Saturday, January 24, 2009

Objectivism & Economics, Part 17

Laissez-faire as a rationalization for fraud. In her essay “The Nature of Government,” Ayn Rand wrote,
A unilateral breach of contract involves an indirect use of physical force: it consists, in essence, of one man receiving the material values, goods or services of another, then refusing to pay for them and thus keeping them by force (by mere physical possession), not by right—i.e., keeping them without the consent of their owner. Fraud involves a similarly indirect use of force: it consists of obtaining material values without their owner’s consent, under false pretenses or false promises.

We will ignore Rand’s odd decision to describe fraud as an “indirect use of physical force” and instead merely note that Rand opposed fraud. While we congratulate Rand for opposing fraud, nonetheless there are serious questions at to her willingness to effectively combat it. It is one thing to oppose fraud verbally; the real question is: What are you willing to do about it?

Alex Epstein and Yaron Brook attempt to answer this question when they write:
In an unfettered free market the desire for profit is satisfied by honest, long-range, rational behavior.... As for the real swindlers, existing laws against force and fraud are sufficient to protect us. If our politicians are indeed concerned about the stock market, let them demonstrate it by eliminating, not adding, regulations and making the market truly free.

Epstein and Brook would have us believe that enforcing “existing laws” is “sufficent” in the sempeternal war against fraud. Yet what does this mean? What specific laws are Epstein and Brook talking about? And why, in the very next sentence, do they insist on the elimination of regulations (that is, of laws) in order to make markets “free”?

One of the main goals of regulation is to increase the integrity and transparency of markets. As Charles Morris explains in Trillion Dollar Meltdown:
It is the transparency and integrity of American financial markets that has made them such a magnet for foreign investment… That hard-won reputation was, to a great extent, the consequence of generally superb American market regulations, epitomized by the SEC.

The American regulatory scheme is based on the insight that government can best support financial markets by ensuring that investors get accurate information…. After a quarter century of antiregulatory zealotry, however, and a parade of fiascos from the S&L crash through the Enrons and WorldComs … the credibility of that system, and with it the attractiveness of American markets, is at risk.


Naive intellectuals like Rand, Epstein and Brook apparently believe that, as long as they ennuciate their disapproval of fraud, they won’t have to worry about anyone using their laissez-faire ideology as a rationalization for crippling the ability of the government to combat fraud. Yet this is part of what happened in the current economic crisis. The deregulation of markets and hostility toward government oversight is an important factor in credit market meltdown of the last year. Many unscrupulous operators in the markets become anti-regulatory and laissez-faire zealots for the simple reason that they wish to do as they like, even if doing as they like means committing fraud. They use laissez-faire ideologies such as Rand’s to rationalize crippling the government’s ability to combat fraud.

While Rand and her disciplines may consider themselves opposed to fraud, they certainly do not appear particularly eager to prevent such abuses. Indeed, they seem to oppose many of the attempts on the part of the government to embattle fraud. Take, for example, Leonard Peikoff’s hostility toward the SEC. On his nineties radio show on KIEV in Los Angeles he stated his desire to see the SEC abolished and declared his approval for insider trading.

What Rand, Peikoff, and other Objectivists fail to understand how difficult it is to enforce laws against fraud. Not every act of fraud is easy to detect or, even when detected, easy to prove in a court of law. White collar criminals, in contradistinction to common street criminals, are usually very intelligent and are very good at hiding their tracks. Corporations in which criminal activity has occurred sometimes, out of embarrassment and fear of Stock Market repercussions, try to conceal the criminal act. Investigations and trials of corporate criminals are very complex and expensive. The complexity of market transactions can serve as cover for fraudulent activity—which is one of the reasons why the SEC tries to keep markets as transparent as possible. They also make government oversight a necessary component to government regulation of markets.

In the laissez-faire model embraced by Rand, the courts are assigned the function of protecting private property and contracts from “breach or fraud.” In other words, the primary (if not sole) weapon for combatting fraud is the lawsuit. Fraud would, presumably, under such a vision of things, become an entirely civil matter, which of course would make easier for fraudulent economic behavior, along with other acts of questionable honesty, to go unpunished. The government and its citizens would be powerless to deal with any types of fraud that are not easily identified by the courts. As any in depth analysis of the relevant economic facts would demonstrate, it is not possible to regulate economic action solely (or even primarily) through lawsuits. That would merely bring about a society sunk in a morass of legal pettifoggery.

The role of the government in combatting fraud must go well beyond the old laissez-faire model of property rights and “freedom of contract.” As F. A. Hayek expressed it in The Road to Serfdom:
To create conditions in which competition will be as effective as possible, to supplement it where it cannot be made effective, to provide services which, in the words of Adam Smith, “though they may be in the highest degree advantageous to a great society, are, however, of such a nature, that the profit could never repay the expense to any individual or small number of individuals”—these tasks provide, indeed, a wide and unquestioned field for state activity. In no system that could be rationally defended would the state just do nothing [beyond protecting property rights and enforcing contracts]. An effective competitive system needs an intelligently designed and continuously adjusted legal framework as much as any other. Even the most essential prerequisite of its proper functioning, the prevention of fraud and deception (including exploitation of ignorance), provides a great and by no means yet fully accomplished object of legislative activity.

4 comments:

Andrew said...

The argument over whether or not sensible regulation is required is a very tired one indeed.

I am curious about the basis of this assertion: "In an unfettered free market the desire for profit is satisfied by honest, long-range, rational behavior"

Is this meant to include ALL market participants? How is this ensured? Surely perpetrators of fraud will always exist.

The tacit implication seems to be that if the market is unfettered such a fantastic amount of wealth will be created and this will ensure everyone has a satisfactory piece of the pie and no one will be reduced to fraudulent activity. This hardly seems plausible.

"It is the transparency and integrity of American financial markets that has made them such a magnet for foreign investment… That hard-won reputation was, to a great extent, the consequence of generally superb American market regulations, epitomized by the SEC"

Just as capitalism requires sound conduct of monetary policy our stock markets require regulatory action to ensure investors have the highest degree of certainty possible. Certainty that they will be as best possible protected against fraud and pernicious business practices.

Its a very good point that this safety brought by regulation would create markets more conducive to growth than "unfettered free-markets" wild and fraught with potential for disasters of fraud and speculation.

Our legal / regulatory structures have evolved out of a need for this type of regulation, taking a step backwards towards deregulation hardly seems intelligent.

Court cases create precedents that help create needed laws to eliminate the need for further redundant court cases, reducing the stress on the legal system and on society. Especially beneficial for those who lack money for court representation and rely on the State to ensure their basic rights are defended.

Why do the Objectivists want us to continually re-challenge previously established conventions of society? Surely our past experiences are valid incorporations into our legal corpus. Can they be proved otherwise? Damaging? Restrictive to prosperity?

George Soros in his "New Paradigm For Financial Markets" clearly lays the blame for the sub-prime debacle right at Greenspans feet and his "Ayn Rand inspired political views".

Rational self interest does NOT regulate effectively and markets do NOT trend towards equilibrium.

Michael Prescott said...

Why do the Objectivists want us to continually re-challenge previously established conventions of society?

Because, in Thomas Sowell's terminology, Objectivists have an "unconstrained vision" of human nature, as opposed to the "constrained vision" that would acknowledge the limitations of intellectual theorizing.

Surely our past experiences are valid incorporations into our legal corpus.

Yes, if we have the humility to recognize that the sum of shared human experience trumps the cerebrations of any one mind (or even a select group of minds), no matter how brilliant. But Objectivists, besotted with the unconstrained vision, refuse to see this.

Sowell's seminal work A Conflict of Visions works out this thesis in fascinating detail.

JayCross said...

Michael,

I just started reading A Conflict of Visions. Always enjoyed Sowell's columns and articles and this should be an interesting challenge to my thinking.

gregnyquist said...

"Because, in Thomas Sowell's terminology, Objectivists have an 'unconstrained vision' of human nature,"

Yes, that's quite true, but Rand's unconstrained vision is particularly unique in that, unlike most who share this vision, she was neither an anarchist nor a socialist. This gives her a near monopoly on all those who have an unconstrained vision but who can't bring themselves to be either socialists or anarchists.

Incidentally, Sowell mentions Rand in his Conflicts of Vision, indicating he doesn't know whether Rand embraced an constrained or unconstrained vision. Yet I believe Michael is right: Rand clearly embraced the unconstrained vision, as any examination of her views of human nature and history will easily demonstrate.