The rhetoric of regulation: free markets are regulated

Lynne Kiesling

Here at KP we study and analyze and talk a lot about government regulation of economic activity. But one thing to which we have not been particularly attentive is the rhetoric of regulation — what meaning, explicit and implicit, do we attach to the word “regulation”?

Into this breach comes an excellent Freeman column from Steve Horwitz that explores the rhetoric of regulation. Steve draws our attention to an important insight that is highly relevant to the cases and industries Mike and I study — the way we use the word “regulation” carries with it an implicit, and incorrect, presumption that in the absence of government administrative rules there would be disorder, manipulation, and chaos. That presumption is incorrect because in the standard sense of our understanding of the word, so-called “unregulated” markets are actually already subject to a set of formal and informal rules that discipline the behavior of all market participants, including both producers and consumers.

In this sense, free markets are indeed highly regulated.  Economic theory demonstrates that free markets operate according to rules that we can recognize and understand.  These rules enable us to make what F. A. Hayek called “pattern predictions” about the behavior of markets.  We know, for example, that when price rises, all else constant, quantity demanded will fall, or that above-normal profits in an industry will bring new sellers into that market — even if we cannot predict either outcome precisely.  Market participants will not act haphazardly, nor will outcomes be chaotic.  People’s behavior is regulated by the laws of economics, which in turn produce orderly patterns.

In other words, rules exist that lead to decentralized coordination in markets, and that decentralized coordination among heterogeneous agents leads to order, even in the absence of administrative “regulation”. Government regulation imposes a set of rules that differs from these organic rules, and may often conflict with those organic rules, with unintended consequences:

However, we could also argue that such intervention reduces the level of regulation in the market because intervention invariably puts a great deal of discretion in the hands of both the “regulators” and those being regulated.  Are “regulated” markets more predictable than “unregulated” ones?  Is it easier for entrepreneurs to anticipate the actions of bureaucrats with discretionary powers or of competitors seeking profits according to the rules of the marketplace?  Is behavior more “regular” when firms are genuinely profit-seeking or when they attempt to manipulate the “regulators” through rent-seeking?

Free markets are regulated, and government regulation that subverts or conflicts with those organic rules often create more distortions than they purportedly resolve. Kudos to Steve for making the rhetoric of regulation more explicit.


6 thoughts on “The rhetoric of regulation: free markets are regulated

  1. It’s a good point, but the title suggests another one: free markets also require government regulation. That regulation includes, most importantly, the protection of property rights. But it also includes limits on fraud and market manipulation. Those policies are regulations just as much as other ones (like, say, price controls). The only difference is whether we like the outcomes or not.

    The rhetoric of “regulation” often suggests that markets work better without regulation, when in fact they desperately rely on it.

  2. Thanks for posting this.

    I most strongly agree with libert. “Free” markets require “regulation.” Not just the kind of intrinsic, organic, economic “laws,” but also the system of property and transactional rules that are sometimes described as the “rule of law.” Such laws have operated for millennia in the west. Today, they appear as property law, variations on the Uniform Commercial Code, and common law.

    I also strongly agree that what most describe as “regulated” markets are nothing more than government programs (largely) designed to pick winners and losers. They are not markets at all.

  3. Agreed. The system of property/contract law/rule of law role of the state is the one that I am most willing to accept as appropriate formal institutions that constitute some of the non-administrative institutional foundations of free markets.

    That said, though, I don’t want to lose sight of the origins of many of those formal institutions, which themselves emerge over time through interaction, adaptation, trial and error, and are ultimately codified after standing the test of time, relevance, and robustness. I actually think that’s one reason why such institutions are more compatible with dynamic economic action, change, and innovation than administrative regulation is, because the imposition of a “non-grown” set of administrative regulations hasn’t ex ante met that test of time, relevance, and robustness.

  4. As I recall from my Economics survey class, these spontaneous regulation mechanisms can be bypassed. Producer conspiracies can determine the price producers charge, thus preventing price mechanisms from operating freely. Producers can back also back legislative candidates who favor so called fair trade policies that set minimum prices by legislation.

  5. I like the view of “regulation” that arises out of the private ordering literature in law and economics, or at least the version described in Amitai Aviram’s article, “Regulation by Networks” which is the part of the literature I’ve read. Article here–name%20fixed.pdf, abstract here

    Generally, in Aviram’s description, the purpose of regulation (whoever is doing it) is to mitigate opportunistic behavior. In the basic analysis there are two options: private regulation (parties to the contract monitor each other and have contractual means for protecting against or mitigating breach of contract or other failures) or third party regulation, where the government steps in to mitigate opportunistic behaviors that spillover outside of private contracts. Aviram’s article describes cases of “regulation by networks”, which may be a cases in which non-government third parties are best positioned to mitigate some opportunistic behavior (as for instance when a credit card company maybe better positioned to detect and prevent fraudulent use of credit cards than either private entities – cardholder, retailers – or governments).

    In this sense market transactions will tend to regulated in many ways, by other private entities that are parties to deals and by governments (and potentially other third party entities) that may be on guard against opportunistic actions. Most discussions about “more” or “less” regulation are really properly framed as questions about which aspects of transactions ought to be subject to private regulation and which to third-party/government regulation (and so the term “deregulation” will frequently be a misnomer, except for cases in which all regulation is suspended, perhaps because it is determined the risks or costs associated with opportunism is determined to be low or in any case is expected to be less than the cost of regulation).

    I’ve discussed the Aviram article here at KP in the context of the role ISO electric power market monitoring. See

  6. What? The USA’s Federal definitions make much more sense (and I’m mostly paraphrasing a ’90s run of exchanges in Forbes, though other vertical (Science, Medicine) policy magazines covered the same vertical concerns):

    In short, Compliance always, Regulate never.
    Still sounds coercive; sorry! Just imagine Jeff Bridges’ Rooster Cogburn handing in all his brown crumpled paperwork for that er, bounty errand of his for now.

    Market membership isn’t regulation; that’s just people deciding value, calling cops etc. when sketchiness and failure happen, calling investors when they do not, etc.
    Regulation sometimes includes industry self-regulation having filed acceptance; not a lot of transparency or resolution in that signal (Did they tell DOE how much leaked? Yes. Happy?)
    Regulation takes on a real component only when the correct regulating agency gives 30ish days notice to particular business entities that they’re out of spec (e.g. leaking like hell and misreporting pathologically) and starts describing the damage and remedial actions sought.
    But that’s 30 days or whatever the market was perhaps accustomed to out, so now I get to softpedal and say real net 30, which is real enough (outside the food and beverage biz.) Plllee-enty of time for new pathology or ready fixes (and their compliance filings, maybe) to avoid Regulation (though technically they’re doing all this Compliance stuff that seems very regulatory.)
    At the point time’s up -and- a regulator had time to review the status (not so automatic, sorry), Regulation splits into perhaps not mutually exclusive cases:

    i- The Industry Regulator consortium buys time for the innovation to get more awesome or the evil, without failing to front fees to the Industry Regulator, to scale.
    r- Regulation QED: charged fees, requested fiscal reporting adjustments accordingly, credit notation, requested bank allocations, audits are requested and a queue of misdeeds and remedial next steps polished released and filed (including a public release.)
    f- Regulation Legislation (stipulating a hypothetical HR4000-2008: Snowshovel Gouging Regulation Act of 2008, passed) forbids (r), until the legislated moiety made up most according to the bill agrees to the expediency of it. The idea is that the most interested opportunists would do the right thing; however, this is very like putting an experimental surgery ward in Wallgreens and letting the managers sort it evenly. (Though better on the face of it than doing it in Senate Sessions, City Hall, etc. with volatility rather than agility in command, as Lynne K. mentions; though aren’t the latter most in tune with the legislation with the finger on (r)?)
    w- The scale of the thing with bad compliance and regulatory calls makes it hard to correct in scope, and changes best practices forever and the industry and (f) struggle a bit for relevance. Buy and hold means you squeeze catastrophic bubbles out sometimes.
    j- Jurisprudence enacted
    a- automatic regulation; taxes, business category stuff that hasn’t been tweaked off default compliance-has-regulation-built-in schedules (board of health, FD, so-you-want-to-generate-power-using-material-commodities), etc.

    See? Simple! It’s Never Regulation.

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