The Regulatory State

I think that the reaction of Keynes to The Road to Serfdom, as recounted in Skidelsky's John Maynard Keynes: Fighting for Freedom 1937-1946, essentially captures the modern political dilemma, and it is particularly applicable to regulation (which is only a subset of government intervention). Recall that Hayek argued that when we intervene in decentralized, free-market decision-making, we are on a slippery slope, at the bottom of which is a dystopian statist nightmare. (As an aside, the failure of the western world to abolish government intervention or to plummet into serfdom is strong evidence of an angle of repose.)

Here is Keynes in response (I draw this from Skidelsky, who highlights the passage on p. 285 of Fighting for Freedom):

You admit . . . that it is a question of knowing where to draw the line. You agree that the line has to be drawn somewhere, and that the logical extreme is not possible. But you give us no guidance whatever as to where to draw it. It is true that you and I would probably draw it in different places. I should guess that according to my ideas you greatly under-estimate the practicability of the middle course. But as soon as you admit that the extreme is not possible . . . you are, on your own argument, done for, since you are trying to persuade us that as soon as one moves an inch in the planned direction you are necessarily launched on the slippery path which will lead you in due course over the precipice.

Skidelsky says that on this point, "it is game, set and match to Keynes." I am inclined to agree. Empirically, we know that governments can intervene fairly significantly in the economy without dooming their people to poverty, slavery, or whatever. (Though an ardent Hakeyian might argue that it is "too early to say," and that the US, Canada, Australia, and western Europe may yet collapse into a Soviet-style hell - or, alternatively, that we are living in such a hell and suffering from widespread false consciousness. On this account, for some reason we fail to appreciate that cap-and-trade is the moral equivalent of chattel slavery.)

And but so, having fairly convincingly refuted Hayek (at least as to his apocalyptic rhetoric), you can't stop there. Keynes goes on to write about the dangers of planning and the importance of having policymakers who are alert to those dangers.

And this is the thing about regulations. They have the following flaws (my list is not exhaustive):

1. Often they are simply misguided. And because they have the force of law, they can seriously distort markets.

2. They are prone to regulatory capture, in which the regulated entities "capture" the regulators (by hiring them, or because of frequent interaction, or by some kind of reverse Stockholm syndrome or something). Then the regulations are used as barriers to entry and are even used to preempt other legal controls that might be imposed.

3. Even when "successful" (i.e., well-intended and intelligently written), they cumulatively impose a serious cost on doing business that functions like a tax, but a tax that raises no revenue. Resources are devoted to understanding them and testing their limits. Arms races ensue.

4. The cost of regulation is increased by the fact that they must be rigorously (if carefully) enforced. This is because an infrequently-enforced regulation may be far worse than either a fully-enforced regulation or no regulation at all. In the first instance, selective enforcement means that some firms will be penalized and some won't, skewing competition. Perhaps more importantly, if enforcement can be avoided by strategic behavior, then firms will devote resources to avoidance instead of compliance (for instance, hiring lobbyists or disguising proscribed behavior). If enforcement is weak, then competition will sometimes favor evasion over compliance, actually driving honest firms out of business. The same dynamic is in play in the area of tax enforcement - if you "cut" taxes by gutting the IRS, then you raise less revenue, but you raise it in a "lumpy" way - some taxpayers pay the full rate, some pay nothing. Better to cut taxes across the board and make everyone pay. Greece appears to have fallen into a horrible equilibrium in this regard.

And so here is the synthesis:

1. Regulations are indispensable in modern life.

2. Regulation is problematic and very difficult to get right.

3. The only reasonable approach is to use some combination of restraint in imposing regulations and effort to recognize and address their known problems. The absence of regulation is not an option, and the indiscriminate use of regulation may be even worse.

So the real ideological battle should be about the former balance - regulatory design vs. regulatory forbearance (an argument in which conservatives have much to say that is valuable - and even when conservatives lose the argument, an appreciation of their critique can enhance regulatory design). Unfortunately, political rhetoric almost always seems to center on the second (untenable) choice between unbridled regulation and no regulation at all.