An Astounding New Theory of Regulation

The usual theory for the need of regulation — and by this I mean micromanaging regulation, not the erection and maintenance of rule-of-law standards — is “market failure.” Economists of a skeptical bent note that most of the egregious practices that seem to require regulation are better seen as simple acts of rights violations (as in the case of fraud) or rational acts in a context where rights have not been firmly established (as in a property commons). The rational response, in both cases, would be to install and maintain institutional practices that define and defend rights, property rights in particular.

Against this position, Paul Krugman:

[T]he libertarian alternative to regulation — just use tort law to make people pay for the damage they cause — doesn’t work in practice, because when push comes to shove politicians will shield the rich and powerful from paying the real cost.

So Krugman’s case for robust regulation is not market failure, nor institutional failure due to a lack of articulation of good rules, but, instead, a clear-cut case of political failure. The market could work, he’s saying, if politicians would let basic government institutions (legal adjudication, in particular) and employees do their work.

Quite an admission, it seems to me.

I have not been following Krugman’s posts on the subject. But he goes on to relate the state of the debate he’s having on his blog:

Commenters say, but isn’t that an equally strong reason to believe that regulation won’t work either?

And at this point we should expect a careful refutation of Kenneth Arrow’s mathematical demonstration why democratic politics cannot ever articulate a constant standard.

No such luck. Instead we get this:

Well, here’s the thing: regulation demonstrably does work where tort law doesn’t. Consider the environmental issue: in reality, the perpetrators of oil spills never pay most of the cost; but in reality, environmental regulation has led to much cleaner air and water. (Look up the history of Los Angeles smog or the fate of Lake Erie if you don’t believe me.)

So why does regulation work? If polluters can buy off the system ex post, after a disaster, why don’t they manage to totally corrupt regulation ex ante? There’s a lot to say about that, and I’m sure there’s a literature I haven’t read. But one thing we tend to forget in this age of Reagan is the importance and virtues of a dedicated bureaucracy: when you have professional government agencies with a job to do, and treat them with respect, that job often gets done.

Regulation does work better in some cases. That seems easy to explain. Why does it work as well as it does? Because it’s allowed to.

It’s rather like saying “private guards and adjudicators cannot control crime as well as the thugs we place on the police force, because our police force regularly beats up the private guards and adjudicators.”

Or saying, as some antebellum whites did say, “Africans-Americans are not capable of learning, so we must keep them as slaves,” while preventing them from accessing the tools of education.

And yes, there’s a vast literature that Krugman has not read. I haven’t read all of it, either. But I’m at least aware of it, and can provide citations, should Krugman actually have an interest in doing some actual research, rather than shoot from the hip.