Monday, October 29, 2012

On Regulation

Regulation is government’s default (and blunt) instrument to bring about (or stop) certain behavior in response to a perceived market failure.  And there are some instances when regulation is needed, such as when dealing with certain types of pollution.  I know of no market for dealing with air pollution, so the government steps in to correct the externality.  However, we’ve completely neglected free market ideas and relied too much on government intrusion into the free market.

There are some that say “markets fail, use government.”  After all, this used to be very reason for regulation.  However, as Don Boudreaux explains in the latest edition of the Freeman, the lack of market perfectionism isn’t reason enough to abandon markets.   One should not assume that benevolent government bureaucrats can write perfect rules, completely devoid of unintended consequences, with zero social costs.  On the contrary, the blunt instrument that is regulation can rarely achieves the high minded effects its proliferators desire. Instead of “markets fail, use government”, think “markets fail, use markets”! 

The Competitive Enterprise Institute goes on to demonstrate that how regulation is practiced differs greatly than how it should work.  They quote from Litan and Nordhaus’s Reforming Federal Regulation

In theory, regulation should arise as a response to market failures. In practice, regulation is more accurately characterized as a government tool for redistributing society’s resources toward those groups that have successfully enlisted the support of the government on their behalf.

Many firms have abandoned traditional pursuits of increasing profits by conforming to consumers’ wants, and instead lobby the legislature.  But here’s a question: can you blame those that rent-seek?  As federal agencies churn out more and more regulation, firms in some markets are essentially coerced into this despicable behavior as a last resort.  Greasing the federal skids is often the only avenue left on the road to survival.  

Lastly, Dan Mitchell over at Cato argues that free markets can and do a good job at self-regulation.  I think his argument centers around the firm’s reputation as the primary tool to regulate behavior.  He uses the airline industry as an example.  In the absence of the FAA, would airlines suddenly curtail aircraft maintenance to save a buck?  Probably not.  An airline with a crashed jet on its hands due to botched maintenance would soon find itself out of business.  Reputation goes a long way in self-regulation, especially in our highly-connected world today.  Twitter, Facebook, and YouTube have transformed how quickly information is disseminated.  Bad firms can run, but not hide.

My closing thought on regulation is that it should be avoided because of its enduring nature.  Regulations are almost never rescinded.  When was the last time Congress passed a law to undo a previous law or the EPA revoked a rule?  Hence, this explains why the code of federal regulations has ballooned to 169,000 pages in length.  The permanence of federal regulation is reason enough to use it sparingly.  Changes occur rapidly in modern economies and federal rules serve only to hinder progress.   Eliminating outdated rules takes enormous effort and often bears little fruit.  We should instead rely on markets.  While not perfect, perfection isn’t the goal.

Markets fail, use markets.

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