Rationality and Institutional Contingency: the Varying Politics of Economic Regulation in the Fire Insurance Industry

Are the politics of economic regulation contingent on institutions? Drawing on arguments about institutional mediation and the institutional bases of rational action, we explore how institutions shape the dynamics invoked in two theories of regulation. We argue that institutional arrangements affect both the clarity and the content of group interests in regulation. Event history analyses of U.S. states’ passage of Žre insurance regulation from 1906 to 1930 support these arguments in several ways. Market-heterogeneity dynamics speciŽed by cartel-capture theory affected the passage of regulation only under some conditions— namely, relatively depoliticized settings with little overt conict or uncertainty about policy outcomes. In addition, interest group dynamics were conditioned by the consolidation of interorganizational Želds around a particular model of market order, which allowed divergent interest groups to converge in support of regulation. The research suggests ways of thinking about theoretical generality and speciŽcity, regulatory politics, and the relationship between institutional theory and rationality. Political interests and conicts often appear universal and unproblematic: Challenging groups Žght for political inuence. Firms have interests in stability, autonomy, and proŽt maximization. While it is clear that interests and conict structure political outcomes, less clear are the processes that deŽne interests and structure conicts or complementarities of interest. An enduring feature of institutional arguments in sociology is that institutional arrangements shape the processes that drive social action and outcomes. Friedland and Alford (1991:245), for instance, argue that “utility maximization, satis* Direct all correspondence to: Tim Bartley, Department of Sociology, University of Arizona, Tucson, AZ 85721; e-mail: [email protected]. 48 SOCIOLOGICAL PERSPECTIVES Volume 45, Number 1, 2002 Žcing, income maximization, proŽt maximization, risk, power, even interest itself are all institutionally contingent.” Similarly, Douglas (1986) argues that institutions shape the terrain of action by classifying, highlighting, and obscuring particular features of a situation. “New institutionalist” research in sociology and political science provides an empirical warrant for thinking of institutions as partially constituting instrumental action (Hall and Taylor 1996; March and Olsen 1989; Powell and DiMaggio 1991). Furthermore, recent neoinstitutional research has begun to move from analyzing the spread of models of order to examining how institutional logics and political regimes moderate the dynamics of organizational behavior—showing that causal mechanisms are contingent on institutional conditions (Dobbin and Dowd 2000; Thornton and Ocasio 1999). Our approach to institutional contingency considers two theories of economic regulation—cartel-capture theory and interest group theory—that provide general accounts of when and why states intervene in industries to control prices, entry, or investment.1 These theories use rational choice models of action and assume that actors maximize economic interests. We focus on institutional sources of interests in regulation and argue that variation in political-institutional conditions may produce variation in the clarity and content of preferences for or against regulation. Cartel-capture theory highlights the market conditions that lead Žrms to use regulation as a tool for creating or maintaining monopoly but typically ignores the way in which policy shapes competitive behavior and the politicization of organizational Želds alters interests in “state capture.” Interest group theory emphasizes the organizing capacities and stakes in regulation of groups both internal and external to an industry but typically pays little attention to institutional shifts over time that may clarify and alter group interests. These two approaches make valuable contributions to understanding economic regulation and the relationship between state policy and private forms of market control. Yet they are more valuable when treated as institutionally contingent. Empirically, we use event-history analyses to examine U.S. states’ passage of rate regulation in the Žre insurance industry from 1906 to 1930. This industry provides fertile ground for examining the institutionally mediated relationships among market forces, interest group politics, and state policy. First, the industry was central to the economic infrastructure of the United States; Žre insurance was required by creditors, and major urban centers frequently had massive Žres (Brearley 1916; Mowbray 1946). Second, the industry was characterized by substantial political and market organization, including cartels, industry associations, and rate-making bureaus. Third, starting in 1909, U.S. states began to pass laws to regulate Žre insurance rate making. Typically, these laws allowed state insurance commissioners to order changes in insurance rates or rate-making practices while also authorizing insurers to form rating bureaus or rate-making associations. In effect, these laws eschewed antitrust principles in favor of “regulated cooperation.” By 1930 thirty-three states had enacted rate regulation, generating substantial variation in outcomes for the purposes at hand. The goal here is quite speciŽc—to examine the contingent character of two theories of regulation. In previous work we have assessed competing theories and found direct effects of institutional factors on rate regulation (Schneiberg and Rationality and Institutional Contingency 49 Bartley 2001). Here, however, we examine how institutional conditions shaped the processes by which regulation emerged rather than test theories or construct a comprehensive account of the outcome. This allows us to identify the speciŽc conditions in which causal mechanisms are most applicable. Methodologically, it implies a focus on interaction effects rather than direct effects of institutional variables. We begin by considering how institutions mediate political processes and then consider one type of mediation in more detail by focusing on the institutional bases of rationality. Next we outline theories of regulation, discuss ways in which institutional factors may shape the interests speciŽed by these theories, and explain how these apply to the case of Žre insurance. After a discussion of methods and measurement, we turn to the results of event-history analyses, which support several ideas about institutional contingency in theories of regulation. VARIETIES OF INSTITUTIONAL MEDIATION As Amenta (1998:19) comments, “Institutional theses typically specify the limits on social policy, but often ignore what drives it. Political theories specify the actors and resources that drive public social provision, but often ignore the systemic limits on political action.” Integrating these approaches requires conceiving of institutions as mediating political processes, or conditioning political dynamics. Beyond Žrst-order “institutional effects” on policy, institutions shape the relationship between behavioral independent variables and policy outcomes (Amenta, Dunleavy, and Bernstein 1994). One view of institutional mediation focuses on political opportunities that shape the organizing capacities and successes of challengers. Outsiders’ political inuence may be limited or ampliŽed by features of the formal political structure and party system, like the basis of party support or presence of “veto points” in the legislative process (Amenta 1998; Immergut 1992). In addition, “policy feedback” arguments suggest that institutionalized policies organize or disorganize constituencies for future political action (Pierson 1994). Further, institutional contexts may change over time and thus modify the effects of other variables (Isaac and GrifŽn 1989; Sutton and Dobbin 1996; Tolbert and Zucker 1983). These arguments suggest that institutions shape political contests as much as do traits of the contestants themselves. Institutions do so, in part, by deŽning payoffs, opportunities, and constraints on collective behavior. In this conception, institutions are “rules of the game”—which are themselves variable. Going further, literature on the “new institutionalism” in sociology and political science suggests that institutions are “constitutive and prescriptive” as well as “constraining and proscriptive” (Clemens and Cook 1999; Hall and Taylor 1996; Schneiberg and Clemens forthcoming; Thelen and Steinmo 1992). Therefore, institutions may mediate the effects of other causal dynamics not only by deŽning political opportunities but also by shaping the interests of political actors and even the actors themselves (Meyer et al. 1997). This line of theory uses a broad deŽnition of institutions as “supraorganizational patterns of human activity by which individuals and organizations produce and reproduce their material subsistence and organize time and space. They are also symbolic systems, ways of 50 SOCIOLOGICAL PERSPECTIVES Volume 45, Number 1, 2002 ordering reality, and thereby rendering experience of time and space meaningful” (Friedland and Alford 1991:243). Thus institutions are not simply “rules of the game” that constrain action but also systems that help to constitute actors and interests. It is this focus on the institutional construction of preferences that motivates our analysis of the politics of regulation. INSTITUTIONAL FOUNDATIONS OF RATIONALITY To specify and delimit the rational choice theories of regulation under consideration, we focus on the social context that underlies rational action. While scholars often leave rationality as a “black box,” we join others (from Weber to cultural theorists to rational choice institutionalists) in examining how social conditions shape deŽnitions of interest and create an infrastructure of clarity and calculability that allows rational choices to be made. By unpacking the black box of rationality, we seek to explain how the intersection of institutions and interests drives the passage of regulation. The basic premise of rational choice theory is as follows: “When faced with several courses of action, people usually do what they believe is likely to have the best overall outcome” (Elster 1989:22). This simple statement presumes a number of conditions of choosing. First, if one is to choose from several courses of action, the options must be commensurable—that is, they must be enough alike that one can compare and rank them (Espeland 1998). Second, if choices are made on the basis of expected outcomes, then rationality requires enough evidence or stability in the context of action to calculate an expected outcome (Heimer 1985). For instance, Elster (1989:33) suggests that “beliefs [or preferences] are indeterminate when the evidence is insufŽcient to justify a judgment about the likelihood of the various outcomes of action.” In this situation, uncertainty may override rationality. Crucially, commensurability, predictability, and the calculation of risk are not merely formal requirements of rational decision making; they are shaped by social context. Rational choice explanations fundamentally rest on institutional conditions for calculation and rationality. Rational choice theorists themselves have recognized cognitive limits on rationality, problems of incomplete information, and the context-bound character of rational choice mechanisms (Bates et al. 1998; Brinton and Nee 1998). In fact, this approach has contributed fundamental insights into how actors craft institutions in response to uncertainty and incomplete information (Akerloff 1970; Alchian and Demsetz 1972; Williamson 1985). Furthermore, work in this tradition has become increasingly self-conscious about explanations that rest on assumptions of full information and theories that are intended to apply only under certain institutional conditions. Yet the institutional conditions for the two rational choice theories of regulation under consideration have gone unspeciŽed, with little consideration of the social contexts that support, inhibit, or deŽne the rational decisions they assume. We seek to contribute to this topic by exploring several ways in which institutions underlie, clarify, and modify interests. Institutional arrangements that provide well-articulated standards make the world more predictable. Weber argued that rational exchange relied on legal and Rationality and Institutional Contingency 51 Žnancial institutions that made the world calculable by enforcing contracts and standardizing taxation and currencies (Collins 1980). Standardization is also central to commensuration, which is “concerned with measuring different properties normally represented by different units with a single, common standard or unit” (Espeland 1998:24). Likewise, institutions make the world more orderly by maintaining classiŽcations and intensely ordered “administrative grids” (Douglas 1986; Scott 1998). An important effect of institutions, then, is to order an otherwise overwhelmingly chaotic set of objects and to draw attention to some objects over others. This is an approach to rationality in which “the individual is seen as an entity deeply embedded in a world of institutions, composed of symbols, scripts and routines, which provide the Žlters for interpretation, of both the situation and oneself, out of which a course of action is constructed” (Hall and Taylor 1996:939). Conversely, situations in which institutions are poorly developed or unsettled can subvert commensurability, predictability, and calculability. As Berk (1994) argues, in periods of “constitutive politics,” the economic landscape is itself up for grabs, leaving economic and political interests ambiguous. In periods of “power politics,” many of the overarching institutional parameters are relatively Žxed, but in constitutive periods, institutional environments may be composed of competing frameworks, conicting standards, and indeterminacy regarding options, the consequences of choice, or the “rules of the game.” Here institutional conditions complicate rather than simplify the task of interpreting reality—producing intractable uncertainties and undermining the conditions for rational choice (Heimer 1985; March and Olsen 1976, 1989). If the assumption that preferences are clear is in need of further speciŽcation, so too are assumptions that conicts or complementarities of interest are structured by “initial conditions” that are relatively stable over time. Rational choice theorists have begun to address the problem of interests changing over time by exploring how preferences get altered through iterative processes of trial-anderror and learning (Axelrod 1984; Greif 1998). Yet such microlevel “bottom-up” accounts are weaker at explaining higher-level institutions that “structure the exchange and the exchange process, that create identities for the subjects involved in the exchange, and that create a subjectively meaningful social context in which the exchange takes place” (Hamilton and Feenstra 1998:159). Changes in these higher-order structures may alter the costs, beneŽts, and risk factors involved in individual calculations of interest and therefore create new complementarities and/or conicts of interest. For instance, the consolidation of an institutional Želd over time may clarify or constitute otherwise inchoate interests and is itself a critical source of initial conditions. These ideas about rationality undergird our exploration of the institutional foundations of interests relevant to capture and interest group accounts of regulation. In discussing these theories, we emphasize that industry groups and outsiders are likely to have clearer preferences about regulatory policy when institutional conditions and disputes over the rules of the game are settled and when institutional environments provide safeguards for predictability or make governance options more clearly commensurable. In addition, policy regimes that shape market dynamics may affect the content of preferences, as could institu52 SOCIOLOGICAL PERSPECTIVES Volume 45, Number 1, 2002 tional changes that reduce the risks involved in implementing regulation—which may end up aligning the interests of previously antagonistic groups. CARTEL-CAPTURE THEORY In the nineteenth-century U.S. economy, Žrms commonly sought to organize markets collectively, via interŽrm compacts or associations, and to pool information, set standards, Žx prices, or develop technical knowledge (Chandler 1977; Fligstein 1990; Schneiberg and Hollingsworth 1990). These historical observations motivate cartel-capture theory’s central claim that economic regulation can also be an attractive option for Žrms trying to organize or stabilize markets. The theory rejects the commonsense notion that regulation is constructed in the public interest to restrict monopoly power or solve market failures. Instead it argues that industries use regulation as a tool for suppressing competition, creating monopolies, and extracting rents (Kolko 1963; Posner 1974; Stigler 1971). For instance, Žrms in competitive industries may be able to better control the market if the state imposes restrictions on entry or allows associations to set minimum prices. According to the theory, Žrms seek regulation when market dynamics of competition and collective action make private means of organizing an industry untenable. Two of the least costly forms of private organization are cartels and priceŽxing associations. Yet these are not always viable market control mechanisms, since the voluntary character of participation opens the door to free-riding, defection from agreements, and other enforcement problems. Regulation may then be an effective alternative if Žrms can create or capture state agencies that will enforce interŽrm agreements and limit competition. In this view, it is market conditions that prompt the shift from cartels to capture. Market size and heterogeneity are particularly important (Bowman 1989; Jacquemin and Slade 1989; Posner 1974; Stigler 1971, 1974). When Žrms are few in number and similar in assets, costs, and strategy, it is relatively easy to form and maintain effective voluntary interŽrm agreements. Here Žrms opt for private cartels. Yet with increased market size and heterogeneity, private organizational strategies become more difŽcult, because of problems of managing large numbers and divergent interests. Here Žrms develop interests in state-enforced cooperation while also increasing their ability to forge “capture coalitions.” SpeciŽcally, large numbers increase Žrms’ political clout, while diversity creates an “asymmetry of interest” in the industry and increases incentives to join the “capture coalition”—to guard against one industry faction using regulation against a nonparticipating group (Stigler 1971). Accordingly, increasing size and heterogeneity prompts a shift from private organization to the state. However, increasing size and heterogeneity beyond intermediate levels may reverse this process. At some point, greater numbers and diversity may subvert Žrms’ abilities to form effective lobbies (Stigler 1974). Indeed, extremely high levels of heterogeneity may make the faction-against-faction incentive for regulation devolve into inŽghting that inhibits Žrms’ political inuence. Growing market heterogeneity may also increase the chances that a subset or “critical mass” of actors will emerge who are interested and capable of organizing markets priRationality and Institutional Contingency 53 vately on their own (Marwell and Oliver 1993).2 Thus, cartel-capture theory suggests that market size and heterogeneity have inverse-U-shaped effects on the likelihood of passing regulation. Institutional Mediator: Anticompact Laws The utility of cartel-capture theory lies in its sophisticated account of how Žrms’ economic strategies shape political outcomes. However, cartel-capture theorists largely ignore the way in which other political conditions shape Žrms’ governance options and strategies. Institutionalists have found that political regimes constitute and alter economic behavior. Research on the development of American capitalism suggests that antitrust laws encouraged the vertical growth of U.S. corporations by constraining their horizontal growth (Hollingsworth 1991). Similarly, Dobbin and Dowd (2000) show that the effects of market dynamics on Žrm acquisitions are conditional on an antitrust regime that limits cartels and enforces competition. Drawing on Dobbin and Dowd (2000), one may expect regimes that ban cartels and enforce competition to create precisely the conditions that cause Žrms to seek regulation. Lacking laws that limit interŽrm cooperation, Žrms will pursue private forms of industry organization. But if this option is blocked by antitrust enforcement, then Žrms’ organizing efforts shift to publicly regulated coordination. Following this logic, we expect market conditions to be more strongly related to the passage of regulation in states with antitrust laws than in states without antitrust laws. In fact, in states that lack policy enforcing competitive behavior, the dynamics of competition and collective action speciŽed by cartel-capture theory should be irrelevant to the passage of Žre insurance rate regulation. A second possibility is that hostile political regimes increase uncertainty for Žrms in calculating the expected costs and beneŽts of regulation. A potential cost of regulation is that it may end up serving as a channel that admits powerful outsiders into industry councils, mobilizes hostile forces, or exposes prices to politics (Bowman 1989; Stigler 1971). When anticompany forces manage to challenge the power of Žrms in an industry, it becomes more difŽcult for Žrms to calculate this expected cost. Furthermore, when policy undermines predominant Žrm strategies without providing alternatives, conict and ambiguity over the creation of new strategies tend to ensue (Dobbin and Dowd 2000). Therefore, politicization of the institutional environment undermines the conditions for the type of rational choice posited by cartel-capture theory. For Žrms, hostile political regimes increase uncertainty while decreasing predictability and the commensurability of public and private governance options. Following this logic, we expect industry preferences for capture to be ambiguous under conditions of political hostility and clearer in less politicized environments. In the Žre insurance case, state “anticompact” laws both enforced competition and politicized institutional environments. Anticompact laws were antitrust laws that banned interŽrm price compacts and collaborative rate making in Žre insurance. They were a response to extensive systems of interŽrm coordination that characterized the nineteenth-century Žre insurance industry. Such systems led 54 SOCIOLOGICAL PERSPECTIVES Volume 45, Number 1, 2002 farm groups, local boards of trade, and local public ofŽcials to stir up a legitimacy crisis for the industry by arguing that cooperation among insurers produced exorbitant rates. Consumer groups also decried arbitrary treatment by company ratemaking associations and ultimately turned to anticompact laws for relief. These laws typically prohibited collusive price-Žxing outright while targeting speciŽc practices such as associations “advising” companies about rates. Ohio passed the Žrst anticompact law in 1885, and Michigan followed in 1887. During the 1890s and early 1900s, anticompact legislation spread rapidly through the populist regions of the country, leaving a band of anticompact states centered largely in the Midwest and the South (see Figure 1). By 1910 the anticompact movement had run its course.3 Anticompact laws constituted the political-institutional context in which rate regulation emerged (Schneiberg 1999; Schneiberg and Bartley 2001). Once states passed rate regulation, they either repealed anticompact laws or allowed them to languish on the books. Nevertheless, the anticompact movement was a deŽning feature of the setting in which Žrms considered regulation as a possible solution to market control problems—and thus decisively shaped the context which cartelcapture mechanisms apply.4 On one hand, anticompact laws enforced market competition, limiting Žrms’ abilities to cooperate openly in making and enforcing rates. At the same time, such regimes represented a conŽguration of power with industry outsiders able to subject the industry and its markets to disruption and political uncertainty. They represented not only a defeat of industry interests in association but also a legitimacy crisis, in which industry organization was subjected to public scrutiny, controversy, and criticism. In addition, where anticompact laws were in place, they often served as platforms for political attacks against insurers. Indeed, insurance companies fought state antitrust intervention because it subjected the industry and its operations to “politics” and to the strategic behavior of politicians who would “play to the gallery” and attack the “insurance combine” in their search for electoral advantage (Schneiberg 1999). For companies, then, these interventions created uncertainty about the prospects for viable market organization and the meaning and consequences of regulation. At this point, we consider it an empirical question whether the primary effect of anticompact laws was to (1) enforce competition and thus spur the dynamics speciŽed by cartel-capture theory or (2) politicize industry governance to such an extent as to foster uncertainty in insurers’ interests in regulation. We model both of these possibilities and allow the data to lend support to one or the other. Table 1 summarizes the predictions of cartel-capture theory and institutionally contingent versions I and II. INTEREST GROUP THEORY Interest group theory looks beyond the Žrms and market conditions speciŽed by cartel-capture theory to consumers, suppliers, and subsectors of an industry. In this view, regulation allows consumers and other industry outsiders to share in the spoils of the regulated industry or to contain concentrated private power. Here regulation reects the relative organizing capacities of producer and conRationality and Institutional Contingency 55