Free Bootleggers & Baptists: How Economic Forces and Moral Persuasion Interact to Shape Regulatory Politics by Adam Smith Page A

first and oldest theory of regulation—so old it has no clear inventor—is the public interest theory. This theory holds that when they take office, politicians and their appointees also take on a new life, putting aside their personal interests to serve the common good. Once ensconced in Washington, representatives lie awake at night trying to find better ways to provide broadly appreciated public benefits, their thoughts unsullied by any narrower interests.
    Whether the problem to be addressed is pollution, unhealthy working conditions, or teenage smoking, a public interest legislator seeks to achieve as much improvement as possible given realistic budget constraints. He is constantly searching for lower-cost ways of achieving public interest goals. The legislator works to build institutions that strengthen (and in some cases repair) beneficial market forces so that markets will be robust. The public interest theory recognizes that politicians are, alas, human—meaning errors and even deliberate acts of chicanery will occur. But these failings are the exception, not the rule.
    English economist Arthur Cecil Pigou (1920) is often (mistakenly) seen as the godfather of the public interest theory. Pigou famously argued that governments could take steps to correct all kinds of problems that plague unregulated private markets. Leaders could address the uncompensated harm done when sparks from railway engines set woods aflame, when land management practices caused rabbits to invade neighboring property, or even when construction practices tended “to spoil the lighting of the houses opposite.” 3 Pigou worried about automobiles that wore out the surfaces of roads, the sale of intoxicants that then required additional expenditures on law enforcement and prisons, and in his own words “[p]erhaps the crowning illustration of . . . the work done by women in factories . . . for it carries with it, besides the earnings of women themselves, grave injury to the health of their children” (Pigou [1932] 2009, 134, 186–87, 196–203).
    The remedy? Pigou called on enlightened leaders to address these problems by taxing unwanted activity, subsidizing desirable activities that tended to be underproduced, and imposing regulations on producers who disregard the social costs of their behavior. 4
    Now, let’s take a peek at President Lyndon Johnson’s Economic Report of the President (1965 , 135–36), in which we get more than a hint of Pigou and the public interest theory:
    In the vast majority of industries, competition is the most effective means of regulation. But in a few industries, technological and economic factors preclude the presence of more than one or a few firms in each market. When these industries provide an important service to the public, direct control is substituted for competition. The independent federal regulatory commissions were established in the transportation, power, and communications industries because competition could not be expected to protect the public interest. In other areas, regulation is aimed at providing the public with reasonably full knowledge of the market. In particular, securities and certain commodity markets become so complex and technical that regulation is necessary to insure that buyers and sellers have access to accurate and reasonably comprehensive information.
    The statement, prefiguring much of the recent rhetoric aimed at banks by the Consumer Financial Protection Bureau, makes a case for antitrust enforcement as well as regulation of certain consumer markets. Government, in President Johnson’s view, was there to protect and further public interests that would be jeopardized by unchecked private action.
    We see a more detailed expression of market failure and public interest theory in President Johnson’s Economic Report of the President (1966). After describing the emerging problems of air and water pollution, the report claims that “in the case of pollution, however, those