Friday, July 11, 2008

The Problem with Deregulation

It's the mantra of the rightwing - deregulate now, deregulate everything. The idea is that it's always better to rely on free enterprise, on the markets to self-regulate. After all, they know what's best, not some bureaucrat regulator.

Brian Mulroney deregulated Canada's airline industry. At the time we had a reasonably stable system of carriers headed by Air Canada and Canadian Pacific Airlines, two flag carriers. Below them were a stable of charter and regional carriers.

One of the advantages of airline regulation was the advancement of public policy. The big carriers were given preferred access to the major, big-city and international routes but they were also expected to bring air service to smaller centres that might otherwise not have been served. Like the early investment in microwave towers, regulated air travel helped open up Canada's remote regions.

Everything seemed to be ticking alone reasonably well when the whole business got overrun by free enterprise in the wake of Mulroney's deregulation of the industry. Air Canada was privatized and began the steady descent that continues to this day. Canadian Pacific got into an aggressive takeover and expansion mood, in the process swallowing Pacific Western Airlines and even Max Ward's Wardair, emerging as the bloated, Canadian Airlines International.

Both airlines engaged in a mutually-destructive air war, each scheduling unnecessary flights trying to muscle the other out on major routes such as Vancouver-Toronto. The revenue lifeblood drained out of both, forcing the final showdown.

The inevitable dog fight ensued (not the aerial kind, the sort that involves dogs tossed into a ring). Canadian tried to salvage itself by overrunning Air Canada. The former People's Airline fought back. Canadian Airlines finally collapsed under its own weight and Air Canada got busy picking at the corpse before wrestling with its own insolvency.

Where are we today? That all depends on your perspective. If you don't recall Canadian air travel at its zenith in the late 70's/early 80's, today's airline service might not look godawful. If you do, it does.

But the airline industry doesn't stand alone as an indictment of deregulation. A more recent example is the sub-prime mortgage debacle in the United States. Rather than intervening to regulate excesses, the Fed sat back and let havoc ensue. In the months leading up to the bubble bursting, two out of three new mortgages in California were "interest only."

America was awash in cheap, unregulated money for which there were far too few legitimately qualified borrowers. That didn't bother many mortgage lenders who weren't planning on holding on to the securities anyway but, instead, bundling them and flogging them out to eager buyers. Lending mortgage money became a means to create product for the "asset-backed commercial paper" market. Insane? Of course. Inherently self-destructive? Absolutely. Yet these realities don't bother the deregulated hucksters who see easy, short-term money and have no plans on being around for the collapse anyway.

These are just a couple of examples of the downside of deregulation. There is an unspoken assumption in deregulation - that the newly deregulated will act rationally and in the best interests of their industry and society.

Government doesn't deregulate an industry hoping it will fail and collapse. Deregulation is always presented as a means to free up and thereby strengthen the affected sector. The logic is always the same - the industry knows better than the government regulating it. In reality that's usually true. The industry usually does know better. However there's a giant leap between knowing what's best for one's own industry and actually doing what's best instead of what offers the greatest, short-term reward or immediate competitive advantage.

I'm not sure whether the problem is inherent in deregulation of itself or in our poor grasp of the deregulation process. Maybe we just don't understand how to deregulate effectively. Maybe we're too quick to throw the doors wide open before laying the groundwork for self-regulation.

Was the implosion of the Canadian airline industry not foreseeable? I think it was. Was the subprime collapse not foreseeable? Sure it was. What about the preceding bubble, the collapse? Not foreseeable? Of course it was. Enron, WorldCom? You decide.

The subprime fiasco may be the straw that broke the camel's back. E.J. Dionne, writing in the Washington Post, claims that a new reality is settling over American capitalism:

"Since the Reagan years, free-market cliches have passed for sophisticated economic analysis. But in the current crisis, these ideas are falling, one by one, as even conservatives recognize that capitalism is ailing.

You know the talking points: Regulation is the problem and deregulation is the solution. The distribution of income and wealth doesn't matter. Providing incentives for the investors of capital to "grow the pie" is the only policy that counts. Free trade produces well-distributed economic growth, and any dissent from this orthodoxy is "protectionism."

"... [In a recent speech, Federal Reserve Chairman Ben] Bernanke sounded like a born-again New Dealer in calling for "a more robust framework for the prudential supervision of investment banks and other large securities dealers."

Bernanke said the Fed needed more authority to get inside "the structure and workings of financial markets" because "recent experience has clearly illustrated the importance, for the purpose of promoting financial stability, of having detailed information about money markets and the activities of borrowers and lenders in those markets." Sure sounds like Big Government to me.

This is the third time in 100 years that support for taken-for-granted economic ideas has crumbled. The Great Depression discredited the radical laissez-faire doctrines of the Coolidge era. Stagflation in the 1970s and early '80s undermined New Deal ideas and called forth a rebirth of radical free-market notions. What's becoming the Panic of 2008 will mean an end to the latest Capital Rules era.

[Chairman of the House Financial Services Committee, Barney] Frank also calls for new thinking on the impact of free trade. He argues it can no longer be denied that globalization "is a contributor to the stagnation of wages and it has produced large pools of highly mobile capital." Mobile capital and the threat of moving a plant abroad give employers a huge advantage in negotiations with employees. "If you're dealing with someone and you can pick up and leave and he can't, you have the advantage."

"Free trade has increased wealth, but it's been monopolized by a very small number of people," Frank said. The coming debate will focus not on shutting globalization down but rather on managing its effects with an eye toward the interests of "the most vulnerable people in the country."

We're only just beginning to recognize that our notions of capitalism are based on a deeply flawed understanding of economics. It's not all "supply and demand" curves any more. Our traditional economic models based on the mythical producer and mythical customer are increasingly failing us. Some of the best minds in the business are now introducing us to the powerful realities of things like social economics and environmental economics. We're beginning to see the notion of "costs" as never before.

We're entering an era in which "growth" may no longer be the saviour of our economies and our societies. We're witnessing the inescapable consequences of massive growth in emerging economies such as China's and India's. We're confronting the realities of resource depletion and renewable resource exhaustion and the resultant excessive demand. This rising tide doesn't float all boats, it causes some to settle lower in the water.

As we adapt to these new economic realities we'll probably require more regulation, not less, to help us adjust. Call it protectionism if you like but unless you've got a better idea...

Now, as I noted a tad prematurely in my previous post, I've gone fishin'. See ya later.


LeDaro said...

If humans were 'angels' and there was no greed then deregulation will work fine and we won't even need government. Until such time regulations are needed to protect everybody and not just the big business.

Anonymous said...

True - regulations are required - economic models are all great on paper - they don't usually factor in the unquenchable human greed.Johnathon(whatever) leave this site to the grown-ups.


LeDaro said...

Still fishing. How many feet did you catch? :)

Mike said...

Well, I'm going to disagree, mostly because you are being lied to. What the banks and finance companies want is not 'deregulation' at all. They don;t have it and it would kill them if it ever came about.

What they want, and what they call 'deregulation', is actually a regime of regulations that allow them to externalize risk, It seems deregulated to the consumer, but it leaves the rules that stack the odds in favour of the house.

How new banks and institutions have you seen form lately? None. How well has regulation worked in the Cell phone industry in Canada? We have the highest rates, the poorest plans the the least selection. Hell, India has better cell deals and coverage than we do.

We don't have 'deregulation' we have a slanted playing field built on regulations that are hidden and called 'deregulation'. don;t be fooled.

Check out Dean Baker's "The Conservative Nanny State" for plenty of other examples.

The Mound of Sound said...

Sorry Mike but I think you're complaining about skewed or malignant regulation, not regulation properly enacted and administered. Recognizing that you're a devoted Libertarian I can appreciate you begin with a bias against regulation. I can also understand that you have a generous supply of examples where regulation has failed - or worse.

We do need to learn to regulate more effectively and with the discipline to do it only in accordance with clear, broadly accepted principles.