Posted by: N.S. Palmer | April 26, 2010

Regulate in Advance, or Clean Up Afterward?

By N.S. Palmer, Ph.D.

Should government regulate some economic activity to prevent problems?

Or should it just let the problems occur, and then depend on the “free market” to correct things in the long run?

Those aren’t really economic questions because they depend on value judgments. But I think that the only correct answers are: “Yes,” and “No.”

Nobel laureate economist Paul Krugman wrote a column for today’s New York Times in which he alludes to that dilemma.

As Krugman explains, one cause of the recent economic crisis was that credit-rating agencies misled investors by giving AAA ratings to investments that were in fact very risky. The credit-rating agencies were paid to rate those investments by the same companies that were selling them. So even with the best of intentions, the credit-rating agencies were under pressure to give good ratings and they had a significant conflict of interest.

Those are the facts. But people disagree on what to do about them. I can’t say “reasonable people disagree” as I normally would, because I don’t believe that there can be reasonable disagreement about the issue. But there is disagreement.

Supporters of the “free market” advocate little more than a Hobbesian view of the economy in which the strongest and most ruthless individuals do whatever they want. In their view, the market will take care of everything. Now that credit-rating agencies have been exposed as less than reliable, investors will take their advice less seriously. Credit-rating agencies, on the other hand, will be under pressure to demonstrate their objectivity, independence, and accuracy. “In the long run,” say these self-proclaimed defenders of freedom, “everyone will be better off.”

That’s their theory. The problem is that the long run is like tomorrow: we never get there. It’s always just over the horizon. The economy operates not in the long run, but in a series of short runs and medium runs.

What happens in an unregulated “free market” is that in the short run, the corrupt, connected, and evil make out like bandits — which they are. Honest people are forced to pay the costs of the robbery. When the dust has settled, the bandits get to keep their loot. The honest people face stagnant wages and 10 percent unemployment. Sound familiar? That’s exactly the story of the recent economic crisis.

One of FDR‘s economic advisors, Harry Hopkins if memory serves, put it very well: “People don’t eat in the long run. They eat every day.” John Maynard Keynes, the most influential economist of the 20th century, put it even more bluntly: “In the long run, we are all dead.”

The idea that the market can take care of everything is simply a prescription to let the corrupt and connected do whatever they want at the expense of honest people.

Economics can’t tell you if  that idea is right or wrong, because economics doesn’t answer questions like that.

But common sense says that it’s better to prevent problems than it is to let them happen, and let the people who caused them keep the loot, and make the victims pay for the cleanup. It’s to prevent such problems that we need government regulation.

The current financial reform bill in the U.S. Senate is far from perfect, but it’s a good start toward more adequate regulation of Wall Street.

Copyright 2010 by N.S. Palmer. May be reproduced as long as byline, copyright notice, and URL ( are included.


  1. Nicely done, Scott.

    I’m no economist, but even I can see that the problem with leaving the free market to correct itself is that if any individual or group grows too rich, they can leverage that mercilessly to perpetuate their position. I can’t see any natural correction for that.

    • Thank you, Jim!

      You’ve nicely summarized the central problem with libertarian indifference to concentration of wealth.

      If a company is rich enough to buy a fleet of oil tankers, it’s rich enough to buy the legislature. And that’s too rich because it slants the laws more and more in favor of the people paying off the legislators.

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