David R. Henderson  

Economies of Scale in Compliance: Auto Industry

The Irony of the Irony of T... 30 Million Non-Poor Americans ...
They [the Department of Transportation and the Environmental Protection Agency] will swoop in with turgid - and then threatening - demands that you sell no cars to the public (no matter how much the public may want those cars) until those cars have complied with every line-item regulation in their repertoire of regulations and codes. Oh, and not just that. Even if by some miracle your new car produces less pollution than a new Prius - even if it is more crashworthy than a new Mercedes S-Class - you will still be required to demonstrate it to their satisfaction. Which if you're not familiar with the way a car company complies with federal ukase involves (for example) destroying dozens of brand-new cars in various types of crash tests to placate Uncle Sam's minions.

And who can afford to destroy a dozen perfectly good brand-new cars? A major automaker can - but not you.

Once you grasp the nature of this symbiotic relationship you will understand why there hasn't been a single successful new car company (outside of politically correct and wholly government-subsidized efforts such as Tesla Motors, producer of the $100k electric Edsel) in decades - and a winnowing of the previously existing herd down to a handful of enormous cartels that are (drum roll, please) "too big too fail."

This is from Eric Peters, "Why the Majors Love Mandates." It's an instance of a more general point that I call "economies of scale in compliance." I wrote about it here and in my Ph.D. dissertation on why large unionized coal mining companies lobbied for the 1966 and 1969 coal mine safety laws.

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COMMENTS (14 to date)
mdb writes:

I work in pharma/biotech and you see this all time. It is why there is no little pharma. A small pharma company's only hope to be successful is to be bought by big pharma. I also worked at consulting firm in years prior to the passage of the new cigarette regs. The firm specialized in FDA regulated environments. Guess who was the biggest client - even though at the time, it was unnecessary? Phillip Morris, they spent millions to get their systems into FDA compliance - then wrote the regs.


Thomas DeMeo writes:

How much of this is government run amok, and how much of this is simply the result of a complex society doing very complex things?

Without government intervention here, the market would have to grow a something else, and it would have many of the same issues. Cars are deadly, and it creates a complex set of problems which can't be wished away. It may be that the market can manage this stuff much better.

The software industry is a good example of a free market building very complex stuff without the government and the results are mixed. We have inane credentialism anyway. We have a tangle of standards, and we have (in my opinion) markets that have not met their potential. It would be interesting to explore how markets can move forward in complex ways without getting bogged down.

Colin K writes:

I think he's vastly overstating the point.

The Ariel Atom is a two-seater that doesn't even have a body, let alone side-impact air bags, and has been quite legal to buy for much of the past decade. Terrafugia is the latest company to attempt to build a flying car, and were able to petition the DOT to regulate their vehicle (also a 2-seater) as a motorcycle rather than a passenger car specifically to get out of all those weight-adding safety features which would ensure that they literally never got off the ground.

The auto industry consolidated into something much like its present form close to a century ago, for plenty of other reasons. The global manufacturers spend billions on advertising annually, have vast dealer and supplier networks, and tooling and other capital investments into the tens of billions. Car buyers are extremely conservative and heavily concerned about things like dealer and warranty support, except where it comes to niche vehicles, which are generally purchased as toys by wealthier and more knowledgeable buyers. And lo, there are a number of such manufacturers out there to supply that demand.

Alex Godofsky writes:

How is "regulatory compliance has economies of scale" an argument for or against regulation? If the regulations are efficient (and even libertarians have to acknowledge externalities yadda yadda) and the market response to them is consolidation, then maybe it really is efficient for large firms to dominate that industry.

Ak Mike writes:

Alex Godofsky - It's an argument against regulation because it suggests that regulation is imposed for the benefit of the large corporations for the purpose of driving out smaller competitors. Thus the impetus driving the imposition of many regulations may be, not the protection of the public, but the protection of the big players. That means that the regulations are not likely to be very protective, or are protective in a needlessly expensive way.

It's like the regulations that require interior decorators to be licensed. Although the claim is that the regulation is for the purpose of protecting the public, in fact it harms the public, and protects only the insiders.

Alex Godofsky writes:

I'm totally on board with that critique - but the simple observation that a regulation introduces an economy of scale isn't enough to support it. It's plausible - likely, even - that an optimal regulatory regime would have the same effect.

David R. Henderson writes:

@Alex Godofsky,
What Ak Mike says. Moreover, consider the regulations on car safety. There's no externality. The buyer has the right incentive to trade off safety and price. Indeed, by making the cars safer for their drivers than the drivers would choose, NHTSA regulations cause drivers to drive more intensely than otherwise. That kills other drivers, pedestrians, and motorcyclists. That was Sam Peltzman's point in his mid-1970s study of auto safety. So here NHTSA is creating a negative externality.

Gus Halberg writes:

Wow. No, really, wow.

Is this a satire?

Do we really not understand why there are no start-up car companies? Really?

It's because it costs millions and millions of dollars to open even a modest-to-small car manufacturer like Tesla. It requires a huge factory complex for the economies of scale to kick in. A Tesla is so expensive b/c they can't ramp up production to truly commercial levels.

Actually, it's probably more like hundreds of millions of dollars. Where is a start-up going to get that kind of money? What well-heeled corporation is going to try to enter such a competetive market.

Why aren't there more oil refineries? Because they're hugely expensive and take years to build. Creating a car plant from scratch would pretty much fall into this category. Does anyone reading this have any idea how BIG a car plant is? I do. I worked in several. We're talking hundreds of acres.

Even to put a bare chasis on wheels with a single seat at a commercial scale would require an enormous initial investment, way beyond the means of anything but the largest corporation. Tech, especially software, is so appealing for entrepreneurs b/c the initial investment is relatively small. No huge factory complex is needed.

That's what keeps new companies from entering the auto market. It's got nothing to do with regulations.

JKB writes:

At least the car companies came by it honestly. Mattel imported lead encrusted toys which prompted a new and strict testing requirement for items targeted at children. Testing Mattel can accommodate quite cost effectively while the requirement drives small businesses out of business and kills the resell and donation market for old items. Now, that is some crony capitalism.

Costard writes:

Alex - the very idea of an "optimal" regulatory regime assumes that you can A) quantify both the benefits and the costs, B) rely on bureaucrats to be both fair and knowledgeable, and C) count on businesses not to influence either the regulators or Congress. Each of these assumptions falls on its face.

The reality is that regulations are always a trade-off. You're buying safety at the cost of innovation. Progress in any given industry almost always involves improvements in safety, as well as convenience/cost/efficiency. Meaning that you're making the future worse to make the present better. Politically it's convenient, and the costs are invisible -- but these are the only things to recommend such an exchange.

Alex Godofsky writes:

Alex - the very idea of an "optimal" regulatory regime assumes that you can A) quantify both the benefits and the costs, B) rely on bureaucrats to be both fair and knowledgeable, and C) count on businesses not to influence either the regulators or Congress. Each of these assumptions falls on its face.

No, it doesn't. Unless the free market outcome literally is the absolutely best possible one, there exists SOME regulatory regime that will improve welfare. You've got a countably infinite number of them to choose from; by assumption at least one will be better than none at all.

This isn't to say anything about the feasibility of finding it, etc. The point is that this feature of regulations - introducing an additional economy of scale - would likely be the result of any welfare-enhancing regulatory regime. It therefore isn't evidence in itself that the current regime isn't welfare-enhancing.

Thomas DeMeo writes:

There are any number of otherwise legitimate markets which would whither and die because the liability risk is both huge and undefined. Regulation allows the risk to be defined so that markets can move forward. A truly free market would become mired in liability risk in many industries.

An auto company needs to define its safety responsibilities, and prove that they fulfilled them. Tens of thousands of people die in cars each year, and car companies couldn't exist unless the resulting liability was standardized so they could understand their costs. There are many high risk industries that would seize up in the absence of regulation.

Ak Mike writes:

Mr. DeMeo - Unfortunately, no. Regulations do not limit liability, usually they create liability, because they impose a huge additional range of limitations and requirements.

For example, wage and hour regulations open up employers to very large liabilities in the event the paperwork is not impeccable. Environmental regulations impose a host of liabilities on businesses, including criminal liabilities. This is also true of financial regulations such as those proceeding from the Sarbanes Oxley act. Limitations on liability come from sources other than regulation.

Julien Couvreur writes:

The argument is seductive at first, but on second thought I don't quite buy it.

Think of the cost of compliance as a artificially mandated investment. If the business is profitable, then bringing some investment upfront to enter the market should not stop new entrants.

Where I do buy the argument is that the costs imposed by government are not subject to competition. So in a free-market situation, companies would still have to invest in safety validation and auditing, which is potentially expensive, but that effort could be made more efficient over time (as opposed to some static set of regulations which bureaucrats have no incentive to optimize).

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