Regulatory Capture and Moral Hazard

The current blogosphere discussion and debate regarding implementation of financial system "reform" is an outstanding illustration of Adam Smith's realization that, businessmen will seek advantage and if that advantage is to be found in the market they will be forced to compete there, if that advantage is within the government then they will rent seek and lobby there. This is the nature of activity - the entrepreneurial impulse may well be deep seeded and the result of evolution and that impulse results in positive sum consequences in the market and is thus productive entrepreneurial activity. Alternatively, that impulse can be directed to an expanding state or government and result in negative sum activity or wealth destroying entrepreneurial activity. Ben Powell and William Baumol have written extensively on this dichotomy with telling historical and contemporary case studies.

Far to little attention is devoted to the impact of the creative destruction of entrepreneurial activity, particularly the radically different results of productive v. wealth destroying entrepreneurism. It is the institutions that direct these human impulses and, as North et al argue the informal institutions - beliefs, conventions, norms etc must be in alignment with the formal institutions. If not, the informal beliefs will prevail and circumvent and eventually weaken the formal institution.

The current US financial system "reform", really a return to the New Deal approach to regulation of business has been hotly debated along lines of regulatory capture by the industry and a resulting moral hazard. Thus the systemic intervention by the state will have relatively predictable and perverse consequences and the secondary and tertiary impact really cannot be anticipated, but will certainly not be what is the stated goal of policy makers and even the industry itself.

What is of concern is the clarity what this set of activities implies about American informal beliefs, norms and conventions regarding the role of the state. This is the most profound result of this recent activity and really makes me think of, what deTocquville described as the American Creed. In his view the admittedly contradictory norms in our society in the early 19th century were liberty, lassiez faire, individualism, egalitarianism and populism. Whatever the accuracy of deTocquville's view it has certainly changed with a shift from the first three to the last two. It is the headly mixture of egalitarianism and populism, mutually reinforing and advanced by the elite and captured by special interests that is a clear and present danger to our children and grandchildren's access to a free and responsible civil society.

In previous posts Boyes and I identified the lack of civil discourse over ideas as a key stumbling block to meaningful engagement and consideration by the public at large for any change. The lack of civility is present on both sides of the debate - the right and the left and libertarians have, on ocassion fallen prey to frustration in our efforts to examine beliefs, formal institutions and the resulting path dependency as these beliefs evolve in a manner that is ultimately immoral.