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One of the virtues of free-market capitalism—perhaps the greatest—is how well it aligns incentives with desired outcomes. If you produce a good or provide a service that other people want, they will pay you for it. If demand for that good or service increases, it’s price will climb, which further incentivizes producers and providers.
Sadly, it doesn’t always work that out that way. Free markets can make tremendous errors and bad players can often get away with deceit and fraud for much longer than we’d like. This is why we have regulations: to impose a level of top-down authority in those areas where bottom-up incentives don’t work.
Of course, designing smart regulations is easier said than done. Simple regulations have the enormous benefit of being predictable and easily-comprehended, but are extremely blunt instruments. Complicated regulations can have the virtue of precision, but are much harder to design and can be difficult to follow if you take their intent seriously and easy to avoid if you don’t. Moreover, poorly-designed regulations often overcompensate for their intended/purported purpose, causing far more harm than they could ever hope to prevent.
If you ever needed a good example of the latter phenomenom, look no further than the latest proposal from Senator Elizabeth Warren (I really should save that sentence as a macro; it’d save me so much time). Warren wants to add an extra level of fines on big pharmaceutical companies who settle with the government, specifically mandating that a percentage of their future profits be used to fund research at the National Institutes For Health.
Megan McArdle offers five excellent reasons why this is a terrible idea, but the one below really takes the prize for explaining just how badly this would work out:
If fines should be higher on pharma violations — and maybe they should be — then we already have two very good ways of achieving that: Congress can mandate them, or regulators can impose them. A percentage-of-profits surcharge is not a good alternative. For one thing, you’re going to end up fining companies based on how profitable they are, not how serious a violation was — you could easily have a situation in which an unprofitable company that committed grave violations ends up paying nothing, while a profitable one that’s guilty of less serious offenses contributes a great deal to the NIH coffers. This is neither just nor efficient.
As Juvenal might have said, Who incentivizes the incentivizers?