Democrats Try Their Hand at Economics

The Colorado Freedom Report:  An independent journal of politics and culture.

The Colorado Freedom Report--www.FreeColorado.com

Democrats Try Their Hand at Economics

by Ari Armstrong, May 25, 2007

On pages 169 to 183 of his book The Elephant in the Room, Ryan Sager describes "How the West Will Be Lost" -- by Republicans. Sager's book, published in 2006, is prophetic. Sager reviews polling data that suggest the Interior West is more secular and less enamored with the Religious Right, especially relative to the South (see particularly pages 175-6). (I voted for Democrat Bill Ritter over precisely this issue.) In addition, Democrats are appealing to fiscal conservatives. "They've appropriated the language of small government, lower taxes, balanced budgets, efficiency, privacy, responsibility, and a whole host of other come-ons designed to lure libertarians [loosely defined] into at least a fling" (page 183).

Okay, so Colorado Democrats haven't exactly toed the line on "lower taxes." Yet, even with respect to Referendum C and the more recent property-tax "freeze," Democrats have tried to argue that their proposals aren't really tax hikes, even though they force people to pay more money to the government.

Recently I've encountered two Democrats who -- gasp! -- actually tried to justify their policies using economic arguments. That's odd in a way. Democrats have been motivated fundamentally by egalitarianism, the view that goods and services should be more evenly distributed (by political force). Egalitarian standards do not inherently depend on meeting any sort of efficiency standard; if anything, economic efficiency is (correctly) seen as anathema to egalitarianism, for efficiency requires that resources flow disproportionately to those who use them most ably. (See the letter by Ludwig von Mises on the subject.)

Economists generally proceed on the notion that people act self-interestedly (even though I believe the typical economic analysis of "self-interest" is shallow at best). There is an easy alliance between many economists, who tend toward free-market thinking, and advocates of individual rights. Both sorts of people tend to argue that individuals should be able to control their own lives free from political force. This new Democratic infatuation with the language of economics, then, is strange. It amounts to trying to push over egalitarian, redistributionist policies on the grounds that doing so benefits those paying the bills.

Of course, Karl Marx was considered to be an economist, too, and his egalitarian prescriptions are well known. No doubt one could find any number of American "economists" who, decades ago, praised the efficiency of the Soviet system. It is no surprise that those with a prior commitment to egalitarianism come to argue that forcing individuals to transfer their wealth to others is good for the "giver" as well as for the recipient. Absurdity in defense of egalitarianism is no vice, apparently. But this move is necessary if egalitarianism is to gain any foothold, because the raw fact that egalitarianism requires sacrificial victims is repugnant to any self-respecting person, especially in America, especially in the Interior West.

On May 21, following a media conference held by the "208" Commission for Healthcare Reform, I listened to State Senator Bob Hagedorn give an interview to Adam Schrager of 9News. Hagedorn expressed general support for the Commission, which selected four proposals that increase government controls over medicine. Hagedorn told Schrager that "market principles will not work" until the "freeloaders" are removed from the system.

I called Hagedorn's remarks an "assault on free markets." He countered that (even) Adam Smith discusses the harms of freeloaders. I answered that, to the extent that freeloaders exist in medicine, that is due to prior government mandates. Hagedorn denied my claim. He further suggested that my view of "free markets" is subjective, just whatever I wish it to mean. I denied his claim. I challenged Hagedorn to a public debate to further work out the issues; he declined (but said he would talk to me further in the Fall).

As I had already been planning to write up the remarks of State Senator Chris Romer regarding "externalities," I decided to review the claims of both senators in a single article (as those claims are closely related). I hereby extend an invitation to Senators Hagedorn and Romer to respond to this article. If they reply, I will publish their comments, in full and unedited, following my own remarks. If I feel that further discussion is necessary, I will then write a reply no more than half as long as the response. I'll offer the senators the final word of, say, a 300-word limit.

Contrary to Hagedorn's suggestion, I mean something quite specific and well-defined by a "free market." A "free market" means that people are free from the initiation of force. (This is a standard definition.) People have the right to control their own lives, bodies, and property, insofar as they respect the equal right of others. People can interact (cooperate, collaborate) voluntarily, free from initiatory force. The government properly defends people from criminals, internal tyranny, and hostile invasion. The government protects people's ability to control their own property and enforces contracts. In short, a "free market" means that people's individual rights are consistently protected and defended.

Hagedorn's claim that the "free market" can work only when "freeloaders" are restricted is true only in a particular context (which is not the context he was assuming). Criminals and looting politicians are in essence "freeloaders" -- they forcibly take wealth from others. Hagedorn, insofar as he advocates the forcible redistribution of wealth, protects and finances freeloaders. Indeed, his solution to the problem of "freeloaders" is to create more of them.

The free market bans freeloading done through the initiation of force. The free market opposes crime and looting (political or otherwise), fraud, localized pollution of individually held property, and the violation of contract. People are not able to freeload in such ways on a free market.

But evidently those are not the sorts of freeloaders to whom Hagedorn was referring. I take Hagedorn instead to be invoking the "free-rider problem," a standard economic problem taught in introductory economics courses and texts. The basic idea is that, when the value of a good or service may be captured without paying for it, some or many people will tend to "free ride" by using the good or service without paying. This results in the good or service being underproduced or not produced. A standard case is national defense. If everyone pays for national defense, nobody will suffer a violent invasion. But if everyone else is paying, the individual may decide not to pay, because defense will remain strong even without the individual's payment. But if everybody behaves this way, nobody will get national defense. This is a rationale for taxation to fund national defense, goes the standard argument.

Since Hagedorn invoked "Saint" Adam Smith, here's a relevant passage:

Into other arts the division of labour is naturally introduced by the prudence of individuals, who find that they promote their private interest better by confining themselves to a particular trade, than by exercising a greater number. But it is the wisdom of the state only which can render the trade of a soldier a particular trade separate and distinct from all others. A private citizen who, in time of profound peace, and without any particular encouragement from the public, should spend the greater part of his time in military exercises, might, no doubt, both improve himself very much in them, and amuse himself very well; but he certainly would not promote his interest. It is the wisdom of the state only which can render it for his interest to give up the greater part of his time to this peculiar occupation... (Wealth of Nations, Book V, Chapter I, Part I, or pages 753-4 in my 2000 Modern Library edition. Jeffrey Rogers Hummel also points to Smith's "public-goods theory," page 89, note 2, though because of pagination differences I don't know whether he has the same examples in mind that I use.)

Later Smith discusses the problem more generally:

The third and last duty of the sovereign or commonwealth is that of erecting and maintaining those public institutions and those public works, which, though they may be in the highest degree advantageous to a great society, are, however, of such a nature, that the profit could never repay the expence to any individual or small number of individuals, and which it therefore cannot be expected that any individual or small number of individuals should erect or maintain. ... After the public institutions and public works necessary for the defense of the society, and for the administration of justice... the other works and institutions of this kind are chiefly those for facilitating the commerce of the society, and those for promoting the instructions of the people. (Book V, Chapter I, Part III, or page 779)

A general note here about Adam Smith: while his work is genius, he is hardly infallible. Murray Rothbard was particularly critical of Smith. Hagedorn himself advocates many policies that Smith never would have supported, and Hagedorn dismisses certain policies that Smith favored. For example, Smith uses the free-rider argument to justify tax-funded "religious instruction" (Book V, Chapter I, Conclusion, or pages 877-8). So I doubt that Hagedorn wishes to appeal to Smith as an unquestioned authority.

I have much more to say about Hagedorn's invocation of the free-rider argument. For now, though, it is useful to turn to Romer's comments about "externalities," a concept with which the free-rider problem is intimately bound.

On May 17, Romer (shown at left) participated in a debate with Senator Shawn Mitchell at an event sponsored by the Colorado Union of Taxpayers. It was a spirited debate covering such issues as the property tax, energy policy, health care, and income inequality.

In his opening remarks, Romer praised Milton Friedman, the economist generally known for his free-market thinking (but nevertheless disfavored by various economists of the Austrian school). Yet, while Romer spoke in favor of markets and healthy incentives, he also said that the "public wants government to solve some things." He said there is a "difference between spending and investing" tax dollars, and he favors the latter. The government needs to assert various controls for "pricing externalities," Romer argued, particularly with respect to global warming.

While Romer did not always clearly apply his "externalities" rationale to the policies he advocated, opting instead for more populist language of what the "public" allegedly "wants" (as deciphered by our Democratic soothsayers), I'll assume that Romer takes seriously the problem of "externalities" as applied to all the issues he discussed. What does that mean?

"Externalities" is another common economic term that basically refers to any cost or benefit that someone imposes on others without payment or compensation. For example, if I place a beautiful statue on my property where all my neighbors can see it, I have provided the "positive externality" of statue viewing. My neighbors get some of the benefit from the statute for which I am not compensated. On the other hand, if I place a horrific piece of "modern" art on my property, that is a "negative externality."

A "free rider" avoids contributing to a "positive externality" from which he benefits or paying for a "negative externality" to which he contributes. (I realize this is a broad definition.) For example, if we consider a clean yard to provide a positive externality and an ugly yard to provide a negative externality, such that the efforts of everyone in a neighborhood impact property values, a "free rider" might neglect to take the effort to clean his yard and/or prevent it from becoming overgrown.

Romer thinks that carbon dioxide emissions by human industry are causing global warming, and so such emissions create an external harm. Romer suggested that a "cap and trade" program, whereby firms that emit carbon dioxide must pay a tax on such emissions with the ability to "trade" pollution "rights," would "let markets work." So, like Hagedorn, Romer expresses appreciation for "markets" while calling on government controls on these markets. (As Ralph Shnelvar pointed out to me, at least "cap and trade" does allow for some market efficiencies relative to more draconian sorts of controls. But my point is that "cap and trade" is not a free-market proposal. And, as I discuss below, "cap and trade" is Romer's only semi-plausible application of externalities theory. (I leave aside Romer's support for toll lanes, which I think are a good idea.)

But several problems immediately arise with the idea of "externalities" as grounds (pretext?) for government controls. We are speaking here of cases beyond the government actions necessary to protect individual rights, which, in economic terms, do limit "negative externalities" and capture positive ones. (Most of this analysis is common among both Public Choice and Austrian economists.)

1. A free market, in which individual rights are consistently protected and people remain free from initiatory force, routinely solves problems of externalities and free riders. David Friedman and many others point out that light houses, a classic case of a positive externality, often were privately funded. So people can voluntarily arrange to handle many sorts of externalities; the problem is basically one of finding a market tool to handle the job. Moreover, moral and social beliefs solve many problems of externalities. For example, many people maintain a clean yard, not only to experience the personal pleasure of living in a clean area and to maintain high property values, but to remain on good terms with their neighbors. My view is that all problems of externalities can be adequately met on a free market.

2. The same thing can at the same time provide both positive and negative externalities of different levels for different people. Perhaps some people would like my horrific piece of modern art (and such art certainly receives enough tax funding). Industry not only emits carbon dioxide, it creates the values that support human life. In many cases these values are produced far beyond the level of compensation received by the firms that create them. Weighing the positive versus the negative externalities is no trivial matter, and only vague guesses are possible.

3. As one audience member pointed out, externalities can't be measured by politicians, so these politicians resort to "made-up figures" for "pricing externalities." So, even granting the existence of a positive or negative externality, there's little reason in any given case to think that politicians will improve matters.

4. Government action is routinely captured by special interests (as the same audience member also noted). For example, with respect to licensure (of trades such as gym training), Mitchell pointed out that the legislature is "regulating willy nilly" based on "some nebulous standard." Such licensure is clearly a case of protectionist legislation that imposes external harms. Mitchell argued that a bill to expand lawsuits against home builders constituted "payoffs to trial lawyers." Other measures provided "payoffs to labor unions." Government is not run by angels. Even if politicians had the best intentions of addressing externalities -- a laughable thought -- they would face constant pressure to pay off interest groups. (I discussed this topic a couple years ago.) Even Romer admitted that he's "not a huge fan of mandates" in energy policy -- even though these mandates were imposed by his own party and benefit particular interests.


Senator Shawn Mitchell, left, glances at his notes as columnist David Harsanyi talks about the ideas behind his forthcoming book, Nanny State.

5. This is an extension of the previous point but an important one in its own right. The greatest generator of negative externalities is modern government. There is no institution that generates more free riding than the government. So politicians who look to the speck of externalities in the market ought to first contemplate the lumber yard of externalities that they themselves are shouldering.

6. The view of "externalities" as used as grounds for government controls would, taken to its logical conclusion, justify subsidizing or penalizing every single business and person in the world. It is thus the perfect theory for politicians who wish to expand their own power and the power of bureaucrats over our lives. The following list contains only a few items that generate externalities: painting your house, dressing attractively, brushing your teeth, studying, developing a morally virtuous character, expressing gratitude, and producing any material good whatsoever. (See Brian Simpson's book, Markets Don't Fail!, pages 95-6, for additional examples.) Of course, some advocate state provision of "public goods" very strictly defined, and others want to address only externalities of (what they believe to be) serious magnitude.

One virtue of a free market, in which individual rights are consistently protected, is that it is governed by objective rules. Whether and to what extent something is an "externality" is fundamentally a subjectivist phenomenon that can only be interpreted subjectively. A ban on the initiation of force, on the other hand, is clear and objective. While courts still have to consider tricky issues such as self-defense and property boundaries, in general people can learn what is and what is not allowed on a free market. Stated positively, you have the right to control your own life and cooperate with others voluntarily. Stated negatively, you must not break your contracts or initiate violence or fraud against others. These are basic moral precepts that children can begin to learn. "Pricing externalities" in the way that Romer suggests, on the other hand, requires an army of bureaucrats led by politicians who are often beholden to special interests.

A free market is characterized by clear rules that people know in advance. A controlled market is characterized by bureaucratic whim and after-the-fact decisions. We can generally know in advance whether our actions will impose force, pollute somebody's specific property, or break a contract. We cannot know whether some politician or bureaucrat might deem, after the fact, that one of our activities has imposed a "positive" or "negative externality."

This leads to a deeper philosophical point. As Ayn Rand points out, human beings survive fundamentally by the use of their reason. And reason cannot operate to the extent that it is subjected to force. A free market provides a clearly defined sphere of action that is consistently protected from outside interference. It is this freedom from the initiatory use of force (and absence of governmental caprice) that enables one to most fully use reason as applied to the task of living. To the extent that politicians and bureaucrats "plan" our lives according to (necessarily) vague and nonobjective standards, and impose these plans with force or threat of force, we are unable to plan for our own lives. A free individual has the ability to apply reason to his or her life and the responsibility to accept the consequences. Elitist rule, on the other hand, promotes dependence, irresponsibility (including free riding), and special-interest conflict.

So how does this analysis apply to the policies favored by Hagedorn and Romer? We'll start with the hardest case first: global warming. There's no way to objectively assign property rights with respect to the emission of carbon dioxide, because essentially everybody is contributing to the problem that will (purportedly) harm everybody. The claim is that the emission of carbon dioxide imposes the negative externality of global warming, and therefore people will not voluntarily act to solve this problem on a free market. In terms of the free-rider problem, the claim is that, if everyone acts to reduce emissions of carbon dioxide, that will supposedly "save the earth," but without enforcement many will defect. Yet we've already noted some of the problems with trying to craft a political solution. We've already seen how special interests (e.g., corn growers) have captured government policies to generate wealth transfers rather than real solutions. My view is that the alleged harms of human-caused warming are typically grossly exaggerated. Regardless, people should address the issue on the free market: through purchasing decisions, business offerings, and voluntary persuasion. (Brian Schwartz recommends articles by Max Borders, Edwin G. Dolan, and Jonathan Rauch. George Reisman has also addressed the issue. Of course, I am not committing myself to complete agreement with any cited author.)

What about health care? Hagedorn didn't recognize the ways that government mandates have generated "freeloaders," so I'll spell out some of the ways for him.

* The federal government forces emergency rooms to treat all comers, regardless of ability to pay. This reduces the incentive to purchase insurance and lower-cost care.

* Federal and state governments impose "guaranteed issue" and "community ratings" on much insurance. This reduces the incentive to purchase insurance until after one becomes sick.

* Medicare reduces the incentive to seek preventative care and purchase long-term insurance earlier in life.

* Medicaid generates numerous pathologies, including prolonged dependency on federal handouts. Medicaid also increases prices for others by spurring thoughtless demand and by pushing some costs of Medicaid onto others. For more on this, see Schwartz's summary in his proposal to the "208" Commission, pages 38-46.

* Because of income-tax distortions, most people obtain high-cost, non-portable insurance through their employers. This generates the problems of losing insurance when losing a job and of some people not buying insurance. It also creates the problem of skyrocketing health costs, which increase the difficulties of the uninsured in purchasing preventative care.

* Because of various mandates on insurance, insurance premiums are much higher than they would be in a free market, resulting in more people not buying insurance. (Especially for this point and the last one, the people in question are not properly considered "freeloaders," but rather victims of political force).

But how does the issue of externalities apply to medical services absent the initiation of force? There are no more inherent externalities than there are with any business. If medicine should be socialized because of externalities, then the entire economy should be socialized by the same reasoning. When an individual purchases medical services, that individual receives the benefits, and no special or significant problem of externalities is created.

Nor are there special or significant externalities related to education. By and large, individuals reap the rewards of earning an education. Even by the interventionist account of externalities, the only possible externality worthy of government attention is the benefit of charity for underprivileged students. (We can also consider charity for medicine.) Certainly that issue doesn't warrant subsidizing rich kids in posh schools and sticking poor kids in failing schools, as typically happens today. In a free market, however, people would address such issues by voluntarily donating to charity, creating sliding tuition rates, etc. (Smith on pages 877-8 grants that education might "with some advantage" be funded voluntarily.)

Senators Hagedorn and Romer each raised a sort of "market failure" argument in an attempt to justify their redistributionist, often egalitarian, rights-violating policies. Both failed miserably, even on their own terms. The only appropriate way to deal with "externalities" and "free riders" is to establish a free market, in which the initiation of force is outlawed and people's individual rights are consistently protected.

The Colorado Freedom Report--www.FreeColorado.com