Trillion Dollar Economists_How Economists and Their Ideas have Transformed Business

by Robert Litan

  Deregulation as a Business Platform

  If the only outcomes of deregulating the transportation industry were lower prices, I would not have discussed the subject so extensively in this chapter. Rather I have done so because the deregulation of transportation has led to the formation of entirely new firms, while also fundamentally changing the way existing firms do business, or even stay alive. Indeed, it is hard to think how our modern economy would have developed over the past three decades, given the digital and Internet revolutions in particular, had the main transportation industries not been deregulated. In short, just as personal computing and mobile telephone operating systems have been platforms upon which entirely new apps firms were born, transportation deregulation has become one of the most important policy platforms for business in the late twentieth and early twenty-first centuries.

  The key was not lower prices, although that helped. Instead, deregulation took the government out of the details of approving both prices and routes, and in the process turned firms that once offered services to customers on a highly rigid basis into flexible providers. And it was the flexibility created by deregulation—the ability of firms to get their goods from point A to point B using airplanes, trucks, or rail—that revolutionized the economy and the businesses operating within it.

  Renaissance Deregulator, Airline CEO, and Scholar: Michael Levine

  Michael Levine isn’t a card-carrying economist—he never completed a PhD in the subject, but his insights, expressed in his articles and in his work, have had important effects on policy.22 Levine’s contributions to economic scholarship reflect his broad experience in both government and the private sector, as well as academia.

  Levine’s unusual career was not surprising given his choice of undergraduate schools, Reed College, which has produced an eclectic array of interesting people (including Steve Jobs, who spent only a year passing through on his way to history). Levine went on to get his law degree from Yale, after which he spent what he claims was the most important educational year of his life, studying graduate-level economics with Professor Ronald Coase at the University of Chicago (a Nobel Prize-winning economist profiled in Chapter 11). Levine was especially taken with Coase’s approach to economics, which was (and still is) rare in the field: to use logic or reason alone, without mathematics or empirical evidence.

  Levine did not follow precisely the same course, however. In 1965, he penned what would turn out to be a highly influential article in the Yale Law Journal documenting how much lower intrastate airfares were than fares on interstate routes of comparable distances. This finding, which later became a major part of the intellectual case against continued airline regulation, also helped bring Levine to Fred Kahn’s attention. When Kahn was selected for the CAB chairmanship, he asked Levine to direct the agency’s domestic and international air divisions, one of the agency’s top staff jobs.

  After the CAB, in the 1980s, Levine turned to the private sector, taking senior executive positions at a number of airlines, including a stint as president at New York Air. It was during these assignments that Levine pioneered the development of the yield management pricing strategies discussed in Chapter 3.

  After his private-sector experiences, Levine returned to academia, establishing an interdisciplinary law and economics program at the University of Southern California’s Law School and the California Institute of Technology. He later held posts at other leading universities and from 1988 to 1992 was dean of Yale’s School of Organization and Management. At this writing Levine is a research professor at New York University’s Law School.

  With all modes of transportation deregulated, shippers could pit the various modes against each other for long-haul traffic. For short-distance traffic, where trucks were dominant, the multiplicity of firms offered much competition. The result is what we have today, which was not the norm during the age of regulation: Any individual or company can call or make arrangements for transportation anywhere in the United States, obtain multiple quotes and shipping times, and then make a decision about who to engage and at what price.

  This total freedom of movement has been the lifeblood of both existing and new businesses in the age of the Internet, and even before. In the 1980s when Japanese manufacturing techniques seemed to threaten the viability of many American firms, one of the Japanese practices most singled out for praise (and worry) was just in time (JIT) delivery. Used heavily by Japanese auto companies, JIT cut down on the need for large inventories of parts, and relied on systems of tracking sales and production so that parts could be ordered just as they were needed, with time allowed for transporting them from their sources to the production line. With few or no spare parts hanging around, the companies didn’t need to spend cash to build stockpiles of parts to insert into the production line, but rather could rely on the parts being there as needed. To be sure, JIT systems were vulnerable to disruption (as the nuclear disaster at Fukushima in Japan proved in 2011) but, on the whole, they proved so successful that they were eventually adopted by U.S. manufacturing firms of all kinds. One of the early proponents was Michael Dell, who formed Dell Computer by using JIT to assemble the component parts of personal computers once they were ordered (that Dell later ran into trouble because PCs were being displaced by tablet devices in no way contradicts the importance of JIT, since tablet manufacturers also use JIT, as do many other manufacturers).

  Now ask yourselves: Could JIT exist in a world where air, rail, and truck routes were tightly regulated? The question almost answers itself: of course not. If there is one word one associates with JIT it is flexibility, and no company relying on JIT to deliver parts and goods exactly when they are needed could compete successfully if it had to rely on transportation modes that were tightly controlled by an elaborate system of government approvals.

  The other major force that has dramatically affected the U.S. economy over the past two decades, of course, is the Internet, and the rapid growth of web retailing. One company, Amazon, symbolizes the power of this phenomenon, but it is hardly the only one. Today, no retailing enterprise of any size can survive without an Internet presence, although the amount of “e-tailing” by conventional bricks-and-mortar companies has not picked up as rapidly as many may have thought.23

  But just as there is a massive physical infrastructure that makes virtual reality possible on the jumble of wires, cables, and switches that constitute the Internet—there is a massive transportation network that enables Internet retailers of all kinds to deliver the goods that customers buy through third-party shippers, such as UPS or Federal Express. That is possible because these transportation networks can pick up ordered items virtually at any place, at any time, without the need to gain advance approval from a regulatory agency, as would have been the case before deregulation. Indeed, the only way companies like Amazon could have launched in a regulated era and promised multiple delivery options (other than the U.S. mail service) would have been to own their own transportation systems—trucks and planes—at the outset, something that few or any startups could have funded.

  The Bottom Line

  One huge irony is that the age of Internet commerce, seemingly untethered from the physical world, would never have developed as rapidly as it did without the fundamental policy reforms that transformed the physical transportation world in the late 1970s and early 1980s. Think about it: a world with far fewer retailers selling goods on the Internet than is the case now. Modern readers probably can’t imagine it—and a major reason is that a lot of transportation economists established that it was the right thing to do decades before the deregulation reforms were adopted.

  Likewise, modern manufacturing would not be what it is today without JIT. But JIT would also not have been possible had the transportation industry been as tightly regulated as it was before 1980.

  The importance of deregulation of transportation, in short, is easy to overlook. Hopefully, this chapter brings to life the extraordinary contributions of economists who helped make
this policy change a reality.

  Notes

  1. Clifford Winston, “On the Performance of the U.S. Transportation System: Caution Ahead,” Journal of Economic Literature LI, no. 3 (September 2013).

  2. Ibid.

  3. See W. F. Bailey, The Story of the First Trans-Continental Railroad—Its Projection, Construction, and History (Minneapolis, Minnesota: Fili-Quarian Classics); Stephen Ambrose, Nothing Like It in the World (New York: Simon & Schuster, 2001).

  4. Elizabeth E. Bailey, “Air Transportation Deregulation,” in Better Living through Economics, ed. John J. Siegfried (Cambridge, MA: Harvard University Press, 2012).

  5. Michael E. Levine, “Is Regulation Necessary? California Air Transportation and National Regulatory Policy,” Yale Law Journal 74, no. 8 (July 1965): 1416–1447, and William A. Jordan, Airline Regulation in America: Effects and Imperfections (Baltimore: Johns Hopkins Press, 1970).

  6. Richard E. Caves, Air Transport and Its Regulators. An Industry Study (Cambridge, MA: Harvard University Press, 1962).

  7. George W. Douglas and James Clifford Miller, Economic Regulation of Domestic Air Transport; Theory and Policy (Washington, DC: Brookings Institution, 1974).

  8. Much of the material in this section is based on an interview I had with Justice Breyer, October 17, 2013. See also Stephen Breyer, Regulation and Its Reform (Cambridge, MA: Harvard University Press, 1982).

  9. U.S. Senate Committee on the Judiciary, Subcommittee on Administrative Practice and Procedure (1975), Civil Aeronautics Board: Practices and Procedures, 94th Congress, 1st Session.

  10. Bailey, “Air Transportation Deregulation,” 193.

  11. This history is based largely on the author’s personal knowledge of Kahn’s background, but also on Thomas K. McCraw, Prophets of Regulation: Charles Francis Adams, Louis D. Brandeis, James M. Landis, Alfred E. Kahn (Cambridge, MA: Belknap of Harvard University Press, 1984).

  12. Interview with Elizabeth Bailey, July 19, 2013.

  13. This history of trucking regulation and subsequent deregulation draws heavily on perhaps the definitive book on the subject, Dorothy L. Robyn, Braking the Special Interests: Trucking Deregulation and the Politics of Policy Reform (Chicago: University of Chicago Press, 1987).

  14. Interview with Darius Gaskins, July 7, 2013.

  15. Winston, “On the Performance of the U.S. Transportation System,” summarizes the various studies. See also sources in endnote 4 for economic benefits from airline deregulation alone.

  16. Capital Group LLC, “Industry Note: Public Policy Success but Financial Failure,” December 12, 2012 (brokerage research report provided to the author by Justice Stephen Breyer).

  17. See Winston, “On the Performance of the U.S. Transportation System”; Bailey, “Air Transportation Deregulation.”

  18. For an excellent description of the new flying experience, with all its warts, see Bill Saporito, “Cabin Pressure,” Time, September 9, 2013, 38–41.

  19. See, e.g., Diane S. Owen, Deregulation in the Trucking Industry (Washington, DC: Bureau of Economics, Federal Trade Commission, 1998); Thomas Moore, “Rail and Trucking Deregulation,” in Regulatory Reform: What Actually Happened, ed. Leonard W. Weiss and Michael W. Klass (Boston: Little, Brown, 1986); Clifford Winston, “U.S. Industry Adjustment to Economic Deregulation,” Journal of Economic Perspectives 12, no. 3 (1998); Clifford Winston and Stephen Morrison, “Regulatory Reform of U.S. Intercity Transportation,” in Essays in Transportation Economics and Policy: A Handbook in Honor of John R. Meyer (Washington, DC: Brookings Institution, 1999).

  20. Jayetta Z. Hecker, “Freight Railroads: Updated Information on Rates and Competition Issues,” Government Accountability Office, www.gao.gov/cgi-bin/getrpt?GAO-07-1245T.

  21. Association of American Railroads, “The Impact of the Staggers Rail Act of 1980,” www.aar.org/keyissues/Documents/Background-Papers/Impact%20of%20the%20Staggers%20Act%20April%202013.pdf.

  22. Telephone interview with Michael Levine, June 26, 2013.

  23. Shelly Banjo and Paul Ziobro, “After Decades of Toil, Web Sales Remain Small for Many Retailers,” Wall Street Journal, August 27, 2013. http://online.wsj.com/article/SB10001424127887324906304579039101568397122.html.

  Chapter 10

  Economists and the Oil and Gas Revolution

  Modern economies wouldn’t be modern without the availability of various forms of energy—electricity, gasoline, diesel fuel, and natural gas. Except for the blending of gasoline with supplements like ethanol, the entire automotive and trucking transportation sector depends on crude oil. Natural gas, meanwhile, once thought to be a low-value fuel and confined to some manufacturing uses and fuel for running electric generators in peak periods, has become the hottest source of energy because it is turning out to be plentiful and is much cleaner to burn than oil or coal.

  Even as late as the beginning of the Great Recession and in the early years of the recovery, however, there was deep pessimism among policy makers and the public about the prospect of continued dependence on foreign oil, especially from countries with less than friendly relations with the United States. This pessimism now seems like ancient history. In a few short years, the combination of hydraulic fracturing (fracking) and horizontal drilling has unleashed a massive increase in oil and gas production, by unlocking these fuels from shale formations throughout the continental United States. As a result, the dependence of the United States on foreign oil has dropped sharply and is widely projected to continue declining. Likewise, the price of natural gas, which is set more in domestic than global markets because it is less transportable, has also declined (though like the prices for other commodities, it also continues to fluctuate).

  This chapter tells the story of how both oil and natural gas—essential to running a modern economy—came to be regulated and then deregulated, the latter consistent with a long line of advice from many economists. I’m not making the claim that the turnaround in U.S. energy markets is due solely to the economists—clearly, the development and use of new technologies, coupled with a revival of the entrepreneurial spirit in this sector, is mostly responsible. But I am making a modest claim that this turnaround would not have occurred had the prices of oil and gas been regulated during the past two decades, and some, if not much, of the credit for that goes to economists.

  I also trace here how the oil and natural gas supply revolutions have affected virtually the entire economy. In this way, the energy revolution, enabled in significant part by sound economic advice, represents another policy-platform technology. Like the deregulation initiatives discussed in the previous chapter, an unregulated energy market has facilitated more rapid growth for existing businesses and contributed to the formation of some new firms.

  The Origins and Decline of Price Regulation of Fossil Fuels

  The stories of how the prices of oil and gas came to be regulated and then deregulated are very different, but they ended up at the same, right place.

  The Oil Story

  The regulation of crude oil prices came relatively late compared to natural gas. Apart from the four years of World War II when oil and virtually everything else was subject to price controls, crude oil prices were largely unregulated (except in Texas, where state authorities limited production in an effort to stabilize prices). This was true until the quadrupling of world oil prices caused by the Arab oil embargo of 1973–1974 prompted the Nixon and then Ford Administrations to limit the prices of “old” domestic oil (oil discovered before the embargo), while allowing newly discovered oil to be bought at world prices. As will become evident in the history of natural gas price regulation below, this split between old and new oil struck a compromise to keep a lid on most oil production in order to contain inflation while preserving incentives for producers to look for new oil.1

  The problem is that once the government interferes with the pricing mechanism of the market, there is no telling how things will turn out—much like what happens when taking a loose thread out of a sweater only to discover
that the sweater itself starts to become unraveled. A similar process happened with crude oil price controls.

  Consider the following series of events. First, the cap on old oil, at about $3 per barrel, encouraged owners of existing wells to cut back production, which meant a cutback in fuels derived from crude oil. Shortages, manifested in long lines of angry motorists at gas stations, were the inevitable result. Second, government officials responded to this problem by introducing a system of odd–even rationing, so that drivers could only fill up on days on which the last digit on their license plates were odd or even (matching the day).

  What is surprising, at least to this author, is that this complicated system of price controls and rationing was introduced and maintained by two successive Republican administrations, or those that ordinarily one would assume never to have the government interfere with the market, at least when it comes to setting or limiting prices. Reportedly, Nixon’s chief economist, Herbert Stein, opposed both the general wage and price controls of 1971 and the oil price controls adopted after 1973, to no avail. Even a Republican administration turned out to be more fearful of both inflation and consumer anger at higher gas prices at the pump than they were of consumers upset by rationing. Roughly three decades later, it was another Republican administration, this one led by President George W. Bush, which abandoned free market principles again to rescue the banking system in order to avert a worse calamity. These episodes illustrate that crises cross partisan lines; they make it hard to stick with rules meant for more quiescent times.