George Stigler was a Nobel-winning economist who applied the economic way of thinking to regulation at a time when doing so was even more unfashionable than it is today. He was also known for his wit.
Near the end of his paper “The Economists’ Traditional Theory of the Economic Functions of the State,” which appears as chapter 7 in his 1975 collection The Citizen and the State: Essays on Regulation, he has a pithy public choice-style insight (p. 112):
We have a long, long list of market failures. These should be corrected if possible, and there are only two alternatives to the market: the state, and prayer. It turns out the two were merged in one.
There’s a lot packed into that bit of pith. Intentionally or not, Stigler was referring to what Harold Demsetz called the Nirvana fallacy. The relevant comparison isn’t between market outcomes and perfection; it’s between market outcomes and possible improvements. This is where economists’ never-ending focus on perfect competition models comes back to bite them in the rear end. Economists and regulators alike pray fervently.
Unable to escape from Hayek’s knowledge problem and public choice concerns such as regulatory capture, regulations not only routinely fail to improve on market outcomes, they often make make matters worse.
As Arnold Kling pointed out, the lesson learned isn’t the idealistic Chicago school motto, “Markets work well. Use markets,” nor is it the Nirvana fallacy-prone MIT-Harvard dictum, “Markets fail. Use government.” It’s the realist GMU-style “Markets fail. Use markets.”
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This brings to mind what Chicago professor Milton Friedman, the 1976 Nobel Laureate in Economics, wrote in his introduction to my mother’s book, “The Regulated Consumer” (1971; reissued in paperback by the Mises Institute, 2007): “Mary Peterson persuasively illustrates for seven selected agencies what might be called the natural history of governmental intervention into economic affairs: a real or fancied evil leads to demands to ‘do something about it’; a political coalition forms . . .; ultimately, the effects are precisely the opposite of the noble objectives of the high-minded reformers without achieving the more mundane objectives of the special interests; yet the activity is so firmly established and so many vested interests are connected with it that repeal of the initial legislation is nearly inconceivable; instead, new governmental legislation is called for to cope with the problems produced by the old; and a new cycle begins.”
As Caspar Weinberger, former Chairman of the Federal Trade Commission and then Director of the Office of Management and Budget, commented in his review of this book, “The idea that you can cure all evils and solve all problems by throwing public funds at them has led us into today’s public policy tangle.”
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