I posted yesterday at how irksome I find it that “free market” has come to mean government guaranteed monopolies, generating obscene salaries for banksters, health insurance, and telecom executives (but not necessarily generating returns for shareholders).
Today, again in keeping with the themes of Free Lunch, we are gonna talk about how important regulation is to a successful free market economy. There are two kinds of regulation that may come to mind. The first probably (because there is much more Sturm and Drang about it) environmental regulation, zoning and other bits of government that deal with what economists call externalities and public goods. Pollution, roads, public education, defense and other forms of government activity fall into this category, and obviously extend beyond just regulation. Regulation is one way to deal with a mixed economy’s need to deal with these issues–truancy laws, pollution restrictions, noise ordinances etc–but that is a topic for the next post.
The other kind of regulation is at least as important, and is absolutely essential to a free market economy’s operation. And,yes, it’s irksome that you may find that sentence contradictory–“How can regulation be essential to a ‘free’ market? I thought the whole point of a free market is that it is self regulated by an Invisible Hand.”
The problem is that there are informational asymmetries in any market economy that have to be dealt with through regulation. Take the simple example of a weekly market, a bazaar, where people sell rice and beans. If there is nobody in charge of certifying weights and measures, then the market will fail. If you have ever been to such a market in a third world country, you’ve seen this. Vendors use balance scales, and weights that have been stamped by an authority. Or, if you read Tom Levenson’s book about Newton and the Counterfeiter that we talked about last week, you’d know similar problems with reliability of the currency threatened to take down the English government. Without a trusted third party confirming that a kilogram is a kilogram, these markets will fail, gradually dominated by short sellers. Oops. I mean people who short their customers, selling less than they claim.
If you think about the US economy for a bit, you realize that this kind of regulation is both pervasive and essential. If, like me, you live in New York, you think of taxi cabs with their certified, sealed meters. If you have a car, you might think of the certifications you see on the gas pump when you fill up. Or when I noticed in the grocery store that my half gallon of orange juice now only had 59 ounces in it, that was only possible because CocaCola/Tropicana were required, by law, to change that value when they cut the packaging size from 64 ounces.
This idea extends beyond weights and measures, of course. The basic principle is the government serves as a trusted third party that certifies to buyers that the seller is honestly offering the goods she is claiming to offer. This principle underlies the role of the FDA, certifying drugs (at certain dosages) as safe and efficacious. It is why we have restaurant health inspectors, certifying that the food being served in a way that assures it is not spoiled or tainted.
I suppose it is obligatory to note that there people who claim these trusted third parties would arise naturally, without government involvement. Libertarians point to Underwriters Laboratory or Consumer Reports as examples. Aside from noting that these are non-profit entities that rely on government subsidy for their existence, the historical evidence doesn’t support this view. Ineffectual, even dangerous patent medicines ruled the marketplace before the FDA. Slaughterhouses made a career for Upton Sinclair. More importantly, the relentless efforts of the regulated to undermine the regulators, even when the government is involved is evidence of the need for a trusted third party, that is actually trustworthy.
We have talked about the decline in effective regulation guaranteeing that consumers get what they pay for in previous Virtually Speaking programs. Marion Nestle comes to mind, with the discussion of pet food poisoning cats, and entering the human food stream. She has been writing recently about a similar topic she has also discussed with us, the conflict of the USDA as a source of nutritional guidance, and as a promoter of US food products.
David Cay Johnston discusses, very early on in Free Lunch, the failure of the government to properly inspect railroad tracks and switches–with the result that commercial rail is now, per million passenger miles, by far the most dangerous way for an American to travel. We will open the program with that tonight–but no spoilers now.
Via email from David: Corroded gas pipelines exploding in the suburbs. We will get to that early.