Tuesday, November 11, 2008

Regulation and Competitive Markets

I have stolen even the title of this post from Mark Thoma, one that's about a month old. But I strongly suggest you read it, even though it is mainly a post quoting a old Thoma post from 2007. It is as realistic and well-stated a view of the limitations of markets and the need to regulate them as I have come across. Just a taste:

Whatever the problem, the private sector - markets and their magic - beats government every time. Or so we are told. But this is misplaced faith in markets. There is nothing special about markets per se - they can perform very badly in some circumstances. It is competitive markets that are magic (though even then we have to remember that markets have no concern whatsoever with equity, only efficiency, and sometimes equity can be an overriding concern).

In order to work their magical efficiency, markets need very special conditions to be present. There must be full information available to all participants. Product quality, locations and prices of alternative suppliers, every relevant piece of information must be known. Not quite sure if the wine is good or not? That's an information problem. Not sure if the used car has problems? Don't know where any gas stations are except the ones beside the freeway in a strange town? No way to be sure if consultants are worth the amount they are being paid? Information problems are common and they can cause substantial departures from the perfectly competitive, ideal outcome.

There's a lot more here, and you will wonder if there's anything that actually does fit the theoretical model of the free market. It seems apparent that there's a "close-enough" quality that dominates the discussion.

(I won't go into it in detail here, but, if there's one thing we've learned from chaos theory and fractals, it is that small changes in initial conditions can lead to large changes in outcomes. Having a market which is 90% free doesn't necessarily mean we'll get 90% of the benefits that free-market theory suggests.)

At any rate, read the whole thing, and try to question to what extent regulation should be balanced with laissez-faire. It's, at least, a discussion we should have more often.

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