Needed: A New Language of Regulation

As the country struggles with the fallout from a series of financial meltdowns, a new, healthy debate is emerging around the interplay of markets, government, and the security of our financial system. But this discussion has been hindered by the assumption that we must choose between "more" or "less" regulation. Unless we can move beyond this dichotomy and develop a new language of regulation, the public dialogue, and the policy that flows from it, will be incomplete and flawed.

The root of the problem is a conception of regulation that exists along a single scale, with one end being pure, unconstrained capitalism and the other, supposedly, socialism. In between these two extremes, the implication is, lie the alternatives before us; we must choose more or less regulation of financial markets, with Republicans reflexively preferring less regulation and Democrats, more. The further, usually unspoken, implication is that regulation hinders the smooth operation of markets, but perhaps this is a price we must pay to prevent disasters, like the one we now face, from occurring in the future.

But this vision of the relation between markets and regulation is all wrong. We regulate markets all the time, not to hinder them from working, but to enable them to function in the first place. We regulate the market in chickens, for example, because no one would buy any chickens at all if they were worried about salmonella poisoning. We also regulate the markets for milk, toys, plastic containers, and more; the dire results of inadequate regulation of consumer products are now evident in China.

And we regulate financial markets heavily, not to prevent them from operating but to allow them to operate. Stock markets, for example, would not last long unless regulators specified and enforced laws against insider trading. And advances in computer trading technology have forced markets to temporarily suspend trading on certain stocks, or to limit the volume of trades, like throwing sand in the gears of a mill stone. Complex markets - those in which goods and services are traded across distance between anonymous individuals - are not machines that go on their own; they need the undergirding of proper regulation or they will fall prey to those looking for opportunities to game the system.

Of course, not all regulation is so benign. Aspiring hairdressers in California, for instance, must first pass a course that includes advanced chemistry in order to obtain a license. It is possible that this may occasionally help their customers (say, when a chemist needs a haircut and forgot some crucial formula having to do with the pH balance of hair follicles). But in most circumstances, such regulation merely raises the cost of becoming a hairdresser and thus allows the hairdressers who do enter the market to charge a higher price.

Rather than a language of more or less regulation, then, we need to talk of pro-market and anti-market regulation. Pro-market regulation is the scaffolding that market exchange is built on; it is a necessity without which we could not enjoy all the benefits of a free market system. Anti-market regulation hinders markets and creates deadweight loss for all of society.

Of course, once you put it this way, regulation ceases to be such a partisan issue. Everyone is, or at least should be, in favor of pro-market regulation. And the events in recent weeks have shown us that even the most ardent free-market purists must bow to realities when certain crucial markets, like the market for loans and credit, cease to work altogether, leaving no alternative but for the government to step in with resources to "prime the pump" and get things moving again. Then again, maybe the fading away of partisanship on regulatory issues isn't such a bad thing, seeing as how it will take real bipartisan consensus to pull us out of our current mess.