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less government or good government?

May 28, 2010

There are many reasons to oppose introducing or increasing regulation, reasons that, depending on the context, are sometimes good or sometimes bad.  Among the good reasons might be that
– new regulation is purely punitive,
– it has been hastily crafted with little understanding of the business that is to be regulated,
– regulation is too rigid or too flexible, permits too much or too little discretion to regulators, or relies on the wrong techniques,
– the proposed new regulation is merely protective of the industry, designed to keep out the competition,
– the regulators will not be properly funded,
– the market is working well and the event spurring possible regulation is an isolated one, or
– the costs of regulation might significantly exceed any benefits.

There are many more potentially relevant considerations. If advocated thoughtfully, these are all are important issues in designing, supporting or opposing regulatory regimes.  We see this debate playing out in the fields of financial, environmental and energy regulation right now.

There is, however, one old shibboleth deeply entrenched in the popular mind and always trotted out by right wing organizations, namely that less regulation is always good. A debate on this issue has surged again in the blogosphere, with an assertion that, when properly interpreted, the recent 2010 Heritage Index of Economic Freedom suggests that America’s supposed leadership in economic success since 1980 is attributable to deregulation.  One need not get into whether what we see all around us, with one disaster after another, really supports the blogger’s # 1 ranking for America to question whether the data can really be interpreted in the way suggested.  A powerful refutation of the entire interpretation has been posted in one of my favorite blogs today. There the author demonstrates that many of the countries to which the Index refers and which do even better in the Heritage Index rankings than the United States are themselves also regulated with what is recognized by people who understand the issues to be strong, good quality regulation and good quality regulators.

The most comprehensive and widely respected economic and historical study of the long history of financial crises around the world clearly demonstrates that a weakening or failure of regulation, when accompanied by rapid financial market liberalization has always led to disaster, the United States being only the most recent example. The book, This Time Is Different: Eight Centuries of Financial Folly by Carmen M. Reinhart & Kenneth S. Rogoff, is one of the best written since the financial crisis of 2008 and is well worth spending some time with.

So the question really becomes not whether we should have regulation whether we have good regulation.  The belief that we somehow ought to pursue an idealistic “state of nature” in which economic freedom would guarantee efficient an safe prosperity is one that holds a deep and romantic grip on our minds– until something goes wrong.  The financial crisis, BP Gulf Spill, the recent Upper Big Branch coal mine disaster in West Virginia, and yesterday’s revelations that even so august a company as Johnson & Johnson tried to cover up a recall of Motrin remind us of the deep truth of Hobbes’ words of long ago, that in a state of nature the life of man is “solitary, poor, nasty, brutish, and short.”

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6 Comments
  1. Scott Sumner permalink

    Where have I ever claimed America is number one? It is not number one in the Heritage rankings (it is number 8), and it is not number one in per capita GDP. I have argued that #9 Denmark has a more free market economy than the US. So I don’t think your comments accurately reflect my views.

    How do mining disasters show the need for regulation? Are you aware that studies have shown OSHA has not improved worker safety?

    I do agree with you that Statsguy’s post is well worth reading, and I agree with most of it.

  2. I’ve reread your post and think that what I said is a fair reflection of what you were trying to say. And are you seriously suggesting that there should not be occupational safety regulation? Or that there should be no safety inspections?

    Studies can be generated to show anything, but we are always engaged in trade offs and initial assumptions will differ.

    I do read the Economist every week, by the way (actually every day online as well), and have spent a lot of time outside the ivory tower and in the trenches. Some of these econometric studies look quite ridiculous from that perspective.

    But I do appreciate your point of view and thank you for posting.

  3. Scott Sumner permalink

    Yes, I think OSHA should be abolished, as it is ineffective and costly. I have a colleague who studies OSHA, and he says the same. I know of no economic theory of market failure that suggests OSHA could help. Where is the externality?

    Again, America ranks number 8, not number one. I never said it ranks number one. If you saw that in your rereading you were mistaken.

    You might want to look at my newest post, which tries to clear up some of these misconceptions.

  4. Well I stand corrected and apologize if I misunderstand your post. I look forward to taking a look.

    On the OSHA, I would not want to defend that particular agency. However, the externality seems to me to be the transfer of risk from an entity that could more efficiently price and manage it (the employer) to a diffuse group of employees who are not as efficiently positioned to do so (particularly if not unionized). The agency would, if working correctly (which I acknowledge is a big IF), then be the agent to promote the more efficient allocation of risk.

    I know this discussion is proceeding at a fairly elementary level, but I do think it is important to engage general readers more fully in the debate, so once again I appreciate your willingness to do so.

  5. Kirstin Wells permalink

    My comment does not pertain to the Baxter/Sumner debate but to Lawrence’s broad question of less government or good government? Having read over much of the proposed regulatory reform, I become more and more cynical about the prospect for “good government” – but consider the alternative. The counterfactual is that we should let markets, with proper incentives, take care of the ills of the financial system rather than try and regulate it away. OK, so free market, where were thou? Models of microeconomic behavior to which the free-marketers would subscribe (if they know them) is that investors in say, certain asset backed securities would be incented to make sure that their investment was wise by doing things like, say, simple due diligence on the underlyings, making sure the credit ratings were assigned by rating agencies without obvious conflict of interest, and researching the market upon which the assets were based (subprime mortgages). Simple, basic, anybody-with-a-decent-MBA research that would be done to make sure an investment was prudent. So, they didn’t obviously. And it wasn’t just one or two shops at one or two random banks, it was systematic (honestly we just didn’t know about the risks!–Rubin). So microeconomic models broke down, and so we can’t necessarily rely on free market principles to regulate markets, but can we necessarily turn to regulation? Yes, a baseline amount is needed (mine safety, offshore drilling), but to correct the type of bold mismanagement that we saw in this past crisis – well I’m not sure there is a regulation for that. Can you tell I’m discouraged? Thanks for letting me vent.

  6. Kirstin, you got that right! Where is a regulation to prevent the monumental stupidity we just saw in the financial crisis? I think there is no magic fix and we will see more crises. But I think we can mitigate them by addressing various dimensions of the problem, from improving the market itself (e.g., greater transparency, better and more honest accounting, etc.) to improving the standing and quality of regulators, to better collaboration in the creation and development of workable and reasonable regulations. I pipe dream perhaps, but one worth striving for.

    Thanks for you post!

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