Is there such thing as ‘certainty-inducing regulation’?

It’s that time of year! Earlier today, the Heritage Foundation released it’s highly-anticipated 2012 Index of Economic Freedom. As expected, the United States fell even lower on the index, landing between Ireland and Denmark at tenth place.

Now I have no quibbles with the way the index is compiled. Indeed, I highly recommend it to anyone interested in issues of economic freedom. But here’s a quote from a analysis of the index that is a little bit less than accurate:

“Well-defined, well-enforced property rights; a stable rule of law that prevents corruption and encourages equal justice; free trade; responsible government spending; ease of doing business; well-reasoned, certainty-inducing regulation: these are the types of factors that energize a society toward productivity and prosperity, and have made the United States the world’s leader in liberty and living standards for going on two centuries.”

Property rights, rule of law, free trade…these are all things that indeed “energize a society” toward economic prosperity. And I personally know the author of this post to be a strong, well-meaning advocate of economic liberty. But “well reasoned, certainty-inducing regulation” is not a prerequisite for a prosperous, productive economy. Let me explain.

The belief that a measure of government regulation can “induce” certainty implies the belief that the market is inherently unstable and would–if left to its own devices–result in chaos (or at least a ‘certainty deficit’, if you will). Thus, certain regulations are actually good for the economy, as without them there may never be such things as economic progress, a growing division of labor, near-full employment, etc. NY Federal Reserve President William Dudley is an example of one who holds such a belief. Speaking at last year’s Bretton Woods conference, he said:

“Policymakers and market participants must acknowledge that the financial system is inherently unstable—that it is prone to booms and busts, and that these episodes can destabilize the real economy.”

Now I’m not advocating the view that government regulation can never increase consumer/investor confidence in the short-term. But this can only be the case if such measures counteract previous measures that distorted the market even worse. I can’t think of any real-life examples at the present, but one can imagine a regulatory measure designed to counteract impending inflation by raising the reserve requirement ratio on fractional reserve banks (not that such a policy would ever take effect in today’s deflation-phobic society), and having the effect of increasing consumer confidence in the purchasing power of the dollar.

But markets are not inherently unstable as Dudley claims, and only become so if there is some sort of coercive intervention in the first place. Indeed, the free market is inherently solvent and stable. No on explains this better than Murray Rothbard:

“Superficially, it looks to many people as if the free market is a chaotic and anarchic place, while government intervention imposes order and community values upon this anarchy. Actually, praxeology—economics—shows us that the truth is quite the reverse…Directly, voluntary action—free exchange—leads to the  mutual benefit of both parties to the exchange. Indirectly, as our investigations have shown, the network of these free exchanges
in society—known as the “free market”—creates a delicate and
even awe-inspiring mechanism of harmony, adjustment, and precision in allocating productive resources, deciding upon prices, and gently but swiftly guiding the economic system toward the greatest possible satisfaction of the desires of all the consumers. In short, not only does the free market directly benefit all parties and  leave them free and uncoerced; it also creates a mighty and efficient instrument of social order.”

I realize that the above quote does not prove the inherent stability of the free market, but only asserts it as truth. For me to answer every objection to this claim on this post would take months…so I leave it to you to investigate Rothbard’s Man, Economy, and State. But suffice it to say that in the most general sense government regulation of the economy can only distort the rational allocation of goods and resources. Whether government intervention in the economy designed to “induce certainty” will be effective depends on the particulars of each individual circumstance and whether or not such a policy will counteract worse, more distortionary policies already existent. But there is no inherent instability in the market that requires some ‘expert‘ to correct.

Mark Skousen (channeling Mises) explains this general principle as applied to financial markets below:

To understand the root cause of financial and economic instability, we need to go back to Ludwig von Mises’s “non-neutrality” thesis in his breakthrough work The Theory of Money and Credit. Mises pointed out that monetary intervention (easy money policies and artificial lowering of interest rates) is the principal source of uncertainty, false expectations, and excessive debt-leverage in the economy and on Wall Street. Under a stable monetary system, a laissez-faire economy would suffer occasional financial mishaps, bankruptcies, and down-days on Wall Street, but there would be no systematic “cluster of errors” that currently characterize today’s global economy.6

No economist, Misesian or not, would ever say that the financial markets will never fluctuate or even “suffer occasional financial mishaps”. But only in a regulated economy are long-lasting recessions even possible. So in sum, the idea of “certainty-inducing regulation” as a prerequisite for economic progress only holds water if the market is inherently unstable–which it is not.

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