Saving Democratic Institutions from Corrupting Markets

Brink Lindsey and Steven Teles’ essay – and the book that lies behind it – are part of a broader liberaltarian challenge. Liberaltarianism, as I understand it, looks to use classical liberalism as a set of foundations for a very different understanding of market and state than libertarianism. Rather than starting from the market order as a beau ideal, and programmatically looking to shrink the state, Lindsey and Teles emphasize the benefits of a well working democracy. This doesn’t mean that they are part of the left – but it does mean that the argument between them and the left is likely to be productive.

To really deliver on their ideas, they need to shuck off some of the residual libertarian language that still holds them back. Here, Ilya Somin’s essay – which looks to pull them back into standard libertarianism – is exactly wrong. To really do what Lindsey and Teles want it to do, a democratically mandated state needs to be more radical in its approach. Rather than simply looking to curb regulatory abuses, it needs to reinvent itself, bringing its role in making and remaking markets to the fore.

Somin’s challenge to Lindsey and Teles emphasizes the general argument (going back to Schumpeter at least) that democracy is vulnerable to regulatory capture, since ordinary voters don’t have the knowledge or incentives to understand what is good for them, and politicians don’t have much interest to act in the public good. However, Somin notably fails to address the key problem which animates Lindsey and Teles – that some forms of regulatory capture are far more pernicious than others. Lindsey and Teles document how we have moved from a world in which much of the capture happened sideways, providing benefits to a broad cross-section of society, to one in which regulatory capture is redistributing income upwards to a narrow elite, creating a feedback loop of increasing inequality.

If anything, self-reinforcing inequality would be worse if we moved to the kind of weak state world that Somin would prefer. Indirect feedback loops would be replaced by direct predation. Moreover, as Christopher Achen and Larry Bartels’ important recent book discusses, democratic “realism” need not lead to skepticism about democracy; it can lead as readily to a focus on the key role played by intermediating institutions such as political parties. This is especially true given that markets have systematic information failures too.

Lindsey and Teles’ arguments plausibly fit well with Achen and Bartels’ stress on how actually-existing-democracy would work much better if power relations were more equal. One of the further attractions of Lindsey and Teles’ approach, as their essay suggests, is that the kind of push-and-shove deliberation that you get in real democracies will be better able to process “big, simple, transparent” interventions than complex regulatory frameworks.

However, Lindsey and Teles’ version of liberaltarianism still has too much traditional libertarian DNA. In particular, it uses concepts such as “regulatory capture” and “rent seeking” that are borrowed from libertarian-leaning public choice, treating the underlying problem of regulation as one of “artificial scarcity, in particular government policies that confer special advantages on favored market participants.”

The most telling critical response to Lindsey and Teles’ book is Mike Konczal’s essay at Medium, which takes issue with many of their specific claims, but also suggests that the “rent seeking” framework is misleading. The concept of “rents” only makes sense as a deviation from the ideal of perfectly competitive markets, where rent-seeking is impossible. Konczal argues that getting rid of the “rents” is a meaningless ambition for modern market regulation, which should instead focus on how markets ought be structured in the first place.

If all markets stem from different combinations of state and private regulation, then perfectly competitive markets are a will-o-the-wisp, luring the unwary ever further into an intellectual swamp. Instead of drifting from the path, democratically mandated politicians need to make practical decisions about which particular kinds of regulated markets are in the public interest, and how best to set interests off against each other to prevent power imbalances from overwhelming the public interest.

The good news is that none of this is really incompatible with Lindsey and Teles’ arguments (plausibly indeed, it provides them with stronger foundations). The awkward implication though is that if Lindsey and Teles want to absorb Konczal’s critique, they have to bring out the more radical implications of their framework. If democracy is the baseline, then an abstract ideal of markets cannot be taken as a given, opening up a host of possibilities.

Here, they could build on Nolan McCarty, Keith Poole, and Howard Rosenthal’s 2013 book, Political Bubbles (henceforth MPR), which draws lessons about regulation from the recent financial crisis (a draft of the introduction is available here). MPR, like Lindsey and Teles, are very far from left-wing radicals. However, by extrapolating the logic of a straightforward and commonsense set of arguments, they reach quite radical conclusions.

MPR argue that simple models of regulatory capture don’t really explain why it is difficult to regulate certain areas of the economy, such as finance. Ideology – and in particular “free market conservative” beliefs that government intervention in the economy is necessarily bad and “fundamentalist free market capitalist” beliefs that government itself is the problem – is one important factor that led to the recent financial crisis. So too is the economic self interest of businesses and the politicians beholden to them.

However, informational capture is arguably equally important. As the financial sector becomes more complex, it becomes more difficult to regulate, because the regulators necessarily have to rely on information from the regulated parties to understand what is going on. Here, the dependency goes the opposite way than in traditional rent seeking arguments – it is not that firms are dependent on a regulator to give them favorable treatment, but that regulators are reliant on firms to give them the information they need to even pretend to do their job.

This problem is essentially insuperable if one treats existing market structures as a given, and just look to reform the internal workings of government. Hence MPR’s proposal to cut the Gordian knot:

The recognition of low capacity argues against sophisticated discretionary regulatory management of the industry and in favor of blunter approaches such as banning the most systematically dangerous products and practices or capping the size of financial institutions. Blunter, less complex, and less lengthy legislation would not only reduce opportunities for financial innovators to find loopholes but also focus the attention of regulators.

In other words, where fundamental market structures get in the way of effective regulation, MPR propose to fundamentally change the market, banning dangerous products and preventing financial institutions from getting sufficiently large to do end runs around regulators. Where markets are both impossible to regulate and likely to have pernicious large scale consequences, we are better off without them. While the big actors that make financial markets have many resources, they are also fundamentally dependent on state regulations. This can provide the state with leverage.

If this sounds like a dangerously radical and left wing idea, it is only because the debate has shifted so far towards fundamentalist free market capitalism over the last few decades. The push for change coming from institutions such as Barry Lynn’s Open Markets Institute and politicians such as Elizabeth Warren is radically centrist, not Marxist, looking to correct the power imbalances that are leading to self-reinforcing inequality rather than to bring through revolutionary upheavals.

Lindsey and Teles’ ideas could play an important – perhaps even crucial – role in providing these reformers with a better understanding of their tools and objectives. Yet to do this properly, it needs to fully deliver on its implied logic. What Lindsey and Teles are pushing towards is a kind of politically grounded neoliberalism, which focuses on how to produce and maintain the conditions of rough power equality that might allow neoliberalism to work. That isn’t, obviously, a left wing political project, but it is one that is both potentially useful, and (unlike much currently prevailing ideology about politics and markets) not obviously self-contradictory.

Also from this issue

Lead Essay

  • Brink Lindsey and Steven M. Teles have largely made their peace with “big government.” They insist, though, that not all big government is good, and they draw on libertarian insights to criticize government action that tends to concentrate wealth and power in the hands of a few. The political mainstream can learn much about doing even big government better, and ironically, some of that insight comes from those who have been most skeptical about big government itself - libertarians.

Response Essays

  • Ilya Somin argues that in our attempts to free the economy and deliver prosperity to more people, there is no substitute for limited government. Government has not only captured the economy; it holds people where they are by making it more difficult to live and work in new places. This reduces economy dynamism as well as limiting individuals’ choices. Human mobility is a key part of the puzzle, he argues.

  • Henry Farrell urges libertarians to give up on the idea of rent seeking. There is no such thing as an unregulated market, so “rent seeking” ends up meaning something like “state action I happen to disfavor.” This will not do, he says, and he urges decisive interventions, particularly in financial markets, to save the neoliberal state. This he characterizes as a mix of market institutions and democracy. Democracy is the part in peril, he argues, not markets.

  • liberal. Though it is out of fashion and more often found a term of abuse today, liberal politics works to ensure that citizens share power broadly, and that no one can wield arbitrary power over another. Reeves suggests that we need even more of this kind of liberalism.