Make Sure the Cure Isn’t Worse Than the Disease

TANSTAAFL.  Every action taken has costs, and sometimes those costs are borne by those who had no say in the matter (“negative externalities” to use the technical term).  The existence of externalities is often used to justify government involvement in markets (pollution tends to be the common example).  Lately, however, protectionists scarcityists have begun using that argument to promote their policies, noting job loss as an externality.  Some, more generally, claim “practical people not tied to free trade dogma understand that trade sometimes is good and that it’s bad other times.”

It certainly is possible that, any given transaction, may have enough unforeseen negative consequences as to have negative net benefits.  However, the bar needed to justify government action is high:

From a purely economic perspective*, protectionists have two tasks before them:

1) Prove that imports cause greater net harm than domestic production


2) Prove the proposed solution minimizes the net loss (or, inversely, maximizes net benefits). This is where comparative institutional analysis comes in.

The mere existence of condition (1) is neither necessary nor sufficient to justify government intervention. If the cost of government intervention exceeds the benefits therefrom, then even though the free market option has a net loss, it is the optimal solution because the resulting intervention would make matters worse!

The existence of condition (1) may require collective action to solve, but it may be more cheaply solved via non-government collective decision making (ie, a firm).**

There may be cases where government decision making is the lowest cost option.  However, it is very much a case-by-case basis.  Blanket legislation (like a tariff) does not allow for the necessary flexibility to make such decisions.  In order to minimize costs (and thus maximize net benefit), freedom must be given first preference, with the burden of proof upon protectionists.

*There could be many other arguments for protectionism, such as legal, or national defense.  I shan’t get bogged down in a discussion here.  I’ll leave that to the experts.

**For a more in-depth discussion on this point, read The Calculus of Consent by James Buchanan and Gordon Tullock, in particular Chapter 5.

The Specter of Competition

In economics, we tend to define market competitiveness in terms of the number of actors (firms, individuals, etc) who participate in the market.  On one end of the spectrum, you have the perfect competition model, where there are so many buyers and sellers that no one actor can affect the price.  On the other end, you have monopoly/monopsony, where there is only a single buyer or seller.  The middle of the spectrum is some form of imperfect competition.

But is that definition sufficient?  For empirical and legal matters, it probably is, but what of economic matters?

In economics, there is often unseen (or “specter”) competition.  Specter competition, I call it thus, is competition that does not exist in any physical sense in the form of a rival economic actor, but is real nonetheless.  It hovers around the economic actor like an omen.  For example, a firm, despite having clear technical monopoly power, keeps its prices low for fear of attracting competition.  A real world example of this can be found with Microsoft (see Boudreaux & Folsom 1999 or McGee 1958).

Specter competition, because of its eldritch nature, can come from anywhere, and often does.  Furthermore, even legal barriers to entry appear to be useless against this form of competition (in fact, may actually attract it).  A perfect example of this is Uber:  Who’d have thought that mobile telephones, the Internet, and a bunch of bored folks with cars and extra time, would be a threat to taxis?  Many of these taxi companies had legal monopolies in their respective cities, but specter competition has torn down their barriers.

Firms, even monopolies, must be on constant vigilance for specter competition, lest they find their previously secure position under attack.  Therefore, I propose a slight addendum to Perry’s Law: Both seen and unseen competition breed competence.

Beggar Thy Neighbor

Imagine you live next door to a family.  They are poor as poor can be: under-eating, wearing rags, no heat, no cool, little water, etc.  They just barely survive.  One day, the adults of the household decide to start working more, and they begin trading (ie, buying and selling) with the wider community.  In a fairly short time, they go from being poor to being moderately wealthy: more food, better clothing, they have a small, old, but operating car now.  They have heat and air conditioning.  In short, they’re moving on up.  They’re not quite at your and your neighbors’ standard of living yet, but they’re getting there.

Now, one of your neighbors says: “That family…oh, they’re bad news.  They’re getting wealthier every day.  If they keep growing at this pace, they’re going to leave us in the dust.  We have to stop them!  I demand we all stop buying from them.”

One would, I should think, reasonably object to such measures.  What’s it matter that the neighbor is improving his life?  Wealth is not a zero-sum game, and a wealthier neighbor is a good thing for the neighborhood.  One would conclude the objecting neighbor is just jealous, just trying to protect his position.

And yet, this is exactly the jealous reasoning employed by protectionists scarcityists.  Warren Platt, a self-proclaimed protectionist, leaves the following comment at Carpe Diem the other day:

I disagree with the narrative that China is 50 years behind the USA [in terms of living standards]. They are not. They are par with us, and are growing much, much faster. They will soon leave us in the dust unless something changes.

Ignoring the factual issues with Warren’s comment, even if the Chinese were on par with the US, so what?  The US is still an insanely wealthy nation.  So long as we resist a glade into scarcityism and socialism, that will continue to be.  What’s it matter if another nation approaches or surpasses us?  That is no reason to impose tariffs to harm both us and them!

China has spent much of the past century in the muck and mire of human poverty, and now that they are finally pulling themselves up, the objection is they threaten our relative position, and must be cast back down.

There are lots of poor arguments for scarcityism, but this is among the worst.

Today’s Quote of the Day…

…is from page 147 of the excellent new book Arguments for Liberty (edited by Aaron Ross Powell and Grant Babcock).  This quote comes from the essay on Contractarianism by Jan Narveson (original emphasis):

Liberalism is exemplified by normative systems that hold two points: (a) that the sole acceptable purpose of rules, laws, and in general interventions must be the good of those intervened upon; and (b) that it is those persons themselves, rather than any supposed authorities, who fundamentally embrace those values.  Individuals, then, are the basic holders of the values that interventionist institutions and personages are to respect….Both are essential.  So-called liberals of the present day tend to think that they, the pundits or theorists or the elected politicians, know what people want better than the people themselves.

The Unseen Costs of Taxation and Regulation

On a EconLog post about E-Verify, commentor “Jay” writes:

I’m confused, if [E-Verify] poorly enforced and therefore only sparsely followed by employers, how does it raise hiring costs?

Jay’s question is an excellent one, and one that gets down into one of the main reasons we have deadweight loss (DWL) stemming from taxes and regulation.  Taxes and regulations change behavior (if they didn’t, we’d only have a transfer of wealth from consumers/producers to the government and there would be no DWL).  The obvious way they change behavior is when people adopt less efficient use of resources (in the case of E-Verify, hiring a worker who may be less productive over a worker who would be more productive because the first worker will pass E-Verify and the second worker won’t).

But evasion of those taxes and regulations are also a cost.  For example, if an employer hires someone who would not pass E-Verify, and as such goes to lengths to ensure his hiring is not caught (paying him under-the-table, hiding him of INS come looking, that sort of thing), these are all extra costs being paid.  Costs of time, or money, or effort that would otherwise have been spent doing something productive (and that’s not even counting the government’s cost of enforcement!).

These costs, while unseen, are very real.  Employers face evasion costs just like anyone else, and will make decisions based upon them, even if they never show up explicitly as some budget item or in an official government report.  These costs will change their actions, and we are all worse off for it.

Today’s Quote of the Day…

…is from Robert Tollison’s forward for the Liberty Fund edition of Jim Buchanan and Gordon Tullock’s classic work, The Calculus of Consent:

“Politics and the market are both imperfect institutions, with the least-cost set of institutions not being obvious in any real case. The moral: We must better understand how institutions work in the real world to make such choices intelligently.”

The Subtle Cruelty of Efficiency Wages

One of the more sophisticated arguments for minimum wage stems from the Efficiency Wages Hypothesis (EWH).  The EWH asserts that firms will sometimes pay higher-than-market wages for their workers.  These wages reduce turnover and increase productivity, making the wages more viable for the firms.  However, it is important to note that with EWH, there is still unemployment in the industry: higher-than-equilibrium wages reduce quantity demanded and increase quantity supplied from the equilibrium point, creating a surplus of labor (unemployment).

Minimum wage activists will cite the EWH for reasons for the minimum wage, claiming the reduced turnover and increased productivity is a positive for the firms.  That much is true.  But how does the EWH increase productivity and reduce turnover?  Workers may be feeling better with a higher wage, so they’ll naturally work harder.  That’s possible.  But the real reason is the cost of losing the job is now higher.  With persistent unemployment in the industry, the threat of firing forces workers to work harder in order to keep their jobs (thus increasing productivity).  Turnover is reduced not out of some sense of loyalty to the firm now paying higher wages but because there are fewer jobs available and they are being competed for by more workers!  

In short, an Efficiency Wage (especially if legally mandated like the minimum wage) gives employers more power over workers; it reduces worker bargaining power and reduces worker ability to leave if conditions are unfavorable to them.

The minimum wage is a very cruel policy.  The minimum wage as an efficiency wage is even more so.