Clear 'Rules of the Game' for Free Market Capitalism

Appreciate all the Seeking Alpha comments I've received on my article titled "It's time to champion real free market capitalism."

Several have said that "real" free market capitalism should have no government involvement.

First, I don't believe that either Friedman or Rand would agree with that statement.

See this clip of Ayn Rand and Mike Wallace from 1959 (watch all 3 clips but the business/free market aspects are in the 2nd clip of the interview).

Wallace specifically asks her if all she cares about is protecting the "robber baron" (i.e., monopolist or oligopolist) capitalists. She clearly says she doesn't want to see monopolies and is favor of breaking them up. She also, of course, played an influential role in the 1st term of the Reagan administration when they (among other things) broke up Ma Bell.

I am not sure she wouldn't have supported keeping Glass-Steagall or breaking up Too Big To Fail Banks.

Friedman and Rand clearly saw a role for government for police, defense, and our legal system. Clearly, an extension of those agencies would touch business. After all, why else would she support the break-up of AT&T (T)?

But let's all -- as proponents of free markets -- think for ourselves instead of only speculating about what Rand would have thought. After the last 2 years, to me, it's clear that government's primary role in relation to a healthy free market system is to set and enforce the "rules of the game" such that the entire game isn't at risk of stopping... as it almost did last year.

Rules of the game means preventing monopolies that inhibit choice. It means -- to me, and I don't care what Friedman or Greenspan used to think on this -- you prosecute no-talent fund managers who cheat their investors by illegally trading on insider information. It means giving shareholders -- the true owners of the corporation -- the right and freedom to toss out under-performing directors.

On the other hand, I don't think the government should be setting pay, deciding that Bear should get bought and Lehman should go under. They also shouldn't be saying that more sub-prime borrowers have the right to own a home as part of "the American Dream."

Strong "rules of the game" set and enforced by the government allows 'real' free market capitalism -- and they would have the secondary benefit of also removing crony capitalists who have stopped competing on ability and instead compete on lobbyist dollars spent.

Comments

[Monty Pelerin:]

Most people cannot conceive of a world without regulations. I can’t either. But I can conceive of a world that most would think ridiculously defunct of oversight.

We tend to view the world in terms of what exists now, instead of what could or should exist. A good economist never ignores the institutional framework, because it provides the incentives to which economic actors respond. A great economist, however, goes beyond the existing. He examines the institutional framework from a normative perspective. Why did the existing framework evolve? What political and business interests produced it? Can patches to the system improve it? Do we need a completely different approach to regulation?

A particularly incisive post on this comes from Cafe Hayek:

"Thomas Sowell has said that economics helps you understand that there are no solutions, only tradeoffs. In that spirit, I want to recommend Arnold Kling’s study of the financial crisis, Not What They Had in Mind. My favorite quote from the essay is a variant on Sowell’s:"

"The lesson is that financial regulation is not like a math problem, where once you solve it the problem stays solved. Instead, a regulatory regime elicits responses from firms in the private sector. As financial institutions adapt to regulations, they seek to maximize returns within the regulatory constraints. This takes the institutions in the direction of constantly seeking to reduce the regulatory “tax” by pushing to amend rules and by coming up with practices that are within the letter of the rules but contrary to their spirit. This natural process of seeking to maximize profits places any regulatory regime under continual assault, so that over time the regime’s ability to prevent crises degrades."

The “Wisdom of Crowds” provides some insight as to why this occurs. Typically, a larger group of people is wiser than a smaller group. When the larger group (the industry being regulated) has financial incentives and the smaller group (the bureaucrats) have no financial interests (or limited in the sense of bribes, perquisites, future employment, etc), there is little hope for regulation succeeding. Either the regulatory body becomes “captured” or outsmarted.

Our regulatory focus is punitive. It is designed to build boxes based on “Thou shall nots.” Such an approach is always behind. It is always dealing with the last horse to escape from the barn. Such a strategy will always fail because of the innovation of business. Only a change in regulatory philosophy that is based on the free market as the policeman has any chance of working. The State mindset is unwilling or unable to recognize this. Hence we will move from one regulatory failure to the next.
Monty Pelerin economicnoise.com

Nov 12 11:58 AM

[frosty:]

"Real free market capitalism" never existed in America nor can it. This is because it gives everyone the ability to cheat everyone else and as a society we don't like cheaters (and especially thieves). This is one reason we have patent and copyright laws for example. Absent regulation, it also gives the wealthy and powerful unfair advantage over others who would have no legal recourse. Imagine what power and money could do to your local lanscape without, for example, zoning regulations.

It's difficult for younger people today to imagine life without antitrust, however I remember when Bell ruled: you could only lease your phone from Bell and couldn't buy it, only Bell could install phones and jacks and wiring, all the equipment was manufactured by Western Electric (a Bell company), and Bell controlled both local and long distance rates. Teddy Roosevelt saw these types of difficulties 100 years ago in many industries and thankfully developed some controls against such monopolists.

Tax policy is another way in which "free market capitalism" is compromised. At the federal and state levels there are times when certain industries or businesses might be favored to encourage oil exploration or develop an 'enterprise zone' for example. Even at the local level, property taxes might be waived to attract a business. Political intervention in the marketplace is not 'free'.

And how about 'defense spending'? Will anyone stand up and say this is a 'free market' system? Or are there favored and out-of-favor contractors? And does congress have a say in any of this? Enough said about that.

Publicly traded companies also have to comply with many financial reporting requirements, all companies have tax reporting requirements, and there are all kinds of fair trade laws, interstate commerce laws, and . . . I could probably go on much longer. But I hope I have made the point.

I like the Sowell quote above as it provides for adaptation where regulation causes the private sector to adjust, which then causes further regulation and further adaptation. What is more fitting in an evolutionary world than an evolutionary market system.

Nov 12 04:38 PM