Market Solutions vs. Regulatory Solutions

Solving Problems: Regulation v. Market Approaches

Problem

A common theme in today’s political discussion is that the Federal Government should “get out of the way” and “allow free markets to work their magic”. In 2015 there are many who would turn policy over to Adam Smith’s invisible hand. Alternately there are many who call out for more federal and state intervention in markets.  The level of discourse between these two positions often amounts to little more than name calling with free market advocates labeling opponents “socialists” and fans of regulation accusing their opponents of being cold and uncaring (among other things!).

Goal of Essay

The intent of this short essay is to offer a few approaches that bridge this gap. In a nutshell there are two messages to be delivered: 

1. To the free market proponents we make the point that markets are only feasible when certain preconditions are present. To promote a market solution when major necessary “ingredients” are missing is futile. Nothing in this article should be construed as anti – market. Indeed by studying the conditions necessary for a market to exist we are promoting the use and existence of markets. There is no doubt that free markets –when they function properly - are a very effective, and efficient means of balancing price, production, and allocation of resources.

1. Conversely – to the policy makers urging the government to right a particular wrong (perceived) we would offer the considerations as a regulatory response is crafted:
• Is a market solution possible? (if so there may be no need for regulation)
• Is self-regulation possible?
• When we go forward with regulation we must carefully weigh and acknowledge the impacts created to achieve the "good".

Example Issues

In order to fix ideas we present some examples (with no intent to be exhaustive) of debates where market solutions are pitted against regulatory solutions. This essay – for the sake of illustrative ease – compares total market solutions to total regulatory solutions. But the reality is that every practical solution is on a spectrum between these endpoints. Indeed part of the art of policy making is finding a proper blend of these two streams of thought.

Example 1
The market will determine wages. Thus many espouse a position that says in the area of Executive compensation or Minimum wages  that government should keep their hands off. Regulatory advocates note that the market has not fixed these “problems” to date and that income disparity is increasing.  It is worth noting that in the case of both executive pay and minimum wage pay – there are many who would argue that there is no problem. So even agreeing that there is a policy issue on the table is difficult.

Example 2

The Cato institute recommends that we leave “questions regarding energy consumption, environmental standards, market structure, and technology to the market rather than government planners”.  Advocates of regulation point to environmental degradation and failure to develop plans for renewable energy sources as proof that the market has failed. The whole topic of climate change has added both urgency and confusion to these discussions.

Example 3

The Market for Healthcare and Healthcare insurance is in some ways ground zero for this debate. Free market proponents such as the Cato Institute promotes the ideas that: “consumers are better off when they, and not the government, are in charge of how their money is spent. This applies to health care, Social Security, and other areas where the government currently controls the dispersal of our tax dollars. In particular, Cato has been a longtime advocate of deregulating the health care industry, so that consumers can afford the health care insurance and treatment of their choice, and privatizing Social Security”. Those favoring regulation note that prior to the Affordable Care Act the uninsured population was growing and that many uninsured were accessing health care services on an emergency basis only.

Informed Market Solutions

To those coming forward with market solutions we note that they should be informed enough about the goods,services, and economics of the situation to to know whether a market can possible work!

It is crucial to know when a market can function properly and when it can’t. The conditions in which a free market will work have been understood for centuries. Indeed Adam Smith – the father of free markets – and capitalism understood them well.

The conditions for an effective free market are:

1. That information about price and product are freely available.
2. Consumers and producers always make rational decisions when purchasing or producing goods and services (i.e., buy at the optimal price and produce at optimal levels).
3. Entry to and exit from the marketplace is easy (low “barriers to entry”).
4. There are a large number of firms within a given industry, each selling a homogenous product.
5. That there is a medium of exchange working within a framework of property laws.

A market may work with some deviation from these ideals – but the farther from the ideal – the more the invisible hand fails. We may challenge each of these assumptions and see how such distortions would adversely affect the effective free flow goods, services, and capital.

For example without knowledge about pricing and quality – available on both sides of a transaction – the market won’t effectively reflect supply and demand. If consumers are motivated by something other than price –e.g. – status or environmental concerns then a market may not function effectively.

Likewise – we can easily see that buyers and sellers may try to violate these conditions. Firms would love to drive out competition and gain power over markets. Likewise – consumers won’t always behave rationally. Thus even within a functioning market – there are pressures to prevent the market from functioning!

However even as we note these concerns about markets we also note that – when the conditions outlined above are present – the market is a highly desirable means of encouraging innovation and development while balancing capital, production, and prices.

Effective Regulatory Solutions

It may be so obvious as to escape notice that the market only works on those considerations, which are factored, into the market transaction. Factors that are external to the transaction – so called “externalities” are left out of market consideration.  The classic externality is pollution. We can imagine a factory that has the ability to dump waste freely into a waterway. Until the cost of that is forcibly considered in the price – the invisible hand won’t deal it with.

Because of externalities and because there are sometimes societal goals beyond markets – regulation is a necessary policy tool.

However it must be recognized that all regulation inherently involves coercion of some sort – either a restriction of rights, a redistribution of wealth, or a requirement to engage in activity not otherwise necessary. Regulation will inherently cause resistance and will require ongoing policing and effort to maintain and enforce. In some cases regulation will actually reduce overall economic effectiveness if it unduly restricts an efficient market place.

To have effective regulatory solutions these downside effects must be both understood and acknowledged. The importance of articulating the “why” of regulation is necessary to promote acceptance of regulations. Without acceptance – the imposition of regulation becomes a flashpoint and causes on going issues – some of which may actually counteract the desired impact of regulations. For example – in the case of minimum wage regulation – employers may decide to go “underground”.

Full exposition of the cost of regulation should always be able to answer the question – is the regulatory cure – with all its costs – better or worse than the problem we are facing.

Illustrative Discussion – Affordable Care Act       

As an illustration the ACA is not ideal. Arguably health insurance and health care services are among the most complicated goods and services that we might consider.  However – we have selected it for discussion because it is such a flashpoint for this debate.

A very basic distinction needs to be made right away. The ACA deals with the market for healthcare insurance. It has many impacts on the market for healthcare services – but those are separate and distinct from the example discussed here.

Since it ‘s inception the ACA has caused much heated debate. Unfortunately – for all the pyrotechnics – the debate has not done much to improve the law (detractors want to destroy the ACA and proponents are forced to defend). In such and attack – defend – mode of argument not much improvement is possible.

Comments to those advocating Market Solutions for healthcare insurance:

1. Recognize that the ACA has consciously tried to create a marketplace with price (available on exchanges) and quality information (gold – silver – bronze policies) but that the complexity of the product is beyond many people’s ability to quantify. However while people may not make totally rationale decisions at the micro level – most can see that having insurance is better than NOT having insurance!
2.  Acknowledge the social goal of ACA – either accept the problem and propose an alternate solution – or own the fact that you don’t intend to fix the problem.
3. Be prepared to address the fact that prior to the ACA the health care system simply left many people out of the process.·      

Comments to those Supporting Regulations:

1. Acknowledge intrusions and income redistribution.
2. Seek to minimize such intrusion.
3. Be open to market solutions

Conclusion

This essay breaks not even an inch of new ground. Rather it re-presents well known elements of market theory and regulation. The intent is to address a political climate where by opposing sides talk -at – or past -one another. I realize that to some extent the so-called dialogue is really posturing and there is not any intent to improve markets or regulation. But I also believe that many people have been immersed in posturing and a dysfunctional political climate so long that the basic points made here bear repeating.

So in a sense – I am seeking political “climate change”.  We will know that this has been successful when we can hear a market conservative voice the rationale for regulation – and a pro-regulation liberal articulate the value of economic markets and freedom.