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THE KNOWLEDGE PROBLEM




M F.A. Hayek, brought into relief an aspect
ISES™S STUDENT,
of the problem facing socialist planners that was only
implicit in the work of his mentor. In his famous
essay, “The Use of Knowledge in Society,” Hayek noted the
162 ECONOMICS FOR REAL PEOPLE




importance of “the particular circumstances of time and place”
in making sensible economic decisions:
Today it is almost heresy to suggest that scientific
knowledge is not the sum of all knowledge. But a
little reflection will show that there is beyond ques-
tion a body of very important but unorganized
knowledge which cannot possibly be called scien-
tific in the sense of knowledge of general rules: the
knowledge of the particular circumstances of time
and place. It is with respect to this that practically
every individual has some advantage over all others
because he possesses unique information of which
beneficial use might be made, but of which use can
be made only if the decisions depending on it are
left to him or are made with his active co-operation.
We need to remember only how much we have to
learn in any occupation after we have completed
our theoretical training, how big a part of our work-
ing life we spend learning particular jobs, and how
valuable an asset in all walks of life is knowledge of
people, of local conditions, and of special circum-
stances. To know of and put to use a machine not
fully employed, or somebody™s skill which could be
better utilized, or to be aware of a surplus stock
which can be drawn upon during an interruption of
supplies, is socially quite as useful as the knowledge
of better alternative techniques. The shipper who
earns his living from using otherwise empty or half-
filled journeys of tramp-steamers, or the estate agent
whose whole knowledge is almost exclusively one
of temporary opportunities, or the arbitrageur who
gains from local differences of commodity prices-
are all performing eminently useful functions based
on special knowledge of circumstances of the fleet-
ing moment not known to others.
163
A WORLD BECOME ONE




In the same essay, Hayek offers an example of how the
price system enables the changing circumstances of a market
participant to potentially influence the choices of other actors
throughout the entire economy, thereby adjusting supply and
demand to new conditions:
Fundamentally, in a system in which the knowledge
of the relevant facts is dispersed among many peo-
ple, prices can act to coordinate the separate actions
of different people in the same way as subjective
values help the individual to coordinate the parts of
his plan. It is worth contemplating for a moment a
very simple and commonplace instance of the
action of the price system to see what precisely it
accomplishes. Assume that somewhere in the world
a new opportunity for the use of some raw material,
say, tin, has arisen, or that one of the sources of
supply of tin has been eliminated. It does not mat-
ter for our purpose”and it is very significant that it
does not matter”which of these two causes has
made tin more scarce. All that the users of tin need
to know is that some of the tin they used to con-
sume is now more profitably employed elsewhere
and that, in consequence, they must economize tin.
There is no need for the great majority of them even
to know where the more urgent need has arisen, or
in favor of what other needs they ought to husband
the supply. If only some of them know directly of
the new demand, and switch resources over to it,
and if the people who are aware of the new gap
thus created in turn fill it from still other sources, the
effect will rapidly spread throughout the whole eco-
nomic system and influence not only all the uses of
tin but also those of its substitutes and the substitutes
of these substitutes, the supply of all the things made
of tin, and their substitutes, and so on; and all his
164 ECONOMICS FOR REAL PEOPLE




without the great majority of those instrumental in
bringing about these substitutions knowing anything
at all about the original cause of these changes.

Have you ever read the list of ingredients on a package of,
say, “Puffy, Deep-Fried Cheese Thingies,” and found some-
thing along the lines of: “This product contains one or more
of the following: coconut oil, palm oil, soybean oil, corn oil,
canola oil, peanut oil, motor oil, snake oil.” When I first did
so, I was puzzled as to how a manufacturer could be uncer-
tain about just which oils were in its product. Of course, I was
mistaken as to what the list meant. For any particular batch of
Puffy, Deep-Fried Cheese Thingies, the manufacturer certainly
knows which oil it is using.
In fact, the vague nature of the list is an illustration of
Hayek™s point. The producer of Cheese Thingies believes
(rightly or wrongly) that its customers don™t care too much
about exactly which sort of oil was used to fry the Thingies in
the bag they just bought, so long as the taste is pretty much
the same as the ones they previously have eaten. Therefore,
whenever the manufacturer must buy cooking oil, it purchases
whatever one is cheapest at that time.
The goal of the manufacturer is simply to increase its prof-
its. However, because it responds to price signals in its efforts
to do so, it also, as an unintended consequence of pursuing
its own end, helps to allocate resources to their most urgent
use. Users who have a greater need for a currently more
expensive variety of oil, for example, a producer of West
African foods who can only achieve an authentic taste with
palm oil, will acquire that oil in the Cheese-Thingies manu-
facturer™s stead. It is as Adam Smith noted long ago: “It is not
from benevolence of the butcher, the brewer, or the baker,
165
A WORLD BECOME ONE




that we expect our dinner, but from their regard to their own
interest.”
Of course, market prices do not “measure” consumer
demand; they only paint a rough picture of it. Prices must
always be interpreted by the entrepreneurs, who are eager to
profit from any perceived discrepancy between current mar-
ket conditions and the true desires of the consumers. The mar-
ket process is driven by the continuing efforts of entrepre-
neurs to better understand what consumers really want, given
the currently available resources. Such knowledge is certainly
not available to any person in the absence of the market
process, just as the knowledge of how to swim cannot be
acquired without getting in the water.
Only in the imaginary state of an evenly rotating economy
would prices precisely reflect consumer demand. In the real
world, where the conditions presented to humans by nature
continually change and human learning is an ongoing
process, we will never reach a state of complete and final
equilibrium. In the world in which we live, no price is ever
perfectly adjusted to the true state of the consumers™ desires.
Nevertheless, market prices are the best possible means for
making those desires known and for motivating entrepreneurs
to fulfill them.



THE CALCULATION PROBLEM AND THE KNOWLEDGE
PROBLEM: TWO SIDES OF ONE COIN




T Mises and of Hayek as to the feasibility of
HE ANALYSES OF
a socialist economy are complementary. Mises showed
that socialism is incapable of achieving an efficient use
166 ECONOMICS FOR REAL PEOPLE




of society™s resources, because its economic planners have no
means by which to perform economic calculation. Hayek
showed that the reason market prices can be used for eco-
nomic calculation is that they reflect the best possible estimate
of how useful the various factors of production will prove to be
in satisfying consumer demand. Today™s prices for the factors of
production are largely determined by those entrepreneurs who
previously estimated consumers™ wishes most successfully.
Their past successes increased the funds at their disposal, giv-
ing them greater means with which to bid for currently avail-
able resources. Each entrepreneur is able to use his personal
knowledge of his “particular circumstances of time and place”
in deciding what price to offer for various factors of production.
A socialist planner could slap some arbitrary “price” on
every good and then proceed to calculate the outcome of
alternative ways of producing goods based on those numbers.
However, since they have no relationship to the actual wishes
of the consumers, they are prices in name only, merely a pale
imitation of market prices. As Mises wrote in Human Action:
Even if, for the sake of argument, we assume that a
miraculous inspiration has enabled the director [of a
socialist economy] without economic calculation to
solve all problems concerning the most advanta-
geous arrangement of all production activities and
that the precise image of the final goal he must aim
at is present to his mind, there remain essential
problems which cannot be dealt with without eco-
nomic calculation. For the director™s task is not to
begin from the very bottom of civilization and to
start economic history from scratch. The elements
with the aid of which he must operate are not only
natural resources untouched by previous utilization.
There are also the capital goods produced in the
167
A WORLD BECOME ONE




past and not convertible or not perfectly convertible
for new projects¦ [in which] our wealth is embod-
ied. Their structure, quality, quantity, and location is
of primary importance in the choice of all further
economic operations. Some of them may be
absolutely useless for any further employment; they
must remain “unused capacity.” But the greater part
of them must be utilized if we do not want to start
anew from the extreme poverty and destitution of
primitive man¦ The director cannot merely erect a
new construction without bothering about his
wards™ fate in the waiting period. He must try to
take advantage of every piece of the already avail-
able capital goods in the best possible way.

Lacking real prices, the socialist director has no clue as to
that “best possible way.”



THE IMPOSSIBILITY OF SOCIALISM




B problem, there are
ESIDES THE CALCULATION/knowledge
other hurdles to be faced in attempting to organize a
socialist society, such as the problem of motivation. In a
market society, people are motivated to increase the satisfac-
tion of their fellows because that is how they get paid. While
Mother Teresa or Albert Schweitzer may perform their work
on purely humanitarian grounds, most people choose socially
useful work because they profit from it. If a mason works hard
at his trade and becomes eminent in his field, he can expect
to directly reap much of the benefit of his hard work. But in
a socialist society, the rewards for his hard work would be
spread across the entire society. The mason could expect to
168 ECONOMICS FOR REAL PEOPLE




receive only a miniscule part of the extra value that his effort
generated.
Historically speaking, we can certainly see that motivation
has been a problem in every society that has attempted
socialism. On that basis, we might decide that it is highly
unlikely that any socialist society could overcome that handi-
cap. But, we must admit, there is no basic principle of human
action that says that people couldn™t all place the good of the
society as a whole, as seen by the central planners, first on
their list of values, however implausible we might think that
might be in reality. Socialists could argue that in the yet
unachieved glory of the socialist paradise, all people will
direct their actions solely toward the good of the common-
wealth. One of Mises™s greatest accomplishments was to show
that, even if everyone acted that way, socialism still could not
achieve a rational allocation of resources.
A race of socialist saints could not engage in meaningful
economic calculation in the absence of market prices. Even if
each such saint sincerely did his best to meet the most urgent
needs of society, he could not determine what means should
be used to fulfill those needs, nor even what the most urgent
needs were. While the problem of motivation makes it highly
unlikely that a socialist society could support the billions of
humans who are alive today, Mises demonstrated that it could
not possibly do so.
Some people have been vexed by Mises calling socialism
“impossible.” “Aren™t there,” they ask, “many historical examples
of socialist societies? Maybe we wouldn™t want to live in any of
them, but surely we must admit that socialism is possible.”
However, what Mises meant is that it is impossible that any
large society, beyond the size of a small, family-based tribe,
could fully implement the socialist agenda without plunging
169
A WORLD BECOME ONE




into economic chaos. Certainly, some societies have called
themselves “socialist.” But all attempts to really follow the
socialist blueprint have been quickly abandoned. Sheldon
Richman, in his essay “To Create Order, Remove the Planner,”
notes:
Immediately after the Russian revolution in 1917,
the Bolsheviks under Lenin and Trotsky tried to
carry out the Marxian program. They got planned
chaos. Trotsky said they stared into the “abyss.”
Chastened by that experience, Lenin enacted the
New Economic Policy, which was a reintroduction
of money and markets. No Soviet leader ever tried
to abolish the market again. That is not to say that
the Soviet Union had a free market. It is to say that
the Soviet Union™s economy was a government-sat-
urated market. There was no actual central plan. In
truth, the plan was revised to reflect what was hap -
pening outside the planning bureau.

As George Mason economist Peter Boettke points out in his
book Calculation and Coordination:
. . . the actual operation of the Soviet economy bore
little resemblance to the predictions of these optimal
planning models. Soviet “planning” seemed to
mostly occur after-the-fact. With the break-down,
and finally the collapse, of the Soviet state, it has
become increasingly apparent that central planning
authorities had little real power to manage the
Soviet economy. . . .
We argue that the mature Soviet system was not a
hierarchical central planning system at all, but was
really a market economy heavily encrusted with
central government regulation and restrictions. The
Soviet state employed these various interventions to
170 ECONOMICS FOR REAL PEOPLE




extract revenue from the economy, as an alternative
to collecting revenue via the use of taxation.

The goal of most socialist movements has been to establish
a worldwide socialist society. Many apologists for socialism
have, in fact, blamed the troubles encountered by past
attempts at socialism on the continued existence of capitalist
countries. Mises demonstrated that the exact opposite is true-
if the dream of worldwide socialism is ever realized, the result
will be complete social disintegration.
Historical examples of nominally socialist states, such as
the Soviet Union, operated within a worldwide market order.
They mimicked the more market-oriented countries™ methods
of production, their products, and their technologies. Soviet
planners even copied commodity prices out of The Wall Street
Journal to use in their calculations. Lew Rockwell told a won-
derful story about Gorbachev™s press secretary. When asked
about his dream for mankind, the secretary replied that he
hoped to see all of the world embrace socialism, except for
New Zealand. “But why not New Zealand?” a reporter won-
dered. “Well,” the secretary responded, “we will need some-
one to get the prices from.”



THE CONCENTRATION OF POWER




T Milan Kundera™s novel, The Unbearable
HE PROTAGONIST OF
Lightness of Being, is a Czech surgeon named Tomas.
When Tomas writes a letter, complaining about the coun-
try™s rulers, to the editor of a dissident publication, his boss
demands that he sign a retraction. Tomas refuses, so he is
“reassigned” from the hospital to a window washing crew.
171
A WORLD BECOME ONE




Although Kundera™s novel is not primarily an anti-socialist
tract, it offers a moving glimpse of human existence under a
state that pervades every aspect of its subjects™ lives. An act of
political protest obviously puts the protester at odds with the
current regime. But in a centrally planned economy, the cur-
rent regime is also his employer, since it is the only employer.
Advocates of socialism often overlook the pervasive control
that a government must assume over the lives of its subjects
in attempting to centrally plan an economy. Ironically, many
socialists have non-mainstream interests in areas besides pol-
itics, such as organic foods, new-age spiritualism, experimen-
tal fiction, or avant-garde theater. An advanced market society
can accommodate such interests, along with a stunning vari-
ety of other divergent tastes and dispositions. Perhaps most
people want white bread, but whole grain is still offered for
sale. The masses may be more interested in a weekend in Las
Vegas than one at a meditation retreat, but nevertheless week-
end meditation retreats are available. Independence Day may
be the bigger draw at the cinema, but The Remains of the Day
still was made.
People whose tastes are significantly different from average
should contemplate the near impossibility of pursuing their
interests in a planned economy. As a society moves toward
socialism, it will become increasingly difficult to supply the
most basic goods. There will be no surplus with which to
indulge fancies for healing crystals or shiatsu-massage ther-
apy.
In a market society, no one is likely to pay you to take a
month-long retreat dedicated to finding the warrior within
you. Your current employer might even fire you if you insist
on taking a month off. On the other hand, neither your
employer nor anyone else can stop you from doing so, or
172 ECONOMICS FOR REAL PEOPLE




prevent you from trying to find other work once you return.
But in a socialist society, taking a month off might well be
considered treasonous. You can vacation if, where, and when
the state says you can.



THE RULE OF THE WORST




M socialism are quite pleasant, decent
ANY SUPPORTERS OF
people. They became socialists because of their gen-
uine concern for the welfare of the weak and the
poor. They are appalled if someone tells them that they pro-
mote tyranny. True, they admit, the record of past attempts to
create heaven on earth has not been pretty: the Soviet Union,
Communist China, Nazi Germany, and other utopian experi-
ments resembled hell more than heaven. But, they assert, that
was because of the evil nature of the people who took over.
They advocate a utopia ruled over by kindly, open-minded,
tolerant people”people like them. A planned economy run
by such people would undoubtedly be preferable to one run
by, say, Pol Pot, who murdered roughly one third of his coun-
trymen during his reign in Cambodia.
However, in what is probably the most famous book to
emerge from the Austrian School, The Road to Serfdom, Hayek
explained why nice people are unlikely to remain in charge
of a socialist state. A centrally planned society requires that a
single will direct all its members™ efforts. It might be the will
of a sole dictator, of a ruling committee, or even of “society as
a whole,” as represented by opinion polls or elections. In any
case, all productive efforts must contribute to a single master
plan.
173
A WORLD BECOME ONE




However that plan is formulated, it is inevitable that many
people will disagree with at least some part of it. How should
dissent be handled? For instance, the nation™s coal miners
might find the wage assigned to them by the plan to be too
low. They refuse to work for such paltry pay.
In a market society, the miners would be free to seek other
employment offering a higher wage. Free competition between
employers seeking to attract workers will tend to move wages
toward a level where it just barely profits an employer to
engage the last worker he hires. (That is the marginal worker.)
If someone can™t find work at the pay he believes he deserves,
the workings of the market process don™t guarantee that he
really isn™t worth as much as he thinks he is. But in a market,
entrepreneurs will continually be searching for such underval-
ued resources, thereby raising the price they fetch.
However, in a socialist state, the coal workers can™t go look
for other work”the plan has assigned them to the coal mines.
If 10,000 coal miners are in the plan, then 10,000 there must
be”otherwise, the plan becomes irrelevant. And the planners
cannot simply raise the miners™ wages until they agree to
work”the level of those wages is already in the plan. Raising
it will require re-planning the entire economy.
What can the directors of the socialist economy do? The
inclination of the well-meaning, decent socialists will be to
talk things over with the miners. The planners should find out
what grievances the miners have, determine what conditions
would make them happier, and inspire them to work because
of their patriotic duty to contribute to the common good.
Based on the outcome of such a dialogue, the plan can be
modified. But once several similar dialogues are underway in
different industries, production will slow to a crawl through-
out the economy.
174 ECONOMICS FOR REAL PEOPLE




The residents of a nation attempting to centrally plan the
economy soon will be faced with a choice. They can either
abandon their march toward socialism, or opt for a strongman
who promises to get things done. If they do not turn away
from central planning, then a strongman will soon be in
charge, as happened in Germany in the 1930s, when Hitler
came to power. Then, when the coal miners refuse to dig coal
at the wage allotted to them in the master plan, the solution
is simple: “Shoot them!” As Hayek says, “the totalitarian dicta-
tor would soon have to choose between disregard of ordinary
morals and failure.” Under a strongman, the people believe
that they have some hope of being able to heat their houses,
even if the hope comes at the cost of the coal miners™ liberty,
and, ultimately, the liberty of everyone.
A market-based society may seem harsh at times. If miners
don™t accept the wage offered by a mine owner, he might fire
them and hire replacements. But at least the miners have the
opportunity to seek work elsewhere, at the highest wage they
can find. When the government is the only employer, there is
nowhere else to go, and no one else with whom to negotiate.
As Hayek says in The Road to Serfdom, the dream of non-
totalitarian socialists relies on “the miracle of a majority™s
agreeing on a particular plan for the organization of the whole
of society.” Absent such a miracle, it is “the lowest common
denominator which unites the largest number of people.”
Whatever set of prejudices can most easily connect with the
most ignorant members of society will tend to win the most
allegiance. Social interaction is increasingly reduced to a con-
test over who can mug whom most quickly.
As that happens, it behooves minorities to watch their
backs. The temptation for the leaders to organize a pogrom
against some minority group will be tremendous. As Hayek
says, “it seems to be almost a law of human nature that it is
175
A WORLD BECOME ONE




easier for people to agree on a negative program”on the
hatred of an enemy, on the envy of those better off”than on
any positive task.” Totalitarian regimes tend to demonize
some unpopular minority, such as Jews in Nazi Germany,
kulaks in the Soviet Union, intellectuals in Pol Pot™s Cambo-
dia, or East Asians in Idi Amin™s Uganda.



THE CHIMERA OF EQUALITY




C experience suggest that every person is
OMMON SENSE AND
inherently, not just accidentally, different. The findings of
genetic science and the teachings of most religions sup-
port that view. In The Constitution of Liberty, Hayek noted that
treating everyone equally under the law would inevitably
result in different people achieving different outcomes in their
lives. Therefore, “. . . the only way to place them in equal
position would be to treat them differently. Equality before
the law and material equality are, therefore, not only different
but in conflict with each other.”
Socialism cannot achieve material equality among all peo-
ple by suppressing only economic freedoms. The other free-
doms we value”of speech, religion, assembly, and so on”all
require the use of scarce resources in their exercise. To be free
to speak, we require, at the very least, a place from which to
talk. To really reach people, we will often have to publish our
ideas in a book or newspaper. But when the state owns all
publishing outlets, it will necessarily decide whose views will
be circulated. The freedoms of religion and assembly require,
among other things, places to worship and assemble”but in
a totalitarian society, the state is the only construction com-
pany, and the only source of building materials.
176 ECONOMICS FOR REAL PEOPLE




The differences among people as to their natural abilities,
their tastes, and their learned skills is the foundation of inter-
personal exchange, the division of labor, and therefore of
extended human society. As Murray Rothbard wrote in Free-
dom, Inequality, Primitivism and the Division of Labor:
The glory of the human race is the uniqueness of
each individual, the fact that every person,
though similar in many ways to others, possesses
a completely individuated personality of his own. It
is the fact of each person™s uniqueness”that fact
that no two people can be wholly interchange-
able”that makes each and every man irreplaceable
and that makes us care whether he lives or dies,
whether he is happy or oppressed. And, finally, it is
the fact that these unique personalities need free-
dom for their full development that constitutes one
of the major arguments for a free society.

Kurt Vonnegut™s short story “Harrison Bergeron” satirizes
attempts to create a society where everyone is absolutely
equal to everyone else. In the world he depicts, those who
can jump higher than the average person must wear weights
on their bodies. Those who are more attractive must be made
uglier. Those who are more intelligent must wear a device that
interrupts their thoughts with a loud noise every few seconds.
Short of measures like those in Vonnegut™s story, the ideal
of absolute equality is a chimera. The Soviet Union was not a
society in which all citizens were equal. The freedom of action
and access to goods of a high-ranking Communist Party offi-
cial was immensely greater than that of the average person.
But the pursuit of that chimera has resulted in some of the
worst tyrannies in history.
11
CHAPTER


The Third Way
ON GOVERNMENT IN THE MARKET
PROCESS




THE DYNAMICS OF INTERVENTIONISM




T many efforts over the years to develop a
HERE HAVE BEEN
“third way” of managing social cooperation, a path that
will take advantage of the efficiency of the market
process while controlling its “excesses.” The fascist movement
in Italy, National Socialism in Germany, and the New Deal in
America were all examples of the search for that path.
However, all attempts to improve market outcomes run
into the same problem that cripples the attempt to create a
socialist society, although to a lesser extent. Outside of mar-
ket prices, based on private property, there is no way to
rationally calculate how valuable an undertaking™s contribu-
tion to society™s well-being is. Arbitrary numbers can be
assigned to gauge the costs and benefits of, for instance, a
new environmental regulation, but they are just guesses. Only
real market prices convey information on the freely chosen
values of acting man.
Mises pointed out that all market interventions are likely to
produce results that are undesirable even from the point of
view of those forwarding the intervention. That is because the


177
178 ECONOMICS FOR REAL PEOPLE




market participants are not supine in the face of interference
with their wishes, and will act contrary to the intent of the
interventionists.
SUNY Purchase economics professor Sanford Ikeda, in
Dynamics of the Mixed Economy, extends Mises™s analysis of
interventionism. Ikeda explains the patterns that the interven-
tionist process is likely to follow. His analysis begins with the
Misesian insight mentioned above.
An unhampered market brings about its outcome through
the voluntary choices of all people in that market. Any inter-
ference with the market process”such as rent control, farm
subsidies, and so on”will, to some extent, thwart the realiza-
tion of people™s preferences. People, in the face of such inter-
ference, will act to reassert their desires. However, the process
has been made less efficient. One reason is the overhead of
the government program itself. Another is the fact that market
forces will reassert themselves, though in unexpected ways. If
apples would be priced at $1.00 a pound on the unhampered
market, but government sets the price at 60¢ a pound, people
will still tend to pay the market price. However, they will go
to the market expecting to pay 60¢ for a pound, and be sur-
prised by paying 60¢ plus 40¢ worth of time waiting in line.
Even the minimal state, which attempts to provide only
protection from the violence of others, runs afoul of such dif-
ficulties. Since the minimal state must tax, it must set the level
of taxes, or, looking at the other side of the coin, it must
decide how much protection to provide. Whatever level of
protection it chooses, some people will be unhappy with that
decision. Since, in a constitutional republic, the level of pro-
tection will be set somewhere in the middle of the range of
desired amounts, there will be a large group of people who
feel they are getting, and paying for, too much of it.
179
THE THIRD WAY




It™s not impossible that those people will choose to just grin
and bear it, but it is very unlikely. Humans act in order to
improve situations they find unsatisfactory, and the people
paying too much in taxes, in their own eyes, have the moti-
vation to act.
Not paying their taxes will subject them to violence from
the state. But since those taxes were imposed on them by
political means, it will occur to them that they can use the
same means to try to gain some compensating benefit. Per-
haps they will lobby to have extra protection for their neigh-
borhood, to have a military base located nearby, thereby
increasing local trade, or to get street lights on their road, in
the name of increased security.
Whatever benefit they wrestle from the state will change
the situation of those who were happy with the old amount
of protection. They are paying the same amount in taxes as
before, but some of their previous benefits have been shifted
to others. Now they have a motivation to form an interest
group and lobby the state to provide them with some new
benefit as compensation for their loss. That creates a dynamic
that tends to produce continual growth in state programs.
Furthermore, however wise and noble the founders of the
state were, state service will act as a magnet for the person
who wants to exercise power over others”as Hayek said, the
worst rise to the top. In order to maneuver his way into a
position of power, such a person will have every reason to
rub salt in some interest group™s wound. By goading “his”
interest group on in its grievance, a politician can build a
“constituency” that he can ride to power.
Such interventionism clouds the interpretation of prices,
interest rates, profits, and losses. Austrian economist Jörg
Guido Hülsmann points out that interventionism involves a
180 ECONOMICS FOR REAL PEOPLE




falsifying of signs. The past price of a good is people™s own
best appraisal of the options available to them, and is a sign for
people trying to estimate the future price. A legally fixed price
is in some ways not a price at all, as it lacks that essential fea-
ture. It bears the same relation to a market price as a wax fig-
ure does to a living person.
With prices altered, entrepreneurs are discouraged from
pursuing genuine opportunities in some areas. For example,
farm subsidies will make the search for more efficient meth-
ods of farming less urgent. Meanwhile, entrepreneurs pursue
other opportunities that, in the unhampered market, would
have been considered superfluous”consider the proliferation
of lobbyists and tax accountants.
Ikeda shows that the problems resulting from one inter-
vention tend to lead to calls for other interventions to fix those
problems. People sense that something is wrong, but unless
they have a firm grounding in economics, it is difficult for
them to trace the problem to the intervention. As each suc-
ceeding intervention moves the market further from its
unhampered state, the process of tracing the problem back
through the myriad distortions becomes ever more torturous.
Nothing could illustrate the situation better than the
“health-care crisis” in the United States. Initial government
interference, in the form of licensing requirements, restricted
supply and drove costs up. A further government intervention,
the wage controls imposed during World War II, led employers
to offer “free” health insurance, which was tax-deductible for
employers but not employees, in order to attract employees.
(Since employers could not raise wages, they competed for
employees by offering more benefits.) The third-party provision-
ing of health insurance made health-care consumers less price
conscious, driving up costs still further. The subsidy of
181
THE THIRD WAY




demand through Medicare and Medicaid added yet another
factor increasing costs. The market responded with strange
entities such as health management organizations (HMOs).
(Notice that we do not see AMOs in the automobile industry,
or CMOs in the computer business.)
In answer to the problems that have developed, the major
policy proposals involve, just as Ikeda predicts, further inter-
ventions to correct the unfortunate consequences of past
interventions.
Even people who generally understand the benefits of the
market cannot see, through the welter of distortions produced
by interventions, any choice but more intervention as a cure
for the worst problems of interventionism. Robert Goldberg of
the National Center for Policy Analysis says:
As most know by now, Medicare currently provides
coverage for hospital therapy and doctor therapy,
but not drug therapy. Failure to cover drugs in the
current system creates perverse incentives that
waste resources and endanger patient health. . . .
Both the Gore and Bush plans [to cover drug ther-
apy] would improve on the current situation. (“Con-
tinue the W. Revolution”)

However, new interventions will add new distortions to
those added by previous interventions. It is impossible to
intervene the economy back onto the path that the unham-
pered market would have taken, as there is no way, in the
absence of the market process, to discover what that path
might have been.
Goldberg acknowledges that under either plan, certain
drugs will be covered, and others that will not. He asks,
“Under which plan will these lists of drugs be more likely to
182 ECONOMICS FOR REAL PEOPLE




be used to limit access to new and better drugs at the price of
increased risk to patients?” But he fails to note that either plan
will certainly have the unwanted effect of focusing prescrip-
tion and research on listed drugs, to the detriment of patients
who might have benefited more from other, unlisted drugs.
When that problem is noticed, there will surely be some
politician recommending another intervention to correct it,
perhaps asserting a patient™s right to a greater variety of sub-
sidized drugs.
Subsidizing drug purchases in any fashion only leads to
further price distortions. While it is true that some of the new
spending on drugs will be shifted from spending on hospitals
and doctors, other shifts will occur from nonmedical goods
into medical spending, where the marginal utility of an addi-
tional dollar spent will have been raised by the new subsidy.
Ikeda™s subsequent work, following in the footsteps of
Charles Murray and others, is exploring the ways in which the
effects of interventionism on social attitudes are similar to its
effects on the market process. In order to survive in a laissez-
faire society, I must either exchange with others for what I need
to survive or convince others to voluntarily support me. I may
want to spend my whole day getting plastered, but I™m unlikely
to survive too long if I do. That fact may motivate me to hold
off on drinking until I™ve done at least a few hours of work.
But in a welfare state, that motivation is absent. With a min-
imum level of support guaranteed, I can drink the day away
without worrying about starving to death. All of that drinking
will further undermine my desire and ability to work, making it
increasingly difficult for me to survive without state assistance.
The attitudes that are most successful in a market soci-
ety”thrift, hard work, responsibility, trust”are gradually
undermined by interventions that relieve people of facing the
183
THE THIRD WAY




consequences of their own actions. They are replaced by
increasing short-term thinking, laziness, dependence, and
suspicion. These attitudes create social problems that lead to
calls for further interventions to “fix” them, such as drug laws
and sin taxes on alcohol, and those interventions further
erode the values most important to a free society.
Our analysis of the intervention process might seem to
counsel despair to those who favor a free economy. But Ikeda
contends that the interventionist process inevitably leads to a
crisis, where the effects of multiple interventions have become
so pernicious that the possibility of a dramatic turn toward
free markets becomes possible. The oil crisis of the late 1970s
offers an example of such a turning point, when a deregula-
tion of the oil industry that would have been unthinkable a
few years before took place fairly rapidly.
When the crisis hits, a turn toward the free market is not
inevitable. The other possibility is to turn toward socialism, in
order to eliminate the remaining “market failures,” and allow
state regulation full sway. Which direction the system takes in
a crisis will depend, to a great extent, on the ideological lean-
ings of the public.
An important aspect of people™s decisions is that they real-
ize there is a choice. When the supposed defenders of the
market order have been pushing a series of interventions as
“free-market solutions,” the public is likely to decide that lais-
sez-faire has been tried, and has failed. That is exactly what
occurred in the 1920s and early ˜30s, as documented by Mur-
ray Rothbard in America™s Great Depression. Several Republi-
can administrations, from the purportedly free-market party,
engaged in an unprecedented amount of economic meddling.
For instance, in his speech accepting the GOP nomination for
president in 1932, Hoover noted:
184 ECONOMICS FOR REAL PEOPLE




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



THE PROBLEMS WITH EFFICIENCY




I several chapters we will look at some specific
N THE NEXT
government interventions into the market. Before we
leave this chapter, however, I™d like to examine a tech-
nique by which interventionism is often justified: the appeal
to efficiency. The basis of the technique is the employment of
equilibrium analysis to demonstrate that the free market has
produced an “inefficient” outcome, and to recommend some
government intervention that will rectify the situation, leading
to increased “social utility.” A leading proponent of such
analysis, Judge Richard Posner, has “described the common
law as a tool to maximize aggregate social wealth.” (I™m quot-
ing Steve Kurtz, interviewing Posner in the April 2001 issue of
Reason.)
Steven Landsburg, in Price Theory, gives an example of the
use of the efficiency criterion for resolving legal disputes
among individuals. A group of ten students would like to burn
down their professor™s house, while the professor is not in
favor of the idea. Landsburg explains how to use the effi-
ciency criterion to settle this dispute:
185
THE THIRD WAY




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

Some of the problems with this approach should be obvi-
ous. First of all, what if it is just the professor™s tool shed the
students want to burn? Perhaps they really love to watch fires,
and would be willing to pay $100 each to watch the shed
burn. Meanwhile, the shed is only worth $500 to the good
professor. It™s “efficient” for the students to go ahead and burn
down the shed, even if they never have to pay the professor.
One thousand dollars of utility has been gained at the expense
of a loss of only $500 of utility. Let™s momentarily set aside any
moral compunctions we might have about allowing people to
destroy or abscond with others™ property because they enjoy
that more than the owner suffers from the loss. Even on its
own terms, such efficiency analysis is a failure, because it
doesn™t take into account the loss of “efficiency” in society
when people don™t feel that their property is secure. Of
course, the magnitude of such a loss is incalculable, because
different social arrangements do not appear as goods for sale
on the market.
Just because we can™t calculate such a figure doesn™t mean
that secure property rights have no value”we might suspect,
in fact, that their value is enormous. Several authors have
186 ECONOMICS FOR REAL PEOPLE




recently written books stressing the importance of property
rights for prosperity, including Tom Bethell (The Noblest
Triumph: Property and Prosperity Through the Ages) and
Hernando de Soto (The Mystery of Capital: Why Capitalism
Triumphs in the West and Fails Everywhere Else). De Soto, for
instance, says that the ordinary people of Third World coun-
tries have a great deal of property, but that they are hindered
in exploiting it because they do not have a clear, recognized
title to the land. He estimates that 81 percent of the rural land
in Peru is owned without legal title, and in Egypt, over 80 per-
cent of all land is owned in such a fashion. The lack of secure
property rights is a major cause of the poverty in those places.
A calculation of efficiency that leaves out the negative effects
of nebulous ownership is like an estimation of the effect of a
nuclear bomb that includes the weight of the bomb but leaves
out the nuclear reaction.
The second problem with such analysis is that the “prices”
used are not prices at all. The parties involved are only asked
to say how much something is worth to them. Why not just
pick a really big number? If you™re not going to have to pay
the price, just name it, then what the heck”say that it™s worth
a billion dollars to you to see the prof™s house burn.
Various tricks, involving possible consequences for lying,
can be used to try to get around this problem, but none of
them solves a more serious problem: We don™t know how
much we value something until we really have to pay for it.
Imagine, if you will, that we visit a children™s swim club and
ask the kids if they™re willing to make the sacrifices necessary
to become Olympic champion swimmers. We™d probably get
many positive responses, despite the fact that perhaps only
one in ten thousand young swimmers really is willing to pay
the costs of becoming an Olympian. Efficiency analysis
implies that we™d be better off if we just asked the swimmers
187
THE THIRD WAY




what they would sacrifice to make the Olympics, and then
appointed those who bid the highest to the Olympic team.
Think of all the training time that would be saved!
It is only in the process of moving toward a goal and expe-
riencing the costs ourselves that we discover what those costs
really are. A smoker suffering from a bad cold may swear he™ll
never smoke again, but it is not until he feels better and is
offered a cigarette that even he discovers whether that oath is
real. Without actually undertaking the discovery process,
“costs” are only guesses as to what the costs might turn out to
be.
Efficiency analysis also assumes that the prices we arrive at
by such quizzes are equilibrium values or final prices. For that
to be true, everyone would have to agree on the future use-
fulness of all of the factors of production. But Austrian econ-
omist Peter Lewin points out:
The whole [market] process is driven by differences
in opinion and perception between rival producers
and entrepreneurs. . . . The values they place on the
resources at their disposal or which they trade, are
not, in any meaningful sense, equilibrium values.
They reflect only a “balance” of expectations about
the possible uses of the resources. One cannot use
such values meaningfully in any assessment of effi-
ciency. (Introduction to The Economics of QWERTY)

The use of Pareto improvement as a criterion for justifying
intervention is plagued by similar problems. Per the Pareto cri-
terion, a policy is considered good if at least one person
affected by the policy is better off because of it, while
absolutely no one is worse off. In simple cases where we can
clearly see a Pareto improvement, we can just voluntarily
implement it. If I™m sitting around with three of my friends, and
188 ECONOMICS FOR REAL PEOPLE




we all feel we™d be better off if we were playing bridge, then
we can just play bridge. We don™t need a “policy” implemented
to get the game going. In real-world policy situations, it™s
almost impossible to conceive of finding Pareto improve-
ments. Even a policy that would unambiguously result in
everyone in the country having more goods would not meet
with the approval of many environmentalists and ascetics.
As market prices are the sole means by which we can cal-
culate economic efficiency, it is ironic that efficiency consid-
erations are often used to justify government intervention in
the economy. It is only when people must actually pay the
cost of their choices that we can be sure that, at least in their
eyes, the choice was worth the cost. The only way we can
know how much it is worth to the students to burn the pro-
fessor™s house is if the students really have to pay the profes-
sor enough that he agrees to let them go ahead. State inter-
vention destroys the very mechanism by which the market
achieves efficient outcomes.
The Pareto criterion and other measures like it are attempts
to formulate a “scientific” gauge of better economic outcomes,
standing apart from the value judgment of the person who is
classifying the outcome. But human judgment creates the cat-
egories of “better” and “worse,” and all judgment is individual
judgment.
12
CHAPTER


Fiddling With Prices While the
Market Burns
, ,
ON PRICE FLOORS PRICE CEILINGS
AND OTHER INTERFERENCES WITH
MARKET PRICE S




G felt the need to interfere
OVERNMENTS HAVE FREQUENTLY
with market prices. Such interference can take a number
of forms. Price floors set a legal minimum on the price
of some good or service. Price ceilings set a legal maximum
on the price. Price targets try to keep a price with a narrow
range: examples include foreign currency exchange rates
“pegged” within a band, and the Federal Reserve targets for
interest rates. And fixed prices, such as the price of taxi serv-
ice in many cities, allow no price flexibility at all.
We™ll examine a few, particularly popular cases of interfer-
ence with market prices.


A PRICE FLOOR




A
years ago, I went to my friend Dick to show
COUPLE OF
him a proposal I was working on. Dick happens to be a
die-hard interventionist. Since it forwarded a new plan for
the government to help the underprivileged, I was sure he
would approve. My proposal ran as follows:


189
190 ECONOMICS FOR REAL PEOPLE




Today, many corporations in our strong economy
have been left behind by the general prosperity.
They may be old-industry stalwarts who have not
been able to gain the skills necessary for a smooth
transition to the electronic economy. Or, perhaps,
they are new companies, just getting going in indus-
try, whose penny stocks are undervalued by
investors. Perhaps, through no fault of their own,
those companies have had a run of hard luck: the
CEO died, a major customer went belly-up, or a
new product from a competitor rendered what they
produce obsolete.

Many employees, suppliers, investors, and cus-
tomers are relying on those very companies. Mean-
while, those businesses are suffering from a simple
lack of capital. If they had sufficient funding, they
could invest in new plants or modern technology
and could then aid other players in the economy by
buying more of their goods, supplying them with
better products, or employing them at higher wages.
Not only is it compassionate to help out those com-
panies, but it will help the economy as a whole by
boosting purchasing power.

Therefore, I forward a proposal. I recommend that
the government set a national floor for stock prices.
A reasonable first estimate of where it should be set
might be $10 per share. Once my law is passed, it
would be illegal to buy or sell the stock of any com-
pany for less than the chosen amount. (Naturally, it
would be $10 per share for the full number of cur-
rently outstanding shares”we can™t have ruthless
exploiters trying to skirt the law by forcing a com-
pany to do a reverse stock split or buy back its own
shares.)
191
FIDDLING WITH PRICES
WHILE THE MARKET BURNS




The effects of the law would be entirely beneficial.
No capitalization would be taken from any other
company to boost the capital of the most-needy cor-
porations. Those corporations, now able to float
shares at least at the minimum price, would quickly
become more prosperous. The flow of funds to
those enterprises would ripple throughout the econ-
omy, spreading wealth all around.

“But wait a second, Gene,” Dick said. “You™re not serious
about this, are you?”
“Yes, quite serious,” I reply. “Why wouldn™t it be a good
idea?”
“Well, first of all, your point about ˜boosting purchasing
power™ is ridiculous. If anyone is buying those stocks at the
new price floor, they now have less money than they would
have had at the old, lower price. In fact, they™ll have as much
less as the company in question now has more. So there is no
increased purchasing power at all.”
“Hmm, you may have a point there. I™ll have to try and
work around that. But do you see any other problems with
my plan?”
“Of course! You heard me say, ˜If anyone is buying the
stocks at the new mandated price™. . . . But why would they?
If yesterday, I was only willing to pay $5 for a share of Dotty
Dotcom, why in the world would I suddenly be willing to pay
$10, just because some new law is passed? I™ll still only pay
what I think an item is worth! Aren™t you the one always going
on about that theory of subjective value?”
“Well, I guess I am. But what do you think would happen
to the shares of Dotty?”
192 ECONOMICS FOR REAL PEOPLE




“Well, they would simply stop trading. Dotty, far from
being able to raise more capital, would no longer be able to
raise any money at all.”
“You have some good points there, Dick. But the funny
thing is, I showed my plan to a few CEOs, and they all loved
it.”
“Were these the CEOs of companies whose stocks were
trading below $10 per share?”
“Well, no, in fact, everyone of them has a stock trading
above $10 per share.”
“Then of course they™d love it! They™re trying to eliminate
competition. Since their shares are currently above $10, their
stock will continue to trade. In fact, without the competition
of the lower-priced stocks, demand for their stock will go up.
They™re simply trying to enrich themselves at the expense of
the less fortunate. They™re a bunch of scoundrels.”
“You know, Dick, you™ve convinced me. My plan is kind
of dopey. Thanks! But you™ve left me with one question.”
“Sure, anything I can do to help.” Dick was feeling quite
confident, having thoroughly debunked my proposal.
“Since you can see how bad my plan is, why do you sup-
port raising the minimum wage? In fact, why do you support
having a minimum wage at all?
“Aren™t low-wage workers analogous to the low-priced
stocks I was describing? Aren™t employers equivalent to the
investors in my scenario, in that they will only pay wages that
seem worth parting with? And aren™t the labor unions, the
main supporters of minimum wage legislation, the same as the
CEOs of the higher-priced companies that I described to you,
enriching themselves at the expense of the less fortunate?”
193
FIDDLING WITH PRICES
WHILE THE MARKET BURNS




It took me a while to revive Dick, but when he finally came
to, he claimed that he couldn™t remember a word of our con-
versation.
Minimum wage laws, at least temporarily, will help those
who already make more than the level at which the wage is
set. But those who would only be hired at a wage below the
minimum wage will simply be shut out of the employment
market. (Recall that employers will hire workers only up to
the point where they expect the revenue from the marginal
[last] worker hired will just exceed his wage.) “Well,” some
will say, “no one could support themselves on such a wage
anyway. Rather than allow businesses to exploit them by pay-
ing below-subsistence wages, it™s better they™re on relief so
they can go to school or care for their kids.”
No doubt some people have been able to make themselves
productive while they were on relief. (J.K. Rowling, who
started the Harry Potter series while on relief, is a prominent
example.) But for most people, it is a trap. For those at the
bottom of the economic ladder, generally the best thing to do
is to start working, at whatever wage they can.
I spent eight years playing in reggae bands. Over time, we
were able to find steady work in local clubs. But that was only
because, when we started out, we were willing to work for
whatever a club would pay”sometimes for nothing! By grad-
ually demonstrating that we could attract and satisfy a crowd,
our wage steadily rose. If the minimum wage law had been
strictly enforced at all of those clubs, we never would have
gotten going at all.
That is the situation of the least-experienced workers. The
most important thing to their economic future is that they
learn that a job is not a right, but an exchange of valued
goods”their labor for the employer™s money. Signs of having
194 ECONOMICS FOR REAL PEOPLE




gotten the notion include showing up on time, being polite to
customers, completing assigned tasks, and so on. Once they
have demonstrated that they understand that central idea then
their wages will rise. I don™t know of any employers who con-
sider receiving government assistance, no matter for how
many years, as a plus on a resume.



A PRICE CEILING




T 2000“2001 was much snowier than the pre-
HE WINTER OF
vious four that we had spent in our current house. Given
the mildness of those previous winters and the lack of
snowfall, we hadn™t bothered to look for a plowing service.
But in the winter of 2000“2001, four different storms each
dumped over a foot of snow in our yard. Now, I sure as heck
wasn™t going to go out there and shovel away that mess”hey,
I™ve been busy writing this book! (I™d send my wife out to do
it, but our driveway is visible from the neighbors™ houses, so
that™s out of the question as well.) So clearly, we needed
someone to plow.
After the first storm, I spotted two men plowing my neigh-
bor™s driveway, and asked them if they would do ours after
they had finished hers. They named a price”one that seemed
fairly high for a small driveway like mine. It was clear to me
that, since these fellows were already going to be across the
street from my house every time it snowed, and it would take
them less than five minutes to clear out my driveway, that they
were each making well over $100 an hour for their work.
I readily agreed. Why? First of all, their price was still lower
than what it would have cost me to clear the driveway myself,
195
FIDDLING WITH PRICES
WHILE THE MARKET BURNS




given the value of my time to me”my opportunity cost. That
condition is, of course, the basis for any exchange”a person
considers what they are giving up less valuable than what
they receive. Further, I understood that all of the plow-truck
operators would be quite busy, and that I would spend time
searching for another operator who might be cheaper. In fact,
I might not find anyone else who would want to take on such
a small driveway at all. I could take their price or leave it.
A common reaction to such situations, in both the popular
press and among politicians with an election coming up, is to
charge that the consumer is being “gouged” by a businessman
making “windfall profits,” taking unfair advantage of the con-
sumer™s predicament. The businessman didn™t do anything to
earn the high profits”instead, he is taking advantage of an
accident of nature that is entirely beyond his or the con-
sumer™s control in order to line his own pocket.
But we should apply Bastiat™s dictum, and contemplate
what is not seen as well as what is seen. In the midst of a
snowy winter, it was true that the plow operators are making
a very high wage right then. But what about the previous four
winters, when they had gotten very little business? During
those winters, the potential supply of plowing had exceeded
the demand for it. Many plow trucks sat idle. Why didn™t the
majority of those truck owners abandon plowing? It is pre-
cisely the possibility of “cleaning up” in a bad winter that per-
suades people to maintain their plows and trucks during mild
winters.
In fact, the plow operators might just as well complain that
I had taken advantage of them during the previous four win-
ters! After all, the lack of snow was neither their fault nor the
result of any efforts of mine. Wasn™t it “unfair” that their busi-
ness should suffer while I was able to save the money that, in
196 ECONOMICS FOR REAL PEOPLE




a normal winter, I would have spent on plowing? From the
point of view of the plowing services, it might be quite
acceptable for the state to legally limit the price they could
charge in bad winters, if it would also mandate that everyone
with a driveway have it plowed several times every winter,
even if it hadn™t snowed. This would even out the income
flow of the plowing services and make their business more
predictable. (Of course, their support for such a law would
depend crucially on how high the legal price was set.)
Whether we like it or not, the vagaries of the natural world
often have a significant impact on our lives. No form of social
organization can dodge that fact. The market does have a
means of dealing with it, however: the activities of speculators
in stockpiling reserves, from which they hope to profit should
an emergency occur. In a market system, stockpiles of food,
oil, clothing, snow shovels, rock salt, plywood, and many
other items needed during severe conditions exist because of
the possibility of large profits should they be needed. Politi-
cians often complain that oil companies are making “excess”
profits during a shortage, from oil that they held off the mar-
ket in good times. But ask yourself, where we would be if
they hadn™t been holding a reserve? Clearly, the shortage
would only be worse! Measures to restrict prices to some “nor-
mal” amount during a crisis only serve to discourage stockpil-
ing”producers are also subject to time preference and, all
other things being equal, would prefer to sell their products
immediately rather than holding them in reserve for an emer-
gency.
Not only are alternate forms of social organization unable
to remove the influence of the natural world on our lives, they
cannot eliminate the speculative nature of stockpiling goods
for unusual circumstances. We do not know what nature has
in store for us next month or next year. Speculation is action
197
FIDDLING WITH PRICES
WHILE THE MARKET BURNS




in the face of the uncertain future: entrepreneurship. The
question is who should be doing the speculating: business-
men who specialize in the relevant market, and who have
their own money riding on getting supplies correct, or gov-
ernment bureaucrats, whose skills are mostly political and
who are betting the taxpayers™ money that they are right?



RATIONING AS A RESPONSE TO INTERFERENCE WITH
MARKET PRICES 1




W of a good is decreed by government
HEN THE PRICE
mandate, instead of emerging from the voluntary
interactions of free market buyers and sellers, con-
sumers will often face a shortage of that item. Of course, every

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