Free markets and government intervention

I am a fierce proponent of free markets. Therefore I am a fierce proponent of government intervention in the market.

Or, to put things less inflamatorily, one thing that often bothers me about US defenders of free markets is how easily they (and we) forget that free markets are created, maintained and curated by, well, the government. Free market conservatives often behave as if free markets are like a state of nature in which ham-fisted government arrives after the fact and wrecks everything when, in fact, it is the opposite. In a state of nature, you have permanent war. Traders and entrepreneurs can only exist once you have a Leviathan to enforce things like private property, money and contracts — all things created and maintained by the State. The rules of the market are set by the State. And if the State doesn’t intervene — justly — in the markets, you cannot have a free market.

To use a more down-to-Earth example, in France retail prices are on average 20% higher than in Germany (and this even though Germany has a higher VAT). Why? Because retail in France is a cartel. France’s big retailers hold local monopolies that they do not contest from each other. Government regulations also play a role — zoning laws prevent the opening of “big box” suburban stores to protect central “mom and pop” stores and other laws make it hard to “squeeze” suppliers. But the big companies have created a comfortable cartel. To create a free market there would require government intervention. Negative intervention, to be sure — scrapping wrongheaded regulations —, but also positive intervention, i.e. good ol’ trust-busting. It is the government’s refusal to step in which is stifling free markets, not the other way around.

The limited liability corporation, the contract-as-legal-document, all of these things are government inventions, and government institutions.

You see this in countless examples.

For example, many on the left point to the ballooning CDS market as one of the causes of the financial crisis (not without merit). The whole market was deregulated! And then the shit hit the fan! Ergo deregulation is bad, and regulation is good! In response, many free market conservatives point out that the success of the CDS market was a form of regulatory arbitrage, a way for banks and other institutions to meet their capital ratio requirements under the Basel rules. Free marketers use this as a Gotcha — see! It was all the government’s fault after all! — but in doing so miss a much more important insight: that all markets are dependent on how they are structured, and they are structured first and foremost by the government. There is no free market in finance, there never was, and there never will be, at least in the sense that these people think. Banks were insured by the government before the crisis. Ten years ago, if you asked anyone if, supposing some catastrophe, the government would let the biggest banks in the US fail, the (honest) response would have been: “Of course not.” (The actual response would’ve been: “It’ll never happen.”)

Free markets require a strong and active government. The US is a “more free market” place than “Europe” (insofar as these broad strokes mean anything), in part because it has a government that is less high about maintaining a free market. There was never any trust busting in France. Among my friends who work in finance in Paris and New York, they scared of the SEC; meanwhile its equivalent the AMF is the butt of jokes.

The reason I write this now is because, as much as I’ve enjoyed Megan’s spirited defense of pharmaceutical and medical innovation — and as much as I agree with her on the merits —, at times she does sound too much as if the pharmaceutical industry as it exists today is an unadulterated free market. In her Bloggingheads with Mark Schmitt, even though I was hootin’ and hollerin’ when she excoriated Schmitt’s attacks on Big Pharma as crypto-socialist, I couldn’t help but take Schmitt’s point that Big Pharma as it currently exists was created and is made possible by the government. Leave alone the FDA approval process — the pharma business is based on patents and copyright, which are government created and enforced institutions if there ever were. When pharma companies pay off generics companies not to bring generics to the market, that is a voluntary transaction between private entities, and yet it is the opposite of a free market. It is, in fact, cartel formation. And it begs for big bad government to come in, perhaps with black helicopters, take people to court and slap big fines.

The question of health care reform vis à vis the healthcare and pharma markets is not whether to leave the market intact or not. It’s how do we structure a market so that the incentives are aligned in a way that serves consumers best.

Just a thought.