CHAPTER 11 The Third Way ON GOVERNMENT IN THE MARKET PROCESS THE DYNAMICS OF INTERVENTIONISM

THERE HAVE BEEN many efforts over the years to develop a “third way” of managing social cooperation, a path that will take advantage of the efficiency of the market process while controlling its “excesses.” The fascist movement in Italy, National Socialism in Germany, and the New Deal in America were all examples of the search for that path.

However, all attempts to improve market outcomes run into the same problem that cripples the attempt to create a socialist society, although to a lesser extent. Outside of market prices, based on private property, there is no way to rationally calculate how valuable an undertaking’s contribution to society’s well-being is. Arbitrary numbers can be assigned to gauge the costs and benefits of, for instance, a new environmental regulation, but they are just guesses. Only real market prices convey information on the freely chosen values of acting man.

Mises pointed out that all market interventions are likely to produce results that are undesirable even from the point of view of those forwarding the intervention. That is because the market participants are not supine in the face of interference with their wishes, and will act contrary to the intent of the interventionists.

SUNY Purchase economics professor Sanford Ikeda, in Dynamics of the Mixed Economy, extends Mises’s analysis of interventionism. Ikeda explains the patterns that the interventionist process is likely to follow. His analysis begins with the Misesian insight mentioned above.

An unhampered market brings about its outcome through the voluntary choices of all people in that market. Any interference with the market process—such as rent control, farm subsidies, and so on—will, to some extent, thwart the realization of people’s preferences. People, in the face of such interference, will act to reassert their desires. However, the process has been made less efficient. One reason is the overhead of the government program itself. Another is the fact that market forces will reassert themselves, though in unexpected ways. If apples would be priced at $1.00 a pound on the unhampered market, but government sets the price at 60¢ a pound, people will still tend to pay the market price. However, they will go to the market expecting to pay 60¢ for a pound, and be surprised by paying 60¢ plus 40¢ worth of time waiting in line.

Even the minimal state, which attempts to provide only protection from the violence of others, runs afoul of such difficulties. Since the minimal state must tax, it must set the level of taxes, or, looking at the other side of the coin, it must decide how much protection to provide. Whatever level of protection it chooses, some people will be unhappy with that decision. Since, in a constitutional republic, the level of protection will be set somewhere in the middle of the range of desired amounts, there will be a large group of people who feel they are getting, and paying for, too much of it.

It’s not impossible that those people will choose to just grin and bear it, but it is very unlikely. Humans act in order to improve situations they find unsatisfactory, and the people paying too much in taxes, in their own eyes, have the motivation to act.

Not paying their taxes will subject them to violence from the state. But since those taxes were imposed on them by political means, it will occur to them that they can use the same means to try to gain some compensating benefit. Perhaps they will lobby to have extra protection for their neighborhood, to have a military base located nearby, thereby increasing local trade, or to get street lights on their road, in the name of increased security.

Whatever benefit they wrestle from the state will change the situation of those who were happy with the old amount of protection. They are paying the same amount in taxes as before, but some of their previous benefits have been shifted to others. Now they have a motivation to form an interest group and lobby the state to provide them with some new benefit as compensation for their loss. That creates a dynamic that tends to produce continual growth in state programs.

Furthermore, however wise and noble the founders of the state were, state service will act as a magnet for the person who wants to exercise power over others—as Hayek said, the worst rise to the top. In order to maneuver his way into a position of power, such a person will have every reason to rub salt in some interest group’s wound. By goading “his” interest group on in its grievance, a politician can build a “constituency” that he can ride to power.

Such interventionism clouds the interpretation of prices, interest rates, profits, and losses. Austrian economist Jörg Guido Hülsmann points out that interventionism involves a falsifying of signs. The past price of a good is people’s own best appraisal of the options available to them, and is a sign for people trying to estimate the future price. A legally fixed price is in some ways not a price at all, as it lacks that essential feature. It bears the same relation to a market price as a wax figure does to a living person.

With prices altered, entrepreneurs are discouraged from pursuing genuine opportunities in some areas. For example, farm subsidies will make the search for more efficient methods of farming less urgent. Meanwhile, entrepreneurs pursue other opportunities that, in the unhampered market, would have been considered superfluous—consider the proliferation of lobbyists and tax accountants.

Ikeda shows that the problems resulting from one intervention tend to lead to calls for other interventions to fix those problems. People sense that something is wrong, but unless they have a firm grounding in economics, it is difficult for them to trace the problem to the intervention. As each succeeding intervention moves the market further from its unhampered state, the process of tracing the problem back through the myriad distortions becomes ever more torturous.

Nothing could illustrate the situation better than the “health-care crisis” in the United States. Initial government interference, in the form of licensing requirements, restricted supply and drove costs up. A further government intervention, the wage controls imposed during World War II, led employers to offer “free” health insurance, which was tax-deductible for employers but not employees, in order to attract employees. (Since employers could not raise wages, they competed for employees by offering more benefits.) The third-party provisioning of health insurance made health-care consumers less price conscious, driving up costs still further. The subsidy of demand through Medicare and Medicaid added yet another factor increasing costs. The market responded with strange entities such as health management organizations (HMOs). (Notice that we do not see AMOs in the automobile industry, or CMOs in the computer business.)

In answer to the problems that have developed, the major policy proposals involve, just as Ikeda predicts, further interventions to correct the unfortunate consequences of past interventions.

Even people who generally understand the benefits of the market cannot see, through the welter of distortions produced by interventions, any choice but more intervention as a cure for the worst problems of interventionism. Robert Goldberg of the National Center for Policy Analysis says:

As most know by now, Medicare currently provides coverage for hospital therapy and doctor therapy, but not drug therapy. Failure to cover drugs in the current system creates perverse incentives that waste resources and endanger patient health. . . . Both the Gore and Bush plans [to cover drug therapy] would improve on the current situation. (“Continue the W. Revolution”)

However, new interventions will add new distortions to those added by previous interventions. It is impossible to intervene the economy back onto the path that the unhampered market would have taken, as there is no way, in the absence of the market process, to discover what that path might have been.

Goldberg acknowledges that under either plan, certain drugs will be covered, and others that will not. He asks, “Under which plan will these lists of drugs be more likely to be used to limit access to new and better drugs at the price of increased risk to patients?” But he fails to note that either plan will certainly have the unwanted effect of focusing prescription and research on listed drugs, to the detriment of patients who might have benefited more from other, unlisted drugs. When that problem is noticed, there will surely be some politician recommending another intervention to correct it, perhaps asserting a patient’s right to a greater variety of subsidized drugs.

Subsidizing drug purchases in any fashion only leads to further price distortions. While it is true that some of the new spending on drugs will be shifted from spending on hospitals and doctors, other shifts will occur from nonmedical goods into medical spending, where the marginal utility of an additional dollar spent will have been raised by the new subsidy.

Ikeda’s subsequent work, following in the footsteps of Charles Murray and others, is exploring the ways in which the effects of interventionism on social attitudes are similar to its effects on the market process. In order to survive in a laissez-faire society, I must either exchange with others for what I need to survive or convince others to voluntarily support me. I may want to spend my whole day getting plastered, but I’m unlikely to survive too long if I do. That fact may motivate me to hold off on drinking until I’ve done at least a few hours of work.

But in a welfare state, that motivation is absent. With a minimum level of support guaranteed, I can drink the day away without worrying about starving to death. All of that drinking will further undermine my desire and ability to work, making it increasingly difficult for me to survive without state assistance.

The attitudes that are most successful in a market society—thrift, hard work, responsibility, trust—are gradually undermined by interventions that relieve people of facing the consequences of their own actions. They are replaced by increasing short-term thinking, laziness, dependence, and suspicion. These attitudes create social problems that lead to calls for further interventions to “fix” them, such as drug laws and sin taxes on alcohol, and those interventions further erode the values most important to a free society.

Our analysis of the intervention process might seem to counsel despair to those who favor a free economy. But Ikeda contends that the interventionist process inevitably leads to a crisis, where the effects of multiple interventions have become so pernicious that the possibility of a dramatic turn toward free markets becomes possible. The oil crisis of the late 1970s offers an example of such a turning point, when a deregulation of the oil industry that would have been unthinkable a few years before took place fairly rapidly.

When the crisis hits, a turn toward the free market is not inevitable. The other possibility is to turn toward socialism, in order to eliminate the remaining “market failures,” and allow state regulation full sway. Which direction the system takes in a crisis will depend, to a great extent, on the ideological leanings of the public.

An important aspect of people’s decisions is that they realize there is a choice. When the supposed defenders of the market order have been pushing a series of interventions as “free-market solutions,” the public is likely to decide that laissez-faire has been tried, and has failed. That is exactly what occurred in the 1920s and early ‘30s, as documented by Murray Rothbard in America’s Great Depression. Several Republican administrations, from the purportedly free-market party, engaged in an unprecedented amount of economic meddling. For instance, in his speech accepting the GOP nomination for president in 1932, Hoover noted:

[W]e might have done nothing. That would have been utter ruin. Instead, we met the situation with proposals to private business and to Congress of the most gigantic program of economic defense and counterattack ever evolved in the history of the Republic. We put it into action. . . . No government in Washington has hitherto considered that it held so broad a responsibility for leadership in such times. (Rothbard, America’s Great Depression)

THE PROBLEMS WITH EFFICIENCY

IN THE NEXT several chapters we will look at some specific government interventions into the market. Before we leave this chapter, however, I’d like to examine a technique by which interventionism is often justified: the appeal to efficiency. The basis of the technique is the employment of equilibrium analysis to demonstrate that the free market has produced an “inefficient” outcome, and to recommend some government intervention that will rectify the situation, leading to increased “social utility.” A leading proponent of such analysis, Judge Richard Posner, has “described the common law as a tool to maximize aggregate social wealth.” (I’m quoting Steve Kurtz, interviewing Posner in the April 2001 issue of Reason.)

Steven Landsburg, in Price Theory, gives an example of the use of the efficiency criterion for resolving legal disputes among individuals. A group of ten students would like to burn down their professor’s house, while the professor is not in favor of the idea. Landsburg explains how to use the efficiency criterion to settle this dispute:

According to the efficiency criterion, everyone is permitted to cast a number of votes proportional to his stake in the outcome, where your stake in the outcome is measured by how much you’d be willing to pay to get your way. So, for example, if ten students each think it would be worth $10 to watch the professor’s house go up in flames, while the professor thinks it would be worth $1,000 to prevent that outcome, then each of the student’s gets ten votes and the professor gets 1,000 votes. The house burning is defeated by a vote of 1,000 to 100. (Landsburg, Price Theory)

Some of the problems with this approach should be obvious. First of all, what if it is just the professor’s tool shed the students want to burn? Perhaps they really love to watch fires, and would be willing to pay $100 each to watch the shed burn. Meanwhile, the shed is only worth $500 to the good professor. It’s “efficient” for the students to go ahead and burn down the shed, even if they never have to pay the professor. One thousand dollars of utility has been gained at the expense of a loss of only $500 of utility. Let’s momentarily set aside any moral compunctions we might have about allowing people to destroy or abscond with others’ property because they enjoy that more than the owner suffers from the loss. Even on its own terms, such efficiency analysis is a failure, because it doesn’t take into account the loss of “efficiency” in society when people don’t feel that their property is secure. Of course, the magnitude of such a loss is incalculable, because different social arrangements do not appear as goods for sale on the market.

Just because we can’t calculate such a figure doesn’t mean that secure property rights have no value—we might suspect, in fact, that their value is enormous. Several authors have recently written books stressing the importance of property rights for prosperity, including Tom Bethell (The Noblest Triumph: Property and Prosperity Through the Ages) and Hernando de Soto (The Mystery of Capital: Why Capitalism Triumphs in the West and Fails Everywhere Else). De Soto, for instance, says that the ordinary people of Third World countries have a great deal of property, but that they are hindered in exploiting it because they do not have a clear, recognized title to the land. He estimates that 81 percent of the rural land in Peru is owned without legal title, and in Egypt, over 80 percent of all land is owned in such a fashion. The lack of secure property rights is a major cause of the poverty in those places. A calculation of efficiency that leaves out the negative effects of nebulous ownership is like an estimation of the effect of a nuclear bomb that includes the weight of the bomb but leaves out the nuclear reaction.

The second problem with such analysis is that the “prices” used are not prices at all. The parties involved are only asked to say how much something is worth to them. Why not just pick a really big number? If you’re not going to have to pay the price, just name it, then what the heck—say that it’s worth a billion dollars to you to see the prof’s house burn.

Various tricks, involving possible consequences for lying, can be used to try to get around this problem, but none of them solves a more serious problem: We don’t know how much we value something until we really have to pay for it. Imagine, if you will, that we visit a children’s swim club and ask the kids if they’re willing to make the sacrifices necessary to become Olympic champion swimmers. We’d probably get many positive responses, despite the fact that perhaps only one in ten thousand young swimmers really is willing to pay the costs of becoming an Olympian. Efficiency analysis implies that we’d be better off if we just asked the swimmers what they would sacrifice to make the Olympics, and then appointed those who bid the highest to the Olympic team. Think of all the training time that would be saved!

It is only in the process of moving toward a goal and experiencing the costs ourselves that we discover what those costs really are. A smoker suffering from a bad cold may swear he’ll never smoke again, but it is not until he feels better and is offered a cigarette that even he discovers whether that oath is real. Without actually undertaking the discovery process, “costs” are only guesses as to what the costs might turn out to be.

Efficiency analysis also assumes that the prices we arrive at by such quizzes are equilibrium values or final prices. For that to be true, everyone would have to agree on the future usefulness of all of the factors of production. But Austrian economist Peter Lewin points out:

The whole [market] process is driven by differences in opinion and perception between rival producers and entrepreneurs. . . . The values they place on the resources at their disposal or which they trade, are not, in any meaningful sense, equilibrium values. They reflect only a “balance” of expectations about the possible uses of the resources. One cannot use such values meaningfully in any assessment of efficiency. (Introduction to The Economics of QWERTY)

The use of Pareto improvement as a criterion for justifying intervention is plagued by similar problems. Per the Pareto criterion, a policy is considered good if at least one person affected by the policy is better off because of it, while absolutely no one is worse off. In simple cases where we can clearly see a Pareto improvement, we can just voluntarily implement it. If I’m sitting around with three of my friends, and we all feel we’d be better off if we were playing bridge, then we can just play bridge. We don’t need a “policy” implemented to get the game going. In real-world policy situations, it’s almost impossible to conceive of finding Pareto improvements. Even a policy that would unambiguously result in everyone in the country having more goods would not meet with the approval of many environmentalists and ascetics.

As market prices are the sole means by which we can calculate economic efficiency, it is ironic that efficiency considerations are often used to justify government intervention in the economy. It is only when people must actually pay the cost of their choices that we can be sure that, at least in their eyes, the choice was worth the cost. The only way we can know how much it is worth to the students to burn the professor’s house is if the students really have to pay the professor enough that he agrees to let them go ahead. State intervention destroys the very mechanism by which the market achieves efficient outcomes.

The Pareto criterion and other measures like it are attempts to formulate a “scientific” gauge of better economic outcomes, standing apart from the value judgment of the person who is classifying the outcome. But human judgment creates the categories of “better” and “worse,” and all judgment is individual judgment.