A Hayekian Walk Down Wall Street

The always enjoyable Candace Smith, Etiquette Advisor to the Stars (my description), has a great short post on the etiquette of going for a stroll. Candace’s post is full of excellent nuggets of general polite rules of walking in public. These rules are not legislation; for the most part, they are convention. People, even those new to the society, quickly pick them up and obey; to not do so would be against their self-interest. These rules developed over time and, as Candace notes, have connections to similar activities we partake in (“The general rule here in the United States: keep to the right and pass on the left, exactly as if one were driving”). These rules, in other words, emerged from human interaction with one another in out society and they exist outside those members (in other words, the rules are not just the reflection of the current members of the society but have power over newcomers as well). In that sense, they are more like laws.

But there is another aspect of Candace’s post I wish to draw attention to: namely, the unarticulated rules. Candace is articulating many of the unspoken rules of walking, but there are things she leaves out, not because of incompleteness on her part but simply because those things are inarticulatable.; they are very loose, vague, indeterminante, and subjective.

Consider her common-sense rule: “Stay mindful and off your phone as you will be moving in and out among others, gauging their movement without bumping into them or pushing up against them.” This rule is simple enough, but what it fully means is not captured in this short sentence. The actual steps needed to be taken will vary from situation to situation, from person to person, from moment to moment. No one could explain all the lightning-quick decisions made while on a walk. Don’t believe me? Try to guide someone who is blindfolded down a street only by your words (articulation). I bet it would be impossible.

These inarticulate rules still influence us despite their inarticulate nature. We try to articulate them as much as we can, like Candace, but even that is incomplete. There is so much background knowledge we need in order to make our actions coherent, to make them in concert with other people.

And that is the fundamental insight of FA Hayek.

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

…is from pages 79-80 of the 2016 Mercatus Center re-issue of Don Lavoie’s 1985 book National Economic Planning: What is Left?

[O]ne can argue that just as an articulated statement only carries meaning to other people because of a shared denominational background in unarticulated assumptions about the use of language, so too do articulated prices only carry meaning to those who calculate with them because of a shared background in unarticulated assumptions about the characteristics of the priced goods and services. Just as articulated statements in science constitute an indispensable aid to our advancement of a largely inarticulate understanding of the world, so too do articulated prices provide an indispensable service to our largely inarticulate production activities. But neither articulated statements nor posted prices have any meaning when divorced from their inarticulate foundations.

JMM: In the wake of any disaster, we see a great effort by many people to unmoor prices from their inarticulate foundations via price gouging legislation. But when this is done, the meaning of the price becomes skewed and sends confusing messages to those who have to deal with the price. Its meaning becomes obscure and gibberish, much like how an understanding of sunlight would become gibberish if the word was divorced from the idea of sunlight.

Prices convey information. We may not like what that information is, but pretending it does not exist is not helpful.

The Definition of Insanity...

The following is an open letter to the editor of the New York Times:

To the Editor:

Your 11 September 2019 article on a new housing bill in California proudly proclaims “California Approves Statewide Rent Control to Ease Housing Crisis.” However, the caption of the accompanying photograph tells us that the headline is incorrect, that the bill will not end ease the crisis, but rather make it worse: “San Francisco has had rent control for decades, but it has not been spared from a housing squeeze and rising homelessness.”

In your article, you allude to some of the economist objections to rent control, and the caption quoted above indicates those objections are correct. But there is very little in the article dedicated to addressing those objections. Most of the article is on the intentions of the bill, intentions that will not be realized. The fact that the California bill calls such control “price caps” does not change this fact. The fact that the California bill is not as strict as other cities’ bills does not change this fact. The fact is: California has taken steps to make the housing crisis worse. Restricting supply will not allow more supply to come to the market.

Jon Murphy

Jon MurphyPrice Theory
Morality and ECON 101

In Fall 2018, I was assigned to teach International Economic Policy (Econ 385) at George Mason University, a trade class for non-economics majors.  As a student of Adam SmithFrederic Bastiat, and Don Boudreaux, I was excited to teach this class. The miracle of the market was such an eye-opener for me as a high schooler. I could not wait to share my love of economics with students!

My enthusiasm was immediately dampened as I realized I faced many students whose mindset seemed hostile.  Extolling the virtues of trade in the standard mutual-gains manner would not fly with this crowd.  I had to find another way.

These are the opening lines to my guest post on EconLog entitled Morality and ECON 101. Do check out the whole thing.

Today's Quote of the Day...

…is from Henry Home, Lord Kames’ 1751 treatise Essays on the Principles of Morality and Natural Religion and can be found on page 87 of the 2005 Liberty Fund edition:

It is agreed on all hands, that justice is established among men for making them good citizens, or, in our author’s words, for public utility; consequently that public utility is the sole end of justice. It ought however carefully to be attended to, that in no case is it made our duty to act for the public good: we are left at liberty by the moral sense to act for the public good if we incline; but the moral sense lays us under no obligation. The good of mankind, or even of our own country, resulting from an endless variety of combined circumstances, is an object too complex and intricate to be taken under consideration by a creature so limited in capacity as man.

JMM: For Lord Kames, a duty is something that is compelled by a [natural] law. It is something heavily imbued within us that goes beyond mere approval or disapproval and can often be compelled. They are “plain and simple acts” (this quote appears later on the same page): things like obeying parents, being grateful to benefactors, not robbing or causing violence, etc. It does not entail benevolence, as these rules are (as Adam Smith would put it about 8 years later) loose and vague and what constitutes a “public good” is highly complicated. Thus our duties are simple to one another, and other virtuous acts are applauded but not compelled; what is virtuous and what is vicious can depend heavily on the situation at hand.

The Paradox of Tariffs for Free Trade

One of the myrid of excuses we’ve heard for Trump’s various trade wars is that the ultimate goal of the tariffs is to reduce/eliminate other countries’ tariffs on US goods (see, for example, here). Indeed, in The Wealth of Nations, Adam Smith mentions as a possible justification for tariffs the “recovery of a great foreign market,” although Smith just hedge on this justification (emphasis added):

The recovery of a great foreign market [from prohibitively high tariffs imposed on domestic goods] will generally more than compensate the transitory inconveniency of paying dearer during a short time for some sorts of goods…When there is no probability that any such repeal can be procured, it seems a bad method of compensating the injury done to certain classes of our people, to do another injury ourselves, not only to these classes, but to almost all the other classes of them. (WN Pg.468.39).

Where the paradox alluded to in my title arises is from this “recovery of a great foreign market.” How much benefit is the domestic nation likely to incur from such a recovery? I argue: not much.

When a nation has relatively free trade already, they don’t stand to benefit particularly much from increased free trade; the nation has already capitalized the gains from free trade. To take an example, when the US entered NAFTA, greatly reducing tariffs between the US, Mexico, and Canada, US real incomes rose only 0.1% (see Paul Krugman’s article “The Uncomfortable Truth About NAFTA”). The US was already a largely free-trade nation and there was already moves toward integration before NAFTA came about. Thus, a small increase in real income. Let’s assume a no-NAFTA world and let’s say the US were to launch a trade war with Mexico to reduce tariffs. The above analysis indicates that, for the US, costs of the trade war (ie, the higher prices paid by domestic citizens) would very quickly outpace the benefits of lower tariffs (ie, increased trade with Mexico). For Mexico, however, they would stand to gain from increased trade more than the US. They would be able to launch a longer trade war as their potential benefits are higher. Thus the paradox: the country least likely to benefit from a trade war to reduce tariffs is the country already free-trade oriented and the country most likely to benefit from a trade war to reduce tariffs is the country tariff-oriented. The free-trade country would stand to lose from the trade war.

One might object, reasonably, that in my example Mexico is relatively small, and thus a larger economy like China would be a bigger boon to the US. While that is true, I argue that it doesn’t change the analysis a whole lot. Real incomes in the US would be unlikely to increase a lot from increased trade with China because, as mentioned already, the US has already capitalized on much of the gains from free trade. US tariffs on Chinese goods are fairly low (even with Trump’s tariffs, but let’s discuss pre-trade war for now). Thus, reducing tariffs even more are unlikely to increase imports a whole lot and unlikely to reduce the prices of those imports a whole lot, thus leaving the consumers of those goods relatively unchanged. Exporters would stand to gain from reduced Chinese tariffs on their goods, but even then it is unlikely to cause a major increase in exports. Currently, US trade with China (total, so imports + exports) works out to be about 3.5% of US GDP. Imports would not likely change, but let’s assume for the sake of argument that US exports to China double if China eliminates tariffs. Total trade with China would rise to 4.3% of GDP, a gain of approximately $180 billion. These improvements, and improvements they are, are relatively small (it’s also worth noting that these numbers are a quick and dirty calculation).

For China, however, they stand to gain. By reducing tariffs, the real income of their consumers would increase dramatically as they suddenly have access to all kinds of goods cheaper. The purchasing power of their wages goes up and their standard of living increases. Their exports likely remain the same, but their imports increase, enriching the nation. Thus, though the US would still benefit from lower tariffs with China, the US’ ability to launch a trade war against China for the purposes of reducing tariffs is limited.

The short version of the above: paradoxically, the nation best equipped to win a trade war where the goal is the reduction of tariffs is the nation that is relatively protectionist. But, if the nation’s government is protectionist by design, a trade war is unlikely to get them to change that stance.

Today's Quote of the Day...

…is from Scott Sumner’s August 24th 2019 blog post at EconLog “There’s No Reason to Go Heterodox” (emphasis added):

During the 1970s, high interest rates did not seem to slow inflation. As a result, all sorts of heterodox theories of inflation were invented. Too much union power, crop failures, monopoly power, budget deficits, oil prices. And each one failed, because it was monetary policy that was driving 11% NGDP growth (1971-81), which made 8% inflation inevitable. As soon as Volcker did an orthodox tight money policy, inflation promptly came down and heterodox theories of inflation were abandoned. Heterodox macro theories are the result of bad macro policies.

JMM: Scott’s final sentence can be generalized: heterodox theories tend to be the result of bad policies. Oftentimes, people (including seasoned analysts) make the mistake of analyzing some event in a vacuum: Outcome X has occurred, standard theory does not seem to have an answer for X, therefore theory must be incorrect/incomplete. Thus, all sorts of theories come about. We’re seeing this with International Trade right now with all the various (and often competing) theories coming out of the White House.

Of course, none of this is to say that heterodox theories are necessarily bad. In a sense, all theories start out heterodox. Rather, this is to say to be careful of tossing out established theory without a darn good reason.

The Perpetual Trade War

The thing with a trade war, like any war, is you need not only a will to win, but an end-game as well. One of the things that have led to the quagmire wars of Afghanistan and Iraq is the clear lack of objectives in the wars. Thus, they become perpetual with any small excuse being used to justify ongoing operations. With no clear and obtainable goal, the war will just drag on and on until the soldiers are tired of fighting and just quit. Just like Vietnam.

Trump’s trade war lacks clear objectives; it lacks an end-game. The supposed reasons for the tariffs change on a daily, sometimes hourly, basis. One moment we’re told they’re to get more “fair” trading practices. The next, we’re told they’re for national security. Then, we’re told they’re to bring back manufacturing jobs. Then, we’re told they’re to chase jobs out of China. Then we’re told they’re to address the trade deficit. Then we’re told they’re to address IP theft.

And all that is just from the Administration! Never mind the vast ad-hoc end-games we hear from the Trumpeteers: they’re to screw over China, they’re just optimal tariffs, they’re to force a regime change in China, they’re because Europe didn’t support us in the Iraq invasion, they’re to screw over the libs, they’re just for negotiating, or my absolute favorite “You need to just shut up and trust Trump knows what is best for you as an American.”

With such disparate and often mutually exclusive, not to mention poorly-defined, goals, how can the trade war ever be won? It can only ever be perpetuated.

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.