Video 6 of 12 of the Libertarian Public Policy guide (Download MP3 Version)

Capitalism 22:11

Even though markets aren’t perfect, most regulations end up being counterproductive. Other regulations, like contract enforcement and rules against fraud, help.

Miron: Today we’re going to talk about capitalism, in particular, the regulation of capitalism. As you know, market economies have all sorts of regulations, in various ways, of various industries, broken into a broad number of general categories – antitrust regulation, consumer protection laws, entry barriers, licensing restrictions, environmental policies, health and safety regulation, and much, much more.

The standard defense of all this regulation is that while markets may well be pretty good at producing goods and services at relatively low prices and in a relatively efficient way, they’re imperfect. There are examples of monopoly, of externalities, of imperfect information. Also are examples where consumers are not good at making decisions on their own behalf. That, in some people’s view, justifies lots of interference with lots of regulation of capitalism rather than just leaving it unregulated.

The libertarian response certainly accepts that markets are not perfect. Nothing is going to be perfect outside of the textbook. There are going to be ways in which any private market doesn’t do exactly what we would like it to do at every moment in time. But the response is simply that regulation is often worse than whatever imperfections exist in the market. So laissez-faire, defined more clearly in a moment, is the lesser of the evil, and we’re going to discuss that in this lecture. We obviously can’t go over every possible regulation, but we’ll talk about the main categories which I think illustrate the kinds of arguments that libertarians make.

The outline is as follows: We’re first going to explain why the libertarian view is not properly understood zero regulation. There are certainly some types of government involvement in capitalism, in markets. The libertarians endorse and think they’re quite beneficial.

Then I’ll go through five different examples of broad areas of regulation: consumer protection, unions, antitrust, environmental policies, and professional licensing as good illustrations of the pitfalls of regulation and why much less is probably a better outcome.

Libertarian views are often characterized as being in favor of unbridled capitalism or no rules, just complete cowboy capitalism and things like that. But that is not properly understood libertarian view. Libertarians absolutely support what you might call rules of the road, various government interventions that lay down some basic lines that people are not supposed to cross, so that the markets can work efficiently. And libertarians view those minimal interventions as being necessary for smoothly functioning markets.

So what are these particular interventions? First and foremost, defining and enforcing property rights. Unless people know who owns what, unless that’s clear, and unless people know what when those property rights are infringed, they have some recourse that allows them to claim that their property has been infringed and collect damages as appropriate. You might see chaos as people make all sorts of claims about each other’s property. Some of that dispute resolution will end up being violent. People fear that they don’t have the right to the fruits of their labors, so they don’t want to invest, they don’t want to acquire education, and so on. Therefore, defining and enforcing property rights is certainly a crucial thing that probably does need government intervention.

Closely related – actually just a version of the definition and enforcement of property rights – is contract enforcement. When people enter into agreements, they want to know that if someone abridges the agreement, the person who is injured has the ability to try to collect the damages that might’ve been inflicted, and to do so in a way which is not usually disruptive, which is not violent, which doesn’t have itself some negative spillovers.

Limits on fraud is another example. If people can’t rely on claims that others make, then you’re not going to get an efficient allocation of goods and services, efficient production, and so on.

So the question is really not whether to have regulation. The view that libertarians are for zero regulation is really just a spin to make it sound unreasonable. The question is what kind of regulation and how much. Libertarians absolutely argue that we should have way, way less and mainly different kinds of government involvement in markets than we currently have. But we’re certainly not arguing for zero.

With that general framework, let’s talk about some specifics. One broad area of intervention is consumer protection policies. Restrictions on advertising, i.e. bans against false and misleading advertising, government agencies that try to prevent bad markets from getting into the marketplace in the first place, such as the consumer product safety commission, warning labels on foods and all sorts of other products that try to tell people that there might be negative side effects or some dangers-associated particular products – those are all examples of consumer protection policies. The claim behind those policies is that unscrupulous firms might try to take advantage of naïve or irrational or stupid consumers, sell them things they don’t really need or want, sell them things that are excessively dangerous so that they have side effects that the consumers won’t be aware of and won’t think about. According to this argument, we need government to protect consumers from themselves because firms are trying to systematically sell them things that they don’t want or in ways that might not be actually in the consumers’ interest.

Of course, there’s a teeny bit of truth in that characterization. Some firms sometimes do unscrupulous things. Firms are of course trying to make money, so they want to sell more things to consumers rather than fewer. But that view that we need regulation ignores a whole bunch of realities that need to be taken into account in balancing protection of consumers against having an efficient, well-run marketplace.

First of all, with respect to advertising, there’s amazingly little evidence that advertising gets people to buy things that they don’t want. The vast majority of advertising is trying to get people to buy one manufacturer’s brand instead of another manufacturer’s brand. Think about Coke versus Pepsi. All those ads are doing very little to get people to become cola drinkers. They’re mainly trying to switch you back-and-forth between one brand and the other. And even all the advertising encouraging brand switching seems to be surprisingly ineffective given the amount that firms spend on it. But in any event, it does not seem to systematically con people into buying things they don’t want and don’t need. Advertising also contains lots of information that is useful to consumers. It would be very hard to try to prevent false, misleading advertising without simultaneously preventing the good aspects of advertising.

A good substitute for advertising are private mechanisms like consumer reports or J.D. Power and Associates or articles in local newspapers about new products or warnings about faulty products and so on. It’s not the case that in the absence of government, consumers would have no ability to get information. There are many sources already, even though the government is trying to protect consumers. And there would likely be far more if the government were trying to take over this role, so consumers would be able to learn from their friends, from their family, from websites, from magazines, from all sorts of sources about which products might be the best, which have the best relation between price and quality, which might be dangerous, and so on and so forth.

Restrictions on advertising are also quite dangerous because they tend to reduce competition. A key way that new businesses, new firms etc. can make inroads against established businesses is by advertising. So any attempt to restrict advertising is going to tend to make firms use weaker claims out of fear of false and misleading claims, and that’s unhealthy for competition in the marketplace, closely related to the next item we’ll get to.

In addition, competition deters false claims. If one car manufacturer is saying things about his cars that are clearly wrong, other than just drive our car because you’ll look good in it, but factual claims about its speed, about its mileage, about whatever, the competing car manufacturers have great incentive to try to debunk those claims. So that’s another huge source of consumer information and protection without any government involvement.

Finally, there is a quasi, a partially government mechanism that helps discipline bad claims and other bad behavior by firms which is toward liability. If you are injured by a product that you’ve purchased, if it made claims that are clearly false and you haven’t been able to benefit in the way the manufacturer promised, the seller promised, then you can sue. Sometimes you can sue in class action suits if there are many people who’ve been injured, and that exercises significant discipline on any business’s desire incentive to make those claims in the first place.

Lastly on consumer protection, it is really hard to engage in this type of activity without creating a false sense of security for consumers. If consumers think the government has done all these good things to make sure there are no bad products in the marketplace, then consumers don’t feel the incentive to go in and use their own brains and to think about what they’re buying and make sure that they are safe. That’s a problem because the government can’t possibly think of all the possible negatives, can’t possibly rule out all the problems. Consumers need to be using their own brains in order to make sure they’re getting a reasonable deal, but the false sense of security from government regulation tends to undermine that.

Switching to another broad category, antitrust policies are policies that try to prevent mergers which might create monopoly power, try to prevent business practices which might tend to give businesses monopoly power and so on. That is, antitrust tries to promote competition. Now this is an interesting area for libertarianism because all of economics suggests that competition is a good thing. We would like there to be a number of firms who are trying hard to get the consumers’ business. That’s going to tend to lead to a situation with a relatively low price, relatively high quality. Prices will be driven down to cost, and consumers will benefit from that competition. So it might seem as though antitrust policy really makes a lot of sense. However, most of the evidence suggests that market power exercised by businesses is actually fairly modest. And a huge amount of the market power we observe in market economies has been created by government. Patents is one example, copyrights another example. Other cases where government has imposed barriers of entry such as licensing, which we’ll discuss later, are all things that government has done to create market power. The examples of strictly privately created market power are few and far between. So the magnitude of the problem that needs to be addressed is probably much smaller than what many people think it is.

In addition, some of the actions that are prevented or discouraged by antitrust policy are potentially quite disadvantageous. The threat that your business might be acquired by someone else and would fire the management and replace it with new management is an incredibly powerful discipline device for markets. Businesses that aren’t performing well, that aren’t doing what their shareholders want, that are trying to line their own pockets, or that are just not very good at running their businesses, are going to get bought out in a world where there are no restrictions on acquisitions, mergers, and the like. But antitrust gets in the way of that by making businesses worry that they can’t acquire those firms because they’ll be accused of an antitrust violation.

Likewise, firms sometimes use antitrust as a weapon. They tell the justice department to go after such and such a business because that business is allegedly doing something that’s anticompetitive. What it’s actually doing is just something that’s better than the business that’s complaining. So antitrust has many times been used strategically by rivals simply to try to get a competitor out of the way. The cases against Microsoft are classic example. Sun Microsystems played an active role in encouraging the government to pursue those suits.

Finally, even if there is monopoly power for some industries at some times for some length of time, that has a very useful benefit so long as it doesn’t last forever, which is that monopoly power and profits that come with it create an incentive for innovation. If you know that, say, PalmPilot has been created, and it’s this great handheld device that combines all your personal affairs, your calendar, your phone, and all that, and people really like it, and they’re paying huge amounts to get it, that gives all other firms the incentive to go out and create a competitive device. And what we’ve seen is this mushrooming of handheld devices that now do way, way, way more than the PalmPilot ever did, and that’s because there were monopoly profits to be competed away. If the government is always regulating those back towards zero, the incentive for the innovation is not going to be there in the first place. So antitrust policy done very, very thoughtfully, in great moderation, by a really competent, benevolent dictator, maybe there’s some role for a little bit of that. But in practice, it seems to do much more harm than good. So libertarians are quite suspicious of antitrust policies.

Another broad category of government intervention in markets is giving protections to unions. Libertarians of course have nothing against unions per se. Libertarians are always in favor of people being able to freely assemble and discuss and do whatever non-coercive things they wish. What libertarians oppose is government protection of unions, i.e. laws, rules etc. that force companies to negotiate with unions, that put restrictions on companies’ ability to deal with unions, such as by saying to a union, “You guys are free to try to negotiate with me, but I don’t want to negotiate with you. I’m going to negotiate individually with each of my employees,” or to say, “You’re free to go out on strike. That’s your right. And I should be free to fire you for going on strike, or I should be free to hire replacement workers.” It’s the restrictions imposed by government on those actions that libertarians oppose. Analysis of the unions is very, very simple. They are unambiguously bad for economic efficiency. Artificially, the government protections help unions raise the price of a key input into all sorts of activities, raise the price of labor, and make it more expensive to produce various goods, services, and so on. They are justified by the union members, by the unions, because they raise wages. But they raise wages for those people who are still in unions, not for everyone. They lead to lower wages for the people who don’t end up being in the unions. They lead to lower wages for people who don’t get the jobs. So their effect on the distribution of income is at best ambiguous, is at best this weird mix of helping some people in hurting others. And they’re simultaneously bad for the efficiency of the economy.

In the U.S. these days, private unions don’t have a huge amount of power except in a few industries. In other countries, private-sector unions are still quite important and play a big role in distorting the allocation of labor. In the U.S. and many countries, public-sector unions are an even bigger issue because they have organized very effectively and do play an important role in raising the cost of providing government services. What everyone thinks about any particular part of government, it should be produced at the least cost. The public-sector unions raise the cost and therefore are also problematic.

Turning to environmental regulation, that’s an interesting area because libertarians are often portrayed as being anti-environment or at least anti-regulation. Nothing could be further from the truth. Properly interpreted, there’s no conflict at all between libertarianism and protecting the environment. It comes down to the definition of property rights. If the property rights to land, to water, to air, and so on and so forth are clearly defined, then we have a market. We don’t have any externalities. We don’t have any negative spillovers because everything is owned by someone who has the right to sue if people damage it. If some company dumps toxic waste on your land and there’s clear ownership as to owns it, that you own that land, then you can sue, and that will be disciplined by the mechanisms we discussed quite readily. It’s only when we have property rights that are not well-defined that there will be significant externalities and there will be problems of reducing pollution and other things like that. So libertarians absolutely endorse proper definition and assignment of property rights to solve environmental issues.

Classic example is fences. In the West, when there were no fences and cattle ranches could graze wherever, they got in each other’s land. There was excessive grazing that made the grazing land less effective. The same thing happened hundreds of years earlier in England. England solved the problem by defining property rights and setting up fences. Then each person had a certain amount of land, grazed their cattle on that land. And that meant that there was no spillover. There was no excessive use of those resources.

Now it is in fact hard to assign property rights in some cases. The air that’s right in front of my face, it will be pretty hard to say, “I own that air and you don’t, I get to breathe it and you don’t,” and so on. So some types of regulation that don’t just assign property rights but say you can’t put certain types of substances into the air or you can’t put certain things into the water may be well justified as a reasonable response to the difficulty of formally assigning property rights. So in the U.S., the Clean Air and Water Acts of 1970 are plausibly an okay compromise that said we should certainly look at them carefully to see if they’re generating benefits in excess of cost. The benefits could be that the air is cleaner and that’s good for people’s health. The water is cleaner, so people can fish, swim, drink the water, and so on. But it could be that the regulations are imposing huge cost and discouraging activity so much that it’s not enough benefit to justify those costs. And the literature finds varying results. Some sorts of regulation that attempt to address the property rights issue seem excessive. Others seem like they might be plausibly motivated, given reasonable assessments of the cost and benefits.

Now all that said, there is of course tons of regulation that libertarians argue is misguided in the environmental area. Endangered Species Act imposes all sorts of restrictions on private property with minimal demonstrated benefit in terms of protecting species, mandated recycling, almost never passes any sort of thoughtful cost-benefit test, all sorts of energy policies that are pushing for solar power, for wind power, and so on and so forth, rarely meet standard economic analyses of cost-benefit calculations, even addressing the possibility of global warming issues and so on and so forth. So while libertarianism is absolutely for certain kinds of environmental policies, especially when they are limited to defining property rights, they’re also quite leery of many because they just don’t pass standard, straightforward economic analyses for having benefits in excess of cost.

Last general category I’ll discuss is professional licensing. Governments erect barriers to entry in a range of professions: medicine, law, plumbing, electrician, hair dresser, many, many, many more. Academia is actually one of the few, to the best of my knowledge, that doesn’t have many government-created barriers to regulation. Harvard could hire someone with zero years of education to be a professor if it so chooses. Government doesn’t get involved in that anyway. But, that aside, many, many professions have these barriers. The effect of these barriers is to lower the quantity of people who are able to provide that service, such as becoming doctors, and apply higher prices because when you reduce quantity, you raise price. And the claim in defense of this licensing is that we raise the average quality of the services being provided. We keep unscrupulous doctors from becoming doctors. And that protects consumers. The evidence doesn’t back up that set of claims. It certainly confirms that licensing reduces the quantity of the service that’s supplied, and it raises the price. That’s exactly as you would expect from standard economics. But the evidence doesn’t support that we get higher average quality, or in any way, shape, or form, enough improvement in quality to justify the fact that we have made a particular service – such as lawyer service, accounting service, medical services – more expensive and therefore introduced an inefficiency, unless we have gotten big improvements in quality, and we don’t see the evidence for that. So these licensing barriers are a lose-lose, and they are especially bad for people of lower incomes because raising the price of course affects them much more than it affects people of moderate or higher incomes.

To summarize, market economies have tons of regulation. Some of that is well-intentioned, clearly. Some of it is not even well-intentioned. Some of it is an attempt to prevent competition for the services of the people already in an industry or whatever. There’s certainly a good case for some government involvement to establish and enforce rules of the road so that capitalism works smoothly. Libertarian view is not for zero government; it’s for these limited types of intervention, definition and enforcement of property rights, contract enforcement toward liability.

There are a few other plausible cases of regulation that libertarians would endorse that are along the same lines, in particular, some kinds of environmental regulation. Overall, however, libertarians argue if we have way too much regulation, we would get substantial benefits from scaling back or eliminating most of it. Thank you very much.

Topics Capitalism