Culture

The Case Against Freedom, Part II: Booms and Busts

monopoly-house

Robert Kuttner, professor at Brandeis University’s Heller School and senior fellow of the think tank Demos, believes that libertarians suffer from a delusion. He claims that the market is incompetent to price certain problems, and must be tightly controlled by government to prevent excess and abuse. In a piece written for The American Prospect, where he serves as co-founder and co-editor, Kuttner touches upon three examples which he believes demonstrate market failure.

The first is catastrophic anthropogenic climate change, which Kuttner offers as an example of negative externality. We addressed such externalities in part one of this series.

The second example Kuttner provides takes us back to 2008:

The other great catastrophe of our time is the financial collapse. Supposedly self-regulating markets could not discern that the securities created by financial engineers were toxic. Markets were not competent to adjust prices accordingly. The details of the bonds were opaque; they were designed to enrich middlemen; the securities were subject to investor herd-instincts; and their prices were prone to crash once a wave of panic-selling hit. Only government could provide regulations against fraudulent or deceptive financial products, as it did to good effect until the regulatory process became corrupted beginning in the 1970s. Deregulation arguably created small efficiencies by steering capital to suitable uses—but any such gains were obliterated many times over by the more than $10 trillion of GDP lost in the 2008 crash.

Kuttner makes a legitimate point, if only coincidentally, when he asserts that government ought to respond to fraud. However, by making that point, he implies that fraud and deception are integral to the market.

Fraud is not a function of the market. It does not belong in an intellectually honest critique of the market. No one aside from the most strident anarchists believe that fraud should go unanswered by government. Therefore, to attack fraud as a function of the market is to attack a strawman.

Kuttner may be conflating “deception” with ignorance. While government properly ought to respond with retaliatory force against fraud, recognizing fraud as a form of compulsion against the innocent, government has no role in protecting consumers from their own ignorance. If I fail to do my due diligence, if I sign on the dotted line or click “I accept” without reading the terms of an agreement or understanding a product or service, the fault lays with me. Failure to act rationally does not make one a victim.

The herd instinct which Kuttner cites as a negative is actually a key mechanism by which the market regulates economic activity. The power of the market is specialization, otherwise known as the division of labor. We each become experts in our chosen field, and rely upon the expertise of others, benefiting through mutual exchange in ways that none of us could accomplish living alone on an island.

Everyday, in a thousand different ways, we defer to the expertise of others. We defer to the engineers of our vehicles regarding their safety and operational integrity. We defer to the vendor at a lunch counter regarding the preparation of our food. We defer to our cellular company regarding the means by which our electronic communication occurs.

Even so, unlike animals, our “herd instinct” is not mindless. We evaluate the trustworthiness of a brand, a company, an individual. We consider track records. We examine history. We seek the advice of others. Then, we make our own decision.

In this way, we each individually act as regulators of the market, providing as many checks and balances as there are individual consumers – far more than government ever could – each motivated by something far more potent than a nebulous “common good.” We’re moved by self-interest.

Kuttner completely ignores the role that government regulation and mandates played in incentivizing the creation of toxic assets. His critique of the market only works in an environment where self-interest is skewed by moral hazard. When those who engage in risky behavior are not bound by the consequences of failure, when they can push those consequences off onto someone else, then they will not reign that behavior in.

That’s what caused the financial collapse, not a lack of government regulation, but a lack of market regulation caused by government. Kuttner unwittingly confesses this by citing a corrupted regulatory process. What he’s referencing is regulatory capture, a phenomenon whereby the entities which are to be regulated gain control of the regulatory apparatus.

Regulatory capture is only possible through government. It only works under compulsion. It would never last, if it manifest at all, in a free market. Without force, without the monopolization of regulation by government, no one can control the hundreds of thousands of checks and balances which react against bad actors – namely consumers.

The housing bubble doesn’t inflate in the first place without government housing initiatives. Sub-prime mortgages and derivative financial instruments based on them don’t manifest without government guarantees. Government created the 2008 financial collapse, not the market.

Kuttner continues:

A third grotesque case of market failure is the income distribution. In the period between about 1935 and 1980, America became steadily more equal. This just happened to be the period of our most sustained economic growth. In that era, more than two-thirds of all the income gains were captured by the bottom 90 percent, and the bottom half actually gained income at a slightly higher rate than the top half. By contrast, in the period between 1997 and 2012, the top 10 percent captured more than 100 percent of all the income gains. The bottom 90 percent lost an average of nearly $3,000 per household. The reason for this drastic disjuncture is that in the earlier period, public policy anchored in a solid popular politics kept the market in check. Strong labor institutions made sure working families captured their share of productivity gains. Regulations limited monopolies. Government played a far more direct role in the economy via public investment, which in turn stimulated innovation. The financial part of the economy was well controlled. All of this meant more income for the middle and the bottom and less rapacity at the top.

Kuttner here completely abandons historic reality. Government activism in the market has skyrocketed in the 21st century.

Government activism actually widens income distribution by protecting favored interests from the market forces which would otherwise keep them in check. Again referencing regulatory capture, the entities best positioned to benefit from government activism are those with the most resources to spend on lobbying and campaigning. This is why a growing mass of the non-partisan disillusioned regard both Republicans and Democrats as tools of corporate interests. We don’t fix that by limiting corporate interests. We fix that by limiting the government which corporate interests seek to buy.

That said, there’s a much more fundamental point to be made here. The premise which Kuttner takes for granted is that income inequality is a problem on its face. He doesn’t bother to tell us why. We’re just expected to know that income inequality is bad. This “knowledge” isn’t based on any rational argument, which is why Kuttner and so many others in his position fail to provide one. Rather, the notion of income inequality as a problem arises solely from an emotion – envy.

What does it matter to me whether you make more money? How am I deprived by your success? What claim do I hold to your wealth? On what basis should we ever, under any circumstances, concern ourselves with the distribution of that which is earned by others?

The only scenario wherein income distribution becomes a moral issue is one where income is distributed by illegitimate means. Income distributed by crime, by theft, by fraud – by compulsion. As an institution of force, government stands uniquely poised to distribute income illegitimately. Indeed, no criminal organization known to man has wielded force to seize wealth from those who earn it better than government.

Outside that context, in a hypothetical free market, the only means by which one can obtain income is through the production of value. In that scenario, one’s income becomes an accurate measure of the value they have produced. Since different people produce different degrees of value, their income will differ accordingly. As long as one’s income has been earned through production and trade, its size should not matter to anyone else. It’s nobody’s business. It has no effect upon the life of anyone else whatsoever, aside from providing the wealthy individual with the means to invest in even more production – providing jobs and opportunity for others.

As we continue in our breakdown of Kuttner’s “libertarian delusion,” we’ll consider his reverence for government regulation and so-called public goods. He takes a run at the “you didn’t build that” argument. Check back soon.