All Commentary
Wednesday, May 1, 2002

Enron and Argentina Are Examples of Market Failure?

Deregulation Is Not the Culprit

In the eyes of New York Times columnist Paul Krugman, nearly everything that goes wrong in the world is caused by the fact that government is not big and powerful enough. In a mid-December 2001 column he blamed both the bankruptcy of Enron and the collapse of the Argentine economy on deregulation. But, as is so often the case with Krugman, the facts point in the opposite direction.

He claims that the Enron bankruptcy was all “about doing away with regulation” of energy prices and of financial trading. Huh? The regulatory budgets of both the Securities and Exchange Commission (SEC) and the Commodity Futures Trading Commission (CFTC) are at all-time highs, and they employ more regulatory bureaucrats than ever. If anything, the Enron debacle proves once again the ineffectiveness of SEC and CFTC regulation. Enron collapsed despite layers and layers of financial regulation.

Krugman’s claim that Enron used its “political clout” to create a “regulatory black hole” in energy markets is equally absurd. There has been very little, if any, deregulation of energy markets: oil, electric power, and natural gas remain among the most heavily regulated industries in the United States, as they have been for over a century. Radical environmentalists in and outside government continue to impose a regulatory blockade on energy development. What Krugman calls “deregulation” is really re-regulation, or a change in the form of regulation. A good example is California’s crazy electric power regulatory regime that blocks energy development while placing price controls on power, thereby guaranteeing periodic shortages and blackouts. He routinely misleads his readers by referring to this Byzantine regulatory morass as “deregulation.”

Like other anti–free-market commentators, Krugman also spreads the false tale that Enron’s chairman, Ken Lay, was a free-market disciple. This too is, well, baloney. Lay was a member of the group of extreme anti-capitalist ideologues known as the Union of Concerned Scientists. He was also a strong supporter of the Kyoto global-warming treaty. He supported this treaty (which the Bush administration refused to sign on to), because he wanted his company to profit from another Byzantine regulatory scheme concocted by the government: the trading of carbon dioxide emission permits. Lay wanted government-imposed restrictions on carbon dioxide emissions to create an artificial market for air pollution “credits” to be purchased to burn coal. A government-controlled and -supervised “market” is not a genuine market, of course, but more like the failed experiments in “market socialism” that occurred in some of the former communist countries.

Enron collapsed primarily because it made some bad business decisions. It reportedly invested billions in failed power plant, utility, pipeline, and waterworks companies in India, Brazil, and Great Britain. When the profits from these investments failed to materialize, investors got wise and dumped Enron stock. The energy-trading business is competitive and, as with all competitive industries, market leaders can expect their profits to be whittled away by new competitors.

If there was accounting fraud, that’s not a result of “deregulation” but the fact that there are sinners in all walks of life. Governments commit accounting fraud all the time; during the Clinton administration it was reported by Gene Epstein of Barron’s that the Social Security and Federal Highway Trust Funds were being plundered and the money placed into the current-year budget so that Clinton and Congress could take credit for balancing the budget. But don’t expect Krugman ever to call for smaller government whenever such fraud is uncovered.

In this respect Enron’s demise is an example of free-market success. The energy trading market in general is thriving; the fact that one firm that once had 25 percent of that market has left the industry is by no means an example of “market failure.”

Wrong on Argentina Too

Krugman is just as wrongheaded in his comments on Argentina. He blames the entire collapse of the Argentine economy on one thing: that country’s adoption of currency boards, as have been advocated by such free-market economists as Steve Hanke of Johns Hopkins University. Once again Krugman commits the post-hoc-ergo-propter-hoc fallacy (after this, therefore because of this). Yes, a currency board existed in Argentina, and yes, its economy has gone down the tubes. But Krugman never even attempts to prove causation. Anything that smells like a free-market institution must, in Krugman’s mind, be the culprit.

In reality, the fault lies with the International Monetary Fund (IMF) and the U.S. government, which have been subsidizing Argentina’s failed statist economic policies for many decades. The IMF promised to subsidize Argentina’s currency-board regime, which caused a flood of investment in Argentine bonds. The Argentine government was known to be hopelessly spendthrift and corrupt, but with the IMF’s guarantee, international investors began earning above-average returns on Argentine bonds with what they saw as virtually no risk. IMF funding created a massive moral-hazard problem.

The Argentine government used this massive influx of credit to enlarge an already bloated government sector, which always causes the private sector to shrink. Government spending doubled during the decade of the 1990s, far outstripping personal income growth. When a recession hit in the mid-1990s, the government responded in a prototypical Keynesian way by spending even more extravagantly and accumulating more debt. Private investors began shying away from Argentine bonds in 2000, at which time the IMF poured another $48 billion down the government rat hole.

The one good thing the IMF did finally was to refuse to continue to bail out Argentina’s politicians, and that is what caused the bottom to fall out of the Argentine economy.

For decades, Argentina has practiced the kind of economic statism that is championed by the likes of Paul Krugman. Its guiding philosophy has been that its economy should be centrally planned by domestic government elites with the help of the IMF bureaucracy. Its politicians were shielded from taking responsibility for the inevitable failures of these policies by IMF and U.S. government foreign aid. Now that the Argentine bubble of economic statism has burst, the Paul Krugmans of the world are frantically seeking to shift the blame to the free market. Sorry, Professor Krugman, it just ain’t so.

Thomas J. DiLorenzo – Department of Economics, Loyola College, Maryland