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CHAPTER 8
Government Regulation of Business
Chapter Goals
The start of this chapter is a good opportunity to remind students of the intersection between the market,
ethics, and the law. The relationship between those forces remains cloudy in student minds. Certainly
some of the reasons for turning to the law (e.g., Market Failure, see p. 332) to regulate business are only
dimly perceived. After the discussion of market failures, the text talks about the constitutional
underpinnings of federal and state regulation; and then takes a closer look at regulation of interstate and
intrastate commerce. Part III begins with an introduction to administrative agencies, along with a highly
condensed look at the law governing those agencies. Students should acquire a sense of the immense
influence of agency activity in one’s personal and business lives. On the other hand, a detailed inspection
of administrative law would likely not be the best use of scarce class time. Finally, the debate over the
wisdom of deregulation is presented. The instructor here has the opportunity to bring to class a variety of
emotionally charged and intellectually stimulating issues from the “real world.”
Chapter Learning Objectives
After completing this chapter, students will be able to:
1. Describe the concept of market failure.
2. Explain some of the considerations involved in deciding to impose government regulations on
business practice.
3. Explain the roles of the police power, the Supremacy Clause, the preemption doctrine, and the
Commerce Clause in regulating business practice.
4. Explain when the federal government has exceeded its authority in regulating commerce.
5. Describe some of the ways in which state and local regulation affects business practice.
6. List some of the federal agencies that regulate business practice.
7. Identify the three broad categories of federal regulatory agencies’ authority.
8. Compare and contrast the federal agencies’ executive, legislative, and judicial roles.
9. Describe the executive, congressional, and judicial controls placed on agency conduct to maintain
appropriate “checks and balances.”
10. Analyze the Federal Communications Commission (FCC) role in regulating indecency in
broadcasting.
11. Evaluate criticisms of the federal regulatory process.
Chapter Outline
Part One—An Introduction
Practicing Ethics: Regulate Video Games?
Even though video games are subject to an industrywide rating system, a number of states have also
legislated restrictions on minors’ access to violent video games. California, for example, approved a 2005
law forbidding the sale or rental of violent video games to minors. The video game industry sued to block
the law; that challenge reached the U.S. Supreme Court in 2011 where the California law was struck
down as a violation of free speech rights. The Court ruled that the statute was a content based restraint
on speech requiring California to establish a compelling reason for the law; a standard the state could not
satisfy.
Video Game Addiction?
A 2009 Iowa State University study found that almost one in ten American children, ages 8 to 18 are
addicted to video games (the study was not limited to games) in much the way some people are addicted
to drugs or gambling. And a 2013 Iowa State University study of 227 juvenile offenders in Pennsylvania
found a strong association between violent video game use and juvenile violence and delinquency.
I. How Much Government?
The alleged link between video game use and social problems, including violence, is one relatively small
example of an enormous array of disputes about the optimal balance between unconstrained business
practice and government intervention in the market.
II. Why Regulation?
A. Market Failure
In theory, government intervention is necessary in a free enterprise economy would be justified only
when the market is unable to serve the public interest—that is, in instances of market failure. Market
failure is attributed to certain imperfections in the market itself.
Imperfect Information
An efficient free market presumes reasoned decisions about production and consumption.
Reasoned decisions require adequate information. Because one cannot have perfect information
and often will not have adequate information, the government, it is argued, may impose regulations
either to improve the available information or to diminish the unfavorable effect of inadequate
information.
A new line of research suggests that decision making among male financial traders is significantly
influenced by testosterone levels. Also, while the free market system assumes rationale decision
making, people might more accurately recognize that they operate with limited or bounded
rationality. Hence, government intervention might be appropriate.
Monopoly
The government intervenes to thwart anticompetitive behaviors throughout the marketplace. The
primary concern in this area was how to deal with the so-called natural monopoly where a single
large firm, such as a utility, was more efficient (a natural monopoly) than several small ones.
Externalities
When all the costs and benefits of a good or service are not fully internalized or absorbed by
producers or consumers, those costs or benefits fall elsewhere as what economists have labeled
externalities, neighborhood effects, or spillovers. Pollution is a characteristic example of a negative
externality. The environment is used without charge as an ingredient in the production process
(commonly as a receptacle for waste). Positive externalities are those in which a decision maker
does not receive the full benefit of a decision because a portion of those benefits “spill over” on to
third parties (often society at large) who were not direct participants in the decision.
Public Goods
Some goods and services cannot be provided through the pricing system because there is no
method for excluding those who choose not to pay. For such public goods, the added cost of
benefiting one person is zero or nearly so, and, in any case, no one can effectively be denied the
benefits of the activity.
B. Regulatory Life Cycle?
Looking at the historical record, law school dean Joseph Tomain argued that a rather predictable
pattern or life cycle typically emerges when the government decides to regulate an industry. Stage
One in Tomain’s life cycle is the free market itself. In Stage Two, a market failure is identified. In Stage
Three, government regulation is imposed in the form of a rule. In Stage Four, regulatory failure occurs.
In Stage Five, the government may respond with regulatory reform to correct the failure, or it may
move to Stage Six, where the regulation in question is simply eliminated. The market, thus fully
deregulated, has returned to Stage One (the free market) and the regulatory life cycle is complete.
Steroids
The steroid scandal in baseball allegedly involving Roger Clemens, Barry Bonds, Jason Giambi, and
other major league stars led the The Des Moines Register to argue for the value of regulation. The
owners and players in big-league baseball resisted any regulation of performance-enhancing
chemicals in their business.
C. Philosophy and Politics
Correction of market failure arguably explains the full range of government regulation of business, but
an alternative or perhaps supplemental explanations lies in the political process. Three general
arguments have emerged.
One view is that regulation is necessary for the protection and general welfare of the general
public.
Another view is that regulation is developed at the request of industry and is operated primarily
for the benefit of industry.
Finally bureaucrats who perform government regulation are themselves a powerful force in
maintaining and expanding that regulation.
Bring Back Danger?
Brothers Conn and Hal Iggulden wrote The Dangerous Book for Boys as a manual of activities for
boys. Their book describes how to make a bow and arrow, hunt and cook a rabbit, build a tree house,
set a trip wire, and so on. They believe that the “safety culture” has gone a bit too far. They point to
that bygone era when every boy had a jackknife. They believe that taking risks is important to a boy’s
joy and maturation.
II. The Constitutional Foundation of Business Regulation
The Commerce Clause of the U.S. Constitution broadly specifies the power accorded to the federal
government to regulate business activity. Article I, Section 8 of the Constitution provides that: “The
Congress shall have the power … to regulate Commerce with foreign Nations, and among the several
States, and with the Indian Tribes.” State authority to regulate commerce resides in the police power
specified by the Constitution. Police power refers to the right of the state governments to promote the
public health, safety, morals, and general welfare by regulating persons and property within each state’s
jurisdiction.
A. Commerce Clause Examined
The Commerce Clause, as interpreted by the judiciary, affords Congress exclusive jurisdiction over
foreign commerce. State and localities, nevertheless, sometimes seek in various ways to regulate
foreign commerce. Such efforts are unconstitutional violations of the Commerce Clause and thus are
unenforceable.
Federal authority over “commerce among the several states,” that is, interstate commerce, affords the
federal government very broad power to regulate commercial activities across the United States and
was designed to create an open, effectively borderless market throughout the nation, wherein goods
would move freely among the states, unimpeded by state and local tariffs and duties. As with foreign
commerce, the states and localities pass laws to influence interstate commerce, often to favor local
economic interests. The judiciary has aggressively curbed those efforts, and in the process, the reach
of the federal government has been dramatically expanded. Even purely intrastate activities can be
regulated by federal government if they have a substantial effect on interstate commerce.
In 2005, the Supreme Court affirmed the Wickard reasoning in an interesting California case,
Gonzalez v. Raich, involving the federal government’s constitutional authority to regulate the use of
medical marijuana. Personal consumption of marijuana, even for medical purposes, has the potential
to displace demand for marijuana in the illegal interstate market thus substantially affecting interstate
commerce.
B. Too Much Federal Power?
Perhaps seeking to demonstrate that the Constitution does not accord unlimited power to the federal
government, the Supreme Court in recent years has issued two particularly noteworthy Commerce
Clause decisions. In the 1995 United States v. Lopez case, the Supreme Court clearly spoke for
states’ rights. The court held that the possession of a gun at a school is not an economic activity that
could, even if repeated elsewhere, have a substantial effect on interstate commerce.
Obamacare
In June 2012, the U.S. Supreme Court, by a 5–4 vote, upheld the constitutionality of the Affordable
Care Act (Obamacare), but the decision raised further doubts about the federal government’s
Commerce Clause power. The core of the Supreme Court review involved what is called the
“individual mandate.” The mandate was challenged and the Court, by a 5–4 margin, ruled that the
individual mandate was, indeed, a violation of the Commerce Clause. However, the Court once
again by a 5–4 margin, ultimately upheld the constitutionality of the individual mandate on the
grounds that it constituted a tax on those who do not have health insurance. The Court ruled that
Obamacare’s individual mandate is constitutionally permissible.
Our Guns: Feds Must Stay Out?
Gary Marbut of Missoula, Montana wants to produce and sell the guns exclusively in Montana from
materials originating in Montana. He has also drafted and promoted the Montana Firearms
Freedom Act, which has been adopted in Montana and which provides, generally, that Montana
guns cannot be subject to federal regulation if made and sold only on an intrastate basis. Gary
recently brought suit seeking a court order affirming the right in Montana to manufacture and sell
guns free of federal regulation.
Legal Briefcase: Heart of Atlanta Motel v. United States, 379 U.S. 241 (1964)
C. Supremacy Clause
Sometimes state law or local law conflicts with federal law. Such situations are resolved by the
Supremacy Clause of the Constitution (Article VI, paragraph 2), which provides that: “This
Constitution and the Laws of the United States … shall be the Supreme Law of the Land.” In the
event of an irreconcilable conflict between federal and state law, the Supremacy Clause, as
interpreted by the courts, provides that federal law will preempt (supersede) state or local law
rendering it unconstitutional.
Nullification
A number of states have passed or are considering laws to at least partially nullify (render void and
inoperative) federal laws they believe to be unconstitutional extensions of federal power. Although
states do have some power to resist federal laws, most constitutional law authorities and the
relevant Supreme Court decisions.
Part Two—State and Local Regulation of Interstate Commerce
The Commerce Clause accords the federal government broad authority over commerce. The federal
government has exclusive authority over foreign commerce. The confusion arises in the middle ground of
interstate where regulation by the federal government or state government or both may be permissible.
The issue with commerce that is clearly interstate in nature but is, nonetheless, subjected to state and/or
local regulation is that regulation is unconstitutional because it (1) discriminates against interstate
commerce or (2) unduly burdens interstate commerce such that the burden imposed clearly exceeds the
local benefits.
Legal Briefcase: Granholm v. Heald 544 U.S. 460 (2005)
I. Summary of State and Local Regulation
The federal government receives greater attention, but state and local rules have an enormous impact on
business practice. The states are primarily responsible for regulating the insurance industry and are
heavily involved in regulating banking, securities, and liquor sales. All states have some form of public
service commission charged with regulating utilities in the public interest. Many states seek to directly
enhance competition via antitrust legislation. Many states have passed laws forbidding usury, false
advertising, stock fraud, and other practices harmful to the consumer.
Big Soda Ban
Inspired by then-mayor Michael Bloomberg, the New York City Board of Health in 2012 approved a ban
on the sale of sugary drinks in containers over 16 ounces in restaurants, stadiums, theaters, and other
establishments regulated by the city health department. The contentious soda ban was struck down by a
local state court judge in 2013, determining the rule wasn’t founded in fact and was riddled with loopholes
and exceptions making it unlawfully “arbitrary and capricious.”
Licensure
Local regulation is much less economically significant than state regulation. Local government
intervention in business typically involves various licensure requirements. Licensure is to protect
the public from unsafe, unhealthful, and substandard goods and services, but critics contend
that licensure is often designed to block the entry of competitors and that the benefits of
licensure are exceeded by its costs in increased prices, decreased services, and administrative
overhead.
Cabs Need Rules
New Orleans recently imposed new rules on all taxi cabs used to pick up passengers at Louis
Armstrong International Airport. The rules require, among other things, credit card machines in
the cabs, GPS devices, security cameras, working air conditioners, working meters, and drivers
who speak English. Legal challenges to the new rules have been unsuccessful, as of this
writing.
Rules and Community Welfare
Many say that they need less government in their lives, but when they are the victims of
problems the market is ill-suited to resolve, those rules become much more attractive.
Legal Briefcase: Voyeur Dorm v. City of Tampa (11th Cir. 2001); cert. den. 122 S. Ct. 1172
(2002)
Part Three—Administrative Agencies and the Regulatory Process
I. Introduction to Administrative Agencies
Suppose an individual start a business: a small, relatively simple business, perhaps a restaurant. One
would quickly come to realize that the government is going to be the individual’s partner in that business.
Taxes, wages, hours, sanitation, safety, advertising, zoning—at every turn a government rule shapes the
conduct of the business. In many case those rules are created and enforced by administrative agencies, a
powerful subset of government little understood by the public but immensely influential in every corner of
American life.
II. The Federal Agencies
Federal law defines an agency as any government unit other than the legislature and the courts. Thus,
the administrative law governing those agencies technically addresses the entire executive branch of
government.
A. History
Congress established the Interstate Commerce Commission (ICC), the first federal regulatory agency
in 1887 for the purpose of regulating railroad routes and rates. The next major burst of regulatory
activity arrived in the 1960s and 1970s when Congress created such agencies as the Equal
Employment Opportunity Commission (EEOC—1965), the Environmental Protection Agency (EPA—
1970), the Occupational Safety and Health Administration (OSHA—1970), and the Consumer Product
Safety Commission (CPSC—1972). The free market enthusiasm of the 1980s resulted in strenuous
efforts to deregulate the economy and reduce the influence of the federal agencies and the
government generally.
B. Creating the Agencies
Federal agencies are of two kinds: executive and independent. Executive agencies usually are located
within the departments of the executive branch of the government. Congress created those agencies
via statutes labelled enabling legislation accorded them substantial authority to regulate a specified
segment of American life.
In creating an agency Congress delegates a portion of its authority to that body. The president,
ordinarily with the advice and consent of the Senate, appoints the administrator or the several
commissioners who direct each agency’s affairs. Commissioners are appointed in staggered terms. In
effect, Congress has created a fourth branch of government.
C. Agency Duties
The authority of the federal regulatory agencies fall broadly into three categories:
Control of supply—some agencies control entry into certain economic activities. The Federal
Communications Commission grants radio and television licenses.
Control of rates—those federal agencies charged with regulating utilities and carriers (Federal
Energy Regulatory Commission, ICC, and CAB) set the prices to be charged for the services
offered within their jurisdictions.
Control of conduct
oInformation—agencies commonly compel companies to disclose consumer information
that would otherwise remain private.
oStandards—where simply requiring information is deemed inadequate for the public
needs, the government may establish minimum standards that the private sector must
meet.
oProducts banishments—in rare circumstances, products can be banned from the market.
III. Operating the Agencies
Agency action is guided generally by the 1946 Administrative Procedure Act (APA), which Congress
enacted to provide a framework for agency rule-making and to detail broad standards for judicial review of
agency decisions.
A. Executive Functions
The basic executive duty of the various agencies is to implement the policy provided for in the
enabling legislation agencies’ own rules and regulations. The agency activity consists of performing
mundane repetitive activities. Agencies enter into contracts, lease federal lands, register securities
offerings, award grants, resolve tax disputes, settle workers’ compensation claims, administer
government benefits to the citizenry, and so on.
