Government as a drug

Few economists today would argue against the need for better rules (transparency) in the financial sector. Unfortunately, as in the days of the Great Depression, the political process in D.C. is likely to give us more instead of better regulation. The current debates remind me of a discussion I started earlier this year here. Every semester I encourage my students to think of the government as a drug (such as ibuprofen or insulin). It's good that we have it. It may be impotent to cure the cause of sickness but it treats some symptoms and preserves lives.

It is important to remember that more government protection is not necessarily better. After a certain point the costs of regulation become unacceptably high, i.e. they start outweighing the benefits. We do not need to take drugs if we are (relatively) healthy. When we get sick, we need the right drug in the right amount. Too much of a good thing, such as a safe and effective drug, may kill us faster than the disease. And to avoid serious unpredictable harmful side effects, it is always prudent to consider first the existing natural cures for our afflictions.

While we are trying to improve the rules in our financial sector, it may be worth the time to examine the unintended consequences of previous regulatory reforms. The fear of unsafe drugs led to the creation of the Food and Drug Administration, where the fear of ruining their credibility is causing the agency's bureaucrats to be biased in their decisions and put safety above efficacy. Government workers are not super-human and are not any less self-interested than the profit-seeking entrepreneurs, or the consumers, or the doctors. We may create a regulatory agency with all the noble intentions but get terrible results if we do not pay attention to the kind of incentives that we give the employees. As for the financial overhaul bill---I hope that Nancy will let us see what's in it before they turn it into law.