Wednesday, March 11, 2009

TO REGULATE OR NOT TO REGULATE : GOVERNMENT IN COMMERCE

AN ESSAY

Yesterday I ran across an interesting passage in the introduction to Germany’s Civil Code (Bürgerliches Gesetzbuch). Unlike England and America, Germany applies civil law, a legal system in which virtually every legal rule finds expression in statutes passed by the legislature. That differs substantially from the Anglo-American tradition, in which many basic legal rules filter down from the supposed wisdom of unelected “common law judges” who make decisions on unique factual issues, which in turn provide binding guidance for similar factual issues in the future. This “judge-made” law dominates private legal ordering, especially in the economic field. The whole notion of “contract” in England and America derives largely from judicial rumination on private transactions. Judges say what “prudent commercial men” should do in particular circumstances, and judges lay down rules that provide legal recourse against naughty bargainers. In theory, these rules are supposed to allow an “equal exchange” between two willing private parties through fair bargaining. But parties to economic exchanges are rarely equal. One party always has something the other does not. This creates a fundamental power disparity that allows the stronger party to force unfair terms on the weaker party. With the industrial revolution and postmodern distribution systems, the disparity in power grew even more. If common law rules provided the only guidance for economic exchanges in this environment, weak parties would not stand a chance. Stronger parties could tyrannize them—legally.

Legislatures in America recognized the dangers inherent in private commercial common law late in the 19th Century. During the so-called “Progressive Age,” they attempted to impose regulations on private dealings between economic actors. They mandated lower work hours, better working conditions, fair prices, mandatory overtime pay, product quality controls and other measures intended to level the playing field between stronger economic actors (industrialists, manufacturers, wholesalers, etc.) and weaker ones (employees, consumers, etc.). Legislatures did this because existing commercial common law actually permitted stronger economic actors to pay workers 5 cents a day under horrific working conditions. In fact, the common law prescribed no standards for pay, working conditions or “fairness;” as long as two parties bargained for something, the law would not question its substance. Of course, this “liberty to contract” existed only in fantasy. Workers take jobs “freely,” but they must work to feed their families and pay their rent. To that extent, workers are not really “free” to choose work terms. They act under economic compulsion: Work or starve. Is that a “free choice?” In the late 19th Century and early 20th Century, employers could dictate any terms they wished. The common law courts called this “freedom to contract.” In practice, it led to blatant unfairness and tyranny. After all, how could a poor worker negotiate with the massive company that paid his wages? If he complained that the contract was “unfair,” a court would merely say: “Well, you bargained for it. So you must adhere to it,” even if the employer reaped all the benefits from the employee’s work.

Fairness does not matter in the commercial common law. The only question is whether two parties voluntarily agree to do or not to do something in return for a promise or performance. If they do, there is no further discussion concerning the fairness of the relationship or the terms it imposes. Nonetheless, legislatures saw that this system led to unfairness. Perhaps they acted from conscience when they began to meddle in commercial affairs. Perhaps their Christian impulses could not countenance weak parties suffering under unfair contracts while strong parties got away with anything they wanted. Whatever their motivation, they took action and laid the foundations for the modern “regulatory State.”

They did not have an easy time, either. In 1905, the United States Supreme Court invalidated New York State’s attempt to limit bakers’ working hours as an “encroachment on the fundamental liberty of master and servant to bargain with one another.” Lochner v. New York, 198 U.S. 45 (1905). In other words, the Court protected employers’ rights to tyrannize their employees because they had a “fundamental liberty” to bargain for contracts as they saw fit. In essence, the Court used constitutional liberty guarantees to advance commercial common law. According to the Court, strong parties in commerce have the “liberty” to bargain any way they damn well please, even if that means forcing workers to labor for 12 hours a day with no overtime. To avoid slavery problems, they must merely say: “If you don’t like it, you can quit.” But can a worker really quit if he has mouths to feed? Therein lies the illusion of freedom in commercial life. Only the strong party has real freedom. The weak party must adhere to the strong party’s terms or he does not get wages or products he needs to survive. This is what happens in unregulated commerce. And the law actually facilitates it.

During the 1930s, the Supreme Court overruled Lochner. See, e.g., Nebbia v. New York, 291 U.S. 502 (1934). By that time, the public could no longer tolerate unchecked commercial power. After all, unregulated business led to the Crash in 1929. That convinced even the moderates that commercial common law could no longer persist; government had to intervene in relationships between private economic actors. With the legal way now clear, Roosevelt’s New Deal ushered in a whole new era of government intervention in commerce. No longer could strong parties force terms on weaker parties. They had to comply with basic norms and standards prescribed by the government. Although this seems “only fair” to us today, it was revolutionary at the time. In commerce, fairness was never the goal—and it still isn’t. Yet legislatures and the People believe that it should be. This fundamental tension stokes the perennial debate between private enterprise (deregulation) and government activists (regulation). Private enterprise wants to do business without interference, while government activists want to stop private enterprise from exploiting its power to tyrannize the weak.

In the decades since the New Deal, private enterprise has adapted its approach. Aided by well-paid lawyers, it complies with regulatory requirements in letter. But in spirit it has slowly reasserted the commercial common law. For example, companies comply with the Food and Drug Administration and Securities & Exchange Commission because if they do not they face fines or prosecutions. When there is an external obligation, they conform. Yet in every case in which regulations do not apply, private enterprise will exploit its power. When private enterprise can tyrannize, it will tyrannize. If private enterprise does not have to provide health insurance to workers, it will not. If a landlord can charge $10,000 per month for a small apartment, he will. In essence, private enterprise follows a simple rule: “I will charge as much as I want because I can.” If someone complains: “Why are you charging me so much? That is unfair,” private enterprise responds: “Because I can.” As long as private enterprise does not violate an external legal obligation, the commercial common law applies. And the commercial common law gives private enterprise a free hand in private dealings.

Unfairness and commerce go hand in hand. In fact, companies “earn the right” to be unfair because unfairness guarantees success. In other words, success entitles the winner to unfairness. Fairness implies that everyone has an equal chance to win in a particular enterprise. Unfairness implies that one party holds superior advantages that reduce or eliminate the other party’s chances to win. If a person has a choice, don’t you think he would prefer to be unfair? After all, you can’t lose if you act unfairly, and who likes losing? This may sound simplistic, but commerce is simple. It is a game, and money is the prize. If an economic actor can maximize his chances to win through unfairness, he will.

Yet unfairness offends our sensibilities. When we fall victim to unfairness, we feel embittered and hurt. When we hear about unfairness that affects others, we feel the same way, even if to a lesser extent. We also feel resentful that strong parties continue winning a “rigged game.” This bitterness and resentment propels us to use the government to curtail unfairness in commerce. When a business practice really rankles us, we employ the regulatory State to crush it. To that extent, the regulatory State provides us a means to correct unfairness in commerce. On the other hand, politicians control the regulatory State. If their constituents benefit from unfair business practices, they will not use the regulatory State to correct those practices. In that sense, commercial unfairness exists as a matter of political grace. If “business hostile” politicians control the government, they will make it harder for private enterprise to tyrannize weak parties. But if “business friendly” politicians control the government, they will refrain from regulation and give private enterprise a free hand. Thus, while government regulation in commerce looks good in theory, it actually does not work without the political will to intervene in private dealings.

So it goes, at least in the United States. But perhaps not in Germany. As mentioned, Germany applies a Civil Code to provide a framework for private economic dealings. Like the United States, Germany is a free market economy. It also has enormous regulatory mechanisms to rein in the unfairness that inheres in private economic dealings. But unlike the United States, Germany has different reasons for regulating private enterprise. While the American government seems to apply regulations only when there is public outcry about particularly atrocious business excesses, Germany appears to regulate on principle. Consider this passage (I translate):

“According to our current understanding, the government’s ordering task cannot limit itself to establishing formal rules of conduct and responsibility in commercial intercourse. Rather, the government must intervene much more, if and to the extent that serious dangers to social justice arise from the exercise of private autonomy. For that reason, the task increasingly falls to the law to protect those who are economically weak…In the field of private law, the main problem for legislation and jurisprudence is—and remains—to fairly deal with and overcome the tense relationship between economic freedom and social justice.” Dr. Helmut Köhler, Einführung in das Bürgerliche Gesetzbuch, München : Deutscher Taschenbuch Verlag (61st Edition 2008).

Here, we see a slightly different approach to “the fairness problem” than we saw in American legislative responses to the issue. As was the case in American law, the Germans appreciate that “private law” (i.e., “commercial common law” in America) is not enough to protect the public. As Dr. Köhler says, “the government cannot limit itself” to prescribing general rules for conduct and responsibility in private commerce. After all, we saw that unregulated commercial common law leads to unfairness, exploitation and—as Dr. Köhler calls them—“serious dangers to social justice.” In the German view, the government has an essential “task” to combat “dangers to social justice.” In the American view, regulation arose to allay public outcry about unfair business practices. It was not concerned—as a matter of principle—with “social justice.” In that sense, the German impulse to regulation has a more principled rationale: It is the government’s “ordering task” to defend social justice as much as it is to provide formal rules for commercial intercourse. The German view also supports the notion that these “serious dangers to social justice” arise from “the exercise of private autonomy.”

This directness is refreshing. In German law, legislators and judges understand that “private autonomy” goes hand in hand with “dangers to social justice.” In the commercial common law, American courts fabricated an artificial reality in which “fairness” flowed from the theoretical “liberty of master and servant” to freely bargain with each other, even though—as a practical matter—the master always had superior power. In the German view, however, the law takes a more realistic approach: It knows that private autonomy grants all power to the superior party. After all, that is what creates “serious dangers to social justice.” In that light, government intervention in commerce is mandatory. In German law, fairness is a governmental concern, because unfairness damages “social justice.” And because the government has a duty to protect “social justice,” it also has a duty to constrain unbridled “private autonomy.”

This interests me because I care about fairness. I think that fairness should be a governmental concern. Yet in American commerce, I am reminded every day that fairness is not the goal. In fact, commercial interests detest fairness. They say it is too difficult and too costly to worry about. They say that courts must never label contracts “unfair” or “unconscionable” because that will merely force them to increase costs on everyone else. That may be true. But that does not excuse the theoretical difficulty in defending unfairness as a business practice. Unfairness pays. And businesses know how to get away with it.

Regulations can only go so far in the United States. Until we make “social justice” an actual “ordering task” for government, we can be sure to get raw deals for as long as we live. It is not enough to wage small wars on especially egregious business practices, such as the Enron fraud or Bernie Madoff's ponzi scheme. These are merely symptoms of a much more entrenched ailment: Institutionalized unfairness in commercial exchange.

Or we can strive to be successful, in which case we win the right to force raw deals on everyone else.

4 comments:

SteveW said...

I strongly disagree with most of this. Private actors overwhelmingly act in a "fair" manner. The cases that make it to the Supreme Court and into Law School Case Books are largely the outliers in terms of level of abuse and do not represent typical transactions in the real world.

Judges are not equipped to determine what fair transactions might be. As an individual who has a family with mouths to feed, give me freedom over imposed fairness any day. I'll take my chances to excel over someone else's imposed mediocrity on my life.

Too much to go deeper, but I think we could plumb the depths of our disagreements here in an interesting discourse going forward.

SteveW said...

I would add one further comment. You attribute a feature to government, again, that you do not believe attainable in the private sector. Why are government actors, which are more powerful than any private actors, not also subject to abuse of that power? I assert that it's ridiculous to propose that strong private actors dominate weak private actors, but that strong government actors do not dominate weak private actors. What is the source of this virtue of government? Why do you not imagine that private actors can have this same virtue, or more precisely, why do you assume they have it in less measure than government actors?

In Lochner, a Baker had to work more hours than he wanted (although one could equally argue that he was trying to get ahead and wanted to work the hours). When governments act badly, they decide who can and cannot get an education, who will have their house torn down for the public road to pass through, who will turn over their pay check to pay benefits to another, and who will stand at the edge of a pit and take a bullet in the back of their skull.

Balthazar Oesterhoudt said...

I knew this one would get you going, Steve!

I put more trust in government for one reason: It has obligations to higher ideals than mere profit, namely, ideals enshrined in the Constitution and the Declaration of Independence. Private actors have obligations only to their own economic enrichment, and that leads to unfairness. To be sure, this is a technical distinction, since many government officials also act unfairly and for themselves. But it is a distinction nonetheless. Private enterprise does not even have a facetious tie to principles such as equality or justice. Its allegiance lies only to maximum commercial enrichment.

I also attribute tyranny to private actors more than the government because individuals have more day-to-day contact with private actors than the government. We can all imagine doomsday scenarios involving secret police, perpetual detention, government-sponsored violence and repression, but the fact is that generally we deal more often with private tyranny--and it is much more subtle than government tyranny. I think that the million commercial indignities heaped upon us each day amount to tyranny, including unfair loan contracts, debt slavery (i.e., get an education, but make yourself an indentured servant paying interest for the next 30 years), high rents, high gas prices and loophole-ridden insurance that enables insurance companies to rake in your money without spending a dime on you. These are unfair private relationships. So while I don't disagree that government can be tyrannical/unfair, too, at least it theoretically has the Constitution as its guide. Private enterprise does not.

This is going to be a fun debate!

SteveW said...

Many of said loopholes (e.g. insurance) are created by governmental policies. There is so much government tyranny that I think it becomes the backdrop and we are blinded to it. Examples - arbitrary speed limits, parking regulations, confiscation of wages from paychecks (the light company wishes they could collect the same way the government does), estimated taxes, licenses for a multiplicity of professions and activities. Most of the above are mandates with criminal sanctions, not merely voluntary transactions where one party has somewhat greater negotiating power.

Secret police and other such nightmares are not to be poo-pooed as worst-case slippery slope arguments, although the non-secret police are maybe a greater threat (and I don't mean local law enforcement necessarily). Governments through war killed more people in the 20th century than any other century in prior human history and most likely more than all other centuries combined. However, governments killed even more of their own citizens during the 20th century than they did in wars. In the USA 7.3 million adults were processed as criminals in 2007, or over 3% of the population that year. 2.3 million were being held in prison at the end of 2006, about 1% overall and almost 2% of men. Over 3% of black men are being held in prison as we speak.

I believe government oppression is more than a libertarian slippery slope argument, and I believe the oppression of government is worse than private actors attempting to overcharge the ignorant, forcing people to fill out extra forms, or even forcing them to defend their contracts in court.

The Declaration of Independence is not legally binding on the government. In my opinion, private and public actors are equally likely to feel inspired by the notions therein. You say private actors are motivated by the profit motive, my response is that government actors are motivated by the power motive.

I know you knew this one would spin me up, but I can't help myself. ;-)