Today's Quote of the Day...

…comes from page 66 of “Miscellaneous Writings”, part of the Liberty Fund’s collection “The Selected Writings of Edmund Burke.” This quote in particular is from Burke’s 1795 treatise “Thoughts and Details on Scarcity”

First, then, I deny that it is in this case [of the laborer working for an employer], as in any other of necessary implication, that contracting parties should originally have had different interests. By accident it may be so undoubtedly at the outset; but then the contract is of the nature of a compromise; and compromise is founded on circumstances that suppose it in the interests of the parties to be reconciled in some medium. The principle of compromise adopted, of consequence the interests cease to be different.

JMM: One of them ore egregious mistakes people make when discussing economics is the idea that labor and management are at odds with one another, that labor is in competition with employers. But in reality, labor enhances employers (otherwise they wouldn’t be employed). Employees cooperate with employers and compete with other employees, not the other way around.

The Subtle Adam Smith

Over the past week, I was in Holland, MI attending a conference sponsored by the Liberty Fund called “Liberty and Responsibility in Adam Smith.” One topic that came up was the face that Smith will sometimes split his discussion of a topic into multiple parts, scattered throughout his book. This, of course, can make interpreting Smith difficult and can lead to some accidental cherry-picking of his writings to justify various things.

An interesting example of him splitting the discussion occurs in the Wealth of Nations. On page 83-84 of the Liberty Fund edition, Smith warns against political power of concentrated groups:

It is not, however, difficult to foresee which of the two parties must, upon all ordinary occasions, have the advantage in the dispute, and force the other into a compliance with their terms. The masters [employers], being fewer in number, can combine much more easily; and the law, besides, authorises, or at least does not prohibit their combinations, awhile it prohibits those of the workmen, We have no acts of parliament against combining to lower the price of work; but many against combining to raise it. In all such disputes the masters can hold out much longer. A landlord, a farmer, a master manufacturer, or merchant, though they did not employ a single workman, could generally live a year or two upon the stocks which they have already acquired. Many workmen could not subsist a week, few could subsist a month, and scarce any a year without employment. In the long-run the workman may be as necessary to his master as his master is to him; but the necessity is not so immediate.

From this passage, one might (reasonably) conclude that Smith would potentially support anti-trust legislation (broadly defined here to include things like trade groups which conspire to control prices of labor, such as cartels).

But Smith’s discussion doesn’t end there. He makes a very similar, but more descriptive, comment later on. On page 145, he writes (emphasis added):

People of the same trade seldom meet together, even for merriment and diversion, but the conversation ends in a conspiracy against the publick, or in some contrivance to raise prices. It is impossible indeed to prevent such meetings, by any law which either could be executed, or would be consistent with liberty and justice. But though the law cannot hinder people of the same trade from sometimes assembling together, it ought to do nothing to facilitate such assemblies; much less to render them necessary.

Notice what is going on: Smith is qualifying his statement and his discussion on page 83-84. Yes, people of the same trade will conspire against the public good. But that conspiracy does not in and of itself justify legislation against it! Indeed, such legislation would be unjust!

Smith is a very nuanced writer. He is hard to pigeonhole into pre-defined political categories. But one thing we see over and over with him is his caution on legislation. Smith certainly has a presumption of liberty and just because some event may justify a legislative response does not mean that legislative response is desirable.

For more on this, see my short piece at Adam Smith Works.

Pegging Minimum Wage to Inflation Will Not Help Minimum-Wage Workers

Whenever minimum wage is discussed, inevitably there is some conversation about “if the minimum wage was pegged to inflation, it would be X by now!” (see, for example) . Politicians and policy experts often then make recommendations to peg minimum wage to some measure of inflation. However, the Law of Demand tells us why this is a poor idea, even moreso than a simple (ie, not-pegged) minimum wage.

The Law of Demand has two parts to it:

1) All else held equal, as the relative price of a good rises, quantity demanded of the good will eventually fall.

2) The longer the relative price of a good remains high, the more elastic demand becomes.

The first part, or the First Law of Demand, tells us that the initial setting of the minimum wage (assuming it is above the equilibrium price), will cause fewer workers to be employed (or some other cut be made depending on the choices firms face).

The second part, or the Second Law of Demand, tells us that if minimum wage were pegged to inflation, employers would look for more and more ways to reduce their labor costs; in technical terms, they will find more and more substitutes for labor (eg, automation). What this indicates is the negative effects of a minimum wage hike will likely be enhanced if the minimum wage were pegged to inflation. Indeed, one of the main reasons minimum wage has so little documented negative effects presently is partly because the real minimum wage is below the prevailing market wage. Pegging minimum wage to inflation would reduce that happy effect.

The Law of Demand is pretty immutable. Minimum wage is no exception to it. You make workers more expensive to hire, people will look for alternatives.

Jon MurphyPrice Theory
Today's Quote of the Day...

…is from Page 403 of the Liberty Fund’s 1982 edition of Adam Smith’s Lectures on Jurisprudence. When Smith writes here “an original contract,” he is referring to the idea of a social contract:

But again, upon the supposition of an original contract, by leaving the state you expressly declare that you will no longer continue a subject of it and are freed from the obligation which you owed it, yet every state claims it’s [sic] own subjects and punishes them for practices, which would be the highest injustice if their living in the country implies a consent to a former agreement. Again, if there be such a thing as an original contract, aliens who come into a country preferring it to others give the most express consent to it, yet a state always suspects aliens as retaining a prejudice in favor of their mother country, and they are never so much depended upon as freeborn subjects. So much is the English law influenced by this principle, that no alien can hold a place under the government, even tho’ he should be naturalized by Act of Parliament.

JMM: Of the more ridiculous statements to come out of popular political discourse is the phrase “If you don’t like living here, you should just get out!” It is employed often when demanding obedience to the current Administration and as a means of quashing objections to current policy.

But, given governments inherent tendency to be suspicious of immigrants (the current Trump Administration is not unique nor outside the bounds of normality in this respect), it implies that the challenge to leave is not given with any honesty. Further, given how many barriers prevent people from leaving, both internally (by the current government) and externally (by other governments), we see that not even governments truly believe in migration as consent.

Adam Smith spoke these words around 1763. Not much has changed here in 2019.

See also David Hume’s essay “Of the Original Contract.”

Today's Quote of the Day...

…is from Don Boudreaux and and Burt Folsom’s Fall 1999 Antitrust Bulletin article Microsoft and Standard Oil: Radical Lessons for Antitrust Reform:

It follows that the best available evidence for whether or not a firm enjoys monopoly power is the firm’s own record at satisfying consumer demands: Do real prices in markets in which the firm offers products fall? Does output in these markets expand? Are innovations in these markets regular? If so, the firm is likely not a monopolist. Like Standard Oil, Microsoft does not behave as though it possesses monopoly power. Therefore, we argue that it, in fact, does not possess monopoly power.

JMM: Economists and antitrust lawyers have developed all kinds of statistics and metrics to try and gauge, from an objective point of view, whether or not a firm is in a monopolist position. This is also true in other realms of economic regulation: trying to identify public goods, externalities, perfect compensation, etc etc. In the end, though, our best tool is to observe that which people do. How people behave tells us a lot about the econoomic conditions we are dealing with.

Economics is About Selflessness

If you walk down the street and ask any random person what they know about economics, I’d be willing to bet you’d get two potential responses: 1) supply and demand, and 2) people are self-interested. Both these responses are generally accurate, but a bit simplistic. To describe the former would require a 700+ page book. So, let me focus on the latter.

In economic models, people are assumed to be self-interested, which simply means that they are trying to improve their lot in life with the resources available to them. If people are motivated by this self-interest (which does not imply a lack of altruism), does this mean that economics is driven by self-interest? Absolutely not; our science indicates otherwise: economic behavior is driven by selflessness.

In order to get a voluntary exchange, both parties need to benefit. This means asking the question “what can I do for the other person?” It is true that the butcher is not benevolent enough to just give us our dinner; we must seek to give him something in return. Thus, we need to know what he wants in return and give it to him.

Free markets are often sold as being a meritocracy, but this is something of a misnomer. The confusion of this term comes up from time to time, especially when trying to examine wage gaps: “Person X is very good at Y. Why does he make less than Person Z who is doing Y’ “? In a free market, the person who earns the highest is not necessarily the person who is the absolute best at doing something, but the person who is best at providing what other people want. Jim may be the best salesman this side of the Mississippi, but if he’s selling encyclopedias door-to-door, we will likely earn less than middling salesman Jack who is selling high-end computers. The merit is based on who best serves others, not who is best.

The interesting implication of this is that markets inadvertently promote virtuous behavior. By encouraging and rewarding selflessness, markets foster virtues like justice and selflessness. This, to me, is a major insight of Adam Smith and liberal economics: the “invisible hand” promotes not just opulence but also virtue. It is a mistake to focus, as some economists do, on the edifice of self-interest; that is merely the beginning, not the end.

Along these same lines, I strongly recommend this article by Sam Fleischacker: “Economics and the Ordinary Person; Re-Reading Adam Smith.”

Against Economic Casuistry

In any science, there is a tendency to lay down rules for conduct following some theory or discovery. Economics is no different. However, I will argue here that, in economics, this tendency is not only wrongheaded, but doomed to failure. As economists, we should resist economic casuistry.

Casuistry is “endeavour[ing] to lay down exact and precise rules for the direction of every circumstance of our behavior,” (Adam Smith, Theory of Moral Sentiments, Pg. 329). Smith is writing in the context of moral philosophy and natural jurisprudence, referring to the moralists who attempt to have a rule for every aspect of human interaction, but his definition and description work for our purposes here.

Economic textbooks, especially at the principles level, has a tendency towards casuistry. Principles books tend to lay down certain rules for economics, especially in the realm of policy. Rules like “always do cost-benefit analysis,” or “if the market has failed in a certain way, government can intervene by doing X,” or “public goods should be provided by government,” etc. Policy conversation in the real world revolve around such rules: “we’ve identified problem X, and so recommend policy Y.” For example, Trump is using national security to justify tariffs. Dani Rodrik identifies all sorts of problems and recommends policy changes in his book Straight Talk on Trade.

But the issue Smith highlights in his discussion of moralistic casuistry, namely that identifying and knowing every rule for every situation is damn near impossible, applies to economics as well. Take, for example, the rule that if a market failure occurs, there is some action the government can take to address the failure. As I have written elsewhere, properly identifying market failures is extremely difficult. A “market failure” requires a comparison to a perfectly competitive market, a comparison which may not be valid with the existence of transaction costs. Furthermore, since benefits (and thus also costs) are subjective, identifying transaction costs themselves is a difficult, if not impossible, task.

John Nye also writes on the difficulties when trying to set polices for dealing with market failures. He discusses that there are already many small Coasian bargains going on around externalities and that policy prescriptions tend to fail to take these into account.

What all this adds up to is one simple fact: identifying market failures is not as straightforward as textbook models represent. As Ronald Coase says, paraphrasing Frank Knight, these discussions ultimately come down to a discussion of morals and aesthetics.

We can do this for all supposed market failures. Identifying public goods, for example, is extremely difficult as the definition relies heavily on the scope of the problem you are looking at. National defense, the quintessential public good, is a public good at a small scale (the Army protecting Washington DC from attack also protects Maryland), but at a large scale, it becomes a private good (the Army can choose whether or not to defend Mexico). So, is national defense a public or private good? Hard to tell. Thus, hard to set rules.

Classifying economic situations and outcomes is not as simple as classifying an animal in biology. A lot of it will depend not only on the actors involved, but the judgement of the spectator, the analyst. As such, it is very loose and vague. Precise rules, like those laid forth in economics textbooks, will tend to fail.

None of this is to say one should just through up their hands and do nothing. There can, indeed need, to be rules. But they should also be loose, more negative than positive. Rules such as private property, where people can do as they wish so long as they do not harm each other. Courts that can interpret issues when conflicts inevitably arise. In short, “thou shalt not” rules rather than “thou shalt.” As economists, we must resist the natural urge to lay down 10,000 commandments, rather going for rules more like the 10 Commandments.

Today's Quote of the Day...

…is from page 57 the 2002 edition of Milton Friedman’s 1962 classic Capitalism and Freedom:

It is not too much to say that the most serious short-run threat to economic freedom in the United States today - aside, of course, from the outbreak of World War III - is that we shall be lef to adopt far-reaching economic controls in order to “solve” balance of payment problems. Interferences with international trade appear innocuous; they can get support of people who are otherwise apprehensive of interference by government into economic affairs; many a business man even regards them as part of the “American Way of Life”; yet there are few interferences which are capable of spreading so far and ultimately being so destructive of free enterprise.

JMM: Freidman wrote these words in 1962. How little things change

What Milton Freidman Gets Wrong About Monopolies

In his excellent book Capitalism and Freedom, Freidman writes (Pg. 28):

Exchange is truly voluntary only when nearly equivalent alternatives exist. Monopoly implies the absence of alternatives and thereby inhibits effective freedom of exchange.

I disagree with the first sentence. The second sentence is flat-out wrong.

Monopolies do not imply the absence of alternatives. There is no economic problem without alternatives. If monopoly implies the absence of alternatives, then that means there are no costs interacting to the monopoly, something we know is incorrect. It also implies there are no substitutes for the monopoly’s good, something we also know isn’t correct. After all, demand curves (even for a monopolist) slope downward.

Perhaps an example will help. Say there are two competitors, one who offers green shirts for sale and one who offers blue shirts for sale. The one who offers blue shirts closes down, so all that is left is the one who offers green shirts. In Freidman's description, the alternatives have fallen from green shirt-blue shirt to just green shirt. But this is incorrect. There is another alternative. The relevant choice is not between green shirt, blue shirt. It is between green shirt, blue shirt and going naked (ie, no consumption). Thus, the next scenario comes down between green shirt and being naked as the day you were born. There is always an alternative. Just because the alternative is undesirable does not mean the alternative does not exist.*

Furthermore, there is always the alternative, that Friedman himself notes earlier in the book (Pg. 13), of producing for one’s self (emphasis added):

The incentive for adopting this indirect route [of producing some goods and exchanging them for other goods voluntarily] is, of course, the increased product made possible by the division of labor and specialization of function. Since the household always has the alternative of producing directly for itself, it need not enter into any exchange unless it benefits from it.

Returning to our example above, we have another always-present alternative: green shirt, nothing, self-production. Like with the “nothing” alternative, the cost of self-production may be extremely high and undesirable, but that does not mean the alternative does not exist.

In regard to substitutes, substitutes always exist. The Law of Demand teaches us that, as prices for one good rise, the demand for substitute goods increases. People seek out alternatives. As prices get higher, the intensity of their search increases. People may develop new alternatives, or they may use things in different manners. For example, if the price of firewood gets high enough, people may start burning phone books. The mere presence of these alternatives help define the shape of the demand curve the monopoly faces.

Along this same point, firms are petrified of competition, either real or shadow competition. A monopoly, by definition, does not face any other direct competitors in their industry (however defined), but that does not mean competition does not exist. As just mentioned, as prices rise, people seek alternatives (substitutes). The longer prices stay relatively high, the greater that search becomes and the more elastic the demand curve becomes. As such, monopolies tend not to capitalize on their positions and capture all the rents they could (for more on this, see this 1999 article by Don Boudreaux and Burt Folsom).

Monopolies can be problematic from an economic perspective, but their existence does not imply the absence of alternatives.

*We could go even farther here and point out that other alternatives are represented by the opportunity cost. I could buy the green shirt, or a pair of pants.

How Do We Decide Who We Can Trust?

Writing for the AEIR, Art Carden has an excellent article entitled “Government is Not a Wise Steward.” In the article, Art is discussing differing ways to use tax dollars. Art writes:

Given its track record, it’s not at all clear to me that the U.S. government — or my state, county, or local government — would be a wise steward of any money I feel like I don’t need. You know those bumper stickers that say something like “It will be a great day when schools have all the money they need and the army has to hold a bake sale to buy a tank,” or something like that? I’m not sure I want more of my money going to an entity that spends so much on tanks and bombs.

Should they [government] give it [tax dollars] to charity? Maybe. Even then, the decision isn’t quite as clear-cut. There are a lot of nonprofits that seem to exist strictly to raise funds, not to actually solve any problems, as Tyler Cowen points out in his book Big Business: A Love Letter to an American Anti-Hero (which I discuss here). Even if we address the possibility that we end up joining a scam like the Bluth Foundation’s battle against TBA, Yoram Barzel famously argued that it is very difficult to give away money in a way that benefits the people we are trying to help. Even for the devoted humanitarian with resources like GiveWell at her disposal, “Give your money to charity” wouldn’t obviously deliver maximal bang for one’s benevolent buck.

The issue of which charity to give to, whether it be private or public money, is always tricky. The point of charity is to do good, and ideally you want your dollars going to purify water in Africa or protect the Icelandic puffins rather than pay someone’s salary in the US. But how do we get that sort of information? How do we get the knowledge needed to know who we can trust, whether it be to save the whales or sell us our dinner? After all, it is not from the benevolence of the brewer, baker, and butcher that we get our dinner.

Interestingly enough, that knowledge is gained through the competition process. Suppliers do not compete with other suppliers on price alone (same with buyers against other buyers). One of the things that they compete on is trust: You trust that the supermarket will sell you non-contaminated food. You trust the bank will not steal your money. You trust that the burger you get from Five Guys in Colorado will be just as good as the one you get in Maryland. As Hayek wrote in The Meaning on Competition, part of the competitive process is to teach us who will best serve us.

Thus, with government as steward, without a robust competitive process, there is no way to generate that kind of knowledge. And with government, it is hardly competitive. In other words, government is unlikely to be a good steward with funds (opting, say, for health care or education over bombs) because it lacks the very ability to get that form of local knowledge needed to know who the best recipients of funds should be.

Of course, the private sector competition is not perfect. As Art points out, there are a lot of difficulties in determining charities. But we only have the information that some charities are relatively better than others because of that competition.

If government were to be a good steward, it would need certain kinds of information, but that information is only available locally and through competition.

Where's Mine?

Today is Frederic Bastiat’s birthday. He was born in 1801 in Bayonne, France. To celebrate, I am rereading his 1850 tract, written mere months before his death, The Law. I came across this line:

Men naturally rebel against the injustice of which they are victims. Thus, when plunder is organized by law for the profit of those who make the law, all the plundered classes try somehow to enter — by peaceful or revolutionary means — into the making of laws. According to their degree of enlightenment, these plundered classes may propose one of two entirely different purposes when they attempt to attain political power: Either they may wish to stop lawful plunder, or they may wish to share in it.

Last week’s Democratic debate captures Bastiat’s observation quite well. Many of the candidates properly recognized some legal plunder going on in the law by legislators and special interest groups. But not a single one of them proposed stopping that legal plunder. Virtually all of them discussed ways in which they, or the people they supposedly represent, want to share in the legal plunder: whether it be “forgiving” various forms of debt, or taxing more of a certain group of people, or whatever.

A concrete example may help here: student loan debt “forgiveness” or “cancellation.” The idea is simple: people have loan debt, and it is substantial. Therefore, if the government were to, in its misguided philanthropy, forgive that debt, people will be made better off. Many of these people wrongfully took loans without understanding them or without fully being told the consequences of borrowing the money they did. Universities and the debt holders benefit from these loans, and many forms of legislation currently on the books promote this wealth transfer from students to universities and credit holders, not the least of which is the subsidized student loan program of the federal government.

But debt cancellation does not end this legal plunder. In fact, since no one proposed removing that legislation, the schema for legal plunder remains in place (this fact alone should raise questions about the effectiveness of debt cancellation even if the problems we are discussing weren’t here, but no one mentions it). Thus, no one is talking about ending the legal plunder, but ways to participate in it. Debt cancellation is a wealth transfer from one group, taxpayers without college degrees and debt holders and future college students, to another group: current student loan borrowers.

The “where’s mine?” mentality is very powerful. I suspect that in a democracy it will be even more difficult to eliminate legal plunder, with most politicians seeking to curry favor by promising “have yours!” The Democratic debates and the entirety of Trump’s trade policy reflects this point.

Today's Quote of the Day...

…is from page 107 of the 2009 Mises Institute re-issue of FA Hayek’s 1948 book Individualism & Economic Order:

In principle the industrial protectionism and government-supported cartels and the agricultural policies of the conservative groups are not different from the proposals for a more far-reaching direction of economic life sponsored by the socialists. It is an illusion when the more conservative interventionists believe that they will be able to confine these government controls to the particular kinds of which they approve. In a democratic society, at any rate, once the principle is admitted that the government undertakes responsibility for the status and position of particular groups, it is inevitable that this control will be extended to satisfy the aspirations and prejudices of the great masses.

JMM: Hayek first wrote these words in 1947. They remain relevant today. Modern conservatives, in an effort to supposedly constrain socialism, turn to the very policies the socialists advocate. They make the mistake of believing, despite all evidence to the contrary, that their intervention is not the blunt hammer of socialism, but rather a precise scalpel that can just cut out whatever problem they see in society and leave the rest untouched.

But once the cutting begins, especially without an appreciation of how interconnected things are, greater damage is done. And to fix the problems of this one cut, other cuts need to be made, and the problem grows exponentially.

The industrial protectionism of conservatives is just a different flavor of socialism than the left-wing variants.

Trump's Tariff Inconsistency

Trump has long argued that imports harm the importing nation: the represent jobs being sent overseas, they are debts, they represent selling out national sovereignty, they are a hollowing out mechanism, etc. Major aspects of his trade war have been to reduce US imports from China, Europe, and other places while increasing US exports. Trump is a proud mercantilist.

Which makes his behavior towards Iran strange. Trump has imposed a number of sanctions on Iran which prevent Iran from importing. If Trump’s justification for tariffs is true, then the economic sanctions levied on Iran will only serve to strengthen them and weaken US and allied economies by limiting exports. Conversely, if he believes the sanctions will harm Iran, then they must equally harm the US when imposed on us by the government.

If Trump’s trade logic were to be taken literally, he should try to flood Iran with US-made goods, thus “destroying” their country, manufacturing, and economy. Any attempt at preventing this would only serve to “make Iran great again.”

Since I made this observation last night, several Trump supporters have tried to square the circle. No explanation was satisfactory (they all were some variation on “you just don’t understand negotiating. Just read Art of the Deal!”), I am open to any attempt to square this circle.

Trump’s only consistency is his inconsistency.'

See also Mark Perry on this.

Today's Quote of the Day...

…is from F.A. Hayek’s 1946 Princeton University Lecture “The Meaning of Competition,” reprinted as Chapter 5 in Individualism and Economic Order. The following appears on page 97:

In actual life the fact that our inadequate knowledge of the available commodities or services is made up for by our experience with the persons or firms supplying them-that competition is in a large measure competition for reputation or good will-is one of the most important facts which enables us to solve our daily problems. The function of competition is here precisely to teach us who will serve us well: which grocer or travel agency, which department store or hotel, which doctor or solicitor, we can expect to provide the most satisfactory solution for whatever particular personal problem we may have to face.

Why Let the State Define Morality?

Over at EconLog, Dave Henderson has a short, but excellent, post on liberty and morality. Henderson discusses the desirability to have non-coercive means of discouraging undesirable behavior. He uses the example of Youtube using their power to de-platform a popular but controversial individual and the subsequent conservative backlash. Henderson does not believe that the government should have the power to censor, but that a private organization may choose who or who not to host. What follows below is an edited and elaborated version of what I commented at EconLog.

I think this is a good example to distinguish between (how I understand) jurisprudence and ethics.

Jurisprudence is rules for how a sovereign should behave, which inherently means what things should be illegal (ie, punished through a coercive state behavior).

Ethics, on the other hand, are the rules for the good life.

Jurisprudence rules are typically precise and accurate (like the rules of grammar). They are often designed and arbitrariness is typically seen as a bad thing for jurisprudence.

Ethical rules, on the other hand, tend to be more loose. “How to live the good life” can have many answers. Some may live the good life by being generous with their resources (and what does this mean?). Some may live the good life by trying to be kind (whatever that means). There are many ways and various combinations of ways to answer the question. It’s worth mentioning that, while these rules are loose, it is not imply they are arbitrary or moral relativism wins the day. For example, what makes a movie good may be relative to a certain degree, but there do appear to be certain barriers that cannot be crossed before a movie is considered “bad.” Things like : clear focus of camera, comprehensible plot, proper sound, etc.

Libertarians tend to conflate jurisprudence with ethics, and as such they tend to make the state the arbiter of morality (despite their frequent objection to such).  An example of this is some of these disgusting behaviors; some libertarians will argue that any behavior that discourages these actions, even when done by private individuals, is bad.  The logic is since these actions do not violate jurisprudence rules, then they must be tolerated. This, then, leaves the distinction of morality solely in the power of the state; so long as the state determines it is legal, it must consequently be moral since it cannot be punished in other ways. Consider segregation: many libertarians will argue (justly or unjustly, I’ll leave to the reader) that the state has no right either in enforcing segregation or enforcing integration. “Of course a person has the right to segregate! Of course they have the right to discriminate who they do business with!” But then they will resist shaming attempts at those same people who are discriminating (they’ll tend to support not shopping there or not inviting them to parties or something, but not other forms of shaming).

But I do think we need to make a distinction here, that we can frown on something for ethical reasons, want to discourage it, but also not think coercion is the proper way to do so. Allowing non-coercive forms of behavior acts as a means of transmitting morality as well. When the state ends up defining morality, it can very well lead to faction and violence.

Operationalization of Theory is Never Straightforward

Over at EconLog, Pierre Lemieux points us to a recent op-ed by Trump economic advisor Peter Navarro. Pierre writes:

The keystone of his claims in this op-ed is the distinction between “pure free trader” and “fair, reciprocal and balanced trader.” The latter concept is at best underdetermined and at worst absurd. There have been as many definitions of “fair” as there have been political theorists and moral philosophers. Is it “fair trade” that American producers have a big advantage as they master the language of international trade better than their German or Vietnamese competitors? Isn’t that the sort of “trade barrier” that Navarro said should be compensated by a tariff in order for trade to be “reciprocal”? Reciprocity is usually a mere excuse for protectionism.

This is a point I routinely make in my classes when I lecture on supposed exceptions to free trade and operationalizing these exceptions.  In theory, it is easy to design a policy where some “unfair advantage” is corrected.  In reality, identifying these barriers is difficult.

My favorite example is rule of law.  The US, compared to many countries, is very non-corrupt.  We have a good judicial system that is relatively unbiased and even-handed.  Contracts are reasonably enforced.  Bribes aren’t really required to do business.  All this reduces the cost of doing business in the US compared to other countries, which is why many firms do business here.

Since the judicial system is run by the government, one can argue it counts as a “subsidy” to reduce costs for businesses.  Thus, an analyst could use rule of law in the US to justify tariffs against US products.

Is that also what Navarro means when he demands reciprocity?  What about our relatively educated workforce (also subsidized, BTW)?  Or our relatively good infrastructure?  All of these would justify, in theory, subsidies on American products by foreign nations given the loose, vague, and indeterminate language of Navarro.  The theory gives no guidance about what is counted and what is not, which means it is left up to the analyst.  Thus, talking about “fair trade” is not as precise as Navarro, or theory, makes it seem.

Once we begin moving away from theory and into interventionist policy making in the real world, the operationalization of the theory gets very loose very quickly. How things are defined is not straightforward and precise. Calculating “optimal” tariffs will depend crucially on the assumptions and definitions of the analyst. What Peter Navarro considers “reciprocity” may not be considered so by Donald Trump, or by you and I. Indeed, for certain definitions of reciprocity (each as theoretically legitimate as the one Navarro uses), one can argue that any Chinese trade barriers on US goods are “fair and balanced” and the actions of the Trump Administration are unfair trade!

At Cafe Hayek, Don Boudreaux highlights a similar theme put forth by our colleague Bryan Caplan and his co-author Zach Weinersmith:

The right question to ask is never “Will it be perfect?” But “Will it be better than the alternative?”

The problem with perfection is not only that men are not angels and fallible. Were it only that, then it would simply be a matter of creating an algorithm for a machine to optimize and then just internalize any externalities. The problem with perfection includes actually defining perfection. A blackboard model of equilibrium is only “perfect” in the eyes of the analyst. Assumptions we have to make to get there are enormous and context-dependent (for more on this point, see Hayek’s 1937 paper “Economics and Knowledge.” Also valuable is James Buchanan’s discussion in Chapter 1 of LSE Essays on Cost). Thus, even determining what policy should be will depend heavily on the assumptions of the analyst (note this lesson holds over from my blog post “Does Economics Imply Liberalism?”. This is all the more reason why it is important to focus on obtainable alternatives as opposed to idealized outcomes.

None of this implies radical anarchism or that policymakers should be paralyzed with fear (although I am sure people will use the arguments here to justify those stances). Rather, what this is to say is that discussions of ideal economic policy are not straightforward, that there is, as Ronald Coase wrote paraphrasing Frank Knight: “[P]roblems of welfare economics must ultimately dissolve into a study of aesthetics and morals.”

Does Economics Imply Liberalism?

Economics as a field of thought as we understand it today began with the Enlightenment period.* As such, the initial study of economics was done through a liberal lens. The economic policy recommendations that came out of this study, popularly known as laissez-faire certainly has a liberal feel to it. Indeed, Smith christened his system developed in The Theory of Moral Sentiments and The Wealth of Nations as “the liberal system.”

But does this foundation imply that economics is inherently liberal? I posit it is not necessarily the case. One can understand economics very well and be illiberal.

Let’s take, for example, a simple supply and demand model. This model serves as the foundation of much of economics (indeed, we can derive pretty much all of economics from one simple fact; resources are scarce. This fact leads us to opportunity cost, which leads us to demand curves, with leads us to supply curves, which gives us the foundation of modern economics). Liberals will often point to the supply and demand model, rightfully so, to show the unintended consequences of illiberal policies; according to the model, minimum wage will lead to unemployment (especially among the marginally employable) or price controls will lead to shortages. These outcomes of the model are cited by liberals.

But those outcomes were also initially cited by illiberals in support of those same policies. The fact that minimum wage kept marginally employable people out of work was a benefit to many initial proponents of the minimum wage (see the Congressional debates on the Davis-Bacon Act). It has been used recently for justification for minimum wage to keep immigrants out of jobs.

But there are other implications of the model. As A.C. Pigou showed, if there are costs that fall on other people, the model suggests that a tax can be imposed to correct for these costs. Ronald Coase showed this logic holds if there are transaction costs to negotiating. Paul Samuelson showed that one of the implications of the model is, given certain assumptions, international trade without barriers can actually harm a domestic nation’s overall economic welfare. More recently, some behavioral economics like Richard Thaler have shown now, again as implied by the model, that certain “nudges” can be applied to correct market failures. All of these are implied by the model and are illiberal in nature.

Liberals can, and do, object to some of the items discussed in the previous paragraph. They cite public choice concerns, or calculation and knowledge problem issues. They cite the self-interest of politicians or the problems of bureaucracy. All of these are important (and also implied by the model as well).

As we can see, the model itself (which we are using here as a segment of economic knowledge) does not imply in and of itself any liberal or illiberal bias. It is, in that sense, apolitical. How the model is applied, what exceptions or policies are proscribed, do not depend, thus, on the economic science but rather on the subjective and estimated probabilities of the individual using the model. For example, let’s say we have two people using the supply and demand model to recommend policy dealing with pollution. An analyst who puts relatively low probability on government’s ability to correctly set a Pigouvian tax would recommend no explicit policy (or, perhaps, something akin to cap-and-trade). Meanwhile, an analyst who has a relatively high probability of the government’s ability to correctly set a Pigouvian tax may recommend such a tax. Both these analysts are guided by the same model, but their recommendations and predictions based of the model are different. They’re not different because one is more ignorant than the other. The objective data being used is the same. What is different is the subjective data each analyst uses.

Economic knowledge does not imply a liberal outlook. Just like any science, it can be interpreted and applied in different ways.

*I am hesitant to give it an exact starting point, such as highlighting Adam Smith as many people do. Smith may have been the first systematic treatment of economics in English, but there were many other authors who were considering the problems of economics before him: David Hume, Francis Hutcheson, Gershom Carmichael, the French Physiocrats (who influenced Smith), and the Salamanca School, just to name a few.

Today's Quote of the Day...

is from page 66 of the Liberty Fund’s 1999 edition of James Buchanan’s Cost and Choice:

In order to estimate the size of the corrective tax [to correct an externality], however, some objective measurement must be placed on these external costs. But the analyst has no benchmark from which plausible estimates can be made. Since the persons who bear these “costs” - whose who are externally affected - do not participate in the choice that generates the “costs,” there is simply no means of determining, even indirectly, the value that they place on the utility loss that might be avoided. In the classic example, how much would the housewife whose laundry is fouled give to have the smoke removed from the air? Until and unless she is actually confronted with this choice, any estimate must remain almost wholly arbitrary.

JMM: The fact that the cost to the external party is almost wholly arbitrary unless they are actually confronted with the choice does not imply that the estimation of the cost is irrelevant. What it does imply, however, is that welfare economics is not as precise and accurate as the blackboard models would have you believe. We should be wary of any scheme that relies on some “optimal” tax, tariff, or price in order to operate. The result of that model is wholly dependent on the analyst’s assumptions about what people would do if actually faced with a given choice.

Why It's Important to Know Reality, Not Just Models

In economic theory, one can calculate who bears the burden of a tax by examining the elasticity of demand and supply for the product the tax is placed on. “Elasticity” is a concept that refers to how responsive consumers and producers are to changes in price. Demand/Supply is relatively inelastic when the consumer/producer changes the quantity demanded/supplied relatively little given a change in price. Demand/Supply is relatively elastic when the consumer/producer changes the quantity demanded/supplied greatly in response to a price change. When a good is relatively inelastic, the producer can pass a large portion of a tax onto the consumer since the consumer is relatively insensitive to price changes. When a good is relatively elastic, the producer must pay some of the tax himself since the consumer is relatively sensitive to price changes.

Price elasticity is applied to the concept of international trade as a way of potentially increasing net national welfare from a tariff. If a home government passes a sufficiently small tariff and there is some elasticity to the good, then some of the tax can be passed on to foreign producers in the form of lower prices received. The net national welfare rises as those losses to the foreign manufacturers are not counted, but there is an increase in tax revenue.

That is what the model says. And it is a variation of this model that commentator “Doctor” Joe B* applies at Mark Perry’s blog Carpe Diem:

A tariff is paid by the seller and the buyer, and how much each pays depends on elasticity of demand.

So far the evidence is that China is eating the tariffs, through price cuts and cheaper yuan.

But Mr. B errs in his assumptions. The assumption of the model is there are no middlemen between the producer and the consumer. If there are, the tax burden would be spread out among all of them depending on their various elasticities.

In real life, few people buy directly from Chinese producers. There are all kinds of middlemen involved: shippers, importers, wholesalers, retailers. When we take into all the middlemen, we see that none of the tax is actually being passed onto Chinese producers. It’s being absorbed entirely by Americans.

Knowing the reality of what your studying will enhance the model. Ignoring the reality leads to faulty conclusions.

*I but “Doctor” in quotation marks because I know for a fact this man holds no PhD.

Today's Quote of the Day...

…is from page 20 of Douglas Rasmussen and Douglas Den Uyl’s 2005 book Norms of Liberty: A Perfectionist Basis for Non-Perfectionist Politics (note that when the author’s say “liberal,” they mean in the classical sense):

Liberals are tempted by the argument that the effects of liberal politics speak for themselves, but this gives the entire moral enterprise over to nonliberals. The effect of this is what we find today: widespread material success due to liberal policies coupled with equally widespread cynicism about or hostility to the moral dimensions of those same policies.

JMM: Yup. Truer now than when those words were written, liberalism seems to lack a moral compass at times. I began reading this book at the insistence of Aeon Skoble when I complained to him of this problem. Many classical liberals focus too much just on economics or the other social sciences, or are interested in classical liberalism as a way of “owning the Left/Right.” But, without a moral foundation, we have no leg to stand on and we cede the argument to our critics.