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Regulatory Capture

Updated on April 17, 2024
Article byPrakhar Gajendrakar
Reviewed byDheeraj Vaidya, CFA, FRM

Regulatory Capture Definition

Regulatory capture refers to a theory that explains the phenomenon of a regulatory agency vested with the liability to oversee a specific industry or domain getting influenced or directed by the special interest groups in that industry or domain.

The negative phenomenon of regulatory agencies’ bias toward interest groups detrimental to society is also known as the economic theory of regulation or capture theory. When special interest groups or monopolies manipulate the regulatory agencies instead of accepting and functioning under their rulings, corruption will spread in society.

Key Takeaways

  • Regulatory capture review points to regulatory agencies responsible for supervising specific markets, industries, or domains getting influenced or directed by the special interest groups in the industries or domains.
  • American economist George Joseph Stigler is one of the main contributors to the theory.
  • Examples include big tech giants spending millions to influence the government through funding academic research.
  • Government can prevent it by analyzing the regulations, removing unnecessary regulations, and evaluating regulatory bodies’ activities using watchdog services.

Regulatory Capture Theory Explained

The regulatory capture concept was popularized by the American economist George Joseph Stigler by developing the Economic Theory of Regulation (1971). It describes an example of private entity influence in public regulation. It occurs when the independent regulatory agencies develop a leaning toward their clients’ views and interests.

Regulatory Capture Theory Explained

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The impact of regulatory capture can cause barriers to the entry of new innovative start-ups. Regulations and regulatory bodies are sometimes boons to big firms or the incumbents of a regulated market and complex for new entrants or start-ups. The big firms or the rent-seekers already maintain successful existing business models complying with regulations. It is easy for rent-seekers to lobby against the new entrants by advocating for reasons like public safety and lack of quality reasons.

Another important situation associated with this is the revolving door phenomenon. In which the professionals revolve around becoming regulators and joining the big companies they were assigned with the responsibility to regulate in the past. The big companies offer high salaries to attract the regulators.

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Example

The costs of complying with laws may be handled far more readily by large corporations than by small businesses. They are powerful and embrace government regulation and lawsuits to keep new competitors who could challenge their business models at bay.

In 2017, Amazon, Apple, Facebook, and Google spent nearly $50 million to influence the United States government. Then, on July 14, 2017, The Wall Street Journal released an astounding revelation on a confidential academic influence-peddling attempt by Google to shape government policy to suit its corporate demands. For instance, Google has contributed to funding hundreds of research articles to protect its market dominance against regulatory constraints.

According to federal records, Amazon lobbied more government entities than any other tech giant in 2018. One of Amazon’s top aims is persuading government agencies to use Amazon’s massive cloud computing capabilities rather than their own. Following it, Amazon participates in the bid for the work via the federal procurement process.

How to Prevent Regulatory Capture?

To prevent the negative phenomenon, governments can employ diverse methods. The establishment of systems and procedures should be transparent with a fair amount of monitoring. The policymakers should study the costs and benefits of regulation to understand the need for regulations and regulatory bodies. Furthermore, utilizing periodic service of watchdog groups is another effective prevention method.

One of the examples of using a watchdog service is the utilization of the GAO service. In the U.S., Government Accountability Office (GAO) is a federal watchdog agency providing fact-based, nonpartisan information to Congress. The supreme audit institution of the federal government investigates federal spending and performance.

The GAO’s investigative work focuses on how public funds are used, the U.S. housing finance system’s structure, and the federal government’s ongoing conservatorship of Fannie Mae and Freddie Mac. Present examination report on whether the Federal Reserve’s role in payments systems presents a conflict of interest, how the Office of Financial Research uses its resources, how the government has used fines collected from banks related to the mortgage crisis, and an investigation into the SEC’s personnel management practices. The GAO has expanded an investigation into whether the Federal Reserve has been too soft on Wall Street banks.

Frequently Asked Questions (FAQs)

What is meant by the term regulatory capture?

Regulatory agencies are designed to protect the public interest and prevent falling into crises. However, the capture phase occurs when regulatory agencies favor the special interest group instead of acting impartial. Subsequently, powerful interest groups will dominate the regulators.

What is an example of regulatory capture?

Amazon, Apple, Facebook, and Google are just a few examples of companies that have spent millions influencing the government. In 2017, the Wall Street Journal revealed a confidential academic influence-peddling attempt by Google to modify government policy to fit its business objectives. In 2018, Amazon lobbied more government entities than any other tech business, according to federal records.

Why is regulatory capture illegal?

It is illegal because it involves corruption and activities against the public interest. The regulatory officials act according to the decisions of interest groups or the dominant players in the industry. Corruptive regulatory processes in the financial market can even lead to a financial crisis in the country.

This has been a Guide to Regulatory Capture and its definition. We explain regulatory capture using its review, examples, and why it is illegal. You can learn more from the following articles – 

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