Do markets work?

September 19, 2008 at 1:25 pm | Posted in economics, regulations | Leave a comment
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The centerpiece of right-wing dogma is that markets work. Left wing dogma, at least in the US, is that markets work most of the time.

I think markets do work, but they often need a framework within which to operate. To those who want to cut back on regulation (including libertarians), I ask – would you want to live in a town of any reasonable size without regulations for stop lights?

Markets need to be tempered by regulations, particularly to account for two factors – externalities (which affect other people) and information asymmetry (where the different parties to the transaction don’t have the same information).

An example of an externality dictating regulations is a noise ordinance – I don’t care how late my neighbors let their kids stay up – there is no real externality that affects me, but I do care how late they let them party at home. I don’t care if someone enjoys a few drinks. But I do care if they drive after that. And I cannot affect these outcomes directly – only by supporting the regulation of these activities.

An example of an information asymmetry can be found in lead paint, or tobacco, or pharmaceuticals. The seller of the product sells a ton of these things. Whether or not they have studied the side effects (pharma, yes, lead paint, perhaps the manufacturer has not), they become aware of the issues from customer feedback over a period of time. But they have no incentive to share information about the product that may hurt their sales. Especially if there is a long time lag between purchasing a product and seeing the negative side effects, traditional information sources such as news articles or customer forums may not work, so the only way to mitigate this is through regulations requiring disclosure. Insider trading is another example.

I would love to hear thoughts for and against regulations, and how regulations can mitigate externalities and information asymmetry. Would you support regulations even where these issues do not exist? Or would you oppose regulations where such considerations do apply? And, perhaps toughest of all, how does one create a framework to determine when regulations are appropriate?

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