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

An Access Advertising EconBrief:

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.