It is a peculiar characteristic unique to our country that Americans talk about political issues in constitutional terms, thereby turning every policy debate into an argument over basic principles. That was my thought when I read about Senate candidate Rand Paul and his “Constitutionalist” view that the federal government has no right to dictate the behavior of private enterprises. Mr. Paul came under fire last week for suggesting that the Civil Rights Act of 1964 went too far when it prohibited discrimination by private businesses. You can read more here (astute students in my Constitutional Law class will observe that Mr. Paul inspired one of the questions on my final exam this year).
Paul objects to federal policies regulating business due to his reading of the U.S. Constitution. His political philosophy might best be characterized as extreme libertarianism. Following the objectivist principles of Ayn Rand, he argues that the public should be left to their own devices and that greater social benefits will accrue naturally over time from the enlightened (and rational) self-interest of individuals. Ironically, Paul’s embrace of self-interest as a moral good in itself is directly at odds with the view of the Framers of the Constitution. The people who designed our constitutional system spent much time criticizing the biases, prejudices, and self-interested motivations of the general public. The system of government that they created was intended to ameliorate the very aspects of human nature that objectivists like Rand Paul celebrate.
In fact, it is difficult to find a historical basis for Rand Paul’s vision of the U.S. Constitution. In 1789, the Framers believed that state legislatures had been captured by parochial commercial interests who wielded power in favor of a self-interested and growing “middling” class. It was the hope of James Madison that “disinterested” elites would come to dominate politics in the federal government, where they would promote policies that promoted the common good rather than narrow economic interests. John Adams seemed resigned to the idea that an aristocracy of sorts would become necessary in the new republic in order to ensure that laws were enacted in the public interest and that the machinery of representative democracy was not corrupted for selfish ends. Neither man was optimistic that any good would result if the general public was left to its own devices.
The Framers would have had little difficulty accepting the idea that the federal regulation of business entities promotes the common good of the nation, in ways that state laws or the private market do not. In a recent post, Professor Michael McChrystal discussed the classic objective of tort law to ensure that responsible parties will bear the economic costs for injuries that they cause. However, at best tort law is an attempt to remedy injuries that have already occurred. In contrast, the federal regulation of business entities is often intended to prevent business entities from imposing costs on third parties in the first place.
Economic theory is helpful here. As defined by Professor Paul Johnson in A Glossary of Political Economy Terms, “[a]n externality exists whenever one individual’s actions affect the well-being of another individual — whether for the better or for the worse — in ways that need not be paid for according to the existing definition of property rights in the society. “
Business entities can maximize their profitability to the extent that existing law allows them to externalize their costs, thereby forcing third parties to bear some of the costs of production for the business’ good or service. For example, a cardboard box producer that dumps chemicals used in the manufacture of its boxes into the environment, without paying for the safe disposal of those chemicals, has externalized its costs of production to the extent that the community surrounding the factory is impacted by the dumping.
When political commentators charge that liberals believe that the government is capable of solving problems, whereas conservatives believe that government is the problem, they are referring to the fact that political liberals tend to see government regulation of the marketplace as a vehicle for reducing the negative externalities that would exist in an unregulated market. Liberals accept the premise that society in general has an interest in limiting externalities through government regulation of the marketplace. It follows, therefore, that liberals tend to view deregulation with suspicion as little more than a policy preference designed to allow business entities to externalize their costs.
Politics is the realm of interest groups, not economists, so it is a given that any attempt to limit externalities through government regulation will at best approximate the identification of the precise costs imposed by externalities and the exact identity of those third parties who would otherwise bear those costs. To recognize that a system of regulation is imperfect in economic terms is not the same as saying that deregulation would be preferable. Rather, what is important is to never lose sight of the fact that all government regulation of the marketplace is essentially a political act. The voters ultimately get to define what constitutes an externality, not economists.
Justice Jackson made this point in Wickard v. Filburn, the seminal case relating to the power of Congress to pass New Deal legislation (and espousing a limited role for the Supreme Court in second guessing Congress’ regulatory choices):
“It is of the essence of regulation that it lays a restraining hand on the self-interest of the regulated, and that advantages from the regulation commonly fall to others. The conflicts of economic interest between the regulated and those who advantage by it are wisely left under our system to resolution by the Congress under its more flexible and responsible legislative process. Such conflicts rarely lend themselves to judicial determination.”
Rand Paul is fond of criticizing the Wickard v. Filburn decision in his stump speeches at tea-party gatherings around the country.
None of us should be surprised if business interests selfishly try to push externalities off on others. Nor should we be surprised if the general public pushes back, and adopts federal regulation as a means to force business interests to bear their own costs. We see this policy debate unfold before us every day. Consider three recent examples:
The financial reform bill soon to be signed by President Obama seeks to address externalities in the financial services industry. During the financial meltdown in 2008, the federal government was forced to use taxpayer dollars in order to prop up investment banks and insurance companies because those financial firms had made disastrous market bets that put their future survival at risk. Had the federal government failed to act, the result would have been a collapse of the credit markets, the inability of homebuyers to get mortgages, and the lack of buyers for the commercial paper that large employers rely on to fund current operations. The freedom of financial institutions to make overleveraged market bets clearly imposed external costs on the credit markets and, by extension, on everyone who relies upon credit.
The congressional overhaul of financial regulation does not go so far as to reinstitute the Glass-Steagall Act, as some had advocated. That would have forced investment banks to segregate funds held by commercial banks, so that bankers could not use the public’s savings accounts as a source of funds to play the market. Whether or not the repeal of Glass-Steagall in 1999 was a mistake, the consolidation of integrated financial services companies that has occurred over the last decade makes unscrambling this particular egg an impractical task.
Instead, the final version of the overhaul bill will increase minimum capital requirements, so that investment banks must keep a larger cash “cushion,” and will also likely include the “Volker Rule” banning proprietary trading (the practice where investment banks use their own money to make market bets), thereby limiting financial firms to trades made on behalf of clients. Derivatives trading is now viewed as so risky an enterprise that the Senate version of the bill bans banking companies from derivatives trading altogether while the House stops at requiring such trades to be insured and to take place on public exchanges. If anything, critics charge that the overhaul bill does not go far enough to reduce the risk of a future financial meltdown.
Health care reform, as enacted this past March in the Patient Protection and Affordable Care Act, is another example of federal regulation intended (at least in part) to address externalities. The requirement that all individuals purchase private health insurance is often cited by critics as an example of the federal government overreaching its constitutional bounds. However, supporters of an individual mandate argue that it is helpful in reducing the public cost incurred when the uninsured use expensive emergency room services rather than the cheaper alternatives available to the insured population. Opponents of the individual mandate dispute the relative significance of these externalities in the context of the size of the entire health care market. However, if the general public believes that these externalities are contributing to the rising cost of health care for the insured, then it is difficult to argue that their representatives are powerless to address them.
Even the ongoing debate over illegal immigration in Arizona can be viewed as a local reaction to the federal government’s failure to deal with the externalities imposed by the employment of undocumented workers. The current system of immigration legislation tolerates the existence of an undocumented workforce that some estimate at over 11 million people. Employers (and consumers) across the nation take advantage of the cheap labor that these workers provide. However, taxpayers in the states along the U.S.-Mexico border bear the economic brunt of this toleration, in the form of higher costs for education, emergency health care, and public safety. Arizona’s choice to make an individual’s illegal presence in the state a crime is born out of a frustration that the current federal immigration laws do not spread the social costs of illegal immigration on an equal basis to employers and taxpayers across the nation.
As Justice Jackson alluded to in Wickard v. Filburn, lawmaking through the political process is how the public allocates the costs of behavior in order to reduce externalities. When voters argue over the best way in which to allocate these costs, they are engaging in a policy debate. Rand Paul and his fellow “Constitutionalists” seek to turn this policy debate into a more basic constitutional question. What is left unaddressed is the moral dimension of this debate: do we as a society have a moral obligation to use the political process in order to reduce externalities that powerful interest groups would otherwise impose on the less well organized (and less well funded) segments of our society? A liberal might answer “yes” to this question; I suspect that an extreme libertarian along the lines of Rand Paul would answer “no.”