Sunday, May 4, 2008

No Trust in the Invisible Hand

People out there seem to have the misconception that Adam Smith had a lot of faith and confidence in the self-interested actions of individuals in the free market. A more realistic way of summarizing the Wealth of Nations, as PJ O'Rourke might put it, is that Smith had even less faith in politicians and bureaucrats. In fact, from Smith's Moral Sentiments it's pretty clear that he trusted a businessman about as far as he could throw one and didn't think that businessmen should be allowed to do so much as have a cup of tea together.

So how do we manage collusion and cartels? The European model usually involved an adversarial process – the government investigates and anyone and everyone touching the misdeed is prosecuted with the full force of the law. The new model, coming from the US and what it has learned from Enron and other scandals involves protecting and helping whistle-blowers. What this may do, more than anything, is help the investigators know what exactly it is that they should be looking for when they go in, which is the lesson now being learned by British regulators.

Getting the incentives right is important, which means that on the one hand regulators need to help and give protection to the informers, but also that the pendulum not be allowed to swing too far the other way. In other markets where Consumer Protection has become involved the incentives have been skewed to the point where frivolous accusations cloud the investigative process and discredit the government's involvement in the monitoring process. Such has been the case in Consumer Protection areas from medical malpractice to spilled coffee.

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