9.1.09

QUOTE OF THE DAY. Daron Acemoglu offers a working paper on the intellectual foundations of economic policy.
Our second too-quickly accepted notion is that the capitalist economy lives in an institutional-less vacuum, where markets miraculously monitor opportunistic behavior. Forgetting the institutional foundations of markets, we mistakenly equated free markets with unregulated markets. Although we understand that even unfettered competitive markets are based on a set of laws and institutions that secure property rights, ensure enforcement of contracts, and regulate firm behavior and product and service quality, we increasingly abstracted from the role of institutions and regulations supporting market transactions in our conceptualization of markets.
Shorter version: there is no such thing as an unfettered market. The use of the expression "unfettered market" is the leper's bell of an approaching straw man (to mix metaphors). Rude observation from the mid-majors: exemplifying theory gives researchers incentives to abstract from institutions and regulations so as to provide the weakest sufficient conditions under which a transaction takes place, preferably with little or no appeal to refinements of equilibrium.

Arnold Kling has skeptical observations at Econ Log. Reason's Steve Chapman, working independently of Professor Acemoglu, elaborates.

So what makes anyone think that future bureaucrats, no matter how vast their authority, will be able to do better? Advocates of stricter regulation often talk as though the choice for protecting investors is between imperfect market mechanisms and foolproof government regulations. In fact, governments, like every other institution, are staffed by fallible individuals who can be fooled as easily as anyone else.

The call for more federal control overlooks inconvenient facts. The first is that con artists will often outfox regulators, if only because they have far more to gain from carrying off a fraud than civil servants have to gain from stopping it. If the SEC couldn't catch the brazen Madoff in eight tries, what suggests we should place greater faith in the ability of other agencies trying to monitor a vast network of financial companies?

I would note only, from my seat in Illinoistan, that fooling the government is often not required, where a simple contribution is possible.

Economist's View offers an immediate literature review.

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