What Government Should Be Doing in the Markets

It’s hardly a secret that the 2012 election is shaping up as a contest between free markets and big government. And while the choice seems clear in the current political environment, it’s important to recall that government does play a critical role in the development and maintenance of functioning markets. Yet, as Tea Partiers, Occupiers, and Ron Paul acolytes all note, government has both abdicated that critical role and inserted itself where it does not belong.

If markets were magical places that flourished whenever government disappeared, Somalia would be the world’s leading economy. Markets are sophisticated mechanisms that enable informed parties to exchange resources, voluntarily, to mutual benefit. There’s a lot packed into that sentence. For markets to work, participants must trust the system. They must believe that they have–or least can access–the information they need to make informed decisions. They must feel free from coercion–both explicit coercion and unacceptable take-it-or-leave-it offers. They must trust the inherent fairness of the system, and they must believe that it is possible to enforce the rules of the marketplace by sanctioning cheaters. The closer an actual market comes to meeting these needs, the better it will function. The further a market drifts from these goals, the more likely it is to fail. It is thus absolutely critical that someone–presumably the government–serve as the market referee and the guarantor of market enforcement.

First and foremost, market participants must believe that courts will honor contracts and property rights fairly, dispassionately, and smoothly. Contracts allow strangers to exchange promises; property allows people to focus on matters in front of them without worrying about possessions that may be out of sight. In the absence of enforceable contracts and property rights, people could never travel far from home, leverage their assets, or exchange current payment or performance for a promise of future delivery with anyone unfamiliar. In short, a society that distrusts its courts cannot progress beyond a tribal or a village economy–even if it employs tribal or village markets.

Our government has abdicated its role as an honest arbiter of contracts and property rights. The time and expense associated with litigation are beyond the means of most Americans. In too many cases, the better funded party wins simply by outlasting its adversary, independent of the merit of the claims. Mechanisms designed to tilt the balance–such as class action suits–often create more problems than they solve. In the absence of significant litigation reform, Americans may soon question the viability of their contracts and their property.

Next, even voluntary exchanges are meaningless if they are uninformed (or poorly informed). The greatest moral argument in favor of markets is that they increase overall social welfare by assigning each resource to the party that values it most. But if people base their subjective valuations on misinformation, the market exchange will often assign resources to parties that undervalue them–simultaneously defrauding the individual victim and reducing overall social welfare.

In many respects, our overly legalistic approach to disclosure legalizes intentional misinformation. The housing and banking crises are perfect illustrations: most of the underlying deals contained full disclosures of all risks, buried somewhere in a sea of paper, bearing the signatures of people who neither read nor comprehended that paper affirming that they understood it. The way around this seemingly intractable problem is not–as many now advocate–to eliminate the markets in complex, risky financial instruments. The solution is to replace our legalistic approach to disclosure with an actual approach to disclosure. The law needs mechanisms establishing that both parties actually understood and were capable of bearing the risks at stake. Anything else guarantees a repeat of 2008–likely with another round of bailouts to save those we deem “too big to fail.”

Government also has a role to play in ensuring that markets remain voluntary. Setting aside the obvious and explicit coercive nature of Obamacare’s individual mandate, the typical source of coercion in markets is concentrated power. Market theorists as prominent as Adam Smith and Friedrich Hayek recognized the desire of powerful monopolists and oligopolists to control markets–both by elevating prices and by reducing quality and variety. Even Objectivists like Alan Greenspan (in his pre-Fed days) noted that government regulation frequently created business interests with enough power to eliminate effective voluntariness from the market.

There is, of course, already a body of law for preventing and combating such concentrations of market power. Antitrust law was once a hot political issue. Teddy Roosevelt, who entered the 2008 campaign as John McCain’s model and the 2012 campaign as one of Barack Obama’s many models, was a crusading, trust-busting, advocate of strong antitrust enforcement. Antitrust was once the weapon of choice of class warriors. By the 1960s, Richard Hofstadter’s “Whatever Happened to the Antitrust Movement?” noted that citizens had lost interest in the issue only because companies had internalized its constraints. In other words, American companies were curtailing their own growth through fear of government enforcement. But neither the economy of Teddy Roosevelt’s day nor that of the 1960s describes the situation today. In the modern economy, most companies possessing market power do so because the government gave it to them: through regulatory policy; through the imposition of high barriers to competitive entry; or through misguided attempts at industrial policy. Antitrust law does play a critical role in the modern economy, but Teddy Roosevelt is a poor inspiration.

As we head into the 2012 debate about the relative merits of big government and free markets; as market fundamentalists attempt to hijack parts of the debate; as American citizens from all walks of life and all political persuasions complain that the system has failed them; and as President Obama attempts to blame business for the failure of government; we must remember to focus on the proper relationship between government and markets.

The government’s job is to ensure that the system is fair, that people can enforce their rights, that people get the information they need, and that concentrated power cannot become effective coercion. Yet, in America today, few people can enforce or protect their rights; intentional, legal misinformation is rampant; and government, rather than monopolists, threatens coercive market exchanges. In short, government has abdicated its appropriate role in the market and assumed an inappropriate one instead. The restructuring of that relationship should be high on the agenda of our next President.