DRI-319 for week of 6-22-14: Redskins Bite the Dust – and So Do Free Markets

An Access Advertising EconBrief:

Redskins Bite the Dust – and So Do Free Markets

The Trials and Appeals Board (TTAB) of the United States Patent and Trademark Office (USPTO) recently suspended validity of the trademarks previously held by the Washington Redskins professional football team of the National Football League (NFL). The legal meaning of this action is actually much more complex than public opinion would have us believe. The importance of this action transcends its technical legal meaning, however. If we can believe polls taken to test public reaction to the case, 83% of the American public disapproves of the decision. They, too, sense that there is more at stake her than merely the letter of the law.

The Letter of the Law – and Other Letters

The federal Lanham Trademark Act of 1946 forbids the registration of “any marks that may disparage persons or bring them into contempt or disrepute.” That wording forms the basis for the current suit filed by a group of young Native American plaintiffs in 2006. The hearing was held before TTAB in March, 2013. This week the judges issued a 99-page opinion cancelling each of the 6 different trademark registrations of the name “REDSKINS” and the Redskins’ logo, an Indian brave’s head in silhouette with topknot highlighted on the left. The decision called the trademarks “disparaging to Native Americans at the respective times they were registered.” The wording was necessary to the verdict; indeed, the dissenting judge in the panel’s 2-1 ruling claimed that the majority failed to prove that the registrations were contemporaneously disparaging.

This was not the first attempt to invalidate the Redskins trademarks – far from it. The previous try came in 1999 when the TTAB also ruled against the team. That ruling was overturned on appeal. The grounds for rejection were both technical and substantive. The judges noted that the plaintiffs were well over the minimum filing age of 18 and that the registrations went as far back as the 1930s. Thus, the plaintiffs had undermined their claim to standing by failing to exercise their rights to sue earlier – if the trademarks were known to have been such an egregious slur, why hadn’t plaintiffs acted sooner? The plaintiffs also cited a resolution by the National Congress of American Indians in 1993 that denounced the name as offensive. The Congress claimed to represent 30% of all Native Americans, which the judges found insufficiently “substantial” to constitute a validation of plaintiffs’ claim.

Meanwhile, an AnnenbergPublicPolicyCenter poll found in 2004 that “90% of Native Americans [polled] said the name didn’t bother them,” as reported in the Washington Post. Team owner Daniel Snyder’s consistent position is that he will “never” change the team name since it was chosen to “honor Native Americans,” the same stand taken by NFL President Roger Goodell. Various Native American interest groups and celebrities, such as 5000-meter Olympic track gold-medalist Billy Mills, have sided with the plaintiffs. Senate Majority Leader Harry Reid jumped at the chance to play a race card, calling the team name a “racial slur” that “disparages the American people” (!?). He vows to boycott Redskins’ games until the name is changed. Roughly half his Senate colleagues sent a letter to the team demanding a name change.

The Practical Effects of the Ruling

Numerous popular sources have opined that anybody is now “free” to use the name “Redskins” for commercial purposes without repercussions. Several lawyers have pointed out that this is not true. For one thing, this latest decision is subject to judicial review just as were previous ones. Secondly, it affects only the federal registration status of the trademarks, not the right to the name. The enforceability of the trademark itself still holds under common law, state law and even federal law as outlined in the Lanham Act. The law of trademark itself takes into account such concepts as “pervasiveness of use,” which reflects actual commercial practice. In this case, the name has been in widespread use by the team for over 80 years, which gives it a strong de facto claim. (If that sounds confusing, join the club.) Finally, the appeals process itself takes at least two years to play out, so even the registration status will not change officially for awhile.

Thus, the primary impact of the ruling will be on public relations in the short run. The same commentators who cast doubt on the final result still urge Daniel Snyder to take some sort of token action – set up a foundation to benefit Native Americans, for instance – to establish his bona fides as a non-racist and lover of Native Americans.

Why the Law is an Ass

There are times when you’re right and you know why you’re right. There are other times when you’re right and you know you’re right, but you can’t quite explain why you’re right. The general public is not made up of lawyers. If judges say the trademark registrations are illegal, the public is prepared to grant it. But, like Charles Dickens’ character Mr. Bumble, they insist that the law is an ass. They just can’t demonstrate why.

The provision in the Lanham Act against disparaging trademarks is the kind of legal measure that governments love to pass. It sounds both universally desirable and utterly innocuous. Disparaging people and holding them up to ridicule and contempt is a bad thing, isn’t it? We’re against that, aren’t we? So why not pass a law against it – in effect – by forbidding disparaging trademarks. In 1946, when the Lanham Act passed, governments were big on passing laws that were little more than joint resolutions. The Employment Act of 1946, for example, committed the federal government to achieving “maximum employment, purchasing power and income.” There is no objective way to define these things and lawmakers didn’t try – they just passed the law as a way to show the whole world that they were really, really serious about doing good, not just kidding around the way legislatures usually are. Oh, and by the way, any time they needed an excuse for spending a huge wad of the taxpayers’ money, they now had one. (Besides, before the war a famous economist had said that it was all right to spend more money than you had.)

The law against disparaging trademarks was passed in the same ebullient mood as was the Employment Act of 1946. Government doesn’t actually have the power to guarantee maximum employment or income or purchasing power and it also doesn’t have the power to objectively identify disparagement. Unlike beauty, a slur is not in the eye of the beholder. It is in the brain of the author; it is subjective because it depends on intent. Men often call each other “bastard” or “son of a bitch”; each can be either deadly serious invective or completely frivolous, depending on the context. The infamous “n-word,” so taboo that it dare not speak its name, is in fact used by blacks toward each other routinely. It can be either a casual form of address or a form of disparagement and contempt – depending on the intent of the user.

Everybody – including even Native Americans – knows that Washington football team owner George Preston Marshall, one of the legendary patriarchs of the NFL, did not choose the team name “Redskins” in order to disparage Native Americans or hold up to ridicule or contempt. He chose it to emphasize the fighting and competitive qualities he wanted the team to exemplify, because Indians in the old West were known as fierce, formidable fighters. Whether he actually meant to honor Native Americans or merely to trade on their reputation is open to debate, but it is an open-and-shut, 100%, Good-Housekeeping-seal-of-approval-certified certainty that he was not using the word “Redskins” as a slur. Why? Because by doing so he would have been committing commercial suicide by slandering his own team, that’s why.

That brings us to the second area resemblance of between the Lanham Act and the Employment Act of 1946. The Employment Act was unnecessary because free markets when left to their own devices already do the best job of promoting high incomes, low unemployment and strong purchasing power than can be done. And free markets are the best guarantee against the use of disparaging trademarks, because the inherent purpose of a trademark is to promote identification with the business. Who wants their business identified with a slur? We don’t need a huge bureaucracy devoted to the business of rooting out and eradicating business trademarks that are really slurs. Free markets do that job automatically by driving offending businesses out of business. Why otherwise would businesses spend so much time and money worrying about public relations and agonizing over names and name changes?

If the only reason for the persistence of legislation like the Employment Act and the Lanham Act were starry-eyed idealism, we could write off them off as the pursuit of perfect justice, the attempt to make government write checks it can’t cover in the figurative sense as well as the financial. Idealism may explain the origin of these laws but not their persistence long after their imposture has been exposed.

Absolute Democracy

By coincidence, another political-correctness scandal competed with the Redskins trademark revocation for headlines. The story was first reported as follows: A 3-year-old girl suffered disfiguring facial bites by three dogs (allegedly “pit bulls”). She was taken to a Kentucky Fried Chicken franchise by a parent, where she was asked to leave, after an order was placed for her favorite meal of sweet tea and mashed potatoes, because her presence was “disrupting the other customers.” Her relatives took this story of “discrimination” to the news media.

Representatives of the parent corporation were guarded in their reaction to the accusation, but unreserved in the sympathy they expressed for the girl. They promised a donation of $30,000.00 to aid in treatment of her injuries and for her future welfare. They also promised to follow up to confirm what actually happened at the store.

What actually happened, according to their follow-up investigation, was nothing. This was the result of their internal probe and a probe by an independent company they hired to do its own investigation. Review of the store’s surveillance tape showed no sign of the girl or her relatives on the day in question. A review of transactions showed no order for “sweet tea and mashed potatoes” on that day, either. KFC released a finding that the incident was a hoax, a conclusion that was disputed by another relative of the girl who was not one of those supposedly present at the incident.

Perhaps the most significant part of this episode is that KFC did not retract their promise of a $30,000.00 donation to the girl – despite their announced finding that her relatives had perpetrated a hoax against the corporation.

The Redskins trademark case and the apparent KFC hoax are related by the desire of interested parties to use political correctness as a cover for extracting money using the legal system. Pecuniary extortion is crudely obvious in the KFC case; $30,000 is the blackmail that company officials are willing to pay to avoid being crucified in a public-relations scandal manufactured out of nothing.

Their investigation was aimed at avoiding a charge of “discrimination” against the girl, which might have resulted in a six- or seven-figure lawsuit and an even-worse PR scandal. But their willingness to pay blackmail suggests an indifference to the problem of “moral hazard,” something that clearly influences Daniel Snyder’s decision not to change the Redskins’ team name. Willingness to pay encourages more blackmail; changing the team name encourages more meddling by activists.

The Redskins case is more subtle. Commentators stress that plaintiffs are unlikely to prevail on the legal merits, but doubt that the team can stand the continuous heat put on it by the PR blowtorch lit by the TTAB verdict. That is where the money comes in – owner Daniel Snyder will have to pony up enough money to the various Native American interest groups to buy their silence. Of course, this will be spun by both sides as a cultural contribution, meant to make reparations for our history of injustice and brutality to the Native American, and so on.

Of course, Snyder may turn out to be as good as his word; he may never agree to change the Redskins’ team name. The NFL – either the Commissioner or the other owners exerting their influence – may step in and force a name change. Or Snyder may even sell the team rather than be forced to change their name against his will. That would leave the plaintiffs and Native American interest groups out in the cold – financially speaking. Does that invalidate the economic theory of absolute democracy as applied to this case?

No. Plaintiffs stand to benefit in an alternative manner. Instead of gaining monetary compensation for their efforts, they would earn psychological (psychic) utility. From everyday observation, as well as our own inner grasp of human nature, we realize that some people who cannot achieve nevertheless earn psychic pleasure from thwarting the achievements of others. In this particular case, the prospective psychic gains earned by some Native Americans from overturning the Redskins name and the prospective monetary gains earned from blackmailing the Redskins’ owner are substitute goods; the favorable verdict handed down by TTAB makes it odds-on that that one or the other will be enjoyed.

This substitution potential is responsible for the rise and continued popularity of the doctrine of political correctness. “Race hustlers” like Jesse Jackson and Al Sharpton have earned handsome financial rewards for themselves and/or clients by demonizing innocuous words and deeds of whites as “racist.” What is seldom recognized, though, is the fact that their popularity among blacks at large is owed to the psychic rewards they confer upon the rank-and-file. When (let us say) a white English teacher is demoted or fired for teaching the wrong work by Mark Twain or Joseph Conrad, followers of Jackson and Sharpton delight. They know full well that the exercise is a con – that is the point. They feel empowered by the fact that they may freely use the n-word while whites are prevented from doing so. Indeed, this is simply a reversal of the scenario under Jim Crow, when blacks were forced to the back of the bus or to restricted drinking fountains. In both cases, the power of the law is used to earn psychic rewards by imposing psychic losses on others.

Legal action was necessary in the Redskins’ case because plaintiffs were bucking an institution that had been validated by the free market. The Washington Redskins have over 80 years of marketplace success on their record; the free market refused to punish their so-called slur against Native Americans. In fact, the better case is that the team has rehabilitated the connotation of the word “redskins” through its success on the field and its continuing visibility in the nation’s capital. Goodness knows, countless words have undergone this sort of metamorphosis, changing from insults to terms of honor.

When plaintiffs could not prevail through honest persuasion they adopted the modern American method – they turned to legal force. However tempting it might be to associate this tactic exclusively with the political correctness of the left, the truth is that it is the means of first resort for conservatives as well. That is the seeming paradox of absolute democracy, which represents the dictatorship of the law over free choice.

Inevitably, advocates of political correctness cite necessity as their justification. The free market is not free and does not work, so the government must step in. The planted axioms – that free markets usually fail while governments always work – are nearly 180 degrees out of phase. The failures of government highlight our daily lives, but the successes of the free market tend to be taken for granted. The famous episode of Little Black Sambo and its epilogue serves as a reminder.

The Little Black Sambo stories and Sambo Restaurants

The character of Little Black Sambo and the stories about him have been redefined by their detractors – that is to say, demonized as racist caricatures that dehumanize and degrade American blacks. This is false. In the first place, the original character of Little Black Sambo, as first portrayed in stories written in the late 19th and early 20th centuries, was Tamil (Indian or Sri Lankan) – a reflection of the ecumenical reach exerted by the term “black” in those days. Eventually, the character was adapted to many nationalities and ethnic identities, including not only American black but also Japanese. (Indeed, he remains today a hero to children of Japan, who remain blissfully untouched by the political correctness familiar to Americans.) This is not surprising, since the stories portray a little boy whose heroic perseverance in the face of obstacles is an imperishable life lesson. Presumably, that is why the stories are among the bestselling children’s storybooks of all time.

When American versions of the story portrayed Little Black Sambo as an American or African black, this eventually caught the eye of disapproving blacks like the poet Langston Hughes, who called the picture-book depiction a classic case of the “pickaninny” stereotype. Defenders of the stories noted that when the single word “black” was removed and any similarity to American or African blacks deleted from the illustrations, the stories attracted no charges of racism. Yet black interest groups echoed the psychologist Alvin Poussaint, who claimed that “I just don’t see how I can get past the title and what it means,” regardless of any merit the stories might contain. The storybooks disappeared from schools, nurseries and libraries.

In 1957, two restaurant owners in Santa Barbara, CA, opened a casual restaurant serving ethnic American food. In the manner of countless others, they chose a name that combined their two nicknames, “Sam” (Sam Battistone) and “Bo” (Newell Bohnett). Over time, Sambo’s Restaurant’s popularity encouraged them to franchise their concept. It grew into a nationwide company with 1,117 locations. Many of these were decorated with pictures and statuary that borrowed from the imagery of the “Little Black Sambo” stories.

The restaurants were a marketplace success, based on their food, service and ambience. But in the 1970s, black interest groups began raising objections to the use of the “Sambo” name and imagery, calling it – you guessed it – racist. Defenders of the franchise cited the value and longstanding popularity of the stories. They noted the success and popularity of the restaurants. All to no avail. By 1981, the franchising corporation was bankrupt. Today, only the original Santa Barbara location remains.

This was certainly not a victory for truth and justice. But it was a victory for the American way – that is, the true American way of free markets. Opponents of Sambo’s Restaurants went to the court of public opinion and made their case. Odious though it seemed to patrons of the restaurants, the opponents won out.

So much for the notion that free markets are rigged against political correctness. In the case of Sambo’s Restaurants, people concluded that the name tended to stigmatize blacks and they voluntarily chose not to patronize the restaurants. The restaurants went out of business. This was the appropriate way to reach this outcome because the people who were benefitting from the restaurants decided that the costs of production outweighed the benefits, and chose to forego those benefits. The decisive factor was that bigotry was (apparently) a cost of production.

Instead of achieving their aim through legal coercion or blackmail, activists achieved it through voluntary persuasion. Alas, that lesson has now been forgotten by both the political Left and Right.

DRI-305 for week of 3-17-13: What is Behind the New ‘Sharing Economy?’

An Access Advertising EconBrief:

What is Behind the New ‘Sharing Economy?’

The once-distinguished British weekly The Economist highlights a new Web-based economic phenomenon in a recent (03/9-15/2013) issue. The name assigned by the magazine to this activity is the “sharing economy” – a dreadful misnomer that conjures up images of 60s counterculture and communes. But however misnamed, the transactions it denotes are a sign that cannot be ignored.

In his Wealth of Nations, Adam Smith explained the growth of markets by citing man’s innate “propensity to truck, barter and exchange.” Ever since, these words have received both veneration and ridicule. Smith’s admirers saw in them a beautifully realized portrait of human nature. Opponents of free markets have scoffed. They long since rejected whatever validity Smith’s “higgling and haggling of the marketplace” might have had in favor of Thorstein Veblen’s picture of “shadowy figures moving in the background;” they see corporate power, not voluntary exchange, as the dominant motif in the market. Since 2008, the Left has pooh-poohed the notion of rational choice by citing the financial collapse as proof of the irrationality of crowds and the infeasibility of deregulated markets.

But now comes The Economist to point out that even as world financial markets were imploding, unregulated private markets were springing up to enrich the daily lives of billions of the world’s citizens. Alas, the magazine itself misses the significance of its own reporting.

The “Peer-to-Peer” Rental Market

Every night some 40,000 people around the world rent rooms from a service that operates throughout the world – 192 countries, 250,000 rooms in 30,000 cities. The customers choose their rooms and pay online. But the provider is not a commercial business chain like Hilton, Marriott or even Motel 6. Instead, a San Francisco-based firm called Airbnb matches up customers with rooms in homes owned by private individuals. The company has operated since 2008, attracting roughly 4 million customers. Room renters choose and pay for their rooms online.

This is perhaps the largest business in the “peer to peer” rental market. Individual consumers rent assets like beds, boats, and cars directly from other individuals rather than from businesses. The rationale for these practices is quite straightforward. You may wish to cut your automotive transportation costs by earning income from giving rides to people whose destinations coincide with yours. Or, viewing the same situation from the other side of the market, you may wish to cut your costs by paying a peer to chauffeur you to a common destination rather than calling a taxi or riding the bus.

Boat ownership is commonly likened to owning a hole in the water into which you pour money. One way to offset this outflow is to rent the use of the boat to peers. The intermediary and clearinghouse for all this activity is the World Wide Web.

Observing and noting this market is easier than pinning a descriptive label on it. The Economist calls it “the sharing economy.” This is surely wrongheaded, if only because we do not associate “sharing” with commercial transactions. Carpooling arrangements, for example, involve a spatial arrangement for the pooling of transportation services. Participants “share” a common space inside a single vehicle for the purpose of reducing joint transportation expenses. But each vehicle’s owner is commonly responsible for fuel purchases. Pooling equalizes travel responsibilities and costs among participants; the net exposure should be zero. The benefits are symmetrical, both in quantity and kind. This is sharing in a true, meaningful sense; the benefits are objectively equal and depend on the shared use.

Charity is another conventional form of benefit sharing. The owner of income or assets shares it (them) with others with no reciprocation except, perhaps, a “thank you.” The mutuality derives from the satisfaction gained through helping.

But the peer-to-peer market is simple commerce, unlike the genuine sharing examples just cited. There is an exchange of money for goods-or-services. The buyer gains the usual consumer surplus – the excess of the maximum price he or she would have been willing to pay over the price actually paid. The seller gains better utilization of existing capacity, whether the capital good is a personal automobile, spare bedroom or pleasure boat. Sellers are no more “sharing” than are taxi drivers, motel owners or charter-boat skippers. Indeed, a better descriptor would be the “utilization” or “capital-utilization” economy. Of course, this clinical language lacks the warm and fuzzy feel of “sharing” but it compensates in accuracy.

The Economist also tosses out the term “collaborative consumption,” which is just as inapropo as “sharing.” Fairness and full disclosure require noting that the terms “sharing economy” and “collaborative consumption” date back several years. They are particularly associated with left-wing authors like Rachel Botsman, whose communitarian views are hostile to capitalism and private property. But The Economist, of all publications, should know that private ownership is essential to the preservation and maintenance of capital goods, without which the peer-to-peer market would vanish into thin air.

Come to think of it, why not follow current buzzword practice and adopt digital vernacular, using The Economist‘s own phrasing? Call it the P2P market.

The Key Role of the Internet

Where has this new economy been all our lives? Did it take over a century for people to wake up to the possibility of using their cars as taxis or rental cars? Was there an epiphany, a la Bell and Watson, when a restaurant habitué decided he could pay his bill by ferrying his fellow diners back and forth for a fee?

Actually, P2P has been operating in the background all along. It ran on word-of-mouth or classified advertising, using referrals as its primary security. This guaranteed that its importance would remain marginal. It took the Internet to turn it into a $26 billion annual, growing enterprise.

First, the Internet gave P2P the reach it lacked heretofore, allowing sellers to reach an unlimited audience at extremely low cost. Second, the Internet provided the security necessary to both sides of the market. For example, taxi drivers lead a notoriously precarious existence at the mercy of their passengers. But insecurity runs in both directions when the driver is not a business owner or employee, operating a highly visible vehicle. On the Web, though, the platform fulfills the role otherwise played by the business in vouching for its representatives. Follow-up reviews and ratings ensure that bad trips are not repeated.

The surest sign that P2P really works is that commercial businesses want a piece of the action. The Economist reports that Avis, GM and Daimler have all acquired their own piece of P2P; e.g., acquired P2P assets or entered the market de novo. The magazine speculates that the acquisition may enable the parent to list its excess capacity-assets on the P2P firm’s website. This looks like a clear case of evolutionary adaptation rather than creative destruction; P2P does not rate to destroy its competing industries but rather to modify their operations for the better.

Last April, The Wall Street Journal reported on the hottest extension of P2P in the financial realm – P2P lending. For roughly a decade, at least two P2P firms – Prosper Loans and Lenders Club – have offered individuals a chance to lend directly to their peers. The loans are extended versions of the payday/high risk loan that has long been a staple of the low-income and pawn-loan credit market. These P2P loans have terms of up to five years and principal amounts ranging up to $25-35,000. They are unsecured and assigned a risk rating based on the borrower’s creditworthiness.

The success of these P2P firms has now attracted the attention of Wall Street. Fund managers have started funds organized along similar lines, offering investors the chance to pool investment capital into funds offering the same types of high-risk, unsecured loans. Risk spreading and high returns make these funds an attractive alternative to current low-yield, fixed-income investments. The high risk means that their fraction of the total portfolio should be low. Naturally, the increase in lending activity will improve terms and outcomes for borrowers.

Lessons Learned

Even if we accept that P2P is an adaptive rather than a disruptive force, this should not obscure the powerful message it conveys. The rise of P2P overturns the conventional thinking that had prevailed since the financial crisis of 2008 and the ensuing global recession. That dominant view has been that market participants do not act rationally. They act emotionally, even hysterically. They are stampeded by mob psychology and incapable of gauging their own interests. Without the wise guiding hand of government regulation, free markets will inevitably devolve into chaos.

To be sure, this view is itself hysterical. It offers no clue as to why or how regulators themselves escape the emotional distractions that sway market participants. It doesn’t explain how regulators regulate markets without actually substituting their own decisions for those of markets. It also doesn’t tell us how regulators are able to perceive the interests of market participants who (supposedly) cannot discern their own interests. Nonetheless, this regulatory view won out (essentially by default) in 2008-2009.

Every major regulatory agency in Washington – OSHA, EPA, FDA, SEC, FTC, DOT, DOE, FMCSA, et al – has presided over a reign of terror for the last four years. If federal-government regulation were the key to safety, America would now be the safest nation on Earth by far. There is no logical or empirical case for this regulatory full-court press, other than the fact that the Democrats won the last two Presidential elections and the Republicans did not. Still, asking Democrats not to regulate is like asking a horse not to eat hay.

P2P offers the perfect test case for the new conventional thinking. Here we have both supply and demand sides essentially pioneering a new market all by themselves. According to today’s party line, this is a sure-fire recipe for disaster. After all, taxi regulators in New York
City have spent decades warning consumers to beware of “gypsy [unregulated] taxicabs.” Riders might be placing themselves in the hands of robbers, rapists or even worse. Unfortunately, New York City hasn’t approved the issue of a single new taxi license (they are issued in the form of medallions) since World War II, so its citizens have conditioned themselves to ignore these admonitions. They actually want to get somewhere without waiting for a bus or walking. Well, if an unregulated commercial vehicle is this unsafe, just imagine how risky P2P must be!

No, according to The Economist, “the remarkable thing is how well the system usually works.” Then again, P2P “is a little like online shopping,” where “15 years ago…people were worried about security. But having made a successful purchase from, say, Amazon, they felt safe buying elsewhere.” And there was eBay, which began essentially as P2P and morphed into a vehicle for professional sellers.

Well, gol-l-l-l-l-e-e, Sgt. Carter, could it be that old Adam Smith was right – not just about mankind’s inherent affinity for trade but also about the self-adjusting character of mutually beneficial voluntary exchange? So it would seem.

Yet The Economist‘s liberal knee cannot help jerking towards regulation. “The main worry,” they declare gravely, “is regulatory uncertainty.” Yes, politicians in America have cast lascivious glances at Internet trade for years, longing to tax it under a guise of benevolent regulation. Since The Economist sails under the banner of …er, economics – where a tax discourages the taxed activity, creates a welfare burden and reduces the well-being of the taxed – it should come out forthrightly against Internet taxation, right?

Wrong. “People who rent out rooms should pay tax, of course [of course!], but they should not be regulated like a Ritz-Carlton hotel. The lighter rules that typically govern bed-and-breakfasts are more than adequate.” Mere readers – being only consumers, humble recipients of The Economist‘s sunbursts of illumination – needn’t expect any illuminating insight on why tighter regulation of Ritz-Carltons is either necessary or beneficial, because none is forthcoming. The editorial’s anonymous author has the wit to notice that incumbent taxi firms are even now mobilizing the forces of regulation to protect their monopoly position. But the magazine’s leftist editorial stance is so ossified that it cannot permit that admission without an accompanying qualification that “some rules need to be updated to protect consumers from harm.” Taxicab regulation is probably the most notorious textbook example of regulatory harm to consumers in the history of economics, but The Economist is bowing its knee to it. (Elsewhere, the magazine laments the absence of even more Keynesian stimulus spending policies to create jobs.)

This is an old story. A precursor to P2P sprang up in black communities throughout the U.S. during the early and mid-20th century. Taxicab service was often sparse in these areas, not merely because of racial discrimination but also because high crime posed serious risks to drivers. Taxi regulation typically prevented black taxicab companies from entering the market or expanding to meet demand. It became common practice for private individuals to frequent grocery stores, barber shops and other high-traffic areas in order to provide “car service.” This service consisted of informal, unmetered charges (sometimes on a flat-rate basis) in return for carriage to and from shoppers’ homes. Carrying of bags and escort duties were usually included in the service.

Researchers have applied the term “jitneys” to the unregistered, unlicensed vehicles used to provide this service. Research is conclusive on two points: Consumers benefitted unambiguously from the service, and jitneys were legally hounded by taxi and bus companies in their jurisdictions. They were made illegal because taxi and bus owners feared and resented the competition and loss of income that this low-cost alternative form of transportation inflicted on them. Amazingly, jitneys still survive today in inner-city America; they are the “missing link” connecting modern P2P with its ancestral forebears.

When the worst that The Economist can cite is that “an Airbnb user had her apartment trashed in 2011,” you can rest assured that today’s P2P system is working extraordinarily well. It is a measure of our times that even a single complaint instantly triggers the demand for more regulation. When abuses occur despite the presence of tight, heavy regulation – as in financial markets – it should be clear that regulation is the problem rather than the solution. When complaints are rare, it hardly suggests a need for regulation.

The word “regulation” itself has become a rhetorical refuge of first resort precisely because its meaning is so vague. There is no clear-cut theory of regulation to explain why it is necessary, exactly what it does or how it does it. To a bureaucrat, this may constitute a highly desirable sort of flexibility. But it is not conducive to favorable outcomes.

All the News That’s Fit to Decode

Readers of The Economist should probably be grateful that the magazine deigned to notice P2P at all. The fact that we have to hack our way through the magazine’s ideological bias and occupational ineptitude to glean any value from the article is a journalistic scandal. Still, these days students of economics have to take our good news where we find it and our sources as we find them.

DRI-221 for week of 11-25-12: Free-Market Environmentalism

An Access Advertising EconBrief:

Free-Market Environmentalism

Stop a random passerby on the street and ask: “What are the three most important functions of government?” One of the answers would surely be: “To protect the environment.” Ask a sample of academicians “Why can’t we simply step back and allow markets to work freely and without interference by government?” and the leading answer would probably be: “Because the adverse effects on the environment would be too numerous and large.” Ask anybody what the biggest threat to the environment is and the answer will probably be something on the order of: “Greedy corporations and businessmen.”

The linkage between free markets and the physical environment may be the most misunderstood relationship in all of economics. It is often overlooked even by professional economists. To the general public, it is a complete mystery.

The Roster of Environmental Disaster

If government action is required – or thought to be required – to protect the environment against disaster, what kind of disaster is in prospect? A backward glance at history supplies various cases and kinds of environmental disaster. Industrial society has inflicted atmospheric pollutants on the air, producing high levels of smog, ozone and particulates in major cities like Los Angeles, Chicago, London, Tokyo, Bombay, Shanghai and St. Petersburg. Cities and towns have polluted water sources by allowing raw sewage to drain directly into them. Dumps and landfills have accumulated unsafe levels of toxins through careless disposal of waste products.

Pollution is not the only type of environmental damage. Land has been abused in myriad ways – through over-cultivation, over-grazing and over-fertilization. Aside from pollution, water has been overused and misused. It has also suffered damage at its sources. Although the process of evolution features extinction as an integral element, living species have been driven to or near extinction by human beings acting outside the boundaries of nature.

Americans have been schooled in the lore of these disasters. The extinction of the North American passenger pigeon in the 19th century, the near-extermination of the bison and the virtual disappearance of the wolf and the bald eagle are the staples of schoolbooks. Likewise the fate of the Dust Bowl in the 1930s and the problems of Southern farming prior to the development of crop rotation methods. Less well-known but no less telling are contemporary abuses resulting from Western cattle ranges and federal farm subsidies.

Virtually all of these examples are given a stylized narrative in which greed and capitalism are faulted. Heedless, bloated industrialists created pollution in order to fatten their profits while blackening the lungs of little children. Eastern meat-packers killed off the passenger pigeon. Rapacious buffalo hunters and their railroad bosses nearly did in the buffalo, ruining the civilization of the American Indian as a consequence. Farmers were too greedy; they should have settled for lower profits and planted fewer crops so as not to overwork the land.

The problem with these explanations is that they are morality tales rather than logical sequences. They provide no clue as to how disaster might have been avoided other than “make bad men with bad motives do good things instead.” The real story of past environmental disaster and prospective environmental policy incorporates the role played by markets and two key free-market institutions – property rights and prices. Disaster ensues when both of these are missing.

The Tragedy of the Commons

Ecologist Garrett Hardin is credited with enunciating the principle of the tragedy of the commons. Passenger pigeons and bison were not privately owned resources; they were a common resource, available to all at no nominal charge. Private owners would have realized that the cost of allowing animal numbers to dwindle below the reproduction point was prohibitive, but in a commons nobody takes that cost into account.

It is important to realize that the “tragedy” had nothing to do with morality per se and everything to do with the institutional framework in which consumption occurs. Pious, religious people; socialists; conservatives; libertarians – everybody behaves pretty much the same when faced with a commons. And they behave similarly in a free-market environment as well.

Property Rights and the Environment

A right to property is embedded in free-market economics and political philosophy. It dates to John Locke and Adam Smith and the founding fathers of the United States. In order to be effective, property rights must include not only ownership, but also the right to control the use and disposal of property. These guarantee that the rights holder has an incentive to protect and conserve the value of the property, which is a (potentially) valuable asset.

Americans have consumed vast annual quantities of beef for well over a century. Why did the comparatively modest demand for passenger pigeons suffice to eradicate them while cattle thrive despite the enormous demand for beef? Cattle are owned; their owners insure that breeding stock survive to reproduce the breeds and maintain the tremendous investment of the owners. Passenger pigeons had no owners; hunters had no practical option but to maximize their kill to get the most out of the limited supply while it lasted. Nobody derived specific benefit from preserving the species, so it vanished.

The bison were well on the way to a similar fate until the conservation movement – the precursor of environmentalism – stepped in, led by Teddy Roosevelt. The public sector barely managed to preserve a precarious survival for the bison until the private sector began commercially harvesting the animal, thus guaranteeing the survival of the species. The bald eagle and wolf were once threatened by hunters, not for their meat but to protect them from taking privately owned animals as prey. Their existence continues to be precarious despite their so-called “protected status” as “endangered species.” Why? Because they have no owners; nobody has a vested economic interest in their survival, only in their extermination. True, they have defenders who are emotionally committed to their well-being, but history and logic tell us that emotion is no substitute for economics.

The clinching argument for property rights as the key to environmental protection was made in Africa, not America. In 1990, economist Tyler Cowen noted that Africa had long struggled with the problem of elephant poaching by hunters. Because the African elephant was rapidly nearly extinction, hunting was banned on the continent. But ivory from elephant tusks was prized throughout Asia for various uses ranging from piano keys to billiard balls to aphrodisiacs. Poachers were willing to flout the law to get ivory for the lucrative black market, and African governments were reluctant to devote the substantial resources necessary to police vast land areas merely in order to save a small population of elephants whose value was merely symbolic and emotional.

In 1979, some African countries began allowing private ownership and commercial harvesting of elephants. Sure enough, elephant populations in countries allowing private property rights in elephants – Zimbabwe, Malawi, Namibia and Botswana – grew to robust levels. Owners had the motivation necessary to protect and breed their elephants. They also had the advantage of having to police only their own delimited property lines. Meanwhile, neighboring countries that did not allow private property rights – Kenya, Tanzania and Uganda, among others – saw continual declines. Kenya’s elephant population fell from 140,000 at the start of its hunting ban to 16,000 as of 1990. From 1970 to 1990, Tanzania’s population fell from 250,000 to 61,000; Uganda’s fell from 20,000 to 1,600.

Today, the principle is well-recognized in its application to ocean fisheries, which are threatened by depletion because they are mostly a public commons rather than protected by private ownership. Large areas of Africa feature barren terrain interspersed with healthy grasslands. The grasslands are privately owned; the barren spots are public lands that have been reduced to desert by over-grazing of nomadic herds. Public roads are the most familiar negative case of the commons and property rights at work, although they are seldom recognized as such. Because roads are publicly owned, nobody owns them. Everybody has an incentive to use them at will and without taking costs imposed on others into account. The inevitable result is rush-hour congestion and gridlock. An owner, though, would not allow that state of affairs to persist. That brings us to the other vital element of free-market environmentalism: prices.

A Price is Right

People react badly to the idea of private ownership because they believe that a private owner will somehow hoard or guard a resource “for themselves.” But it will very seldom be in the owner’s interest to prevent exploitation of a resource, simply because public demand will make it worthwhile to make it available. Because the resource has long-term value, the owner will want to use it only to the extent, and in such a way that, the long-term value is preserved. This notion is strikingly congruent with the idea of “conservation” that formed the original basis of the environmental movement.

Limitation of usage implies limitation of demand. The classic means to this end is charging a price for usage, which rewards the owner while signaling to the user that the resource is limited in quantity. Higher prices limit demand more effectively than lower prices; whether they are more rewarding to the owner technically depends on the price-elasticity of demand, or the responsiveness of buyer demand to changes in price when the other determinants of demand (income, tastes, prices of substitute and complementary goods) are unchanged.

Once again, people instinctively react against paying a price for goods and services. “Free” sound intuitively preferable. But free is only better in the very rare cases when the goods really were provided at no cost. Sunshine is truly a free good. Tangible goods and most services merit a price because this allows the buyer to compare the expected value received from consumption with the cost of production embodied in the price. (That cost of production will reflect the value of alternative output foregone in the production of the good under consideration.) Politicians who promise us free stuff are doing us no favor, since this merely wastes resources and ultimately gives us less stuff to enjoy.

Because resources in a commons are not owned, they typically do not command a price. Sometimes governments will try to remedy this deficiency by assigning a price of sorts to publicly owned goods, but this price does not reflect the true cost of production and the value of foregone alternative output because the government price is not the outcome of a competitive market. This kind of price – not prices charged by private owners – is the one of which the public should beware.

The failure to charge a (proper) price is the second major source of environmental disaster. For well over a century, municipalities have charged a flat fee for water usage. In effect, this levies an effective price of zero, since the flat fee does not change no matter how many times the consumer turns on the tap. (A true price is marginal, applying to each successive unit purchased.) Consequently, this encourages consumers to use water not only for drinking and bathing, but for washing dishes, cars and dozens of successively lower-valued uses. Meanwhile, the actual production of water requires resources for distribution and purification. Those resources have alternative uses that merit the application of a price tag on each successive unit of water consumed.

Various parts of the western United States, such as the Central Valley in California, would be unsuitable for agriculture without irrigation. The federal government has built dams, diverted streams and distributed water far below cost to farmers. This has enabled the production of crops that would otherwise not be produced. The future survival of the Colorado River, perhaps the key waterway in the southwestern U.S., is imperiled due to repeated impoundment of its waters for use by farmers and ranchers. Because the river is not owned, the farmers and ranchers do not pay a proper price for its use – and the river is on the road to extinction. Not only that, the land is being used in ways for which it is inherently unsuited. This is a classic tragedy of the commons and failure of pricing.

Good Guys and Bad Guys

The simplistic environmentalist tale reduces life to a cinematic conflict between good buys and bad guys, in which the outcome depends on the strength and purity of the participants. Today, American colonists and founders are cast as bad guys who despoiled the purity of the North American wilderness. American Indians are cast as the good guys, the “indigenous peoples” who lived in harmony with nature a la Rousseau. And American frontiersmen did indeed kill game and clear land without concern for the consequences of their actions on the supply.

But so did the Indians. The Plains Indians, for example, routinely migrated throughout a region, killing off buffalo and other game and freely polluting and despoiling land in their immediate vicinity. After all, they had no need to conserve natural resources when their numbers were so tiny in a vast natural preserve the size of North America. When local resources became scarce, they simply moved on. Then as now, economics was the prime mover, not philosophy or morality.

Air Pollution – the Special Case

The reader will have observed the absence of air pollution in the property rights and pricing examples discussed thus far. The logic previously developed explains that. Unlike animals, land and water, air is much less amenable to private ownership. (Nation states assert ownership to “air space,” so clearly the concept of owning air is not infeasible. The trick is to bring it within the private domain.)

Once more, it is tempting to treat the issue of air pollution as a morality tale. And once more, this temptation should be resisted. The world’s worst cases of air pollution are located within the borders of socialist or communist states, ostensibly dedicated to principles of social justice, public ownership and fair shares for all. Air is a classic commons, and the basic principles of property and pricing apply just as strongly to good guys as to bad guys. Indeed, in this context it would seem that the only good guys are those who strive to bring property rights and pricing to the public.

While the general public associates capitalism with pollution, the truth is just the opposite. The most capitalistic countries should be the least-polluting ones in theory and tend to be least-polluting in practice. This agrees with common sense (a quality in short supply among the general public). Capitalism operates under private property. Private owners don’t want to run down the value of their property or allow others to do so; thus, they are averse to pollution. Socialism implies public (i.e., government) ownership, which means the absence of incentive to protect property value and impede polluters. Passing laws to make government responsible does not actually make government responsible – as the old saying goes, who watches the watchers? Consequently, it is not surprising that Soviet Russia and Communist China were the champion polluters of the 20th century. In the U.S., the famous case of Love Canal was originated not by Hooker Chemical Co. but by the government to whom they sold their property, which actually polluted the canal.

The modern-day environmental movement is sometimes dated from the publication of Rachel Carson’s book Silent Spring in 1962. This is the point when the movement changed from emphasizing conservation to promoting a vague, indefinable concept of “the” environment as a holistic entity rather than a collection of heterogeneous elements. Prior to this, the strongest opponents of pollution were libertarian political philosophers like Murray Rothbard – the same people who were also the strongest defenders of free markets and capitalism. These libertarians took a per se approach to air pollution, forbidding it in principle as a violation of property rights.

More recent free-market environmentalist approaches take a different tack, noting that the economic approach is to compare the costs and benefits of any activity. If the benefits of steel production outweigh its costs – even when pollution costs are taken into account – then forbidding steel production in order to cut pollution to zero is too harsh. The idea should not be to ban pollution altogether – it should be to encourage efficient production in which the benefits of the produced output outweigh the costs of production including pollution. When regulating pollution, the emphasis should be on cost-effective pollution abatement. That is, we want to urge producers to find the best, least-costly ways to limit pollution.

In the past, governments have regulated industrial pollution by hiring experts to dictate the “right” ways to produce things, then requiring businesses to follow those rules. But the problem is that this “one-size fits all” approach is very inefficient. As F.A. Hayek noted, free markets are superior because they generate information about “the economics of particular time and place.” Each business should have the freedom to decide the best way to cut pollution based on its own particular circumstances and sources of expertise. Instead of telling businesses how to produce, government should simply tell businesses what outcome to achieve in terms of pollution reduction, and then leave the means of achieving that outcome to them.

Large Numbers and Small

For many years, economists believed that government regulation was the only way to handle all issues involving the environment. Because the existence of a commons entailed costs that a user would never take into account, so the argument went, the action of government was required to bring these costs into play. The cost was called an “externality” because it was external to the calculations of those participating in the non-governmental production and consumption of the good. Government would enter the picture by levying a tax on the good equal to the amount of the externality, thus “internalizing” it and forcing the user to take that cost into account in his or her consumption decisions.

In 1960, law-and-economics specialist Ronald Coase stunned the economics profession by pointing out that, in general, this approach was wrong. The problem was not an externality; the problem was the absence of property rights caused by the commons. The minute property rights are assigned, the rights holder has an incentive to internalize the externality without any interference by government. In fact, this solution is greatly preferred to government action since the property owner will probably know the costs involved while the odds are greatly against government knowing the correct size of the tax necessary or having an incentive to levy it even if it did know. This Coase Theorem eventually (and belatedly) earned Coase the Nobel Prize in economics.

Because the Coase solution will necessitate negotiation between property rights holder and counterparty (property owner and consumer, say), this still leaves air pollution as the hard case. The usual circumstances of industrial pollution involve very large numbers of third parties affected by the pollution. The business owner(s) will find it prohibitively costly to negotiate with each victim individually and the victims will find it too costly to organize in order to negotiate with the business owner. Thus, this “large numbers” case still leaves a role for government as regulator of air pollution.

Not Market Failure – Education Failure

The logic of free-market environmentalism is compelling – so much so that it extends beyond the environmental domain. Specialists in monetary and financial economics have pointed out that the federal government turned banking into a commons through federal insurance programs. The FSLIC and FDIC were ostensibly intended to reduce worry of S&L and bank failures by insuring deposits up to stated values. Unfortunately, this allowed owners of financial institutions to take investment risks beyond the norm because neither they nor the depositors were worried about the consequences – the taxpayers were the ones ultimately on the hook if the S&L or bank went bust due to bad investments. Thus, both the S&L crisis of the early 1980s and the financial crisis of the late 2000s were tragedies of the commons, analogous to the environmental disasters reviewed above.

In view of all this, why isn’t the logic of free-market environmentalism widely known and practiced? The only answer must be that the economics profession, whose members are disproportionately members of and supported by government, has done a deplorable job in educating the public about economics. If economists refuse to teach economics, who can we look to?