DRI-416: ‘Recession Ride Taxi’ is the Epitome of Capitalism

“We are all of us teachers,” was Nobel laureate-economist Milton Friedman’s thumbnail sketch of his profession. Teachers are continually on the lookout for real-life illustrations of their subject. Last week, National Public Radio (NPR) provided a dandy.

Apparently NPR saw no need to interpret its facts with the use of economic logic. Fortunately, we can remedy that monumental oversight.

Eric Hagen’s “Recession Ride Taxi”

In a June 26, 2012 story, NPR introduced its audience to Eric Hagen, a taxicab owner-operator in Burlington, VT. Like many a taxi driver, Hagen traveled a roundabout route to his profession. Laid off his job as a Wall Street banker during the Great Recession, Hagen next worked for the American Red Cross – a job that would presumably earn the approval of Barack Obama and the NPR audience. Unfortunately, it didn’t earn enough money to pay Hagen’s mortgage.

So, like millions of Americans before him, Eric Hagen found himself pushing a hack to pay his bills. But unlike his predecessors, Hagen had both the institutional freedom and the native instincts to sell himself and his service to the public.

For upwards of a century, taxis have priced their services using taxi meters that recorded both mileage and time. Eric Hagen’s method for determining his taxi fares is: “Whatever the passenger can afford.” He names his business “Recession Ride Taxi.” Not surprisingly, his stated business rationale is that many people can’t afford to pay traditional taxi rates because they are experiencing hard times. Listeners are cordially invited to the conclusion that he is being kindly and altruistic by letting each passenger set the fare.

But don’t passengers double-cross him by low-balling their rates – or even stiffing him completely? “People know there’s value in a service,” Hagen replies, “and they’re generally not going to try to get over on you.”

Never has NPR accepted a businessman’s rationale so unblinkingly. “At a time when former colleagues on Wall Street continue to feel public scorn,” the station intoned piously, “Hagen says Recession Ride Taxi is running on trust.”

And Now for the Rest of the Story…

At this point, the late Paul Harvey might have intervened with: “…and now it’s time for the rest of the story.” It begins with the recognition that Hagen is not practicing altruism, but rather the most calculated kind of economic logic. His technique dates back at least to 19th-century railroads and country doctors. Airlines have used it for decades. It underlies the success of Priceline, among other online companies.

It is called price discrimination. A seller charges different prices to different buyers (or groups of buyers) for the same good or service at the same point in time. The different prices are not functionally related to different costs of serving the different buyers or buyer groups.

Why would a seller choose this strategy in preference to the simper one of charging a uniform price to all? To earn larger total revenue and profit. It won’t always be either feasible or desirable to discriminate on the basis of price, but the potential advantage in doing so lies in the possibility that different buyers differ in their sensitivity to price. The term economists use to denote sensitivity to price is price-elasticity of demand.

Two prime sources of demand for taxis in large urban markets are out-of-town visitors (tourists and business travelers) and low-income natives. The visitors have fewer and less satisfactory substitutes for taxi travel and tend to have higher incomes. Thus, they are less sensitive to price and more willing to pay higher prices than are natives, who can acquire their own cars or beg a ride, take a bus or subway or simply walk. In the vernacular, we say that visitors’ demand is more price-inelastic (less price-sensitive). Thus, it is in a taxi owner’s interest to charge differential prices, the higher one being assigned to visitors.

Even within groups of buyers whose price sensitivity is broadly similar, there will still be individual variations in price elasticity. The dream of a taxi owner would be to somehow charge each rider the highest price he or she would be willing to pay for the trip – what the economist calls the reservation price. That would constitute the practice of perfect price discrimination and would result in the maximum collection of revenue. Of course, this is only the stuff of dreams; no seller has enough individualized information about customers to realize their dream.

Now the method in Eric Hagen’s seeming madness starts to take form.

Crazy Like a Fox

The knee-jerk response of most people would be that a seller who allowed his customers to set the price is crazy. But Eric Hagen is really allowing individual customers to tell him what price they will accept – information he can’t get any other way. His modus operandi has the general appearance of a system of perfect price discrimination, except for one thing – he can’t be sure that the price they pick will be their reservation price. In fact, he can be pretty sure it isn’t.

Still, he has gained a great deal compared to the standard, taxi-meter-determined, single-price model. Consider the comments of one regular customer, sous chef Alan Flanders. “I’d be walking to work this morning if it weren’t for Eric.” That sounds pretty extreme, but NPR pointed out that “in most cabs, this ride would cost more than $20.” But because “Hagen takes whatever amount Flanders can afford, today it’s $12.” From the consumer’s standpoint, a 40% discount on a daily commute is a stunning saving.

We have a reflexive tendency to compare the $12 Hagen collects with the $20+ he “could” have collected from a regular taxi-metered ride. Wrong, wrong, wrong. Mr. Flanders makes it clear that at a price of $20, he was walking to work, not taking a taxi. Hagen’s alternative take was $0, not $20+. The genius of Recession Ride Taxi is that it brings customers into the market who otherwise wouldn’t ride taxis at all. A taxicab driver’s competition consists not merely of his fellow cab drivers, if there are any. It also includes subways, buses, shuttles, walkers, self-drivers, people who oblige hitchhikers – every alternative means of transportation. (In Burlington, VT, the second-most-popular commuting method is walking.) His most expensive input isn’t gas or repairs – it is time. His worst enemy is an empty cab.

No wonder that the motto of veteran cab drivers has always been “keep the meter running.” In this case, Eric Hagen has taken that excellent axiom to its logical extreme. He has realized that the best way to keep the meter running is to throw the meter away.

The Implications of Profit Maximization

Not long ago, President Barack Obama made headlines by stating that profit maximization by business owners served their interests at the expense of the general societal interest. This has long been an article of faith and a general principle on the left wing. Adam Smith founded the modern study of economics in 1776 by observing that trade proceeded on the principle of mutually beneficial voluntary exchange. The left has treated this concept with a mixture of incredulity and disdain, but mostly as if it were a deus ex machina invented to excuse the excesses of capitalism.

Members of the right wing and economists have responded by citing the role played by profit in allocating resources. It is fluctuations in profit, the argument runs, which allow consumers to direct the activities of producers – increasing profits cause producers to redirect resources toward goods and services in high demand, falling profits draw resources away from things for which demand is waning. This thinking is correct and conclusive, as far as it goes. But, as the example of Recession Ride Taxi suggests, it doesn’t go nearly far enough.

Eric Hagen is admittedly and avowedly utilizing a particular pricing technique. An economist recognizes this technique as price discrimination, which is practiced by sellers expressly to increase their total revenue and profit. In the great American tradition of motivational deception, he disavows a desire for personal gain while seeking exactly that. But the overarching significance is that his customers gain from his pursuit of profit maximization and his gains in total revenue and profit.

A layman will be persuaded of this result by hearing the testimonials of Hagen’s customers. The economist is used to hearing people lie about or rationalize their actions, but expects people to act in their own interests; the proliferation of Recession Ride Taxi’s customers means that buyers are better off riding it than not. Hagen claims that he averages 20 trips per day, the average fare running somewhere between $10 and $15. That works out to an annual income in the $50-75,000 range. Not Park Avenue territory, but not bad for low-skilled labor.

The presumption that the interests of buyer and seller are inexorably at odds is utterly false. Adam Smith’s dictum has found its practical expression – unwittingly unearthed by NPR, the unlikeliest of sources.

The Implications for Regulation

The agency of NPR isn’t the only improbable feature of this case. Economists would have quoted heavy odds against the taxi business being the locus of innovative entrepreneurship. For nearly a century, in most cities and towns of the U.S., taxicabs have been stifled under a choking blanket of regulation.

Early in the 20th century, the taxicab began to threaten the streetcar as a means of commercial passenger transport. Because of relative easy of entry into the business and low labor-skill requirements, taxis were plentiful, cheap and competitively attractive to riders. Streetcar companies combined with the largest taxi companies – usually Yellow Cab – to cartelize the taxi market by tightly regulating taxi fares and entry into the business. Fare schedules – soon replaced by taxi meters – and strict limitations on the number of taxi licenses issued combined to prevent effective competition among taxi firms. This raised profits for incumbent firms but harmed consumers. In New York City, where the number of taxi licenses has not increased since World War II, the monopoly profits capitalized into the price of a (transferable) taxi license (called a medallion) have raised its value to over six figures.

Strict regulation has been another hallmark of the Obama administration. The tacit premise has been that markets are not self-regulating, beneficial mechanisms, but rather treacherous, double-edged swords that cut safely only when their every move is guided and supervised by appointed regulators. (Where these regulators acquire the moral wisdom and practical knowledge required to manipulate markets is never specified.) One might have supposed, then, that a story on NPR about mutually beneficial success in the taxi industry would have featured regulators as the prime movers and market principals as passive reactors.

The truth is just the opposite. Eric Hagen is a lone entrepreneur who succeeded by discarding the most sacred tool of taxi regulation – the taxi meter. Indeed, in most American cities, what he did would be illegal. Even if it were technically permissible, owners of airport buses, municipal buses, shuttles, and competing taxi firms would throw a fit about it – which leads us to still another field of significance.

Implications for Antitrust

Traditionally, the practice of price discrimination is viewed with ambivalence by economists. On the one hand, when different consumers within a particular geographic market face different prices for the same good, this is inefficient. Each consumer will maximize his or her utility by arranging consumption so as to equate personal willingness to sacrifice alternative consumption with the objective rate of tradeoff offered by the marketplace, where the latter is embodied in the price paid. Suppose, for example, that one consumer faces a $5 price for good X and another consumer faces a $3 price. The first consumer’s personal marginal valuation of X is $5; the second consumer’s personal marginal valuation of X is $3. Give each the opportunity to trade in X at a price of $4 and both will do so – the first would gain by buying more X and the second by “selling” (consuming less) X. That tells us that the initial position was inefficient.

Carrying this logic to its ultimate end requires that all consumers in a given market face equal prices of a good or service, in order for consumption to be efficient – that is, for all consumers to get the most satisfaction.

The theory of equilibrium price formation studied by students in their college price theory courses brings about just this outcome. The problem is that the underlying assumptions behind this theory are seldom spelled out fully enough for the students to appreciate its highly abstract character. In fact, it often seems that economists (and lawyers) are often unaware of it. Goods are assumed to be homogeneous; each seller is assumed to supply an infinitesimal fraction of the total market amount; all buyers and sellers are assumed to possess all relevant information about available goods, costs and future contingencies.

Undoubtedly, this accounts for the prima facie structure against price discrimination in the Clayton Act, one of the earliest antitrust enactments. Price discrimination is inefficient, according to the textbooks. Those same textbooks also describe a perfectly competitive industry as one in which no seller possesses any power over price – but price discrimination couldn’t exist in this environment.

A price-discriminating seller must have some discretion over price. He must also be able to segment or divide his market into identifiable groups or individual buyers and prevent them from re-selling the good or service – otherwise, the low(er)-price buyers could themselves re-sell the good to the high(er)-price buyers at a slightly lower price, thereby spoiling the would-be discriminator’s party.

Real-world markets are a good deal messier than textbook ones. The information assumed by textbooks can only arise from a market process, and the equilibrium outcome proudly touted is an ever-receding goal. Recession Ride Taxi displays the opportunistic tenor of true capitalism – regulation strands sous chefs without a ride to work and the free market comes riding to the rescue with an improvised solution – imperfect, but a major improvement on the status quo.

This has always been true. Consider our early historical examples. A railroad often provided the only timely means of getting farmers’ crops to market, and the railroad magnate would sometimes charge farmers more for a short haul on which he faced no competition than for a long haul served by one or more competing roads. Outrageous! The first federal regulatory agency, the Interstate Commerce Commission (ICC), was created to remedy just such excesses. And so it did – by raising the long-haul rates into equality with the short-haul rates! This ended the price discrimination but it worsened the exercise of monopoly pricing power.

Country doctors often served sparse, strung-out populations that were unattractive markets. In order to increase their total revenue, country doctors charged much higher rates to wealthy patients, whose price-elasticity of demand was much lower than their poorer neighbors’. Communities encouraged this as a means of attracting physicians. Doctors rationalized it as favoring the poor; this inaugurated the practice of treating physicians as noble, self-sacrificing healers rather than ordinary businesspeople.

Clearly, price discrimination could be a good thing when it promoted competition and enabled consumers to enjoy a good or service that otherwise would not be provided. And regulations against it were no panacea for improved consumer welfare. Economists took this lesson to heart by qualifying their disapproval of price discrimination to cover only those cases where it harmed competition and promoted monopoly. It is perfectly obvious that Eric Hagen has enhanced both competition and consumer welfare with his Recession Ride Taxi.

Can We Generalize the Example of Recession Ride Taxi?

It may occur to the reader to wonder: If Eric Hagen’s Recession Ride Taxi is a boon to consumers and a specimen of marketing genius, where has it been all our lives? Why hasn’t it swept all before it over the course of one century of taxicab-industry history?

The short answer is two-fold. First, it’s been there all along, right under our noses. Second, it is right for some market circumstances and wrong for others. Most American cities represent intermediate cases, in which a mix of Hagen’s technique and conventional techniques are currently optimal. But the best approach would be to junk all forms of taxicab regulation and give the “Hagen System” full scope to operate.

Veteran taxicab drivers in virtually all American cities have utilized a species of the Hagen System by engaging in informal negotiation for taxi fares. Although variation of fares by time of day is typically illegal, it is common practice among business travelers and longtime drivers to vary airport fares by time of day. This helps travelers by securing passage and gaining discounts. It helps drivers by increasing capacity utilization during slack periods of demand.

A more comprehensive allegiance to Hagen’s methods is practiced by drivers who develop a personal clientele, which they service to the exclusion of radio calls and street hails. This tends to evolve naturally into a system of tailored fares, negotiated informally between driver and customer. (Depending on circumstances and the letter of the law, the taxi meter may or may not be engaged during the trip, but its reading is irrelevant.)

The central principle of Hagen’s Recession Ride Taxi – customer-chosen fares – practically requires this kind of repeat-customer format. Hagen may give lip service to “trust” in his customers, but he wants and needs the freedom to drop the occasional customer who stiffs him or intends to repeatedly shortchange him. He undoubtedly does this not by explicitly refusing to carry, which is illegal in most cities, but by “inadvertently” lengthening his response time to the deadbeats until they drop him. (This highlights a subtle but important aspect of the business – that the taxi fare is determined not just by the monetary fare but also by the time taken for the cab to show up.)

Why hasn’t this approach – developing a personal clientele – utterly overshadowed the visible taxi market of radio calls and street hails? Much taxi business is opportunistic, arising from unique and unforeseeable circumstances that cannot be handled in a personal, repeat-customer framework. Even more telling is the fact that the repeat-customer system requires the driver to incur substantial dead mileage and time wastage in servicing what often amounts to a predetermined route. In densely packed cities with large, continuous taxi demand like New York City, Las Vegas and Washington, D.C., drivers can operate much more efficiently “on the radio” and the street by taking their next call at the closest location.

But small towns like Burlington, VT face a taxi problem not unlike the old country doctor scenario. With around 40,000 people and no other close metropolitan areas, Burlington needs to generate a critical mass of driver income in order to get any taxi service at all. Price discrimination is the tried-and-true means of accomplishing this. Economic theory predicts that the Hagen System will predominate in this setting.

Most American cities fall in between these two clear-cut cases. They are oppressed by taxicab regulation and high meter rates that have suppressed or virtually killed off demand among low-income and minority populations. (Sometimes this demand is services by informal car or bus service provided by jitneys – vehicles owned by private individuals not affiliated with a business.) The climate is favorable for the Hagen System, but it is employed only at the cost of violating the law. Big government has created so many laws, almost all of which are counterproductive and contain innate incentives for violation, that governments cannot begin to enforce most of them. Thus, enforcement is lax to non-existent.

Nonetheless, the case of Recession Ride Taxi sharpens the case against taxicab regulation. Taxi meters are not valuable ipso facto; neither are newer computer systems for automatic dispatch that have largely replaced human taxicab dispatch. Technology should be judged according to the economic value it creates for consumers. The only way to do that is to allow the market to value technology and govern its use. The illusion that sellers set price is just that – an illusion, a mirage. Pricing is a negotiation between buyer and seller and either should be free to initiate the process. When regulation interferes with that freedom, it harms those it is ostensibly set up to protect.

Thanks, NPR

We have discovered that the simple case of a single taxicab driver in Burlington, VT is, in reality, a microcosm for capitalism at work. How much of the panorama we unfolded above was dealt with by NPR in their report on Eric Hagen’s Recession Ride Taxi?

None of it. NPR ignored every relevant economic issue, presenting the case as if it were nothing more than what the late Richard Nadler satirically called “caring and sharing.” Still, we should be grateful to NPR for at least reporting the news. There is no precedent for expecting this station to produce an incisive interpretation.

DRI-391: The Man Who Won World War II

World War II was the transcendent historical event of the 20th century. It brought some 100 million men, representing most of the world’s nations, under arms. Between 50 and 70 million people died. In an event of this size and scope, who would so foolish as to assign credit for victory to one particular individual?

Five-star General of the Army Dwight D. Eisenhower, that’s who. Reviewing the war in his memoirs, Eisenhower named one person as “the man who won the war for us.” That man was Andrew Jackson Higgins.

Today few remember Higgins. Reviewing his story does more than restore rightful place to a forgotten hero. Higgins’ story teaches one of the most important lessons in economics.

Andrew Higgins and the Development of the Higgins Boat

Andrew Higgins was born in Nebraska in 1889. After dropping out of high school, Higgins entered the business world. In the 1920s, he started a lumber import/export business and operated it with his own large fleet of sailing ships. To service them, he built a shipyard. A few years along, Higgins designed a shallow-draft vessel with a spoonbill-shaped bow for coastal and river use, which he named Eureka. This boat was able to run up onto and off riverbanks to unload people and cargo. Higgins proved to be a genius at boat design and eventually shipbuilding replaced lumber trade as the primary business of Higgins Industries.

The Eurekaattracted the interest of the U.S. Marine Corps for use as a landing craft. It beat a boat designed by the Navy’s Bureau of Construction and Repair in tests in 1938 and 1939. The Eureka‘s only drawback was that men and cargo had to be offloaded over the side, risking exposure to enemy fire.

Since 1937, the Japanese navy had utilized ramps on its landing craft. Higgins directed his engineer to emulate this principle. The result was the unique landing craft whose technical name was “Landing Craft, Vehicle, Personnel,” (LCVP) but which became better known as the “Higgins Boat.”

The Higgins Boat was one of the most revolutionary advances in the history of military technology. Heretofore, maritime invasion forces had to disembark at port cities – a substantial disadvantage since the opponent could predict the likely arrival location(s) and accordingly prepare bristling defenses. A large army had to travel in large troop ships which, of necessity, were deep-draft vessels. Troop ships would run aground and founder if they tried to dock at most coastal locations. Only at ports with natural deep harbors could they safely dock and unload.

The Higgins Boat allowed men and equipment to be transferred from troop ships to smaller, shallow-draft vessels that could run right onto an ordinary beach, drop their ramps, unload men and equipment and then withdraw to repeat the process. This meant that opponents now had to worry about defending the majority of a coastline, not just one or a few ports.

Amazing as it seems today, the Higgins Boat did not win immediate acceptance upon rolling off the assembly line. Its fight for survival paralleled that of the Allies in the early stage of the war itself.

The Entrepreneur vs. the Bureaucracy

In the early part of World War II, authority for designing and building the Navy’s landing craft was entrusted to the Bureau of Ships. Higgins was viewed coolly by the Bureau. What could a Nebraskan teach the Navy about shipbuilding? Besides, the department had designed and built its own model. Somehow, the Navy could always find an excuse for dismissing Higgins’ designs even when they defeated the Navy’s boats in head-to-head competition.

There was one other minor obstacle standing between Higgins and the bureaucrats at the Bureau of Ships. He hated their guts, viewed their work with contempt and said so openly. “If the ‘red tape’ and the outmoded and outlandish Civil War methods of doing business were eliminated, the work could be done in the Bureau of Ships very efficiently with about one-sixth the present personnel,” Higgins observed. Fortunately for Higgins, he managed to sell his ideas to other friendly powers, this keeping himself in business even though lacking honor in his own land. “If the power structure in place during the early months of the war had stayed in place,” said historians Burton and Anita Fulsom in their book FDR Goes to War, “Higgins would have been out of work and Americans, according to Eisenhower, would have either lost the war or had victory long delayed.”

Two unlikely saviors came to Higgins’ aid. The first of them was none other than Franklin Delano Roosevelt. The President had waged a bitter fight with Republicans in favor of his New Deal economic policies for more than two terms in office, only to watch those policies fail to restore the U.S. economy to its pre-Depression levels of income and employment. His Treasury Secretary, Henry Morganthau, Jr., confessed to his diary that administration policymakers had tried everything they could think of to revive the economy – and failed. Despite Roosevelt’s unwavering faith in the New Deal – and in himself – he sensed that he would need the support of the business community in order to win the war.

Thus, FDR changed tactics abruptly, going from excoriating businessmen as “economic royalists” to abjuring them to ramp up production of war materiel in the national interest. Suddenly, it became politically correct to view business as part of the team, pulling together to win the war. Roosevelt announced this change in philosophy even before Pearl Harbor, in a fireside chat of May 26, 1940. He was fond of describing the change as a switch from “old Dr. New Deal” to “Dr. Win the War” – a characterization that reveals as much about Roosevelt’s view of himself as Physician-In-Chief for the country as it does about his strategy.

Part of Roosevelt’s new emphasis involved the creation of the Truman Committee, headed by then-Senator Harry Truman of Missouri, to investigate government waste and mismanagement. Truman’s efforts in his home state had made him very popular, so when the Marines went to bat with his committee on Higgins’ behalf, the combination was too much for the Bureau of Ships to resist. Truman told the Bureau to produce a landing craft and test it in competition with a Higgins Boat. The test took place on May 25, 1942.

Each boat carried a thirty-ton tank through rough seas. The Navy’s craft barely avoided the loss of cargo and all hands. The Higgins Boat delivered the tank to its destination. The Committee declared Higgins’ design the winner.

Truman was scathing in his verdict on the conduct of the Bureau of Ships. “The Bureau of Ships has, for reasons known only to itself, stubbornly persisted for over five years in clinging to an unseaworthy …design of its own… Higgins Industries did actually design and build a superior [design],” only to run up against the Bureau’s “flagrant disregard for the facts, if not for the safety and success of American troops.”

The Entrepreneur vs. the Rules

Higgins’ trials and tribulations did not cease when he won government contracts to produce his landing craft (and other boats, including PT boats). He succeeded in scrounging up the capital necessary to expand his boatbuilding plant in New Orleans into a facility capable of supplying the armies of the Free World. But in 1942, fully automated manufacturing plants did not exist – Higgins next faced the problem of attracting the labor necessary to man the plant. Even in peacetime, that problem would have been daunting. In the wartime environment of wage and price controls, the chief legal inducement for attracting labor, a wage increase, was limited.

Higgins attitude to this and other problems can be appreciated from his own summation of his personal philosophy: “I don’t wait for opportunity to knock. I send out a welcoming committee to drag the old harlot in.” Higgins raised wages to the allowable maximum. Then he helped to set a precedent that persists to the present day by offering free medical care to his employees. Since this did not qualify as a wage, it was exempt from the controls and from the confiscatory wartime income-tax rates as well.

One plentiful source of labor was black workers. But this was New Orleans; segregation reared its ugly head. Higgins gritted his teeth and complied, while providing equal wages and benefits to all workers.

Shortages of metals and minerals were a throbbing headache. Higgins treated it by buying steel on the black market and stealing some items (such as bronze) that he couldn’t buy. (He later paid for stolen materials.)

Victory in Europe

Andrew Higgins went from employing 50 people in a plant worth $14,000 to hiring 20,000 employees to work seven huge plants. Over 10,000 Higgins Boats were produced, comprising most U.S. landing craft. His plants also built PT and antisubmarine boats.

Prior to landings in Sicily and North Africa in early 1943, Eisenhower moaned that “when I die, my coffin should be in the shape of a landing craft,” since they were killing him with worry. By D-Day, Higgins Boats had forced Hitler to stretch his defenses thin along the French coast. Although favoring the port of Pas-de-Calais, Hitler set up a string of defenses in Normandy as well. The Germans had concentrated nearly enough firepower to defeat the American landing at Omaha Beach, but “nearly” wasn’t enough to thwart the eventual beachhead. Meanwhile, the other four landings went relatively smoothly; the Higgins Boats had made it impossible for Hitler to keep all his bases covered. As Rommel and other high-level strategists recognized, once the landings succeeded, the war’s outcome was a foregone conclusion. Even Hitler couldn’t conceal his admiration for Higgins, calling the boat builder the “new Noah.”

On Thanksgiving, 1944, Eisenhower gave thanks for the Higgins Boats. “Let us thank God,” he intoned, “for Higgins Industries, management, and labor which has given us the landing boats with which to conduct our campaign.” And after the war, in his memoirs, Eisenhower laid it on the line: “Andrew Higgins is the man who won the war for us… If Higgins had not designed and built those LCVPs, we never could have landed over an open beach. The whole strategy of the war would have been different.”

The Thanks of a Grateful Nation

Along with many of the other entrepreneurs whose Herculean efforts supplied the American, British, Chinese and Russian armies, Andrew Higgins was rewarded after the war with an IRS investigation into the “excess profits” earned by his firms during the war. Since his death in 1952, his name has been placed on a Navy ship and an expressway in Ohio. Recently, a memorial (including a statue) has been raised to him in his hometown of Columbus, NE.

At his death, Higgins held some 30 patents.

The Economic Lessons of Andrew Higgins and American Entrepreneurship in World War II: The Value of Profit Maximization

The story of Andrew J. Higgins is perhaps the most dramatic of many similar stories of American entrepreneurship in World War II. Jack Simplot developed a process for dehydrated potatoes that enabled him to feed American soldiers around the globe. After the war, he turned his expertise to frozen foods and ended by supplying frozen French fries to the McDonald’s fast-food restaurant chain. Henry Kaiser was the preeminent wartime shipbuilder. He cut average construction time per ship by a factor exceeding ten (!). Like Higgins, he sometimes resorted to buying steel on the black market. Before the war, he built roads. After the war, he switched to steel and aluminum.

Men like Higgins, Simplot and Kaiser were entrepreneurs of demonstrable, and demonstrated, skill. Today, we relate their exploits with something resembling awe, yet it should have been no surprise that they succeeded. Their success often came on the heels of government’s failure at the tasks they undertook; this should likewise come as no surprise. The fact that government actively resisted their best efforts should dismay us, but not surprise us. After all, we have seen the same lessons repeated since the war.

Consider the test of the Higgins Boat, in which the Navy landing craft designed by the Bureau of Ships faced off against the Higgins Boat. Had the Higgins Boat lost the contract, the Allies would have lost the war or been seriously threatened with losing it. (So said Dwight Eisenhower, the man who led the Allied war effort.) The tacit premise behind government regulation of business is that – of course – government regulators will always act in the “public interest” while private businessmen act from greedy self-interest which must run athwart the general welfare. Yet in this case, government bureaucrats spent years acting in a manner directly contradictory to the public interest, albeit apparently in their own interest. (So said Harry Truman, certainly no advocate of laissez-faire capitalism.)

Should we be surprised that it was the profit-maximizer who won the war and the government bureaucrats who pursued their own interest at the risk of losing it? Certainly not. Higgins had spent his life in private business, where he could gain success and happiness only by building boats that worked. The naval bureaucrats did not have to build boats that worked in order to “succeed” in their domain; e.g., remain bureaucrats and keep their staffs and budgets intact. We know this because they succeeded in thwarting Higgins’ design for five years in spite of Higgins’ triumphs in testing against the Navy. Indeed, granting a contract to the boat that worked would have threatened their success, since their own design and model would have been replaced.

The only surprising thing about the episode is that how close America came to losing the war. Had FDR not done two things that were utterly unexpected – namely, abandon his allegiance to the New Deal and set up the Truman Committee to overrule wasteful measures undertaken by bureaucrats – we might have done just that. In that sense, it might with some justice be said that it was really FDR who won the war. And, in fact, Roosevelt made several additional decisions that were crucial in determining the war’s outcome. Naming George Marshall as Chief of Staff is one such decision. Marshall chose men like Eisenhower, Omar Bradley and George Patton for key commands, in each case jumping them over many other men with seniority and more impressive resumes.

The problem with calling FDR the guarantor of victory is that each of his good decisions only offset other decisions that were dreadfully bad. FDR wouldn’t have had to abandon the New Deal had he not adopted such a disastrous mélange of counterproductive and unworkable policies in the first place. The appointment of Marshall merely undid the damage done by the appointment of mediocre yes-men like Harold Stark and Henry Stimson, to high administrative and cabinet positions in the military bureaucracy.

The Second Lesson: Abandonment of the New Deal

FDR’s abandonment of the New Deal illustrates the second lesson to be drawn from the example of Higgins and his fellow entrepreneurs. Conventional thinking posits wartime as the time of preoccupation with “guns,” whereas in peacetime we can safely concentrate on “butter.” Butter production, so tradition tells us, is effected using markets and a price system, but guns are a different proposition entirely. Combating militarism demands that we use the methods of the militarists by turning the country into an armed camp, as did Germany and Japan.

However difficult it may have been to see through this fallacy at the time, it is obvious in retrospect. America won the war with production, by supplying not only its own needs but those of Great Britain, Russia and China as well. Those needs included not only military goods narrowly defined, but foodstuffs, clothing, medicines and all manner of civilian goods as well. It is highly significant that both Roosevelt and Churchill concurred in urging major motion picture studios to maintain the volume and quality of their products rather than sacrificing resources to the war effort. They realized that movies were part of the war effort.

Put in this light, Roosevelt’s decision to substitute “Dr. Win-the-War” for “Dr. New Deal” takes on vastly more meaning. Without even consciously realizing it, he was admitting the failure of his own policies in peacetime as well as their unsuitability for war. And war’s end brought this lesson home with stunning force. During the war, Roosevelt had abandoned New Deal staples like the WPA and the CCC. After the war, President Truman was able to retain various “permanent” features of the New Deal, like Social Security, banking and stock-market regulation and pro-union regulations. Pervasive control of the price system faded away along with the gradual obsolescence of wartime price controls.

FDR had predicted that it would take total employment of 60 million to absorb the ramped-up levels of total production reached during the war. (Before the war, total employment had been only 47 million.) Keynesian economists predicted a return to Depression, with unemployment ranging from 10-20%, after the war unless massive federal-government spending was undertaken. Instead – appalled at the unprecedented level of federal-government debt as a percentage of gross national product – the Republican Congress of 1946 cut spending and taxes. The result was an increase in civilian employment from 39 million to 55 million and total employment (including government workers) reached Roosevelt’s goal of 60 million without the New Deal-type spending he had envisaged. Unemployment was 3.6%. Annual growth in gross national product reached an all-time high of 30%.

Wartime entrepreneurship battered New Deal economic policy to its knees. 1946 delivered the coup de grace.

The Third Lesson: The Primacy of the Price System

The third and final lesson to be learned concerns the impatience of the entrepreneurs with bureaucracy, rules and laws. In particular, their resort to the black market was exactly what patriotic citizens were being implored not to do during the war. Should we be surprised that entrepreneurs won the war by ignoring the anti-market directives of the bureaucrats?

Hardly. Everybody seemed to take for granted that normal commercial attitudes and impulses should be suppressed during wartime, that the success of any collective goal requires the suppression of all individual wants. But upon reflection, this simply cannot be true.

As usual, the most cogent analysis of the problem was provided by F. A. Hayek, in a short essay called, “Pricing Versus Rationing.” He pointed out that in wartime politicians’ standard recourse is to controls on prices and rationing of “essential” war materials by queue. Any professional economist would, he declared, recognize the fatuity and futility of that modus operandi. “It deprives industry of all basis of rational calculation. It throws the burden of securing economy on a bureaucracy which is neither equipped nor adequate in number for the task. Even worse, such a system would deprive those in control of even the whole economic machine of essential guides for their plans and reduce major decisions of policy and even strategy to little more than guesswork.” This will “inevitably cause inefficiency and waste of resources.”

In other words, the best policy for allocating resources in wartime is the same as the best policy for allocating resources in peacetime; namely, use the price system to determine relative values. Where so many people go wrong is by blithely assuming that because so many military goods are now required, command and control must be used to bring them into existence by forbidding the production of other things. But among the many problems caused by this approach is that the production of any good for a military use means the foreclosure of resource use for production of some other military good. Without a price system to determine relative values, the war itself cannot be run on any kind of rational or efficient basis. This is another reason why the Allies were lucky to win – the Axis were wedded to a Fascist, command-and-control economic system that foreswore free markets even more than the Allies did.

Black markets are the outgrowth of prohibition and/or price controls. They arise because legal, licit markets are forbidden. Whether it is bootleg liquor during Prohibition, illicit drugs in contemporary America or under-the-table trading of ration coupons during wartime, a black market is a sign of a free market trying to escape confinement. Higgins, Kaiser, et al were illustrating the logic of Hayek. Rationing and price controls are just as bad in wartime as in peacetime. They were violating statutory law, but were obeying the higher wartime law of salus populi suprema lex.

The Man Who Won World War II

The man who won World War II was not a soldier. He was a businessman. He won it by applying the great economic principles of free markets. This transcendent truth was acknowledged by World War II’s greatest soldier. The power and meaning of this should persuade even those unimpressed by the logic of economic theory itself.

DRI-460: Can Economics Help Man Peacefully Coexist With Dogs and (Big) Cats?

An old journalistic maxim states that it is only news when man bites dog, not vice-versa. These days, the demand for raw material that can be fashioned into a retail product called “news” far outstrips the supply. Thus, animal bites become “attacks” and injuries escalate into “maulings.” Two incidents in 2012 have attracted considerable attention and comment. They are a springboard for a look at the relationship between man and animals, using economics as our analytical tool.

Dog Bites Denver Anchorwoman; Cheetahs Bite Scottish Wife and Daughter

The first incident occurred a few months ago in Denver, CO. A local fireman rescued a dog from icy waters. The rescue made NBC affiliate KUSA-TV’s local news. Anchorwoman Kyle Dyer decided to invite the fireman and dog onto her midday interview show for a “feel-good” interview segment.

During the course of the program, Dyer approached the dog and knelt next to it – apparently to pet or embrace it. The dog bit her in the face. After cosmetic surgery and a significant recuperative period, the newswoman is back on the job.

The second episode took place last week in South Africa. A Scottish family on vacation visited a game preserve that included a petting zoo. Among the animals there were two cheetahs. After being assured that the cheetahs were “tame,” the wife and her 8-year-old daughter approached and began playing with the cheetahs.

One of the cheetahs grabbed the girl by the leg. The woman, who had been lying with or on top of the other cheetah, was bitten and scratched. The husband, who was photographing the visit to the petting zoo, caught all this on camera.

The Implicit Theory of the Victims

There is an implicit or unconscious theory behind the actions of the Denver anchorwoman and the Scottish couple. Ms. Dyer’s avowedly “feel-good” segment would utilize time-worn techniques to elicit sympathy for the dog and the fireman by manipulating the audience’s emotions.

Those techniques required the physical presence of dog and rescuer so as to figuratively reenact the rescue. Questions directed to the rescuer would be the one means of effecting this result. The anchorwoman would coax “spontaneous” reactions from the dog in order to milk emotion from the audience. The entire segment would take on the character of a theatrical production, with each participant playing a role intended to get specific reactions from the audience.

Unfortunately, the dog was not up on his part and did not follow his cues. The reaction of the station’s operations manager – that the dog exhibited “behavior nobody predicted or understood” – is not unlike one that might have been proffered to excuse the engagement of an employee who later committed a crime. “He had no previous criminal history. How could we know that he would go bad?”

The reaction of the Denver authorities suggested that blame for the biting should be assigned to the dog’s owner – even though the dog was held on short leash at the time. Law enforcement announced that the owner would be prosecuted under local law for “not having control of the dog at all times” and “allowing it to bite” (!).

The notion that the anchorwoman herself might have induced the bite was never even contemplated. The reasons for this lapse are clear. Her intentions were perfectly benign, even noble. How could she possibly be at fault, then? And it is, indeed, perfectly obvious that she never considered the possibility that she might be bitten – an outcome even more professionally hazardous than it was personally injurious. (How many successful news readers with scarred faces come readily to mind?)

Yet the comments of professional dog behaviorists left no doubt about where they placed blame for the biting. One insisted that “the dog was trying to tell her [Dyer] ‘I am going to bite you.'” Another summed up the incident by saying that “she [Dyer] did everything wrong.”

Man-made Law vs. Dog Rules

The implicit theory followed by the station, the anchorwoman and the DA was that “good” dogs are those that obey man-made statutes, while “bad” dogs do not. Moreover, dogs apparently may “go bad” suddenly and unpredictably, in the manner of people who “go postal” and commit random acts of violence.

This implicit theory runs completely counter to what we know about dogs. Dogs act according to dog rules, which have nothing to do with man-made statutes. Contrary to the impression created by countless movies and television shows, dogs are not moral creatures. While this is not quite the same thing as saying that they are unaffected by what we call emotions, it does mean that we should quit judging dogs by human standards of behavior.

The anchorwoman approached unhesitatingly, without waiting for a sign of approval from the dog. While this is common practice in human society and convenient for theatrical purposes, it is a clear violation of dog rules. Dogs are pack animals. They automatically treat non-pack members with caution and suspicion, an instinct inherited from their wolf ancestors. In the wild, failure to be on guard against strangers can cost your life.

The anchorwoman bent over the dog – preparatory to delivering a hug or kiss, perhaps. This is a friendly gesture among humans. But towering directly over a dog is perceived by the dog as a gesture of dominance. It may be tolerated – if the dog is submissive. But a dominant dog may aggressively reject such an overture, by growling or biting. Since dogs do not wear signs saying “I am dominant” or “I am submissive,” humans should avoid this behavior with unfamiliar dogs. Thousands of children suffer facial bites each year when bending down and attempting to kiss dogs.

Another implicit theory popular in human circles treats a dog’s bite as a hostile gesture, comparable to a blow struck in anger by one human against another. Lacking the multiple modes of expression available to us, dogs economize by assigning multiple meanings to their limited vocabulary. Biting is used to warn, as in this case. Dogs also bite each other when playing. Biting is an instinctive, reflex response used in ways analogous to a human shout or cry.

Although dogs certainly bite to inflict injury or death, their teeth are poorly adapted for this purpose, being rather short and blunt. It is difficult for a dog to inflict severe damage with a single bite without precise delivery to a strategic location, such as face or groin; dogs, like wolves, do the greatest damage by working in packs and tearing flesh with their carnassial teeth. That is why dogs are omnivores rather than strict carnivores. Cats, in contrast, are pure carnivores whose long, sharp teeth make them ideal killers. (That is why the danger of infection is so much greater for cat bites than for dog bites.)

Reports of the incident sometimes referred to it as an “attack.” This is semantically dubious, since an attack is, by definition, an offensive action and our explication of dog rules marks this particular bite as a defensive reaction.

We can sum up the attitude implicit in conventional thinking about dogs by the public and the law. “Dogs are smaller, four-legged versions of human beings, with limited powers of reasoning but a mental structure and moral outlook nonetheless comparable to ours. When they act in ways we find inappropriate, we may feel free to judge them by human standards; e.g., by punishing them for their sins.”

The Implicit Theory of Cheetah Tameness

The Scottish couple who visited the South African game preserve was also applying an implicit theory of human-animal interaction. We will call it the theory of “cheetah tameness.”

The idea of cheetah tameness may strike many readers as inherently absurd. Aren’t cheetahs carnivorous wild animals, like lions and tigers? Isn’t a “tame cheetah” an oxymoron, like a chaste prostitute?

Actually, mankind has been reducing cheetahs to captivity and domesticating them for centuries, at least since the days of ancient Egypt. Sometimes the objective has been perpetuation of the species, as when cheetahs are bred inside zoos. Sometimes the cats have been privately owned and raised as pets. The upshot is that the appellation of “tame” has often been applied to cheetahs, unlike other big cats. The question is: What practical implications and limits apply to this status?

Accounts of the bites suffered by the woman and her daughter suggest that the couple interpreted the concept of tameness in roughly the following way: “Because the two cheetahs were born in captivity and raised as pets by human beings, the cheetahs essentially considered themselves human and accordingly behaved in ways consonant with that belief – subject to the mental and physical limitations imposed by their actual physical status as cheetahs, of course. The family could behave toward the cheetahs as if they were human, by approaching them, playing with them, even lounging with and lying upon them – all without fear of suffering physically at the cheetahs’ hands… er, paws.”

Put so baldly, this sounds naïve, even idiotic. Yet nothing less could explain the couple’s behavior. Why else would they allow their 8-year-old daughter to play with the animals? Why would the husband complacently photograph their interactions with the cats – and continue to do so even as the action became bloody and dangerous? Why would the wife – who described the cheetah’s thought processes as being “like children” – feel free to lie down upon one of the cheetahs?

Cheetahs are large felines. Cats are playful animals who bat each other with their paws. Cats sometimes bite owners who act in non-approved (by the cats) ways; e.g., by scratching the cats’ stomachs or teasing them by waving their hands or other objects within reach.

Here again, accounts of the cheetah episode refer to it as an “attack.” Even more than in the Denver case, this word is an obvious misnomer. A cheetah is the fastest land animal in the world, created by nature to reach and kill wild game and defend it in a world of competing predators. If the cheetahs had really attacked the Scottish family, those people would be dead. An attacking cheetah would not have grabbed an 8-year-old girl – small enough to qualify as “prey” in the cheetah perception – by the leg. The cheetah would have bit her in the throat and made short work of her. The “mauled” wife would not have been in any shape to give interviews to the press afterwards; the husband would not have been able to complain that “the authorities should have made sure that the petting zoo was safe before allowing tourists” to visit it. Both husband and wife would both have been in the morgue.

The Implicit Theory of Justice

The issue of intent is worth raising because the implicit theory of justice applied to animals in such cases is so heavily dependent on it. For example, dogs that bite are often killed because they are “proven biters” or because “we cannot risk it happening again” – arguments devoid of justification because all dogs are biters and there is no logical or empirical link between one bite and a subsequent one.

Human beings are moral creatures. Punishment for misbehavior achieves at least three worthwhile purposes – protection from actual misbehavers, deterrence from misbehavior by potential misbehavers and revenge against misbehavers to ease pain felt by victims and relatives. Cognizance of our mistakes is the logical prerequisite for this. Indeed, that is the basis for the most common legal definition of insanity – the inability to distinguish right from wrong.

None of these arguments applies to animals, which have no moral sense, cannot be deterred from reacting instinctively and are unaware that their statutory punishment constitutes revenge for misbehavior. The implicit theory of justice behind punishing animals for injuring humans rests on a false analogy between animals and humans. We use words like “euthanasia” to soften the impact of the fact that we kill animals in reaction to our own mistakes; pejoratives like “attack” and “maul” frame the animals for crimes in order to justify capital punishment.

The issue is further clouded by irrelevant considerations like “animal rights” and allegations of “sentiment for animals.” The assignment of rights to non-sentient creatures incapable of exercising them raises too many logical obstacles to warrant serious consideration. Insistence on logic in the evaluation of human/animal interactions does not elevate sentiment – it downplays it. The sentimentalists are those who judge animals by our standards.

Having said all that, it is not difficult to see where the romantic, sentimental tendency to humanize animals came from.

Modern Neuroscience and the Economic Theory of Knowledge

Over half a century ago, a future Nobel laureate in economics, F. A. Hayek, published a revolutionary study in theoretical psychology called The Sensory Order. Among the book’s numerous insights was one that has subsequently been picked up by modern neuroscience – that we gradually create and improve our fragmentary understanding of a vast, complex reality by developing theories about the world to substitute for the unavoidable gaps in our specific knowledge.

Hayek integrated his theory of human psychology with his economic theory. The latter stressed the importance of markets as disseminators of knowledge that is dispersed and decentralized in the brains of billions of people the world over. Throughout the 20th century, economists made extensive use of the concept of equilibrium, a state of affairs in which nobody can gain from changing their current pattern of behavior. The most frequent example of equilibrium is the clearing of markets – that is, the state in which prices equate ex ante quantities offered for sale with desired purchases.

Hayek pointed out that economists overlooked – or deliberately refrained from mentioning – that equilibrium presupposed full knowledge about production and consumption opportunities. Only the operation of free markets could in fact generate that knowledge and make it widely available. And since human perception is fragmentary and subjective, markets perform the irreplaceable function of gradually bringing the subjective perceptions of billions of people into line with the true, objective facts of reality. They do this by bringing to light information that would otherwise not exist or be transmitted to those most in need of it.

The Evolution of Human Understanding of Animals

The interaction of human beings and animals goes back as far as our knowledge of the human species. Most animals were a source of labor, food or observation. Domesticated dogs and cats threw in their lot with man thousands of years ago – well, actually, it is unclear who joined up with who. Improbable as the implicit theories described above may seem, their underlying basis has been accepted throughout mankind’s history, until quite recently. (Competing theories have tended to be even less plausible, such as those elevating animals to the status of deities as was done in ancient Egypt and in India.) After all, we really had little choice except to compare animals to what we knew.

When did the traditional view of animals change? What caused the change? Hayek pointed out that, far from requiring rationality on the part of market participants, markets tend to promote rationality by rewarding it. Here, the rewards began with the Industrial Revolution and accelerated dramatically with the surge in economic growth that accompanied the 20th century.

For most of human history, domestic animals served two primary purposes – companionship and labor. Their value in chose uses was stable but low. Domestic animals were a source of companionship; this rewarded knowledge that improved their health and longevity. Those developments had to await comparable innovations in human medicine and nutrition. Meanwhile, the companion value of dogs and cats provided a sustaining incentive maintain the population.

Dogs and cats provided a source of labor on farms for centuries, during which time human life was predominantly rural. There was little scope for improvements in agricultural productivity generally or the factor productivity of domestic animals, so while the romantic view of animals had obvious shortcomings there was little motivation or ability to improve on it.

When the worldwide engine of economic growth shifted into overdrive, this opened up opportunities for domestic animals. As humans became healthier and started living longer, the companion value of domestic animals increased. Improvements in human medicine gradually percolated down to veterinary medicine, and the increased companion value made it economically feasible to employ them.

Wealthier societies can afford to focus more time, energy and resources on aesthetic concerns like human treatment of animals, which produced more, better and healthier domestic animals. More and more uses for the animals were developed. Seeing-eye dogs were followed by bomb-sniffing dogs and medical-therapy dogs. That last category now includes dogs specialized to detect their owners’ seizures and low-blood-sugar episodes and act upon the discovery.

Higher productivity meant that domestic animals became better investments, which meant that learning what made them tick became more economically desirable and feasible. Books and television programs by veterinarians and trainers became big sellers. Thus, objective truth about animals was transmitted from those best qualified to apprehend it to those who wanted and needed it the most.

This economic process picked up speed and momentum in the second half of the 20th century and became the avalanche of today. It is now commonplace to see articles in the popular and business press marveling at the time and expenditure allocated to pets, but much less space is devoted to the enormous increase in the value created by them and enjoyed by their owners. And yet economic theory suggests that domestic animals are capital goods – long-lived producer goods used to produce other goods, assets that produce a stream of value over a period of years. Their value is derived from the net present value of this stream of output that they produce.

At long last, we are shedding the romantic view of dogs as either good dogs or bad dogs, Lassie or the Hound of the Baskervilles. It is no longer sensible to assassinate a few million potential productive assets every year in municipal animal shelters – thus, the trend toward no-kill shelters, pet rescue and adoption programs.

Hayekian Equilibrium in the Market for Domestic Animals

Cases like the Denver and South African ones show that our subjective perceptions have still not caught up with the objective reality of animals. But our analysis also proves that markets have wonders in improving the lives of both people and animals – and can do even more if we let them.