Thursday, September 10, 2009

On Regulation

Everybody has preferences. However, the preferences of two individuals seldom match completely. Nevertheless, in some areas of life, large groups of people share a very similar preference concerning a specific topic. All things equal, they would be happier if things were run this particular way.

That's the basis of regulation. A shared desire by a group of individuals to have things done a specific way, and to have means with which to control the compliance with and punish deviations from this process.

The benefits of regulation are apparent: without it, the quality of a product could not be assessed by the end customer. Regular shoppers in a supermarket have no way whatsoever to ensure that the products they buy have been manufactured in a healthy, worker-friendly, clean facility and that what's inside the box matches what is advertised on the ouside. That's why many customers demand regulation of these products.

When you hear regulation, you probably think of the state. Government needs to regulate market products so that an impartial and trustworthy judgement can occur. However, there are some serious issues with state regulation:

1) The state is a monopoly service. If you entrust the state with regulating your daily life, you are opening the door for abuse and misconduct. Think of it that way: those who are mandated to regulate the safety of your food are probably tenured bureaucrats. They have no competition because expensive government regulatory processes have made it impractical for a market competitor to emerge. Now, a cunning food capitalist knows that and decides to bribe these bureaucrats into looking the other way when his contaminated food hits the shore. The consequences for you may be severe health problems, the consequences for the bureaucrats, if any, may amount to an inquiry which does not lead to anything meaningful. All the while, the government agency responsible will continue to exist and live off your taxes. Market competitors may be prone to corruption as well, but in their case, a whole fortune is at stake - when a food regulator gives his okay to a food that is contaminated, there's no need for a lengthy trial to make him pay. His stock will tank, he will be facing class action lawsuits before he knows what's happening and his quality seal will be an embarassment, not a desired product anymore. In short, he may go bankrupt for just one mistake. Not only does that prevent corruption, but it's a much greater motivation for meticulous work than an oath to uphold public safety and the Constitution.

2) But Monopoly regulation is not only unsafe, it is also impractical. Let's assume that a 75% majority of people feels that cars are unsafe and should be regulated to have more safety features. In a democracy, chances are that a party will pick up this vibe and implement such a thing later on. Now, cars have many more safety features, but have also doubled in price as a consequence. Now, only 55% are still in favor of mandatory safety schemes. The renegade 20% can't afford a car anymore. Unfortunately, it would take some time to abolish this new regulation and the newly created state agency that monitors car regulation IF a major party were to support it, but right now, health care and various wars are on the popular agenda and so it might take a few decades to fix the problem. A free market regulatory agency could just award a special seal to expensive cars with lots of safety features so that worried customers have the option of either purchasing a very safe, but very expensive or a not-so-safe, but cheap vehicle. Different strokes for different folks.

3) Finally, monopoly regulation may have unintended consequences which make the situation worse for some people. Let's take working hour regulations as an example. Let's say the state legislates that one employee may only work 8 hours a day. That's great for employees, right? Well, Joe Sixpack happened to earn just enough to make ends meet when he was working 10 hours a day for the man. Now that he's only allowed to work 8 hours at his job, he won't make enough to make a living. So he has to get a second job. Unfortunately, he doesn't find anything that allows him to work 2 hours per day, the minimum would be 5 hours per day. So, thanks to our 8-hours-a-day limitation, Joe is now forced to work 13 hours a day, even though his preference at the current price for his labor would've been 10. This is somewhat related to my point about impracticality, but in this case, it's not about having an upside and a downside (for example, more safety, but higher cost), but about having downsides only. This, too, is possible with monopoly regulation.

But how would a free market regulate? According to demand. Whenever an enterpreneur senses that people would like to have certainty about specific aspects of a product, he is free to create a quality seal which advertises this specific quality. It is his job to promote this seal to create both customer recognition and company demand for it so that the extra-cost imposed on businesses by admitting a quality control will be considered worthwhile. It is likely that renowned companies with a reputation for good quality control will eventually extend their sphere of influence on the general market, but there's also a lot of potential for niche quality testers in market areas with comparatively small profit expectations. For more on the issue, I recommend the video to the right.

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