1 00:00:00,140 --> 00:00:02,910 Of the r word, regulation. 2 00:00:02,910 --> 00:00:05,440 Now, regulation often gets a bad name, and 3 00:00:05,440 --> 00:00:09,290 it especially has a bad name among the kind of people who tend to like Bitcoin. 4 00:00:10,390 --> 00:00:14,680 Regulation is some bureaucrat who doesn't know my business, or 5 00:00:14,680 --> 00:00:17,480 what I'm trying to do, coming in and messing things up. 6 00:00:17,480 --> 00:00:20,450 It's a burden, it's stupid, it's pointless, etc.. 7 00:00:20,450 --> 00:00:24,930 Now, those arguments often are correct, but I want to talk in a little more 8 00:00:24,930 --> 00:00:30,070 detail, in this section, about reasons why regulation might sometimes be justified. 9 00:00:31,180 --> 00:00:34,962 The argument against regulation is pretty common, it's pretty well understood, 10 00:00:34,962 --> 00:00:36,357 I'm not going to repeat it here. 11 00:00:36,357 --> 00:00:40,387 And so, you'll hear me talking mostly about reasons why regulation might be 12 00:00:40,387 --> 00:00:41,600 a good idea. 13 00:00:41,600 --> 00:00:44,150 Because that argument is not as well understood, and 14 00:00:44,150 --> 00:00:47,970 I want to lay it out here a little bit. 15 00:00:47,970 --> 00:00:51,190 Just to be clear, the fact that I'm spending most of this section talking 16 00:00:51,190 --> 00:00:56,720 about why regulation might be good, shouldn't be read as an endorsement of 17 00:00:56,720 --> 00:01:00,980 widespread regulation or as a feeling that regulation is the greatest thing ever. 18 00:01:00,980 --> 00:01:04,540 It's simply that I want to bring a little bit more balance to the discussion, 19 00:01:04,540 --> 00:01:08,850 in a community where regulation is often considered as always bad, 20 00:01:08,850 --> 00:01:11,880 or just stupid by nature. 21 00:01:11,880 --> 00:01:17,090 All right, so, the bottom line argument in favor of regulation is just this, 22 00:01:17,090 --> 00:01:22,890 that when markets fail and produce outcomes that are bad and 23 00:01:22,890 --> 00:01:26,240 often agree to be bad by pretty much everyone in the market. 24 00:01:26,240 --> 00:01:29,380 Then regulation can step in and try to address the failure. 25 00:01:30,540 --> 00:01:33,280 So the argument for regulation when there is an argument, 26 00:01:33,280 --> 00:01:38,380 starts with the idea that markets don't always give you the result that you like. 27 00:01:39,700 --> 00:01:42,398 So let me give you an example of a way in which the market can fail. 28 00:01:42,398 --> 00:01:45,453 And this is a classic example called the lemons market, 29 00:01:45,453 --> 00:01:49,170 which originated in a discussion about used cars. 30 00:01:49,170 --> 00:01:52,370 So, let's talk about a market, in concept. 31 00:01:52,370 --> 00:01:53,410 A market for widgets. 32 00:01:53,410 --> 00:01:55,660 Some kind of good that we want to sell. 33 00:01:55,660 --> 00:01:58,539 And let's say that widgets can be either low-quality widgets or 34 00:01:58,539 --> 00:02:00,570 high-quality widgets. 35 00:02:00,570 --> 00:02:03,930 A high-quality widget costs a little bit more to manufacture 36 00:02:03,930 --> 00:02:09,050 than a low-quality widget, but it's much, much better for the consumer who buys it. 37 00:02:09,050 --> 00:02:12,010 Consumers like high-quality widgets much, much better. 38 00:02:12,010 --> 00:02:16,220 Now an efficient market, a market that's operating well, would therefore deliver 39 00:02:16,220 --> 00:02:21,320 mostly high-quality, or I'll write it HQ, widgets to consumers, why? 40 00:02:21,320 --> 00:02:24,780 Because the price of the high-quality widget will be just a little bit higher, 41 00:02:24,780 --> 00:02:25,800 but the widget will be so 42 00:02:25,800 --> 00:02:28,963 much better that almost everyone will buy the high-quality widgets. 43 00:02:30,150 --> 00:02:34,482 And so this is what you'd hope a market would provide in under certain 44 00:02:34,482 --> 00:02:37,109 assumptions a market will provide that. 45 00:02:37,109 --> 00:02:39,166 Now, let's suppose that customers for 46 00:02:39,166 --> 00:02:43,430 some reason can't tell a high-quality widget apart from a low-quality widget. 47 00:02:43,430 --> 00:02:46,830 What if they really can't tell which widgets are good, and 48 00:02:46,830 --> 00:02:47,840 which widgets are not? 49 00:02:47,840 --> 00:02:50,600 Think of a used car from the classic example. 50 00:02:50,600 --> 00:02:53,010 You're looking at a used car sitting on the lot. 51 00:02:53,010 --> 00:02:54,660 Well, gee, it looks pretty good. 52 00:02:54,660 --> 00:02:57,210 But you can't really tell if it's going to break down tomorrow or 53 00:02:57,210 --> 00:02:59,160 if it's going to run for a long time. 54 00:02:59,160 --> 00:03:01,760 The dealer probably knows if its a lemon but 55 00:03:01,760 --> 00:03:03,800 you as the customer can't tell the difference. 56 00:03:03,800 --> 00:03:06,370 So you can't tell high-quality from low-quality. 57 00:03:06,370 --> 00:03:11,218 So if you think about what happens, where incentives drive people in this 58 00:03:11,218 --> 00:03:14,812 kind of lemons market, you can see that as a consumer, 59 00:03:14,812 --> 00:03:18,900 you're not willing to pay for a high-quality widget, why? 60 00:03:18,900 --> 00:03:20,570 Because you can't tell the difference. 61 00:03:20,570 --> 00:03:24,050 And so if the used car dealer says, sure this one is perfect. 62 00:03:24,050 --> 00:03:25,150 It's not a lemon at all. 63 00:03:25,150 --> 00:03:26,390 Go ahead and buy it. 64 00:03:26,390 --> 00:03:28,450 It's only an extra $100 dollars. 65 00:03:28,450 --> 00:03:31,730 Well it might be that you'd happily pay $100 for a higher quality car, 66 00:03:31,730 --> 00:03:34,480 but you don't really know whether that car, 67 00:03:34,480 --> 00:03:36,330 whether that widget really is high-quality. 68 00:03:36,330 --> 00:03:40,966 So if you really can't tell which widgets are high-quality versus low-quality, 69 00:03:40,966 --> 00:03:45,040 then you're not willing to pay extra for the high-quality one. 70 00:03:45,040 --> 00:03:48,832 And if consumers are not willing to pay extra for a high-quality one, 71 00:03:48,832 --> 00:03:53,148 then producers can't make any extra money by selling a high-quality widget. 72 00:03:53,148 --> 00:03:57,731 In fact, they lose money by selling a high-quality widget because they don't get 73 00:03:57,731 --> 00:03:59,060 any price premium. 74 00:03:59,060 --> 00:04:03,450 They'd be better off buying the slightly cheaper low-quality widget and selling it. 75 00:04:03,450 --> 00:04:08,160 And so the result is, if consumers really can't tell which widgets are high-quality 76 00:04:08,160 --> 00:04:12,575 and which are low-quality, the market gets stuck in an equilibrium where only 77 00:04:12,575 --> 00:04:17,960 low-quality widgets are produced, and consumers are generally unhappy with them. 78 00:04:19,260 --> 00:04:20,880 Now this outcome is worse for 79 00:04:20,880 --> 00:04:24,570 everybody than a properly functioning market would be. 80 00:04:24,570 --> 00:04:28,560 It's worse for buyers because they have to make do with low-quality widgets, 81 00:04:28,560 --> 00:04:31,580 when in a more efficient market, they could have bought 82 00:04:31,580 --> 00:04:35,600 a widget that was much much better for only a little bit higher price. 83 00:04:35,600 --> 00:04:37,760 It's also worse for producers. 84 00:04:37,760 --> 00:04:42,090 Because the widgets that are on the market are all lousy, 85 00:04:42,090 --> 00:04:44,050 consumers don't buy very many widgets. 86 00:04:44,050 --> 00:04:46,280 The widget market is relatively small. 87 00:04:46,280 --> 00:04:49,260 And so there's less money to be made selling widgets than there would be 88 00:04:49,260 --> 00:04:50,560 in a healthy market. 89 00:04:50,560 --> 00:04:55,660 And so both consumers and producers are worse off in a world where consumers 90 00:04:55,660 --> 00:04:59,100 can't tell the difference between high-quality and low-quality widgets. 91 00:04:59,100 --> 00:05:00,140 That's a market failure. 92 00:05:00,140 --> 00:05:02,873 It's called an asymmetric information failure and 93 00:05:02,873 --> 00:05:06,422 the result is a market that's sometimes called the lemons market. 94 00:05:06,422 --> 00:05:10,120 Okay, so how can we fix this? 95 00:05:10,120 --> 00:05:13,300 Well, there are some market-based approaches that try to fix 96 00:05:13,300 --> 00:05:14,570 a lemons market. 97 00:05:14,570 --> 00:05:18,060 The first market-based approach relies on the seller's reputation. 98 00:05:18,060 --> 00:05:22,511 The idea is that if a seller tells the truth to consumers about which widgets 99 00:05:22,511 --> 00:05:25,551 are high-quality, and which are low-quality, 100 00:05:25,551 --> 00:05:29,246 then the seller might get a reputation for telling the truth. 101 00:05:29,246 --> 00:05:33,255 And once they have that reputation, then maybe they can sell high-quality widgets 102 00:05:33,255 --> 00:05:36,087 for a higher price, because consumers will believe them. 103 00:05:36,087 --> 00:05:38,399 And therefore, the market can operate more efficiently. 104 00:05:39,460 --> 00:05:41,920 The problem with this is, yes, this sometimes works. 105 00:05:41,920 --> 00:05:43,299 But sometimes it doesn't, 106 00:05:43,299 --> 00:05:46,466 depending on the precise assumptions you make about the market. 107 00:05:46,466 --> 00:05:50,442 But if you think about it, this is not going to work as well as a market where 108 00:05:50,442 --> 00:05:52,830 consumers can really tell the difference. 109 00:05:52,830 --> 00:05:55,570 Because for one thing, it takes a while for 110 00:05:55,570 --> 00:05:58,420 a producer to build up a good reputation. 111 00:05:58,420 --> 00:06:00,130 In order to build up a good reputation, 112 00:06:00,130 --> 00:06:02,780 they have to sell high-quality widgets at low prices for 113 00:06:02,780 --> 00:06:07,630 a while until consumers learn that that seller is telling the truth. 114 00:06:07,630 --> 00:06:10,879 And that makes it harder for an honest seller to get into the market. 115 00:06:12,430 --> 00:06:16,955 The other problem that can occur, is that that seller, even if they've been honest 116 00:06:16,955 --> 00:06:20,522 up to now, if for one reason or another their sales are shrinking or 117 00:06:20,522 --> 00:06:24,664 they think they want to get out of the market, their incentive is to massively 118 00:06:24,664 --> 00:06:27,436 cheat people all at once and then leave the market. 119 00:06:27,436 --> 00:06:30,590 Rather than continue to be honest and then leave the market. 120 00:06:30,590 --> 00:06:34,320 And so in the beginning, of a seller's presence in the market and 121 00:06:34,320 --> 00:06:38,520 at the end of a seller's presence in the market, reputation tends not to work. 122 00:06:38,520 --> 00:06:43,820 This sort of reputation based approach also tends not to work in businesses where 123 00:06:43,820 --> 00:06:47,080 consumers don't do repeat business with the same entity or 124 00:06:47,080 --> 00:06:50,060 where the product category is very new. 125 00:06:50,060 --> 00:06:54,510 And so there hasn't been enough time for sellers to build up a reputation, 126 00:06:54,510 --> 00:06:59,500 like say in a high tech market like say Bitcoin exchanges. 127 00:06:59,500 --> 00:07:01,980 The other market based approach is warranties. 128 00:07:01,980 --> 00:07:06,190 That's the idea that a seller could provide a warranty to a buyer that says, 129 00:07:06,190 --> 00:07:09,450 if this thing turns out to be low-quality, if it doesn't work well for 130 00:07:09,450 --> 00:07:13,520 you, I'll give you a new one, I'll pay you back or something like that. 131 00:07:14,700 --> 00:07:18,020 And that can work up to a point as well but there's also a problem as well. 132 00:07:18,020 --> 00:07:20,673 That this warranty is just another kind of product, 133 00:07:20,673 --> 00:07:24,187 which could also come in high-quality and low-quality versions. 134 00:07:24,187 --> 00:07:27,852 A low-quality warranty is one where the seller doesn't really come through when 135 00:07:27,852 --> 00:07:29,940 you come back with a broken product. 136 00:07:29,940 --> 00:07:32,660 They don't really replace it, they don't really give you your money, 137 00:07:32,660 --> 00:07:34,850 they make you jump through all kinds of hoops. 138 00:07:34,850 --> 00:07:36,440 And so this is not a panacea either. 139 00:07:38,220 --> 00:07:42,717 So, if you have a lemons market which has developed, and if these market based 140 00:07:42,717 --> 00:07:47,220 approaches don't work for the particular market that you're dealing with, 141 00:07:47,220 --> 00:07:49,491 then regulation might be able to help. 142 00:07:49,491 --> 00:07:52,777 And there are three ways in which regulation might be able to address 143 00:07:52,777 --> 00:07:54,410 a lemons market. 144 00:07:54,410 --> 00:07:59,200 First, regulation could require disclosure, they could require say, 145 00:07:59,200 --> 00:08:02,670 that all widgets be labeled as high-quality or low-quality and 146 00:08:02,670 --> 00:08:05,260 then have penalties on the firms for lying. 147 00:08:05,260 --> 00:08:08,530 That gives consumers the information that they were missing. 148 00:08:09,710 --> 00:08:14,062 A second approach to regulation is to have quality standards, is to require 149 00:08:14,062 --> 00:08:18,418 that no widget can be sold unless it meets some standard of quality testing. 150 00:08:18,418 --> 00:08:22,530 And have that standard set so that only high-quality widgets can pass the test. 151 00:08:22,530 --> 00:08:25,440 That way you have a market that's all one kind of widget, but 152 00:08:25,440 --> 00:08:27,510 at least it's high-quality widgets. 153 00:08:27,510 --> 00:08:30,796 Assuming that the regulation works as intended. 154 00:08:30,796 --> 00:08:36,036 Or you could have required warranties, so that all sellers have to issue warranties, 155 00:08:36,036 --> 00:08:39,410 and then enforce the operation of those warranties, so 156 00:08:39,410 --> 00:08:43,099 that sellers are really held to the promises that they make. 157 00:08:44,220 --> 00:08:47,720 So, all of these are forms of regulation, which obviously could fail, 158 00:08:47,720 --> 00:08:51,460 which might not work as a tenant, which might be miswritten, or misapplied. 159 00:08:51,460 --> 00:08:53,520 They might be burdensome on sellers, and so on, 160 00:08:53,520 --> 00:08:57,650 but there's at least the possibility that regulation of this type 161 00:08:57,650 --> 00:09:01,420 might help to address the market failure, due to a lemons market. 162 00:09:01,420 --> 00:09:05,900 So this is one example of how regulation can be an efficient thing to do 163 00:09:05,900 --> 00:09:08,950 if it's done well when there's a certain kind of problem. 164 00:09:08,950 --> 00:09:14,004 Namely, the inability of consumers to tell the difference between a high-quality and 165 00:09:14,004 --> 00:09:15,830 a low-quality product offering. 166 00:09:15,830 --> 00:09:19,510 And so people who talk about Bitcoin exchanges for example, and argue for 167 00:09:19,510 --> 00:09:23,660 regulation of them, sometimes point to them as an example of lemons market. 168 00:09:25,880 --> 00:09:30,750 Another example of a market failure, or a place where the market doesn't operate 169 00:09:30,750 --> 00:09:36,750 the way that you would like it to in order to serve consumers, is price fixing. 170 00:09:36,750 --> 00:09:41,310 Price fixing simply is a case where different people are selling a product in 171 00:09:41,310 --> 00:09:44,950 a market, and they just agree with each other that we're going to raise prices. 172 00:09:44,950 --> 00:09:47,110 Or we're not going to lower prices. 173 00:09:47,110 --> 00:09:50,240 Related to price fixing is an agreement not to compete, 174 00:09:50,240 --> 00:09:53,770 where companies that would otherwise go into competition with each other, 175 00:09:53,770 --> 00:09:55,350 agree not to compete with each other. 176 00:09:55,350 --> 00:09:58,770 For example, if there were two bakeries in town, they might agree that 177 00:09:58,770 --> 00:10:02,320 one of them will only sell muffins and the other will only sell bagels. 178 00:10:02,320 --> 00:10:05,380 And that way, there's less competition between them than there would be, 179 00:10:05,380 --> 00:10:07,359 if they both sold muffins and bagels. 180 00:10:08,490 --> 00:10:12,957 As a result of the reduced competition, presumably prices go up, and 181 00:10:12,957 --> 00:10:16,757 the merchants are able to foil the operation of the market. 182 00:10:16,757 --> 00:10:20,755 Because after all, the reason that the market protects consumers well in its 183 00:10:20,755 --> 00:10:24,280 normal operation, is through the vehicle of competition. 184 00:10:24,280 --> 00:10:29,060 That sellers have to compete in order to offer the best goods at the best price to 185 00:10:29,060 --> 00:10:32,950 consumers, and if they don't compete in that way, then they won't get business. 186 00:10:32,950 --> 00:10:36,770 So an agreement to fix prices or an agreement not to compete circumvents that 187 00:10:36,770 --> 00:10:40,410 competition and prevents competition from operating in the market. 188 00:10:40,410 --> 00:10:42,550 So another way that the market can fail, 189 00:10:42,550 --> 00:10:44,910 is when people take steps that prevent competition. 190 00:10:46,040 --> 00:10:49,280 These kinds of agreements, either an agreement to raise prices or 191 00:10:49,280 --> 00:10:52,570 an agreement not to compete, these are illegal in most jurisdictions. 192 00:10:52,570 --> 00:10:55,710 This is part of anti-trust law or competition law. 193 00:10:55,710 --> 00:11:00,673 In general, antitrust or competition law is aimed to prevent 194 00:11:00,673 --> 00:11:05,539 cases where the markets gets stuck in a situation where there 195 00:11:05,539 --> 00:11:09,653 isn't enough competition to protect consumers. 196 00:11:09,653 --> 00:11:13,582 Or cases where somebody acts in a deliberate way to try to prevent 197 00:11:13,582 --> 00:11:16,090 someone from competing them. 198 00:11:16,090 --> 00:11:20,260 Acting in a way other than, simply offering good products and good prices. 199 00:11:20,260 --> 00:11:22,060 Antitrust law is very complicated. 200 00:11:22,060 --> 00:11:26,174 I've given you sort of a sketch of it but this is another instance where we know 201 00:11:26,174 --> 00:11:30,416 that there are failures that can occur and where the law will step in to prevent, 202 00:11:30,416 --> 00:11:34,369 in the easy cases, things like price fixing or agreement not to compete. 203 00:11:34,369 --> 00:11:38,399 But in more difficult cases, even some attempts to reduce competition in 204 00:11:38,399 --> 00:11:42,480 the market, through say mergers or other kinds of activity. 205 00:11:42,480 --> 00:11:45,532 Another example where regulation might be helpful.