My first post this week led to some interesting discussion in the comments, which has in turn led me to this post.  One issue that came up there was, and I paraphrase: “Okay, fine, markets really do benefit the poor, but the dispute between modern liberals and libertarians is not over ‘markets’ but over ‘free markets.’  Libertarians don’t want the regulations that liberals do and saying that ‘markets’ help the poor doesn’t help us resolve this issue.”  Fair enough.  So why might libertarians, and bleeding heart ones at that, argue that markets should be free of government regulations?

The short answer, which I will assert here and defend below, is that whatever the intent behind government regulation of markets, it almost always ends up working in the interest of the rich and powerful and does little to protect the interest of those with modest means and little access to power.  If a commitment to social justice demands that we care first and foremost about the least well off among us, supporting government regulation may well violate that commitment.

The problems begin when people underestimate the task facing regulators.  As Mises, Hayek, and other Austrian-influenced economists have pointed out, markets are very sophisticated epistemological ecosystems.  As Hayek made clear 66 years ago, the problem we face when try to “construct” an economic order is how to best make use of all of this knowledge, which is dispersed, contextual, and often tacit.  His answer was that the price system enables us to make use of the knowledge possessed by others, even when those others cannot articulate or put into statistics exactly what it is that they know.  Our acts of buying and selling cause prices to change and enable those prices to serve as surrogates for the underlying knowledge.  Without directly accessing others’ minds, we are able to have some knowledge about what they value that, in turn, enables us to allocate resources in ways that match those valuations.

Mises and Hayek also argued that because this knowledge is structurally dispersed, contextual and tacit, it cannot be aggregated by government planners and regulators (nor, it’s worth noting, by private actors).  The only way to make this knowledge available to others is in surrogate form through the price system.  This, they argued, is why attempts at planning economies (such as socialism) are doomed to fail:  the planners cannot make use of anywhere near as much knowledge as the price system allows people to make use of.  The result is that it is only the limited knowledge of the regulators that dominates, not the wisdom of crowds that emerges from free markets. Without a price system we are blind;  when we regulate markets, we are vision impaired.

So one problem facing regulators is that they lack the knowledge necessary to know what people value and how much, so in deciding what to regulate and how, they are acting on incomplete and often erroneous information.  By trying to override the market, they are substituting a less informationally-rich system for a more rich one.

Even well-intentioned regulators will face these problems, often not just not solving the problem they are working on but creating more in the process.  In the face of these repeated failures, it’s very easy to imagine, and there’s plenty of evidence to support it, that regulators and the politicians who oversee them will start to act in their own political self-interest.  Without the ability to make reliable decisions on the objective merits, self-interest will slowly dominate.  Regulators will try to serve the needs of those who will keep them in power and supply them with healthy budgets.  So-called “Capture Theory” explains that it then becomes easy for regulators to be “captured” by the industries they regulate and then regulate in ways that favor the industry.

Of course once the power to regulate is granted, those directly affected by possible regulations will use their wealth and power to lobby the political process to intervene in ways that benefit them.  For example, about 75% of antitrust cases are initiated not by the government but by private firms unhappy with how their competition has behaved.  Private actors constantly engage in lobbying and rent-seeking for regulations that will benefit them and/or harm their competition.

Those who stand to gain concentrated benefits from regulation, such as firms, will lobby to get regulations that benefit them, while the costs are dispersed across hundreds of millions of us, none of whom have any incentive to object, nor the resources or power to affect the outcome.  As markets get increasingly politicized, it will be those with the best access to the political process who will call the tune and benefit from the regulatory process.  They, suffice it to say, will not be those who are the primary concern of people focused on social justice.

Specific regulations, of course, will have a variety of problematic effects,  often landing on the shoulders of the least advantaged, e.g., the ways in which minimum wage laws worsen unemployment among the least skilled workers, usually the young and non-white.  For me, as an economist, the argument against a great deal of regulation is precisely that it harms the least well off it is trying to help and provides unwarranted privileges for those who need them least.  There is plenty of historical evidence of the role of big business in lobbying for and helping to write a whole variety of regulations.  As I’ve argued elsewhere, this is a feature of the mixed economy, not a bug.  My First Law of Political Economy is “No one hates capitalism more than capitalists,” and the mixed economy is not accidentally rigged to benefit the powerful.  That is why it’s there in the first place.

As long as the state regulates, the possibility of private profits will lure with those with power and resources into that game and it’s a game they will inevitably win.  And the losers will be those without the power and resources.  Free markets don’t give us utopia, but I really do believe they do better by the poor than do regulated markets for the reasons I’ve outlined.