Dennis Hammer is a writer and finance nerd with six years of investing experience. He writes about personal finance for Wealthsimple. Dennis also manages his own investment portfolio and has funded several businesses in the past. Dennis holds a Bachelor's degree from the University of Connecticut.
Almost every industry in the western world is regulated in some way. Regulations can control how industries operate, how much they can charge, and what they can sell. Regulations vary in strength, as well. Some make little tweaks to industries. Others make profound changes.
The financial sector is one of the most heavily regulated industries in industrialized countries all over the world. The United States, Canada, and the U.K. (along with the European Union) have thousands of regulations that govern banking, securities, and money.
Sometimes, however, regulations fail to achieve their goals, put excessive strain on an industry, or create unintended consequences. This is when governments need deregulation.
What is Deregulation?
Simply put, deregulation is the removal of regulations. It’s when the government (at any level:federal, state/province, or local) reduces or eliminates regulations it previously put in place.
Governments typically create regulations in three ways: 1) Directly through legislation, 2) Through executive action, or 3) By creating agencies (such as the the Securities and Exchange Commission in the U.S.) and giving them the power to create, modify, and eliminate regulations. Governments deregulate using the same mechanisms, but can also de facto deregulate by declining to enforce regulations.
Regulation supporters admit that regulations can suppress economic activity, but they say that cost is worth what we gain. For instance, forcing banks to keep cash on hand (for account holders to withdraw) limits how much the bank can lend (and thus make money), but it protects people who need access to their money.
Want to take advantage of a deregulated investment climate? Invest as little as a dollar on autopilot with Wealthsimple — take our free risk survey and we'll provide you with a personalized portfolio to suit your needs.
Arguments for Regulations
People in favor of regulations argue that this kind of oversight protects both investors and institutions.
For example, regulations in the United States force public companies to publish financial information each year. This provides investors with accurate and timely information to help them make investment decisions.
If this regulation didn’t exist, companies could mislead investors to get their money, which would ultimately obliterate people’s confidence in public investment. If people don’t trust investing, they won’t bother.
Arguments Against Regulations
People who support deregulation typically claim that regulations overburden businesses. They feel that some regulations create more harm than good, and ultimately stunt economic activity and investment.
For instance, let’s say that a regulation restricts how much interest Acme Bank can charge its borrowers. Complying with the regulation limits how much profit this bank can make. Supporters of deregulation argue that limiting the bank’s ability to earn profit means the bank can’t grow or create more jobs as quickly as it could without the regulation.
Deregulation supporters also argue that no one forces the bank’s customers to take out loans at high interest rates. If people refuse to pay those rates, the bank would be forced to lower them. If people agree to pay those rates, then there’s no foul-play. The market, they say, would self-regulate.
In some cases, regulators grow too cozy with the industries they’re supposed to regulate, and corruptly create regulations that unfairly support existing companies. Deregulation proponents say these kinds of regulations should be stamped out quickly.
What Does Deregulation Mean?
There’s no simple answer here. Since regulations can serve a number of purposes, it’s hard to lay out the effects of deregulation without talking about specific regulations.
For instance, let’s take a regulation that exists to stop companies from consolidating into massive monopolies. If we remove that regulation, there’s a good chance some businesses will consolidate into dangerously large companies. That said, we can’t be sure they’ll consolidate, because other regulations or economic forces may prevent it.
Does deregulation lead to more competitiveness and lower prices? Again, it depends. Some companies could pass their savings on to customers, but there’s no guarantee. It may just end up in the pockets of the company’s managers and shareholders. That’s great news if you own stock, but not so exciting if you’re a customer.
What is Airline Deregulation?
Airline deregulation usually refers to the Airline Deregulation Act of 1978, a piece of legislation in the United States that removed restrictions on the airline industry.
Why was the industry heavily regulated? The industry saw rapid growth and exponential complexity in the 1950s and early 1960s. The government stepped in to ensure passenger safety and stabilize the industry by regulating everything from routes to fares to flight schedules.
In the 70s, however, analysts complained that burdensome regulations created high barriers to entry for new airlines, prevented the government from responding quickly to industry needs, and supported monopolistic practices by existing airlines. It also kept ticket prices high.
The federal government began deregulating the airline industry in the 70s, culminating in the Airline Deregulation Act. The European Union, United Kingdom, Australia, Ireland, and several South and Central American nations deregulated shortly after.
Did airline deregulation work? The effects are a mixed bag. On one hand, prices have declined steadily. It may seem expensive, but it’s actually more affordable than ever (adjusted for inflation) to fly. It’s also far easier for new airlines to get a foothold in the industry.
On the other hand, deregulation didn’t prevent consolidation. In fact, there are fewer airlines than ever in the United States, and thus less market choice.
Bank and Energy Deregulation Explained
There are two other important industries to mention whenever we talk about deregulation: Banking and energy.
Banking regulation has been historically used to limit banks’ autonomy and their ability to take on a lot of risk. Basically, the government doesn’t want banks making too many risky bets with depositors’ money. If a bank lost all of its money, regular people who use that bank for their checking and savings accounts would lose everything.
Banking deregulation typically gives banks more control over how they invest their money and how much cash they have to keep on hand, letting the bank take more risk. U.S. banks were deregulated with the repeal of the Glass-Steagall Act in 1999.
Shortly after, banks invested in risky derivatives, which is largely considered the cause of the 2008 financial crash. Foreign and domestic pressure caused the U.S. to implement the Dodd-Frank Wall Street Reform Act in 2010, a halfway point between Glass-Steagall and no regulation.
Energy deregulation refers to the practice of allowing retail power sellers into the market where public utilities previously had monopolies. In many places of the world, only one energy utility is allowed to sell to a region, which means consumers don’t have any choice. The way these utilities deliver power, how much they can sell it for, etc. is highly regulated.
Many local governments have removed these restrictions to one degree or another over the past few decades, allowing new players into the market. The intent is to introduce competition and lower prices for consumers. Results have been mixed.
Trade stocks commission-freeStart trading