Friday, April 17, 2009

A time for regulation

The free market has been responsible for a lot of technological progress. It is also responsible for the improvement of life standards and the continued increase of productivity in the economy. It has also been known to bring prices down through price competition.

But a free market has also been responsible for a lot of the problems and inefficiencies in the economy today. This comes largely from the selfish pursuit of individuals to maximize their gains, or their utility, even if it comes at the expense of the whole.

A doctor wishing to guard against malpractice liabilities may prescribe more tests than is necessary, thus increasing healthcare costs for everyone. Meanwhile, patients seeking to recover more than is justified may also be contributing to the doctors’ fears of malpractice liabilities. Meanwhile, overall costs go up, not just for those whose healthcare really warrants it, but also for those who may otherwise have gotten treatment for much less.

A bank trying to earn more fees will underwrite more loans than is prudent, but unload the risky assets to investors seeking more yield. To fool themselves of their prudence, they will seek the input of ratings agencies, themselves seeking to earn more fees, to provide AAA ratings to these assets. As more transactions make underlying asset prices go higher, the greater momentum there is for everyone to earn more by doing more of the same.

Individual agents doing what is best for them in a free market society. Actions that lead to worse consequences for society as a whole. So, do we dismantle the free market?

Unfortunately, there is no better alternative for now. The free market works best because of two things: As an organism, it has 1) no ideology ,and 2) no conscience. Hence, we could say that there is no one vested interest in a market that is truly free. What happens is the consequence of actions made by consenting parties to achieve their individual goals. What clears a free market is generally the greatest good for the greatest number.

Nonetheless, not everyone in the market is equally bright, equally informed, or equally just. Very often, the best outcomes in a market go to those who can game the system – those who are more bright, more informed, and less attuned to justice and fairness.

Sometimes, market outcomes come about from unintended consequences of actions made by individual agents not trying to gain more, but just seeking to protect themselves. Consider the doctor in the example above.

We might say that these outcomes happen precisely because the market has no conscience. We might also say that the market is myopic, only seeking what is best among participants at that point in time. Who’s to say that the best outcome is being attained when companies mine all the world’s oil, and pollute the environment, in order to meet the never-ending demand for goods of a growing population, at the most affordable price for the greatest number? What happens tomorrow, when all the resources are mined out, and the environment is unalterably changed? Who’s to pay for that?

Other people might say this is where government comes in, to provide the macro insight, the long-term planning, and….to wit, the necessary conscience to society. But is the government really the best entity to provide these? And what if its efforts to undertake these functions undermines the original advantages of having a free market?

There is no permanent right answer. We should just do our best to see what is most optimal given current circumstances, and know that since society is made up of individuals and group making actions that affect the whole, there will come a time when the pendulum will lead us back to where we were before.

Today is the day for more regulation. Tomorrow, we can dismantle those that just get in the way.

No comments: