Had he gone to Washington in the 1930s (and been alive), Scottish philosopher/economist/free-market champion Adam Smith (1723 – 1790) would've lambasted lawmakers as they "despeculated" Wall Street through a financial regulatory overhaul inspired by the 1929 market crash. Smith opined (over 150 years prior) that unfettered free markets, while imperfect, regulate themselves with more fairness and efficiency than any well-intended government could. And though politicians back then tried in earnest to make financial markets "safer," their actions had very negative consequences, which only exacerbated and likely extended the Great Depression.
Fast-forward about 80 years to June 15, 2010. Inspired by another difficult economic and market environment, Congress passed a "rewrite of rules touching every corner of finance"—the most significant financial reform since the 1930s—extending the government's power to regulate financial markets. Their goal is to make markets safer and prevent another 2008-like financial crisis, which many blame on prior decades of deregulation (though I think that argument is bunk).
Regulation per se isn't bad—especially if it increases information flow and market transparency. And most free-market proponents (me included) readily agree a "free market" shouldn't mean participants can abandon ethical responsibility. But amid the current pervasive "regulate first, ask questions later" mentality, I remember Adam Smith and believe some of his concepts are worth a review.
Smith's 1776 book, An Inquiry into the Nature and Causes of the Wealth of Nations (better known as The Wealth of Nations), is often considered the foundation of modern economic theory. He preferred a free-market economy over a regulated economy. Why? Because he believed individuals free to pursue their own interests make decisions that, over time, unwittingly benefit society as a whole—more so than decisions made on behalf of society by a relative few who deliberately promote it. Smith argued that the forces of self-interest, private ownership, and competition (left unfettered) combine to form an invisible hand that guides an economy while promoting public welfare. Smith wasn't opposed to government involvement—he just preferred their role be restricted to protecting property rights and enforcing established laws of competition. Smith recognized that competition was ultimately the most effective and fair market regulator.
For example, in a competitive environment where individuals are free to choose what/where/when they buy, what happens to a seller who charges a high price for widgets when an identical (or better) widget is offered for less by another seller? Rational buyers choose the cheaper/better widget. This forces the other seller to compete by lowering prices and/or increasing quality to avoid losing business (i.e., getting slapped around by Smith's invisible hand). This process benefits all consumers and doesn't require government intervention—unless pre-established rules are broken. When such violations occur, law enforcement is appropriate. But free-market folks will tell you they prefer such action be limited to upholding and/or restoring the integrity of competition, rather than to enact solutions that avert market forces and reduce competition (aka, "market engineering"). All market participants should succeed based on their own merits and as allowed by the laws of supply and demand. Legislators shouldn't have the power to handpick (or even influence) winners and losers.
Adam Smith would cheer former Federal Trade Commission Chairperson Deborah Platt Majoras as she described in a 2006 speech what she learned through years of enforcing competition. Here's an excerpt, though I encourage you to read the entire speech:
I have learned that it is not easy to trust the market when we have the power to intervene. Put another way, it is easy to give in to the temptation to intervene in a market when we do not like the results that market forces are producing. The hard part is having the strength to let the market work on its own, enforcing the rules without regulating market outcomes.
Last year, I read with interest the remarks of a European leader on the passage of a law that was intended to benefit consumers. "[L]et us favor competition. Not wild competition, which destabilizes whole fields and endangers economic sectors, but rather regulated competition, to give more purchasing and economic power to consumers." Well, competition is supposed to be a bit "wild" in the sense that not all will win or even survive. But the prospect of winning is what stimulates the competition in the first place, and if it is aggressive, consumers will benefit from the low prices and improved products and services that are produced. Years ago, an American jurist, Judge Learned Hand, summed it up this way: "The successful competitor, having been urged to compete, must not be turned upon when he wins." Similarly, former Assistant Attorney General Thurman Arnold, nearly 70 years ago stated that "the economic philosophy behind the antitrust laws is a tough philosophy. [Those laws] recognize that someone may go bankrupt. They do not contemplate a game in which everyone who plays can win."
To believe everyone can win is nice and all, but it's unrealistic, uninspiring, and creates a false sense of security. As Majoras described, competition works best when it's pervasive and remorseless. That such a seemingly "savage" landscape actually helps ensure society's welfare is tough for some to grasp. But a system that embraces free markets (or even "free-ish" markets like we have in the US) will offer losers endless opportunities to win, just as winners are always at risk of losing. Even the biggest free-market failures throughout history pale in comparison to the world's many free-market successes. Conversely, some of the worst and longest-lasting economic failures have come at the hands of government engineering—the Great Depression is just one example.
As for the current regulation binge specifically aimed at our financial system, we would have preferred more true reform aimed at transparency and reducing regulatory redundancies. Didn't happen. But still, what we got wasn't nearly as bad as early proposals (though passionate Smith supporters have their doubts). There will likely be unintended consequences—as is typical with any new legislation—but the US doesn't have and never has had truly unfettered free markets. We've dealt with messy, ill-thought-out regulation since Adam Smith first imagined that invisible hand. That's not to say clunky regulation is great, just that it is, and markets have always found a way to deal with it.
Clearly, no "perfect" economic system exists. But history shows us the economic theories Adam Smith espoused long ago, when applied, have created more opportunity and wealth for more people around the world than any other system thus far.