Posts tagged public choice
Today's Quote of the Day...

…comes from the Preface of Mordenkainen’s Tome of Foes: A Dungeons and Dragons Supplement:

Perhaps it’s no accident that this book contains Mordenkainen’s first expression of the Balance. In here, he starts to describe the multiverse as a collection of opposing forces, each one trying to tip the scales of fate in its favor. But where does that leave us—all the soldiers in all these wars? Surely for the soldiers of all sides, a war is better when it is over.

Are you a soldier? What war do you fight? Whose side are you in? Law or Chaos? Evil or Good? Can you be sure that Mordenkainen would judge you as you judge yourself? When he puts his thumb on the scales to preserve the Balance, can you be certain that the weight of that finger will not crush you?

JMM: Protectionists often like to argue they are merely trying to get “a level playing field.” But, just like Mordenkainen putting his finger on the scale to restore the Balance, many people are crushed in the mean time. To the protectionist, they are simply dismissed as merely casualties that need to be sacrificed in the name of The Balance Of Trade. They are merely pawns to be sacrificed on their chessboard of politics.

And sometimes there are those who support The Balance but then find themselves crushed by the finger. Whirlpool, for example, who demanded tariffs in the name of fairness only to find themselves get crushed by the very fingers they demanded balance the scale.

Beware the sugar-coated words of those claiming to maintain some Balance; for those of us who live in the real word, who do not have the privilege of playing God, will often find themselves poisoned by those same words.

The Presumption of Liberty in Adam Smith

As I discussed the other day, Adam Smith had a presumption of liberty that permeates his “liberal system.” There were exceptions that could be made, naturally, but these exceptions mere existence did not in and of themselves justify the sovereign to act. Consider one such example discussed in the Wealth of Nations (emphasis added):

Were all nations to follow the liberal system of free exportation and free importation, the different states into which a great continent was divided would so far resemble the different provinces of a great empire. As among the different provinces of a great empire the freedom of the inland trade appears, both from reason and experience, not only the best palliative of a dearth, but the most effectual preventative of a famine; so would the freedom of the exportation and importation trade be among the different states into which a great continent was divided. The larger the continent, the easier the communication through all the different parts of it, both by land and by water, the less would any one particular part of it ever be exposed to either of these calamities, the scarcity of any one country being more likely to be relieved by the plenty of some other. But very few countries have entirely adopted this liberal system. The freedom of the corn trade is almost every-where more or less restrained, and, in many countries, is confined by such absurd regulations as frequently aggravate the unavoidable misfortune of a dearth into the dreadful calamity of a famine. The demand of such countries for corn may frequently become so great and so urgent that a small state in their neighbourhood, which happened at the same time to be labouring under some degree of dearth, could not venture to supply them without exposing itself to the like dreadful calamity. The very bad policy of one country may thus render it in some measure dangerous and imprudent to establish what would otherwise be the best policy in another. The unlimited freedom of exportation, however, would be much less dangerous in great states, in which the growth being much greater, the supply could seldom be much affected by any quantity of corn that was likely to be exported. In a Swiss canton, or in some of the little states of Italy, it may perhaps sometimes be necessary to restrain the exportation of corn. In such great countries as France or England it scarce ever can.

Page 539.39

In short, there may be good reason to limit exports of food to a neighboring country if they are so famished that they would draw away local food production due to higher prices. However, this potential exception does not in and of itself justify the prohibitions. Smith goes on to say (emphasis added):

To hinder, besides, the farmer from sending his goods at all times to the best market is evidently to sacrifice the ordinary laws of justice to an idea of public utility, to a sort of reasons of state; an act of legislative authority which ought to be exercised only, which can be pardoned only in cases of the most urgent necessity. 

Page 539.39

The act of interfering in trade is a sacrifice of the ordinary laws of justice, the laws the sovereign is sworn to uphold in the liberal system of Adam Smith (for the list of sovereign duties, see Pg. 687.51). Thus, Smith reasons, the sovereign should only undertake these exceptions, not when it is merely justified, but when it is “urgent[ly] necessary.”

Another example of this high burden of proof exists in his discussion of the national defense exception to free trade. Smith writes:

There seem, however, to be two cases in which it will generally be advantageous to lay some burden upon foreign for the encouragement of domestic industry.

The first is, when some particular sort of industry is necessary for the defence of the country. The defence of Great Britain, for example, depends very much upon the number of its sailors and shipping. The act of navigation, therefore, very properly endeavours to give the sailors and shipping of Great Britain the monopoly of the trade of their own country in some cases by absolute prohibitions and in others by heavy burdens upon the shipping of foreign countries.

Pg. 463.23-24

However, Smith goes on to say this mere justification is not enough (emphasis added):

When the act of navigation was made, though England and Holland were not actually at war, the most violent animosity subsisted between the two nations. It had begun during the government of the Long Parliament, which first framed this act, and it broke out soon after in the Dutch wars during that of the Protector and of Charles the Second. It is not impossible, therefore, that some of the regulations of this famous act may have proceeded from national animosity. They are as wise, however, as if they had all been dictated by the most deliberate wisdom. National animosity at that particular time aimed at the very same object which the most deliberate wisdom would have recommended, the diminution of the naval power of Holland, the only naval power which could endanger the security of England.

Page 464.30

The acts of navigation, which were indeed a violation of the ordinary laws of justice, were justified and proper (note this word “properly” appears in his initial justification in paragraph 24) in this particular case because war with Holland was inevitable and imminent. National defense, then, is not a broad exception to the liberal system of free importation and free exportation, but rather a very specific exception in the face of imminent national danger.

The duties of the sovereign in Smith are threefold: defend the nation from outside invasion, enforce the rules of justice domestically, and provide public works that are necessary and proper for the nation. These actions imply a presumption of liberty within the liberal system. The sovereign certainly has the right as a sovereign to perform certain actions that may violate liberty, but this power is one that must be executed with propriety as it violates the role of the sovereign as administrator of justice. Violations of the most ordinary laws of justice should not be undertaken lightly, and as these above quotes show (and many others throughout the Wealth of Nations, Theory of Moral Sentiments, and Lectures on Jurisprudence, not to mention his own correspondences), mere justification for a sovereign act is not enough to authorize such an act.

Adam Smith and the Nirvana Fallacy

Adam Smith was no anarchist. Indeed, at the time he was writing, he was a fairly conservative liberal (interesting that those of us who follow Adam Smith’s teachings are considered radical). Adam Smith did have a strong presumption of liberty, but this presumption was not absolute. Under certain conditions, a jural superior (such as a sovereign or magistrate) could violate this presumption of liberty.

But Smith’s analysis did not stop there. He also explored the nature of the jural superior. While Smith does have a science of the legislator, he also repeatedly emphasized that jural superiors are also human beings like us.

To give one such example, in the Theory of Moral Sentiments, Smith writes on how it is a natural human reaction to feel resentment and revenge when once does something against us. Indeed, not rendering gratitude where gratitude is due can cause this passion to arise (see Part 2, and especially Section 2). This jealousy can cause us to act in a harmful and unjust manner; beneficence cannot be extracted by force. But, while Smith is examining jural equal relations here, he also applies this same sentiment to national governments and legislators. In The Wealth of Nations, when Smith is discussing a potential use of tariffs to reduce/eliminate tariffs by other governments, he begins by stating that, when one nation raises tariffs on another “[r]evenge…naturally dictates retaliation, and that we should impose the like duties and prohibitions upon the importation of some or all of their manufactures into ours. Nations, accordingly, seldom fail to retaliate in this manner“ (Page 467.38). Revenge, that natural emotion according to Smith, is applied to national governments here and not just individuals. Smith goes on to tell of a trade war between the Dutch and French which became a shooting war.

After this story, Smith lays out his potential exception to the aforementioned presumption of liberty (Emphasis added):

There may be good policy in retaliations of this kind, when there is a probability that they will procure the repeal of the high duties or prohibitions complained of. The recovery of a great foreign market will generally more than compensate the transitory inconveniency of paying dearer during a short time for some sorts of goods. 

Page 467.39

However, he immediately follows it up with a reminder that we are dealing with people here. The science of a legislator may recommend this policy, but we must remember we are dealing with people with passions, not necessarily a dispassionate legislator:

To judge whether such retaliations are likely to produce such an effect does not, perhaps, belong so much to the science of a legislator, whose deliberations ought to be governed by general principles which are always the same, as to the skill of that insidious and crafty animal, vulgarly called a statesman or politician, whose councils are directed by the momentary fluctuations of affairs.

Page 467.39

He then brings us back to the presumption of liberty:

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 those classes, but to almost all the other classes of them. his may no doubt give encouragement to some particular class of workmen among ourselves, and by excluding some of their rivals, may enable them to raise their price in the home-market. Those workmen, however, who suffered by our neighbours prohibition will not be benefited by ours. On the contrary, they and almost all the other classes of our citizens will thereby be obliged to pay dearer than before for certain goods. Every such law, therefore, imposes a real tax upon the whole country, not in favour of that particular class of workmen who were injured by our neighbours prohibition, but of some other class.

Page 467.39

By starting with a reminder that revenge is a natural passion within our breast and a story about a war of jealousy between two nations, Smith argues that the probability that higher domestic tariffs will lead to the reduction of foreign tariffs is not particularly high.

Smith avoids the trap that many economists after him would fall into: the Nirvana Fallacy. A term first coined by the late Harold Demsetz, the Nirvana Fallacy is when one compares an imperfect current situation to an idealized alternative. Mid-Century economists often made this mistake by pointing to market failures and justifying some policy to correct these failures. Public Choice economics expanded on the Nirvana Fallacy by assuming government actors are just like market actors. Smith did not fall into this trap, and thus his presumption of liberty was extremely strong in his eyes.

The fun thing about reading Adam Smith is seeing insights in his work that would, for one reason or another, be lost to economists only to be discovered centuries later. The example above of the Nirvana Fallacy is one, but Smith also had many insights into Law & Economics.

Adam Smith had a presumption of liberty, and while that presumption was not absolute, he was under no impression that the mere existence of a justification for policy X or Y was in any way sufficient to create policy X or Y. After all: “They whom we call politicians are not the most remarkable men in the world for probity and punctuality” (Lectures on Jurisprudence, Pg. 539).

Today's Quote of the Day

Comes from Ball State University economist Steve Horwitz, who writes on Facebook:

The question remains: why do we want to leave "essential services" in the hands of people operating under institutional incentives that put their self-interest at cross-purposes with providing the essential services in question? When your whole manner of raising and allocating funds is completely separate from actually providing those services, you are at the mercy of third parties with their own interests at stake.

Food is pretty essential, but Kroger doesn't "shut down."
Clothing is pretty essential, but Lands End/Eddie Bauer etc don't "shut down."
Amazon doesn't "shut down."

If you really think services are "essential," why would you leave them in the hands of people whose incentives are primarily, if not exclusively, political, rather than oriented toward service provision?

The great virtue of the market process is it turns self-interest toward the greater good. The great vice of politics is it turns self-interest against the common good.

Jon Murphypublic choice
On the Optimal Tariff and the Law of Demand

In his 1987 Economic Review article detailing the history of optimal tariffs, Thomas Humphrey writes:

“[The optimal tariff model] assumes unrealistically (1) that foreign countries will not retaliate with tariffs of their own, (2) that elasticities of supply and demand in foreign trade are not so large in the long run as to render the tariff ineffective, (3) that the optimum tariff rate can be precisely identified and skillfully administered, and (4) that politicians can resist pressures to raise tariff rates above the optimum level” 

All four of these objections of the optimal tariff model are difficult to overcome when addressing the model as a policy procedure. I have written on some of these other points before (as have many people far smarter than I). However, I want to focus on point #2 and I’ll try to keep this not wonky.

That the optimal tariff model depends on elasticities of supply and demand is not controversial. Indeed, that is how the calculation of the tariff works. However, given condition (2) above, we can see the optimal tariff is, at best, a short-run policy. This follows from the Law of Demand.

Most people tend to think of the Law of Demand in its common form: all else held equal, an increase in the price of a good will reduce the quantity demanded of that good. But there is a second Law of Demand: the longer a price remains relatively high, the more elastic the demand for a good becomes.

Given that the goal of a tariff is to increase the relative price of a good, then as long as the tariff remains in place, the more elastic demand for that good becomes. Indeed, if the tariff remains in place and, again, everything else held equal, over enough time, the tariff could cause the demand curve for a good to become perfectly elastic. A perfectly elastic demand curve would indicate no consumer welfare gains from the trade. The elimination of consumer welfare would then mean that the tariff is a net welfare loss for the country in question. So, an optimal tariff cannot persist in the long run, only in the short run given the Second Law of Demand.

Some might object by saying: “But wait, Jon, you sly and handsome devil! That would just mean the optimal tariff would need to be reduced. There’s no reason to think the tariff would eventually become a net welfare loss.”

Indeed, it may very well be that some benevolent government can milk the tariff for everything its worth by constantly adjusting the optimal tariff as the elasticities change. However, this is where public choice comes into play. As Gordon Tullock discussed in 1975, government support of firms is very difficult to remove. Domestic producers have capitalized on the gains the tariff has provided them. To remove the tariff is not to eat up “extra normal” profit for monopolizing firms, but rather to eat into normal profit for them. These firms are legitimately harmed, profit-wise, by the removal or alternations of these protections like an optimal tariff. Any adjustment to an optimal tariff, even if demanded by the economic scenario is likely to be fought tooth-and-nail by affected firms. The resulting stagnation will likely result in an optimal tariff that is too high! Any short-run gains from the optimal tariff (assuming all the above conditions are met) would likely be eaten up by this un-optimal tariff that results from the changing elasticity and lack of change in the statuary tariff.

In a general-equilibrium theoretical framework, an optimal tariff makes perfect sense. But, once public choice enters the fray, the reasonableness of an optimal tariff goes out the window. And, as my professor Garett Jones likes to say: in a knockdown fight between general equilibrium and public choice, public choice wins every time.

HT to Dallas Weaver, whose comment on this Cafe Hayek blog post inspired this post.