We blame corporations for failures of government

A friend posted on his Facebook page something implying that corporations were evil, citing climate change as an example. I definitely agree that we should act to prevent catastrophic climate change, or rather that we should have acted long ago. However, placing the blame at the feet of corporations is misguided.

It is the nature of the free market that corporations will generally do the right thing if externalities — the “collateral damage” of an economic transaction — are properly represented in the price. Really, they will. The harm to the environment from fossil fuel use is a good example of an externality, a cost paid not by the buyer or the seller, but rather by society as a whole. If you can buy gas without the cost to the environment being factored into the price, then you’ll want more of it, and corporations will be happy to sell it to you. You consume too much gas because the price doesn’t cover the real costs of you using it.

When corporations do the wrong thing, it’s generally a political problem. A major responsibility of governments is to represent economic externalities in the free market, e.g. by placing Pigouvian taxes on activities which produce negative externalities. For example, a “carbon tax” on the consumption of fossil fuels would raise prices, effectively forcing consumers to pay the whole cost of fossil fuel use, rather than just part. Consumers would react by finding ways to be more efficient, like buying more fuel-efficient cars, using (and voting for) public transit, finding ways to work from home, etc. Corporations would react to the change in demand, producing more fuel-efficient cars, less gasoline, better tools for remote work, etc.

The flip side of Pigouvian taxes is subsidies on things that produce positive externalities, like green energy, or funding research. And where those don’t work well for some reason, regulation might be called for. There are costs to regulation — regulatory agencies need to be staffed, and corporations often have to hire people to deal with regulatory obligations. Regulations are also blunt instruments that don’t allow for as much innovation around addressing the actual concerns that motivated them. And regulatory agencies are opportunities for corruption. To make things worse, regulations tend to live on even when their utility decreases — you can count on regulators to work hard to justify their existence so they can keep their jobs — so corporations have to comply with an ever-growing pile of regulations from which the dead wood is virtually never removed. So there are many potential problems with regulation! But sometimes you just don’t see a good way to get the desired result by representing externalities in the free market, so despite the costs and risks, you have to regulate.

Pigouvian taxes, subsides, and regulation are powerful levers that government can and should use to guide economic activity to produce results that are good for society. If we had instituted a carbon tax 50 years ago and used that money to fund research into alternative energy sources — and then later to subsidize nascent green energy technologies — we would be in a very different situation today. But instead we subsidized fossil fuels! What a monumentally stupid failure of government! And of course it had the predictable disastrous effect. That was the result of money being allowed to influence politics, which is in itself a political problem — a huge one.

Government sets the rules of the game that corporations play. If the rules say that the way to win is to make gas-guzzling vans for consumers unconcerned about artificially low gas prices, then that is precisely what they will do. Whenever corporations are doing the wrong thing, you should ask yourself what the government did, or failed to do, to incentivize the right thing. What were the rules of the game?

In fact, by setting the game up wrong, we might as well say that government forces corporations to do the wrong thing. Even if corporate executives want to do the right thing, doing so would put them at a disadvantage relative to their competitors, perhaps even putting them out of business. Corporations have little choice but to play the hand they are dealt. Or perhaps to bribe politicians and regulators, but in a sense that too is part of the hand corporations are dealt — if the opportunity is there and the rewards outweigh the risks, then any corporation not cheating is at a disadvantage. The rules corporations are given should strongly discourage corporate money from influencing politics, but they do not. And of course monopolies are bad news, but the existence of monopolies is itself a failure of government.

Government is responsible for creating the conditions in which the free market yields good outcomes for society.

Yes, there is the occasional Enron that is just pulling some scam. But the vast majority of corporations are like lasers in that they are not inherently “evil,” but if you don’t set them up correctly they are probably going to ruin things. They play the hand they are dealt by government. But WE GOVERN POORLY in the US, and as a result corporations are too often given the wrong incentives, so — predictably — they do the wrong things.

Update: Here’s Milton Friedman’s article “Why Government is the Problem.”