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.

Posted by Jim Newton on Jun 12 2012. You can follow any responses to this entry through the RSS Feed. Comments can be made below.