For this entry in our series, I am simply going to quote Ron Paul (all emphasis is mine):

Since the bailout bill passed, I have been frequently disturbed to hear “experts” wrongly blaming the free market for our recent economic problems and calling for more regulation.  In fact, further regulation can only make things worse.

It is important to understand that regulators are not omniscient.  It is not feasible for them to anticipate every possible thing that could go wrong with whatever industry or activity they are regulating.  They are making their best guesses when formulating rules.  It is often difficult for those being regulated to understand the many complex rules they are expected to follow.  Very wealthy corporations hire attorneys who may discover a myriad of loopholes to exploit and render the spirit of the regulations null and void.  For this reason, heavy regulation favors big business against those small businesses who cannot afford high-priced attorneys.

The other problem is the trust that people blindly put in regulations, and the moral hazard this creates.  Too many people trust government regulators so completely that they abdicate their own common sense to these government bureaucrats.  They trust that if something violates no law, it must be safe.  How many scams have “It’s perfectly legal” as a hypnotic selling point, luring in the gullible?  Many people did not understand the financial house of cards that are derivatives, but since they were legal and promised a great return, people invested.   It is much the same in any area rife with government involvement.  Many feel that just because their children are getting good grades at a government school, they are getting a good education.  After all, they are passing the government-mandated litmus test.  But, this does not guarantee educational excellence.  Neither is it always the case that a child who does NOT achieve good marks in school is going to be unsuccessful in life.  Is your drinking water safe, just because the government says it is?  Is the internet going to magically become safer for your children if the government approves regulations on it?  I would caution any parent against believing this would be the case.  Nothing should take the place of your own common sense and due diligence.

These principles explain why the free market works so much better than a centrally planned economy.  With central planning, everything shifts from one’s own judgment about safety, wisdom and relative benefits of a behavior, to the discretion of government bureaucrats.  The question then becomes “what can I get away with,” and there will always be advantages for those who can afford lawyers to find the loopholes.  The result then is that bad behavior, that would quickly fail under the free market, is propped up, protected and perpetuated, and sometimes good behavior is actually discouraged.

Regulation can actually benefit big business and corporate greed, while simultaneously killing small businesses that are the backbone of our now faltering economy.  This is why I get so upset every time someone claims regulation can resolve the crisis that we are in.  Rather, it will only exacerbate it.

Key points:

1. Regulators are not omniscient.  They do not have the power to see either the large-scale outcomes of their regulations, nor the ways in which someone might find a loophole.  And attorneys get paid more than regulators.
2. Regulation favors big business over small ones (and I would add existing businesses over new ones).  Big businesses have the manpower to work through endless regulations, and can hire the attorneys to find the loopholes.  Thus, you get big businesses who can skirt the law, and small businesses who are no longer able to compete.  The big businesses can look very magnanimous by proposing additional regulation, but that can just be a cover to keep their power.
3. Regulation encourages average people to put their trust in the regulation, assuming that the regulators have controlled for everything they need.  This creates a moral hazard, because it means that consumers no longer exercise proper judgment, assuming that the regulators have done adequate planning.  The judgment shifts from the individual's judgment to the beaurocrats.  I think we've had enough experience with beaurocrats to know that such a move is unwise.
   
4. Regulation, by creating a confining space, shifts the question from "how should I solve this problem" to "what can I get away with".  The market can react quickly to bad behavior, but beaurocracies react slowly to changing conditions.  Therefore, regulation can actually prop up bad behavior, and discourage good behavior.

This doesn't mean that all regulation is bad.  But it does mean that an economy which is governed more by regulation than by free market principles will likely be more morally hazardous than the reverse, and tend to have more systematic injustice than the reverse.

People tend to think that any regulation will make the situation better, but in fact it is really easy for regulation to harm a situation.  It easily leads to morally hazardous situations which favor the big guy over the small guy, even when the subject of regulation is the big guy.