On Terrible Policies and Terrible Diseases

A friend of mine recently recounted a debate he had with a liberal on libertarianism. His counterpart claimed that in a libertarian world, the FDA would not exist and we would all die of a terrible disease. Sound familiar?
This is a common argument. It has many flaws. I think we can all agree that under laissez-faire, as under any system, some people will do bad things some of the time. Some producers will try to dilute their medicines, take short-cuts in production processes, etc. The question is whether the government is better at policing bad activity than the market. A priori, there is no reason to think that it is. There are several ways that markets police themselves:
1. Reputation. Once people discover that a product is bad, it does not take long for profits to nose-dive. Firms can either: (a) cut corners now, earn high profits in the short term and nothing in the long term, or (b) make their products as diligently as possible and earn a long stream of moderate profits for years to come. The second strategy is almost always more profitable.
2. Asset markets. Stock prices do not just take account of current business conditions, they actually account for a firm’s prospects of long-run performance. What’s more, these markets react instantaneously to news, so stock prices immediately reflect new information the instant it hits. People who claim that businesses have an incentive to cut corners in the short run don’t understand that these asset markets take advantage of the best information available about the future. If a share price does not reflect the actual long-run health of a firm, people can make money by buying or selling shares until the value is accurate.
3. Competition. Rival companies have an incredibly strong incentive to find flaws in their competitor’s products and vociferously publicize them.
4. Information markets. If an industry is not good at policing itself, this provides an opportunity for others to make a profit in the “information industry.” This includes consumer magazines like Consumer Reports or buyer’s services like those that millions use when they buy cars. There is no reason to believe that these wouldn’t pop up if the FDA were eliminated.
What are the FDA’s incentives to police accurately and thoroughly?
1. Reputation? The FDA already has a bad reputation. They certify drugs that are unsafe and keep other, life-saving drugs off the shelf. Their profits are unaffected by this. If you try to stop ‘shopping’ at the FDA, the IRS will bang on your door and arrest you.
2. Competition? There is only one game in town. The FDA has no rivals looking over its shoulder.
3. Asset markets? Fat chance. Unlike stock owners, regulators and politicos have no incentive to look past the next election. Political institutions ensure that almost no one thinks about the long term (witness the impending Social Security crisis).
4. Information markets? The public is notoriously misinformed about political realities. This is because it costs money, time and effort to make oneself informed and unlike in private interactions, it just doesn’t pay off to be informed about politics. The chance that any one vote is decisive is about 1 in 60,000,000 (that was the actual probability going into 2004) so this gives voters little incentive to do their homework and learn whether the regulators are doing their jobs well.
People often assume that economists denigrate regulations because we fear that it hurts business. Actually, the opposite is true. The problem with regulation is not that it hurts business, but that it hurts consumers (it tends to enrich politically powerful business leaders). Regulations like those promulgated by the FDA raise the price of goods. They also raise the cost of doing business so that fewer firms enter the business in the first place. This grants a de-facto monopoly position to those firms already in. This is why, historically, producer groups and not consumers are usually the chief constituencies pushing for regulations!
In some cases, regulatory bodies flat out set monopoly rates. This is what happened in the case of the very first federal regulatory body, the Interstate Commerce Commission. It was instituted to keep railroad rates low. Within a very short time, railway barons were using the Commission to raise rates not lower them. Before the Commission, barons had tried unsuccessfully for years to establish monopoly cartels, but the cartels would always break down. With the Commission setting prices by law, government effectively established a cartel that was unsustainable under laissez-faire.
All of this is to say that I seriously doubt we will all die of a horrible disease were the FDA to be abolished.

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