Consumer Safety: Government regulators don’t need more power

Consumer Safety: Government regulators don’t need more power

The past 10 years have seen spectacular events that are still unraveling in most powerful nations. We have seen how the U.S. economy is experienced anemic growth and struggled to recover from the worst recession seen since the Great Depression of the 1930’s and  how Europe is faced a Sovereign Debt Crisis that is threatening the political union and the overall well being of the Western European population. Financial Markets are in a constant mode of volatility, and any errors by policymakers are immediately shown with fatal results. What is more curious, and unfortunately, it has taken by surprise to most economists and political leaders, is that for the most part, these events have been preceded by grave errors in Corporate Social Responsibility. Scandals such as Enron, WorldCom, Bernie Madoff’s Ponzi scheme and issues related in consumer products such as drug and meat safety have unleashed a series of attacks to “unfettered” free markets and capitalism, pushing for more regulations and more State interference, with the pretense of protecting the consumer from evil speculators and the “wild swings” of the market economy. The purpose of this essay is to analyze how a complete belief in overregulation and interference in markets is the problem, and therefore dismantle the outcry for more state interference.

How the Free Market protects consumers

When the majority of the population attempt to envision a world without interference with the market, a typical question arises which is normal due to the genuine concern people have for their lives and of others: How consumers be protected without the Government stepping in? The answer to this question is not an easy question, but first it is important to understand that consumer safety is an issue that it is analyzed on a cost-benefit manner in the context of economic incentives and trade-offs. As Economist Gene Callahan puts it “Safety is not an absolute value that automatically trumps all others. Even the most die-hard consumer protectionists realize that safety must be traded against other factors” (Mises Daily). This is very important to understand because it is the premise that provides the answers to the root problems of why more regulation is not the answer. The next concept that is important to understand why more regulators is not the solution for consumer safety is to understand how the tradeoff between safety and other factors occurs. This phenomenon occurs only through the system of Profit and Loss. This mechanism is what allows entrepreneurs to allocate resources and factors of production in an efficient way. In the words of Callahan, “It is the desires on the part of entrepreneurs to make profits by satisfying consumer demand what guides this trade-off between safety and other features, such as price. It is this price discrepancy between different factors of production and the final consumer that generates the opportunity for entrepreneurial profit” (Mises Daily). This is important to understand, because the Government is not operated under the mechanism of profit and loss, rather, its operations are highly centralized and based on an annual budget, which makes the process of allocating resources very inefficient. In this sense, Entrepreneurs due to the profit motive can tell whether they have satisfied consumer’s demand by reviewing their financial statements at the end of each quarter or at the end of the year, if they have achieved profits. On the other hand when government authorities step into a particular market to provide consumer safety and for example mandates an specific feature, it destroys the mechanism by which entrepreneurs might discover what features consumers valued more, like price-quality features vs. safety, for example. Also, the biggest safety for consumers is provided through the market process of competition. In a competitive market, producers and manufacturers compete against each other to satisfy customer demands the best possible way at the best price-quality-safety ratio. This can be seen in the electronics market, where iPhone and Samsung Galaxy for example, compete for the best Smartphone in the market, giving consumers excellent technologies and features, at a low price and high quality. Scholar Walter Williams shows how competition in the market place protects consumers by giving the following example: “What motivates a grocery store manager to have sales, introduce new products and services, and incessantly search for other ways to please us and make us loyal customers? The easy answer is the seek for profits, but in order to do that, he must lure is into his store, pleasing us more than the alternative, his competitor (The Freeman Online).

How the market reacts spontaneously to failures in consumer safety

Overall, companies do not want to create safety issues for its consumers. Most companies operate with the best intention to satisfy the consumer. Otherwise, the market, which is dynamically efficient, exposes the socially irresponsible producer in the way of losses, loss of market share and even bankruptcy. And this is very important, because there are concrete examples of companies acting in a socially responsible manner without the need for more regulatory power. One example is what Mattel’s Toy Company CEO did after having to recall toys because of led tainting safety issues. According to Robert Eckel, “Mattel hired more inspectors, ensuring full time supervision in all production plants and requiring that each batch of products be tested for lead before being put to sales” (Katel). This shows that responsible companies and private affairs take into consideration safety issues without the need of overregulation. Of course it doesn’t mean that regulation is bad or that no regulation is whatsoever necessary, however it means that the call for more regulatory power is not the de facto answer, rather the answer is for current regulators to enforce the laws and to allow competitive market forces to further protect consumers. The whole concept of the market failure that economists behold assumes that only market participants make mistakes and that state institutions are somehow made of people belonging to a “finer clay” to quote Frédéric Bastiat. As my friends at the Mercatus Center at George Mason University would say: “Markets Fail, Government Fails, so let’s use markets”. It also reminds me of this excellent quote from Peter Boettke, professor of Economics at George Mason University: “If you bound the arms and legs of gold-medal swimmer Michael Phelps, weighed him down with chains, threw him in a pool and he sank, you wouldn’t call it a ‘failure of swimming.’ So, when markets have been weighted down by inept and excessive regulation, why call this a ‘failure of capitalism’? This is important also because it reflects the importance of corporate social responsibility, stakeholder approach and why corporate social responsibility matters.

More regulators will protect consumers?

The purpose of this section is to present specific examples showing how the call for more regulators does not warrant success against past events; rather, the issue is whether the current regulators are doing their job correctly and not overburdening businesses, entrepreneurs and individuals.

  1. Bernie Madoff’s Ponzi scheme scandal: Bernie Madoff became famous after confessing to defrauding his clients of $50 billion. The Ponzi scheme which consisted in paying investors with other investor’s money only came to conclusion due to the downturn in the market in the wake of the financial crisis of 2007, where people started demanding their money back due to animal spirits, fear and lack of confidence. The problem here is that well known investor’s and wall street analysts warned the SEC and other regulators well in advanced, many years before the Ponzi scheme went bust, and the regulators did not even pay attention and just let it go by. According to Chidem Kurdas “In any event his beyond-belief performance was brought to the attention of the SEC and other agencies by at least two people acting independently. One was a hedge manager named Michael Berger and the other was Harry Markopoulos, an analyst and trader frustrated because he failed to achieve the robust returns Madoff reported, after using quantitative analysis to demonstrate that Madoff’s return were unattainable under the derivatives strategy that he was claiming, and the SEC looked the other way” (The Freeman online).
  1. The Housing Bubble and Financial Crisis of the years 2004-2008: This episode in the U.S. economy was so severe, that is actually difficult to find a starting point. I will start with the ratings agencies, the most important being Standard and Poor’s, Moody’s and Fitch. These rating agencies were paid by government regulators (moral hazard) in order to determine what investments are safer, less risky, and which ones are not safe and riskier. These agencies are indeed regulators and intent to protect consumers in finance. The rating agencies rated mortgage backed securities and subprime loans with the highest ratings possible (AAA), knowingly or perhaps naively not knowing that these products where indeed junk as the market system later revealed when the bust came down in 2007. Another area of the financial crisis was Fannie and Freddie Mac, two government sponsored entities (GSE’s) who guaranteed mortgages and in fact regulated the housing industry, except that it engaged in reckless lending and a irresponsible lending practices by relaxing lending standards and loaning money to unqualified applicants and home buyers, clearly not protecting consumers. What makes people think that more of the same, more regulators will not fall again and fail to protect consumers, or perhaps what makes people think regulators have superpowers? That’s something I’d like to hear back with a response.
  1. The Sarbanes-Oxley Act: This regulation was created and passed as a measure to protect consumers against accounting and finance frauds, such as the ones that occurred with Enron, World Com and others. The problem with this type of regulation is that usually what is not seen is what results in aggravating the problem. These of course are the unintended consequences. The most important unintended consequence of this particular regulation is the increase in compliance costs that make businesses in finance and accounting operations very expensive and difficult. Performing a cost-benefit analysis, the costs outweigh the benefits; as a result, the unintended consequences tend to cast a big shadow into the original intents of the law. The first unintended consequence that one can see is that this act will certainly increase compliance costs for companies. Compliance costs are extremely burdensome for corporations, and according to BusinessWeek’s article “Honesty is a Pricey Policy”, the estimated cost for section 404 compliance of the Sarbanes-Oxley act is of $7 billion in the first year.

Michael Novak and Ayn Rand

Michael Novak through his work Business as a Calling teaches us how market forces, like competition and entrepreneurship, allows for the best allocation of resources and therefore to determine which values are more important for people and for consumers to determine how much they value safety and therefore satisfy their needs. According to Novak, “Enterprise is the creation of surprises. Enterprise is an aggressive action not a reaction, it forces others, and other businesses through competition, to provide the best satisfaction in values, to make others react” (Business as a Calling). On the other hand, Ayn Rand also provides theory and knowledge that defends the market and the notion that more power to regulators is not the solution through her essay what is Capitalism? Ayn Rand explains how it is only through the market system and free enterprise that values are discovered, and she also explains in this essay how the profit motive is what allows entrepreneurs to allocate resources and establish a cost-benefit analysis that would allow to know what degree of safety, quality and price satisfies the need of the consumer, as opposite through overregulation and government interference. Ayn Rand states that “values are to be discovered to man’s mind, men must be free to discover, to translate their knowledge into physical form, to offer products for trade” (What is Capitalism) or the following, “It is in this regard to a free market that the distinction between an intrinsic, subjective and objective view of values is important to understand. The market value of a product is not its intrinsic value, rather what the individual considers the value of such product” (What is Capitalism).

Conclusion

The notion that consumers are safer when more regulation and more government power is enacted is way overblown. The issue here is not whether regulation is a good thing or not, but whether there are ways in which over regulation destroys the incentive of free markets to detect and correct imbalances. Also, it is important to understand how a private profit seeking entrepreneur is more efficient in allocating resources, providing safety to consumers and providing a real quality product or service that satisfies their needs. The opposite is the alternative that many mainstream voices want, government takeover and overburdening regulations that prove to be inefficient, ineffective and what’s worse, it doesn’t keep people safe.

regulatory capture

Advertisements

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s