One reason that people support larger government is because they assume government rules and programs will accomplish their stated goals. However, this rosy view is often not supported by reality. Let’s look at an interesting example that was in the news recently.
A May 19th Wall Street Journal article points out that certain ritzy neighborhoods have more bank branches than normal. For example, one upscale midtown Manhattan neighborhood that boasts Versace and Ferrari stores also boasts one bank branch for every ten residents.
That’s a lot of banks per person! Why do certain expensive neighborhoods, like the Manhattan example and others listed in the article, have so many bank branches per capita?
The reason may not be what you’re thinking. This appears to be an effort by banks to comply with a federal law called the Community Reinvestment Act (CRA).
Community Reinvestment Act
The CRA was enacted in 1977 as an attempt to stop “redlining.” Redlining means that banks are reluctant to lend money in certain poor or minority neighborhoods.
Banks typically wish to comply with the CRA because failure to comply can be costly. It can tarnish a bank’s reputation as well as block banks from expanding or merging with other banks.
At this point, you may be wondering how the number of bank branches in ritzy neighborhoods can possibly be related to the CRA. It turns out that some upscale neighborhoods are classified as low-income neighborhoods for CRA purposes. And branches located in these “low-income” neighborhoods help banks comply with CRA rules.
Wait, why are these upscale neighborhoods considered “low income?” Because regulators rely on older Census Bureau data that can be outdated and unreliable.
Compliance vs Value
To recap, (a) banks are opening branches in wealthy neighborhoods because (b) regulators classify them as low-income neighborhoods, and (c) this helps banks comply with regulations.
This is an example of how people look for ways around rules they think don’t make sense. When people are forced to comply with such rules, they comply to the least extent possible, and they comply with the letter of the law, not the spirit.
Here’s the problem. When people do things purely for compliance, there is no guarantee that those actions make sense for the overall good of society. They might, but they might not. After all, such actions are done for compliance, not because they add value.
This helps explain why Big Government leads to worse economic results than free-market capitalism. Big Government involves lots of compliance with lots of rules, and compliance does not necessarily add value.
In sharp contrast, free-market capitalism is always oriented toward creating value. Free-market transactions naturally lead to economic wins for both buyers and sellers. Voluntary transactions don’t get completed unless both buyer and seller perceive value.
This helps explain why free-market capitalism excels at creating value. Buyers and sellers are always focused on value-creation, always trying to figure out what makes economic sense.
Regulators will likely catch up to the fact that “low-income” neighborhoods like the Manhattan example are not actually low-income, and correct the situation. However, it’s possible that similar problems could then pop up with other neighborhoods.
This reminds me of what I call whack-a-mole government. Like the arcade game where you try to hit a ‘mole’ that pops up through a hole. If you’re too slow, the mole disappears and then pops back up in a different hole. And so on, in a game of action and reaction.
Government often works in a similar way. If government enacts a new regulation that is onerous, or doesn’t make sense economically, consumers or businesses will change their behavior to avoid it. At some point, government may notice that people are avoiding the regulation and revise it to make it harder to avoid. Consumers or businesses may again change their behavior to avoid it. Rinse, wash, repeat.
The Dodd-Frank law gives us an example of whack-a-mole from the banking industry. Dodd-Frank reduced the fees that banks are allowed to charge on debit card transactions. Did banks say, “well, we don’t need that money anyway,” and do nothing about it?
No. They offset the loss of the debit card fees by cutting back on free checking accounts and increasing fees for low balances and overdrafts. Mandated fee reductions in one area popped up as fee increases in a different area.
Of course, government needs to have some rules. We just need to acknowledge three realities about government rules.
First, if the rules don’t make sense, people will try to find a way around them. I’ve mentioned two examples, but there are many. Black markets are a vivid example. The Volkswagen attempt to fake diesel emissions test results is another.
Second, government rules do not automatically accomplish their stated goals. When banks open lots of bank branches in wealthy neighborhoods, it does nothing to help people in poor and minority neighborhoods. When government takes away fee revenue in one area, banks make up for it by raising fees in another. When government sets unrealistic emissions targets, automakers might fake test results.
Third, a profusion of government rules will generate lots of non-value-added activity. Lots of bureaucrats set and revise rules. Lots of consumers and businesses evaluate the rules and devise ways to avoid ones that don’t make sense.
A better way
Here’s a better approach that recognizes these three realities: Make the burden of taxes and regulations limited and light.
This will reduce the incentive for people to avoid taxes and regulations. It will also minimize resources spent on wasteful, non-value-adding activity. The narrower focus for government will better ensure that it can accomplish its stated goals, ideally the most important ones.
Best of all, this will result in more growth and a higher standard of living.
I encourage you to enter comments or questions below. Two rules: 1) be reasonably polite, 2) address the issue and avoid personal attacks.