Thursday, April 09, 2015

Ironically, regulation brings freedom

Time Magazine is running an interesting story about the impact of marijuana legalization in the US upon the profits of the drug cartels. Sales of recreational and medical marijuana have hit $2.7 billion in 2014 and projections suggest sales will top $4 billion by 2016. They have also noticed that violence in Mexico has taken a dive, but not all of the that decline can be attributed to legal marijuana sales and that is not what this article is about. But it is somewhat positive news to see that the violence in Mexico is on the decline.

The Time Magazine article presents a certain irony: consumers of marijuana prefer the regulated, tax-paying sources rather than the unregulated black market sources.

Clearly, the consumers want to know what is in the product, they want to know that they're not financing violence and they want to be able to show that they purchased it legally, without fear of going to jail. The takeaway I get from the article is that indeed, a little bit of regulation can lead to freedom in life.

There is another point to this post. Even if the government didn't step in to regulate, the cartels would do the regulating, but with a far heavier hand and response to errors. In the regulated, transparent world of legalized marijuana, you don't die for botching a deal. You do better next time. In the "free market" world of the cartels, every move is scrutinized and every mistake carries a very painful penalty. So, even in the "free market" there is regulation.

This is probably something that free market proponents don't want you to notice. Promoters of free markets like to pretend that the market is rational, pure, unfettered and free to make the best choices for the consumer. What they don't tell you is that having a 3rd party arbiter, a regulator, to observe each transaction, provides a forum for conflict resolution that you won't find with the cartels. Where the cartels use force as the first resort, regulators use diplomacy.

Creating a taxable, transparent market in marijuana has another benefit. Like guns, we know that if guns are banned, the only people getting guns are the criminals. But if we regulate the market, keep records and create forums for conflict resolution, we know who has the guns and the pot. But we don't arrest them just for the purchase, we just keep track of what is going on for the safety of all.

Contrast the American legal marijuana scene with the unregulated market of credit default swaps before the collapse of the housing bubble. Yes, I know this is an unusual segue, but it makes my point. Various entities had bet against each other in the years leading up to the collapse. Some bought credit default swaps, some bought insurance against them. Some were betting against the homeowner, and some were not. Either way, the market was almost completely unregulated with no accountability. No one knew who had what, so when time came to lay the cards down, some of the biggest finance firms in the country folded. Some others sought government protection for a bailout.

This is the point about regulation and the free markets. The regulation of a market can actually make it free, up to a point. If the transactional cost of regulation is too high, the market will not move, and black markets are created. If the transactional costs are low, then more people are willing to participate and that allows capital and products to move. The market adjusts to the regulation and finds a way to make a profit. Everyone is happy.

So when someone comes to you with a proposal for a free market or a "free trade agreement", remind them that the market isn't rational. The drug cartels and finance firms like Goldman Sachs and HSBC know this, too. They just won't admit it.
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