In Part I of this series, I argued a fundamental reason our government is broken is the political selection process favoring ideological warriors over pragmatic problem solvers. I introduced my “Funnel of Futility” theory: as ideology becomes increasingly important in one’s decision-making process, the more futile working with an ideological opposite becomes. In contrast, as more data-intensive decision-makers interact, the partisan gap narrows, and government becomes more useful and efficient.

In Part II of this series, I suggested that government has overshot its equilibrium position in the modern U.S. economy, and Americans ought to make every effort to rein it in. That said, I suggested this site does not advocate a wide-ranging dismantling of every government department. As such, I advocated that the scalpel is always preferable to the hack saw when rolling back government overreach.

In Part III of this series, I maintained that equality of opportunity does not imply equality of outcomes. I further maintained that this site whole-heartedly and enthusiastically supports institutions that promote and recruit people based on a purely meritocratic system. The more data that an institution uses to measure its people, the better. That said, Reflections of a Rational Republican vehemently opposes government favoritism towards certain groups based on immutable characteristics such as race or sex. Rewarding certain groups who have earned their status, such as veterans, is acceptable since that is based on a person’s actions rather than something that one is either born with or not.

In Part IV of this series, I argued that free markets are preferable to tightly controlled ones. I further maintained that though markets may be chaotic, they are the single most efficient mechanism for price discovery in modern societies. Tightly controlled markets tend to be far more inefficient than free ones, because controlling entities like governments have no more information about that market than most individual participants. When governments impose too many regulations or try to maintain tight control of different industries, prices rise, and competition and quality tend to weaken. I concluded that the market is not a force of good or evil. It is like water. It will always take the path of least resistance.

Today, I will introduce the fifth official guiding principle of Reflections of a Rational Republican — government does have a role in mitigating negative externalities and market failures that unencumbered capitalism can generate.

…But Government Has a Role in Mitigating Negative Externalities and Market Failures That Unencumbered Capitalism Can Generate

Those with the most extreme libertarian impulses might argue that an ideal government is one that only provides for the legal enforcement of contracts, and for a strong national defense. I will not make such a strong ideological claim here. In fact, complete and unencumbered laissez-faire capitalism can sometimes be very harmful if one fails to account for business’ negative externalities. An externality is defined as a cost or benefit derived involuntarily by a party as the result of a transaction between producers and consumers. Pollution is one example of a negative externality.

Reflections of a Rational Republican believes government has a role in establishing systems and regulations that curb negative externalities when business has little incentive to do so. Government also has a role in helping reduce the negative impacts when markets fail.

That said, government regulations should balance their costs against their projected benefits. Heavy-handed and unnecessary regulation is worse than useless — it can result in real damage to the economy and people’s lives. In fact, Reflections of a Rational Republican believes that in recent years, the pendulum has swung too far toward overbearing regulation. That said, this site does not forswear all regulations whatsoever, and acknowledges that regulations can sometimes be very useful policy tools to address negative externalities and instances of market failure. Here are some examples of regulations that have worked well or better than their designers anticipated.

Food Can Kill You (In Some Countries)

When Americans sit down for a meal in the United States, they rarely if ever have to question if the food they eat will kill them. If they have allergies to peanuts, for instance, they can simply look at a food package’s label and act accordingly. In some countries, it is not safe to eat anything someone sells. In fact, it was not safe in the United States a hundred years ago.

Source: FDA

A century ago, conditions in the American food and drug industries were unsafe. According to the FDA, use “of chemical preservatives and toxic colors was virtually uncontrolled”, sanitation was primitive as it became necessary to transport food to growing urban population centers, milk “was still unpasteurized,” and the farms did not test their cows for tuberculosis. Furthermore, medicines “containing such drugs as opium, morphine, heroin, and cocaine were sold without restriction,” and labels “did not list ingredients and warnings against misuse.”  The public was literally at the mercy of the snake oil salesman.

As such, the FDA is a good example of government protecting the lives of its citizens against the negative externalities that can result from unfettered free market capitalism.

Annihilating Acid Rain

People first observed the impact of acid rain “in the mid 19th century,” when some “noticed that forests located downwind of large industrial areas showed signs of deterioration.” English scientist Robert Angus Smith first coined the term “acid rain” in 1872 after he observed “that acidic precipitation could damage plants and materials.” Scientists did not consider acid rain a serious problem until the 1970s, when they “observed the increase in acidity of some lakes and streams.”

Acid rain is a broad term referring to precipitation containing higher than normal amounts of nitric and sulfuric acids. The precursors to acid rain are sulfur dioxide and nitrogen oxide emissions. Electric power generation that relies on burning fossil fuels like coal accounts for roughly two-thirds of sulfur dioxide and one-quarter of nitrogen oxides emitted in the United States. In other words, acid rain is largely a negative externality related to coal-fired power production.

Acid rain is a serious problem because it “causes acidification of lakes and streams and contributes to the damage of trees at high elevations.” Acid rain also “accelerates the decay of building materials and paints.” Sulfur dioxide and nitrogen oxide gases also “contribute to visibility degradation and harm public health.”

To curb the negative externalities of coal-fired electric power plants, Congress passed the Clean Air Act of 1990, which provided for a cap-and-trade program to limit sulfur dioxide and nitrogen oxide emissions.

By most accounts the program has been a resounding success. The EPA estimates that the benefits of its Acid Rain Program are ~$50 billion annually, “due to decreased mortality, hospital admissions, and emergency room visits.” The program has also succeeded in dramatically reducing sulfur dioxide and nitrous oxide emissions since 1989 as the maps below attest.

Source: EPA

TARP Intervention Necessary to Prevent Monumental Market Failure

“The strategy was a breathtaking intervention in the free market. It flew against all my instincts. But it was necessary to pull the country out of the panic. I decided that the only way to preserve the free market in the long run was to intervene in the short run.”

— President George W. Bush in Decision Points

Anyone who knows anything about the modern financial system knows that without faith, money would not work. The government can literally print as many dollars as it likes, but the moment that people believe the dollar is no longer worth the paper on which it is printed, it becomes worthless.

During panics, people and markets behave irrationally. In 2008, I worked at a Wall Street firm and lived through the irrationality. I watched the market value companies for less money than the cash those firms had in the bank.

It simply did not make sense. It was a panic.

By buying the big banks’ troubled assets, the government necessarily intervened in the market by putting a floor on market values. This action likely prevented a much more pronounced economic crisis. Without this intervention, the overall market could have collapsed. That said, it might not have. However, had you been President of the United States at that time, would you have taken that risk?

While the market is efficient most of the time, government has a role for softening the blows of more extreme market volatility, market failure, and the impact of business’ negative externalities.