Rob's Rule (With a Little Help from Adam Smith)

Robert C. Smith, managing partner of Chartwell Capital Advisors, introduces us to Rob's Rule in a recent post. In his essay in RealClearMarkets he rails against "so-called experts" who think they can "ignore market signals for they think they are smarter than markets."  He claims that these experts "think they can manage the economy, but they can’t." 

He recalls examples like "the Clinton Administration’s 1995 misuse of the Community Reinvestment Act . . . Here the government forced the private sector to allocate capital to where the government thought capital should be allocated as opposed to what the owners of such capital wanted. Banks were forced to make bad loans because “experts” thought it was a good idea."  Those investments in "bad loans" led many to conclude that lending policies imposed by the CRA resulted in the sub-prime mortgage crisis.  (Summary of arguments in favor and against this conclusion here).

He takes aim at the economics of crime, claiming that the refusal of some prosecutors to prosecute property crimes below $1,000 has resulted in a wave of sub-$1,000 property crimes. 

He also applies "Rob's Rule" to healthcare.  He argues that when a third party pays the cost of healthcare and the purchaser (the patient) has no ability to know the price of a service at the point of purchase, that prices will naturally rise.

Rob's Rule, then, seems to be that individuals will benefit and overall value will increase when individuals make pricing and capital allocation decisions, rather than "so-called experts" empowered by government fiat.  If Rob's Rule sounds familiar to you, you're right, because nearly every aspect of Rob's Rule comes from the thinking of Rob's namesake, Adam Smith. 

Adam Smith on Markets

Adam Smith (1723-1790), of course, was a Scottish economist and lecturer at the University of Edinburgh where he famously published several books on the philosophy of economics.  A primary thrust of his writing was that the policy of mercantilism, where the state mandated capital investments into industries that the state believed would be beneficial, resulted in less welfare than if private investors had been left to make their own decisions.

To this end, Smith wrote:

It is not from the benevolence of the butcher, the brewer, or the baker, that we expect our dinner, but from their regard to their own interest. We address ourselves, not to their humanity but to their self-love, and never talk to them of our necessities but of their advantages.  The Wealth Of Nations, Book IV, Chapter II, p. 456, para. 9.

And also:

It is the highest impertinence and presumption… in kings and ministers, to pretend to watch over the economy of private people, and to restrain their expense... They are themselves always, and without any exception, the greatest spendthrifts in the society. Let them look well after their own expense, and they may safely trust private people with theirs. If their own extravagance does not ruin the state, that of their subjects never will.  The Wealth Of Nations, Book II, Chapter III, p.346, para. 36.

Policy-makers who think like Adam Smith would not compel lenders to invest in sub-prime mortgages.  By acting in their own self-interest, lenders will make capital allocations based on their own percentage of risk and gain.

Policy-makers who think like Adam Smith would not direct prosecutors to adopt an arbitrary policy of declining to prosecute crimes below a specified threshold.  Doing so merely advertises to would-be criminals that they will pay no price for crimes below that threshold (thereby increasing precisely that kind of wrongdoing). 

Adam Smith also would not have divorced a decision to purchase healthcare service from the duty to pay for that service.  Divorcing purchasing power from purchasing responsibility makes the decision to purchase "free," thereby ensuring that decision will be made many more times than would be the case if the decision were not free. 

Rob's Rule reminds us of a conclusion from another famous book, that "What has been will be again, what has been done will be done again; there is nothing new under the sun."