Instead of regulating markets, create regulated marketplaces

Let consumers decide if they want protections and update accordingly

In general, it’s a good thing when people exchange goods and services. The fact that the trade was mutually agreeable means that both parties are now better off. What happens when we prevent people from engaging in trade? Then we’ve denied them the opportunity to have a win-win situation, which makes them worse off.

This is important because some policies effectively prevent people from trading. For example, laws against selling marijuana reduce marijuana sales. The impact of these policies depends on how much exchange they prevent. Very few people would participate in a market for getting zapped by a taser even if it existed, so banning such trade wouldn’t hurt peoples welfare much; but banning people from exchanging food would consign almost everyone to starvation.

I wouldn’t be surprised if someone, somewhere paid to be tased.

Regulations on markets act to reduce exchange since they restrict what kinds of deals can be made. Minimum wage laws prevent people from offering their labor for lower prices, which prevents any arrangements that require cheap labor. These regulations are intended to help, and sometimes the benefits outweigh the cost of blocking trades. Some regulations can even enhance a marketplace. For example, car markets have information asymmetries, so Lemon Laws are used to assure buyers.

But whatever the justification for regulating a marketplace, there’s no reason that it has to apply to everyone. Instead, states can create a regulated marketplace where people play by the rules while everyone else can trade outside of it. People who prefer the protections of the regulations can use the regulated marketplace, while trades that would have been prevented can still proceed.

Applying this to the market for cars, the government could offer a certification for cars that comply with a certain set of regulations¹, and provide protections for consumers similar to lemon laws. But car dealers and consumers can always go outside the system and exchange an uncertified car. The relative popularity of each market depends on how much value the consumer protections add. The regulated market will be popular if consumers want high safety standards and are willing to pay the extra expense for a certified car².

The great thing about this approach is that it gives states feedback on how valuable their regulations are. If nobody decides to use your marketplace, your regulations aren’t really protecting anyone, and you should loosen them.

This is also why regulated marketplaces should be the default. With universal regulation, its hard to tell what impact it’s having, but if a regulated marketplace grows to encompass virtually all trade, you can feel confident that system-wide regulation is a good idea. Its also adaptive, if conditions change, people can switch markets faster than policy can change.

There’s also no need to stop at one regulated market and one unregulated market. Several different levels of consumer protections can be offered, resulting in a sort of polycentric law. States can experiment with different types regulation and see what consumers want; bad regulation wouldn’t be as damaging as it is today since consumers can quickly move to better markets.

Not all forms of regulation can use this system. Laws that create a public good or limit negative externalities need to apply to all citizens. There are also some situations where the presence of an unregulated market can undermine the regulated market. For instance, if banks engage in unregulated transactions while also being part of the formal financial system, they would create a lot of systemic risk.

That being said, I think most regulations should be reconsidered under this approach. If there isn’t a good reason why it should apply to everyone, then we should at least see what happens when unregulated trade is allowed. Worst case, we go back to a state-wide ban.

I hope more states experiment with this approach. It protects consumers without preventing anyone from finding win-win bargains outside the market. Even better, it provides good information about regulations leading to adaptive, rational policy.

1. Of course, regulations on things like vehicle emissions will still have to apply to all cars.

2. Taxes and subsidies can be different for each market, meaning that buisnesses and consumers pay for the regulations they actually use.