Comment: The Road to Enron

For the past quarter-century, America has been
deregulating capitalism in
expectation of a more dynamic and efficient economy. In fact, average economic
growth since 1976 has slightly lagged that of the previous quarter-century, when
capitalism was more highly regulated. But there has been a much more serious set
of consequences--widening inequality, the dismantling of public remedy, and the
neutering of the Democratic Party as a medium of progressive politics.

A brief recap: The economy faltered in the early 1970s, largely because of
the first oil shock and the collapse of the system of fixed exchange rates
anchored by the U.S. dollar. Inflation and then "stagflation" served politically
to discredit Keynesian economic policies as well as economic regulation. What
followed was new prestige for market fundamentalism--the idea that capitalism is
best left alone. (This conceit came back into intellectual fashion around the
time that the last economists who personally remembered 1929 died or retired.)

The president was Jimmy Carter, a Democrat. His chief economist, Charles
Schultze, believed that regulation distorted allocation of economic resources,
exacerbated inflation, and retarded innovation. And even if workable in theory,
regulation was often politically corrupted in practice. Schultze preferred the
selfcorrecting genius of markets. What followed was the first wave of
deregulation--of airlines, natural gas, trucking, and, a little later, electric
power, banking, and much of telecommunications. A parallel populist critique
championed by Ralph Nader, pointing out that regulators often got captured by
regulated industries, merged with a business critique by people who just wanted
regulators off their backs.

When Ronald Reagan took office in 1981, deregulation was no longer the
province of centrist economists like Schultze, who were intellectually honest if
politically naive. It was in the hands of full-blown conservative ideologues,
energized by business-funded think tanks and professorships. For economic
deregulation to work at all, it needed to be complemented by vigorous antitrust
enforcement. But Reagan's people threw antitrust overboard, too. By the time a
Democrat returned in 1993, deregulation was conventional bipartisan wisdom. For
the DLC wing of the people's party, deregulation was also a terrific way to raise
money from business.

To see why this emperor is naked, just recall a sampling of the
past month's headlines. In theory, all that capitalism needs to keep itself
honest is a vigilant consumer. But as the Enron affair shows, there are just too
many opportunities for insiders to enrich themselves that ordinary consumers
can't fathom, much less redress. In the absence of ground rules enforced by
parties outside the market system--namely, government--opportunism abounds and
capitalism goes haywire.

More than 30 years ago, Jessica Mitford wrote about "The American Way of
Death"--how funeral homes take advantage of unwary grieving families who are in
no condition to be vigilant consumers. A wave of regulation followed. Last month
we learned of a funeral operation that did not bother to cremate bodies as
promised--it was cheaper just to let them stack up. Capitalism continues to breed
new forms of opportunism. Regulation requires not a onetime fix but an ongoing

Last month, a report on nursing homes from the U.S. Department of Health and
Human Services, 10 years in the making, showed that more than 90 percent of
these homes are chronically understaffed and that patient care suffers as a
result. George W. Bush's response was that consumers need to be better informed.
You can just imagine an 89-year-old sovereign consumer, perhaps with diabetes and
Alzheimer's, traipsing around with a walker, investigating comparative staffing
levels at diverse nursing homes. Bush's response is doubly insulting: Most
nursing homes are financed by Medicaid, whose rates are set so low that decent
staffing is impossible. But if Medicaid raised its reimbursements, regulation
would still be needed to ensure that the money went to better nursing care, not
to line the pockets of entrepreneurs.

Only the details change. In the 1920s, public-utility holding companies got
control of local utilities, sold watered stock to the public, enriched insiders,
and raised prices. Same story as Enron, different particulars. New Deal
legislation prohibited such abuses--but it has been under assault for a decade
from a new generation of wannabe sharks who disparage "Depression-era regulation"
as hopelessly out of date.

Most of the intellectual premises of deregulation have been disproved
by subsequent events. For starters, regulation was never more than a trivial
factor in the inflation of the 1970s, which was mostly a macroeconomic event.
Second, there are whole areas of the society that can't be left to the free
market because of hidden costs or benefits--what economists call externalities.

For instance, health care can't be a pure market because we don't leave its
provision to private supply and demand--otherwise, people who couldn't afford
care would just die. Along the way, they would spread infectious diseases.
Education also is not a free market; if it were, half of America's kids wouldn't
go to school, because their parents can't afford tuition. Drug manufacture is not
a pure free market, because government offers research dollars, provides patent
protection, and assures that drugs are safe and effective (lately, pressured by
industry, it has been doing less of the latter). The environment can't be a free
market, because factories have long treated the air and water as a free sink.

Leaving aside health-and-safety regulation, even in areas where supply and
demand supposedly do the job, such as airline deregulation, the results are
dismal because of monopoly power and the default of antitrust. For the most part,
the big airlines have used their market power to crush new competitors (the one
exception is Southwest, which flies mostly from smaller airports). Fares have
become a crazy quilt--bargains mixed with shameless gouging. On average, consumer
prices actually fell at a faster rate under the old, regulated system, because
airlines were able to invest stable profits in new generations of planes. At
best, "deregulation" needs to be a form of regulated competition, with government
setting the rules of engagement.

Labor deregulation--of pensions, bargaining rights, trade standards,
health-and-safety protections--has also affected labor markets and left workers
with fewer protections. This, in turn, weakens unions, allows companies to play
off worker against worker, and contributes to a general widening of inequality in
society. The promised general gains to the economy never quite materialize.
Instead, executive pay just keeps soaring.

The intellectually honest advocates of deregulation contended, naively, that
leaving matters to the market would yield outcomes uncorrupted by politics. But
even with relative deregulation, as in the case of airlines or gas pipelines,
government is still necessarily involved. Government, after all, defines basic
property rights; it defines unfair trade practices. And when things go wildly out
of kilter, government has to pick up the pieces. Enron did not favor a brand of
deregulation that would help sovereign consumers to shop around for the best
deal. It favored rigging the rules so it could make a killing--and spent a
fortune politically to get the rules it wanted.

In practice, the age of deregulation has been an age of intensified corporate
lobbying and heightened conflicts of interest, not market purity. The
connection between government and business has become more corrupt, not less.
But despite the practical failures, the ideology lives on. And Democrats (with
some heroic exceptions like Ted Kennedy and Henry Waxman) as well as Republicans
have become complicit in this process. When savings-and-loan executives lobbied
in the early 1980s to be allowed to speculate with federally insured deposits,
both political parties jumped on the bandwagon. Campaign contributions were
bipartisan. Only later did taxpayers pick up the tab.

After more than two decades, deregulation has resulted in a witches' brew of
old-fashioned corruption, just plain bad public policy, and the withering of
political opposition in the face of conservative ideology and business money. The
process of dismantling rules that protect consumers, workers, pensioners, and
investors is at least as vulnerable to influence peddling as the process of
upholding them. There may be efficiency gains to be had from some brands of
deregulation, but they are more than offset by spectacular meltdowns--the
savings-and-loan scandal, the California electricity bill, Enron, airline
monopolies, nursing-home disgraces, toxic dumps, drug-company price gouging, and
on and on. All of these demand regulation in the public interest.

Perhaps the most damaging effect of all is the eclipse of an
opposition politics. Embrace of deregulation by "pro-business" Democrats is more
than a mistaken philosophical conversion. It is richly rewarded by business
campaign contributions. Today, there is only the shadow of a mainstream movement
to re-regulate. It reasserts itself, piecemeal, whenever scandal is
overwhelming--as in the case of Enron. But in the 1990s, Democrats as well as
Republicans pressured regulators to ease up. In the think-tank world and in
academia, plenty of business-funded university chairs, journals, and research
institutions tout the benefits of deregulation (Cato, Heritage, the American
Enterprise Institute, and a center at Harvard on "risk assessment," among them),
but only a handful of researchers are looking skeptically at the actual record.

So we need both an intellectual and a political counteroffensive, as well
as a Democratic Party willing to return to its populist, mixed-economy roots.
This issue of the Prospect offers a modest start, with a special section
suggesting what needs to be re-regulated and why. Nothing about the new economy
changes time-tested truths about capitalism: It is a dynamic system of innovation
and creative destruction. Either we harness it for general benefit, using the
instruments of political democracy, or the destruction overwhelms the creativity.

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