Free Markets Are Regulated
The myth of disorder.
In recent years defenders of markets have begun to realize is that language matters. In earlier columns I wondered about the usefulness of the term “capitalism” to describe the free market (see this and this). Here I’d like to explore how the terms “regulation” and “deregulation” are used and what exactly they mean in the market context.
The usual dichotomy is between the “unregulated” or “deregulated” market and the “regulated” market, which includes significant government intervention. Advocates of free markets have long made the case for the advantages of unregulated markets and exposed the problems associated with regulation, often using spontaneous-order arguments. The fundamental insight of economics from Adam Smith forward has been that free markets are capable of producing order without design. We do not need “regulation” in the sense of State intervention for markets to generate socially beneficial outcomes. And when we do attempt to “regulate” them through the State, the result is a variety of undesirable unintended consequences.
Order without Design
This is all correct, of course, but it misses an opportunity to emphasize even more strongly the idea that markets produce order without design. The language of “unregulated” or “deregulated” markets makes it difficult to talk about order without design because those very words seem to suggest that there is no order to the marketplace. A “regulated market” in contrast sounds orderly. I think we can get around this problem by arguing that free markets are in fact highly regulated and that government-“regulated” markets often lack any meaningful regulation.
Merriam-Webster offers this definition of “regulate” first: “to govern or direct according to rule.” It also includes a second definition: “to bring order, method, or uniformity to.” One understanding of “regulated” is that some process operates according to a rule or rules and thereby is orderly. This is the sense we use when we talk about a regulated physical process being predictable and orderly, or to describe something that repeats in predictable ways, for example, “our regular waiter” at the local restaurant.
In this sense, free markets are indeed highly regulated. Economic theory demonstrates that free markets operate according to rules that we can recognize and understand. These rules enable us to make what F. A. Hayek called “pattern predictions” about the behavior of markets. We know, for example, that when price rises, all else constant, quantity demanded will fall, or that above-normal profits in an industry will bring new sellers into that market — even if we cannot predict either outcome precisely. Market participants will not act haphazardly, nor will outcomes be chaotic. People’s behavior is regulated by the laws of economics, which in turn produce orderly patterns.
Government attempts to improve on markets are often described as “regulation.” In some sense this is accurate: Government does try to impose its own set of rules that are intended to produce something more orderly in the eyes of the regulators. In addition, economists can make similar pattern predictions about the unintended and undesirable results of that regulation, for example that a price ceiling set below the market-clearing price will produce a shortage.
State Reduces Order
However, we could also argue that such intervention reduces the level of regulation in the market because intervention invariably puts a great deal of discretion in the hands of both the “regulators” and those being regulated. Are “regulated” markets more predictable than “unregulated” ones? Is it easier for entrepreneurs to anticipate the actions of bureaucrats with discretionary powers or of competitors seeking profits according to the rules of the marketplace? Is behavior more “regular” when firms are genuinely profit-seeking or when they attempt to manipulate the “regulators” through rent-seeking? Bob Higgs’s concept of “regime uncertainty” captures how government intervention makes markets less regulated by undermining rules that generate predictability for participants.
In the free market truly competitive firms can’t simply do whatever they wish, at least not if they want to make profits and continue as viable enterprises. Their desire to make profits regulates their behavior in ways that drive them to serve consumers by expanding and diversifying output and reducing prices. In contrast to the implicit picture of “unregulated” markets in which firms can do whatever they wish, economics depicts the free market as governed by clear rules.
Years ago, Hayek pointed out that the question facing societies is not “to plan or not to plan” but “who should plan – individuals and firms or the state?” Similarly, the question is not to regulate or not to regulate, but which type of regulation – market rules or State discretion – works better.
In other words, free markets are regulated.
Comment by John Miller on 26 May 2011:
Good stuff! I am very much digging some of the discussion on marketing, presentation, and semantics.
Knowing the origin of the world capitalism, addressing critics who associate unregulated with bad, and (from the mises institute) advocating a change of tense in referring to the ‘freed’ market rather than the ‘free’ market are huge when communicating with those outside the libertarian community.
Zealot to the athiest: “Big bang? You don’t think that all this could just happen, do you?!”
Statist to the libertarian: “Unregulated? You don’t think that things would just happen, do you?!”
Comment by Kent Lalley on 26 May 2011:
“In the etatist state entrepreneurs are at the mercy of officialdom. Officials enjoy discretion to decide questions on which the existence of every firm depends. They are practically free to ruin any entrepreneur they want to. They had the power not only to silence these objectors but even to force them to contribute to the party funds of nationalism.” — Ludwig von Mises
Comment by Russ Nelson on 26 May 2011:
Never confuse legislation for regulation.
Comment by D. Saul Weiner on 26 May 2011:
We should also refer to state rules of exchange as interference in the market (per Mises) rather than regulation, which is a question-begging term.
It is also worth noting that for the market to self-regulate, as suggested, there needs to be recourse to a sound legal system for situations when fraud arises or other torts take place.
Comment by Tyler Watts on 26 May 2011:
Right on, Steve!
I made a similar argument with specific reference to the financial industry here:
http://www.soundmoneyproject.org/?p=4469
I think it’s high time to drop the misleading “regulation vs. deregulation” rhetoric. Let’s instead talk about market-based, or better yet, “competitive” regulation, versus government-based, or “bureaucratic” regulation.
Comment by Warren Gibson on 26 May 2011:
The market requires respect for property rights. Some say this means government must provide a legal system that prohibits and punishes rights violations — which one might call a form of regulation. Others say markets can provide these services and no government is necessary.
Comment by Steve on 26 May 2011:
I have been involved with small manufacturing companies for over 40 years and I thought you post was excellent. However, I am not sure I understand how the market self regulates large corporations like GE and Exxon?
Pingback by A Few Random Morning Links … | The Pretense of Knowledge on 27 May 2011:
[...] A Few Random Morning Links … May 27, 2011By adminFree Markets Are Regulated [...]
Comment by John Papola on 27 May 2011:
Tremendous post, Steve. People’s behavior is clearly constrained in a system of competition and free association (the “market”). But the government “regulator” faces dramatically fewer real constraints and must therefor rely far more on “self-regulation” to prevent abuse of their discretionary authority. As a result, believers in state intervention tend to also be those who argue for the “great man” theory of governance. If one we had the “right guy” on the job, they claim, usually in dismay that the “right guy” is rarely ever found. I personally find that view to be a childish approach to political economy.
Comment by Joel Lemmon on 27 May 2011:
If a Congress of 535 people are relied on to be together the ‘right guy’ regulation will mathematically nearly never be the ‘right guy’ (the body as a whole). Two reasons: each individual senator and congressman acts for their small constituency, they can not pass regulation with the whole market’s best interest intended or they would only sometimes represent the wishes of their constituency. Second, if best interests of market as a whole was the intent, Congress is constantly being voted in and out every 2 and 6 years, regulations would be changing with the tide. Business is not always ethical or moral. However as with Capitalism, a free mostly unregulated market seems the best of all available options. But as always, if we could “only” get the RIGHT GUY. How often as history has taught us is this going to occur? Do you prefer whims or the reliability of human nature?
Comment by Jeff Erickson on 28 May 2011:
This is an important post in the battle to win the rhetoric war for free markets. The usual argument on the pro-regulation side is that an unregulated market lets the mean, selfish big companies take advantage of the little guy and thereby make unfair profits. The argument is often based on the notion, whether stated or unstated, that we as consumers are powerless to control a big company and therefore they will run roughshod over us, doing what they please. Your post is the perfect comeback – markets unregulated by government can still be regulated by the market itself. If a company is making ‘unfair’ profits, in a market unfettered by government intervention, some other company will rise up to try to get a piece of those profits. Then we have competition for market share and prices will fall (or service will improve).
People should be more afraid of government-regulated markets than free markets. In government-regulated markets market power (and thus pricing power) goes to the politically well connected, to those who have the biggest purse-strings and use them to get the ear of senators and representatives. In such regulated markets our only hope is that the regulators will get it right. I’d rather put my hope in a system where everyone is free to pursue their own best interests. Then if I don’t like the way a company is treating me, or the price they charge for a product, I stand a much better chance of finding some other company that I will be much happier with. That seems more likely to produce a positive outcome than writing to my senator to complain about a company and asking them to please give me some better choice.
Pingback by Unregulated by Government is Still Well Regulated | Smith, Hayek live on! on 28 May 2011:
[...] Horwitz has a post on the FreemanOnline that is just excellent. It makes the point that a market unregulated by the [...]
Pingback by The rhetoric of regulation: free markets are regulated « Knowledge Problem on 3 June 2011:
[...] this breach comes an excellent Freeman column from Steve Horwitz that explores the rhetoric of regulation. Steve draws our attention to an important insight that is [...]
Comment by ConfusedPigeon on 17 June 2011:
It is quite simply amazing how hard it is to understand such a simple truth. There is nothing simpler than how a market “works” and grows, yet it is regulated. It actually has stringent controls that can not be bribed, manipulated or “petitioned against.” It is an organism unlike government which could more likely be compared to a cancer, spreading after repeated attempts to kill it. The other truth that is so simple is that, lefties won’t change. They can’t. Or they can, but they would have to go against thousands of years of adapting. Once men attain power, money or influence, they will not relish the opportunity to relinquish said privileges. They will fight to not just keep them, but to also increase them. Therefore, although people “should” be more afraid of government regulated markets, they won’t be. Once that type of market is set up, it becomes a mainstay, and change is violently fought against.
What is most ridiculous is that government can not control the actions of a handful of people effectively, (ie. DePape’s minute of fame, etc) much less the millions of decisions every day that are required to successfully run commerce. Yet they “try”. You know, we free market idiots only need to “change”, “feel” the urgency and “try” harder…
It saddens me that such a logical well written post will fall upon mostly deaf ears. But politicians have never had very good hearing.
Comment by Larry Motuz on 3 October 2011:
Strange article. It abstracts market outcomes entirely from the common interests people have in ensuring that products are safe, that competition is not predatory (since predations destroy actual market efficiencies that would exist in the absence of such predation), &c.
It is neither interference nor anti-competitive to have laws and regulations uniformly applied to all market participants to protect the people overall from immoral or lawless actors. Indeed, In the absence of laws, markets seldom amount to much. Good laws expand trade, which is why countries without those laws tend, on balance, to not have developed their markets.
To say markets can substitute for self-government is nonsense.