Actually the problem is that people aren't able to compare airlines based on space. You can sort by price, departure time, number of stops, airline, connection time, total time, arrival time, but I've not seen a flight booking site offer filters based on amenities or comfort metrics of any kind.
In the absence of that information, people are going to be making decisions without consideration of those things and so the airlines will race to reduce their costs.
This market failure is not caused by a lack of regulation of seat size, but by a lack of important information. There is apparently a desparate need for a new flight booking service to provide that information.