Skip to: Content
Skip to: Site Navigation
Skip to: Search


Opinion

Markets fail. That’s why we need markets.

It may sound odd, but only free and open markets, not government regulation, can quickly and effectively clean up the mess that markets sometimes make.

(Page 2 of 2)



The first is that they strangle new innovations before they can emerge. Thus proposals for a Consumer Financial Protection Agency, a systemic risk regulator, a public health insurance plan, a green jobs policy, or any attempt at top-down planning may do more harm than good.

Skip to next paragraph

The second danger has to do with the nature of political economy. Politics creates its own kind of innovators who can be as destabilizing to markets as market actors themselves – but in far more pernicious ways. 

Economists call these political entrepreneurs “rent-seekers.” Rent-seekers gain wealth, not by creating it, but by channeling it through political favors. Examples include government-sponsored monopolies, “targeted” tax breaks for special industries, and legislative loopholes inserted by lobbyists. 

The boom in housing and mortgage securities that ended so badly was fueled by government policies that were encouraged by rent-seekers in the real estate, home building, and mortgage finance industries. 

Rent-seekers aren’t partisan. They used President Bush’s push for an ownership society to promote sketchy mortgage products. Before that, they used President Clinton’s push for a fairer economy to compel banks to make loans to poorer neighborhoods. In both cases, rent-seekers turned political slogans into profit, but at a steep cost to society when the boom ended.

The response to the current economic crisis has perpetuated and even intensified this process, as hundreds of billions of dollars of taxpayer funds have been used to prop up the very firms that took such reckless risks. The bigger the bad bet, the bigger the bailout. 

This gets to the key difference between markets and governments. When innovation-driven excesses and imbalances are recognized in the marketplace, the system can correct itself quickly. This is less the case when government policy failure occurs. 

Because political failure is less publicly tolerable than market failure, the temptation becomes for policymakers to avoid acknowledging their role in creating or perpetuating problems. Or they double down on bad bets. So rather than recognize the government’s central role in the housing boom and bust and quickly changing its ways, we see the federal policy apparatus continuing to throw good money after bad in the mortgage market and on Wall Street.

Markets fail; but they learn from their failures. That’s why we need markets. Government can promise to guarantee our prosperity; but only markets can really deliver.

Arnold Kling is an economist with the Mercatus Center’s Financial Markets Working Group at George Mason University. Nick Schulz is DeWitt Wallace Fellow at the American Enterprise Institute for Public Policy Research. They are coauthors of “From Poverty to Prosperity: Intangible Assets, Hidden Liabilities and the Lasting Triumph Over Scarcity.”

Permissions