The Interest

The bright face of market design is the engineer choosing the rules to make a market work — clearing the medical match, ordering the spectrum, saving the dying. But the engineer's premise, that the rules are chosen, cuts both ways. If the rules of a market are chosen, then the choosing is itself a process with its own logic and its own beneficiaries; and the author places at the center of this volume the question the bright examples postpone: not how a market should be designed, but who designs it, and in whose interest. The rules of real markets are not, for the most part, written by disinterested engineers. They are written by legislatures and regulators, lobbied by the firms they govern, contested by the groups they affect — and the rules that emerge bear the marks of that contest. To understand the design of markets, one must understand the design of the rules: the political economy of who gets to write them.

The naive view of regulation is that it is imposed on industry by the state in the public interest — a constraint placed on private greed by a guardian acting for the common good. The economic study of regulation began by doubting this, and Sam Peltzman, building on the work of others, gave the doubt its general form. Regulation, in this view, is not a gift bestowed by a disinterested sovereign but a product, supplied by the political system to those who demand it and can pay for it — in the currency politics runs on, which is political support: votes, organization, money, the ability to reward or punish the rule-maker. The rules of a market — who may enter, what they may charge, what they must disclose, whom they must serve — are valuable, for they redistribute wealth among the parties to the market; and what is valuable will be sought, by those it would enrich, from those who can grant it. Regulation is the outcome of this seeking: a thing produced and allocated, like any other, to those who bid most in the political market.¹

Stigler's first statement of this idea held that regulation tends to be captured by the industry it governs — written, in effect, by and for the regulated, who have the most concentrated interest in it. Peltzman's contribution was to generalize: the regulator, he argued, is not simply the agent of the industry but a broker among competing interests, who allocates the benefits of regulation so as to maximize his own political support. The producers want high prices and protection from entry; the consumers want low prices and wide access; and the regulator, needing support from both, does not simply hand the rules to one side but balances them — granting the industry enough to keep it quiet and contributing, while granting consumers enough to keep them from revolting, settling on a design that maximizes the political support flowing to the rule-maker rather than the welfare of any party. This is why regulation so often pleases no one fully and serves the public imperfectly: it is not designed for the public, nor purely for the industry, but for the rule-maker's own political account — a balance struck among those who can repay him, weighted by what each can pay.²

If the regulator balances competing interests, why does regulation so often tilt toward the producers — toward the airlines and the doctors and the banks it is supposed to govern? The answer lies in the asymmetry of the interests, an asymmetry the volume on the commons studied as the logic of collective action. The producers are few, organized, and intensely interested: a rule that raises their prices or bars their rivals is worth a great deal to each of them, enough to justify the cost of lobbying, organizing, and contributing. The consumers are many, unorganized, and diffusely interested: the same rule costs each of them a little, too little to justify the trouble of fighting it, and they face the free-rider problem in organizing against it. So in the political market for rules, the concentrated few outbid the diffuse many — not because the rule-maker is corrupt, but because the few can deliver more political support per unit of stake than the many can. The design of the market tilts toward those who care most per head and can organize to express it; and those are, almost always, the producers, the incumbents, the parties the rules govern. The rules end up written, in large part, for the regulated.³

The marks of this are everywhere in the design of real markets. Occupational licensing that protects incumbents from competition under the banner of consumer safety. Entry restrictions — medallions, certificates of need, franchise grants — that limit the number who may compete. Standards and disclosure rules written to advantage the firms that helped write them. Tariffs and quotas that shield domestic producers from foreign rivals. Each is a rule of the market, ostensibly serving the public, in fact redistributing toward the organized interest that secured it. This is related to, but distinct from, the waste of rent-seeking that the volume on rent examined: there the concern was the resources squandered in the competition to capture a rent; here the concern is the design itself — that the very rules that constitute the market are shaped by the contest for advantage, so that the market's structure, not merely some prize within it, is the spoil. The political economy of regulation is not a story about a few bad rules but about the origin of the rules as such: they come from a process that weights interests by their power to repay the rule-maker, and the market that results is shaped accordingly.⁴

The interest, then, supplies the dark answer to the question the bright examples raised. Markets are designed — but the designers are not, for the most part, disinterested engineers; they are the political system and the interests that work upon it, and the rules they produce are weighted toward those who can best repay the rule-maker, which means, by the asymmetry of organization, the concentrated incumbents the rules govern. The design serves the designers, or those who can pay the designers; and the recurring discovery, as the author has it, is that the rules of the market bear the fingerprints of power. But this is still the middle of the story, not its depth. We have seen that markets are built — the rulebook; that the design shapes the outcome — the auction, the match; and that the design is shaped by interest — the interest. The flagship must now gather these into the capstone of the whole family: the recognition that the market itself, the impersonal market the price families took as the given of economic life, is the most authored of institutions, built by whom and in whose interest, with consequences that reach all the way to the wealth and poverty of nations. The next plate is the flagship: the architect.⁵

The bright engineer is one answer to the question of who designs the market; the political market for rules gives the darker and more common one. Regulation, Peltzman showed, is not a gift from a disinterested sovereign but a product, allocated to those who can best repay the rule-maker in political support; and because the concentrated few can repay more per head than the diffuse many, the rules tilt, more often than not, toward the incumbents they govern. The licensing, the entry barriers, the favorable standards, the tariffs — the very architecture of real markets — bear the marks of the contest to write them. This is the design of markets seen from the side of power: not the engineer improving the world, but the interest shaping the rules to its advantage. The flagship must now bring the volume, and the family, to its conclusion: that the market is built, by whom and in whose interest, and that the answer is the deepest determinant of why some nations prosper and others do not. The next plate is the architect.