Today’s guest post is by long time commenter Cowboy.

JMB275 had asked me to share a few thoughts relative to discussing how much market regulation is reasonable, and where to draw the line. I don’t intend for this post to be a total consideration of that question, but perhaps to just serve as an introduction as how to think about the issue.

Open any introductory level economics textbook and one of the first topics you’ll be introduced to is the partitioning of economic analysis into the categories of normative economics, and positive economics.

  • Normative economics is that part of economics that expresses value judgments (normative judgments) about economic fairness or what the economy ought to be like or what goals of public policy ought to be. (Emphasis mine)
    (http://en.wikipedia.org/wiki/Normative_economics)
  • Positive economics is the branch of economics that concerns the description and explanation of economic phenomena. It focuses on facts and cause-and-effect behavioral relationships and includes the development and testing of economics theories…Positive economics as such avoids economic value judgments. For example, a positive economic theory might describe how money supply growth affects inflation, but it does not provide any instruction on what policy ought to be followed.
    Still, positive economics is commonly deemed necessary for the ranking of economic policies or outcomes as to acceptability, which is normative economics. Positive economics is sometimes defined as the economics of “what is”, whereas normative economics discusses “what ought to be”. (Emphasis mine)
    (http://en.wikipedia.org/wiki/Positive_economics)

The first question to ask then is, “what should the economy do?” Now generally the response at a rudimentary level will have something to do with the equitable distribution of wealth and other resources, including the division of labor. Even when considered in isolation that response isn’t entirely satisfying because it leaves so much uncertain as regarding what is “equitable”.  Furthermore, it does not adequately address a more fundamental perception of human nature, fairness. Even more complex is that the way society views fairness, and to a lesser extent, equity, varies across culture and even within cultures.  So, how do we decide in such a way that all parties are in agreement? It would seem only natural that disagreements will arise over something as ambiguous as fairness and equality. After all, what is fair is not always equal and what is equal is not always fair.

Exploring the normative question “what should an economy do?” even further, we will have to recognize other competing ideals besides equality, where each alternative presents us with cost/benefit tradeoffs that are not always easy to quantify, and therefore subject to a wide range of opinions. For example, Milton Friedman as well as most parties to the classical liberal movement would argue that the highest ideal should be political and economic freedom. While this is not advocacy for anarchy, it is a philosophy of limited government interference that allows the distribution of wealth to be largely market regulated. Few classical liberals will debate that this system provides wealth disparities and even some poverty, however they argue that the greater good of maximizing political and economic freedom outweighs the desire for economic equality.

Most readers will have recognized by now that the American ideals we were brought up with tend to favor sentiments of liberty and freedom, and so we should all be on the same page then, right? Of course this is not true, so then why not? Economists spend a great deal of time trying to express models of rational behavior, by calculating Opportunity Costs (any web resource should be adequate, so look it up yourself), or essentially the quantifiable tradeoffs between opportunities. This works fine when used for standard business and financial problems, such as the classic make or buy decisions. In that scenario it is easy to quantify each opportunity directly in financial terms. However, many of the problems that we deal with are not easily converted into a standard unit of measure. For example, how do we balance accounts between efficient production (high volume, low cost) and environmental effects? The same is true of liberty and equality. How do we express these ideals in comparable units so as to determine how much equality we are willing to exchange/sacrifice for one more theoretical unit of liberty. This is where most of the debate comes from when considering the normative implications of market regulation. While there may be something of an American ethos regarding freedom, our respective weighting of that “good” against other needs tends to vary from person to person, and not surprisingly along the socio-economic spectrum­­­.

Having in mind a view of what it is that an economy should be doing, an equally difficult task arises in deciding what, if anything, ought to be done to direct us towards these ideals. This requires an assessment of the current state of the economy, which can often be difficult to measure. To be clear, measuring things like unemployment or changes in the price level are not overly taxing, but explaining these observations in terms of cause and effect is where significant debate occurs. For example, a popular debate that made the rounds about a few years ago was whether a New Deal era law, The Glass-Steagall Act, was to blame for the housing crisis. The law was designed to separate the banking activities of consumer lending institutions (Standard savings and loan banks) from Investment Banks (Firms that underwrite and market corporate securities). The fear was that banks that participated in both activities may be encouraged to engage in risky behavior. This law was repealed in 1999, and some argue that it was this repeal that encouraged banks to take greater risk in issuing home loans, through stimulated demand from investment banks wanting to increase the volume in their derivatives portfolios.   The counter argument is that most of the financial institutions had already taken advantage of loopholes that allowed them to function with minimal imposition from the law, and that the real driver behind risky lending was the regulatory pressure to lend to low-income and low-income minority Americans, through overhauls in the Community Reinvestment Act.

Perhaps of equal concern to determining appropriate regulations is managing the unintended consequences and the practical implementation of various regulations. Many regulations seem to start with the right idea of recognizing a problem and wanting a fix, but as the old saying goes, “the devil is in the details”. I attended a private presentation a few years ago in Salt Lake City, presented by former Governor Mike Leavitt, while he was acting as director for Health and Human Services. The topic was health reform, and health insurance regulation. A point he made that has kind of stuck with me was that when law makers pass laws, they often get a sense of tunnel vision to where they fail to take into consideration just how onerous compliance is when taken en masse. He said that most laws when seen in isolation actually make sense and often address a legitimate need. The problem is that over time these regulations have accumulated into an unmanageable burden just on account of the sheer volume of regulation.  This creates a problem where many business owners and executives feel that the law has set them up to fail. Not because they have no interest in being compliant, but because accessing resources that provide adequate awareness and compliance solutions are very costly, or hard to integrate.

My thoughts – I would argue that regulation is neither a good thing nor a bad thing, but that on a case by case basis of course it can be either. Part of my concern with current legislation is that we have recently seen a great deal of substantial compliance and reporting regulations that are consuming huge resources, diverting attention away from productive activities, and lending to overall market instability. This has many employers and firms behaving very cautiously in anticipation of higher cost, lower employment, and reduced demand for their products and services. While the sheer volume of regulation is onerous, it always has been. The greatest challenge that I see is the unpredictability in the market place. Because there is uncertainty, firms are careful to take actions that could be substantially taxed, such as hiring employees. Where possible many will consider technological substitutes for labor as the cost of labor continues to rise through required wages and administration of employees.

So as not bore anybody to tears with a long and dry post, I suppose I would like to posit a few discussion questions.

  • What role should government play in economic activities?
  • How do we balance freedom and equality – which is more important?
    • What concessions in freedom should we be willing to make for greater equality?
    • What concessions in equality should we be willing to make for greater freedom?
  • What kinds of things should be regulated, and what should be left for markets to decide