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a few words on “regulation”

May 21, 2010

“Regulation” is now part of our common parlance. One is almost as likely to find animated controversy in popular media on regulation of the environment, health care, oil and gas drilling, mining and, of course, banking, as one might find debates on “freedom of expression,” “privacy,” and “separation of church and state.”   Yet, like these other concepts, “regulation” is a rather complicated concept with exceptional technical detail in its application.  So the term is worth a few moments’ reflection.

An ancient word deriving from Latin, “regulation” means a lot of things, from controlling or governing and activity through oversight or supervision to creating a framework for such activity through rules and orders (“regulations”).  There is a whole range of regulatory structures and techniques.  What is important is that regulation is not the activity itself.  To regulate trade, for example, is not to trade but to create the conditions under which trade takes place.

Why is this important?   It is not just an academic point.  Take the stock market.  Registering and trading stocks are market activities, but the market does not exist by itself as some kind of natural phenomenon; it has to be created and maintained, and this is where regulation comes in.  So regulation is as necessary to markets as market conduct itself.  Sometimes this is forgotten, particularly in debates about the role of government in regulation.  At one end of the spectrum extreme libertarians take the position that markets are or should be self-regulating and that all forms of government intrusion are illegitimate.  At the other end, extreme socialists or communitarians believe that “market” activity is really a usurpation of the functions of the collective–whether this be a community or state.

The genius of America, historically, has been to create a balance between the enormous efficiencies of relatively free market behavior and the need to create and maintain such markets in the first place.  This is why antitrust law, which seeks to preserve competition in markets, is so important:  without competition markets can naturally degenerate toward the winner-take-all situation of a monopoly.  Without other forms of government regulation, markets also tend to “externalize” the costs of market activity as a result of “inefficiencies,” such as insufficient or one-sided information, or “market power” (where one party enjoys disproportionate bargaining power because of size or some other advantage).  This externalization leads us to pay more for products than would be the case in a genuinely competitive market, or to pay for the damage inflicted by risks that a market participant–say a bank or hedge fund–generates because the market participant did not properly manage those risks and pulled other participants down with it when it failed.  Such bailouts are always resented because innocent parties have to bear the costs of damage inflicted by irresponsible actors.

“Deregulation” is a related term that came into vogue in the United States in the early 1970s when heavy-handed regulation of the airline, telecommunications and energy industries was seen to be counterproductive.  Over the past 40 years we have witnessed wide scale deregulation across numerous industries.  Although the deregulatory movement had begun earlier under President Carter, Ronald Reagan, in a famous turn of phrase in his First Inaugural Address (1981)–“government is not the solution to our problem; government is the problem”–symbolically and ideologically set the stage for an era of “deregulation” that lasted until 2008 when the financial crisis cast great doubt on the merits of relying too heavily on “market discipline” as a form of self-regulation.  Yet even in this period of deregulation, regulation did not disappear, nor could it.  Adam Smith is often taken out of context for the view that markets can be self or “naturally” regulated (Adam Smith, Inquiry into the Wealth of Nations II.iv.i.9), yet Adam Smith himself was at pains to delineate an important role for governments in creating and sustaining such markets in the first place, and he also presupposed important other moral constraints without which markets could not operate efficiently over the long term.  (See Amartya Sen, Capitalism Beyond the Crisis, N.Y. Rev. Books, March 26, 2009.)

So no matter where we stand on the ideological spectrum, with extreme exceptions, regulation is understood to be a complex activity without which markets cannot function properly.  Quite apart from the maintenance of free and competitive markets, regulation is also used as the technique by which public safety standards are applied and enforced, to incent market activity considered socially desirable, and to apply other kinds of correctives that only collective, not individual, action can ensure (protecting the commons).  There are many reasons why, even in a free market economy, we have extensive regulation. The trick is how to develop and maintain fair, democratic and effective regulation–and this of course presents much more of a difficult challenge than first meets the eye.

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4 Comments
  1. ijbaxter permalink

    Great post…. eagerly awaiting more!

  2. I agree in part with your brief comment on regulation, but I totally reject your opinion on antitrust law. Your said: “This is why antitrust law, which seeks to preserve competition in markets, is so important: without competition markets can naturally degenerate toward the winner-take-all situation of a monopoly. Without other forms of government regulation, markets also tend to “externalize” the costs of market activity as a result of “inefficiencies,” such as insufficient or one-sided information, or “market power” (where one party enjoys disproportionate bargaining power because of size or some other advantage).”

    The problem with antitrust law is that it’s a non-objective law.

    Under this law, a business-owner is already condemned as a criminal from the moment he starts his own business, regardless of his line of business or corporate practice. According to this law, a business-owner can be held liable for monopoly or for a mere “attempt to monopolize”, “to combine or conspire, expressly or impliedly, with any other person or persons”, “to monopolize any part of the trade of commerce within the country”, among others. If evaluated very carefully, there is only one distinction in the legal treatment given to a businessman or to a criminal: the rights of the criminal are protected much more objectively than the businessman’s.

    –> http://fvdb.wordpress.com/2010/08/07/3494/

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