If we consider development to be the general increase in well being of a population, then we have to recognize that there are times when the increase in one type of measure (real income) is countered by the negative action of another type of measure (disease rates). In these cases, government often steps in to regulate the problem. However, there are times when government regulation is necessary and other times when it is ill-advised. How can we tell the difference?
Two Kinds of Official Interference
First, let’s clarify that there are two types (that we will discuss) of official interference with the natural cycles of the economy. The first, which I am calling “regulation”, involves absolute limits on behavior. This includes laws against criminal activity (not allowed at all) and certain types of pollution (allowed up to a certain point), and efficiency regulations (every toilet sold must use 15 liters or less). The second type, which I am calling “market manipulation”, includes setting fee rates for public services (trash collection), and collecting taxes on undesired activities (cigarette sales).
Why Do We Need Any of It?
In certain quarters there is a general resistance to the idea of any kind of government interference, and they are not without reason, as many times government regulation can backfire from its intended effect. However, there are times when economic forces alone are not sufficient to protect the general well being of a population. Consider pollution. The graph here (from this report) compares the ozone limit exceedances of Los Angeles and Houston. The limits exceeded are set according to levels of ground level ozone (smog) that will negatively affect people’s health. And exceedances of these levels are bad, but this many days with exceedances is even worse. There is a significant negative health impact. Los Angeles and Houston each are large cities with vibrant economies and warm, sunny weather which exacerbates this problem.
So, back to the point. We need government interference in this instance, because otherwise the natural inclination of the parties responsible for the ozone is to continue to cause more. As there are numerous small scale producers (mostly automobiles and scattered industries) and one general overall distributed effect, there is no market incentive to reduce the pollution. Strict regulations in California have greatly reduced the severity of the problem there, but it still remains one of the worst in the United States. Is that really the best we can do?
When Market Manipulation is Prefered to Regulation
As mentioned in this earlier article, in cases of efficiency, it is often better to use market manipulation rather than regulating efficiency. That means either a tax on something the government doesn’t directly supply (tobacco products) or a higher price on something the government does supply (water). This has several advantages. One is that the regulator does not have the burden of keeping up with the changing technology. The other is that the regulator does not have to choose between different uses of the same resource (for example, between water used for manufacturing and water used for agriculture). They can just raise the effective price through direct control or through taxes until the overall consumption is equal to the ability to produce it for a positive resource (water) or the areas ability to tolerate it (generalized pollution like ozone reactants). In any case where the potential downside is generalized harm over a wide area from a pollutant or resource depletion when beyond a particular threshold (when otherwise a certain amount of pollution of resource depletion is acceptable), market manipulation is greatly preferred over regulation.
When Regulation is Preferred to Market Manipulation
Sometimes, however, certain behaviors must be halted or only allowed in insignificant amounts. An individual or corporation may have a economic incentive to continue a behavior even when a nearby population is harmed. Regulation can be affected either by not allowing the release of a hazardous substance for example, or by requiring a enterprise owned buffer zone between the release and any population. This kind of official interference is needed for the release of extremely harmful substances and also for localized pollution like mercury or other heavy metals. This is for circumstances where death, deadly disease, developmental defects and any major disruption of human life results as comparable to crimes against persons or property that are outlawed. In general, any case that does not meet the criteria in the last sentence of the paragraph above should be a candidate for regulation. But, regulation should always be the second choice only to be employed in cases where manipulating the market for the good of the population is not sufficient.