve so as to make things worse for consumers by reducing competition. Minimum capital requirements, licenses to operate, and similar restrictions increase barriers to entry.

From and investor's point of view increased barriers to entry will increase profits, but be aware that this may all ready be reflected in the price. It is most useful for value investors looking for a safe source of profits — what Warren Buffet calls a moat.

Regulator capture may be reversed if failure become apparent, or consumers become active enough: banking after the global financial crisis is a good example of this.

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