Wednesday, February 1, 2012

Musings about capitalism - Government regulation

This, the second post in my series on free market capitalism, explores the role of government regulation, building on the discussion of free markets in the first post.

Pure free market capitalism is devoid of government regulation. I know of no nation that has a pure free market capitalist economy. Most people are grateful for at least some government regulation.

Some government regulation protects consumers from unethical business practices. Ironically, the Republican Party advocated many of the first rules that the United States imposed on businesses following the scandals, shenanigans, and shoddy service that characterized many rapidly growing U.S. firms in the second half of the nineteenth century.

For example, consumers reasonably expect that food products they purchase are safe to consume and accurately labeled. Truth in packaging laws, rules about product purity, and so forth are all ways that government regulates capitalism. As a society, we recognize that few individual consumers have the desire, expertise, or resources to perform these important functions for themselves.

In an unregulated economy, only market forces would prevent a supplier from diluting milk with water. Few consumers would know if a producer diluted milk with 1 or 2 percent of water. At some level (10% or 20%? I don’t know; I’ve never had diluted milk, thanks to the Federal Food and Drug Administration and similar agencies in other countries), consumers would begin to suspect something is amiss. If the dominant producers gradually increase the amount of water added to their milk, they may be able to sell the milk to an unsuspecting public, thereby increasing the volume sold at minimal additional cost.

Consumers in the United States unknowingly bought horsemeat sold as beef and meet packaged in unsanitary conditions before early twentieth century outrage led to government regulation of the meat industry.

More recently, consumers have worried about insecticides in orange juice (the media reports suggest this contamination was unintentional) and baby formula imported from china diluted with plastics (this appears intentional in an effort to cut costs and increase profits).

Some government regulation attempts to ensure fair competition. For example, a firm cannot legally sell goods and services at a loss to force a competitor out of business.

Similarly, government regulation attempts to ensure fair competition between capital and labor. In unregulated capitalism, workers have just one right, i.e., to quit. On occasion, employers have even sought legislation to prevent workers from quitting while preserving the employer’s right to layoff or otherwise terminate a worker’s job (e.g., the coal mining industry in the first half of the twentieth century). Unions, at their best, counterbalance the power of employers with the power of workers. However, maintaining that balance is comparable to walking a tightrope. Many employers want to restrict the ability of workers to form unions (a right rooted in the right to free association guaranteed in the U.S. Bill of Rights) and unions incessantly struggle to limit employers’ powers, e.g., stipulating extensive legal requirements that an employer must meet before laying off employees.

Another set of government regulations attempt to ensure fair competition between enterprises in one’s own nation and those in other nations. Tariffs, which have fallen out of favor, were intended to keep the cost of imports disadvantageously high. Free trade legislation has the opposite purpose: removing barriers to trade to allow competition to drive down the price of goods and services. Outsourcing abroad and the move of many manufacturing jobs overseas are the latest results of competition (the survival of the fittest) as domestic firms increasingly have to compete with a growing number of foreign firms.

Yet other government regulations (the tax code, e.g.) are efforts by various special interests to give certain products, services, or producers a competitive edge. In the never ending struggle for the survival of the fittest, government regulations can give producers significant advantages (e.g., the military has to buy domestic goods and the federal military academies for many years had to serve real butter, not margarine, to their cadets and midshipmen).

Government actions that prefer one set of goods/services/producers over another (and there are literally hundreds of thousands of this type of government action in the U.S.) give those receiving the preference an unfair competitive advantage. Those receiving preferential treatment argue vociferously in favor of their treatment, usually citing multiple reasons. But all such regulation necessarily disadvantages others. Otherwise, those who receive the preferential treatment would not invest scarce, costly resources in advocating for the regulations.

Some government regulations add little value to the competition. Illustrative of excessive regulation are mandated lengthy product warnings, worded in almost incomprehensible language and printed in fonts so small that they discourage reading. No matter how well intentioned the regulation mandating such warnings, these rules have little or no practical value, adding cost without benefitting consumers.

Other government regulations provide an incentive for innovation (patents, trademarks, and copyrights – the basis of intellectual property rights) but also can diminish competition, even creating unintended monopolies. This allows excessive profits and distorts market efficiency. Without intellectual property, commercial firms would have no incentive to conduct drug research, for example. Discovery of a new drug and obtaining government approval for it as effective and safe is a lengthy, expensive process (perhaps too much so!). However, once approved a new drug that treats a previously untreatable condition can provide a company with a significant revenue stream and outsize profits. The challenge is to balance an incentive for developing new drugs with society’s need to keep healthcare affordable.

In general, regulations are good that enhance competition (1) by enabling consumers to have reasonable trust in the goods and services purchased and (2) help to provide a level field for competition. Regulations are bad that (1) give some competitors an unfair competitive advantage or (2) do not add value to society or free market competition.

Sadly, political discourse in the United States (and most other Western nations) is so impoverished and polarized that informed discussion of a topic as complex as beneficial government regulation of free market capitalism, striking appropriate balances between competing goods, almost never occurs. Demagogues shout for more regulation; other demagogues shout for less government regulation.

What the economy, consumers, and businesses badly need is the right regulation. The mortgage bubble underscores this problem. Mortgage sellers had warped the playing field so they had no long-term investment in the ability of buyers to pay a mortgage; buyers had allowed greed to overwhelm common sense. Politicians, regulators, and academics who articulate basic principles for determining what and how to regulate will help us restore free market capitalism to an even keel.

Properly regulated free market capitalism is the most efficient (least waste) and effective (most productive) economic system. Such a system best enables human flourishing. My next post on this subject will explore the cost of capital; the third post will examine free markets and the fourth post consider Christian ethics and free market capitalism.

The third post in this series on capitalism will examine the cost of capital and the fourth post will present a Christian ethical perspective on free market capitalism.

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