Great column by Arnold Kling and Nick Schulz on how markets really operate – and why government intervention either causes problems or prevents markets from fixing them. For those of you who care to get in the weeds, this is one of the reasons why the “Austrian School” of Hayek and Mises is better for understanding economics than the (also great) “Chicago School” of Friedman and Becker:
Two camps have fought the political and philosophical battle for influence over the economy in the United States for the past 100 years. They differ in their views over the nature of markets and government. And both are wrong. One camp makes it sound as if markets can do no wrong. …The other camp argues, “Markets fail, and that’s why we need government.” …In the wake of the financial crisis that gave way to the broader economic downturn, the advocates of government involvement in the economy are once again on the march and traditional defenders of markets are in retreat. And so we have seen government advance its role with partial ownership of many big banks, with a take-over of automotive firms, with a large “stimulus” program, with proposals for cap-and-trade for carbon emissions, and with a major initiative on healthcare. …Over the past two generations, a different view of markets and government has begun to emerge, one whose moment may have arrived. It is a view that believes both traditional camps have overlooked some important aspects of markets. …This view can be summarized as “Markets fail. That’s why we need markets.” …According to this view, entrepreneurs at work in the economy–in finance, high tech, manufacturing, services, and beyond–are constantly experimenting, creating new business models, techniques, and technologies that upend the established order of things. Some new technologies and innovations are genuine improvements and are long-lasting welfare enhancers. But others are the basketball equivalent of pump fakes–they look like the real deal and prompt market actors to leap hastily into action, only to realize later that their bets were wrong. Given this dynamic, markets are unpredictable, prone to booms and busts, characterized by bouts of exuberance that are rational or irrational only in hindsight. But markets are also the only reliable mechanism for sorting out this messy process quickly. In spite of the booms and busts, markets drive genuine long-run innovation and wealth creation. When governments attempt to impose order on this chaotic and inherently risky process, they immediately run up against two serious dangers. The first is that they strangle new innovations before they can emerge. Thus proposals for a Consumer Financial Protection Agency, a systemic risk regulator, a public health insurance plan, a green jobs policy, or any attempt at top-down planning may do more harm than good. The second danger has to do with the nature of political economy. Politics creates its own kind of innovators who can be as destabilizing to markets as market actors themselves–but in far more pernicious ways. Economists call these political entrepreneurs “rent-seekers.” Rent-seekers gain wealth, not by creating it, but by channeling it through political favors. Examples include government-sponsored monopolies, “targeted” tax breaks for special industries, and legislative loopholes inserted by lobbyists. The boom in housing and mortgage securities that ended so badly was fueled by government policies that were encouraged by rent-seekers in the real estate, home building, and mortgage finance industries.