Tuesday, April 19, 2005

A Little Regulation

Not 15 minutes after I finished reading Collapse: How Societies Choose to Fail or Succeed do I discover Publius referencing Jared Diamond in this post regarding the coming oil wars. Now, that is what I call a coincidence.

Anyway, while Publius limits himself to discussing the oil problem (something Diamond decidedly does not do), he nails the problem that we're facing.
As Diamond might explain, when you have multiple parties competing for scarce resources, you should expect conflict. And that’s essentially where we are today. The economies of the world powers need reliable supplies and suppliers of oil. In addition, they need to remove potential threats to these stable supplies of oil. Thus, as we might expect, we are beginning to see these world powers engage in a string of seemingly isolated global conflicts to secure supplies of oil – both in the sense of physical conquest and/or in the sense of removing threats to the stability of oil-producing regions. This is what I mean by the "Oil Wars."
On the one hand, this is a fairly elementary stuff. If you need something bad, you will go a long way to get it. If others get in your way, things have a tendency to get ugly. It's not exactly what you would call rocket science. And if that something is something like drugs, everyone gets on board. But, if that something is oil, there's a segment of the population that has a tendency to go batshit.

This reaction was typified a few weeks ago when I was listening to Rush Limbaugh pontificate on his radio show (yes, I know, I know -- I don't know what the hell I'm doing listening to that show either). He had been asked whether or not he was worried about the finite nature of the oil reserves here on planet Earth. His response was, essentially, that (a) oil isn't that scarce and (b) the market will solve this problem.

Thus, the idea that scarce resources could play a role in conflict is unacceptable because it challenges the notion of the "magical" market, a divine system that, when left alone, will rain blessings down upon all earthly creatures. Surely, they claim, the market would address the issue of resource scarcity long before it would be resolved through armed conflict.

Generally, I'm not one to forcibly disabuse the faithful of the objects of their adoration. If it makes you happy to believe in spirits, the Easter Bunny, or a the talents of John Travolta, who am I to stop you. In this situation, though, I can't let this pass. Too much is at stake.

There are many ways to look at the modern capitalist market, but one analogy that I find to be incredibly useful is that of an ecosystem. In essence, the market is the environment in which business entities compete for consumer dollars. And, just like natural ecosystems, the entities that are best suited to the environment succeed and thrive, while those less suited tend to evaporate (through bankruptcy or buyout). This dynamic is what creates the market efficiency so beloved by its libertarian/conservative advocates. The threat of failure pushes these business entities to constantly improve and adapt in order to succeed. They are forced to constantly streamline and reduce waste. Over time, this process transforms them into incredibly proficient operations.

So, I acknowledge without complaint that markets are indeed incredibly efficient systems. The problems arise when you take the next step and ask "what are markets efficient at accomplishing?"

The answer is simple: generating profits. While there are many beneficial aspects of this goal, it is in of itself an amoral pursuit. There is nothing inherently good or bad about it-- it merely is what it is. The positive and negative repercussions arise out of the ancillary effects of this pursuit. Therefore, the mistake that is made is assuming that the positive effects vastly outweigh the negative ones. Sometimes they do, but often they do not.

Some of the negative effects stem from the scope of the specific business entity's profitability forecast. The activity of a company is often determined by its outlook. If a company is forward-looking and concerned about profits 100 years in the future, it will take measures to assure that its current activity will not preclude future profits. However, if they are concerned only with their next quarterly report, they will take actions that provide the highest profits currently available regardless of the effect that that will have on the future. Thus, economic resources can be plundered for short-term gain, leaving those in the future without what they need to conduct business.

Other negative effects are related to what is commonly referred to as the collective action problem. The basic idea is that rational entities acting independently cannot address collective issues. For example, if all farmers in a town allow their cattle to graze all in the town commons, the land will soon be overgrazed and useless to everyone. However, they cannot choose to independently limit their grazing because others would simply take advantage of the situation by allowing their cattle to graze further. In such a situation, those acting on behalf of the group are punished while those acting on their own interests are rewarded. To solve the problem, limits must be established and enforced collectively.

There are many such collective action problems in the modern market. Many natural resources are finite (oil) or are slow to recover from exploitation, yet independent business entities cannot unilaterally decide to conserve them. The production of industrial pollutants damages the environment for everyone, yet businesses cannot independently assume the costs of prevention and cleanup. The fact that businesses compete with each other means that they cannot be trusted to consider the interests of anyone but themselves.

Finally, profit is itself a nebulous concept. Profits can be achieved in many ways. In the most general sense, increasing profits are derived from a widening gap between revenue and cost. However, reducing cost can be achieved by increased efficiency or by externalization. If an operating cost can be taken off the books and revenue is neutral, profit increases and the behavior is rewarded. But lots of cost externalizations are bad for society at large. For example, hard rock mines typically force the public at large to pay for the environmental damage they cause. The profitability of the mine increases, yet we are worse off collectively.

Defenders of the market might complain that I am ignoring the fact that consumers have the ability to pressure business entities that act irresponsibly. Supposedly, consumers will recognize bad actors and boycott their products. Sometimes this does occur and, when it does, it can be very effective. However, more often than not, such consumer resistance fails to materialize. There are three reasons for this. First, consumers lack the time, energy, and information required to consistently exert such pressures. The modern market is far too complex and compartmentalized for consumers to fully comprehend the effects of their market choices. A consumer might be unhappy about the environmental consequences of copper mining, yet unable to discover which of their consumer products contain copper from the offending mines. Second, consumers often do not understand the severity of certain corporate bad actions. Some environmental damage is difficult to perceive and frequently requires high levels of expertise to truly comprehend the threat. Finally, consumers are independent actors as well. In so, they might disproportionately benefit from certain consumer choices in spite of the fact that the collective is damaged. For these reasons, consumers can never be the final arbiter of appropriate business practice.

The market accomplishes many things very well. A large percentage of our modern comforts are derived from the market system. Whenever possible, it is advantageous to use market solutions to accomplish our collective goals. However, unfettered markets do not work purely for our benefit; they work purely for their own. Sometimes the interests of the market align with ours and in those instances we should give it free rein. But, when our interests diverge, we must change the market environment so that it produces results that are beneficial to us. Like it or not, this means regulation. There are systemic costs for imposing regulation, but the consequences for failing to do so are much more severe. How and what we regulate is an ongoing discussion and is something that we should constantly be refining. Yet, the question of whether or not to regulate should be settled.

The free market is a tool. It is neither good nor evil. It is merely a thing. It is how we use the market that will determine whether or not it is our salvation or our ultimate undoing. It can go either way -- but, if you want a world your children can live in, the choice is clear. A little regulation is, without a doubt, a good thing.
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