The Free Market and Scams: Is the Market Self-Regulating?

One of the most common arguments in favor of a regulated market is the prevalence of scams, or fraudulent business practices, to put it more eloquently.

Just this morning, I was listening on the radio to a woman interested in refinancing from an adjustable rate mortgage.  She had a conversation with a Countrywide mortgage agent who was trying to get her to falsify her financial information (income) to get a good loan.  Her telling made things seem very sketchy: after much discussion, for instance, she finally got him to admit that there was a $10,000 closing cost fee, which the agent claimed was an industry requirement, or some such.  Little did Mr. Slick know that the woman had worked in the financial sector, and could smell a rat when she saw one.  When she tried to back out of it, he pressured her with talk about how the rates have been fluctuating, and could go back up the next time she called looking for a loan.

It all sounds pretty sleazy.  The woman concluded with explaining how she wasn’t a fan of over-regulation, having worked in the financial sector, but that the current situation obviously wasn’t working, and so more regulations were needed.  Something to that effect.

How can the free market possibly solve a scam-related issue when it appears to be the source?

Actually, the source of scams are dishonest business schemes, or dishonest businessmen, depending on your perspective, but not the free market.  Nothing inherent to the free market discourages honesty, integrity, etc.  In fact, the free market encourages it.

Let’s take two companies as an example.  Both are competitors.  Both enter the market at the same time, and are virtually identical except that one is honest and the other is not.  What will happen in the long run?  Assuming they are both identical, they will likely get the same level of business up front.  Over time, what will a dishonest corporate policy tend to do?  In a free market, where competition is very stiff, dishonest competitors drive themselves out of business.  Factors like new market entrants and private certification services would all work to this end.

But what about the short-term?  What is the reprieve for those who have been “scammed?”  How can the market really prevent this?  There are many market options.  A serious contractual breach could become a tort or criminal issue.  Or, if an individual is concerned about an upcoming risky investment or purchase, there would certainly be (as there is today) firms who stake their reputation on being not risky, but being a safe bet.  And so they could be turned to.  Or a company could offer a “money-back guarantee” to convince individuals investments are not risky.  Or investment insurance could be purchased in the event of a sketchy investment is forthcoming.  All are strong market possibilites and would be implemented without government interference (many already have been).  Further, they cost the individual nothing more than they are willing to pay.

Government regulation, however, always has a cost associated with it, and the cost has little to do with willingness of the average citizen.  First, the cost of enforcement/inspection must be paid for.  The taxpayer usually pays for this.  Note this is compulsory, unlike the voluntary funding for market alternatives.  Second, the consumer must deal with a restricted supply of goods (and thus a higher price per item) from otherwise compliant companies due to their compliance cost.  Third, regulations act as a market barrier to other competing companies.  And so the cost reductions that come from unfettered competition are eliminated.  Cost reductions are much more minor than they would otherwise be.

This also goes to quality and value.  Unhampered market competition drives up quality and value.  Monopolies and regulated markets do worse in this respect.  Did government regulation make Toyota and Honda, for instance, the most trusted names with respect to quality in the automotive industry?  The incentives were already there, in the market.  No legislation or extra-market regulation was needed to achieve this benefit.

But all we have to do to investigate an over-regulated market is to look at, say, the commercial aviation industry.  Right now, there are two big global players: Boeing and Airbus.  Both have recently announced delays of a year for their newest airplane.  A year delay for a new product?  How can they get away with this?  Oh, that’s right, they don’t really have any competition.

Regulation rewards ineptitude and incompetence.  It keeps companies afloat, so long as they are “compliant,” and limits the competition by increasing the cost of starting and maintaining a business.  Regulation keeps a monstrous company like Countrywide going, despite their weaknesses.  After all, a high cost of regulation tends to keep out the smaller companies, limiting competition.  Choices are more limited than they otherwise would be, lower in quality, and more expensive.

So long as we trust the government to regulate our companies and keep them in order, instead of letting the market regulate itself, we are placing our trust where it ought not be placed.  Why should the government be so capable and even altruistic when both the market and the individual, two infinitely more efficient models, are supposedly incapable, sleazy, and inept?

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Filed under Austrian Economics, fiscal policy, Libertarian, politics, role of government

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