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May 17, 2011

The Free Market Needs Government to Function

This post is my response to a brilliant commentary by Bill Schubart, most but not all of which I agree with. You can read his original at The Free Market: An Enduring Myth (Guest Post by Bill Schubart).

Bill's conclusion is:

"I believe in consistent, strategic regulation that is enforced. I believe that businesses - like citizens - need rules and consequences. The application of different rules and judicial consequences for different economic classes, and a blind adherence to economic absolutes will only further erode our once pioneering economy."

Business certainly does need rules for the sake of both business people and their customers. IMHO it is the proper role of government to enforce truth in advertising and labeling, product safety, externalities, prevention of monopoly or regulation of monopoly when there is a good public purpose for a monopoly to exist.

Even the earliest marketplaces depended on government regulation of weights and measures. Without this enforcement, merchants who give fair measure are at an economic disadvantage to those who shave weights. There is a race to the bottom at the expense of both consumers and merchants who want to play fair. Caveat Emptor is a lousy slogan for a market.

Product safety is a more sophisticated form of truth-in-labeling; not only should a product do what it's sellers say it will do; it shouldn't do what isn't supposed to do – poison you, for example, or get caught in your children's throats. Setting the standard for safety can be abused by government; but it is still a government responsibility. For example, milk which makes us sick obviously should be banned. Does that mean all non-pasteurized milk should be banned? Wheels shouldn't fall off cars – that's easy; but should the government have mandated airbags when consumers clearly were not willing to spring for them? We will always have arguments about how far safety regulation should go and how much we consumer should be protected from ourselves; but it is good for both businesses and consumers to have the government regulate safety. Business people can afford the cost of a safe product when they know that their competitors will also have to comply with safety rules.

Externalities are the cost of a product which businesspeople, left to themselves, will impose on society as a whole. Polluting the air or a river as part of a manufacturing process is an obvious example. No steelmaker in a competitive economy, no matter how socially responsible that steelmaker, could afford effective pollution control if the steel mill next door is allowed to pollute without limit. The clean steel would be priced out of the market. Once there are a clear set of standards for emissions – assuming there is effective enforcement and real penalties for violation – it becomes more expensive to make steel the dirty way. Allowing a business to socialize costs is just that – a perverse form of socialism in which some get private gain at public expense.

Although a successful economy requires competition, individual businesses would just as soon limit competition. I've been there – it's a real pain when a competitor cuts prices just when you were beginning to make a profit. It's expensive to keep putting out new and improved versions of your product. Pesky competitors might lock up your suppliers or steal your best employees – and all you've taught them. Without enforced laws against price fixing and monopolies, competition tends to go out of markets. The societal gains of capitalism require competition; the individual goals of capitalists are often best met by avoiding competition. Government has a crucial role of resolving this contradiction in favor of the market. Monopolies can be formed by businesses, labor, or professions; in some cases the monopolies are enforced rather than prohibited by government policy. Until recently expensive and very profitable telecom monopolies were written into law almost everywhere in the world; there is a serious attempt in the US to deny workers a secret ballot when deciding whether or not to join a union; and current law requires that many medical procedures be done by expensive doctors rather than technicians. Since monopolies are very profitable for monopolists – business or labor, the excess profits can be used to make campaign contributions or buy politicians outright. So government often fails to enforce competition –and we need a trustbuster like Teddy Roosevelt to break up too-cozy relationships of big business, big labor, and big government. We are probably there now with respect to financial institutions at least.

I disagree with Bill Schubart's assertion that digital networks make enforcement of antitrust much more difficult than it used to be. Conspirators can't seem to resist leaving a trail of email and text messages, much to the delight of competent prosecutors. If you burn a letter or memo, it's gone; if you delete your copy of an email, it's still there on your company's servers, in the sender's email, on various backups, and on incompletely erased disks. Count on it. I also disagree with Bill that prices which are close to identical are a reliable sign of collusion; they may also be the sign of a very efficient market in which customers know all the prices so everyone is forced down toward cost at the speed of electronic communication. My wholesale telephony company had one major competitor with a cost structure as low as ours; if one of us was charging a tenth of a cent per minute more than the other, we quickly found out as our customers switched vendors. We didn't talk to each other but our customers talked to both of us.

Capitalism rewards the efficient and punishes the inefficient. It's brutal but effective in forcing effort and innovation and punishing dumb or overpriced schemes or excessive compensation (eventually). When some escape the consequences of their bad management – investment banks, for example – capitalism simply doesn't work. If capitalism doesn't regulate business failure, if failure is subsidized by government, then there is no market regulation and government regulation is required as for any monopoly. There is no better argument for regulation of banking than TARP. Does that mean that we should have intense government regulation of the financial market? No, that regulation will just lock in the dominant position of those who are "too big to fail" and stifle innovation; moreover, modern worldwide electronics probably do make this regulation impossible to enforce. What we need is to break up any institution of any kind which is "to big to fail". Let the losers lose.

As Bill said, both businesses and citizens need consequences.

Related posts:

We've Been T*RPed

Election Analysis: It Was TARP that Boiled the Tea

Bankers and Oak Trees


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