Corruption—Is It Worse in Free or Government-Regulated Markets? [Good Life series]

Bad things happen in free markets. Some people lie, cut corners, commit fraud, and write bad checks. Others renege on contracts, offer or accept bribes, give kickbacks, embezzle, and more.

Often this translates into an argument for government regulation. Free markets maximize liberty, the argument runs, so they give much more scope to immoral individuals, so government regulation is needed to rein in the immorality.

Countering that is a claim that free markets can do a good job of policing themselves. Firms and individuals are concerned with their reputations, so successful ones especially will guard themselves against scandal. Savvy customers can look after their interests, do their homework before buying, and spread the word about mistreatment. And litigation is always a fallback for the serious cases of bad behavior.

But then a scandal occurs in the business world — Enron’s accounting fraud or Bernie Madoff’s Ponzi scheme, for example — and the other side of the debate is re-energized. See! We finally caught some of the bastards! That sort of behavior is business as usual, it feels, and the free market obviously cannot police itself, and more government regulation is clearly needed.

Not so fast, the other side responds, because government regulation introduces whole new cans of worms with many new opportunities for corruption. Not to be cynical, but haven’t government officers — politicians, bureaucrats, and regulators — also been known to demand bribes, dispense favors, accept kickbacks, and lust for power? Give the political-types power over multi-billion-dollar chunks of the economy and you will get a lot more new corruption.

Political regulation also attracts the type of businessmen who are skilled at gaming the system and who prefer using lobbying and the tools of politics to get rich instead of having to earn it in the free market.

Enron, for example, was a classic cronyist company within one of the most regulated business sectors—energy. Citibank, which has been bailed out several times in the last half-century, is another “connected” company in another of the most government-regulated sectors—banking.

So here’s our problem: both free-market and government-regulated economies will have corruption. How do we tell which will have more and which will have less? And how can we avoid the tiresome He-said-she-said style of argument with both sides robotically asserting their ideological prior commitments?

Fortunately, modern social science is coming to the rescue. Much better data is now available, and faster computers and more sophisticated statistics give us better tools for mining it.

One way to tell is by looking at data comparing countries around the world. Some nations are more clean and others are more corrupt. And some nations are more free and others are more regulated.

On cleanliness and corruption: Transparency International does good work measuring corruption. Every year it publishes an index ranking 180 or so countries from most clean to most corrupt. Nations such as Denmark, New Zealand, and Canada, typically rank as relatively clean. Other nations such as Zimbabwe, Venezuela, and Uzbekistan are notoriously corrupt. And nations such as Argentina, Thailand, and Ethiopia are currently in the middle of the pack.

On freedom and regulation: DoingBusiness.org is an index published by the World Bank Group. It ranks 189 economies from most-to-least free along many business dimensions: How easy is it to get a license? Establish title to one’s property? Get protection for contractual agreements? Hong Kong, Switzerland, and the United States typically rank high for the ease of doing business. Meanwhile, the most controlled and difficult-to-do-business economies include those of Bolivia, Haiti, and Angola. And in the middle of the pack are nations such as Russia, Morocco, and Costa Rica. (Another useful index is the Economic Freedom Index.)

So we can perform a test: Array nations along a spectrum from Most Clean to Most Corrupt. Then array nations along a spectrum from Most Free to Most Government-Regulated. Now compare the two lists: Are the most-free nations also the most clean? Or are they more corrupt? Do the more controlled-and-regulated nations have less business corruption? Or are they the most dirty?

Check for yourself and don’t take my word for it—but the data show a very strong correlation: The most business-friendly economies are the least corrupt, and the most hostile-to-business economies are the most corrupt.

That’s only one test, and of course many international cultural factors contribute in complicated ways to moral health or corruption.

So what if we confined ourselves to investigating one nation? Increasingly good data are available about the United States. One crude measure of regulation in the USA has been to count the number of pages in the Federal Register, the government’s constantly-updated publication of its laws and regulations. Some of those regulations are new and some are modifications, and some of the regulations are minor tweaks and some involve major overhauls. But the bulk of the Federal Register does tell us something about regulatory trends.

An excellent step forward is the Mercatus Center’s excellent Regdata site, which takes up the sticky problem of measuring degrees of regulation across different business sectors. The insight here is that, say, Finance and Entertainment are both huge economic sectors, but banking in New York is more tightly regulated than movie-making in Hollywood. Or to take another pairing: Energy production, with a major center in Houston, is much more controlled than Computer production, with major centers in Silicon Valley and Redmond.

So what if we try to count the quantity and the strictness of regulations within each business sector? Then we can more accurately assess and compare different sectors: Agriculture, Transportation, Communications, Sports, Finance, Wholesale, Retail, Energy, Entertainment, Education, Mining, Manufacturing, Utilities, and so on. (And Regdata lets you make your own cool charts.)

Next take up the Corruption side of the comparison: In what sectors have the most notorious corruptions of our generation occurred? Enron, WorldCom, Arthur Andersen*, Solyndra, Bernie Madoff, Countrywide, Bear Stearns, and so on. Make your own favorite list of scandals.

Now for the payoff question: Is it a coincidence that the worst corruptions seem to be in the most regulated sectors — banking, energy, housing, and transportation?

By contrast, consider some other huge corporations: Apple, Intel, Warner Brothers, and the National Football League. They operate in much more lightly-regulated business sectors — computers, entertainment, and sports — and they have many fewer and more mundane scandals.

Solving the problem of corruption is a pressing problem, even in the relatively clean countries. It drains resources from the productive and diverts them to the unproductive. Perhaps more dangerous is the demoralization that corruption causes, as more people conclude that creating wealth honestly is a fool’s game and that they might as well grab what they can before the unscrupulous get there first.

So, yes, in a free market there will always be some corruption. But we should be open to the hypothesis, increasingly confirmed by social science, that even more regulation means politicizing the business world even more, and that the kinds of corruption that politics enables are far more destructive.

[* Arthur Anderson was found guilty in 2002 of obstruction of justice in the wake of the Enron scandal, though the US Supreme Court overturned the decision in 2005 on the grounds that the jury had not be instructed properly.]

[This article was originally published in English at EveryJoe.com and in Portuguese at Libertarianismo.org.]