Monday, June 4, 2012

Hayek On The Need For Rules in Government

Friedrich A. Hayek
From the WSJ:  Rules for America's Road to Recovery (by John B. Taylor):  "As Hayek taught us, predictable policies help restore economic prosperity and preserve freedom. America's economic future is increasingly uncertain. A reform strategy built on predictable, rules-based fiscal, monetary and regulatory policies will help. As they undertake changes, reformers should pay close attention to what the great economist and philosopher Friedrich A. Hayek wrote in the last century. Hayek argued that the case for rules-based policy goes beyond economics and should appeal to all those concerned about freedom. He wrote in his 1944 book, "The Road to Serfdom," that "nothing distinguishes more clearly conditions in a free country from those in a country under arbitrary government than the observance in the former of the great principle known as the Rule of Law." Hayek added, "Stripped of all technicalities, this means that government in all its actions is bound by rules fixed and announced beforehand - rules which make it possible to foresee with fair certainty how the authority will use its coercive powers in given circumstances and to plan one's individual affairs on the basis of this knowledge." Rules make the economy work better by providing a predictable policy framework within which consumers and businesses make decisions. But they also protect freedom, a concept Hayek developed in his 1960 book, "The Constitution of Liberty." Hayek traces the relationship of the rule of law to freedom back to Aristotle, and then to Cicero, about whom he wrote, "No other author shows more clearly ... that freedom is dependent upon certain attributes of the law, its generality and certainty, and the restrictions it places on the discretion of authority." Hayek also quotes from the Second Treatise of Civil Government by John Locke, the father of classical liberalism who had a profound influence on America's Founding Fathers: "The end [purpose] of law is not to abolish or restrain, but to preserve and enlarge freedom ... where there is no law, there is no freedom." But skeptics ask how a system of policy rules can work when politicians and government officials want to "do something" to help the economy. A rules-based system with less discretion sounds good in theory, they say, but rules mean you do nothing, and that is impossible in today's charged political climate and 24-hour news cycle. Hayek had an answer to this. In "The Road to Serfdom" he wrote that it was wrong to say that the "characteristic attitude [of a rules-based system] is inaction of the state" and presented a counter example to this common view, saying that "the state controlling weights and measures (preventing fraud) is certainly acting." Consider other examples. Rules for monetary policy do not mean that the central bank does not change the instruments of policy (interest rates or the money supply), or provide loans in the case of a bank run. Rather they mean that they take such actions in a predictable manner. But in the years immediately preceding the 2008 financial crisis, monetary policy deviated from predictable rules-based policy that worked in the 1980s and '90s, i.e. the Federal Reserve held rates too low for too long. Moreover, government regulators did not enforce existing rules on risk-taking at banks and other financial institutions, including Fannie Mae and Freddie Mac. Then came the discretionary stimulus packages and exploding debt, the regulatory unpredictability associated with ObamaCare and Dodd-Frank, which includes hundreds of rules still waiting to be written, and the unprecedented quantitative easing through which the Federal Reserve bought 77% of new federal debt in 2011. The U.S. tax code has become particularly unpredictable. The number of provisions expiring has skyrocketed to 133 in 2010-12 from 11 in 2000-02. And now the epitome of unpredictable policy is upon us in the form of a self-inflicted "fiscal cliff" where virtually the entire tax code will be up for grabs by the end of this year. It is deviation from a rule or a strategy that creates uncertainty and hinders prosperity. Thus, regulators who decide not to act when financial institutions take on risk beyond the limits of the rules and regulations are not being faithful to the law and indeed to the rule of law. What can citizens do to achieve a more rules-based system? Here Hayek issued a warning. In a chapter in "The Road to Serfdom" called "Why the Worst Get on Top," he argued that there is a bias against individuals in government who firmly believe in rules-based policy. People who have the ambition to get to the top frequently have a bias toward interventionism. Some will claim, of course, that crises force policy makers to deviate from predictable rules. One can argue that bailouts and other discretionary interventions were needed during the panic of the fall of 2008, and perhaps they prevented a more serious panic. But that is like saying that the person who set fire to your house should be exonerated because he helped put out the fire and saved a few rooms."