The market is a distortion

Commentators and politicians of more conservative persuasions often criticize certain behaviors that they label as “market distortions.” Regulations, government spending, and progressive taxation are all said to distort the market because they change the economic incentives of certain behaviors. For instance, imposing fines on firms that dump poison into rivers distorts the market because if fines are high enough and properly enforced, the incentive to cheaply dispose of poison that way is destroyed. A firm then might have to undertake extra costs to dispose of the poison differently which might have various other effects on profits, wages, and prices.

Typically conservatives aim this bit of criticism at government actions like spending and regulation, but other policies that they support distort in similar fashions. Subsidies, corporate tax breaks, and individual tax deductions all have the exact same distorting influences as programs conservatives so often deride. Deductions and loopholes alone accounted for over $1 trillion in tax expenditures in 2010. Of course, these kinds of programs are typically targeted towards corporations and middle to higher-income individuals which no doubt makes their distorting influence more bearable for the conservative crowd.

As Mike Konczal points out, this kind of distortion manages to fall under the radar of most Americans, even those who actively benefit from the programs. The majority of those who receive a mortgage interest tax deduction do not realize that the deduction is nothing more than a way that the government spends through the tax code. It is functionally identical to setting up a mortgage interest welfare program in which the government sends out checks to those paying off a house. Just as that program would, the mortgage interest tax deducation distorts the housing and lending markets as well as the alignment of consumer incentives.

These sorts of programs — which are hardly if ever mentioned in the market distortion screeds of the small government advocates — make up what Suzanne Mettler refers to as the Submerged State (pdf). But instead of attacking the Submerged State for its market-distorting influences, the conservative commentators almost exclusively use the rhetoric to go after things like the minimum wage and labor unions. Recall Michelle Bachmann’s notable 2005 comment that we could wipe out unemployment if we got rid of the minimum wage, the suggestion being that the minimum wage introduces a distortion that affects the types and number of jobs that are available.

Labor unions are attacked as market distortions because their collective bargaining strength permits workers to command greater compensation than they would otherwise receive bargaining alone. This is claimed to have “job-killing” effects because so long as other locales do not permit unions to operate effectively, owners of capital looking to make as much money as possible may move to those locales where they can squeeze more profit out of the workers. (see also: What warnings about job-destroying regulations really mean)

Two things about the discussion of market distortions always baffle me. The first is that the label is used by itself to be synonymous with “bad.” Those who rely on the concept to provide policy commentary take it as a given that just calling something a “market distortion” is enough to argue that it is a bad thing. Unless you have some sort of fetish for the market, that assumption is completely off. An argument needs to be provided to explain why a specific market distortion is bad that makes a point other than simply remarking that it is one. For instance, consider the market distortion that consists of the government ban on leaded gasoline. This policy has a huge impact on public health, in particular the development of children, precisely because it distorts the market. To claim then that market distortions are an evil in and of themselves is totally foolish.

The second problem with the rhetorical device is that it relies upon the assumption that there is such a thing as a market without distortions. The fact of the matter is that the market is itself a distortion. Distortionary government policies are necessary to generate markets in the first place — granted these policy distortions are so entrenched that people do not even think of them as such.

For instance, consider certain aspects of the legal system in the United States. In that system, there exists laws which forbid individuals from taking over a house or building that someone else has a government-issued titled over. In addition to the law, the state has imposed taxes in order to hire police to enforce these laws — with violence if necessary — through the arresting of those who do not comply. A prison system is also built up in order to impose severe punishments to skew the personal incentives away from performing such an action. All of these policies are distortions. They affect the economic incentives surrounding the non-consensual seizure of property that someone has a title to.

Without those distortions, a great many people — for instance the homeless and very poor — might very well decide to simply take from others. But with the laws, police, and prisons set up, an enormous disincentive is imposed for that kind of behavior, distorting the decisions that they then make. But this kind of property protection is a baseline necessity for the existence of any market to begin with. I am doubtful you would find any conservative commentator arguing that the government distortions that create the market itself are wrongful despite the fact that they use the term in such an all-encompassing, pejorative way.

As I have mentioned previously, this whole enterprise of trying to describe behavior by appealing to specific baselines — in this case the market — is wrongheaded. We should not be asking ourselves whether something is a market distortion or not, especially since the market itself is a distortion. Instead, we should be asking ourselves who is owed what and why? From the answer to that question, we can decide whether a distortion is good or bad by determining whether it ensures that individuals are given what they are due. Treating distortions as categorically good or bad is simply untenable in any given ideology — especially the laissez-faire one — and also has the unfortunate additional quality of making absolutely no sense.