Knowledge that Transforms

Work on this paper was begun during visits to the International Finance Division of the Board of Governors of the Federal Reserve System and the Research Department of the International Monetary Fund and completed during visits to the Bank of France and the Institute for Advanced Study in Berlin. I gratefully acknowledge the support and hospitality of all these institutions while absolving them of responsibility for the views expressed here. Research assistance was provided by Ansgar Rumler andfinancial support by the Center for German and European Studies of the University of California. For comments on portions of this work I thank Tamin Bayoumi, Lorenzo Bini-Smaghi, Paul De Grauwe, Jeffry Frieden, Alexander Italianer, Peter Kenen, Paul Masson, Thomas Mayer, Ronald McKinnon, Jacques Melitz, Richard Portes, Gianni Toniolo, Jiirgen von Hagen, and Charles Wyplosz.

The authors are grateful to Avner Ben-Ner, Jacques Defourny, Saul Estrin, Felix FitzRoy, Barbara Lee, Bentley MacLeod, Egon Neuberger, Jeffrey Pliskin, Stephen C. Smith, and three anonymous referees for comments on various drafts of this paper. Jones acknowledges with gratitude thefinancial assistance of the National Science Foundation (Grant # 9010591). Of course, all remaining errors and any omissions are entirely the responsibility of the authors.

ECONOMIC DEREGULATION of American industry is one of the most important experiments in economic policy of our time.1 In 1977, 17 percent of U.S. GNP was produced by fully regulated industries.2 By 1988, following ten years of partial and complete economic deregulation of large parts of the transportation, communications, energy, and financial industries that total had been cut significantly-to 6.6 percent of GNP.3 The political forces behind the decision to change the market conditions under which roughly $600 billion of U. S. output is produced were strong and varied, but according to political scientists Martha Derthick and Paul Quirk (1985, p. 36), deregulation would never have occurred if economists-especially microeconomists-had not generally supported it through their research.4 In retrospect, it is fair to ask: were microeconomists able to develop a theoretical and empirical framework to explain regulation and its effects and to form predictions of deregulation's effects? Were they able to predict the actual effects of deregulation? This paper surveys the evidence to address these questions and of-

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