Anger-fed populism now is no better a policy compass than libertarianism masquerading as capitalism was during the Bush administration. This may become evident all too quickly as public rage—generated by the catastrophic risk-taking of many Wall Street traders—is fanned by Washington legislators desperate to make up for their own decade of neglect. The faux surprise emanating from Washington—does anybody else think "gambling in Casablanca"?—is generating proposals that are emotional retorts, not wise policy.
The economic cataclysm we are living through now is the consequence of 30 years of intentional destruction of the rules needed to keep capitalism on track. Capitalism does not survive in a vacuum, despite libertarian desires to the contrary. Just as democracy needs rules or it descends into anarchy, so capitalism needs rules to guide the behavior that becomes wealth creation.
What we should be seeking, and what has not emerged from the cacophony of Washington, is a principled guide to the intersection between government and the market. Here are four principles that might begin that discussion:
• Only government as enforcer can ensure adequate integrity, transparency and fairness to customers, shareholders and competitors. Notions of self-regulation when fundamental competitive advantages are at stake are foolish. This was made evident by the remarkable observation—accurate and devastating at once—of a lawyer for a company accused of doing very bad things who said to me in defense of his client: "Yes, we did what we are accused of doing, but we are not as bad as our competitors."
• Markets, like democracy, require competition. Everybody claims to love it, but we all hate it in practice. It is human nature. Yet the structure fails without it. That is why government must put in place firm policies and enforcement against monopolistic behavior designed to squash the innovative spirit of competitors. It is no coincidence that a remarkable explosion in information technology erupted after the AT&T monopoly was broken up.
• Market failure is a critical concept for, and integral to, the free market. If you don't understand the notion of market failure, you will never be able to understand where intervention is appropriate, and where it is not. And the notion of "externality"—a cost or a benefit to society that is not captured in the price of private transaction—is one of the keys to understanding market failure. It makes sense to regulate pollution—from a pure free-market economic perspective—because society is bearing the cost of pollution strewn into the atmosphere. The most important externality we now need to confront is risk. We have socialized risk through massive bailouts and privatized gain by leaving the upside exclusively to the insiders. That system will fail over and over if we do not shift the burden of risk back to those who expect the gain.
• Certain core principles that we believe are central to our sense of community and purpose will not emerge from pure market dynamics: absent a minimum wage, the market would continue to drive wages down to an unacceptable level; the market would tolerate discrimination without laws prohibiting it. Yes, this is all conceptually akin to the notion of market failure enunciated above, but it is different in that numbers cannot begin to capture the harm to society from violation of these core principles.
So where does that leave us with respect to some of the ideas floating around in Washington these days? Setting CEO compensation when public money is not involved is a bad idea and has not worked; rather, the process of corporate governance should be fundamentally rewritten to empower shareholders, who actually own the companies. Reworking leverage ratios and capital requirements for banks and "nonbank" banks is a great idea, because the systemic risk faced by the entire economy is a negative externality that the individual company does not price into its decisions.
What we need to restore to the Washington debate is logic, not anger; principles, not wrath. The dynamism of our economy, and our capacity to emerge from the current debacle, depend upon it.