Paradox of Deregulation

Why market fundamentalism eventually leads to more government, not less.

The Private Abuse of the Public Interest:
Market Myths and Policy Muddles

by Lawrence D. Brown and Lawrence R. Jacobs
University of Chicago Press, 151 pp.

In the waning days of the Bush administration, as venerable Wall Street firms collapsed, credit markets froze, stocks crashed, and economic indicators deteriorated, free market, antiregulatory Republicans found themselves with no choice but to partially nationalize the banking industry. It was a Shakespearean denouement for the conservative movement. For nearly thirty years, the right had dominated political debate on the strength of the simple argument that government was the problem and free markets the solution.

That ideology produced the deregulation of the banking system that began in earnest the year Ronald Reagan was elected to the presidency. Even after the savings-and-loan fiasco of the 1980s and 90s, the pro-market doctrine was potent enough to produce the repeal in 1999 of the sixty-six-year-old Glass-Steagall Act, which tore down barriers between investment and commercial banking activities. And a dogged belief in free markets sustained the adamant passivity of the libertarian Federal Reserve chairman Alan Greenspan, the Wall Street alumnus Robert Rubin, and the Bush economic team in the face of clear dangers posed by unregulated financial derivatives, predatory lending practices, and overly leveraged institutions and consumers. In short, the forces that brought about this falls crisis can be traced in large measure to a thirty-year project to minimize the governments role in the financial marketplace.

Yet even at the end of the line, in September of 2008, Treasury Secretary and former Goldman Sachs CEO Henry Paulson demonstrated that his heart remained
with the private sectorinitially proposing that the government swallow near-worthless securities from banks while recapitalizing them. Only after the markets balked at Paulsons strategy was he forced, along with his fellow conservatives, to accept that reality had stampeded their belief system. And so the government became part owner of major banks to save an industry that once had emblematized the virtues of markets.

As Lawrence D. Brown and Lawrence R. Jacobs demonstrate in The Private Abuse of the Public Interest: Market Myths and Policy Muddles, the era of conservative dominance has wrought a cyclical pattern: first comes the fervent advocacy of market-based policy ideas, followed by their implementation, which causes damage that can only be fixed by extensive governmental intervention. Although the financial sector unraveled in the weeks surrounding the books publication date, Brown and Jacobs tell very similar stories (albeit less dramatically) in three other realms: education, health care, and transportation. Their central argument is that “an era dominated by market enthusiasts and bi-partisan agreement that government is the problem produced not only market-oriented policies that fall short of promised outcomes but also more government.”

Brown and Jacobs discern five phasesakin to the five acts of the Bards tragediesin the cycle. First, conservatives deem the central problem in every arena to be an insufficient reliance on markets. So in education, for example, conservatives saw disappointing student achievement and decided that the overriding cause was public school bureaucracies that suffocated innovation. Second, conservative policy experts propose a simple solution: a substitution of market forces for government. In education, the purest model of that approach was Milton Friedmans school voucher idea, which would replace public school systems with stipends to parents that they could use to shop for the best school, including private parochial institutions. The competition unleashed by that approach, Friedman and his disciples claimed, would produce educational innovations and liberate parents who were unhappy with their limited neighborhood public school options.

The third step in Brown and Jacobss framework is legislative action to implement the ideas proposed by the market worshippers. Milwaukee led the way on the school vouchers front, followed on a smaller scale by voucher programs in Cleveland and Washington, D.C. However, in most places the voucher concept faced massive political resistance (all eight voucher referenda on state ballots over the years were trounced). So pro-market advocates embraced the considerably less controversial alternative of charter schools that could operate outside of established rules governing the public school system.

The fourth phase is when the seductive simplicity of free market theory meets complicated institutional reality. As Brown and Jacobs put it: “… consumers, providers, and complex organizations behave in ways that do not always follow the script. The incentives that were expected to accompany competition did not consistently appear on cue.” Sticking with the education case, researchers examining the Milwaukee and Cleveland voucher programs found that parents lacked information that would enable them to be discerning shoppers, often failed to explore different options, and in some cases left their children for years in private schools that were deeply flawed. Study after study generally showed that test scores of voucher students attending private schools were little or no better than those in the public ones, and that the promised benefits to the overall school system from competition didnt come to pass. Charter schools likewise proved to be a very mixed bag in terms of test scores and other measures of quality.

The final stage is when political backlash forces policymakers to respond to the unintended consequences and failures of the market-based approachescausing government to grow and thereby subverting the original goals of the pro-market adherents. So, for example, in Minnesota, California, and other states, fraud and mismanagement by operators of charter schools and lax supervision by their sponsors resulted in new laws and regulations entailing greater government oversight. And in the cities with voucher plans, government oversight has ratcheted up over time in response to a multitude of unforeseen problems, such as gross financial mismanagement by some of the private schools.

The main argument and big picture that Brown and Jacobs present is basically right, and the fact that their framework applies to cases that they dont even delve intolike banking deregulationunderscores the validity of their analysis. But as often happens when academics try to write about public policy for a general readership, this slender 151-page book sometimes teeters between obtuseness and oversimplification. For example, nonexperts will likely feel their heads spinning as the authors explore transportation then education then health care and back again for each of the five phases of their framework. The analysis would have been much easier to follow if Brown, a professor of health policy and management at the Mailman School of Public Health at Columbia University, and Jacobs, the director of the Center for the Study of Politics and Governance at the University of Minnesotas Humphrey Institute, had simply told each policy tale one at a time, from start to finish. It also would have helped if the University of Chicago Press had waived its cumbersome citation style for this nonacademic book.

The authors are somewhat imprecise about a number of points, including what constitutes a market-based policy. They critique the No Child Left Behind Act and the managed care approach to health cost containment as if both entail simply replacing the government with markets, when thats not really the case with either examplethe rationales for both problematic policies went well beyond unleashing competitive market forces. Likewise, charter schools can be justified as an experiment worth pursuing for reasons that have little to do with market pressures and competition, though conservatives most certainly have tried to claim ownership of the charter idea by glomming pro-market, antiteachers union rhetoric onto it.

With a presidential candidate openly campaigning for more rather than less regulation, as Barack Obama has just done successfully, the United States has clearly entered a new era. When the inevitable reaction pushing for a return to free markets comes back around, the lesson of this insightful book is clear: dont go there unless you want even bigger government to clean up after the failures that are sure to follow.

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Greg Anrig

Greg Anrig is the vice president for policy and programs at the Century Foundation.