Sunday, November 9, 2008

Give Me Liberty or Give Me Competition

As recriminations fill Republican airwaves, one question the party should ask itself is whether it is the party of competitive markets or the party of free markets. When the dust settles from the 2008 elections, one casualty will be the automatic alliance between economic libertarians and advocates of the Invisible Hand.

The Competitive Markets Point of View

The Invisible Hand operates in perfectly competitive markets to guarantee that the pursuit of individual profit will lead to economic efficiency, national growth and the distribution of riches according to each person’s (marginal) contribution to creating those riches. However, as nature abhors a vacuum, business abhors competitive markets because competition is the enemy of profit. That is why both Adam Smith and Milton Friedman advocated strong government intervention to maintain competitive markets and roll back the tendency of free markets to concentrate power, collude, conspire and even corrupt (Enron, WorldCom, big tobacco, Three Mile Island…).

Adam Smith and the “freshwater” economists who evangelize “free market” capitalism are actually advocating “perfect competition.” The “free” in “free market” refers to freedom from concentrated market power and from a government menu of prices and outputs levels. It refers to markets where all workers and all businesses face a full and identical range of choices and where none can influence the choices of its competitors. In particular, perfect competition requires:

  • infinitesimally small businesses selling things and services that are perfect substitutes for their competitors’ products
  • perfect information about what things and services are worth, now and in the future
  • prices that reflect all the downstream impacts of products and services
  • some mathematical niceties, like rationality and free disposal

Game theory and behavioral economics have added complexities but have not changed Adam Smith’s proposition that perfect competition requires active and robust government intervention. Even if we set aside do-gooder interventions motivated by distributional, environmental, political or other ethical objectives, we are still left with a competition-based case for government interventions such as:

  • product labeling and corporate disclosure requirements
  • laws against insider trading of securities
  • antitrust, anti-predatory practices laws
  • product liability laws
  • standards setting
  • inspections
  • compensatory tariffs
  • etc.

The Free Market Point of View

In contrast, the libertarian meaning of “free market” capitalism is that government should leave workers and businesses alone. It is primarily motivated by the ethical belief that private entities have a right to do whatever they choose unless there is a compelling reason for governments to restrict their choices in order to protect other people’s choices.

Under the libertarian approach to free markets, there is no rigorous theoretical connection between libertarian ideals and economic efficiency except through “natural law” arguments that are sometimes more hortatory than theoretical. Even if Mussolini could make the trains run on time, the argument goes, that wouldn't make it right. Libertarians generally observe that when governments meddle, they make things worse. This observation overlaps with the Invisible Hand economists’ desire to get the government out of setting prices and outputs.

The Split

For a long time, examples of inept and ineffectual government interventions, contrasted against steady growth in wealth and income in the private sector, papered over the fundamental incompatibility of the two approaches to free market capitalism and allowed them to coexist in the Republican party.

Two things have changed, recently. One is that the financial crisis has proven once and for all that private entities left to themselves do not reliably make economically optimal or even selfishly smart choices. Unregulated markets are far from perfectly competitive, as market power is highly concentrated, some private entities hide and distort information unless corned like rats, and they daily make decisions with societal impacts far beyond their own bottom lines (“externalities,” in economics-speak).

The second change is that for most of the past decade or so, corporate profits and income among the wealthiest individuals have risen strongly while middle and lower class incomes have fallen in inflation-adjusted dollars. The increasingly stark contrast between the growth in national output and stagnation in worker bee incomes and security has made it harder for the Joe the Plumber argument to stick: that we should help the business class because their success will trickle down, or at least because we are likely to join their ranks one day.

Now, Samuel Joseph Wurzelbacher notwithstanding, the Joe the Plumbers of the Republican party have begun to divide over the choice between the right to be left alone and the right to a fair fight.

Our schoolroom pledge to uphold “liberty and justice for all” takes on new meaning. One persuasive (for some) line of argument is that there is no justice without personal liberty, so we must get government out of our private economic lives. Another persuasive (for others) line of argument is that being stuck at the losing end of an uneven playing field is its own sort of prison, so liberty and justice require government to level that playing field by negating the anticompetitive tendencies of private enterprise.

Both are legitimate Republican points of view, up to now mashed together with faith in the integrity, intelligence and efficiency of private enterprise acting as the glue. But that glue dissolved in the 2008 elections. As free markets appeared to be neither efficient nor benevolent, some of the Republican electorate stuck with free markets as intrinsically just and an end in itself, while others turned to government intervention to restore competitive markets and enable stable and efficient outcomes. The Republican party needs to confront that schism and decide where it stands between free markets and competitive markets.


entaroadun said...

There is an intersection between libertarianism and competitive markets, and that is "truth in advertising". Much of the public policy prescriptions aimed at encouraging competition fall under this umbrella. The key question for libertarians is, "Do private individuals have a fundamental right to lie or mislead?" If not, then the government has a role in enforcing truth and transparency.

TheSwingVoter said...

Agreed, though the laissez-faire purist would say that truth-telling can and should be enforced either by reputations (like eBay buyer and seller scores), retaliation (flip side of the enlightened self-interest coin) or private arbitration (e.g., the local sheriff, who libertarians seem to feel is one of their own).

I often wonder, though, if we start itemizing public goods like truth-telling, collective security and rule of law, do we end up with government by another name? In other words, is government observationally equivalent to a private, voluntary association motivated by a sophisticated self-interest? After all, it is perfectly conceivable and not uncommon for a person to voluntarily give up some voluntarity. Think of the party-goer who gives his car keys to a friend and says, "don't let me drive home." Or Odysseus, who commanded his sailors to bind him and not release him until safe from the Sirens. It may not be one small step, but it may be a continuous series of tiny steps from there to the Social Contract. Expand that intergenerationally, so the contract is between a family and all other families rather than an individual and all other individuals, do we end up with the status quo?