Government must keep large companies from failing.
This is the nature of externalities. As every first-year economics student learns, the costs incorporated into the supply and demand curves, which set the equilibrium prices in free markets, sometimes do not adequately reflect the true cost to society of the good's production. For example, Guide Corporation in Anderson can make so many automobile parts each year with a cost of, say, $10 million dollars, as long as they can dump their toxic chemicals (HMP-2000) into the Anderson sewers.
That cost is eventually reflected in the price, which is selected to maximize their profits. They don't care what happens after they dispose of the chemicals, since after the chemicals are gone it costs them nothing. But the chemicals ended up killing all of the 1.4 million - 187 tons of - fish in the White River from Muncie to Indianapolis. What's the cost of 1.4 million dead fish? The state sued Guide Corp., which ended up paying $14 million in damages - a mere $10 per fish.
The point, of course, is that the cost to society of those dead fish - comprised, for example, of the loss of enjoyment to fishermen, the cost of carting away the dead fish, the stench of rotting fish carcasses - was not reflected in the price Guide Corp. charged in the sale of its auto parts.
Externalities are a form of market failure, where the free market simply fails to efficiently allocate resources. If you want to solve them at all, the only way to do so comprehensively is through government action; charitable contributions themselves fail from a tragedy of the commons.
One tool to solve the externality allocation problem is the so-called Pigovian tax, in which the government simply taxes the market so that the cost to society is reflected in the price. As an example, consider the federal gasoline tax, which now stands at 18.4 cents per gallon. The purpose of this tax is to both fund the interstate highway system and reflect the cost to society of carbon dioxide emissions.
Another tool is regulation, which is rather heavy-handed. As a matter of principle, if the goal can be reached through economic incentives, such as purposeful taxation, rather than direct intervention, economic incentives are more appropriate; bureaucracy carries a cost of its own.
One of the chief differences between libertarians and progressives is on how extensively externalities pervade the economy. I am inclined to regard the economy as an intensely interconnected weave of business relationships; what happens to someone else will, quite likely, affect me. As a consequence, the rather retributive strain of libertarian thought is not entirely accurate; if I make poor financial decisions and my family goes bankrupt, this will have a negative effect on my daughter's future, even though she's done nothing to deserve this. The cost of my failure is much more than merely the effect of my defaulted debt on my creditors' balance sheets, and this additional cost is not reflected in the free-market price of a loan to me.
Therefore, to correct for these and similar failures, the government should step in and regulate the economy. There are other arguments to support regulation, of course, but this is a large one.
The problem with banks or automakers that are "too big to fail" is similar: the economy acts as a sort of echo chamber, with the failure or success of a single company amplified throughout the country. When very large companies fail, many other corporations are caught up in the tidal wave and go bankrupt themselves. The cost of this multiplier effect to society and the whole economy is not, in my understanding, reflected in the direct cost of failure to shareholders and creditors.
So it is the government's job to step in and limit the damage caused by the collapse of the automakers and the various investment banks - and, hopefully, regulate big, important companies in the future so that the expected cost of their failure reflects the true cost of their failure.
Write to Neal at necoleman@bsu.edu
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