Monday, October 18, 2021

Government Makes the Market

Early retirement has been a blessing in these long days of the pandemic. Our days went from a non-stop juggling of work, parenting, cooking, and cleaning to, well, a leisurely juggling act of the same things. Mrs. Done by Forty decided she wanted to keep working and it's been a very good thing for both of us: she's happiest when she gets to put her PhD to use and getting to do so from home is kind of a dream scenario. 

My time is filled with puzzles, toys, crayons and walks with Toddler AF, along with diapers and eye gazing and coaxing Baby JC to sleep. In the breaks, there are a lot of online board games and yard work.

There's also time for reading, which is proving to be a complete joy. The hours after Toddler AF goes to bed are precious. After the dishwasher is loaded and cold brew is started for the next day, I can lie on the couch and get some time alone with a book from the library. It's the best way to end the day.

I finally finished Robert Reich's Saving Capitalism and so much of it rings true to me. But the part that broke my brain is the realization that the traditional framing about government and the free market (that the free market just exists and thrives and then government regulation comes along and hampers it) is a complete falsehood. In fact, the free market doesn't exist without government.

(I'll pause so my three conservative readers can yell at the screen.)

From Saving Capitalism:

"There can be no 'free market' without government. The 'free market' does not exist in the wilds beyond the reach of civilization. Competition in the wild is a contest for survival in which the largest and the strongest typically win. Civilization, by contrast, is defined by rules; rules create markets, and governments generate the rules." 

In other words, competition in the wild is anarchy: literally anything goes because there are no rules. You can assault and kill your competition for resources. You can kill your competition and turn them into resources. It's all on the table.

Thankfully, civilization and economic markets are not like that. What we think of as a free market is not this sort of wild free-for-all but, rather, a competition with many rules and mechanisms, all of which are established by government. Without government, there is no free market as we know it today.

For example, let's say that you invent a new mousetrap and want to sell it for money. In a market without governments, what is stopping someone from simply stealing your idea and copying it? (In a market with government, a patent is that thing.)

What is stopping someone from literally stealing all the mousetraps you made? (In our markets, it's government entities like police departments, courts, and jails that stop that.)

But let's say you aren't convinced yet. You believe the conventional wisdom: governments don't create markets; free markets simply exist in the world. Further, things would operate best if government regulation didn't interfere. So let's dive in to those assumptions.

Reich argues there are five building blocks to capitalism, and government is essential to each:

    "PROPERTY: what can be owned
    MONOPOLY: what degree of market power is permissible
    CONTRACT: what can be bought and sold
    BANKRUPTCY: what happens when purchasers can't pay up
    ENFORCEMENT: how to make sure no one cheats on any of these rules"
    Let's quickly run through these building blocks, to illustrate how government is not only a key component, but a required one, to make capitalism and free markets work.

    Property: what can be owned. Who gets to decide what can and cannot be owned in the first place? Can an idea be owned? A person? 

    And can all people own all types of property? Can a child own and sell land? Can women or people of color?

    Government is the entity that answers these questions and provides guiderails for what can be owned in free markets. Though they often make huge mistakes in these areas (e.g. - two hundred fifty years of American slavery), the larger point is that government has an essential role in legislating what can be owned and by whom.

    Monopoly: what degree of market power is permissible? Often, monopolies are rightly thought of as bad for competition. But they're also sometimes necessary to bring ideas to market. For example, in this country an artist has a specified time when they have a monopoly on a book or song they've created before it enters the public domain. But without that period of monopoly, artists and businesses would have much less incentive to create the product in the first place: their intellectual property could be pirated and sold by rivals immediately. This concept applies to everything from the written word to new prescription drugs. The limited time of protected monopolies, like patents, create incentives for business to invest in research and create new products.

    These monopoly protections are only possible because of government. To what degree and length a monopoly can exist is determined by lawmakers. In some cases, businesses buy up competitors to create a monopoly: then governments can break up that entity, to create competition. But in all cases, the role of governments is clear: to strike a balance of market power that will spurn innovation and competition.

    Contracts: what can be bought or sold. So let's say your company just locked up some new business after an RFP. You negotiate a contract for a specified number of units over the next three years and, after delivery...the payment never comes. Your calls to the buyer go unanswered.

    What keeps the buyer accountable? Well, the contract does.

    But what keeps the contract from just being a piece of paper that can be ignored by an unscrupulous business partner? Government does. Courts and judges do.

    Bankruptcy: How much risk would you be willing to take as a business owner or consumer if you were on the hook for any and all debt, regardless of circumstances? How much would you be willing to borrow to launch new products or expand to a new facility?

    Bankruptcy, the ability to seek relief for debts that cannot be repaid, encourages businesses to take measured risks that have positive expected returns, and also encourages lenders to perform due diligence to ensure that those risks truly are measured. Indeed, without bankruptcy, lenders would have less incentive to perform such due diligence: bad loans to unqualified borrowers would not matter, since the loan couldn't be forgiven.

    Again, this building block of capitalism exists because of government.

    Enforcement: On the most basic level, what keeps criminals or rival businesses from simply stealing products from stores at gunpoint? What keeps organized crime from taking over businesses entirely? Despite their overwhelming downsides, police and courts and jails do. While they do a terrible job at protecting citizens, these institutions do a fairly good job of ensuring the gears of capitalism keep turning. They're good for markets.

    All this omits the myriad other ways that government is crucial to business. The public roads and airports and postal service integral for moving goods. The public utilities like water and electricity and gas that all businesses rely on. The seed money for companies like Tesla and SpaceX. The publicly funded schools and universities that train the workforce and management. It goes on and on. 

    But the old criticism from conservatives, that the free market would do so well if only government would stay out of things, is both hopelessly partisan and undeniably false. Government makes the market.

    **Photo is from Damien at Flickr Creative Commons.

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    1. Exactly right.

      In addition to the examples you've cited there are many others. The gov't provides enormous subsidies to farmers and farmland owners. The gov't bankrolled the detached home suburbs (for whites) through the FHA. The gov't effectively owns all bank accounts under $250k through the FDIC. The auto, airline, and banking industries are backed fully by the US gov't as we've seen with numerous bailouts over the years. We know now the gov't will not allow a major collapse of the status quo in these industries. Most US student debt is fully backed by the US gov't. That is, most of that money is literally backed by the US gov't. Which is why Biden could wipe most of it in an instant. There are many more examples no doubt.

      1. Sorry for the late reply and yes, there are so many other good examples of how the government is critically important for our functioning markets. FDIC insurance is a huge one that we take for granted, now that the depression is nearly 100 years in the rear view mirror. And yes, the complete collapse of the economy would have happened a few times without government coming in to save markets.

    2. Don't usually comment but I really enjoyed this article. Now while I'm not yelling at the screen (usually) I am what most would consider a conservative, although I prefer libertarian.

      A few thoughts I had as I read this...
      1. I do believe that governance is needed, and to say otherwise is foolish...I think most "conservatives" struggle with how much government they want/need.

      2. Most everyone gets mad at a situation only when it doesn't benefit their agenda. I.E. Trump did this executive order and I hate it so I'm against executive orders, Biden does this executive order and I like it so Yay executive orders...and ofc vice-versa. No one stops to think maybe I wouldn't like it if the roles were reversed.

      3. Going along with #2, most people dislike lobbyists (if they aren't on "your team") because the absurd amount of money that goes into making policies, allowing monopolies, etc...what would happen if we reduced the amount of influence and power the central government had so that gradually lobbyists no longer mattered? Is this the best solution? Is this even doable? Just some random thoughts I had. Good read as always and I appreciate counterpoints to free market without government.

      No government is great until my neighbor is pooping on my lawn and no one is around to fine him lol...I mean no one wins in a poop war.

      1. Hi there, libertarian friend. Glad I haven't scared off all my conservative leaning readers.

        I agree that there's a discussion for 'how much' government is the right amount. Mostly I wanted to address the old saw of "government interfering with the free market", and how it is utilized to justify any and all cuts to government and regulation, under the premise that the cuts will allow the free market to operate better, more profitably, etc.

        Given that I've spent my whole life in a free market, I hadn't fully understood how much government is indeed required for & responsible in the market. It's a needed partner: markets as we know them can't exist without regulation from government.

        I agree that partisanship is widespread: I'm very clearly a partisan and I don't try to hide it. It helps that my political opponents are terrible people who are loved by no one, not even their mothers.

      2. Don't have access to the laughing-crying emoji but if I did that's what I would reply with. Thanks for that last paragraph because my Monday is a bit brighter now.

    3. I agree with the main premise of this book and article, but what happens to the 'free markets' when the government is corrupt? Virtually every harmful monopoly I see is supported or protected by the government. The regulations also seem to favor the incumbents over the innovators. In order to have a truly free market, you must have a truly free government that protects it. That is pretty rare these days, with the overwhelming influence of big money.

      1. Hi there, Bret.

        I agree that governments are never free from corruption. Seems like it's table stakes, though I suppose I'll take an imperfect democracy over the available alternatives.

        That said, I don't know if I agree with the point on regulations favoring incumbents over the innovators. There are times when that's the case, but taking a look at the very top performers in our markets seems that innovators are taking incumbents to the woodshed, likely due to a severe lack of regulation. Amazon is out there wrecking every incumbent brick and mortar store there is, in part, due to the fact that governments allowed them to not charge sales tax for a decade or two, and to suppress/avoid collective bargaining. Netflix completely obliterated Blockbuster and cable companies. Tesla is government funded and has a market cap greater than almost all car makers.

        Overall, I'd say our economy & government are both very friendly to innovators and very light on regulation.

        Though you did specify monopolies but, by their nature, these only can exist because of government. By their nature, they are protected specifically because of govt. Maybe that's your point.

    4. SavvyFinancialLatinaJanuary 4, 2022 at 9:13 AM

      Crazy liberal over here (as I am dubbed by my very conservative white in law family). I have plenty of criticism on the government but I am not an anarchist.

      Fundamentally, civilizations need governance. Bureaucracy is part of government. And much as it frustrates me...the reason there is bureaucracy (and sometimes too much?) can be good for civilizations that create long standing empires.

      1. Agreed! And even beyond just the inefficiencies, we should also mention the huge efficiencies in the markets which governments allow.

        We take for granted the smoothly functioning economy that allows business owners to set up shop without worrying that organized crime will demand protection money, that the business's goods or the entire business can be stolen at any moment.

        The value to a market to operate relatively freely BECAUSE of courts & contracts is immeasurable.

      2. SavvyFinancialLatinaJanuary 10, 2022 at 9:16 AM

        Yes, I completely agree. Also, having the trust that a contract will be withheld in a court of law, also, makes companies evaluate and reflect risk in a contract.

    5. As I was reading this, a couple of reflections came to mind:

      It's evident that governance is essential, and denying its necessity seems unwise. It appears that many individuals who identify as "conservatives" grapple with determining the extent of government required or desired.

    6. It is fascinating how government policies can shape the market dynamics. I'm currently researching write my dissertation for me uk, focusing on the UK market. If anyone has insights or can recommend sources that discuss this topic in depth, I'd greatly appreciate it.