The Case for Regulation: The Former Reagan Adviser and Wall Street Journal Editorial Writer Offers Some Surprising Insights

By Roberts, Paul Craig | The International Economy, Fall 2011 | Go to article overview

The Case for Regulation: The Former Reagan Adviser and Wall Street Journal Editorial Writer Offers Some Surprising Insights


Roberts, Paul Craig, The International Economy


The economic mess in which the United States and Europe find themselves and which has been exported to much of the rest of the world is the direct consequence of too much economic freedom. The excess freedom is the direct consequence of financial deregulation.

The definition of free markets is ambiguous. At times it means a market without any regulation. In other cases it means markets in which prices are free to reflect supply and demand. Sometimes it means competitive markets free of monopoly or concentration. "Free market" economists have made a mistake by elevating an economy that is free of regulation or government as the ideal. This ideological position overlooks that regulation can increase economic efficiency and that without regulation external costs can offset the value of production.

Before going further, let's be clear about what is regulated. Economists reify markets: the market did this, the market did that. But markets don't do anything. The market is not an actor; it is a social institution. People act, and it is the behavior of people that is regulated. When free market economists describe the ideal as the absence of any regulation of economic behavior, they are asserting that there are no dysfunctional consequences of unregulated economic behavior.

If this were in fact the case, why should this result be confined to economic behavior? Why shouldn't all human behavior be unregulated? Why is it that economists recognize that robbery, rape, and murder are socially dysfunctional, but not unlimited debt leverage and misrepresentation of financial instruments? The claim, as expressed by Alan Greenspan along with others, that "markets are self-regulating" is an assertion that unrestrained individuals are self-regulating. How did anyone ever believe that?

When Federal Reserve Chairman Alan Greenspan, Treasury Secretary Robert Rubin, Deputy Treasury Secretary Larry Summers, and SEC Chairman Arthur Levitt browbeat Brooksley Born, head of the Commodities Future Trading Commission, and prevented her from doing her duty to regulate over-the-counter derivatives, they committed one of the most stupid policy mistakes in economic history.

The financial crisis that resulted has spread its devastating effects everywhere. The explosions in public debt and money creation, resulting from efforts to bail out the financial system from its own stupidity, have brought the U.S. dollar and the euro, the two reserve currencies of the international financial system, under pressure, undermining confidence in the reserve currency status of the currencies and the international financial system, as the price of gold indicates.

Obviously, the lack of financial regulation was dysfunctional in the extreme, and the social costs of the policy error are enormous.

Thirty-three years ago in an article in the Journal of Monetary Economics (August 1978), "Idealism in Public Choice Theory," I developed a model to assess the benefits and costs of regulation. I argued that well-thought-out regulation could be a factor of production that increases GNP. For example, regulation that contributed to the quality and safety of food and medicines contributed to specialization in production and lower costs, and regulations enforcing contracts and private property rights add to economic efficiency.

On the other hand, bureaucracies build their empires and extend their regulations into the realm of negative returns. Moreover, as regulations increase, economic managers spend more time in red tape and less in productive activity. …

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