Trade-Offs and Public Policy

This semester, I have been studying Law & Economics with Robin Hanson at GMU.  In class, we have been discussing the legal system, how it is structured, and other ways to structure it.  Questions we’ve pondered include: why can one appeal on matters of law and not matters of evidence?  Why are rules of evidence what they are?  Should all contracts be enforced or what limits should be placed on them?  Why are property taxes structured they way they are?  Why common law in the US as opposed to civil law?  Etc.

Simultaneously, I am evaluating a book for my course this summer: Trade-Offs by Harold Winter.  Trade-Offs is a public policy-focused look at economic reasoning.  In the book, he points out one of the dangers of public policy analysis (Page 5, original emphasis):

Even if there is agreement on the broad objective of maximizing social welfare, policy objectives may differ due to differences in the definition of social welfare.  A good example of this can be found in the economic analysis of crime.  To deter crime, we must use resources for the apprehension, conviction, and punishment od criminals.  But should the benefits that accrue to individuals who commit crime (also members of society) be added to social welfare?  If yes, this may suggest that fewer resources can be used to deter crime, because crime itself has offsetting benefits.  If not, crime is more costly to society, and more resources may be needed for deterrence.  Notice, however, that it is a fact that a criminal reaps a benefit from commiting a crime (or why commit the crime?), yet it is an opinion as to whether that benefit should be counted as social welfare.  Policy objectives and definitions of social welfare are subjectively determined.

What is also subjectively determined, as explained by Carl Dahlman in his 1979 Journal of Law & Economics article The Problem of Externality, is the effectiveness of the policy change proposed.  When a policy proposal is made, the proposer implicitly assumes that whatever institution he is invoking (government, market, etc) can necessarily solve the problem he’s subjectively identified better than the status quo (otherwise, why would he make such a proposal?).

All this subjectivity means that discussing “optimal” policy gets really tricky.  Optimal tariffs, Pigouvian taxes, optimal forms of law, legislation, etc are going to depend greatly on how we measure social welfare.  When discussing tariffs, should the welfare of foreign producers and consumers be counted?  If so, why?  If not, why not?  When discussing Pigouvian taxes, should the welfare of clean-up companies be taken into account (eg, the laundromat who loses business because fewer people are washing soot-caked clothes) and is government necessarily the best solution?  What makes sense given a certain accounting of social welfare doesn’t with a different accounting.

Answers to these questions can go a long way in helping us consider supposed market failures: whether something optimal or suboptimal will depend a lot on how these trade-offs and welfare are measured (to Winter’s point above, if the welfare of criminals is taken into account, there may be too much police activity.  If the welfare of criminals is not, there may be too little).  In this sense, optimality is in the eye of the beholder.

I’d argue that the subjective nature of social welfare policy suggests a strong presumption of liberty for people to choose their own way.  Indeed, there is no initial reason to believe any given action taken by an individual is somehow sub-optimal given the subjective nature of social welfare.  Even something like pollution is subject to these conditions.  This realization also should force economists (and their consumers) to ask the question “what are we assuming?” and “how are my biases affecting this analysis?”

Economists rarely argue about data.  It’s somewhat rare that someone made a math mistake or jumbled data (ideally, that gets caught long before publication).  Outcomes are not in question, but the subjectivity of trade-offs are.

Unfair Trade and General Rules

Unfair trade has dominated the political conversation lately. Allegations that China, South Korea, Mexico, Canada, and many others are being unfair, whether they pay too low or they subsidize some industry, or their tariffs are too high, whatever, abound. These allegations justify the use of tariffs to punish the offending nation(s). Free trade, they say, cannot exist in the face of such injustice and, while it is a fine general case, exceptions must be made for these injustices to be corrected.

But do injustices that occur from a general rule justify exceptions therefrom or to even overturn the rule?

Consider the following general rule: All people in the United States, when accused of a crime, will be tried in an open court before a jury of their peers.  The ruling of that jury, barring legal issues, is final.

With that rule in mind, consider the following:

A man is accused of rape.  The evidence seems straightforward.  After a long trial, the jury retires to deliberate.  After a few days of deliberation, the jury returns a verdict of “not guilty.”  There is an uproar within the local community.  “He was clearly guilty!” they cry.  “The decision should be overturned!  The jury system failed to deliver justice!”

The natural inclination of any spectator of this situation would be to decry the jury rule.  It had clearly failed to deliver its promise.   But would overturning such a rule be in the best interests?  I think prudence and wisdom suggest “no.”  Or, at least, extreme caution.

A general rule, like trial by jury, serves a particular purpose.  By nature of its generality, it will not be perfect in all cases.  But because it is so general, it can work in most cases.  In the case of the jury process, the particular purpose of this rule is to prevent unfair prosecutions and to have evidence judged on its merits; by presenting to a lay audience, it is a test to see if it is plainly obvious that a crime has been committed.  Wisdom and prudence suggest that, since this rule has persisted so long, caution should be exercised before overturning it.  it may lead to undesired consequences (perhaps tyranny, in the case of juries).

To extend this to trade, the general rule is that people may trade with whomever they want so long as it is voluntary.  There are relatively few ways in which the state can object to trade (obviously prohibited items like drugs, prostitution, etc).  But this general rule has led to some undesirable outcomes: people have lost jobs to import competition and automation.  Some of these job losses, it is observed by some, occurred because this competition is “unfair” due to state subsidies, tax preferences, etc.  They, therefore, want to overturn the general rule (or create exceptions to it).  Tariffs, restrictions, or outright bans are often banded around as solutions.

But, again, prudence and wisdom urge caution before overturning such a rule.  Could it lead to a “slippery slope?”  Are the protections granted by the general rule worthwhile?  Would the exceptions to the general rule that are granted lead to other forms of rent-seeking, and unfair actions taken by domestic groups (eg, everyone starts clamoring for protections)?  The benefits of the general rule are obvious; the costs and consequences, not so much.

Even if we grant that the actions taken by some governments to “support” their trade position are indeed unfair, like the jury example above, creating exceptions to the general rule may achieve more mischief than good.

A final point in conclusion: none of this is to claim status or say the status quo is always and everywhere preferable.  General rules can, and should, be examined and overturned when necessary.  Rather, what this post is to do is to urge caution when it comes to overturning general rules; a willy-nilly attitude can destroy any and all respect for law and legislation.

Can Protectionism/Scarcityism Encourage Industry?

Short answer: not likely

Long answer: Protectionists Scarcityists like to argue that protectionism is needed (or can otherwise) to encourage industry.  Foreign competitors use “unfair” practices to undermine the domestic industry and protectionism scarcityism is there to protect the industry from these shenanigans.  This, in turn, will foster more domestic investment and encourage industry.  But how likely is this to be?  Let’s take a look at the logic.

From a protected industry perspective, it is possible that scarcityist policies encourage some investment in that protected industry.  Domestic production increases (although this is merely a substitute for some of the imports and overall output decreases).  This increased production may encourage more investment, but it is hardly guaranteed to.  These protected industries are protected from competition, so there isn’t much incentive to invest and improve; they are output restrictors.

Enlarging our view to the economy as a whole, scarcityism is far more likely to reduce investment and industry.  As I pointed out above, scarcityism works because it reduces output, forcing prices to rise.  This necessarily means consumers have to spend more to achieve the same standard of living.  In turn, this means fewer savings and since savings are funds used for investment, this means less investment.*  Additionally, since imports are reduced, foreigners now have fewer dollars with which to buy exports or invest in the US economy.  Reduced savings, and thus reduced investment, comes from this area as well.

There are secondary effects of scarcityism as well.  Not only does it reduce overall output in an industry, it encourages the use of wasteful use of current resources.  The protected firms are using less efficient methods of production, which is eating up resources that could otherwise have been released for more valuable purposes.  This, in turn, means fewer resources for industry to use and grow.

In order for scarcityism to foster growth, it’d require an awful lot of luck and some highly specific conditions which are improbable in the real world.

*Note that this same logic holds even if consumers switch to a cheaper substitute for the now-more-expensive goods.

Today’s Quote of the Day…

…is from page 229 Karl Menger’s 1883 book Investigations into the Method of the Social Sciences, specifically Appendix VIII “The ‘Organic’ Origin of Law and the Exact Understanding Thereof” (original emphasis):

However, law can also come into being, and even under the most original conditions, in another way essentially different from the above: by authority. The man in power or intellectually superior can set certain limits to the discretion of the weak men subject to him or of those mentally inferior. The victor can set certain limits for the vanquished. He can impose on them certain rules for their action to which they have to submit, without considering their free conviction: from fear. These rules, however similar they appear on the surface to those of national law, are both by origin and by the guarantees of their realization essentially different from the law which grows out of the convictions of the population and the realization of which was also originally an affair of the nation. Indeed, they can be in direct contrast to national law; they are really statute, not law. But the strong man has an interest in calling them ”’law,” in cloaking them with the sanctity of law, in connecting them with religious  traditions, in elevating them so that they become the objects of religious and ethical education. This is the case until the habit of obedience and the sense of subjection developed by them recognize in them something analogous to law and until this habit and sense scarcely distinguish any longer those rules limiting the discretion of the individual which are produced by the convictions of the nation from those which power prescribes for the weak.

JMM: What Menger means here by “national law” is not some national convention or agreement (in fact, he explicitly rejects the “social contract origin” theory of law), but rather what is more akin to custom and tradition: something that evolved over time to serve a purpose (protect individual interests) and is widely accepted and respected by members of the society.

What Menger does in this paragraph is draw a distinction between “national law” (the subject of the essay thus far) with statutory law.  The primary difference is how these two are established: national law (which is properly called law) is established through human interaction.  Statutory law is established through authority (ie imposed).  The two have superficial similarities only.

This is not to say that statutory law is inherently less desirable that law.  What it is to say is that statutory law can become unhinged from morality, in which case we are faced with the Bastiat Dilemma: “When law and morality are in contradiction to each other, the citizen finds himself in the cruel alternative of either losing his moral sense, or of losing his respect for the law—two evils of equal magnitude, between which it would be difficult to choose.”  To treat statutory law as some “will of the people” or the object of some “divine intelligence” (to use Menger’s term elsewhere in the essay) is to fundamentally misunderstand law.

 

Some Questions for Protectionists

Protectionism is, by definition, state-action.  The argumentation is that trade with foreign nations make us worse off (with few exceptions) and we need to protect our industries in order to grow.  Protecting our industries, from unfair competition, from competition in general, whatever the reason, will make people better off than in free trade.  This claim, however, leads us to some questions:

  1. Why is foreign trade a collective-action problem?  In other words, if people were actually made better off via protectionism, what is preventing them from acting in a manner to better themselves naturally?  Why is government needed?
    1. If there is a Prisoner’s Dilemma type situation or some other coordination problem, that doesn’t necessarily prevent a non-government solution from arising.  As Elinor Ostrom discusses in “Governing the Commons,” the Prisoner’s Dilemma is not an inescapable trap.  People can get out of it through various interactions with each other.  To justify government action, there’d need to be some barrier preventing people from getting to the socially optimal outcome point.  What are the barriers that prevent this from occurring?
  2. Why is there a coordination issue at the international trade level but not the intranational trade level?  Protectionists never demand restrictions on intranational trade, preferring to let people act.  What is unique about intranational trade that allows for coordination that international trade does not?  In other words, why are people’s actions at the intranational level sufficient to generate overall prosperity but those exact same actions are insufficient, indeed detrimental, to overall prosperity at the international level?

A Difference Between Enforcement and Creation

At Cafe Hayek, Don Boudreaux links to his Freeman article from December 2003 on the source of rights.  Don’s article is excellent, but there is a subtlety that I think needs to be highlighted and discussed to prevent misunderstanding.

There is a difference between the enforcement of rights and the creation of rights.  Those who enforce are not necessarily the same as those who create.  For example, let’s say I create a business: I design the product, I market it, I sell it, etc.  However, to protect my business, I hire someone to patrol the grounds when I am not around.  While I created the business, she enforces my claim to the business.  It’d be incorrect to conclude that, because she enforces the claim, she thereby created the claim.  She was just chosen as the method of the enforcement; the claim (in this case, the business) preceded her.  Indeed, it had to.

The same is true of rights.  A government may be desirable to enforce and protect rights (like the nightwatchman in my example above), but those rights need to precede the enforcement.  So, the fact that an agency enforces something does not mean that it also creates.  Pointing to the government as an enforcer does nothing to show that it is the originator.

The Logical Impossibility of Absolute Rights

There is an important implication of my post from yesterday (or, perhaps more accurately, I should say this post as important implications that lead to yesterday’s post): universally absolute rights are logically impossible.

We tend to hear arguments by libertarians and anarcho-capitalists that certain rights, namely property rights, are absolute (for example, see Murray Rothbard’s article here).  No one can prevent us from doing what we want with our property (including our bodies) or enjoying our property as we see fit.  While on the surface, this seems reasonable, it is a logically impossible thing to enforce.

Let’s consider an example, similar to the one I gave yesterday.  Two neighbors have an abutting piece of land.  One neighbor, Joe, has a pool and a nice backyard he enjoys lounging in.  However, one thing he does not like is the smell of smoke and the sound of loud noises.  These things reduce the enjoyment of his property.  The other neighbor, Bob, has a backyard as well, but he likes to sometimes hold barbeques, bonfires, and parties.  When he does this, he generates noise and smoke that inevitably flow over to Joe’s yard.  In other words, Joe’s “stuff” is being messed with.

If both parties have absolute property rights, how can this situation be resolved?  If Joe cannot request, require, or negotiate some end to Bob’s activities, his ability to enjoy his property as he sees fit is diminished by Bob’s actions.  Likewise, if Joe’s ability to enjoy his property is maintained, then Bob’s enjoyment of his property must necessarily be reduced by reducing or eliminating his barbeques, bonfires, and parties.  Either way, someone‘s property right is not absolute.  Something has to give.

It is important to note there is no necessary need for state intervention here.  Joe and Bob can (and likely will, absent major costs) find some mutually beneficial arrangement.  But that arrangement must result is someone’s rights being attenuated.  If one of them has an absolute right, the other cannot.

The question should not be whether some rights are absolute or not.  Absolute rights are a logical impossibility.  Rather, the question should be how to resolve conflicts that inevitably arise when rights collide.  If libertarians cannot address these conflicts, then we necessarily secede the argument of conflict resolution to the statists.  By insisting on absolute rights, a logical impossibility, we state outright libertarianism has no place in the real world as it cannot resolve conflicts.  This has to end.