regulation

Not-So-Random Thoughts (VII)

UPDATED 07/14/13

In “The Reality of the Wartime Economy,” Steven Horwitz and Michael J. McPhillips bang the drum for Robert Higgs’s account of the role of World War II in ending the Great Depression. Horwitz and McPhillips conclude:

The debate over World War II’s role in ending the Great Depression has enormous relevance in connection with the current anemic recovery from the Great Recession. We have offered evidence to support Robert Higgs’s argument that the wartime macroeconomic data significantly overstated the degree of genuine economic recovery. Higgs’s evidence rests on his reinterpretation of several traditional macroeconomic indicators to compensate for the distinct features of a wartime economy. We show that if one digs below the aggregates and looks at how American households lived during the war, as shown in the media, letters, and journals, Higgs’s case appears to be even stronger. Whatever the war’s effects on seemingly booming conventional macroeconomic aggregates, it entailed a retrogression in the average American’s living standards, and that disconnect should alert us to those aggregates’ limitations. Whenever government commands resources, those who finance this acquisition, whether through taxation or purchase of government bonds, incur opportunity costs. Whether the diverted resources go toward building tanks and guns or toward repairing bridges and roads does not alter this fact. As we continue to debate the effectiveness of large-scale government expenditure to speed recovery from the Great Recession, we should not be looking at the wartime experience of the 1940s as a guide.

I quite agree with the bottom line. (See especially my posts “A Keynesian Fantasy Land” and “The Keynesian Fallacy and Regime Uncertainty.”) But there is reason to believe that the glut of saving during World War II helped to fuel the post-war recovery. (See my posts “How the Great Depression Ended” and “Does ‘Pent Up’ Demand Explain the Post-War Recovery?“)

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Highly recommended: “What Difference Would Banning Guns Make?” at Political Calculations. The answer is “not much, if any.” Violence will out, especially when the demographics are right (or wrong, if you will). Which leads to my post “Crime, Explained.”

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A Bipartisan Nation of Beneficiaries” (The Pew Report, December 18, 2012) suggests (unsurprisingly) that

a majority of Americans (55%) have received government benefits from at least one of the six best-known federal entitlement programs.

The survey also finds that most Democrats (60%) and Republicans (52%) say they have benefited from a major entitlement program at some point in their lives. So have nearly equal shares of self-identifying conservatives (57%), liberals (53%) and moderates (53%).

What choice is there when the state (a) robs us blind and (b) penalizes initiative and success? In those conditions, most of us respond as one would expect — by feeding at the public trough. See, for example, “The Interest-Group Paradox.”

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An increasingly regulated economy, that’s what we have, according to “Counting All the U.S. Government’s Regulations” (Political Calculations, October 18, 2012). And a heavy price we pay for it, as I’ve documented in “The Price of Government, Once More,” and the many posts linked to therein.

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UPDATES:

Rich Lowry of National Review, famous mainly for having fired John Derbyshire, continues his attack on what Timothy Sandefur calls “Doughface libertarians”:

… Lincoln said, “I have no purpose to introduce political and social equality between the white and black races.” How could he say such a thing? Well, he said it in his debates with Stephen Douglas, when he was playing defense…. (“The Rancid Abraham Lincoln-Haters of the Libertarian Right,” The Daily Beast, June 17, 2013)

Not so fast, Mr. Lowry. Lincoln wasn’t just playing defense. See “The Hidden Tragedy of the Assassination of Abraham Lincoln,” wherein Lincoln’s plan for the colonization of blacks is discussed.

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From Michael Ruse’s “Does Life Have a Purpose?” (Aeon, June 24, 2013):

… Today’s scientists are pretty certain that the problem of teleology at the individual organism level has been licked. Darwin really was right. Natural selection explains the design-like nature of organisms and their characteristics, without any need to talk about final causes. On the other hand, no natural selection lies behind mountains and rivers and whole planets. They are not design-like. That is why teleological talk is inappropriate….

This reminds me of Sandefur’s post, “Teleology without God,” which I addressed in “Evolution, Human Nature, and ‘Natural Rights’” and “More Thoughts about Evolutionary Teleology.”

Constitutional Confusion

Will Wilkinson’s “The individual mandate: A taxing distinction” is rife with confusion about the Constitution:

…Suppose I sell a novel to a publisher. If the publisher cuts a check to my agent, and my agent cuts a check to me, did I really not do business with the publisher? Of course I did. The middle man is irrelevant to whether or not business has been done between the publisher and I. Likewise, if I cut a check to the government and the government cuts a check to Raytheon, I did business with Raytheon.

…If forcing me to hand a dollar to Raytheon and taking a dollar by force and handing it Raytheon are two materially equivalent ways of making me do business with Raytheon, and they are, then the undisputed power of Congress to tax and spend was a power to force me to do business with private companies all along.

One principled libertarian line on this question is that government has the power to tax only for the purpose of spending on the provision of those public goods, such as the common defence, which voluntary exchange on the free market cannot be relied on to provide…. A ruling to the effect that government may not force citizens to do business with private entities could be useful to a libertarian legal activist precisely because there really is no sound distinction between mediated and unmediated transactions….

The “libertarian line,” principled or not, is irrelevant to the meaning of the Constitution, which is not a libertarian document but a political one. The issue at hand — the constitutionality of the individual mandate — cannot be resolved by invoking libertarian principles; it must be resolved by invoking constitutional principles.

The Constitution gives the federal government the power to raise and employ armed forces in the defense of the nation. The taxing power is used legitimately (in constitutional terms) when it enables the exercise of that power. When Wilkinson is taxed to help defray the cost of national defense, he is not being forced to do business with Raytheon. He is being forced (legitimately, under the Constitution) to support the national defense, which happens to involve purchases from Raytheon (among many things).

One need not get into the messy business of defining public goods to find fault with the individual mandate, as a constitutional matter.  The mandate is constitutionally wrong because there is no constitutional writ for such a thing. Obamacare, of which the mandate is an integral element, is nothing less than an attempt on the part of the federal government to commandeer and direct all economic activity that is conceivably related to a fictional entity called the “market for health care.” The mandate is an attempt to further that scheme by forcing individuals to engage in commerce — a power that can be read into the Constitution only by those who would prefer to have a federal government of unlimited power.

Finally, it is hogwash to say that “there really is no sound distinction between mediated and unmediated transactions.” I am not “doing business with Raytheon” because some of my tax dollars go to Raytheon. I am doing business with the federal government as a (constitutionally legitimate) provider of national defense. But if the federal government forces me to buy health insurance (or pay a hefty penalty), I am doing business with an insurance company, not with the federal government.

Related posts:
Unintended Irony from a Few Framers
Freedom of Contract and the Rise of Judicial Tyranny
Social Security Is Unconstitutional
The Constitution in Exile
What Is the Living Constitution?
Blame It on the Commerce Clause
The Slippery Slope of Constitutional Revisionism
The Real Constitution and Civil Disobedience
The Constitution: Original Meaning, Corruption, and Restoration
The Unconstitutionality of the Individual Mandate
Does the Power to Tax Give Congress Unlimited Power?
Does Congress Have the Power to Regulate Inactivity?
Obamacare: Neither Necessary Nor Proper

Lay My (Regulatory) Burden Down

The Office of the Federal Register, undoubtedly proud of its role in the imposition of rules on Americans, publishes a statistical summary of its handiwork, from which I derived the following graph:


Source: Go to OFR page headed Tutorials, History, and Statistics and under Statistics click on XLS. Number of pages of rules for 1936-1975 estimated from the relationship between the number of pages of rules and the total number of pages in the Federal Register for 1976-2010.

Not all of the rules adopted since 1936 are still in effect, of course, but the graph gives a good indication of the growth and weight of the regulatory burden that hampers Americans and their enterprises. Do not take solace in the slower growth of rule-making pages since 1976; the page count continues to rise. Any number greater than zero represents the foreclosure of consumers’ and producers’ options — the further diminution of liberty, in other words.

How bad is it, economically? A report issued under the aegis of the U.S. Small Business Administration (yes, an arm of the central government) concludes that

the annual total cost of all federal regulations in 2008 was $1.752 trillion. Of this amount, the annual direct burden on business is $970 billion. Economic regulations represent the most costly category, with a total cost of $1.236 trillion, and with $618 billion falling initially on business. Environmental regulations represent the second most costly category in terms of total cost ($281 billion), and the cost apportioned to business is $183 billion. Compliance with the federal tax code is the third most costly category ($160 billion), and the cost of occupational safety and health, and homeland security regulations ranks last ($75 billion). (Nicole V. Crain and W. Mark Crain, Lafayette College, “The Impact of Regulatory Costs on Small Firms,” for SBA Office of Advocacy, September 2010, p. 48; cited and summarized on SBA’s website, here)

In other words governmental impositions in 2008 — a regulatory burden of $1.75 trillion and spending of $5.02 trillion — accounted for 47 percent of that year’s GDP ($14.29 trillion, in current dollars). As I have shown in other posts (e.g., here and here) the cumulative effect of governmental impositions is far greater than that.

Related reading: Henry I. Miller, “Red Tape and Pink Slips: Obama’s Imaginary Regulatory Reform,” The American, February 2, 2012

Related posts:
The Price of Government
The Price of Government Redux
The Mega-Depression
Ricardian Equivalence Reconsidered
The Real Burden of Government
Toward a Risk-Free Economy
The Rahn Curve at Work
The Illusion of Prosperity and Stability
The “Forthcoming Financial Collapse”
Estimating the Rahn Curve: Or, How Government Inhibits Economic Growth
The Deficit Commission’s Deficit of Understanding
Undermining the Free Society
The Bowles-Simpson Report
The Bowles-Simpson Band-Aid
Build It and They Will Pay
Government vs. Community
The Stagnation Thesis
America’s Financial Crisis Is Now
Money, Credit, and Economic Fluctuations
A Keynesian Fantasy Land
“Tax Expenditures” Are Not Expenditures
The Keynesian Fallacy and Regime Uncertainty
The Great Recession Is Not Over
Why the “Stimulus” Failed to Stimulate
Regime Uncertainty and the Great Recession
The Real Multiplier
Vulgar Keynesianism and Capitalism
Why Are Interest Rates So Low?
Economic Growth Since World War II
The Commandeered Economy
Estimating the Rahn Curve: A Sequel
The Real Multiplier (II)

Regulation as Wishful Thinking

Paul Krugman is arguably a better advocate of regulation than a philosopher (unless the philosopher also has a Ph.D. in economics). But Krugman has met his match in Steven Landsburg, who slices and dices Krugman’s latest justification of the nanny state. Landsburg’s effort might render this post superfluous, but I began to write it before learning of the latest Krugman-Landsburg confrontation (the dénouement of an earlier one is here). There is more to be said and, unlike Landsburg, I am not a sucker for the concept that underpins regulation: the social welfare function (about which, see below).

IMPETUS

This post is inspired by Jason Brennan’s offering at the Bleeding Heart Libertarians blog, “A Simple Libertarian Argument for Environmental Regulation.” Brennan writes:

Libertarians are often very hostile to environmental regulation. Why? Reflecting on the argument below should help us understand their grounds and whether the grounds are any good.

1. Pollution and other kinds of environmental externalities impose costs upon others. A polluter forces others to bear the costs of his activities. Pollution tends to violate people’s property rights, as well as certain rights they have over themselves (such as the rights against having their health compromised against their will).

2. Government regulation of environmental issues is USUALLY/OFTEN/SOMETIMES effective, and is USUALLY/OFTEN/SOMETIMES more effective than using courts to defend the rights mentioned in premise 1. Courts are SOMETIMES/OFTEN/USUALLY ineffective in protecting these rights.

3. Therefore, government should have the right to issue environmental regulations in order to protect property rights, rights to life, and rights to health.

I don’t see how a libertarian could deny premise 1. So premise 2 does all the work. Premise 2 is an empirical premise. We can debate which word (“usually”, “often”, or “sometimes”) belongs in each sentence to make premise 2 true. However, unless the libertarian believes we should instead have “never” in the first sentence of premise 2, then it seems the libertarian has a strong case for favoring some government regulation of environmental issues….

Brennan is wrong to say that “premise 2 does all the work.” Premise 1 does just as much “work,” in a negative way, because it ignores positive externalities. Further, Brennan’s premise 2 omits to mention that regulation — however effectively it may address particular problems — is, on the whole, counterproductive. Brennan’s conclusion (#3) would be flawed, even if premises 1 and 2 were complete and correct, because it rests on the utilitarian presumption of a social welfare function.

In a follow-up post, “Objections to the Simple Libertarian Argument for Environmental Regulation,” Brennan writes:

[H]ere are some objections [to the earlier argument]:

A. The Mission Creep/Abuse Objection: Though 3 is true, if we give government the power to enforce the rights mentioned in 2 through environmental regulation, government will abuse and misuse this power. It will misuse/abuse it so much that it won’t be worth it. It’s better just to leave things to courts, and if that doesn’t work, just let people pollute.

B. The Cost-Benefit Objection: While government is sometimes effective at enforcing rights, cost-benefit analysis shows that the EPA and other such agencies, even when acting without abuse and in good faith, spend/cost far too much for every year of life saved. Against, it’s better just to leave things to courts or even just let people pollute.

C. Other Unintended Consequences Objection: Allowing government to try to solve the problem causes various other negative consequences, and isn’t worth the cost.

D. The Market Can Fix It Objection: There are some market-based (e.g., Coasean) means to solve these problems.

Having been thoroughly schooled in public choice and all the usual stuff, I see the point behind A-D. There’s significant truth behind each of these objections. However, if you’re one of those libertarians who believes the government should issue no environmental regulations (and many libertarians do believe this), you seem to me to be far too pessimistic about A-C and/or optimistic about D. Do the facts really turn out to imply that the optimal amount of government environmental regulation is none?

In the following sections, I expand on my statements about the premises (#1, #2) and conclusion (#3) of Brennan’s original post. Along the way, I address points A, B, C, and D of Brennan’s second post. I also address Brennan’s implicit assumption that regulators can arrive at an “optimal amount” of regulation. This is simply nonsense on stilts because, among other things, it contravenes “public choice,” in which Brennan claims to have been “thoroughly schooled.”

NOT ALL EXTERNALITIES ARE NEGATIVE

A polluter may be producing something that is of value not only to the purchasers of that product but also to others who derive benefits from the purchasers’ use of the product, benefits for which those others do not pay. In other words, negative externalities may be accompanied by positive externalities.

Consider electricity, which in the United States is generated mostly by fossil-fuel and nuclear-power plants. Coal-fired plants still generate about half of America’s electric power; nuclear plants account for another 20 percent. Both types of plants are perennial targets of environmental activists, who cavil at the emissions of coal-burning, the possibility of nuclear accidents, and the problem of containing or disposing of coal ash and radioactive waste. The stance of environmentalists — which is essentially the stance of the Environmental Protection Agency — is to reduce pollution and eliminate risk without regard for the positive externalities of power generation.

And those positive externalities are vast. The availability of electricity has made possible countless inventions and innovations, to the benefit of producers and consumers who did not pay a penny more to power companies for the benefits thus derived. Those inventions and innovations would not have been possible — and will not be possible — if not for the availability of electricity. To the extent that coal generation makes electricity cheaper and more widely available, it encourages beneficial inventions and innovations. One can say that a positive externality of coal-generated electricity has been a higher rate of economic growth — more jobs and greater prosperity — than would otherwise have been possible.

I have made a rough estimate of the value of the positive externalities of electrical power, as follows:

1. The tables for value added by industry at the Bureau of Economic Analysis (BEA) website do not subdivide the utilities industry into categories (electric power, water, etc.). I therefore used the values given for the entire utilities industry as an upper bound of the value added by private electric-power companies. That value was 1.8 percent of GDP in 2008. Many governments (including the federal government) are in the power-generation business, but the value-added by government power utilities is not available, so I took as an upper bound the value added by government enterprises (federal, State, and local), which was 1.1 percent of GDP in 2008. Power-generating entities in the United States therefore add — at the very most — about 3 percent to the nation’s total economic output.

2. But the value added by power generation — something less than 3 percent of GDP, according to the BEA — fails to account for the fundamental importance of electric-power generation to America’s economy. It would not be a great exaggeration to say that the overnight loss of power-generating capacity would set the economy back to its status circa 1900. That was after factories had begun to use electricity but before it came into wide use in large cities. Real GDP per capita in 1900 was about 1/8 of the value it reached in 2008.

3. Try to think of an economic activity that does not depend on electricity. Given the pervasive dependence of all parts of the American economy on electricity, it would be difficult to deny that the power industry’s positive externality (its social return, if you will) is upwards of 7/8 of GDP, whereas the nominal value-added of electric power is less than 3 percent of GDP. That, my friends, is a positive externality to end all positive externalities.

REGULATION IS COUNTERPRODUCTIVE

Regulation is counterproductive for several reasons. First, it curtails positive externalities. Nothing more need be said on that score. The other reasons, on which I expand below, are that regulation cannot be contained to “good causes,” nor can it be tailored to do good without doing harm. These objections might be dismissed as trivial if regulatory overkill were rare and relatively costless, but it is pervasive, extremely costly its own right, and a major contributor to the economic devastation that has been wrought by the regulatory-welfare state.

Who Regulates the Regulators?

Regulators do not stop regulating when they (might) have done some good. Regulatory overreach is endemic to regulatory activity and cannot be separated from it. A lot of bad inevitably accompanies a bit of good. This happens because the regulatory agenda is driven by a combination of

  • activists” whose specific (and mostly aesthetic) objectives (kill the pipeline, don’t drill in ANWR, save the spotted owl, etc.) are intended to to limit economic activity and consumer choice;
  • scientists who are eager to join the consensus about the latest environmental craze, just to be part of the action and also to grab their share of government-funded research — which, not coincidentally, tends to lend credence to the scare-of-the-month that justifies regulation;
  • regulatory “capture,” through which incumbent firms “help” regulators in ways that favor incumbent firms and limit competition; and
  • politicians and bureaucrats who play to “activists,” incumbent firms with deep pockets, and the general public (by claiming to be pro-environment), while extending their reach and power — because that is what politicians and bureaucrats like to do.

Regulation as a Blunt Instrument

Regulation substitutes one-size-fits all “solutions” for the tailored outcomes of free markets (including Coesean bargaining) and civil litigation. The result is a consistent pattern of government failure, which is amply documented. (See, for example, the 144 issues of Regulation that have been published to date.) Regulation might be defensible (though not by me) if it were a matter of occasional failure, but it is not. Resorting to regulation to “solve a problem” is like playing Russian roulette with five bullets in a six-shooter.

At its best, regulation mimics the results that would have obtained anyway, as seems to have been the case with automobile safety regulations. These did no more than allow the continuation of a long-running trend toward safer autos and highways, but at the cost of making autos less affordable for low-income persons.

At its worst, regulation prevents consumers from obtaining life-saving products. This can happen indirectly, through the generally stultifying effect of regulation on economic activity (estimated below). And it can happen directly, as with the Food and Drug Administration’s notorious record of delaying the availability of health- and life-saving medicines. (For more on the high cost of regulation, see W. Kip Viscusi and Ted Gayer’s “Safety at Any Price?” in Regulation, Fall 2002. For a good example of government imposing a dangerous one-size-fits-all burden on the populace, see Kenneth Anderson’s post, “The Science Is Settled: You’re Just Too Stupid to Live,” at The Volokh Conspiracy.)

A pervasive form of regulation, which usually is not labelled as such, is the Fed’s manipulation of interest rates and the supply of money. How has that worked out? Business cycles have become more volatile since the creation of the Fed in 1913. The worst downturn in American history — the Great Depression — can be chalked up, in large part, to the Fed’s loosening of credit in the late 1920s, followed by its contraction of the money supply in the early 1930s. We owe the Great Recession, which lingers, to the “perfect storm” of low interest rates (thanks to the Fed) and the regulation of housing markets (to encourage home-ownership by low-income persons) via Fannie Mae and Freddie Mac.

Environmental regulation is no different than any other kind, resting as it does on aesthetic preferences, half-baked “scientific” theories (AGW being the latest and perhaps the most egregious of the lot), and the unholy alliance of “bootleggers and Baptists.” The “bootleggers” are incumbent firms; producers of “green” products and such-like; and politicians and bureaucrats, who stand to gain power and prestige from their “unselfish” efforts. The “Baptists” are smug do-gooders who just will not leave the rest of us alone to figure things out for ourselves.

The Interest-Group Paradox

Environmental regulation and regulation in general are integral to the vast and vastly destructive regulatory-welfare state that has rise up in America since the early 1900s. That growth is the result of a phenomenon which I call the interest-group paradox.

Pork-barrel legislation exemplifies the interest-group paradox in action, though the paradox involves more than pork-barrel legislation. There are myriad government programs that — like pork-barrel projects — are intended to favor particular classes of individuals. In the case of environmental regulation, the favored classes are “activists,” bureaucrats, incumbent firms, “green” enterprises, and the politicians who benefit from their symbiotic relationships with the aforementioned. The support for each program is “bought” at the expense of supporting other programs. Because there are thousands of government programs (federal, State, and local) — each intended to help a particular class of citizens (at the expense of others) — the net result is that almost no one in this fair land enjoys a “free lunch,” despite almost everyone’s efforts to do just that. This is the interest-group paradox.

The interest-group paradox is like the paradox of thrift, in that large numbers of individuals are trying to do something that makes certain classes of persons better off, but which in the final analysis makes those classes of persons worse off. It is also like the paradox of panic, in that there is a  crowd of interest groups rushing toward a goal — a “pot of gold” — and (figuratively) crushing each other in the attempt to snatch the pot of gold before another group is able to grasp it. The gold that any group happens to snatch is a kind of fool’s gold: It passes from one fool to another in a game of beggar-thy-neighbor.

If you want regulation, you must pay the political price by backing other programs, for which you will seek payment in the form of additional regulation, and so on, ad perpetuum.

The Final Tally

The direct cost of regulation is about 10 percent of GDP: $1.5 trillion in today’s dollars. The indirect cost of regulation cannot be separated from the cumulative burden of the regulatory-welfare state. But that burden would not be as large as it is were it not for the integral role of environmental regulation in the working of the interest-group paradox. I have estimated that the establishment and expansion of the regulatory-welfare state over the past century has reduced real GDP by about 70 percent from the level it would have attained if the state had not been expanded beyond a “night watchman” role.

The price tag is so large that everyone (“activists,” regulators, etc.) pays in one way or another, through fewer choices, fewer jobs, and lower real incomes. And it cannot be otherwise because, as noted above, the bad inevitably comes with the good. To believe or claim otherwise is to indulge in the Nirvana fallacy and wishful thinking.

FUNDAMENTAL FLAW: THE MYTH OF THE SOCIAL-WELFARE FUNCTION

Costs aside, regulation is based on an epistemological error. The urge to regulate presumes a social welfare function that can be maximized — or improved, at least — by limiting the negative externalities that flow from certain economic activities.

For example, an environmental regulation might cause the owner of a polluting factory to buy and operate some kind of equipment that reduces the factory’s emissions. When the owner complies, those who live near the factory are presumed to be better off. And perhaps the benefits extend farther afield. But, in any case, the factory owner’s higher costs are likely to have untoward effects, for example, fewer jobs for factory workers and higher prices for the purchasers of the factory’s products.

When a proponent of regulation is confronted with this reality, he is likely to shrug and say that the costs (fewer jobs, higher prices) are worth the benefits (less pollution). Whence the moral authority to make that kind of judgment? It implies the existence of a social-welfare function, to which the proponent of regulation is privy.

This is nothing less than utilitarianism in the modern garb of cost-benefit analysis. The theory of cost-benefit analysis is simple: If the expected benefits from a government project or regulation are greater than its expected costs, the project or regulation is economically justified.

But cost-benefit analysis has a fundamental flaw, which it shares with utilitarianism: One person’s benefit cannot be compared with another person’s cost. (This objection vanishes when parties are free to engage in Coasean bargaining, but regulation preempts that option.) Suppose, for example, that the City of Los Angeles were to conduct a cost-benefit analysis which “proved” that the cost of  constructing yet another freeway through the city would be more than offset (i.e., would yield a “net benefit”) because it would reduce the imputed cost of time spent in traffic by workers who drive into the city from the suburbs.

Yes, that is how cost-benefit analysis works. It assumes that the costs borne by one set of persons (taxpayers, consumers, unemployed factory workers, etc.) can be offset by the benefits that accrue to other persons (commuters, persons who live near factories, environmental “activists,”, etc.).  It is the creed of “the greatest amount of happiness altogether.”

A moment’s reflection will tell you that there is no such thing as “the greatest amount of happiness altogether.” If A steals from B, A is happier for having obtained money with little effort, while B is less happy because he has less money. Does A’s gain in happiness cancel B’s loss of happiness. If you say “yes,” welcome to the world of psychopathy.

And you do say “yes,” implicitly, if you believe in environmental regulation — or any kind of regulation that effectively redistributes income or wealth.

THE ALTERNATIVES TO REGULATION: MARKETS AND COMMON LAW

Given all that I have said in the preceding sections, it seems clear that the burden of proof is (or should be) on those who wish to substitute regulation for markets and common law. It is also clear that, despite Brennan’s wishful thinking, government is incapable of delivering an “optimal amount” of regulation — whatever that might be. Markets may be imperfect (from the standpoint of the non-existent omniscient arbiter), but they are less imperfect than government.

General Arguments for Markets and Common Law Instead of Regulation

Is it wishful thinking to suppose that markets and civil litigation can deal with pollution and other kinds of negative externalities? Not at all:

Free-market environmentalism can also be expected to grow. It is the proven private alternative to costly and ineffective command-and-control schemes for protecting endangered species and habitats. To avoid the tragedy of the commons, one can look to the creation of more private, voluntary arrangements for “property rights” over animals, fish, and ecologically sensitive lands—via auctions of cleverly designed contracts to limit kills and catches and via binding covenants to preserve natural lands in perpetuity. Conservation banks, first created in 1995, now number 70 and represent another approach to environmental protection for endangered birds and animals. (Reason Foundation, “Transforming Government through Privatization,” Annual Privatization Report, 2006)

Terry L. Anderson, executive director of the Property & Environment Research Center (PERC) gives many examples of free-market environmentalism at work in “Markets and the Environment: Friends of Foes?” For much more, see PERC’s large catalog of publications. And PERC is but one of the many organizations doing serious scholarly work in the field of free-market environmentalism.

If you are old enough to remember the Love Canal disaster, you will assume (as I did) that it was the fault of the chemical company that had been dumping waste in the abandoned canal. Not so, according to Richard L. Stroup:

[L]iability for pollution is a powerful motivator when a factory or other potentially polluting asset is privately owned. The case of the Love Canal, a notorious waste dump, illustrates this point. As long as Hooker Chemical Company owned the Love Canal waste site, it was designed, maintained, and operated (in the late 1940s and 1950s) in a way that met even the Environmental Protection Agency standards of 1980. The corporation wanted to avoid any damaging leaks, for which it would have to pay.

Only when the waste site was taken over by local government—under threat of eminent domain, for the cost of one dollar, and in spite of warnings by Hooker about the chemicals—was the site mistreated in ways that led to chemical leakage. The government decision makers lacked personal or corporate liability for their decisions. They built a school on part of the site, removed part of the protective clay cap to use as fill dirt for another school site, and sold off the remaining part of the Love Canal site to a developer without warning him of the dangers as Hooker had warned them. The local government also punched holes in the impermeable clay walls to build water lines and a highway. This allowed the toxic wastes to escape when rainwater, no longer kept out by the partially removed clay cap, washed them through the gaps created in the walls….

Nor does the government sector have the long-range view that property rights provide, which leads to protection of resources for the future. As long as … divestibility, is present, property rights provide long-term incentives for maximizing the value of property. If I mine my land and impair its future productivity or its groundwater, the reduction in the land’s value reduces my current wealth. That is because land’s current worth equals the present value of all future services. Fewer services or greater costs in the future mean lower value now. In fact, on the day an appraiser or potential buyer can first see that there will be problems in the future, my wealth declines. The reverse also is true: any new way to produce more value—preserving scenic value as I log my land, for example, to attract paying recreationists—is capitalized into the asset’s present value.

Because the owner’s wealth depends on good stewardship, even a shortsighted owner has the incentive to act as if he or she cares about the future usefulness of the resource. This is true even if an asset is owned by a corporation. Corporate officers may be concerned mainly about the short term, but as financial economists such as Harvard Business School’s Michael C. Jensen have noted, even they have to care about the future. If current actions are known to cause future problems, or if a current investment promises future benefits, the stock price rises or falls to reflect the change. Corporate officers are informed by (and are judged by) these stock price changes. (From “Free Market Environmentalism,” at the Library of Economics and Liberty.)

The Siren Song of Government Intervention

Stroup stumbles, however, by saying that

when many polluters and those who receive the pollution are involved, how can property rights force accountability? The nearest receivers may be hurt the most, and may be able to sue polluters—but not always. Consider an extreme case: the potential global warming impact of carbon dioxide produced by the burning of wood or fossil fuels. If climate change results, the effects are worldwide. Nearly everyone uses the energy from such fuels, and if the threat of global warming from a buildup of carbon dioxide turns out to be as serious as some claim, then those harmed by global warming will be hard-pressed to assert their property rights against all the energy producers or users of the world. The same is true for those exposed to pollutants produced by autos and industries in the Los Angeles air basin. Private, enforceable, and tradable property rights can work wonders, but they are not a cure-all.

If a cure-all is required, one ought to pray for miracles. Short of miracles, the question is whether it is better to rely on government action or voluntary action, supplemented by civil litigation. I say “or” precisely because government action precludes the alternatives. It is “better” to rely on government if one wants a dictated outcome, is willing to impose the costs of attaining that outcome on persons who are not involved in the situation at hand (e.g., distant taxpayers), and is indifferent to the unintended consequences of government action. It is better to rely on voluntary action, supplemented by civil litigation, if one cares about liberty and economic efficiency (as found in Coasean solutions to conflicts of interest).

Taking smog in the L.A. basin first: It belongs to that class of “problem” which includes choosing to live in areas that are prone to hurricanes, floods, and fires. The obvious voluntary solution — for those who find smog, etc., not worth whatever benefits may accrue to living with it (e.g., higher income) — is to quit the locale. Along comes government to impose one-size-fits-all solutions that also impose costs on persons who do not live in areas where there is smog, etc. The immediate results of government intervention are a disincentive to move and massive subsidization of those who choose not to move by persons who have their own problems to contend with. Further results are

  • disincentives to entrepreneurs who would come forward with ameliorative devices (e.g., air-filtration systems and catalytic converters);
  • disincentives to persons of a charitable bent who would take it upon themselves to help low-income persons afford ameliorative devices and even help to underwrite the development of such devices;
  • moral hazard, that is, putting the non-movers in a position to incur further losses that will be subsidized; and
  • the playing out of the interest-group paradox, wherein those who are subsidized agree (tacitly) to subsidize persons who seek subsidization or other favors from government.

Entrepreneurship is thought to be unlikely (in the circumstance) because of the free-rider problem, but the free-rider problem is overstated. Further, charity (giving without the expectation of more than psychic return) is one proof against the presumption of economic paralysis that is embedded in the statement of the free-rider problem.

Regardless of the arguments against regulation, most politicians and left-wingers would say that it is proper to respond “collectively” to pollution because, after all, that is the hallmark of a “just, caring society,” in which “we” take care of each other. Are disincentives to entrepreneurship, charity, moral hazard, cross-subsidization, and plain old theft by government really the hallmarks of a “just, caring society”? Not at all; they are the facts of life that politicians and leftists prefer to ignore because they prefer collective action (at the point of government’s gun) to effective action. The invocation of a “just, caring society” is a cheap political trick, played by leftists and politicians. In the case of politicians, it is a sign of  (cheap) compassion that helps them win elections, feed at the public trough, and slake their power-lust.

No “Problem” Is Too Big for Private Action

Stroup, despite his evident understanding of the power of markets to solve “problems,” seems to hold a viewpoint in common with knee-jerk advocates of government action: If a “problem” exists, it is only a “problem,” not an incidental, negative aspect of beneficial activity. And its “solution” cannot come at too high a price, that is, whatever price government imposes through regulation, inasmuch as “optimal regulation” is a pipe-dream.

Moreover, the “problem” may be so pervasive that only government can solve it. Why? Because those who suffer negative externalities are unable to bargain with or take legal action against the parties responsible for the externalities. Who are those parties? They are us! We — the users of electricity and the many other products and services whose creation results in the emission of  carbon dioxide — may be joined in an unwitting suicide pact, despite the warnings of  “seers” like Al Gore, James Hansen, Michael Mann, et al.. Those warnings (blatantly hypocritical in Gore’s case) amount to this: “We” (but not “they”) must surrender a large portion of the material gains that have been wrested from nature through ingenuity and industriousness; otherwise, there will be dire consequences for all. (Perhaps it would have been better if our distant ancestors had not learned how to make fire, with all of its dire consequences for humans and their possessions.)

I have written so much about the issue of AGW (e.g., here, here, here, here, here, here, here, here, here, here, and here) that I will not bother to address its validity here. I will assume, merely for the sake of argument, that it is a possibility. But saying that it is a possibility does not mean that it is a dire emergency. Consider, for example, these excerpts of Nobel laureate Ivar Ginever’s letter of resignation from the American Physical Society:

In the APS it is ok to discuss whether the mass of the proton changes over time and how a multi-universe behaves, but the evidence of global warming is incontrovertible? The claim (how can you measure the average temperature of the whole earth for a whole year?) is that the temperature has changed from ~288.0 to ~288.8 degree Kelvin in about 150 years, which (if true) means to me is that the temperature has been amazingly stable, and both human health and happiness have definitely improved in this ‘warming’ period.

If AGW is truly a problem — and not just a “problem” that “demands” government action — it is evidently not an emergency that requires immediate, concerted action by a central authority. To the contrary, if it is a problem it can be addressed by a variety of voluntary actions. These include the gradual migration of heat-sensitive individuals and economic activities to cooler parts of the globe and the development and spread of ameliorative technologies for those persons and activities that cannot or will not migrate. All such adaptive behavior will become more possible and affordable if economic growth is not choked off by regulations that arbitrarily stifle economic activity by curbing the emission of so-called greenhouse gases. (That a large proportion of individuals and economic activities would thrive as their environment warms a bit seems to be lost on climate-change alarmists.)

If the possibility of AGW does not justify government action, what about a true global emergency? Imagine, for example, that reputable scientists around the globe detect a large asteroid that is almost certain to strike Earth in two years, and that the likely result of the strike is the end of human life on the planet. Would that not justify concerted government action?

Again, I say “no.” What it would justify — and encourage — is action by independent (but possibly cooperative) teams of scientists and engineers, underwritten by various groups of super-rich individuals and large corporations. Why should such individuals and corporations fund an effort that would benefit upward of seven billion free riders? Because the existence of those individuals and corporations would be at stake, and many of them would welcome the glory and/or increased sales that would undoubtedly accompany a successful anti-asteroid operation.

I refer you, again, to my earlier post about the free-rider problem, and the link that is embedded in the post. In both posts, I argue that defense and justice — among other so-called public goods — are nothing of the kind. They are goods that, in a relatively open polity like that of the United States, are better provided by an accountable state than entrusted to competing private entities. It should be obvious — and it is obvious to all but obdurate anarcho-capitalists — that such entities would be the equivalent of warlords. The law of the jungle would replace the rule of law. That possibility is the only excuse for the state’s monopolization of justice and defense. But nothing — not even “externalities” — excuses the state’s intrusion into economic activity that is peaceful and voluntary.

Related posts:
Fear of the Free Market — Part I
Fear of the Free Market — Part II
Fear of the Free Market — Part III
The Social Welfare Function
Risk and Regulation
A Short Course in Economics
The Interest-Group Paradox
Addendum to a Short Course in Economics
Utilitarianism, “Liberalism,” and Omniscience
Accountants of the Soul
Ricardian Equivalence Reconsidered
The Real Burden of Government
Utilitarianism vs. Liberty
Toward a Risk-Free Economy
Rawls Meets Bentham
The Rahn Curve at Work
The Case of the Purblind Economist
The Illusion of Prosperity and Stability
Estimating the Rahn Curve: Or, How Government Inhibits Economic Growth
Luck-Egalitariansim and Moral Luck
Understanding Hayek
The Destruction of Society in the Name of “Society”
What Free-Rider Problem?
Human Nature, Liberty, and Rationalism
Utilitarianism and Psychopathy

Obama’s New Regulatory Regime

Eric Posner, writing in The New Republic (“Obama’s Cost-Benefit Revolution“), comments on Obama’s new executive order about cost-benefit analysis and regulation. Posner offers some background:

Long ago, cost-benefit analysis was a rallying cry for conservatives. It was brought to government by none other than Ronald Reagan, in Executive Order 12291 of 1981. Reagan was riding the wave of the deregulatory movement, which held that regulation of industry was excessive and stunted economic growth. His order stipulated that agencies should issue regulations only after finding that the benefits exceeded the costs.

Outraged liberals charged that cost-benefit analysis was a pretext to stifle regulation, and that it was arbitrary because of the difficulty of attaching dollar values to lives, environmental goods, and other regulatory benefits. Conservatives replied that cost-benefit analysis blocks bad regulations: Why would one support a regulation that produces higher costs than benefits? At the time, the alternative was regulation that seemed to reflect no more than the instincts of bureaucrats (or the agendas of interest groups), accompanied by impenetrable bureaucratese. The debate continued in this vein for decades, but over time, positions shifted. Some liberals came to see cost-benefit analysis as a good-government tool that promotes transparency and accountability, while some conservatives began to wonder whether it confers legitimacy on the New Deal state.

Cost-benefit analysis — even when it is done well — is a sham. But Obama’s approach (an extension of Clinton’s) reveals it as a scam:

Now, the press has reported that Obama’s executive order, which explicitly renews Clinton’s, signals victory for business. But the executive order also provides plenty of wiggle room that can be exploited by pro-regulatory forces, as indeed did Clinton’s before it. Unlike Reagan’s original order, which simply asked agencies to perform cost-benefit analysis, Clinton’s allowed agencies also to take account of “equity.” Obama’s adds that agencies should take account of “human dignity” and “fairness,” values, it helpfully notes, that are “difficult or impossible to quantify.” This is problematic because quantification is the point of cost-benefit analysis. Cost-benefit analysis works in the first place only because it imposes mathematical discipline on agencies. They must supply evidence that a proposed regulation has certain benefits and costs, monetize those benefits and costs, and report a number. If the number is greater than zero, then the agency may regulate. If agencies can instead point to unquantifiable benefits such as the promotion of human dignity, they can do whatever they want, and the main selling point of cost-benefit analysis—government transparency—is eliminated.

The sham to which I refer above is this:

One person’s benefit cannot be compared with another person’s cost. Suppose, for example, the City of Los Angeles were to conduct a cost-benefit analysis that “proved” the wisdom of constructing yet another freeway through the city in order to reduce the commuting time of workers who drive into the city from the suburbs. In order to construct the freeway, the city must exercise its power of eminent domain and take residential and commercial property, paying “just compensation,” of course. But “just compensation” for a forced taking cannot be “just” — not when property is being wrenched from often-unwilling “sellers” at prices they would not accept voluntarily. Not when those “sellers” (or their lessees) must face the additional financial and psychic costs of relocating their homes and businesses, of losing (in some cases) decades-old connections with friends, neighbors, customers, and suppliers. (This is from “Greed, Cosmic Justice, and Social Welfare“; see also “Modern Utilitarianism.”)

Throwing “equity,” “human dignity,” and “fairness” into the equation takes us from sham to scam. As Posner says,  “[t]hese wiggle words … might be licenses to agencies to regulate however they want to.” There’s no “might” about it.

Well, there is a kind of “might” about it. The might of government regulators to force their preferences on us.

The Illusion of Prosperity and Stability

For reasons I outlined in “The Price of Government,” the post-Civil War boom of 1866-1907 finally gave way to the onslaught of Progressivism. Real GDP grew at the rate of 4.3 percent annually during the post-Civil War boom; it has since grown at an annual rate of 3.3 percent. The difference between the two rates of growth, compounded over a century, is the difference between $13 trillion (2009’s GDP in 2005 dollars) and $41 trillion (2009’s potential GDP in 2005 dollars).

As I said in “The Price of Government,” this disparity

may seem incredible, but scan the lists here and you will find even greater cross-national disparities in per capita GDP. Go here and you will find that real, per capita GDP in 1790 was only 4.6 percent of the value it had attained 218 years later. Our present level of output seems incredible to citizens of impoverished nations, and it would seem no less incredible to an American of 1790. In sum, vast disparities can and do exist, across nations and time.

The main reason for the disparity is the intervention of the federal government in the economic affairs of Americans and their businesses. I put it this way in “The Price of Government”:

What we are seeing [in the present recession and government’s response to it] is the continuation of a death-spiral that began in the early 1900s. Do-gooders, worry-warts, control freaks, and economic ignoramuses see something “bad” and — in their misguided efforts to control natural economic forces (which include business cycles) — make things worse. The most striking event in the death-spiral is the much-cited Great Depression, which was caused by government action, specifically the loose-tight policies of the Federal Reserve, Herbert Hoover’s efforts to engineer the economy, and — of course — FDR’s benighted New Deal. (For details, see this, and this.)

But, of course, the worse things get, the greater the urge to rely on government. Now, we have “stimulus,” which is nothing more than an excuse to greatly expand government’s intervention in the economy. Where will it lead us? To a larger, more intrusive government that absorbs an ever larger share of resources that could be put to productive use, and counteracts the causes of economic growth.

One of the ostensible reasons for governmental intervention is to foster economic stability. That was an important rationale for the creation of the Federal Reserve System; it was an implicit rationale for Social Security, which moves income to those who are more likely to spend it; and it remains a key rationale for so-called counter-cyclical spending (i.e., “fiscal policy”) and the onerous regulation of financial institutions.

Has the quest for stability succeeded? If you disregard the Great Depression, and several deep recessions (including the present one), it has. But the price has been high. The green line in the following graph traces real GDP as it would have been had economic growth after 1907 followed the same path as it did in 1866-1907, with all of the ups and down in that era of relatively unregulated “instability.” The red line, which diverges from the green one after 1907, traces real GDP as it has been since government took over the task of ensuring stable prosperity.

Only by overlooking the elephant in the room — the Great Depression — can one assert that government has made the economy more stable. Only because we cannot see the exorbitant price of government can we believe that it has had something to do with our “prosperity.”

What about those fairly sharp downturns along the green line? If it really is important for government to shield us from economic shocks, there are much better ways of getting the job done that they ways now employed. There was no federal income tax during the post-Civil War boom (one of the reasons for the boom). Suppose that in the early 1900s the federal government had been allowed to impose a small, constitutionally limited income tax of, say, 0.5 percent on gross personal incomes over a certain level, measured in constant dollars (with an explicit ban on exemptions, deductions, and other adjustments, to keep it simple and keep interest groups from enriching themselves at the expense of others). Suppose, further, that the proceeds from the tax had a constitutionally limited use: the payment of unemployment benefits for a constitutionally limited time whenever real GDP declined from quarter to quarter.

Perhaps that’s too much clutter for devotees of constitutional simplicity. But wouldn’t the results have been worth the clutter? The primary result would have been growth at a rate close to that of 1866-1907, but with some of the wrinkles ironed out. The secondary result — and an equally important one — would have been the diminution (if not the elimination) of the “need” for governmental intervention in our affairs.

Related posts:
Basic Economics
The Economic and Social Consequences of Government

The Price of Government

UPDATED on 04/17/10, to include GDP estimates for 2009 and slight revisions to GDP estimates for earlier years. The bottom line remains the same: The price of government is exorbitant.

he federal government is mounting an economic intervention on a scale unseen since World War II. The excuse for this intervention is that without it the present recession will turn into a full-blown depression. Yet, with the Democrats’ and RINOs’ “stimulus” barely underway, the economy already shows signs of rebounding from an economic dip that bears no comparison with the calamitous gulch that was the Great Depression.

Despite the horror stories about a financial meltdown, what we have experienced since late 2007 is not much more than the downside of a typical, post-World War II business cycle. (For more on that score, see this post — especially the third graph and related discussion.) Would it have been worse were all failing financial institutions allowed to fail? I doubt it. Hard, fast failure leaves in its wake opportunities for the organization of new ventures by investors who still have money (and there are plenty of them). But those same investors are being shouldered out and scared off by Obama’s schemes for nationalization, taxation, regulation, and redistribution.

What we are seeing is the continuation of a death-spiral that began in the early 1900s. Do-gooders, worry-warts, control freaks, and economic ignoramuses see something “bad” and — in their misguided efforts to control natural economic forces (which include business cycles) — make things worse. The most striking event in the death-spiral is the much-cited Great Depression, which was caused by government action, specifically the loose-tight policies of the Federal Reserve, Herbert Hoover’s efforts to engineer the economy, and — of course — FDR’s benighted New Deal. (For details, see this, and this.)

But, of course, the worse things get, the greater the urge to rely on government. Now, we have “stimulus,” which is nothing more than an excuse to greatly expand government’s intervention in the economy. Where will it lead us? To a larger, more intrusive government that absorbs an ever larger share of resources that could be put to productive use, and counteracts the causes of economic growth.

Can we measure the price of government intervention? I believe that we can do so, and quite easily. The tale can be told in three graphs, all derived from constant-dollar GDP estimates available here. The numbers plotted in each graph exclude GDP estimates for the years in which the U.S. was involved in or demobilizing from major wars, namely, 1861-65, 1918-19, and 1941-46. GDP values for those years — especially for the peak years of World War II — present a distorted picture of economic output. Without further ado, here are the three graphs:

The trend line in the first graph indicates annual growth of about 3.7 percent over the long run, with obviously large deviations around the trend. The second graph contrasts economic growth through 1907 with economic growth since: 4.2 percent vs. 3.6 percent. But lest you believe that the economy of the U.S. somehow began to “age” in the early 1900s, consider the story implicit in the third graph:

  • 1790-1861 — annual growth of 4.1 percent — a booming young economy, probably at its freest
  • 1866-1907 — annual growth of 4.3 percent — a robust economy, fueled by (mostly) laissez-faire policies and the concomitant rise of technological innovation and entrepreneurship
  • 1908-1929 — annual growth of 2.2 percent — a dispirited economy, shackled by the fruits of “progressivism” (e.g., trust-busting, regulation, the income tax, the Fed) and the government interventions that provoked and prolonged the Great Depression (see links in third paragraph)
  • 1970-2008 — annual growth of 3.1 percent —  an economy sagging under the cumulative weight of “progressivism,” New Deal legislation, LBJ’s “Great Society” (with its legacy of the ever-expanding and oppressive welfare/transfer-payment schemes: Medicare, Medicaid, a more generous package of Social Security benefits), and an ever-growing mountain of regulatory restrictions.

Had the economy of the U.S. not been deflected from its post-Civil War course, GDP would now be about three times its present level. (Compare the trend lines for 1866-1907 and 1970-2008.) If that seems unbelievable to you, it shouldn’t: $100 compounded for 100 years at 4.3 percent amounts to $6,700; $100 compounded for 100 years at 3.1 percent amounts to $2,100. Nothing other than government intervention (or a catastrophe greater than any we have known) could have kept the economy from growing at more than 4 percent.

What’s next? Unless Obama’s megalomaniacal plans are aborted by a reversal of the Republican Party’s fortunes, the U.S. will enter a new phase of economic growth — something close to stagnation. We will look back on the period from 1970 to 2008 with longing, as we plod along at a growth rate similar to that of 1908-1940, that is, about 2.2 percent. Thus:

  • If GDP grows at 2.2 percent through 2109, it will be 58 percent lower than if we plod on at 3.1 percent.
  • If GDP grows at 2.2 percent for through 2109, it will be only 4 percent of what it would have been had it continued to grow at 4.3 percent after 1907.

The latter disparity may seem incredible, but scan the lists here and you will find even greater cross-national disparities in per capita GDP. Go here and you will find that real, per capita GDP in 1790 was only 4.6 percent of the value it had attained 218 years later. Our present level of output seems incredible to citizens of impoverished nations, and it would seem no less incredible to an American of 1790. In sum, vast disparities can and do exist, across nations and time. We have every reason to believe in the possibility of a sustained growth rate of 4.4 percent, as against one of 2.2 percent, because we have experienced both.

We should look on the periods 1908-1940 and 1970-2009 as aberrations, and take this lesson from those periods: Big government inflicts great harm on almost everyone (politicians and bureaucrats being the main exceptions), including its intended beneficiaries. Such is the price of government when it does more than “establish Justice, insure domestic Tranquility, [and] provide for the common defence” in order to “promote the general Welfare, and secure the Blessings of Liberty to ourselves and our Posterity.”