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Competition Can Improve on Apparent Market Failure

When products create no externalities, like pollution, and markets have perfect information and are relatively unconcentrated, competition, not direction or regulation from government, is clearly the best route to human welfare. But it does not follow that when production creates externalities, or information is imperfect, or markets are concentrated that centralized regulation is the best response. Government regulation can make things worse. Bureaucrats may lack information to improve on the failures of market even if they were wholly benevolent, because decentralized processes, like markets, are usually best at providing the self-correcting mechanisms that produce good information. And bureaucrats cannot always be depended upon to act in the public interest. Their regulatory decisions may be deranged by their own interests, including their own interests in creating a larger bureaucracy or providing better outside options for themselves when the leave government.

Thus, it is always important to remember that competition can often prove better than regulation even when markets are imperfect. Take the example of protecting consumers against low quality goods. Observers have sometimes argued that government regulation of quality is necessary when quality is difficult to evaluate, because consumers may be misled and not be able to get recompense. It is noted correctly that breach of warranty suits are often impractical or too expensive. But markets then can create other mechanisms to protect consumers. For instance,  companies spend a lot of money advertising their products and themselves. By creating these assets, they give consumers better assurance of quality. If the consumers do not get it, they can badmouth the product. Competition through advertising makes the companies hostage to consumers without any government intervention.

Or think of ride-sharing companies today and the protection of public safety. These companies provide a continuous rating system of drivers. I know I would trust a driver who had been rated well scores of times in the last few months more than one who has passed some bureaucratic test years ago. Thus, even if regulation for a particular public good was once necessary, it always needs to be evaluated against the new competitive alternatives that technology offers.

Competition can also improve the regulatory system itself. Instead of making the nation the locus of regulation, we can choose to rely on the states. This decentralization creates competition between regulatory authorities. Now it is sometimes said that inter-jurisdictional competition leads to a race to the bottom, but that is often not the case. Most scholars of corporate law believe that competition in the regulation of the corporate form has led to a race to the top. To cite one example, Delaware is the home of most corporations because it has the most efficient corporate law. Even in the case of pollution, states and localities have very good incentives to regulate to provide clean waterways and other pollution-free amenities to attract businesses and people.

The point here is not argue that centralized regulation is never necessary, but to provide a reminder that even when markets are imperfect, competitive processes can complement and sometimes outperform regulation. It follows that government should create institutions and norms that help bureaucrats make the right trade-off between competition and regulation because left to their own devices they will too often prefer regulation because of their own bureaucratic and ideological interests.

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