Markets: Sometimes you just have to love them (Part 4)
It should come as no great shock that people are everywhere. People are the driving force behind the consumer sector (as buyers), people are the driving force behind business operations (as employees at all levels, including the most senior positions) and people are the driving force behind government (as politicians, bureaucrats, judges and the like). Markets have the ability to efficiently/objectively bring people together in their first two roles so as to satisfy individual and societal objectives.
To perform these tasks properly, however, both parties to a market transaction must be so inconsequential as to have no manipulative capabilities. Such inconsequentiality almost certainly exists among consumers, but not necessarily among businesses, and thus the need for government activity within the marketplace.
With potentially powerful/manipulative people also inhabiting the hallowed halls of government, however, the need to identify the proper role of government is essential. Without such an assessment, manipulation by government can be highly destructive to individual/societal goals.
So, what is this essential role of government? Very simply, to promote certainty within which consumers and businesses can operate. Not a certainty of outcomes, but a certainty that market mechanisms will be permitted to operate without manipulation.
In this essential role of government, it is important to recognize implied limitations, as well as the risks associated with any deviation. In effect, government should always serve as a kind of “economic doctor” that keeps a light finger on the competitive pulse of the economy via enforcement of regulatory functions — allowing competition to proceed, but in a competitive and non-manipulative fashion.
Failure to properly engage in this role of government can, in the long run, lead to a “stampede of excessive behavior” by large numbers of consumers and producers, thus perverting market mechanisms. And this stampede of excessive behavior — brought about by changes in what economists call cross-price elasticities of demand — can be manifested as either excessive speculation or hedging on a widespread basis.
For example, consider the housing bubble. During the Bush administration, a desired goal was to increase homeownership rates. An admirable goal, but one which generally requires painstakingly slow increases in a nation’s living standards. In an effort to speed up the process, government promoted undue housing speculation by relaxing regulatory oversight of the quality of bank assets, followed by an easy-money policy to lower interest rates, and directed government-sponsored enterprises (Fannie and Freddie) to channel more loans to low-income borrowers.
The results? A speculative fervor that altered the market-driven actions of both consumers (homebuyers) and businesses (builders, banks, etc.) and produced a short-term speculative frenzy. In time, the realities of the marketplace brought the speculative party to an end and the suffering continues today.
Or, at the other extreme, consider the seemingly non-stop efforts by government to undo the housing sector damage they caused by enacting one temporary fix after another — a fiscal stimulus of $800 billion-plus in 2009 as well as huge stimuli at year’s end in both 2010 and 2011 and increased spending and reduced taxes of a temporary nature. But such temporary measures, by their very design, must eventually come to an end and a day of reckoning will follow.
It is that unknown day of reckoning that produces the opposite stampede to excessive behavior: extreme caution on the part of both consumers and businesses. In the case of consumers they hedge against an uncertain future by holding down expenses as much as possible and increasing savings when given the chance, such as when their disposable incomes advance due to lower taxes.
Businesses will also engage in this very logical hedging operation so as to provide the means necessary to cope with the future (government-inspired) uncertainty. In part, they will likely hold down costs as much as possible — for example, by not hiring new workers that may be laid off at a later date when the day of reckoning arrives — or by hoarding financial resources, as with businesses that are now holding some $2 trillion in cash-like assets.
So, what is the optimum course of action that government can follow so as to allow markets to work best without excessive behavior? In short, enforce current antitrust laws with vigor to promote certainty that market mechanisms will be permitted to operate without manipulation. Resist the temptation to engage in short-term fixes. And be guided by an essential element of the Hippocratic Oath taken by doctors: first and foremost, do no harm.
Dr. James Newton serves as chief economic advisor to Commerce National Bank and is an auxiliary faculty member in economics and statistics at OSU-Marion and OSU-Newark. Dr. Newton’s views do not necessarily reflect those of Commerce National Bank or OSU-Marion/Newark.