What Rube Goldberg could teach us about economics

Rube Goldberg was a San Francisco-born American cartoonist and the genius behind a long-standing series of cartoons illustrating impractical humorous and endlessly-enjoyable contraptions. His name, in fact, became synonymous with "a comically involved, complicated invention, laboriously contrived to perform a simple operation." Some of his inventions can be found at the Rube Goldberg website, as well as elsewhere on the internet.

If someone were to actually build a device modeled on his illustration for automatically snapping a photograph or for automatically wiping one's mouth with a napkin after taking a spoonful of soup, he would put in a lot more effort than he would save with the machine, and what's more would have to constantly monitor the thing in order to replace the popped balloons, frightened dogs, flying birds, spilled cups of molten metal, and other components that would be used up with every iteration!

In spite of the obvious silliness of such machines, many people are under the misconception that the economy (and the business world that drives the economy) resembles some kind of huge Rube Goldberg device, always prone to breaking down unless the government hovers over it to adjust and regulate and repair it at every turn.

In the long-running debate over whether free enterprise and free markets tend to blow up without careful government supervision and restraint, or whether well-intentioned government regulation of free enterprise and free markets tends to lead to unintended consequences and even to economic disasters, many people today have been fooled into believing the first scenario is true.

Put a little differently, the debate is between those who see the economy as an elaborate Rube Goldberg contraption, always in need of tinkering to prevent a huge calamity, and those who see the government as the Rube Goldberg contraption, creating a problem where none really existed and inviting disaster with its well-intentioned, but ill-conceived, solutions.

This very issue is on display this week in the Supreme Court, which is considering a challenge to the accounting oversight board known as the PCAOB, or Public Company Accounting Oversight Board, created by the Sarbanes-Oxley legislation that was signed into law in 2002. Sarbanes-Oxley and the PCAOB built an enormous and unwieldy bureaucratic apparatus where none existed previously, and its supporters argue that without it the entire economic system will no doubt break down. In fact, the problems it creates far outweigh any dubious benefits (just like the humorous devices envisioned by Mr. Goldberg).

In a story discussing the PCAOB that aired yesterday on National Public Radio, the case facing the Supreme Court is framed as another attack on the New Deal legacy of creating unelected government agencies (the "alphabet soup" we blogged about in "Four-letter government words" and about which Milt Friedman once joked: "any three letters chosen at random would probably designate an agency or part of a department that could be profitably abolished").

That NPR segment concludes with a serious-sounding quotation from former SEC Chairman Rod Hills (1975-1977) who declares that the issue may be "a philosophical argument that's kinda fun, but it's too serious." In other words, attacking the constitutionality of these government agencies is dangerous. He states gravely, "What they are really trying to do, after all these years, would do far too much damage to our system," apparently referring to those who would dare to challenge the legitimacy of government bodies such as the PCAOB.

The first response to this argument is to note that it demotes serious constitutional questions to the status of frivolous, esoteric debates for philosophers (akin to the oft-pilloried debate over how many angels can dance on the head of a pin). Such arguments, while "kinda fun," must take a back seat to pragmatism: if we don't do this (never mind if it's constitutional or not), you businessmen will blow yourselves up, and take the rest of us with you!

The second response to this argument is that it is by no means a given that without Sarbanes-Oxley style regulation there would be irreparable "damage to our system." In fact, we would argue that such regulation often leads to disastrous unintended consequences.

Proponents of ever-increasing regulation point to the recent financial panic as proof positive of their position. The authors of the script for the NPR story, for instance, have reporter Nina Totenberg begin her comments the with the line, "sitting here today, as Congress debates what measures are needed to avoid a repeat of the financial institution failures of the last year . . .” -- as if it is obvious to everyone that more legislation from Congress is needed in order to keep the system from blowing up again. Invoking the recent catastrophe is a way of tilting the discussion that follows towards the concluding quotation from Rod Hills.

What is not mentioned, of course, is that it was a misguided attempt to pile up more accounting regulation (and remove flexibility) that helped cause the financial meltdown of 2008 in the first place. New mark-to-market accounting regulations that went into effect at the end of 2007 -- and which were the brainchild of another former SEC Chairman Richard Breeden (1989 - 1993), who argued extensively for such regulation in the early 1990s and whose cause was taken up by later SEC Chairmen -- contributed more to the financial implosion of 2008 than any supposed lack of government regulation.

We are not arguing here that there should be no accounting rules, and that markets should become the "Wild West," where anything goes. We have explained previously, such as in our earlier post entitled "Free enterprise vs. free markets," we acknowledge that markets absolutely require what we called "a series of rules and regulations in order to ensure smooth and orderly operation and the ability of all parties to evaluate and compare different capital investment opportunities, much the same way a game of basketball requires rules to enable the game to take place."

But fraud was already illegal before Sarbanes-Oxley. The idea that more and more regulation will somehow make fraud go away is a fantasy. Penalizing everyone to try to stop a few bad actors has an enormous cost -- and the bad actors typically figure out ways to try to go around the new regulations anyway.

Almost lost in the NPR story is a quotation from frustrated accountant Brad Beckstead, who notes that the onerous and sometimes arbitrary requirements of the Sarbanes-Oxley legislation created a serious obstacle to his clients, who were primarily small, entrepreneurial, start-up companies -- the very agents of the kind of innovation essential to economic health and economic growth!

While some might say this is just the price of safety, as Rod Hills in his quotation above seems to say, it can be argued that government regulation that goes beyond preventing fraud and violence actually can have other unintended consequences that can lead to huge disasters. The mark-to-market rule is one example.

Other well-intentioned government intrusion we have noted as partially culpable in the 2008 disaster include the CRA, the quasi-government entities Fannie Mae and Freddie Mac, and the Federal Reserve in its attempts to steer the economy instead of simply providing a stable currency with which individuals and companies small and large could transact their business.

The view that government must constantly tinker and regulate to prevent the economy from blowing itself up has enjoyed such a long period of acceptance, and is reinforced by so many voices in the media and in the classroom, that many investors are unaware of the arguments we have laid out here for the opposite view.

Implicit in the joke behind every Rube Goldberg cartoon was the clear common-sense understanding that those elaborate contraptions were entirely unnecessary and that left to themselves, people in general have no problem opening doors, wiping their mouth with a napkin, teeing up a golf ball, or sharpening a pencil. When government builds ridiculous contraptions that are totally unnecessary, it shouldn't surprise anyone when they break down. Rube himself in the video clip above acknowledges that "you can't get something for nothing," although the government often seems to try.

The recent financial disaster should actually cause people to reexamine the assumptions that have led to the kind of well-intentioned government regulation that contributed to the crisis.

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