Wednesday, December 30, 2009

Big business vs. big government

Steven Pearlstein has a column in today's Washington Post which uses the old trope about the necessity of big government to protect against free market excesses. You hear this argument a lot, where an acknowledgment of the free market's virtues are swiftly accompanied by warnings over the need for strong government oversight. President Obama trotted out this line of thinking in his inaugural address:
Nor is the question before us whether the market is a force for good or ill. Its power to generate wealth and expand freedom is unmatched, but this crisis has reminded us that without a watchful eye, the market can spin out of control -- and that a nation cannot prosper long when it favors only the prosperous.
Each time this argument is employed I pay close attention to the citations of alleged market failure. Almost inevitably they are thinly reasoned or sourced, a pattern that Pearlstein continues:
Americans understand that free markets are the best vehicle for generating innovative products and ever more efficient ways of producing them. But recent experience also reminds that innovation and the competitive dynamic are not always what they are cracked up to be.

When investors engage in herd behavior and deploy scarce capital merely to bid up the price of real estate or financial assets, that does nothing to improve economic output or efficiency.

The nation's stock of human capital is not increased when people compete for admission to elite universities and graduate programs by spending ever-increasing amounts of money on consultants and test-preparation courses, or when the schools themselves raise tuitions to finance a self-destructive race to lure the best students, the best athletes and the best teachers.

What good is competition if it drives corporate executives to knowingly engage in increasingly risky behavior simply to boost short-term profits and stock prices even at the expense of long-term value creation?

And what good is innovation that is used to snooker consumers, mislead investors or subvert sensible regulation?
What's interesting is that in these first two examples of alleged failure, government policy played a key role. The real estate boom was aided and abetted by a loose monetary policy, government agencies which bought up tons of risky mortgages and a general policy bent in favor of home ownership. The financial sector, meanwhile, is arguably the most regulated segment of the U.S. economy.

I fail to see why competition among universities to become the best is a bad thing and hardly regard test-prep spending as a major concern. More relevant is the fact that higher education is thoroughly dominated by non-profit institutions and hardly a classic example of big business.

As for corporate compensation, why that is a concern of anyone other than the shareholder? And what is the alternative to competition? Government management of the economy? Has that ever worked out well? It's also worth noting that government policy, which taxes wage income and capital gains at different rates, provides a bias towards stock compensation.

Pearlstein's last point, meanwhile, is so non-specific that it is impossible to respond to.

If big government is so necessary to guard against private sector evils, why do its advocates struggle so mightily to justify its interventions?

Update: I should point out that Steve Pearlstein responded to an email I wrote, in which I laid out some of these same criticisms, to say that he very deliberately did NOT say that government is needed to guard against things like the real estate boom. He further stated that he only disagrees with those in the business community who "make the reflexive argument that all innovation is good and anything that might result in less innovations of any sort is bad." In addition he allowed that not all private sector shortcomings have a government solution.

Re-reading his column, he doesn't necessarily come out in favor of big government solution, stating "And while it is now beyond dispute that labor markets today are generating incomes that are increasingly unequal, governments have found it remarkably difficult to come up with cost-effective programs that successfully offset those effects." I may have been unfair in my characterization of his argument.

That said, the point remains that the more prominent examples cited by Pearlstein of alleged market failings actually reveal themselves to be more public policy shortcomings than proof of capitalism's Achilles heel.

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