DRI-192 for week of 5-24-15: Why Incremental Reform of Government Is a Waste of Time

An Access Advertising EconBrief:

Why Incremental Reform of Government Is a Waste of Time

Any adult America who follows politics has seen it, heard it and read it ad infinitum. A person of prominence proposes to reform government. The reform is supposed to “make government work better.” Nothing earthshaking, understand, just something to improve the dreadful state that confronts us. And if there’s one thing that everybody agrees on, it’s that government is a mess.

Newspapers turn them out by the gross – it’s one of the few things that newspapers still publish in bulk. They can be found virtually every day in opinion sections. Let’s look at a brand-spanking new one, bright and shiny, just off the op-ed assembly line. It appeared in The Wall Street Journal (5/27/2015).The two authors are a former governor of Michigan (John Engler) and a current President of the North America Building Trades Unions (Sean McGarvey). The title – “It’s Amazing Anything Ever Gets Built” – aptly expresses the current level of exasperation with day-to-day government.

The authors think that infrastructure in America – “airports, factories, power plants and factories” are cited specifically – is absurdly difficult to build, improve and replace. The difficulty, they feel, is mostly in acquiring government permission to proceed. “The permitting process for infrastructure projects… is burdensome, slow and inconsistent.” Why? “Gaining approval to build a new bridge or factory typically involves review by multiple federal agencies – such as the Environmental Protection Agency, the U.S. Forest Service, the Interior Department, the U.S. Army Corps of Engineers and the Bureau of Land Management – with overlapping jurisdictions and no real deadlines. Often, no single federal entity is responsible for managing the process. Even after a project is granted permits, lawsuits can hold things up for years – or, worse, halt a half-completed construction project.”

Gracious. These are men with impressive-sounding titles and prestigious resumes. They traffic in the measured prose of editorialists rather than the adjective-strewn rhetoric of alarmists. And their language seems all the more reasonable for its careful wording and conclusions. Naturally, having taken good care to gain the reader’s attention, they now hold it with an example: “The $3 billion Transwest Express [is] a multi-state power line that would bring upward of 3,000 megawatts of wind-generated electricity from Wyoming to about 1.8 million homes and businesses from Las Vegas to San Diego. The project delivers on two of President Obama’s priorities, renewable power and job creation, so the administration in October 2011 named [it] one of seven transmission projects to ‘quickly advance’ through federal permitting.”

You guessed it; the TransWest Express “has languished under federal review since 2007.” That’s eight (count ’em) years for a project that the Obama administration favors; we can all imagine how less well-regarded projects are doing, can’t we? In fact, we don’t have to use our imaginations, since we have the example of the Keystone XL Pipeline before us.

Last month, the Bureau of Land Management pronounced the ink dry on an environmental-impact statement well done. That left only the EPA, the Federal Highway Administration, the Corps of Engineers, the Forest Service, the National Park Service, the Bureau of Reclamation, the U.S. Fish and Wildlife Service (!) and the Bureau of Indian Affairs (!!) to be heard from. At the rate these agencies are careening through the approval process, the TransWest Express should come online about the time that the world supply of fossil fuels is entirely extinguished – a case of exquisitely timed federal permitting.

According to Messrs. Engler and McGarvey, the worst thing about this egregious case study in federal-government overreach is that it leaves “thousands of skilled craft construction workers [to] sit on their hands.” Apparently, the Obama administration was in general agreement with this line of thought, because “President Obama’s Jobs Council examined how other countries expedite the approval of large projects” and its gaze fell upon Australia.

“Australia used to be plagued with overlapping layers of regulatory jurisdiction that resemble the current regulatory structure in the U.S.” before it installed the type of reform that the two authors are laying before us. The Australian province of New South Wales “now prioritizes permit applications based on their potential economic impact, and agreements among various reviewing agencies ensure that projects are subject to a single set of requirements.” As a result of this sunburst of reformist illumination, “permitting times have shrunk… from a once-typical 249 days to 134 days.”

Mind you, that was the President’s Jobs Council talking, not the authors. And the President, listening intently, created an “interagency council… dedicated to streamlining the permitting process.” Just to make sure we knew the President wasn’t kidding, “the White House also launched an online dashboard to track the progress of select federal permit applications.”

At this point, readers might envision the two authors reading their op-ed to a live audience consisting of Wall Street Journal readers – who would greet the previous two paragraphs with a few seconds of incredulous silence, followed by gales of hilarious laughter. Doubtless sensing the pregnancy of these passages, the authors follow with some rhetorical throat-clearing: “It has become clear, however, that congressional action is needed to make these improvements permanent and to require meaningful schedules and deadlines for permit review. Fortunately, Sens. Rob Portman (R-Ohio) and Claire McCaskill (D-Mo.) have introduced the Federal Permitting Improvement Act.”

“The bill would require the government to designate a lead agency to manage the review process when permits from multiple agencies are needed. It would establish a new executive office to oversee the speed of permit processing and to maintain the online dashboard that tracks applications.”

“The bill would also impose sensible limits on the subsequent judicial review of permits by reducing the statute of limitations on environmental lawsuits from six years to two years and by requiring courts to weigh potential job losses when considering injunction requests.”

Ah-hah. Let’s summarize this. President Obama, whose world renown for taking unilateral action to achieve his ends was earned by his selective ignoring and rewriting of law, confronted a situation in which two of his administration’s priorities were being thwarted by federal agencies over which he, as the nation’s Chief Executive, wielded administrative power. What action did he take? He turned to a presidential council – a century-old political buckpassing dodge to avoid making a decision. The council proceeded to do a study – another political wheeze that dates back at least to the 19th century and has never failed to waste money while failing to solve the problem at hand. When the study ostensibly uncovered an administrative reform purporting to achieve incremental gains in efficiency, the President (a) “streamlined the process” by telling two of the agencies who were creating the worst problems in the first place to cooperate with each other via an additional layer of bureaucracy (an “interagency council”) and created an “online dashboard” so that we could all watch the ensuing slow-motion failure more closely. All these Presidential actions took place in 2011. It is now mid-2015.

And what do our two intrepid authors propose to deal with this metastatic bureaucratic cancer? Congress will point its collective finger at one of the agencies causing the original problem and give it more power by making it “manager” of the review process. (This action implies that the root cause of the problem is that somebody in government doesn’t have enough power.) Of course, the premise that “permits from multiple agencies are needed” is taken completely for granted. Next, Congress would establish still another layer of bureaucracy (the “executive office”) to “oversee” the very problem that is supposedly being solved (e.g., “speed of permit processing”). (This implies that we have uncovered two more root causes of the problem – not enough layers of bureaucracy and not enough oversight exercised by bureaucrats.) A classic means of satisfying everybody in government is by getting every branch of government into the act. Accordingly, Congress points its collective finger at “the courts” and tells them to “weigh” job losses when considering requests for injunctions against projects. (The fact that this conflicts with the original “potential economic impact” mandate doesn’t seem to have concerned Congress or, for that matter, Messrs. Engler and McGarvey.) Finally, Congress throws a last glance at this unfolding Titanic scenario and, collective chins resting on fists, rearranges one last deck chair with a four-year reduction in the statute of limitations on environmental lawsuits.

The most amazing thing is not that anything ever gets built, but that these two authors could restrain their own laughter long enough to submit this op-ed for publication. The above summary reads more like a parody submitted for consideration by Saturday Night Live or Penn and Teller.

Two questions zoom, rocket-like, to the reader’s lips upon reading this op-ed and the above summary. What good, if any, could possibly result from this kind of proposal? Why do these proposals pop up with monotonous regularity in public print? The answers to those questions give rise in turn to a third question: What are the elements of a truly effective program for government reform and why has it not emerged?

Why Doesn’t Incremental Reform Work? 

The reform proposed by Messrs. Engler and McGarvey is best characterized as “incremental” because it does not change the structure of government in any fundamental way; it merely tinkers with its operational details. It aims merely to change one small part of the vast federal regulatory apparatus (permitting) by improving one element (its speed of operation) to a noticeable but modest degree (reduce average [?] time needed to secure a permit from 269 days to 134 days). And the rhetoric employed by the authors stresses this point – aside from the attention-grabbing headline, they are at pains to emphasize their modest goal as a major selling point of their proposal. They’re not trying to change the world here. “Americans of all stripes know that something is seriously wrong when other advanced countries can build infrastructure faster and more efficiently than the U.S., the country that built the Hoover Dam.” They use words like “bipartisan proposal” and “strengthen the administration’s efforts” rather than heaping ridicule on the blatant hypocrisy and stark contradiction of the Obama administration’s actions. They want to get a bill passed. But do they want actual reform?

Superficially, it seems odd that two authors would propose reform while opposing reform. Yet close inspection confirms that hypothesis not only for this op-ed, but in general. The authors deploy the standard op-ed bureaucratic argle-bargle that we have absorbed by osmosis from thousands of other op-eds – “infrastructure,” “permitting,” “priorities,” “job creation,” “streamline [government] process,” “expedite approval,” “implemented reforms,” “economic impact,” “manage the review process,” “lead agency,” “executive office.” The trouble is that if all this really worked, we wouldn’t be where we are today. The TransWest Express review wouldn’t have begun in 2007 and still be in limbo today. The Obama Administration wouldn’t have started remedial measures in 2011 and still be waiting on them to take effect in 2015. The U.S. wouldn’t be staggering under a cumulative debt load exceeding its GDP. The federal government wouldn’t have unfunded liabilities exceeding $24 trillion. The Western world wouldn’t be supporting a welfare state that is teetering on the brink of collapse.

Who are John Engler and Sean McGarvey? John Engler was formerly the Governor of Michigan. At one time, he was considered the bright hope of the Republican Party. He began by trying to reform state government in Michigan. He failed. Instead, he was co-opted by big government. Detroit went on to declare bankruptcy. John Engler left office and went to work for the Business Roundtable. Business organizations like the Chamber of Commerce exist today for the same reason that other special-interest organizations like La Raza and AARP exist – to secure special government favors for their members and protect them from being skewered by the special favors doled out to other special-interest organizations. Sean McGarvey is President of North America’s Building Trades Unions, a department of the AFL-CIO that performs coordinative, lobbying and “research” (i.e., public-relations) functions. Unions can achieve higher wages for their members only by affecting either the supply of labor or the demand for it. There is precious little they can do to affect the demand for labor, which comes from businesses, not unions. Unions can affect the supply of labor only by reducing it, which they do in various ways. This causes unemployment, which in turn exerts continuous public-relations pressure on unions to support “job creation” measures. But true job creation can come only from the combination of consumer demand and labor productivity, which underlie the economic concept of marginal value productivity of labor.

In the jargon of economics, all these organizations are rent-seekers that seek benefits unobtainable in the marketplace. They represent their members in their capacities as producers or input suppliers, not in their capacities as consumers. In other words, rent-seekers and the op-eds they write structure their pleas for “reform” to raise the prices of goods and inputs supplied by their member/constituents and/or provide jobs to them. Virtually all the op-eds appearing in print are written by rent-seekers striving to shape pseudo-reforms in ways that suit their particular interests.

In the Engler-McGarvey case, there are two possibilities. Possibility number 1: The Federal Permitting Improvement Act actually passes Congress and actually achieves the incremental improvement promised. In this wildly unlikely case, Mr. Engler’s business clients benefit from the modest reduction in permitting times. Since the entire wage and hiring process for infrastructure processes – government or otherwise – is grossly biased in favor of union labor, Mr. McGarvey’s clients benefit as well. Possiblity 2: As the above Summary suggests, the likelihood of actual incremental improvement is infinitesimal even if the legislation were to pass, since it requires efficient behavior by the same government bureaucracy that has caused the problems requiring reform in the first place. So the chances are that the result of the reform proposal will be nil.

As far as you and I are concerned, this represents a colossal waste of time and money. But for Messrs. Engler and McGarvey, this is not so. They are creatures of government. The next-best alternative to positive benefits for their client-constituents is no change in the status quo. For Mr. Engler, the status quo gives the biggest companies big advantages over smaller competitors. For Mr. McGarvey, the status quo gives unions and union labor big advantages that they cannot begin to earn in the competitive marketplace. Unions have been losing market share steadily in the private sector for many years. But they have been gaining influence and membership in the government sector, which is ruled by legislation and lobbyists.

Op-eds and reform proposals like this one allow people like Mr. Engler and Mr. McGarvey to earn their lucrative salaries as lobbyist and union president/lobbyist, respectively, by sponsoring and promoting pseudo-reform policies whose effects on their client-constituents can be characterized as “heads we win, tails we break even.”

But what about the effects on the rest of us?

What Would Real Reform Require – and Why Don’t We Get It?

A fundamental insight of economics – we might even call it THE fundamental insight – is that consumption is the end-in-view behind all economic activity. All of us are consumers. But this very fact works against us in the realm of big government, because this diffuses the monetary stake each one of us has in any one particular issue as a consumer. A tax on an imported good will raise its price, which rates to be a bad thing for millions of Americans. But because that good forms only a small part of the total consumption of each person, the money it costs him or her will be small. The cost will not be enough to motivate him or her to organize politically against the tax. On the other hand, a worker threatened with losing his or her job to the competition posed by the imported good may have a very large sum of money at stake – or may believe that to be true. The same is true for owners of domestic import-competing firms. Consequently, there are many lobbyists for legislation against imports and almost no lobbyists in favor of free, untaxed international trade. Yet economists know that free international trade will create more happiness, more overall goods and services and almost certainly more jobs than will international trade that is limited by taxes and quotas.

This explains why so many op-ed writers are rent-seekers and so few argue in favor of economic efficiency. True reform of government would not focus on the aims of rent-seekers. It would not strive to preserve the artificial advantages currently enjoyed by large companies – neither, for that matter, would it seek to preserve the presence of small companies merely for their own sake. True reform would allow businesses to perform their inherent function; namely, to produce the goods and services that consumers value the most. The only way to effect that reform is to remove the artificial influence of government from markets and confine government to its inherent limited role in preventing fraud and coercion.

Based on this evaluation, we might expect to see economists writing op-eds opposing the views of rent-seekers. Instead, this happens only occasionally. Economists are just as keenly attuned to their self-interest as other people. Most economists are employed by government, either directly as government employees or indirectly as teachers in public universities or fellows in research institutions funded by government. At best, these economists will favor the status quo rather than true reform. Only the tiny remnant of economists who work outside government for free-market oriented research organizations can be relied upon to support true reform.

Incremental Reform Vs. Structural Reform 

Incremental reforms are sponsored by rent-seekers. They are designed either to fail or, if they succeed, to yield rents to special interests instead of real reform. Real reform must be pro-consumer in nature. But the costs of organizing consumers are vast. In order to mobilize a reform of that scale, it must offer benefits that are just as vast or greater in size and scope. That means that true reform must be structural rather than incremental. It cannot merely preserve the status quo; it must overturn it.

In other words, true reform must be revolutionary. This does not imply that it must be violent. The reform that overturned Soviet Communism, perhaps the most powerful totalitarian dictatorship in human history, was almost completely non-violent. Admittedly, it had outside help from the international community in the political and moral form from people like Lech Walesa, Pope John, British Prime Minister Margaret Thatcher and, most of all, President Ronald Reagan.

As the efforts of the Tea Party have recently demonstrated, pro-consumer reform cannot be “organized” in the mechanistic sense. It can only arise spontaneously because that is the least costly way – and therefore the only feasible way – to achieve it.

We are unlikely to read about such a reform in the public prints because most of them are owned or sponsored by people who have vested interests in big government. These interests are usually financial but may sometimes be purely ideological. Big government may be a means of suppressing competition. It may be a means of subsidizing their enterprise. It may be a means of providing a bailout when digital competition becomes too fierce. In any event, we cannot look to the op-ed pages for leadership of real government reform.

DRI-173 for week of 1-25-15: Anti-Price-Gouging Laws: The Cure Is the Disease

An Access Advertising EconBrief:

Anti-Price-Gouging Laws: The Cure Is the Disease

This week, New York City Mayor Bill De Blasio announced an impending snowfall of two to three feet, accompanied by high winds. In anticipation of the upcoming blizzard, he slapped the city with a travel ban, effective at 11 PM on the following day. Only official snow-clearance and law-enforcement vehicles would be allowed on the streets. He seized the opportunity to remind New Yorkers that the travel emergency would trigger enforcement of New York State’s anti-price-gouging law, which forbids raising prices on goods and services beyond pre-emergency levels. Violations would be punished sternly, he assured his audience.

Oops. In the event, the blizzard forecast proved… er, optimistic in the quantitative sense or pessimistic in the qualitative sense. Snowfall fell short of one foot, causing no end of local grumbling by the ingrates who couldn’t simply be satisfied to avert disaster.

To economists, though, the real disaster isn’t the unavoidable inclement weather that strikes every year, nor is it the occasional failure of accurate weather forecasting. It is the self-infliction of wounds by laws passed to constrain a non-existent practice called “price-gouging.” The law purports to cure a non-existent ailment. The cure is far worse than anything the “disease” could inflict.

State Laws to Prevent and Punish “Price Gouging”

Nobody knows the origin of the term “price gouging.” It probably derives from the exercise of monopolies granted by monarchs under the old English common law, which is where we get the term “monopoly.” Since nobody could legally compete with them, they could figuratively gouge their price from the consumer’s hide without interference.

With the advent of big government in the 20th century, it was only a matter of time until this resentment of sellers was written into law. Legislatures needed a pretext for acting against sellers, though. Academia provided it in the 1930s with the “Imperfect Competition” revolution in economic theory. Led by Edward Chamberlain and Joan Robinson, this school pointed out that few, if any, actual markets corresponded to the textbook definition of a “perfect” market. Perfect competition required that no individual seller supply a sufficient quantity of output to materially influence market price through its pricing and output decisions. It also required that consumers view the output of each seller as homogeneous – otherwise, product quality might confer some degree of market (pricing) power on an individual seller. There should also be no barriers to entry into, or exit from, the market.

So all markets were “imperfect” and all sellers possessed “market power.” This homely truth gave the profession the small opening it needed to make a huge leap of logic: Most sellers were monopolists who must be restrained by the benevolent and enlightened force of government regulation from exercising their monopoly power. This conclusion provided a rationale for government intervention at the level of individual markets, or microeconomics. It was analogous to the role played in the 1930s by Keynesian economic theory in justifying government intervention at the macroeconomic level.

In World War II, the federal government’s Office of Price Administration (OPA) levied price controls, or maximum prices, on hundreds of industries. Although the public rationale for these controls was to prevent inflation, they served to accustom both the public and private business to the notion of government control of the price system. In practice, patriotism was at least as important in enforcing the price controls as inflation-control. Business owners who raised prices were open to charges of “war profiteering.” This was unpatriotic; it was “taking advantage of the crisis to make money” when they should have been “doing their part by sharing the sacrifice” borne by everybody else. In peacetime, the rationale of monopoly regulation could be slipped neatly into the vacuum left by inflation-fighting and patriotism.

In the late 1970s, the U.S. struggled in the throes of an “energy crisis.” The upward spike in oil prices initiated by the Organization of Petroleum Exporting Countries (OPEC) had hit Western industrialized nations hard. Threatened with across-the-board cost increases and associated widespread unemployment, their central banks chose the same remedy that is now being employed: rapid money creation. This created accelerating inflation but did not do much to resolve the unemployment problem. The melding of stagnation and unemployment gave rise to a hybrid term of disaffection, stagflation.

It was against this backdrop that home heating fuel prices in New York State rose dramatically in the fall of 1978. The evolving American tradition was to blame the seller for the underlying conditions of supply and demand giving rise to an existing price. That is just what the New York state legislature did when it passed the first state law proscribing price-gouging. It took four years for Hawaii to produce the second such law in 1983. Connecticut and Mississippi followed suit in 1986. Then came the deluge; eleven more states joined the party in the 1990s and sixteen more in the first decade of the new millennium. Today, 38 states have laws forbidding price-gouging in some form. Just what is it that these laws forbid, anyway?

Amazing as it seems, the answer is far from clear. But the common denominator between the laws is the notion that special circumstances or “emergency” justify a significant curtailment of pricing freedom. When we try to determine what the curtailment is, why it is justified and which circumstances qualify as emergencies, we find ourselves shrouded in ambiguity.

In a reasonable world, a judicial review of these statutes would undoubtedly find them void for vagueness. But that is hardly their worst drawback. Even if it were possible to objectively and precisely define an emergency and specify a quantitative curtailment of price tailored to it, we would not want to do anything so perverse and counterproductive even if we could.

The Economics of Emergency Behavior

How do people behave in emergencies? Why do governments and opponents of free markets object to that behavior? What kind of behavior is desirable in those circumstances?

Consider the example posed by the impending blizzard in New York City. In these situations, people routinely rush to acquire advance stocks of common everyday consumption goods. Included in this category are such goods are food (eggs, milk, water, ice, coffee, soft drinks, bacon, meat), fuel (gasoline, propane, heating oil) and household supplies (toilet paper, light bulbs, paper towels, batteries, radios, shovels, ice melt) and suitable clothing (heavy coats, gloves, hats, boots). The vast majority of this behavior is simply a reallocation of purchases in time, or an intertemporal reallocation of demand. There is nothing invidious or harmful about this. Indeed, it obeys the simply principle of preparedness that we all learned as children, whether in the Boy Scouts or in school.

Governments typically act as though this is the result of panic – as if, because everybody can’t immediately purchase everything they want from stocks immediately on hand, it must be a bad thing. But this is ridiculous. There is no reason to treat this increase in demand differently than any other increase in demand for any other reason. After all, those affected certainly have good reasons for wanting the extra stocks, with their government promising them that a blizzard of unprecedented proportions will certainly descend upon them! The only question is: What is the best way of getting the people the extra goods they need, allowing them to push their purchases forward in time to prepare for the emergency?

The Laws of Supply and Demand are the best means ever invented for solving that problem. They act automatically and immediately without the need for government action or intervention. The Law of Supply says that sellers will produce more output for sale at relatively higher prices. The Law of Demand says that buyers will wish to purchase less relatively high prices. When the blizzard announcement is made, people rush to stores and to their computers to make purchases. At the previously existing prices, people would be willing to purchase vastly increased quantities of goods. But they don’t get those vastly increased quantities – at least, not instantaneously. The Law of Supply says that sellers will be willing to supply larger quantities of output, all right – but only at higher prices. Well, at successively higher prices consumers are progressively less enthusiastic about buying more output – they still want more, mind you, just not as much as they would if price were held rock steady. Eventually, price will rise enough to equate the willingness of sellers to produce and sell more and the willingness of buyers to buy more. In this context, “eventually” means a matter of hours or a day or so.

Notice that the oft-expressed fears of government are shown to be groundless. There is no need for government to step in, regulate price or otherwise prevent an economic disaster caused by panic reactions to the weather disaster. Changes in price induce the necessary changes in behavior that do two things – cause sellers to produce and sell more goods and people to want less. The combination of those two things solves the problem.

There is a second kind of behavioral reaction common to some types of disaster emergencies, such as hurricanes and tornadoes. The disaster may cause large amounts of destruction. This may give rise to additional demand for goods for replacement purposes in addition to the intertemporal reallocation demand just analyzed. The replacement demand case is best considered as an addendum to the first case, by assuming that the price system has solved the reallocation demand adequately but now faces the problem of handling the replacement demand for goods that have been destroyed or damaged by the disaster. This will include many of the same goods mentioned above, but also capital goods and consumer durables such as homes, vehicles, buildings and infrastructure. The goods may be demanded in final form or may need to be reconstructed or repaired, in which case the inputs required will be In demand.

Replacement demand differs from reallocation demand in that the latter merely reallocates demand while the former increases it. Replacement demand actually increases the amount of goods demanded locally. There is obviously some scope for increasing the needed goods by drawing on local stocks and by drawing resources away from the production of other goods, as well as by pressing unused local resources into service. But the only way to fully satisfy replacement demand is by importing goods and resources into the local area from outside; that is, from other cities, states, regions and even countries.

Once again, the price system solves this problem. Higher local prices will increase profits locally; the higher local profits will attract resources from other cities, states and regions. The increase in resources will comprise an increase in supply that will reduce the shortfall in replacement goods. As long as a shortfall exists, local demand will keep prices high. Those high prices will keep profits high enough to attract outside resources. If the affected area is large enough and the time frame long enough, international investment may even be attracted to the area. Only when the shortfall in replacement demand is eliminated will prices no longer signal the need for an inflow of goods and resources from outside.

The cases of reallocation and replacement demand do not exhaust all the possibilities created by emergencies and disasters, but they do handle those targeted by state price-gouging laws. We can see that those laws are a clear case of reinventing the wheel. So far, so bad. Now – how does the reinvention work?

Anti-Price-Gouging Laws: Reinventing the Wheel Square 

So the price system solves the problem posed by the need for emergency disaster planning. Is it possible that anti-price-gouging laws might solve it better? Or fairer?

Anti-price-gouging laws are intended to stop price from rising or, more precisely, to stop price from rising beyond a certain point. In the analysis presented above, the price system solved the problem of emergency disaster planning precisely through the medium of an increasing price. Thus, the laws are an economic contradiction in terms. They seek to solve a problem by denying the solution to the problem. So the only way anti-price-gouging laws could improve on the price system would be by substituting another solution for price increases as a means of getting more goods and resources and persuading people to want fewer goods and resources.

They do not substitute any alternative solution. There is no alternative solution. Instead, they assert that an alternative state of affairs – a lower price and fewer goods and resources – ought to be preferred to the one that the price system would bring about. The laws do not explain or justify the superiority of the alternative they exalt. They just assert it.

The laws are justified by rhetoric. The rhetoric claims to be protecting consumers against rapacious sellers who are taking advantage of them by raising prices in an emergency. This contravenes the basic logic of economic exchange, which says that exchange occurs between a willing buyer and a willing seller. So how can either one be “taken advantage of?” The laws assert that it is “unfair” to charge higher prices in an emergency than under non-emergency conditions. This also contravenes established legal precedent, which defines a “fair price” as one agreed upon by a willing buyer and a willing seller. So how can such a price be “unfair?” It also contravenes centuries of human behavior, during which higher prices have been charged for emergency medicine than non-emergency medicine, for emergency hotel rooms than non-emergency hotel rooms and so on.

Since particular anti-price-gouging laws specify exact limits on price increases during emergencies compared to pre-emergency prices, it behooves us to deal with this specific issue. Take the example of a 10% limit on price increases – which, as it happens, is the limit imposed in more than one state. The emphasis placed on this number by proponents is the “fairness” of a 10% gross margin. But this is a non-sequitur. In the first place, there is not and never has been any objective standard of fairness by which 10% (or any other number) could be adjudged fair.

Now go beyond the issue of fairness to consider the internal logic of the process itself. We previously discussed the dynamic reactions of sellers and buyers, in which each group react to the rising price by, respectively, increasing output and reducing desired purchases while continuing to want more than is available. As price goes up by 1%, 2%, 5%, 9%…the law and its proponents approve the outcomes. But suddenly when the price hits 10% – bang! This adjustment process must stop even when some sellers and buyers want it to continue. This is self-contradictory nonsense; law proponents cannot justify this arbitrary limit without explaining why production and sale above the 10% limit is wrong while it is right below the limit.

Proponents argue that complaints by the citizenry justify restriction of high-priced production and sales. But complaints about speech don’t justify arbitrary restrictions on the First Amendment. The law has not traditionally allowed third parties to prohibit economic transactions among consenting transactors except on moral grounds – and anti-price-gouging laws make no valid moral case.

Another way of looking at this same example is to ask: Why do the laws allow any price increases at all? It would seem that proponents are guiltily aware that people want and need more goods and resources and that price increases are necessary for provision of them. As in the age-old joke (“we’ve already established what you are; now we’re just arguing about the price”), anti-price-gouging proponents have implicitly given up and recognized the truth about economic logic, but are determined to argue about the price of those additional goods and how it is determined.

To sum up briefly, anti-price-gouging laws do not solve the problem they purport to address because they do nothing whatever to provide more goods and resources to local areas affected by disaster emergencies. The rhetoric they assert in support of their claims of fairness – which attempt to persuade constituents that they should be happier with lower prices and fewer goods and resources – is illogical and contradicts common practice and long historical experience.

Anti-price-gouging laws not only reinvent the wheel – they reinvent it square.

Black Markets and Other Costs of Shortages

In wartime, which we can view as the ultimate emergency, governments commonly levy comprehensive wage and price controls that prevent prices from rising at all. These are even more draconian than current anti-price-gouging laws. Governments print money to finance the expenditures necessary to conduct the war. When the printed money finds its way into the income stream, it forms the basis for additional demand for goods and services. Citizens attempt to bid up the prices for goods and services. But the price controls do not allow this to happen. The result is chronic shortages.

Economists know this process well. Every microeconomics textbook describes it. Buyers must incur substantial “shoeleather costs” associated with being first in line to get goods and services; failing to do so may frustrate their purchase desires. Those costs are an increase in the effective economic price paid for the good or service. The quality of goods and services is degraded as sellers try to reduce quality as an alternative to raising price. The existence of a shortage allows sellers to pick and choose the buyers who will be satisfied and those who will be disappointed. If sellers have a taste for discrimination, they can exercise it freely. In efficiently functioning competitive markets, on the other hand, this taste is severely constrained by the fact that market-clearing penalized a seller who discriminates against a willing buyers. The output not sold to that buyer may go unsold – either permanently or for a long interval.

Most pertinent to the example of anti-price-gouging laws is the case of black markets. A short-run shortage means that the highest price a consumer would be willing to pay to get one more unit of the good or service is well above the market-clearing price that would prevail if government had never slapped on the controls in the first place. Of course, that extra-high price is not a legal price. But in an emergency, some consumers will be willing to disregard legal niceties to get their hands on the good or service. And sellers will be willing to violate the law to earn the super-high rate of profit that this super-high price will generate. Thus, conditions are perfect for existence of a black (illegal) market.

By passing anti-price-gouging laws, governments deliberately create the ideal environment for black markets. When black markets flourish, politicians put on their sternest face and solemnly promise to punish the evil, greedy malefactors.

Recent Attempts to Rehabilitate Anti-Price-Gouging Laws

Opponents of free markets now control the political process throughout the world. They hold the upper hand in public discourse. Emboldened by their superior status, they have recently sought to rehabilitate the long-moribund intellectual case for anti-price-gouging laws. We can best summarize these attempts by quoting from a prominent source. Harvard University political philosophy Professor Michael Sandel’s book What’s the Right Thing to Do? argues that economists stress economic welfare and freedom at the expense of virtue.

“Emotion is relevant,” claims Sandel – thereby rejecting millennia of philosophical argument in favor of reason and against emotion. Proponents of anti-price-gouging laws reflect “something more visceral than welfare or freedom. People are outraged at ‘vultures’ who prey on the desperation of others and want them punished, not rewarded with windfall profits… Outrage of this kind is anger at injustice… Greed is a vice, a bad way of being, especially when it makes people oblivious to the suffering of others… Price-gouging laws cannot banish greed, but they can at least restrain its most brazen expression, and signal society’s disapproval of it.” Sandel champions the idea of “shared sacrifice for the common good.”

Sandel’s ideas encapsulate the quintessence of 20th-century liberal though – pure undifferentiated emotion, all logic and intellectual distinctions distilled out. If “emotion is relevant,” where do we start and stop in admitting it into the argument? Obviously, we start with the political constituents of liberals and stop when all its political opponents have been demonized. Subjective terms of opprobrium like “vultures,” “greed” and “windfall profits” have no objective correlative in science or logic. The behavior he complains of has specific economic value in achieving the goals of those he pretends to champion; that is, the greed of the vultures turns out to benefit the outraged sufferers and the windfall profits are the necessary by-product of their deliverance.

When goods and resources flow to the disaster area from the outside, people on the outside have fewer goods and services and those within the disaster area have more. This is real shared sacrifice in true economic terms, not the phony symbolic shared sacrifice Sandel pontificates about. This is the price system at work.

Are emergency-room doctors vultures? Do ambulance companies earn windfall profits? Are hotel owners greedy? They participate in everyday, routine market transactions in which prices rise in response to special, emergency circumstances. Why aren’t they accused of being evil and immoral?

Because there’s no political profit in it, that’s why. So much for the “new” arguments for anti-price-gouging laws, same as the old.

If Governments Know the Truth, Why Do They Enact Anti-Price-Gouging Laws?

It is obvious that governments know the economic truth about anti-price-gouging laws – otherwise, they would not allow any price increases at all during emergencies. So why do they insist on enacting laws that can only hurt people without helping them?

The answer is depressingly clear. In the environment of big government and absolute democracy, governments exist to further their own power, not to serve the needs of the public at large. Proponents of anti-price-gouging laws are opponents of free markets. These people constitute a special interest. Government serves this special interest by serving its own interest; e.g., the interests of politicians, bureaucrats and government employees.

Politicians observe the protests of anti-free-market groups. They respond with alacrity by promising to restore “fairness” with anti-price-gouging laws. Of course, this will require new laws. The laws will require a new agency or expansion of an existing agency. This will require hiring more employees and more administrators, as well as a bureaucrat to oversee them. Legislators will oversee the budget of the agency. The agency will exert power over all the businesses in the state at any time designated as an “emergency.” Legislators have the privilege of deciding what constitutes an emergency, giving them additional power over those businesses. Politicians will curry favor with the public by posing as a public savior and benefactor during every emergency, rather than being excoriated for taking a “do nothing” stance.

Government is in the business of producing more government, not benefitting the public. It benefits only that subset of the public directly connected with itself. That general rule applies to anti-price-gouging laws as it does to all other aspects of government not strictly within its true, narrow province.

There is no objective crime or bad outcome called “price gouging.” But the laws enacted to prevent it do have objectively bad outcomes and therefore constitute an evil in themselves.

DRI-248 for week of 10-19-14: The Economic Inoculation Against Terrorism

An Access Advertising EconBrief:

The Economic Inoculation Against Terrorism

Last week’s EconBrief analyzed the military adventures undertaken by Great Britain and the United States over the last two centuries and found uncanny and unsettling similarities. In particular, we detected a growing tendency to intervene militarily to settle disputes coupled with a growing distaste for war per se. Given the lack of close substitutes for complete victory in military conflict, this is a disastrous combination.

Both Great Britain and the United States found increasing need to use military force but were increasingly reluctant to apply maximum force with promptness and dispatch. The British dithered when confronted by Islamic fanaticism in the Sudan and ended up suffering the loss of a national hero, vast prestige and the need to intervene finally anyway. The British then faced one revolt after another in southern Africa, Ireland, India and Palestine. In each case, they reacted in measured ways only to be excoriated when finally forced to take stronger action. Ultimately, they abandoned their empire rather than take the actions necessary to preserve it.

Compare the actions taken by Great Britain in India against the passive resistance led by Gandhi with those that would have been taken by, say, a totalitarian nation like Nazi Germany, Soviet Russia or Communist China. The British were repeatedly forced to back down from using force against Gandhi – not by superior force or numbers wielded by the Mahatma but by their own moral qualms about exerting the force necessary to prevail. By contrast, Gandhi would never have gained any public notice, let alone worldwide acclaim, had he lived and operated under the Third Reich. Hitler’s minions would have murdered him long before he rose to public prominence. In Soviet Russia, Gandhi would have earned a bullet in the back of his head and unmarked burial in a mass grave. In Red China, Gandhi would either have undergone re-education or joined the faceless millions on the funeral pyre in tribute to revolutionary communism.

Lawrence in Arabia: Visionary or Myopic Mystic?

Director David Lean’s magnificent film Lawrence of Arabia acquainted the world with the story of British Col. T.E. Lawrence, an obscure officer who seized the opportunity to unite disparate and warring Arab tribes in guerilla warfare against the Germans in the Ottoman Empire during World War I. Playwright Robert Bolt’s screenplay depicts the Arabs as simple, childlike victims of wily colonial exploiters. Lawrence is a martyr who seeks to restore Arabs to their former historical glory by casting out the foreign devils from Arabia – “Arabia for the Arabs.”

Lawrence is continually frustrated in his campaign to organize the Arabs into an effective and cohesive fighting force. Tribal and religious divisions separate Arabs from each other almost as much as from the Turks.  Why can’t they view themselves as Arabs, he wonders, rather than as members of particular tribes or sects?

When Lawrence succeeds in whipping his guerilla force into fighting shape, he turns them into a virtual column of the British army and becomes instrumental in winning the war in the Middle East. He assumes that, once united in war, the Arabs will remain so in peacetime. They will stand fast against the British and French colonialists and reclaim their heritage. When this hope proves illusory, he retreats home to England in disillusion.

The perspective of economics allows us the insight that Lawrence was doomed to disappointment from the start. In wartime, people of all races, creeds and nationalities are able and willing to put aside personal priorities in favor of the mutual overriding priority of winning the war. At war’s end, however, there is no longer any single overriding priority strong enough to claim universal allegiance. Now each pursues his or her own interest. Of course, this pursuit of individual interest can still produce broadly beneficial results. Indeed, it should do just that – provided the disciplining forces of free markets and competition are given free play. But in post-World War I Arabia, the ideas of Adam Smith and free markets were as alien as Dixieland jazz. Economically, Arabia was primitive and aboriginal. Its tribes were dedicated to warfare and plunder – just as the aboriginal peoples of Australia, New Guinea, North America, South America and Africa were before modern civilization caught up with them. There was a tradition of trade or exchange in aboriginal culture – but no tradition of freedom, free markets and property rights.

The Flame that Ignited the Arab Spring

Of course, Arab society did not stall out completely at the aboriginal stage of primitive, nomadic desert life. Arabs were naturally blessed with copious quantities of petroleum, the vital economic resource of the 20th century. Though mostly unable to develop this resource themselves, they did play host to companies from Western industrialized nations that created infrastructure for that purpose. The resulting cultural interaction paved the way for modernization and a measure of secularization. Thus, from a distance the major cities of the Middle East might be hard to distinguish from those of the West. Up close, though, the differences are stark.

The noted South American economist and political advisor Hernando De Soto led a joint research study into the origins of the Arab Spring of 2011. He recounted his experiences in the recent Wall Street Journal op-ed, “The Capitalist Cure for Terrorism” (Saturday-Sunday, October 11-12, 2014). The seminal event of this movement was the self-immolation of a 26-year-old Tunisian man named Mohamed Bouazizi. Judging from Western coverage of the Middle East, one would expect him to have been unemployed, disaffected and despairing of his plight. As De Soto and his team discovered, the truth was far different.

Bouazizi was not unemployed. He was a street merchant, one of the most common occupational categories in the Arab world. He began trading at age 12, graduating to the responsible position of bookkeeper at the local market by the time he was 19. At the time of his death, he was “selling fruits and vegetables from different carts and sites;” i.e., he was a multi-product, multiple-location entrepreneur. It seems clear that he was not driven to extremity by idleness and despair. So what drove him to public suicide?

Like most of his trade, Bouazizi operated illegally. His dream was to obtain the capital to expand his business into the legal economy. He wanted to buy a pickup truck for delivering his vegetables to retail outlets. He longed to form a legal company as an umbrella under which to operate – stake clear title to assets, establish collateral, get a loan for the truck.

This dream seems modest to America ears. But for Bouazizi it was unattainable. “Government inspectors made Bouazizi’s life miserable, shaking him down for bribes when he couldn’t produce [business] licenses that were (by design) virtually unobtainable. He tired of the abuse. The day he killed himself, inspectors had come to seize his merchandise and his electronic scale for weighing goods. A tussle began. One municipal inspector, a woman, slapped Bouazizi across the face. That humiliation, along with the confiscation of just $225 worth of his wares, is said to have led the young man to take his own life.”

“Tunisia’s system of cronyism, which demanded payoffs for official protection at every turn, had withdrawn its support from Bouazizi and ruined him. He could no longer generate profits or repay the loans he had taken to buy the confiscated merchandise. He was bankrupt, and the truck that he dreamed of purchasing was now also out of reach. He couldn’t sell and relocate because he had no legal title to his business to pass on. So he died in flames – wearing Western-style sneakers, jeans, a T-shirt and a zippered jacket, demanding the right to work in a legal market economy.”

Asked if Bouazizi had left a legacy, his brother replied, “Of course. He believed the poor had a right to buy and sell.”

Mohamed Bouazizi was not alone. In the next two months, at least 63 people in Tunisia, Algeria, Morocco, Yemen, Saudi Arabia and Egypt set themselves afire in imitation of and sympathy with Bouazizi. Some of them survived to tell stories similar to his. Their battle cry was “we are all Mohamed Bouazizi.” It became the rallying cry of the Arab Spring, bringing down no fewer than four political regimes.

The Western news media have been heretofore silent about the true origins of the Arab Spring. It did not originate in “pleas for political or religious rights or for higher wage subsidies.” None of the “dying statements [of the 63] referred to religion or politics.” Instead, the survivors spoke of “economic exclusion,” a la Bouazizi. “Their great objective was ‘ras el mel‘ (Arabic for ‘capital’), and their despair and indignation sprang from the arbitrary expropriation of what little capital they had.”

Das Kapital or Capital?

Nobody speaks with greater force on this subject than Hernando De Soto. He is the Latin American Adam Smith, the South American champion of free markets and property rights. He is now the world’s leading property-rights theorist, having ascended upon the deaths of Ronald Coase and Armen Alchian. And he put his own ideas into successful practice in his home country of Peru by leading the world’s only successful counter-terrorist movement in the 1980s.

The Shining Path was a Marxist band of terrorist revolutionaries who tried to overthrow the Peruvian government in the 1980s. They were led by a onetime university professor named Abimael Guzman. Guzman posed as the champion of Peru’s poor farmers and farm workers. He organized Peru’s Communist Party around the idea of massive farming communes and used the Shining Path as the recruiting arm for these communes. Some 30,000 resistors were murdered. Officials were kidnapped and held for ransom. This strategy gave Shining Path control of the Peruvian countryside by 1990.

De Soto was the government advisor charged with combatting Shining Path. He didn’t forswear the use of military force, but his first move was toward the library and the computer rather than the armory. “What changed the debate, and ultimately the government’s response, was proof that the poor in Peru weren’t unemployed or underemployed laborers or farmers, as the conventional wisdom held at the time. Instead, most of them were small entrepreneurs, operating off the books in Peru’s ‘informal economy.’ They accounted for 62% of Peru’s population and generated 34% of its gross domestic product – and they had accumulated some $70 billion worth of real-estate assets [emphasis added].

This new learning completely confuted the stylized portrayal of poverty depicted by Guzman and his Shining Path ideologues. It enabled De Soto and his colleagues to do something that is apparently beyond the capabilities of Western governments – eliminate three-quarters of the regulations and red tape blocking the path of entrepreneurs and workers, allow ordinary citizens to file complaints and legal actions against government and provide formal recognition of the property rights of those citizens. An estimated 380,000 businesses and 500,000 jobs came out of the shadows of the informal economy and into the sunlight of the legal, taxed economy. One result of this was an extra $8 billion of government revenue, which rewarded government for its recognition of the private sector.

Having put the property rights of the poor on a firm footing, De Soto could now set about eradicating Shining Path, confident that once it won the guerilla war it would not lose the peace that followed. In true free-market fashion, Peru reworked its army into an all-volunteer force that was four times its previous size. They rapidly defeated the guerillas.

In this connection, it is instructive to compare the effect of military intervention in Peru with that undertaken elsewhere. The military interventions undertaken by the U.S. and earlier by Great Britain served to recruit volunteers for terrorist groups by creating the specter of a foreign invader imposing an alien ideology on the poor. In Peru, volunteers flocked to an anti-terrorist cause that was empowering them rather than threatening them, enriching them and their neighbors rather than bombing them.

Peru stands out because the economic medicine was actually given. Other links between poverty, terrorism and lack of property rights can be cited. In the 1950s and 60s, Indonesia was home to Communist and terrorist movements. It was also a land that consistently thwarted its entrepreneurs, many of whom were immigrant Chinese, in ways reminiscent of an Arab state. The southern half of Africa has long been known for stifling entrepreneurship through bureaucratic controls and monopoly, often combined with nepotism and corruption. This began as a colonial inheritance and has passed down to the line of despots that has ruled Africa since the advent of independence.

All We Are Saying Is Give Economics a Chance

The American public is repeatedly sold the proposition that the world is dangerous and becoming more so with each passing day. Alas, the kind of military interventions practiced by the U.S. have not lessened the danger in the past and have, in fact, increased it. The only tried-and-true, time-tested solution to the problems posed by terrorism is economic, not military. We refer retrospectively to World War II as “the good war” because our cause seems so unimpeachably just when juxtaposed alongside the evils of Fascism and the Holocaust. But it is not moral afflatus and good intentions that justify war. It is the postwar economic miracles worked in German and Japan that set an invisible seal on our rosy memories of World War II. By contrast, for example, the defeat of Germany in World War I now seems Pyrrhic because the war and subsequent draconian peace terms produced Germany’s interwar economic upheaval and resulting lurch into Fascism.

The evil of war lies in the rarity of its success, not the oft-cited barbarity of its practice. The U.S. went to war in Korea, Vietnam, Kuwait, Iran and Afghanistan to counter real evils. We enjoyed considerable military success and achieved some of our goals. But we did not achieve victory. Last week’s EconBrief reminds us how overwhelmingly difficult it was even for Great Britain and the U.S. – each far and away the foremost military power of its day – to achieve their ends through war. Only in South Korea was long-term success attained, and there it was due to economic victory rather than military victory.

Careful study of world poverty and terrorism will uncover an economic phenomenon, against which military measures are largely unavailing and police tactics are merely a stopgap.

“They” Can’t Adapt to Free Markets and Institutions

One entrenched obstacle to adopting Hernando De Soto’s game plan against terrorism is the conventional thinking that certain cultures are inherently unable to absorb the principles of economics and free markets. This argument is so vaguely made that it is never clear whether proponents are arguing the genetic or cultural inferiority of the affected peoples. Recently it has been applied to former Soviet Russia when attempts to acclimate the Russian people to free markets failed. The interesting thing about this episode is that it began with the proposition that Western economic consultants could design market institutions and then superimpose them on the Russian people. In other words, elite analysts began by assuming that Russians could easily adapt to whatever economic system was designed by others for their benefit, but then took the polar opposite position that Russians were incapable of adapting to free markets. No provision was made for the possibility that – having lived for centuries under rigid autocracy – Russians might need time to adapt to free institutions.

For centuries, Chinese were considered inferior and suitable only for low-skilled labor. That is the task to which most immigrant Chinese were consigned in 19th-century America. While Chinese in China failed to achieve economic development throughout most of the 20th century, immigrant Chinese were the world’s great ethnic economic development success story. Eventually Taiwan and mainland China joined the ranks of the developed world and another development myth bit the dust.

When the short-term results of the Arab Spring dislocations disappointed many in the West, Arabs became the latest people accorded the dishonor of being deemed unable to accommodate freedom and free markets. Perhaps the most concise response to this line of thought was given indirectly by Arab leaders responding to De Soto’s charge that their countries lacked the legal infrastructure to bring the poor into the formal economy. “You don’t need to tell us this,” one replied. “We’ve always been for entrepreneurs. Your prophet chased the merchants from the temple. Our prophet was a merchant!” In other words, the Arab tradition accommodates trade, even if their legal system is hostile to it.

Once again, this space stresses the distinction between the Rule of Law – which abhors privilege and worships freedom – and mere adherence to statutory law – which often cements tyranny into place.

Bringing Free Markets and Property Rights to the Middle East

As far as Western elites and the Western news media are concerned, the only kind of Middle East economic reform worth mentioning is foreign aid. But over a half-century of government-to-government foreign aid has proven to be an unqualified disaster. Economists like William Easterly and the late Lord Peter Bauer have written copiously on the pretentions of Western development economists and the corruption of Western development agencies. This is the deadest of dead ends.

De Soto’s approach is the only institutional approach worth considering. Apparently, it is actually receiving consideration by the beneficiaries of the Arab Spring. Egypt’s President, Abdel Fattah Al Sisi, commissioned De Soto and his team to study Egypt’s informal economy. That study found that Egypt’s poor get as much income from capital, in the informal economy, as they do from salaries in the formal economy. More precisely, some 24 million salaried citizens earn about $21 billion per year in salaries while owning some $360 billion in unrecognized assets that throw off roughly an equivalent amount of yearly income. As De Soto recognizes, this income is approximately 100 times the total of all Western financial, military and development aid to Egypt. It is also “eight times more than the value of all foreign direct investment in Egypt since Napoleon invaded more than 200 years ago.”

The problem is that much of this value is locked up in bureaucratic limbo. “It can take years to do something as simple as validating a title in real estate.”

 This is the real secret to achieving economic development in the Middle East. It is also the secret to fighting terrorism and preserving American security.

DRI-275 for week of 6-1-14: The Triumph of Economics in Sports: Economics Takes the Field to Build Winning Teams

An Access Advertising EconBrief:

The Triumph of Economics in Sports: Economics Takes the Field to Build Winning Teams

In the previous two EconBriefs, we spoke of a popular attitude towards sports. It looks nostalgically to a hazy past, when men played a boys’ game with joyous abandon. Today, alas, sports are “just a business,” which is “all about the money.” As elsewhere, “greed” – a mysterious force no more explicable than a plague of locusts – has overtaken the men and robbed them of their childlike innocence.

This emotional theory of human behavior owes nothing to reason. It is the view now commonly bruited by those who describe the financial crisis of 2008 and the Great Recession as the outcome of free markets run rampant. People are irrational, so the result of “unfettered capitalism” must naturally be chaotic disaster.

Economics is the rational theory of human choice. For a half-century, it has opposed the irrationalists from two directions. Its free-market adherents have been led by the Chicago School of Frank Knight, Milton Friedman and George Stigler. That school embraced a theory of perfect rationality: perfect knowledge held by all market participants (later modified somewhat by a theory of information only slightly less heroic in its assumptions), perfectly competitive markets and (where necessary) perfectly benevolent government regulators and/or economist advisors.

The neo-Keynesian opponents of Chicago accepted individual rationality but asserted that individually rational actions produced perverse results in the aggregate, leading to involuntary unemployment and stagnant economies. Only counteracting measures by far-seeing government policymakers and regulators – following the advice of economist philosopher-kings – could rescue us from the depredations of free markets.

The debate, then, has largely been defined by people who saw market participants moved either by utter irrationality or complete rationality. But our analysis has revealed instead an evolutionary climate in which participants in professional sports pursued their own ends rationally within the limits imposed by their own knowledge and capabilities. The great free-market economist F.A. Hayek observed that capitalism does not demand that its practitioners be rational. Instead, the practice of capitalism itself makes people more rational than otherwise by continually providing the incentive to learn, adapt and adopt the most efficient means toward any end. Professional sports has exemplified Hayek’s dictum.

Early on, in its first century, the pursuit of individual self-interest left baseball owners, players and fans at loggerheads. The first owner to address himself to the task of improving the product provided to sports fans was Bill Veeck, Jr., who introduced a host of business, financial and marketing innovations that not only enhanced his own personal wealth but also treated his fans as customers whose patronage was vital. The attitude of ownership toward fans prior to Veeck can be gleaned from the dismissal by New York Yankees’ general manager George Weiss of a proposed marketing plan to distribute Yankee caps to young fans. “Do you think I want every youngster in New York City walking around wearing a Yankees’ cap?” snorted Weiss. Veeck made owners and administrators realize that this was exactly what they should want.

Although few people seemed to realize it, economics had yet to play its trump card in the game of professional sports. Economics is the study of giving people what they want the most in the most efficient way. What sports fans want the most is a winning team – and that is exactly what economics had failed to give them. It failed because it had never been deployed toward that end. Even Bill Veeck, despite his success in improving the on-field performance of his teams, had not unlocked the secret to using economic principles per se to win pennants and World Series.

As sometimes happens in human endeavor, baseball had to traverse a Dark Age before this secret was finally revealed.

The Dark Age: Municipal Subsidies and the Growth of Revenue Potential

During Bill Veeck’s swan song as baseball owner in 1975-1981, baseball had entered the period of free agency. The reserve clause tying players to a single team had been drastically modified, allowing players to eventually migrate to teams offering them the best financial terms. As we indicated earlier, this development – viewed in isolation – tilted the division of sports revenue from ownership to players.

This created the pretext by which owners were able to extract subsidies from municipalities throughout the nation. Owners could truthfully claim that they were earning less money as a result of free agency. What they left out was that they were earning more money for a host of other reasons. The obscure nature of player depreciation hid the true financial gains of sports-team ownership from the public. Moreover, the early years of free agency coincided with the advent of massive new revenue sources for owners. Television had brought baseball to millions of people who otherwise saw few games or none; broadcast rights were becoming a valuable asset of team ownership. Radio-broadcast rights increased in value as the increased visibility of teams and players enhanced their popularity. These increases were just gaining speed when the vogue of sports-team subsidies became a national pastime of its own.

The movement of baseball teams had long been viewed as analogous to the movement of businesses. Even the loss of popular teams like the Brooklyn Dodgers and New York Giants to westward expansion of baseball in Los Angeles and San Francisco was grudgingly accepted, since baseball still remained in New York City and the Mets were added as an expansion franchise in 1962. But when the Athletics moved from Kansas City to Oakland in 1967, Missouri Senator Stuart Symington decided that the federal government could not countenance “unfettered capitalism” in the baseball business. He demanded that major-league baseball replace Kansas City’s lost franchise. This opened the floodgates to the intrusion of politics in baseball.

If it was fair for politicians to dictate where major-league baseball should operate, then franchises should be able to demand favors from local governments – or so reasoned baseball owners. And demand them they did.

Owners demanded that teams build new, larger, better-appointed stadiums for their sports teams. Cities should fund construction, own the stadiums, operate them, maintain them and lease them to the sports teams for peanuts – otherwise, owners would pack up and move to a city that would meet their demands.

What was in it for the host city? After all, not everybody is a sports fan. Owners sensed that they needed something to offer the city at large. Thus was born one of the great con games of the 20th century: the notion of sports as economic-development engine of growth. Owners seized on the same thinking that animated the dominant neo-Keynesian economic model. They sponsored “economic-impact studies” of the effect sports teams had on the local economy. In these studies, spending on sports took on a magical, mystical quality, as if jet-propelled by a multiplier ordained to send it rocketing through the local economy. And everybody “knew” that the more spending took place, the better off we all were.

It is hard to say what was worse, the economic logic of these studies or their statistical probity. It was not unusual to find that a study would add (say) the money spent on gasoline purchases at stations adjacent to the stadium to the “benefits” of sports team presence. Of course, this implies that locating the team as far as possible from the fans would increase the “benefits” dramatically; it is a case of cost/benefit analysis in which the costs are counted as benefits. This novel technique inevitably produces a finding of vast benefits.

As time went on, sale of team artifacts and memorabilia was added to the list of supplemental revenue. Larger stadiums, lucrative TV, radio and cable rights, team product sales – all these drove revenues to owners through the roof as the 20th century approached its close. With municipalities subsidizing the ownership, maintenance and improvement of stadiums, it is no wonder that the capital gains available to owners of sports teams were phenomenal. Ewing Kauffman bought the Kansas City Royals’ franchise for $1 million in 1968. At his death in 1993, the team’s value was estimated at well over $100 million.

One might have expected the usual left-wing suspects to recoil in horror from the income redistribution from ordinary taxpayers to rich owners and rich ballplayers – but no. Newspaper editorialists threw up their hands. The economists who supported free agency said that the major-market teams would get the best players, didn’t they? And hadn’t things worked out just that way, before free agency as well as after? If small-market taxpayers want to win – or even have a team at all – they’ll just have to ante up and face the fact that “this is how the game is played in today’s world.” Besides, doesn’t economic research show the economic-development benefits of sports teams?

Heretofore, economics had operated beneficially, albeit in a gradual, piecemeal way. Now the distortion of economics by the owners and their political allies meant that it was serving the ends of injustice.

Economics – and baseball fans – needed a hero. They got one – several, actually – from a pretty unlikely place.

Middle American Ingenuity to the Rescue

Bill James was born in tiny Holton, KS, in 1947. From childhood, he was a devoted sports fan. Like countless others before him, he was fascinated by the quantitative features of baseball and studied them obsessively. He was unique, though, in refusing to take on faith the value of conventional measures of baseball worth such as batting average, fielding average and runs batted in. James developed his own theories of baseball productivity and the statistical measures to back them up.

In 1977, he published the first edition of his Baseball Abstract, which subsequently became the Bible for his disciples and imitators. James was suspicious of batting average because it deliberately omitted credit for walks. (Ironically, walks were originally granted equivalent status with hits in computing batting average; “Tip” O’Neill’s famous top-ranking average of .485 in 1887 was accrued on this basis. The change to the modern treatment took place shortly thereafter.) While it may be technically true that a walk does not represent a “batting” accomplishment, it is certainly the functional equivalent of a single from the standpoint of run-producing productivity. (Veterans of youth baseball will recall their teammates urging them to wait out the opposing pitcher by chanting, “A walk’s as good as a hit, baby!”) Moreover, walks have many ancillary advantages. Putting the ball in play risks making an out. A walk forces the opposing pitcher to throw more pitches, thereby decreasing his effectiveness on net balance. Waiting longer in the count increases the chances that a hitter will get a more hittable pitch to hit, one that may be driven with power. For all these reasons, James made a convincing case that on-base percentage (OBP)is superior to batting average as a measure of a hitter’s run-producing productivity.

Rather than the familiar totals of home runs and runs batted in, James argued in favor of a more comprehensive measure of power production in hitting called slugging percentage (SP), defined as total bases divided by at bats. This includes all base hits, not just home runs. Instead of runs batted in, James created the category of runs created (RC), defined as hits plus walks times total bases, divided by plate appearances. James also sought a substitute for the concept of “fielding average,” which stresses the absence of errors committed on fielding chances actually handled but says nothing about the fielder’s ability or willingness to reach balls and execute difficult plays that other players may not even attempt. Moreover, fielding must be evaluated on the same level with offensive production since it must be just as valuable to prevent run production by the opposing team as to create runs for the home team.

These measures and maxims formed the core of Bill James’ theory of baseball productivity. His Baseball Abstract computed his measures for the major-league rosters each year and analyzed the play and management of the teams each year. Gradually, James became a cult hero. Others adopted his methods and measures. The Society for American Baseball Research (SABR) sprang up. The intensive study of quantitative baseball – eventually, sports in general – came to be known as “sabermetrics.” Even with all this attention, it still took decades for Bill James himself to be embraced by organized baseball itself. That, too, happened eventually, but not before sabermetrics left the realm of theory and invaded the pressbox, the front office and the very baseball diamond itself.

Moneyball Takes the Field

Billy Beane was a high-school “phenom” (short for phenomenal), a term denoting a player whose all-round potential is so patent that he “can’t miss” succeeding at the major-league level. Like a disconcerting number of others, though, Beane did miss. He played only minimally at the major-league level for a few years before quitting to become a scout. He rose to the front office and was named general manager of the Oakland Athletics in 1997. Beane’s mentor, general-manager Sandy Alderson, taught him the fundamentals of Bill James’ theories of baseball productivity. To them, Beane added his own observations about player development – notably, that baseball scouts cannot accurately evaluate the future prospects of players at the high-school level because their physical, emotional and mental development is still too limited to permit it. Thus, major-league teams should concentrate on drafting prospects out of college in order to improve their draft-success quotient.

Beane hired a young college graduate from HarvardUniversity – not as a player but as an administrative assistant. Paul DiPodesta was an economics major who was familiar with the logic of marginal productivity theory. The theory of the firm declares that managers should equalize the marginal productivity per dollar (that is, the ratio of output each unit of input produces at the margin to the input’s price) between inputs by continually adding more of any input with a higher ratio until the optimal output is reached. Of course, the problem in applying this or any other economic principle to baseball had always been that the principles were non-operational unless a meaningful measure of “output” could be found and the inputs contributing to that output could be identified. That was where Bill James and sabermetrics came in.

In 2001, the Oakland team had won the Western Division of the American League. But their star player, Jason Giambi, has been wooed away by a seven-year, $120-million dollar contract offered by the New York Yankees. It was the age-old story, the “Curse of the Bambino” all over again in microcosm. Oakland’s success had ramped up the value of its players on the open market; replacing those players with comparable talent at market rates would bust the payroll budget. Various other Oakland players were lost to injury or disaffection or free agency. Throughout baseball, opinion was unanimous that the Athletics were in for hard times until the team’s talent base could be rebuilt through player development.

Beane and DiPodesta used the most basic sabermetric concepts, such as ONB, SP and RC, as their measures of productivity. Using publicly available information about player salaries, they calculated player productivities per dollar and discovered the startling number of players whose true productivity was undervalued by their current salaries. Methodically, they set out to rebuild the Oakland Athletics “on the cheap” by acquiring the best players their budget could afford through trade or purchase of contracts. They substantially remade the team using this approach. Despite a slow start, their rebuilt club eventually tied the all-time major-league baseball record by winning 21 straight games and successfully defended the Western Division championship in 2002 and 2003. Author Michael Lewis outlined their story and the rise of sabermetrics in baseball in his 2003 best-selling book Moneyball, which later became a 2011 movie starring Brad Pitt that received six Academy Award nominations.

For the first time, baseball management had explicitly used an economic production function – marginal productivity theory with an operational definition of product or output – to maximize a meaningful object function – namely, “wins” by the team. And they succeeded brilliantly.

Money See, Money Do

In 2003, new Boston Red Sox owner John Henry hired Bill James as a consultant to management, to put the theories of sabermetrics into practice in Boston. During 2001 and 2002, the team had lugged the second-highest payroll in major-league baseball to disappointing results. But in 2003, with a lower- (6th-) ranked payroll, the Boston Red Sox laid the ghost of Babe Ruth by winning their first World Series since 1918. Over the succeeding decade, the Red Sox became the success story of baseball, winning the World Series three more times.

Was this a case of what Rocky’s manager Mickey would call “freak luck?” Not hardly. Thanks to the success of Oakland and Boston and Michael Lewis’s book, the tale of Bill James and sabermetrics traveled. Throughout baseball, sabermetrics ran wild and economics reigned triumphant. In 2003, the Detroit Tigers lost an American-League-record 119 games. In 2006, with only the 14th-highest payroll out of 30 major-league teams, the Tigers won the American League championship. In 2008 and 2009, the Washington Nationals were the worst team in baseball. In 2012, with baseball’s 20th-highest payroll, they had baseball’s best record. In 2010, the Pittsburgh Pirates lost 105 games. In 2013, with baseball’s 20th-highest payroll, they made the post-season playoffs. The Cleveland Indians rebounded from sub-.500 seasons to playoff finishes twice between 2006 and 2014, despite never ranking higher than 15th in the size of their payroll; usually, they ranked between 20th and 26th.

The crowning achievement was that of the perennial cellar-dwelling Tampa Bay Devil Rays. Cellar-dwelling, that is, in the size of their payroll, but not necessarily in the season standings. After years of dismal finishes, the 2008 TampaBay team became American League champs despite ranking 29th (next to last!) in the size of their payroll. They have made the playoffs in four of the six subsequent years, but their payroll continues to languish at the bottom of the major-league rankings.

The New Frontier

Does this mean that the generalization about large-market teams getting the better players and enjoying the better results was and is a lie? No, it was and still is true. But like all economic propositions it is subject to qualification and careful statement.

First, it is a ceteris paribus proposition. It is true that “you can’t beat the stock market (averages)” but every year some people (particularly professional investors) do it. You can’t do it systematically by trading on the basis of publicly available information. The few people who succeed do it on the basis of (unsystematic) luck or by uncovering new information (legally) before it becomes generally known. The market for professional sports is not nearly this efficient; techniques of sports productivity evaluation are not nearly as refined and efficient as those of stock evaluation and trading, which leaves much more room for systematic exploitation by techniques like those of sabermetrics.

Second, the term “large market” is no longer limited by geography as it has been during the first century and a half of U.S. professional sports. Ted Turner’s promotion of the Atlanta Braves using his cable-TV stations blazed the trail for turning a local team into a national one, thereby increasing the value of the team’s broadcasting and product rights. Today, there is no inherent geographic limitation of the size of the market for any team – no reason, for example, why the Kansas City Royals or Chiefs could not become “the world’s team” and sit atop the largest market of all.

The Evolutionary Approach to Free Markets

The correct approach to economics is not the irrationalist view that has clouded our understanding of professional sports. Neither is it the perfectionist view of the ChicagoSchool, which has oversold the virtues of free markets and damaged their credibility. It is certainly not the remedial view of the neo-Keynesian school, which has failed whenever and wherever tried and is now undergoing its latest serial failure.

The evolutionary approach of the true free-market school, so nobly outlined by Hayek and his disciples, fits the history of baseball like a batting glove. It is now in full flower. Taxpayers need no longer be violated by owners who promote false economic benefits of sports and hide the real ones. Fans no longer need languish in a limbo of psychological unfulfillment. Economics – not politicians, regulators or academic scribblers – has come to the rescue at last.

DRI-146 for week of 12-29-13: Catholic Doctrine and Economics: History and Evidence

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Catholic Doctrine and Economics: History and Evidence

Pope Francis’s recent apostolic exhortation denouncing capitalism earned plaudits from mainstream media and the political Left. Last week’s EconBrief exposed the Pope’s rhetoric as emotive, superficial and devoid of intellectual content. Two questions follow: First, what impelled the Pope to comment at all? Second, what accounts for his assurance that the case for capitalism “has never been confirmed by the facts?”

Catholic Socio-economic Doctrine

Hostility to money, trade and finance by organized religion and the Catholic Church in particular dates back centuries. Religion developed in opposition to political absolutism. Prior to the rise of specialization and markets, economic stasis was the rule. Wealth was attained by military conquest and plunder rather than economic growth or, on a small scale, by banditry rather than business. Thus, wealth itself was suspect, as was its expression via money. Life expectancy was short and investment possibilities were scant, so the need for finance was correspondingly limited. Thus, financiers were viewed askance.

This view found expression within the Catholic Church in the prohibition of usury, defined as loaning money at interest. Since there was no economic theory to speak of, there was no recognition of principles such as time preference. Consequently, when medieval nobles purchased indulgences from the Catholic Church, the Vatican had no compunctions about insisting on paying less than the nominal value of a noble’s right to receive annual rents on his land. That is, the noble might own land on which he contractually received the equivalent of $30 per year in annual rent from the lessee, and the Church would pay less than $30 to gain title to that contractual payment. The Church was charging rent to the noble; i.e., was itself guilty of the usury it forbade its flock to commit.

This historic example tells us several things – that interest is an ineradicable, inevitable category of human action even outside of a monetary context; that the Church was slow to appreciate the economic logic governing human action; and that church doctrine tended to inhibit rather than accommodate change and progress.

By the 19th century, the Industrial Revolution had dramatically widened the scope of human possibility. Productivity was now increasing rapidly. Economic growth was a reality. War was more destructive and less beneficial to the victor. But all this was gained at a price – the time-honored ways of society were changing. Rather than embrace change, the Catholic Church lined up against it. After witnessing a century of political upheaval and the birth of socialism and communism, the Vatican issued its first formal statement on social policy in 1891 – the Rerum Novarum. Fourteen subsequent papal encyclicals followed, refining the doctrine and developing several fundamental principles.

Man is made in the image of God and thus inherits the quality of human dignity. This is expressed in various ways, one of which is through work. The principle of subsidiarity allows individuals to attain self-expression in their work and thus contribute to the communal welfare. While the principle of private property is recognized, however, it is subordinated to enjoyment of “the goods of the whole Creation,” which are “meant for everyone.” The principle of distributism governs the allocation of goods in a fashion consistent with “social justice.”

Which political system – capitalism, socialism or communism – is optimal for achievement of social justice? None of them, according to explicit Catholic doctrine. Communism not only violates private property but also renounces religion – so much for that. “Unfettered capitalism” is not acceptable either – here we can see the roots of Pope Francis’s call for subordination to government authority, which apparently acts as surrogate for the Church in enforcing social justice. As for socialism – well, the longtime affinity between Catholicism and the political Left suggests that this is the de facto preference of a sizable fraction of the flock.

If the above summary seems vague by the standards of political economy, there are good reasons for that. The Vatican had to somehow reconcile the rapidly evolving standards of science and technology and the brute facts of modern economic life with the basic teachings of the Church – without alienating the flock and causing an exodus of believers. Obviously, it took refuge in comforting generalities and uplifting rhetoric at the expense of logic. If there are no hard edges or bright lines drawn, then the faith can dodge its contradictions and practical shortcomings just well enough to survive.

It was this doctrinal tradition of emotive uplift and vague generalization that Pope Francis called upon in his latest apostolic exhortation. For over a century, the Church had relied upon government as its deus ex machina in social policy, and Pope Francis was certainly not about to deviate from that playbook now.

Economic History and the Church

Pope Francis’s quaint ideas about capitalism were not generated spontaneously within his brain. They were the outgrowth of a long history of antipathy expressed toward capitalism and free markets by historians and commentators, some of them affiliated with the Church. This attitude began at the time of the Industrial Revolution. We can simplify it by breaking it down into two key propositions: first, that the industrial factories worsened the lot of the working population and the poor by substituting an inferior lifestyle for a preferable one spent working on farms; and second, that factories were especially harmful to children, who were shamefully exploited and maimed by the factory system.

One of the leading historians of the Industrial Revolution and child labor, Clark Nardinelli, characterized the opponents of industrialization as the “Romantic movement.” During the “golden age” (e.g., prior to the Industrial Revolution), “England was populated with sturdy yeoman farmers who…produced enough for a comfortable subsistence for their families.” And shortfall in material goods was “more than compensated for [by] the serenity and beauty of rural life.” The Industrial Revolution “tore workers away from the land and forced children to enter the labor market” rather than enjoy a joyous, pastoral existence as carefree as it was healthful. Although the best-known Romantics today are writers such as Coleridge and Wordsworth, the Catholic Church provided a great deal of moral support and front-line activism to this movement. It also drew upon the Romantic literature for much of its later doctrinal expression.

The reality of industrial life and child labor, both pre- and post-Revolution, had little to do with Romanticism. It was driven by economics.

Prior to the Industrial Revolution, economies were predominantly agricultural. At the time of the American Revolution, for example, over 90% of U.S. output was produced on farms. Beginning in the mid-1700s, economic productivity began a long upward climb that is still underway today. It started with the birth of factories housing production processes for raw materials and finished goods. This affected agriculture at first by drawing away labor and other resources from farms to cities. Eventually the Revolution spread to agriculture itself; many machines and processes for producing and harvesting farm goods were invented. The increase in agricultural productivity led to huge increases in supply and lowered prices. Since increases in demand were less-than-commensurate with these supply increases, the result was a net exodus of resources away from agriculture and toward industry. This transformation occurred around the world and continues to accentuate the trend toward urbanization today.

British economist N.F.R. Crafts estimated that British per-capita income rose from $333 in 1700 to $399 in 1760 to $427 in 1800 to $498 in 1830 to $804 in 1860 (all figures expressed in 1970 U.S. dollars). As Nardinelli infers, this implies that economic growth occurred very slowly prior to 1760, slowly from 1760 to around 1820 and much faster between 1820 and 1860. According to detractors of free markets (to whom Nardinelli attaches the non-partisan label of Industrial Revolution “pessimists”), workers drawn into the factories were actually made worse off by the transformation.

Nardinelli estimates that the lowest 65% on the British income totem-pole received about 29% of all income in 1760. By 1860, this share had declined – but only to about 25%. (This relatively glacial pace of change is consistent with rates of change in the 20th century, too, despite loud protestations about the rapid pace of inequality.) On average, this would justify only a modest downward adjustment in the per-capita near-doubling of real income in Crafts’ figures, to about a 70% increase.

Within the historical profession, debate over the effects of the Industrial Revolution has raged for well over a century. “Optimists” like T.S. Ashton and R. M. Hartwell assembled data on real wages to overcome the anecdotal impression left by “pessimists” that life was a living hell for factory workers and children. Pessimists were left to argue that countervailing factors like urban crowding, unemployment and pollution overcame the material wealth created by capitalism to make workers worse off after all. But the best that pessimists have been able to manage is a case that the rate of growth was slow prior to 1840 and only began to accelerate thereafter.

Among many factors complicating the evaluation is the fact that the Romantics overlooked all the drawbacks of pre-Industrial life. While the factor system may have worsened air pollution, for example, the relative decline in air quality was not as great as it might seem. The widespread use of horses for transportation, for example, was a substantial source of air pollution. Agriculture caused water pollution and reduction in land quality, both of which were ameliorated by the outflow of resources from agriculture to cities. The fact that life expectancy in Great Britain rose 15% from 1781 to 1851 does not tell in the pessimists’ favor. The strong population growth between 1760 and 1830 is the only thing that kept per-capita growth in real income from being even larger, but this cuts both ways – it holds down per-capita income but suggests that dis-amenities of industrial life were not life-threatening in magnitude.

The Truth About Child Labor

History books throughout the 19th and early 20th centuries were replete with gruesome tales of children mangled and crushed by machinery or driven to early graves by the unhealthy hours and working conditions inside factory walls. Beginning in the 1940s, however, what the late Paul Harvey would have called “the rest of the story” started to emerge. Even before the Industrial Revolution, children normally worked on farms, either from age 12 onwards as outdoor farmhands or as younger hirelings of cottage industries. Outdoor farm labor was hardly less arduous and dangerous than factory labor. And it was certainly less remunerative. Today, child labor survives not in Western factories but rather in the subsistence agricultural economies of Africa and India.

There is no systematic evidence of child abuse and mistreatment of child labor by factor owners – which is what we would expect of factory owners who were dependent on child labor for substantial productivity. That productivity earned substantial wage income – this was what lured the children into work in the first place. Thus, the Industrial Revolution did not result in the exploitation of child labor, regardless of how the term “exploitation” is defined. Factories and other industrial employments were not a magnet for child labor; rather, large-scale child labor was a localized phenomenon confined mostly to portions of Great Britain and the American South where cotton mills were numerous. Children were ideally suited for textile production, which explains their sudden rise to prominence at the strategic moment in the Industrial Revolution. Employment of roughly 122,000 children in the textile mills of Lancashire, Yorkshire and Cheshire constituted the bulk of child labor – about 203,333 – in England and Wales. Since the total population of children was over 2,400,000, child labor accounted for only a little over 8% of the population of children. As the Revolution went on, the need for more technologically sophisticated labor militated against the use of child labor.

Free Markets and the Poor: Evidence from Around the Globe

Not surprisingly, the Pope’s proclamation and its ecstatic reception triggered indignant reaction from knowledgeable sources. One of America’s leading experts on economic policy, John Goodman of the NationalCenter for Policy Analysis, recalled his participation in an economic conference called by Pope John Paul II in 1996. Contrary to longstanding Church policy, then-Pope Karol Wotyla sought counsel from free-market economists before issuing his encyclical Centesimus Annus. This time, Pope Francis pointedly ignored economic logic and principles in adhering to traditional Church doctrine.

In an op-ed entitled “Papal Economics,” Goodman noted that for some 100,000 years, most of mankind subsisted on a real income equivalent to $1 per day, rarely reaching $3 per day. Then, about 200 years ago [actually, closer to 250], capitalism began to blossom throughout the world with the spread of free markets. Today, even the poor in the wealthiest countries are better off by thousands-fold.

Economists Benjamin Powell and Darren Hudson, writing on “Pope Francis’s Erroneous Economic Pontifications” for the Independent Institute, take on the Pope’s assertions directly. After excoriating “trickle-down” economics, the Pope further maintained that “when the glass [of economic growth] is full, nothing ever comes out for the poor.” Citing the specific case of China, the world’s most populous nation and formerly home to its largest quotient of poor residents, the authors remind the Pope that since 1980, 500 million people have been lifted out of poverty under the new, market-friendly economic policies pursued within China. This could hardly have been the work of the Catholic Church, since Christianity was condemned by the Communist regime of Mao Zedong and barely tolerated subsequently.

The Pope’s confident assertion that faith in free markets and economic growth as a tonic for the poor has “never been confirmed by the facts” was next to fall to the authors’ analytical scythe. They calculate that the average annual per-capita income of the poorest 10% of the population in the world’s freest countries exceeds $10,000 annually. In the world’s least-free countries, that same average annual per-capita income is less than $1,000.

But surely the Pope’s headline-grabbing point about capitalist inequality is ironclad? After all, today even defenders of capitalism and free markets fall over themselves apologizing for the widening gap between rich and poor. But Powell and Hudson utilize the most popular tool of left-wing student economists, the quintile tables, in comparing income distribution in most-free and least-free countries. The share of total income going to the poorest 10% of the population in the freest countries in the world is 2.76%. In the least-free countries, that same share of total income is less – 2.57%.

The quintile method (in this case, actually a decile method) is an analytically inferior method of parsing the mysteries of income distribution because it aggregates huge numbers of individuals inside each quintile (or decile) and hides the results of changes felt by them. Only the overall averages are visible. Just as bad is the fact that the individual components of the quintile do not stay the same over time. People are born and die. Even more pertinent to the analysis, their incomes change so much that they leave one quintile and move to another one. Historically, Americans have been quite mobile between quintiles; that is, they are likely to spend time at both the low end and the high end at different points in their lives.

Left-wing students of income distribution tend to act as though the makeup of the quintiles did not change – as if the poor remained in the poorest 20% (or 10%) all their lives. The evidence suggests that some do, but most don’t. This radically changes the implications of inequality between quintiles, since it is completely different to spend your whole life poor than (let’s say) to spend a few years poor, a few years well off, a few years very well off and a few years rich. It is no accident that the Left prefers the quintile method. Socialism began as a movement proposed by French philosopher Saint Simon, who longed to operate an entire national economy as if it were one big factory; in short, to pretend that a nation was a single collective entity.

Messrs. Powell and Hudson graciously agreed to play the comparative income-distribution game in the left-wing ballpark by employing the quintile method, a technique containing inherent bias against free-market outcomes. Yet the free-market side still won, which makes the victory all the more telling.

The immediate reaction to this analysis is to wonder what Pope Francis would respond when confronted with the refutation of his arguments. In fact, he has already responded. He told an interviewer that “I was not speaking from a technical point of view but according to the Church’s social doctrine.”

Exactly. Since 1891, the Catholic Church’s social policy has served the vital function of allowing Popes to speak out of both sides of their mouth on social policy. To the public, they can appear to address real-world problems and public-policy issues directly by using terms and phrases that seem to have real-world referents. To the cognoscenti, though, they can de-fang their comments by translating them into the vague mush of Catholic doctrine, chock-full of good intentions and nobility but unrelated to any logical or practical program. That is the way to understand Pope Francis’s latest apostolic exhortation, as just another in the long line of these duplicitous exercises.

The only exception in this deplorable line of double-talk was provided by John Paul II. John Goodman noted that, in Centesimus Annus, John Paul actually came out and said that capitalism was the most efficient instrument for utilizing resources and effectively responding to needs. It can hardly have been coincidental that John Paul was also the courageous Pope who joined with Ronald Reagan and Margaret Thatcher to topple Communism in the Soviet Union and Eastern Europe. He recognized the role played by capitalism in overcoming Communism and restoring religious freedom to his home country and a substantial chunk of his flock worldwide. He knew that capitalism created prosperity and that material security and leisure time enhance the quality of religious observance.

Summing Up

The Pope’s latest apostolic exhortation earned headlines and fawning press coverage for the Papacy but broke no new ground in theology or public policy. Pope Francis was simply plowing inside the same furrow cultivated by his predecessors for over a century. The Catholic Church’s exhortations can be traced back to the Church doctrine first codified in 1891. With only one exception, this policy has followed a consistently vague and unproductive line since its inception.

The Pope’s confident assertion that free-market economics has no provenance is the outgrowth of over a century’s worth of mistaken history. Accurate revisions in estimates of real wages and a more realistic comparison of life prior to the Industrial Revolution have put the effects on workers and children in proper perspective. Poor workers gained from the Industrial Revolution; children were not exploited but rather benefitted from relatively high wages and favorable working conditions within factories.

The world’s freest countries and economies not only enable their poorest citizens to have much higher real incomes than poor people in the least-free countries, those poorest people also enjoy larger shares of total income than the poorest people in the least-free countries. In short, Pope Francis was wrong about nearly everything he said.

DRI-221 for week of 12-8-13: What’s (Still) Wrong with Economics?

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What’s (Still) Wrong with Economics?

Taking stock is an end-of-year tradition. This space devotes the remainder of the year to explaining the value of economics, so it’s fitting and proper to don a hair shirt and break out the penance whips as 2013 fades into the distance. What’s wrong with economics? Why doesn’t its productivity justify its title of queen of the social sciences – and what could be done about that?

This omnibus indictment demands an orderly presentation, organized by subject area.

Teaching: Although the motto of the Econometric Society is “science is measurement,” a better operational definition is “science is knowing what the hell you’re talking about.” On that score, economics has a lot to answer for. A science is only as good as its practitioners, who regurgitate what they are taught. Teaching is the first place to lay blame for the shortcomings of economics as a science.

In the past, economics has seldom been taught at the secondary level. That is changing, but only slowly. The subject is so difficult to master and absorption is such an osmotic process that an early start would vastly improve results. It would also force an improvement in the standard mode of teaching.

At the college level, economics is taught by teaching the same formal theory that Ph. D. students are required to master. Granted, college freshmen begin at the most basic level using far simpler tools, but they learn the same techniques. As the successful business economist Leif Olsen (among others) has pointed out, the tacit premise of college economics instruction is that all students will go on to study for their doctorate in the subject.

That is absurd. It forces textbooks to concentrate on force-feeding students bits (or chunks) of technique, supposedly to insure that all students are exposed to the tools and reasoning used by working economists. The use of the word “exposed” in this context should call to mind a disreputable man clothed only in a raincoat, accosting impressionable females in a public park. That captures both the thoroughness and duration of the exposure to each technical refinement, as well as the depth of understanding and relative appeal to the emotions and intellect on the part of the students.

What is needed here is textbooks and teachers that cover much less ground but do it much more thoroughly. Only a tiny fraction of students seek, let alone obtain, the Ph. D. The rest need to grasp the basic logic behind supply and demand, opportunity cost and the role of markets in coordinating the dispersed knowledge of humanity. This requires intensive study of basics – something that would also benefit today’s eventual doctoral candidates, many of whom never learn those basics. The only textbook serving this need that comes quickly to mind is The Economic Way of Thinking, by the late Paul Heyne.

In addition to the benefits accruing to undergraduate education, other advantages would follow from this superior approach. As it now stands, graduate students in economics are hamstrung by the subject’s austere formalism. The mathematical approach is now so rigorous at the highest levels of economics that the subject bears a stronger resemblance to engineering or physics than to the political economy practiced by classical economists in the 18th and 19th centuries. If this so-called rigor added value in form of precision to the practice of economics, it would be worth its cost in pain and hardship.

Alas, it doesn’t. Even worse, graduate students have to spend so much time grappling with mathematics that they lack the time to absorb the basic elements underlying the mathematics. Often, the mathematical models must eliminate the basic elements in order make the mathematics tractable. We are then left with the anomaly of an economic theory that must truncate or amputate its economic content in order to satisfy certain abstract scientific criteria. This obsession with formalism has substituted bad science for good economics – the worst kind of tradeoff.

The reader might wonder who benefits from the status quo, since beneficiaries have not been evident in the telling thus far. The current system creates a narrow road to academic success for career economists. They must fight their way through the undergraduate curriculum, then labor as part-time teachers and research assistants while taking their own graduate courses. Writing the Ph. D. dissertation can take years, after which they have a short time (usually six years) in which to write publishable research and get it placed in the small number of peer-reviewed economics journals. If they succeed in all this, they may end up with tenure at an American university. This will entitle them to job security and opportunity for advancement and a sizable income. If they fail – well, there’s always the private sector, where a small number of economists attain comparable career success. It is the survivors of this process, the tenured faculty at major American colleges and universities, who benefit from the system as it exists.

Perhaps this privileged few are an extraordinarily productive lot? Well, there are a tiny handful of the professoriate who produce research output that might reasonably be classed as valuable. Most articles published in professional journals, though, are virtually worthless. Nobody would pay any significant money to sponsor them directly. That’s not all. In addition to the arid mathematics employed by the theoretical research, there is also the statistical technique used to generate empirical articles. For several decades, the primary desideratum in statistical economics has been to obtain “statistically significant” results between the variable(s) in the economic model and the variable we are trying to understand. If questioned about this, the average person would probably define this criterion as “a large enough effect or impact to be worth measuring, or large enough to make us think what we are measuring has an important influence on what we are studying.”

Wrong! “Statistical significance” is a term of art that means something else – something that is more qualitative than quantitative. Essentially, it means that there is a likelihood that the relationship between the model variable(s) and the variable of interest is not due to random chance but is, rather, systematic. Another way of putting it would be to say that statistical significance answers a binary, “yes-no” question instead of the question we are usually most interested in. The big question, the one we most want the answer to, is usually a “how much” question. How much influence does one variable have on another; how great is the importance of one variable on another? The question answered by statistical significance is interesting and useful, but it is not the one we care about the most. Yet it is almost the only one the social sciences have cared about for decades. And, believe it or not, it is apparent that many economists do not even realize the mistake in emphasis they have been making.

Yet it is not the small number of beneficiaries or even their ghastly mistakes that indicts the current system. Rather, it is economic theory itself, which insists that people benefit from consumption rather than production. It is consumers of economics – students and the general public – who should be reaping rewards. The benefits earned by tenured professors are not bad if they are earned by providing comparable benefits to consumers rather than merely reaping monopoly profits from an exclusionary process. But students are lowest on the totem pole on any major university campus. Tenured faculty members teach as little as possible, usually only two courses per semester. Teaching is little rewarded and often poorly done by tenured and non-tenured faculty alike. Academic lore is filled with stories of award-winning teachers who neglected research for teaching and were dumped by their university in spite of their teaching accomplishments.

The late Nobel laureate James Buchanan characterized the position of academic economists today to “a kind of dole;” that is, they are living off the taxpayer rather than earning their keep. Administrators are fellow beneficiaries of the system, although they are pilot fish riding the backs of all academicians, not merely economists.

The Public: Consumers of economics include not merely those who study the subject in school but also the general public. Economists advise businesses on various subjects, including the past, present and future level of economic activity overall and within specific sectors, industries and businesses. They provide expert witness services in forensics by estimating business valuation, damage and loss in litigation, by representing the various parties in regulatory proceedings and particularly in antitrust litigation. Economists are the second-most numerous profession in government employment, behind lawyers.

For some seventy years, economists have played an important role in the making of economic policy. One might expect that economists would play the most important role; who is qualified to decide economic policy if not economists? In fact, modern governments place politicians and bureaucrats ahead of everybody when it comes to policymaking regardless of expertise. This has created a situation in which we were better off with no economic policy at all than with an economic policy run by non-economists. Still, the recent efforts of professional economists do not paint the profession in a favorable light, either.

The problem with public perception of economics and economists is that they have come to regard economics as synonymous with “macroeconomics;” that is, with forecasting and policymaking aimed at economic statistical aggregates like employment, gross domestic product and interest rates in the plural. This is the unfortunate byproduct of the Keynesian Revolution that overtook economics in the 1930s and reigned supreme until the late 1970s. The overarching Keynesian premise was that only such an aggregative focus could cure the recurrent recessions and depressions that Keynesians ascribed to the inherent instability and even stagnation of a private economy left to its own devices.

It is ironic that every premise on which Keynes based his conclusions was subsequently rejected by the four decades of extensive and intensive research devoted to the subject. It is even more ironic that the conclusion reached by the profession was that attention needed to be focused on developing “microfoundations of macroeconomics,” since it was the very notion of microeconomics that Keynes rejected in the first place. And the crowning irony was that, while Keynes ideas filtered down into the textbook teaching of economics and even into media presentation of economic news and concepts to the general public, the rejection of Keynesian economics never reached the news media or the general public. Textbooks were revised (eventually), but without the fanfare that accompanied the “Keynesian Revolution.”

So it was that when the financial crisis of 2008 and ensuing Great Recession of 2009 reacquainted America with economic depression, Keynesian economists could reemerge from the subterranean depths of intellectual isolation like zombies from a George Romero movie without triggering screams of horror from the public. Only those with very long memories and a healthy quotient of temerity stood up to ask why discredited economic policies had suddenly acquired cachet.

When the Nobel Foundation began awarding quasi-Nobel prizes for economics in the late 1960s, a good deal of grumbling was heard in the ranks of the hard sciences. Economics wasn’t a real science, they maintained stubbornly. A real science is cumulative; it creates a body of knowledge that grows larger over time owing to its revealed truth and demonstrated value in application. Economics just recycles the same ideas, they scoffed, which go in and out of fashion like women’s hemlines rather than being proved or disproved.

From today’s vantage point, we can see more than just a grain of truth in their disparagement – more like a boulder, in fact. What macroeconomist Alan Blinder referred to in a journal article as “the death and life of Keynesian economics” is a perfect case in point. Keynesian economics did not arise because it was a superior theory – research proved its theoretical inferiority. Not only that, it took decades to settle the point, which doesn’t exactly constitute a testimonial to the value of the subject or the lucidity of its doctrines. Keynesian economics did not triumph in the arena of practical application; that is, countries did not eliminate recessions and depressions using Keynesian policies, thereby proving their worth. Just the opposite; after decades of pinning his hopes on Keynesian economics, the British Labor Party leader James Cavenaugh renounced it in a celebrated denunciation in the mid-1970s.

No, Keynesian economics made a comeback because it was politically useful to the Obama administration. It enabled them to spend vast amounts of money and direct the spending to political supporters on the pretext that they were “stimulating the economy.” If economics had to justify its existence by pointing to the results of “economic policy,” economists would be thrown out into the street and forbidden to practice their craft.

In the early 1960s, Time Magazine put John Maynard Keynes on its cover and proclaimed the death of the business cycle. This obituary proved to be premature. Like Icarus, economists tried to fly too high. Their wings melted by the solar heat, the profession is now in freefall, putting up a bold front and proclaiming “so far, so good” as they plummet to Earth. The only remedy for this hubris is to straightforwardly admit that economics is not a hard, quantitatively predictive science in the mold of the natural sciences. Its fundamental insights are not quantitative at all but they are absolutely vital to our well-being. When combined with such other social sciences as law and political science, economics can explain patterns of human behavior involving choice. It can unlock the key to human progress by making the knowledge sequestered in billions of individual brains accessible in useful form for the mutual benefit of all. Thanks to economics, billions of people can live who would die without its insights. These benefits are anything but trivial.

Economics can even ameliorate the hardships imposed by the business cycle, as long as we do not expect too much and can resign ourselves to occasional recessions of limited length and severity. In this regard, success can be likened to hitting home runs in baseball. Trying to hit home runs by swinging too hard usually doesn’t work; making solid contact is the key to hitting homers. Many great home-run hitters, including Hank Aaron and Ernie Banks, were not large, powerful men who swung for the fences. They were wiry, muscular hitters who hit solid line drives. The economic analogue of this philosophy is to allow free markets to work and relative prices to govern the allocation of resources rather than trying to use government spending, taxes and money creation as a bludgeon to hammer the efforts of markets into a politically acceptable shape.

Remedies: In thinking about ways to right its wrongs, economics should take its own advice and fall back on free markets. Rather than trying to administratively reshape the academic status quo and tenure-based faculty system, for example, economists should simply support privatization of education. This is simply taking current professional support of tuition vouchers and charter schools to the next logical level. Tenure is a protected academic monopoly, unlikely to survive in a free private market. If it does, this will mean that it has unsuspected virtues; so much the better, then.

Recent decades have seen the rise of applied popular economics books written to bring economics to the masses. The best-known and most popular of these, Freakonomics, is among the least useful – but it is better than nothing. Better works have been submitted by economists like Steven Landsburg (The Armchair Economist) and David Friedman. Their worthy efforts have helped to turn the tide by correcting misapprehensions and redirecting focus away from macroeconomics. This is another good example of reform from within the profession that does not require economists to sacrifice their own well-being.

Perhaps the one missing link in economics today is leadership. Revolutions in scientific theory and practice are typically effected by individuals at the head of scientific movements. In economics, these have included men like Adam Smith, David Ricardo, Karl Marx, the Austrian economists of the 19th century, Alfred Marshall, Keynes and Milton Friedman. Today there is a leadership vacuum in the profession; nobody with the intellectual stature of Friedman remains to take the lead in reforming economics.

Given the woes of economics and economic theory, a new candidate seems unlikely to come riding over the horizon. It may be that economists will have to prop up an intellectual giant of the past to ride like El Cid against the ancient foes of ignorance, apathy, prejudice and vested interest. There is one outstanding candidate, the man who saved the 20th century in life and whose wide-ranging thought and multi-disciplinary theory is alone capable of midwiving a new sustainable economics of the future. That would be F.A. Hayek. Recent stirrings within the profession suggest a growing acknowledgment that Hayek’s economics have been too long neglected and explain the crisis, recession and current stagnation far better than anything offered by Keynes or his followers. There is no better body of work to serve as a model for what is wrong with economics and how to correct it than his.

DRI-277 for week of 11-3-13: Why Are There No Economists Among Leading Opinion-Molders Today?

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Why Are There No Economists Among Leading Opinion-Molders Today?

Today the discipline of economics occupies a strange position within the general public. The Financial Crisis of 2008 and ensuing Great Recession brought economics to the daily attention of Americans more forcefully than since the Great Depression of the 1930s. The Federal Reserve’s monetary policies, particularly its recent tactic of Quantitative Expansion (QE) of the stock of money, have made monetary policy the object of attention to a greater extent than at any time since the days of stagflation and supply-side economics during the Reagan administration in the early 1980s. One would expect to find economists occupying center stage almost every day.

Not so, surprisingly enough. Contrast the position of economics today with, say, that in the 1960s and 70s, just prior to Ronald Reagan’s election as President. At that point, three economists were familiar on sight and sound to a great many Americans: John Kenneth Galbraith, Paul Samuelson and Milton Friedman. Today, the venues, space and time available to economists far outnumber those existing forty years ago. Yet no economist today even approaches the influence and familiarity of the Big Three in their heyday. A brief recollection of each is in order for the benefit of younger readers.

The Big Three of Yesteryear: Galbraith, Samuelson and Friedman

The Big Three economists of yesteryear bestrode the 20th century like colossi and stood tall into the 21st. They were all born and died within a few years of each other: Galbraith (1908-2006) slightly outlasted Samuelson (1915-2009) and Friedman (1911-2006) in longevity although he died first, in April 2006. They were all self-made and experienced the Depression first hand. Each was a prolific writer but appealed to a different audience.

The best-selling writer of the three was John Kenneth Galbraith, whose literary zenith produced The Affluent Society (1958) and The New Industrial State (1967). Compactly put, Galbraith’s thesis was that Americans were satiated with consumer goods but starved for so-called “public goods;” i.e., the goods government was uniquely situated to provide. The economy thrived not on competition but on monopoly exercised by giant corporations, who artificially created the demand for their products via advertising rather than merely responding to the inchoate demands expressed by consumers. Since consumer wants depended on the same process that satisfied them, that process of want-satisfaction could not be justified or defended as simply “giving the people what they want.” Therefore, government was not merely allowed but morally required to tax and regulate business to restrain their behavior and acquire the resources necessary to redress the imbalance between public and private spending. Galbraith’s views resonated with the general public much more than with the economics profession itself, where only the New Left, radicals, institutionalist admirers of Thorstein Veblen and quasi-Marxists found them attractive. Needless to say, Galbraith’s ideas seem quaint today in light of the decline and fall of the supposedly invulnerable giant corporations he worshipped.

In addition to his economic works, which also included American Capitalism (1952) and A Theory of Price Control (1952), Galbraith wrote novels and memoirs of his travels and tenure as Ambassador to India. His iconoclastic views – he minted the phrase “the conventional wisdom” – and ironic style endeared him to the general public, whose distrust of authority he shared. This seems odd of a man whose World War II service as deputy head of the Office of Price Administration made him one of America’s chief bureaucrats, but Galbraith’s early life was spent on a farm in Canada. Another of his books was a novel satirizing America’s foreign-policy establishment (“Foggy Bottom”). Perhaps the chief object of his scorn over the years was the corporate hierarchy, whose morals and mores he never tired of mocking despite his exaggerated opinion of their power over markets.

Paul Samuelson was the leading theoretician among American economists and the first American awarded the economics version of the Nobel Prize in 1970. His scholarly articles numbered in the hundreds, but he is remembered today chiefly for two books: Foundations of Economic Analysis, based on his doctoral dissertation, which signaled a turning point in economics to mathematics as the formal mode of analysis; and Economics, his all-time best-selling college text that combined principles textbooks in microeconomics and macroeconomics in order to integrate the two analytically into the so-called “Neoclassical synthesis. Samuelson combined the elements of classical price theory as developed by Alfred Marshall and refined by subsequent generations with Keynesian macroeconomics as modified from Keynes by the neo-Keynesian generation that included Samuelson himself, Franco Modigliani and James Tobin, among others. This book (really, a double book) taught generations of economists through over twenty editions from the 1940s until the 21st century.

Samuelson’s central conceit was that individual free markets worked beautifully, but markets in the aggregate were prone to unemployment or inflation. This aggregate shortcoming could only be corrected by government spending directed by… well, by men like Samuelson himself; although he always refused to take a policy post in the Democrat administrations he supported and advised.

As with Galbraith, it is difficult for non-economists today to credit the veneration Samuelson inspired in certain quarters. In the late 1950s, Samuelson began predicting that the Soviet Union would soon overtake the U.S. in per-capita GDP (then GNP). He retained this prediction in successive editions of his textbook – until the final overthrow of the Soviet Union in 1991. Galbraith and Samuelson made an odd couple of Keynesians – the former supporting massive government spending in spite of his distrust of the bureaucracy and the latter embracing deficit spending by government because he had faith in the ability of government to fine-tune aggregate economic activity. Samuelson shared a forum in Newsweek Magazine in an alternating column with the third member of our Big Three, Milton Friedman.

Friedman became well-known among fellow economists long before he attracted public notice. He won the John Bates Clark medal awarded to the leading economist under the age of 40 and published a notable collection entitled Essays in Positive Economics that contains some of the best expository writing ever done in his subject. 1957 saw what he considered his best piece of work, A Theory of the Consumption Function, which successfully reconciled cross-section data on aggregate consumption among different groups over the same time period with time-series data on consumption among all groups over time.

In the early 1960s, Friedman published two books within a year of each other that catapulted him to public attention and professional eminence. Capitalism and Freedom made both the political and economic case for free markets, an analytical position that had almost deteriorated through neglect. A Monetary History of the United States, which he co-authored with Anna Schwartz of the National Bureau of Economic Research, made an empirical case for the money stock as perhaps the chief economic variable of interest both historically and for policy purposes. Milton Friedman became the world’s chief exponent of the Quantity Theory of Money, which had been around ever since David Hume in the 18th century but had never before been put to such comprehensive use in economic theory. Ironically, Friedman’s single-minded focus on the money stock proved to be his Achilles heel. Although still greatly respected for his manifold contributions to economic theory and his prodigious talents as a defender of freedom and popularizer of economic thought, Friedman’s monetary theory is little regarded among professionals of all ideological stripes.

As the 60s and 1970s wore on, Friedman headed up the disloyal opposition to Keynesian economics within the economics profession. Keynes had been posthumously crowned king in the 1950s and early 60s as Western economies began to adopt the policy of spending their way to prosperity. But the advent of simultaneous high inflation and high unemployment, or “stagflation,” in the 1970s put paid to the Keynesian tenure atop the profession. Friedman and Edmund Phelps independently and more or less simultaneously developed the hypothesis of a “natural rate of unemployment” that defied Keynesian efforts to reduce it via deficit spending. Only through continually increasing injections of money into the economy – producing ever-increasing rates of inflation and resulting unrest – could unemployment be reduced and held below this “natural rate.” Friedman’s Nobel Prize, received in 1976, was by this time a foregone conclusion.

In 1980, Friedman reached his zenith of public popularity with the best-selling book and accompanying PBS television series Free to Choose. This was a popularized version of Capitalism and Freedom, updated for the 80s. For the first time, an economist had scaled the heights of public popularity, professional acclaim and policy prominence. Like Samuelson, Friedman preferred to exercise his influence outside of government. Unlike Samuelson, though, Friedman had actually worked for government in World War II. It was Milton Friedman, of all people, who devised the concept of government tax withholding to streamline the process of revenue collection.

Vacuum at the Top

Today, economics is omnipresent in our lives. Yet there is nobody in the public square whose position rivals that of the Big Three of yesteryear. The closest would be Paul Krugman, who has written several popular books, whose Nobel Prize is spelled exactly like the one received by Samuelson and who believes that the stock of money can play an important role in economic policy. In other words, he is a pale shadow of Galbraith, Samuelson and Friedman.

Noted economist Sam Peltzman probed this seeming paradox in an article published in the May, 2013 issue of Econ Journal Watch, 10(2) pp. 205-209, entitled “Why Is There No Milton Friedman Today?” Peltzman’s analytical qualifications are impeccable. He has carved out a distinguished career as a critic of government regulation. His crown jewel is a famous 1975 study on automobile safety that introduced the pioneering concept of “risk compensation” to the social sciences.

Risk compensation refers to the behavioral effects created by safety improvements and regulations. When people take more risk in response to safety improvements and/or regulation, this change in behavior has been christened the “Peltzman Effect.” Thus, Sam Peltzman has been given the greatest scientific honor of all – a scientific principle has been named for him.

Peltzman notes the absence of successors to the Big Three. He especially abhors the vacuum created by the loss of Milton Friedman. Peltzman’s explains it by citing Friedman’s unique talents. The first of these was his knack for communicating economic insights to the masses. The same expository skill Friedman brought to his professional work equipped him to educate the general public.

Peltzman illustrates Friedman’s style with a revealing anecdote from his own (Peltzman’s) academic career. Peltzman’s first graduate-school class was Friedman’s legendary class in Price Theory at the University of Chicago. The students “eagerly awaited our introduction to the technical mysteries of our chosen profession. Instead, we got an extended paraphrase of an article entitled ‘I, Pencil,’ in which a humble pencil tells us of the herculean coordination problem required to get itself produced and distributed and of the virtues of markets in solving that problem.” Peltzman correctly attributes the essay to Leonard Read, founder of the Foundation for Economic Education and its journal, The Freeman, in which the essay originally appeared. Peltzman’s points are that Friedman’s pedagogy was time-tested and simple and he employed it before professional audiences as well as public ones.

Friedman’s second unique virtue was his zest for combat. Libertarian economists were scarce in Friedman’s day and he knew his arguments would be received with scorn and incredulity. Nevertheless, his rejoinders were cheerful and clever; he relished the opportunity to buck the tide of collectivist conformism. And his devotion to his principles was unyielding. “All against one makes for a good show,” observes Peltzman, “and Friedman liked the odds.” This brings to mind the answer made by John Wayne’s character J.B. Books, the dying gunfighter in the movie The Shootist, when asked to account for his luck in surviving so many gunfights over the years: “I was willing.”

It is clear that even Galbraith and Samuelson couldn’t measure up to Milton Friedman by Peltzman’s criteria. Galbraith had the communication skills and debating talent but little worthwhile to communicate; his theory badly needed shoring up. Samuelson had the theory but communicated largely by writing letters to his fellow economists in the language of differential equations. His text worked well enough for a captive academic audience but nobody ever characterized his persona as “dynamic.” Both these men were, to some greater or lesser extent, arguing for the status quo, while one of Friedman’s books was titled The Tyranny of the Status Quo.

So far, so good. Peltzman makes a concise, compelling case for Milton Friedman as sui generis. Now, though, Peltzman tries to explain why today’s economists do not measure up to the standard set by Friedman. Although his observations of the economics profession seem descriptively accurate, his attitude toward their change in behavior is disturbingly complacent.

The Contemporary Economist as Engineer

In assessing the state of the profession today, Peltzman at first sounds optimistic. It’s true that there is no Milton Friedman leading the charge for freedom and free markets. But that isn’t due to a lack of free-market economists. “There are…numbers of them within our gates, perhaps more than in Friedman’s time…But they lack something that Friedman had in…his time.” Actually, they lack several somethings.

First, they lack the kind of dedicated, first-rate opponents Friedman had in abundance. “…The range of belief within economics has narrowed, partly because of Friedman’s efforts…the modal economist is less [interventionist]… than the modal economist of Friedman’s era…Market solutions…are given a respectable hearing or are part of the consensus today (think flexible exchange rates or unregulated railroad rates). There is less room today for a good fight among economists.” Apparently, Peltzman does not read Paul Krugman’s column in the New York Times.

If this sounds dubious, just listen to Peltzman’s next assertion. “Consider…what has happened in the aftermath of the financial crisis of 2008. The chattering class pronounced with excited joy that Capitalism is now Dead, but the political center hardly moved, and in some countries even moved right – to fiscal rectitude, labor market reform, etc. Hardly any left party that moved away from socialism in Friedman’s heyday has moved back since. What is a committed free-market economist spoiling for a good fight to do when the other side is not so far away?”

This narrative hardly sounds like a description of the multi-trillion dollar stimulus, multiple bailouts of big banks and financial firms, government seizure and handover to autoworkers of two of the Big Three auto companies, impending nationalization of health care, regulatory reign of terror and Federal-Reserve money-creation and asset-purchase binges that have characterized the U.S. since 2008. Contrary to Peltzman, events since 2008 have conformed more to Newsweek‘s famous cover headline: “We Are All Socialists Now.” And what has today’s “modal economist” done in response to this overwhelming frontal assault on free markets?

If Peltzman’s judgment that the economics profession has gravitated toward freer markets were correct, we would expect to read protests from our modal economist. Instead, he has, according to Peltzman, turned into “a much cooler customer. This one tends to be less committed to any politico-economic system.” Wait a minute – what happened to all those “numbers of …free-market economists…within our gates” just a minute ago? We could sure use them, because it now turns out that among the cooler customers, “the animating spirit is more the engineer solving specific problems than the philosopher seeking a unified world view. The questions asked tend to be smaller than, say, the connection between capitalism and freedom.”

Strangely, Peltzman doesn’t seem perturbed about this loss of ideological fervor, because “the skill with which the question is answered tends to be greater than in times past.” What about their professional duty to educate the public in the great truths of economics? “At some point,” Peltzman declares airily, “today’s leading economists may want to communicate their results to a wider audience. But this is an afterthought, in the sense that what is valued within the profession – the skill in obtaining the result – is not what the outside audience is interested in.”

Peltzman is surely wrong about the outside audience, who is intensely interested in “the skill in obtaining the result” because (at least in principle) it should affect the veracity of the result. Presumably what Peltzman meant to say is that the audience doesn’t care what method economists use to get the answer as long as they get the right one. And in this connection, it is hard to see what economics profession Peltzman is referring to – surely not the one that actually exists. For over two decades, Deirdre McCloskey and Steven Ziliak have proclaimed that econometric practice within the social sciences – in economics and elsewhere – is scandalously incompetent. Most empirical articles in the leading professional journals over-rely upon and misuse the principle of “statistical significance.” Thus the foundation of empirical economics has rotted away – and with it has gone Peltzman’s claim of greater skill.

Peltzman is not merely blind to the failings of his profession today; he is complacent about its future prospects. “It is hard for me to see a reversal of the kind of trends I have described…in…fields where the engineer has replaced the philosopher. Perhaps an economic calamity will shake things up in economics. But we had one in 2008, and very little changed within the profession. There was a period of befuddlement [after which] economists went back to their tinkering and were largely irrelevant to the political response to the crisis.”

Peltzman’s complacency even extends back to Friedman’s work. He attributes the fact that “there is no serious socialist faction left within economics” to “Friedman’s success,” which “makes it harder for someone to follow in his footsteps.” Peltzman declares flatly that “there is no serious political/economic alternative to some form of capitalist organization in any major economy.” Peltzman cannot have forgotten – can he? – that this was exactly the point made by Ludwig von Mises and reinforced by Mises and his student F.A. Hayek in the Socialist Calculation debates of the 1930s. This was a central contention of Hayek in his great polemic The Road to Serfdom in 1944. It was Hayek, the guiding spirit behind the Mont Pelerin Society of worldwide free-market economists who sparked Friedman’s interest in political activism in the late 1950s. Friedman admitted all this in his Introduction to the 1994 edition of The Road to Serfdom and in interviews with Hayek’s biographer, Alan Ebenstein.

Peltzman’s most outrageous error is his claim that “the Fed chairman learned from Friedman not to permit a credit freeze to turn into a monetary implosion.” Milton Friedman would have slit both wrists and reclined in a warm bath before endorsing the policies followed by Ben Bernanke before, during or after the Financial Crisis of 2008. Friedman’s criticism of Federal Reserve policy during the Great Depression did not pertain to a “credit freeze” but rather to the wholesale failure of banks throughout the U.S. and resulting nosedive taken by the money stock when deposits were destroyed. A credit freeze – whatever else it might entail – implies no such rapid decline in the money supply and therefore does not demand a “helicopter drop” of money, a la Milton Friedman, in order to cure it. Peltzman’s jaw-dropping attempt to imply a posthumous endorsement of Bernanke by Friedman is as inexcusable as it is inexplicable.

Peltzman has chosen the wrong model for his model economist – Friedman rather than Hayek. He has also chosen the wrong model for his modal economist – the engineer rather than the philosopher. In The Counter-Revolution of Science (recently republished under its original planned title, Studies on the Abuse and Decline of Reason), Hayek outlines the disastrous effects of subjecting society to control by the “mind of the engineer.”

The engineer strives to bring all aspects of a problem under his conscious control in order to achieve a technical optimum. He chafes at external constraints such as prices, incomes and interest rates; they are not “objective attributes of things but reflections of a particular human situation at a given time and place.” He sees them as meaningless, irrational interferences with his optimization techniques. When an engineer confronts a machine, for instance, he typically strives to gain the maximum power or energy output from given inputs of resources. In fact, as Hayek points out, the engineer’s technical optimum is usually just the solution that would obtain if the supply of working capital or resources was unlimited or the interest rate was zero. In adopting the perspective of the engineer, the economist is losing his own unique perspective. A good real-world example of the engineering perspective gone wrong in economic practice would be the misguided activist economic policies of former-engineer Herbert Hoover in trying to combat the Great Depression.

Peltzman correctly recalls that Milton Friedman advanced the view that the profession should pursue “positive economics” by formulating hypotheses and testing them empirically. But Peltzman neglects to inform his readers that today this viewpoint is as dead as the dodo – deader, actually, since today we can clone dodos back to life but we are not about to resurrect the canard that econometrics can be used to test predictive hypotheses in the social sciences in the same way that laboratory experiments test natural scientific hypotheses. In academic economics today, nobody believes that anymore. The massive, sausage-producing enterprise of submitting articles to refereed professional journals for acceptance continues, but purely as a ritual for granting tenure. Nobody now pretends that this process has any value above the purely ceremonial. It is now axiomatic in economics that econometrics does not prove anything, test any hypotheses or rule out (or in) any part of economic theory.

The format mathematical models economists swear by give the appearance of scientific rigor, but this is spurious. In order to reduce actual human activity to systems of solvable equations and stable equilibria, economists have to remove so much realistic detail that their models are unrecognizable to the layman. They are virtually useless for making quantitative predictions. We know this because, as the former Donald McCloskey put it, economists cannot answer “the American question: If you’re so smart, why aren’t you rich?”

Today, economic policy is taking measured that economists have warned against for centuries. The attempt to create wealth and induce prosperity by massive money creation is traditionally a tactic of desperation, one that inevitably ends in crisis and chaos. Yet economists sit silent instead of rising in indignant protest. And Peltzman appears to approve both the desperation tactics and the compliance of his profession.

Actually, Peltzman does betray deep-seated doubts about the current path of economics profession in his last sentence. It reads: “But one wonders still: is this only the calm before the storm?” And one wonders if Peltzman will have cause to regret his failure to speak out.

Whither Economics?

Sam Peltzman has courageously taken on one of the great contemporary mysteries. It is a missing-persons case. Where did the economist go in our public discourse? Peltzman succeeds in finding his quarry, all right. But having found him, he is distressingly indifferent to the runout. His confidence in the methods and motives of today’s economists seems utterly misplaced. Without realizing it, Peltzman himself is providing part of the explanation for the absence of economists from public discourse. He is sanctioning the abandonment of what they do best – teaching the philosophy behind economics – in favor of what they do worst – pretending to employ the methods and techniques of engineering in the foreign realm of economics.

DRI-270 for week of 10-6-1: How is Job Safety Produced?

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How is Job Safety Produced?

The best-selling book on economics in the 20th century was probably Free to Choose, the 1980 defense of free markets by Milton and Rose Friedman. It contained a chapter entitled, “Who Protects the Worker?” In it, the authors highlighted the tremendous improvement in the working conditions and living standards of workers from the Industrial Revolution onward. What, they inquired rhetorically, accounted for this? The Friedmans suggested “labor unions” and “government” as the likely top two answers to any poll taken on this subject.

One of the nation’s leading experts on the subject of risk and safety is W. Kip Viscusi, long an economics professor at Harvard, Duke and Vanderbilt universities and now affiliated with the Independent Institute. In an essay on “Job Safety” for the Fortune Encyclopedia of Economics, Viscusi wrote: “Many people believe that employers do not care whether their workplace conditions are safe. If the government were not regulating job safety, they contend, workplaces would be unsafe.”

The Friedmans and Viscusi knew something that the general public doesn’t know about job safety; namely, that free markets and competition are what keep workers safe. The notion of a “market” for risk or safety seems hopelessly abstruse to most people. The general attitude toward competition can best be described as ambivalent. Still, it is the job of economists to make the complex understandable. Herewith an explanation of how job safety is really produced.

Compensating Differentials

Most people seem comfortable with the fact that wage differentials exist between jobs. Moreover, the direction of difference is not random. Different types of manual labor may differ radically in the element of physical risk to which workers are subjected – coal mining, for example, presents a much higher probability of death or severe injury than does loading-dock work. The greater the risk associated with an employment, the higher the wage its workers will command.

In free markets, wages result from the interaction of supply and demand. Does the “risk differential” reflect variations in the supply of labor or the demand for it? Either or both. The toll of current and future mortality in coal mining – from accidents and “black-lung” disease, respectively – tends to restrict the supply of labor to the profession, driving up miners’ wages on that account alone. Coal’s high-BTU content makes a miner’s output from a 40-hour workweek much more valuable than that of the dock worker, so the demand for coal miners exceeds that for dock workers – a factor also tending to drive miners’ wages above those of dock workers.

This logic extends to other characteristics of employment, beyond those ordinarily associated with risk. Library work is viewed as pleasant because of its low-key, low-stress, peaceful character and attractive environment. This attracts a plentiful supply of applicants for low-rung library jobs (pages and assistants) and the continuous pursuit of graduate degrees in library science (required for librarians). This bountiful supply of labor tends to depress wages within libraries below those of comparable other jobs, such as clerks, cashiers, tellers and such. The particular attractions of library work influence people to accept lower wages than would otherwise be acceptable – in effect, library employees receive part of their payment in kind rather than in cash.

Economists use the term compensating differentials as shorthand to denote and explain differences in work-related remuneration that compensate for differences in how different jobs are perceived or experienced. The phenomenon was first observed and categorized by the great Adam Smith in 1776 in his magnum opus, An Enquiry into the Nature and Causes of the Wealth of Nations. Smith observed that positive wage differences would exist for occupations that were dirty or unsafe, such as coal mining or butchering, those that were odious, such as performing executions, and those that were difficult to learn.

Compensating differentials play a key role in job safety. Opponents of markets – who tend to be the same people promoting government regulation of job safety – insist that employers are too parsimonious to spend money on job safety. And why should they? From the employer’s standpoint, the anti-market man maintains, expenditures on job safety are a waste because they are a cost that does not contribute to the employer’s revenue. The compensating differentials argument supplies a potential motivation for the employer’s investment in safety. A safer workplace will increase the worker’s willingness to accept lower wages, thus allowing the employer to recoup his investment over time, just as if the investment allowed him to earn more revenue.

This positive incentive may have a negative counterpart as well. The ability of workers to sue for tort injury provides an incentive to improve worker safety. (In this regard, Viscusi makes a vital distinction: Firms must correctly understand and anticipate liability in order to feel this incentive. The most famous tort liability case was the massive asbestos liability case, in which longtime principles of tort liability were overturned in order to find large companies like Johns Manville liable for worker illnesses contracted many years before the link between asbestos and mesothelioma was uncovered.)

The Market for Job Safety

The most common way of assessing risk is to calculate the approximate rate of death or injury per annum. For example, a job requiring physical labor entailing moderate risk might result in one death per 10,000 workers per year. Workers in this employment should expect to earn a modest premium – perhaps $500 – $700 per year – over workers doing labor involving essentially no risk of death. Another way to view this premium would be to call it the amount that workers would willingly give up to avoid the risk they bear.  And this amount also sets a ceiling on what employers would pay to improve jobsite safety, since any amount below this will save the employer money, while any amount above it will cost more in safety expenditures than the amount the employer could save in avoided wage premia.

The market for safety is one in which workers assess the risk characteristics of jobs they contemplate. Their assessment determines their willingness to work at that job and the wage at which they will work. It is obvious that the successful functioning of this market demands that workers correctly assess a job’s risk/safety profile.

“How well does the safety market work?” Viscusi asks rhetorically. “For it to work well, workers must have some knowledge of the risks they face. And they do.“[emphasis added] He cites one study showing that 496 workers correctly paired a higher risk of injury with a higher level of danger in their industry. Only 24% of workers in women’s outerwear manufacturing and communications equipment characterized their industry as “dangerous.” But 100% of workers in logging and meat products described their industry as dangerous – correctly, as it turned out.

Are workers ever wrong about the risks they face? Well, they sometimes mis-estimate the level of risk they face, not by assuming it to be zero but by wrongly assuming to be higher or lower than it is. But the evidence strongly suggests that the market does work.

Another datum supporting this conclusion is the general reduction in job risk throughout the 20th century. As real income rose throughout the century, we would expect that workers would take some of their gains in the form of risk reduction; that is, they would deliberately seek out less job risk because the increase in real wages allows them this luxury. In effect, this implies that safety (or risk-reduction) is a normal good, something workers choose to “purchase” more of when their real incomes rise. In fact, that is exactly what did happen over time. Real wages roughly tripled from 1933 to 1970 and average death rates on the job fell from about 37 per 1,000 workers to about 18.

Still another aspect of the market for safety is the incentive it provides to learn. This applies to both employee and employer. Do workers keep track of new information developed about job-related safety hazards? Yes; the evidence of this is the high quit-rate (about 33%) for workers to learn that job risk has risen since their initial hire. Since the hiring and training process is expensive for employers, this represents an incentive for them to hold down those risks.

Government Regulation as a Way to Improve Job Safety

To Americans under forty years of age, it must seem as though the federal government has always been omnipresent in economic life. Actually, the bulk of federal-government regulation is the legacy of two historical periods – the New Deal administration of President Franklin Roosevelt from 1932-1945 and the Great Society regime of President Lyndon Johnson from 1963-1968. Most of the non-financial regulatory apparatus, including the agencies dealing with health and safety, were created in the late 60s and early 70s. The publicity created by the muckraking exposes of consumer activist Ralph Nader played a key role in stimulating the implementing legislation for these agencies. (Viscusi’s career began with the two years he spent as an apprentice in the Nader organization prior to his academic training.)

In 1970, the federal Occupational Safety and Health Act created the agency called OSHA (Occupational Safety and Health Administration). The agency is an attempt to engineer a theoretically safe workplace and implement it by government fiat. This de-glamorized mission statement highlights the agency’s glaring flaw: the substitution of technological criteria for purposes of solving economic problems. OSHA’s attempt to ban formaldehyde from the workplace in 1987 resulted in rulemakings that were estimated to cost $72 billion for each life they purported to save. To add insult to this grievous injury to economic logic, the U.S. Supreme Court ruled that OSHA regulations could not be subjected to any cost-benefit test, thus enshrining the agency’s right to commit acts of fiscal and economic lunacy with apparent impunity.

It seems difficult to believe that the judges could not envision the possibility that the $72 billion committed to saving that life had alternative uses that included saving multiple other lives. Yet the idea that the Constitution should codify any kind of respect for economic logic remains outside the legal mainstream to this day, despite the efforts of scholarly judges like Richard Posner and Frank Easterbrook to bring their substantial economic learning to bear.

Viscusi notes that “increases in safety from OSHA’s activities have fallen short of expectations. According to some economists’ estimates, OSHA’s regulations have reduced workplace injuries by at most 2 to 4%.” He compares the fines OSHA collects in the average year (about $10 million at the time Viscusi wrote) to the size of the aggregate risk premium embedded in U.S. wages (about $120 billion at that point). Obviously, the market for safety was disciplining employers and employees alike much more powerfully than OSHA.

As the Friedmans pointed out, though, “government does protect one class of workers very well; namely, those employed by government.” Government employees have job security and incomes linked to the cost of living. Their civil-service retirement pensions are also indexed to inflation and superior to anything available from the Social Security system most Americans are tied to by law. Those government employees who retire early enough to log enough quarters of private-sector employment to qualify for Social Security benefits can “double-dip” from the government pension trough. Needless to say, this is not exactly the concept that OSHA, et al, were designed to further.

Labor Union Bargaining

The role of labor unions in securing improvements in job safety is limited to whatever provisions the union might succeed in embedding into negotiated labor contracts. Unions cannot add to the market incentives to improve safety – incentives that would exist whether unions existed or not. Indeed, if anything, the opposite is true.

Unions can succeed in raising the wage received by their members. They do this either by restricting the supply of labor by limiting the legal supply of workers to union members, or by legally bargaining for a wage higher than the one that would otherwise prevail in a free market. Either way, the result of this above-market wage is unemployment of labor. To the extent that workers leave the unionized industry for employment elsewhere, the higher unionized wages are counterbalanced by lower wages elsewhere.

The wage premium for risk will represent a lower fraction or percentage of the higher, unionized wage than of the market-level wage. Thus, labor unions dilute or lessen the impact of wage premia in creating job safety for workers.

Risk Compensation

The most powerful development in the economics of risk and safety over the last four decades has been the recognition of risk compensation behavior as an offset to rulemaking by government. In the early 1960s, University of Chicago economist Sam Peltzman began to investigate federal-government automotive safety laws designed to force automobile companies to add safety equipment to cars.

The laws made no sense to him. He could see that car companies had incentives to add safety improvements to cars, provided customers wanted them – and he didn’t doubt that many consumers did. But he didn’t see why the companies had to be, or should be, forced to do something that that might well be in their own interest anyway or, alternatively, might not make sense at all.

Peltzman’s research, summarized in a now-classic 1975 article in the Journal of Political Economy, found that the safety regulations did not improve safety on net balance. That is, they either failed to improve actual safety or the lives saved or injuries avoided were offset by other lives lost and injuries incurred because of the laws and safety measures taken.

The key overall principle at work was risk compensation. Safety measures like air bags, seat belts and anti-lock brakes made people feel safer. Consequently, the most risk-loving individuals drove faster and incurred more driving risk to offset the death-and-injury risk that had been reduced by the new safety measures and equipment.

Peltzman’s results were initially greeted with massive skepticism. But forty years of research have vindicated them resoundingly. The “Peltzman Effect” is now recognized worldwide by social and physical scientists. It has been verified empirically in research involving motorcycle and bicycle accidents as well as automobile crashes, and in such diverse fields as athletics, children’s play, recreational pursuits like skydiving and fields like insurance and finance.

Really, risk compensation is not nearly as counterintuitive as it seems upon first exposure. The logic of command-and-control government rules is that most people are mindless robots who are incapable of perceiving incentives, let alone acting in their own interest – but who are capable of following rules laid down by government.  Alternatively, they are docile enough to pay fines ad infinitum after racking up violations. The glaring exceptions are government rule makers, who are well-informed and well-intentioned enough to make the rules that the robots are supposed to follow.

Nothing about actual human behavior suggests that human beings conform to this model. Evidence clearly reveals human beings as rational subject to the informational constrains under which they all labor. The idea that we react to the presence of rules that run counter to our predilections is fully consistent with this picture. It is perfectly clear why OSHA’s rules have “fallen short of expectations” – because OSHA failed to realize that when they force people to obey rules against their will, they take happiness away that people will strive to regain. That is true by definition; that is what “against their will” means.

The Common Sense of the Free-Market Approach to Job Safety

In free markets, workers demand a “wage premium” to reflect the degree of danger or “unsafety” they perceive in a job. They don’t “demand” it by walking into an employer’s office and banging on the desk – they don’t have to. They just work only when and where wages rise sufficiently to compensate them for the risk they bear. This voluntary approach allows the amount of work supplied to equal the amount employers seek at the equilibrium market wage. This contrasts with the approach of labor unions, which creates involuntary unemployment by insisting on a bargained, above-market wage and/or working conditions that employers would not voluntarily provide.

The common sense of the wage premium can be expressed in figurative terms: “In our (workers’) opinion, this wage premium reflects the degree of danger – above the norm or average – that we associate with this job. You (the employer) are free to make any safety modifications in the job or working environment that will cost less than this amount (in the aggregate), but beware of spending more than this. Meanwhile, we have freely chosen to accept the currently-existing risks – as we perceive them.”

This provides a framework for efficient improvements in job safety. Without it, we are left with vague, grandiose rhetoric about how “nothing less than absolute safety is tolerable for our workers” or “how would you like your son or daughter to work in such an environment.” That kind of nebulous talk is complete rubbish. Every human being willingly takes risks every day of their lives, consciously or not. One of the most important parts of growing up is learning the risks of everyday life – which ones are necessary, which ones are reasonable and which ones are foolish. It makes no sense whatever to whine that people “shouldn’t have to risk their lives mining coal” so “big corporations can make profits.” Does it make sense to say that people can willingly risk their lives climbing mountains, fighting bulls, racing automobiles, jumping out of planes, fighting fires and so on – but they can’t risk their lives to keep people warm in the winter? Free markets allow the individuals directly concerned – workers, employers and consumers – to gauge the risks and calculate which improvements in safety are worth making and which aren’t. It recruits the people most willing and able to bear risk by offering them a premium for their efforts. It warns the timid by differentiating jobs according to risk – if all jobs paid the same a tedious and dangerous process of trial and error would be required to learn which jobs they should avoid.

Contrast this reasoned, rational approach with that of government regulatory agencies. They substitute their own technological, engineering view of safety for the free-market approach and impose it on the public in the form of command-and-control, one-size-fits-all, take-it-or-leave-the-country rules and regulations. One might reply that engineers have a more informed view of safety than do workers and employers. Yet research by leading experts like W. Kip Viscusi shows that market wage premia closely track technological and ex post statisticalmeasures of risk. And the government approach runs the risk of being skewed by politics; the regulatory agency’s objective studies may be overridden by a determination to please their bosses in the administration or Congressional patrons upon whom their funding depends.

The final word belongs to formal logic, which declares that there is no such thing as a pure engineering optimum in resource allocation. An engineer can determine (say) the optimum output from given inputs into a particular machine, but he or she can never determine the value to place on the inputs or output. Only producers and consumers can do that; that is why we need markets to solve economic problems. The formaldehyde case, noted above, shows the ghastly extremes to which engineers and bureaucracy can go when given free rein.

How is Job Safety Produced?

Our investigation reveals that job safety is produced primarily by free markets through wage premia and voluntary improvements in safety enacted by employers. It is produced much less efficiently, less productively and more haphazardly by government and even less proficiently by the actions of labor unions.