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( 10)


motivated to lower their prices. If the price is too low, some
buyers will be disappointed in their attempt to acquire goods,
and will be motivated to bid more.
In the absence of interference with the market, such as a
legal floor or ceiling for a price, sustained gluts and shortages
will not occur. But, as we saw in the previous chapter, price-
fixing can change that. The setting of a minimum wage, and
the fact that governments allow unions to employ coercion to
achieve nonmarket wages for their members, result in an
ongoing glut of labor on the market, or, as we usually refer to
that glut, unemployment.
While it is true that all goods supplied represent a demand
for other goods, not all of the goods are demanded immedi-
ately. Some supply is a demand for present goods, and some
a demand for goods that the supplier hopes will be available
at various times in the future. The supplier (i.e., the worker,
capitalist, or entrepreneur), having successfully exchanged his
product for money, expresses a future demand by saving part
of the proceeds. It is precisely the setting aside of immediate
demand that makes available resources that can be used to
create capital goods, that will be employed making consumer
goods, that will satisfy future demand.

Capital has a structure because our plans have structures.
All plans are executed over time. A particular capital good will
enter a plan at some specific stage on the way toward a con-
sumer good. We can call this the time structure of supply.
Demand will have a similar structure: some goods will be con-
sumed over long periods of time, some goods are set aside for
later use, and money is set aside by people planning to use it
to purchase consumer goods at a later time. The better aligned
are the time structure of supply and the time structure of
demand, the more smoothly the economy will function.
The market price that generates that alignment is the inter-
est rate: the price for time. When the central bank sets an
interest rate, it is engaged in price-fixing in the market for
time. The essence of the situation is not particularly different
than any other sort of price-fixing. But because the market is
for time, the negative effects of the artificial price take time to
appear. (The state would not be likely to undertake, deliber-
ately, interventions in the time market for which the negative
effects appeared immediately but the positive ones only much
later!) And because of that time lag, it is harder to trace the
later problems to the earlier intervention”after all, the initial
results of an artificially lowered interest rate appear to be
entirely salubrious.
The Austrian theory of the business cycle does not rely on
entrepreneurs being slow or unable to learn. Of course, error
is a key part of the theory”the error being the conceit on the
part of the central bank that it can guess the “correct” interest
rate better than the free choices of those lending and bor-

Unsafe at Any Speed


W possibility of an unregulated
market, one question that arises frequently is how
consumers can be protected against unsafe products
without government intervention.
Safety is not an absolute value that automatically trumps all
others. Highway safety would go up if everyone drove a
multi-million-dollar armored-personnel carrier or if everyone
was forced to drive at two miles an hour. The mere fact that
no one is suggesting those ideas illustrates that even the most
die-hard of consumer protectionists realize that safety must be
traded against other factors. Products need not be “absolutely
safe,” whatever that would mean, but merely “safe enough.”
However, government efforts to ensure that products are safe
enough run into an insurmountable barrier. Having crippled
the price mechanism via its intervention, the government has
no means by which to gauge what trade-off consumers desire
between safety, cost, convenience, and other product features.
In an unhampered market, it is the effort on the part of
entrepreneurs to make profits by satisfying consumer demand


that guides that trade-off. Let us imagine the market for chain
saws to be in a plain state of rest, where it also happens to be
the case that all producers are manufacturing saws that are
equally safe. Now the producers, in their efforts to make prof-
its, have reduced the costs to produce such saws to the min-
imum level that they could, given the means available to
them. Competition will also drive those entrepreneurs to make
the best saws that they can at any given cost. Thus any safety
improvements can come about only with an increase in costs.
Let us further imagine that there are safety improvements
that at least some consumers value more than the cost of
adding them. This will mean that there are factors of produc-
tion, be they safety engineers, quality inspectors, automatic
shut-off devices, or so on, that are underutilized in meeting
consumer demand, and therefore are priced below the level
that would fully account for their value in yielding consumer
satisfaction. The discrepancy between the prices of the factors
of production and the prices of the final consumer products
they might yield creates an opportunity for entrepreneurial
profit. An entrepreneur can purchase those undervalued
resources and use them to create a product that will sell for
more than his costs. We have good reason to suspect that
some entrepreneur, in the endless quest to find further
sources of profit, will realize that the discrepancy exists and
act to eliminate it.
True, the market process does not guarantee that every
such opportunity will be found. However, aside from the
search for profits, there is no possible procedure, other than
guessing, to discover those opportunities. Furthermore, guess-
ing without prices, while it might occasionally get the right
result, does not even provide a way to detect success after the
fact! Entrepreneurs have feedback as to whether they did a
good job of estimating consumer demand; was the venture

profitable? On the other hand, if the government steps into the
chain saw market and mandates a certain feature, it destroys
the very mechanism by which we might discover whether
consumers valued such a feature more than its cost. Since all
chain saws will now have the feature, consumers must pay for
it whether they want it or not. No one can say whether con-
sumers find this to be a reasonable trade-off, since they no
longer are able to express their preferences by choosing
between saws with and without the feature.
There is not even any guarantee that in requiring some
safety feature the government will not make us less safe, as it
might have overlooked another, more important element of
safety. Michael Levin, in his Free Market article “Labeling and
Consumer Choice,” talks about his surprise at finding his son™s
new jacket had no drawstring. The reason the manufacturer
had removed this feature was pressure from the Consumer
Product Safety Commission. Apparently, some children had
gotten their drawstrings caught in something and been
injured. But perhaps the risk of pneumonia in cold climates is
greater than the (minimal) risk of getting the string caught.
Who knows? The government found a couple of cases of
harm and saw the opportunity to “act decisively.” But, as
Levin points out: “Meanwhile, in the chilly New York wind,
my son can™t figure out how to tighten his hood.”
When presented with these arguments, a friend of mine
commented: “OK, but I don™t have the time to research the
safety of every product I buy, while the government can
employ people to do so full time.”
That is certainly true. If every consumer were left entirely
to his own devices in determining product safety, the world
would be a riskier place. But implicit in this concern is the
idea that if the government does not fulfill such a role, then

no one can. It overlooks other important sources of safety
information, which would function even more effectively in
an unhampered market than they do at present. Not only do
such sources exist, but they have the distinct advantage that
the decision whether to use them or not is voluntary. Perhaps
I don™t care how safe my chain saw is, as long as it chops up
trees “real fast.” In that case, why should I be forced to pay
for safety evaluations that don™t interest me?
One source of privately supplied safety information is
independent consumer publications, such as Consumer Reports.
While they provide consumers with good information today,
the demand for safety information, and hence the supply of it,
is dampened by the fact that these groups are competing with
the “free” consumer information and protection from the gov-
ernment. (It™s not free to us as taxpayers, of course, but since
we pay for it whether or not we use it, there is no additional
cost in making use of it in our role as consumers.) Some reli-
gious or ethnic groups have a tradition of private safety stan-
dards as well, such as the “kosher” designation on foods.
Or have a look at nearly any electric item you own and you
will see a “UL Mark.” It stands for “Underwriters Laboratories.”
The UL Mark is applied to as many as 17 billion products
every year, to show that the product meets some standard of
safety. UL has been providing the service for more than 100
years, long before the regulators got into the business. It™s also
completely private, a company with 6,000 employees that
examines 20,000 different types of products. Its marks are
forced on no one. The existence of organizations like Under-
writers Laboratories depends on the fact that most businesses
consider it disadvantageous to kill their own customers, both
because it will tend to give one a bad name, and because mar-
keting studies have consistently shown the dead to be far less
avid consumers than the living.

There is always the risk that a testing organization might
become beholden to some big client, and grow less than rig-
orous in testing that client™s products. However, using that fear
as a justification for government safety standards is flawed in
two respects. First of all, it simply assumes that government
agencies are free from such difficulties. The Public Choice
School has long since debunked that idea.
The second problem is that it ignores the fact that compe-
tition is the consumer™s best friend, here as elsewhere. In an
unhampered market, if a testing organization is not perform-
ing up to snuff, there is an opportunity for competitors to
draw away customers and make a profit by pointing that out.
That is, in my estimation, the most significant source of safety
information on any company™s products: its competitors. No
one else in the economy has as much motivation to study
Company A™s widgets as competing widget-maker Company
B. The means by which such knowledge can be propagated
to the consumer is advertising. Examples of companies that
have relied heavily on advertising the high safety standards of
their products include Volvo and Michelin.
Empirical work on product safety bears out our theoretical
considerations. Economist Ronald Coase describes the results
of an extensive study of U.S. drug regulation by Sam Peltzman
as follows: “The gains (if any) which accrued from the exclu-
sion of ineffective or harmful drugs were far outweighed by
the benefits foregone because effective drugs were not mar-
keted” (Essays on Economics and Economists). Reason maga-
zine contributor Jacob Sullum, in his article “Safety That Kills,”
contends that federal airline safety regulations most likely cost
lives. Sullum also points out, in “Alcohol Blindness,” that
because of federal regulations, there are strong restrictions on
mentioning the health benefits of moderate alcohol consump-
tion. Dickinson College economist Nicola Tynan has done

extensive research indicating that the socialization of the
water supply in nineteenth-century London, done in the name
of public safety, often created the large epidemics it was sup-
posed to alleviate. In addition, private water suppliers were
increasing water safety well before the government acted.
People have different tolerances for risk, and different
views of the benefits of risky activities. Government regula-
tions, with their one-size-fits-all view of this trade-off, are sim-
ply an attempt by some people to make that choice for every-
one else. They are unsafe at any speed.


P closely akin to safety”in some
cases, such as bungee cords, “quality” might even be
a synonym for “safety.” It is also another area where
some people have claimed that there is market failure, and a
need for the government to “step in and correct” the outcome
of the market process.
One particular product that has often been accused of
unconscionably poor reliability is computer software. Wall
Street Journal tech columnist Walter Mossberg wrote a column
a few years ago entitled “I™m Tired of the Way Windows
Freezes!” in which he indicts the reliability of his PC software.
As Mossberg puts it, “[Computers] should just work, all the
time.” In a similar vein, San Jose Mercury News tech columnist
Dan Gillmor complains, “the attitude [of the technical industry]
toward reliability and customer service has been scandalous.”
Over the years, any number of other writers have sounded
similar themes: computer systems are too buggy, there™s no

excuse for a single defect in software, if programmers built
bridges we™d be afraid to drive on them, and so on. In their
view, software defects are a moral issue, instead of simply a
result of the well-known trade-off between schedule, cost,
and quality. For them, there is no trade-off possible”defects
are a moral failing, and a complete absence of defects must
be assured, whatever achieving that goal does to the cost and
the schedule.
What all of these writers allege, knowingly or not, is that,
in the market for software, consumer sovereignty has been
violated. The consumers would prefer bug-free software,
whatever the cost, but greedy companies, thinking only of
their profits, somehow force the current, inferior breed of soft-
ware on them.
But is achieving bug-free software always in the con-
sumer™s best interest? Let™s contemplate an example. I once
went to work for a partnership that trades stocks with the part-
ners™ capital. There, the people who specified the software,
the people who managed its development, the people who
paid for that development, and the end users were all the
same people. There was little risk that those people, in their
role of managing development, were misrepresenting their
own interests as users of the end product. Nevertheless, I was
shocked at the haste with which the traders put my first, prac-
tically untested, development effort into use. One of the part-
ners explained to me that this was not recklessness or igno-
rance, but simple accounting sense. For a company creating
an automated trading system, one measure of its quality
would be the ratio of good trades (i.e., trades the designers
intended the system to make) to bad trades. If the average
cost for a bad trade is $6,000, and the average benefit of a
good one $4,000, then once the system generates 61 percent
good trades, it is profitable. Any pre-release testing beyond

that point is costing the firm money. Further testing may make
the system more profitable, but once it achieves 61 percent
reliability it is worth releasing.
After the publication of Mossberg™s column, one woman
wrote in, saying, “I never have to reboot my refrigerator, no
matter what I put in it.” But a refrigerator does the same thing
with all input”keeps it cold. It doesn™t have to connect to
your head of cabbage, format your waffles, recalculate the
spiciness of your horseradish, or spell-check the labels on
your pickles. In fact, it keeps cooling even if you have noth-
ing in it”something that we would consider a bug in a piece
of software. A refrigerator is a fairly simple device, and a
refrigeration engineer could explain the inner workings of one
to us in about half an hour. On the other hand, modern com-
puter systems are among the most complex devices humans
have ever constructed. To achieve a moderate understanding
of the inner workings of Windows NT or Linux, starting from
scratch, would take years.
Complaining along the same lines, Gillmor writes, “The
appliances we use at home do not crash.” He seems blissfully
unaware of the existence of washing machine repairmen,
plumbers, electricians, telephone repairmen, and the dozens
of other trades that help maintain our homes.
Fantasies about life in an ideal world where there is a sur-
plus of everything are irrelevant to economics. In such a
world there would no longer be economic goods, and the sci-
ence of economics would cease to be of importance. Con-
sumers would no doubt love to have software that contained
every feature they might ever want to use, was completely
without defects, and merely appeared on their hard drive at
no cost. But here in the real world, where resources are
scarce, we must choose A while foregoing B. Software can be

made more reliable only by leaving out features, or increasing
the cost of developing it, or both. Consumers™ preferences in
regard to this trade-off are embodied in their actual purchases.
Gillmor says: “[Consumers] just don™t want to consider the
possibility that low prices can mean not-so-great service. . . .
People have to patronize the companies that provide quality,
and have to be willing to pay more.” He doesn™t consider that
consumers might be well aware that there is a trade-off
between price and service, and could rationally choose a lower
price at the expense of service. Someone using an on-line bro-
kerage might decide that saving $15 a trade is worth suffering
the service being down for one hour a month. Why shouldn™t
a consumer make that trade-off if he feels it is in his interest?
Even in the market most thoroughly dominated by
Microsoft”desktop operating systems”consumers are able to
make their own choices on quality in software every day.
There were, at the time Gillmor was writing, two major vari-
eties of Windows on the market. Windows 98, the cheaper of
the two, was much more prone to crashing than Windows NT,
the more expensive (in terms of learning time and administra-
tion costs, as well as initial price). This fact was well publicized
in reviews and advice columns. Yet consumers overwhelm-
ingly opt for Windows 98. Shouldn™t they have that option?
Whatever one thinks of the degree of “market power” that
Microsoft wields, it certainly spends a great deal of time and
effort putting out new releases of its products. As is often
lamented, the releases tend to focus on new features, and
generally contain about the same number of bugs as previous
ones did. But if customers truly cared more about the bugs
than the new features, then even from a monopoly position,
wouldn™t Microsoft want to focus on that area, so as to sell
more upgrades?

There is no reason to conclude that consumers are not get-
ting roughly the level of software reliability they prefer, given
the scarcity of resources available to produce software. (I say
roughly because Austrians do not believe that we can possi-
bly arrive at the “equilibrium always” state of the evenly rotat-
ing economy.) But let us imagine that entrepreneurs have
made a general mistake, and badly misestimated the desire for
quality software. Either explicitly or implicitly, views like
those described above contain calls for the government to do
something about the problem. Many interventionists believe
that once they have found an area in which the market™s
behavior is, in some sense, less than optimal, they have fully
justified the case for government intervention. But as Ronald
Coase points out, they have barely begun: Even if most soft-
ware is, in some sense, “too buggy,” what evidence exists that
some government intervention could improve the situation? A
common suggestion is to enforce a licensing system for soft-
ware engineers. However, such schemes, by driving up the
cost of entry, serve to protect the salary of those who can
acquire the licenses, and to raise the cost of software. There
is no evidence that practitioners who have, for instance, a
bachelor™s degree in computer science produce software that
is more reliable than those who have entered the field with no
formal training. Who can better judge the competence of soft-
ware engineers for the task at hand than the entrepreneurs
who hire them? Who better knows “the particular circum-
stances of time and place”?
The attempt to replace the actual preferences of con-
sumers, as expressed in their willingness to pay real prices for
real products, with fanciful musings about an ideal world in
which ends are achieved without expending any means
(except jawboning!) is doomed to disappoint. Such frivolity is
not an attempt to strive toward an unrealizable standard, as

there is no striving involved on the part of the daydreamer.
Instead, these ideas, when acted upon by the state, only serve
to cripple our ability to create the most desired of the less-
than-perfect goods that we less-than-perfect beings actually
can create.

One Man Gathers What Another Man Spills


B A.C. Pigou was instrumental in devel-
oping the theory of externalities. The theory examines
cases where some of the costs or benefits of activities
“spill over” onto third parties. When it is a cost that is imposed
on third parties, it is called a negative externality. When third
parties benefit from an activity in which they are not directly
involved, the benefit is called a positive externality. The study
of externalities, a part of welfare economics, has been an
active area of research since Pigou™s efforts early in the twen-
tieth century.
There are standard examples that illustrate each type of
externality. Pollution is a typical case of negative externality.
Let™s say I operate a factory along a river, making foozle dolls.
As a by-product of my manufacturing, I dump lots of foozle
waste into the river. That imposes a terrible cost on the peo-
ple downriver, because, as everyone knows, foozle waste
stinks to high heaven. If neither my customers nor I have to
pay that cost, our choice as to how many foozle dolls should
be made will be, in a sense, incorrect. If I had to pay those
costs, I would have chosen a smaller number of dolls. Instead,


I chose to produce “too many” dolls while the people down-
river are forced to foot the bill for part of my activity.
Pigou recommended taxing activities that produce negative
externalities. Emission taxes on factories are an example of his
approach. Another common policy adopted has been to reg-
ulate the amount of the activity legally permitted, for example,
laws that forbid loud parties after a particular time of night.
A positive externality will arise when some of the benefits
of an activity are reaped by those not directly involved. A typ-
ical example would be improving the appearance of one™s
property. If I paint my house, not only do I benefit, but so as
well do all of my neighbors, who now have a nicer view.
When such a positive externality exists, it can be contended
that I will produce “too little” of the activity in question, since
I don™t take into account the benefits to my neighbors.
The traditional policy responses to positive externalities
have been for the state to subsidize or require the activities in
question. For example, the U.S. government subsidizes
research into alternate energy sources. Primary education,
often said to have positive externalities such as producing
informed citizens, is mandatory (as well as subsidized) in most
Lionel Robbins challenged Pigou™s analysis in the 1930s.
Robbins pointed out that, since utility is not measurable, it is
invalid to compare levels of utility between different people,
as Pigou™s theory required. Robbins recommended using the
criterion of Pareto improvement, which we met in Chapter 11,
as the basis of welfare economics. A policy had to make at least
one person better off (in that person™s own estimation) and
none worse off before economists could say it was unambigu-
ously better. But Robbins held that if we just assume people

have an equal capacity for satisfaction, economists still can
recommend certain state interventions.
The notion of justifying economic intervention on the basis
of welfare analysis was dealt a severe blow in 1956, with the
publication of Murray Rothbard™s paper, “Toward a Recon-
struction of Utility and Welfare Economics.” Rothbard showed
that it is only through preference demonstrated in action that
we can gauge what actors really value, and that to try to
deduce values from mathematical formulas, without the evi-
dence of action, is a hopeless cause. Only when people
demonstrate their preferences by exchanging can we say with
any certainty that both parties felt that they would be better
off in the subsequent state than in the prior one. Since Pigou™s
solution involves imposing taxes and subsidies by fiat, with-
out voluntary exchange, the numbers it relies on are mere
Nobel Prize-winner Ronald Coase further undermined
interventionist welfare analysis with the publication of his
paper, “The Problem of Social Cost,” in 1960. Coase demon-
strated that as long as property rights are clearly defined and
transaction costs are low, the individuals involved in a situa-
tion can always negotiate a solution that internalizes any
externality. Consider the case of river pollution from the foo-
zle factory, which we noted above. If the people downriver
from the factory have a property right in the river, the factory
will have to negotiate with them in order to legally discharge
waste through their property. We can™t say what solution the
participants might arrive at”the factory might shut down, the
people downriver might be paid to move, the factory might
install pollution control devices, or it might simply compen-
sate those affected for suffering the pollution. What we can
say is that, within a system of voluntary exchange, each party
has demonstrated that it prefers the solution arrived at to the

situation that existed before their negotiations. (After all, either
party can maintain the status quo by refusing to negotiate.)
Furthermore, we should note that negotiating between the
parties affected allows them to use the “particular circum-
stances of time and place,” with which they alone are famil-
iar, to arrive at a solution. The factory owner may be aware of
an alternative foozle input that does not pollute the river. The
people downriver might know that the river is stinky anyway,
and it™s best to move. Regulators generally cannot take such
specific knowledge into account in their drafting of edicts.
If transactions costs are high, it may be difficult to negoti-
ate a solution. In those cases, the best solution again is to have
clear property rights. For instance, it is hard for a factory cre-
ating air pollution that spreads over a wide area to negotiate
with each person affected. In such a case, we might want to
define property rights so that each person has a right to be
free of airborne pollutants that exceed a certain level on his
Case studies have illustrated the resourcefulness of volun-
tary exchange in accounting for potential externalities. A
common example of a positive externality in economics was
the production of fruit trees and beekeeping. The growers of
fruit trees provide a benefit to beekeepers: flowers. And bee-
keepers provide a benefit to the growers: pollination. How-
ever, the standard analysis contended that neither party had
an incentive to take account of the benefit to the other. Thus,
there would be “too few” orchards and beekeepers. However,
economist Steven Cheung studied those markets and found
that the parties involved had accounted for the externalities
quite well, through contracting with each other to raise pro-
duction to preferable levels. As Cheung pointed out, previ-
ous economists had only to look in the Yellow Pages to find

“pollination services,” rather than simply assuming that the
market had failed.
Social pressure also plays a role in handling potential exter-
nalities. If I don™t paint my house, my neighbors will start to
grouse. I may not get invited to the next block party. Hayek
contends that those who value liberty should prefer social
pressure directed against “deviant” behavior to outright bans.
(“Deviant,” in our case, meaning simply behavior of which
many people disapprove, but which does not violate anyone
else™s right to life or property.) If I highly value having a house
painted mauve, I can ignore my neighbors™ mocking glances
and jeers. But if the government regulates house colors, I™m
Loyola University economist Walter Block has continued
work on externalities in the tradition of Rothbard. Block has
challenged the traditional distinction between public goods,
which must be produced collectively because of the positive
externalities they create, and private goods, the production of
which may be left to the market. The proposed list of public
goods has included such items as postal delivery, roads,
schools, garbage pickup, parks, airports, libraries, museums,
and so on”just think of the activities your city government
undertakes. The consensus has run that unless such goods are
provided through government action, people will attempt to
become free riders, enjoying some of the benefits of such
goods while letting other people pay for them.
Block points out that the flaw in such analysis is that almost
any good might be viewed as providing some benefit to third
parties. What about socks? Doesn™t the fact that other people
wear socks, and I don™t have to smell sweaty feet all day,
provide me with a benefit for which I™m not paying? Must
socks, therefore, be considered a public good, that only the

government can supply in adequate quantities? Such logic,
followed to its conclusion, would lead to a centrally planned
economy, as the price and quantity supplied of all goods
would be set based on the state™s cost-benefit analysis, not on
consumer evaluation.


P KRUGMAN ADDRESSED energy policy and traffic prob-
lems in his 2001 New York Times article, “Nation in a
Jam,” saying:
But you don™t have to be an elitist to think that the
nation has been making some bad choices about
energy use, and about lifestyles more generally.
Why? Because the choices we make don™t reflect the
true costs of our actions.

We™ll let his contention that “the nation” makes choices
slide. Krugman contends that “the nation” does too much driv-
ing, since each additional driver produces negative externali-
ties for other drivers. We™ll also set aside the question of how
Krugman can tell what the cost of those externalities is, apart
from market prices. We™ll grant him his estimate that the cost
of traffic congestion in Atlanta was $2.6 billion in 1999. Each
additional person™s decision to drive cost other people $14 in
lost time.
Krugman fails to ask why those costs are not borne by the
drivers in question. We don™t go to the opera expecting to find
several other people vying for our seat. We never encounter
two-hour delays in the checkout line at the supermarket.
Those resources are privately owned, and, in the interest of

making a profit, the owners have a strong incentive to ensure
that their customers have a pleasant experience. While it is
true that private businesses usually desire more customers and
sometimes fail to plan adequate capacity for those who show
up, such situations are most often corrected quickly. No one
wants to own the business that™s “so crowded that no one
goes there anymore.” If a private road owner found that his
road was overcrowded, he would simply raise the price of
using the road.
Recall the last time you met unexpected highway con-
struction on the way to work. In my area, encountering such
a project can easily add an hour to one™s commute. Multiply
that hour by the number of people stuck in the jam, and you
can see that a whole heap of costs have been imposed on
drivers by the road operator: the government.
Why is the government free to impose those costs? Both
because we pay for government roads whether or not we use
them and because the government has made it very difficult
for private companies to build roads, the government has a
near monopoly on routes for car travel. With the market
process for evaluating the relative importance of roads, travel
speeds, established property uses, pollution, and so on
severely crippled, the government cannot rationally allocate
scarce means among desired ends. Political pressure comes to
dominate the allocation of resources.
For example, John Rowland, the governor of Connecticut
as I write this, commented on the state™s branch rail lines in
1997: “Given the ridership on these lines, it is by no means
outrageous to say it would be cheaper for the state to pur-
chase cars each year for most of the riders.” On some lines
each passenger was being subsidized more than $18 per trip.
But when his plan to eliminate those lines was faced with

strong opposition, mostly from wealthy individuals who relied
on the lines for access to New York City, the plan was
dropped. We are entitled to wonder if the campaign contri-
butions of the individuals in question didn™t play a role in cal-
culating the “cost” of closing those lines.
As Sanford Ikeda points out, such interventions also have
the effect of making political action increasingly attractive,
when compared to voluntary exchange. The more my eco-
nomic well-being is determined by the political process, the
more likely it is that I™ll increase profits by lobbying than that
I™ll increase profits by producing. Further, the more my neigh-
bors are using political pressure, the less resistant I will be to
the idea of doing so. If no one else is using politics to achieve
his personal ends, then I may be very reluctant to become the
first to do so. But if many other people are pursuing that
avenue, my resistance to joining them is likely to decline dra-
matically”after all, I can tell myself, I™m only trying to “even
the score.”
The state has repeatedly intervened in the transportation
market. Roads are often provided at no extra cost to the users.
The property on which the roads were built was often seized
by eminent domain, so that the supposed construction cost
did not reflect the true cost of acquiring the needed land. The
supply of taxis and jitneys, which can to some extent substi-
tute for having one™s own car, has been artificially limited. Of
course, other modes of transportation have had their own his-
tory of interventions. We have no idea of what a transporta-
tion market that had developed unhampered for the last sev-
eral centuries would look like.
But it might strike us as odd that the very process that cre-
ated the externalities in the first place”interventionism”is
usually what is offered as the solution to them. Instead of

seeking ways to allow the market in transportation to do its job,
most recommendations call for further interventions intended to
clean up the unwanted effects of past interventions.
For instance, Thomas Sowell, in his book Basic Economics,
suggests that a law requiring mud flaps on cars is justified,
Even if everyone agrees that the benefits of mud
flaps greatly exceed their costs, there is no feasible
way of buying those benefits in a free market, since
you receive no benefits from the mud flaps you buy
. . . but only from mud flaps that other people buy.

But Sowell™s problem arises only because roads are pub-
licly owned. The owner of a private road could internalize the
benefit by requiring mud flaps and advertising the fact. Those
who preferred that they pay for mud flaps as long as every-
one else does, as well, can make use of roads requiring them.
Krugman does not explicitly call for a particular policy in
his column. But when he says that the government should
place a high priority on “getting those incentives right,” we are
to understand that he means imposing new taxes on fossil
fuels, on car ownership, and other interventions into the trans-
portation market.
But there is no way for the government to “get incentives
right” without market prices, the very thing eliminated by
intervention. It is simply not possible for the government to
guess the prices that might have arisen on an unhampered
market. Each subsequent intervention intended to fix an ear-
lier one will add new distortions and generate new unin-
tended consequences.
Regulations that require a certain average miles-per-gallon
figure for a manufacturer™s sold cars led directly to the explosion

of sport utility vehicle (SUV) sales. Since SUVs are considered
to be trucks, not cars, they are held to less stringent fuel-effi-
ciency standards. Government efforts to increase overall gas
mileage steered consumers into buying less efficient trucks,
instead of station wagons, which were subject to the regula-
tions. The general response has been, predictably, a call for
new regulations on SUVs. Ford, for one, has tried to head off
new legislation by increasing the fuel efficiency of its SUV
Often, some proponent of new regulation will contend that
following the regulation will actually increase profits, and is
the right thing to do for purely business reasons. For exam-
ple, Steve Gregerson of the Automotive Consulting Group said
of Ford™s decision in the Houston Chronicle: “It™s a smart busi-
ness decision. They™re creating a vehicle that is going to be
accepted in the marketplace and has better fuel economy but
offers some of the utilitarian functions of the SUVs.”
But if it really is a smart business decision”and perhaps it
is!”then surely some entrepreneur will do it without legisla-
tive pressure. Only if one believes that our best entrepreneurs
just happen to be legislators does the argument make sense.
The free market is not a panacea. It does not eliminate old
age, it won™t make babies™ poop smell good, and it won™t
guarantee you a date for Saturday night. Private enterprise is
fully capable of awful screwups. But both theory and practice
indicate that its screwups are less pervasive and more easily
corrected than those of government enterprises, including reg-
ulatory ones.

Stuck on You


P recently and prominently been for-
warded as an example of market failure. The idea is
that markets can get “stuck” on a path that is clearly
inferior to another option. However, no individual market par-
ticipant is in a position to change things”that is the sense in
which the market is stuck. For each individual, the cost of
switching to the better path is too great. But if a person knew
that everyone else would switch, he would prefer to do so.
A simple example would be the choice of which side of the
road to drive on. Let™s say it™s discovered that driving on the
left, as in the U.K., is significantly less stressful than driving on
the right, such as in the U.S. Knowing that, I might prefer to
drive on the left. But I surely don™t want to be the first person
to start driving on the left! Since everyone else is in the same
boat, we keep driving on the right.
Therefore, conclude those alleging market failure, only the
government is powerful enough to move the market off of the
inefficient path. Popular literature parades out a trio of cases
to illustrate path dependence.
The three stars of this show are:


• The Dvorak keyboard, a “superior” alternative to our
current QWERTY standard.
• The Betamax video cassette format, which lost out to
VHS in the consumer market.
• The Macintosh operating system, supposedly prefer-
able to the dominant Windows/Intel (Wintel)
The term “superior,” economically speaking, means supe-
rior in satisfying the consumers™ needs, given the current con-
figuration of the factors of production. An engineer may view
a Mercedes as superior to a Honda, but the fact that Mercedes
does not outsell Honda is not a failure on the part of the mar-
ket. It is a reflection of the market™s ability to meet the needs
of the mass of consumers. From an economic perspective, the
claim that the “unlucky loser” technologies listed above are
superior turns out to be false. There is no evidence that the
triumph of alternate standards was a violation of consumer
sovereignty. What™s more, we have no reason to suspect that
government supervision of the development of those tech-
nologies could have resulted in a better outcome.
A few examples illustrate how commonplace the idea is
that Dvorak, Betamax, and Macintosh were superior products,
that the market capriciously rejected:
Jared Diamond, writing in the April 1997 issue of Discover
Magazine, tells us:
The infinitely superior Dvorak keyboard is named
for August Dvorak. . . . QWERTY™s saga illustrates a
much broader phenomenon: how commitment
shapes the history of technology and culture, often
selecting which innovations become entrenched
and which are rejected.

The August 1998 issue of Wired Magazine contains the
claim: “But of course, ˜fittest™ in technology does not always
mean ˜best™”hello, Macintosh and Betamax.”
Paul Kedrosky introduces us to a leading proponent of
such arguments, again in Wired Magazine, as follows:
Brian Arthur . . . is the founding father of “increas-
ing-returns economics,” a new branch that is exam-
ining how dominant players in emerging markets
can stifle innovation by locking people into inferior
technical standards. Think of the old battle between
VHS and Beta, and you begin to understand why
superior technologies don™t always win the tug of
war for market share.

Our triumvirate is the major evidence put forward by the
proponents, such as Arthur, of “strong path dependence,” the
keystone of “increasing return economics.” The theory is that
in the high technology world, as opposed to older manufac-
turing industries, a company™s profit margin often increases
with each additional customer. A typical example used is that
of Microsoft, where it is contended that, while each additional
sale of Windows adds a diminishing amount to Microsoft™s
costs, each sale adds an increasing amount to the value of
Windows. (The claim itself is questionable. It only takes into
account the physical cost of the product, ignoring the fact that
each additional customer will be a harder sell than the previ-
ous one, and is likely to require more tech support.) Increas-
ing-return economics claims that because of the putative size
advantage, the early market leader will be able to crush late
arrivals. That leads to strong path dependence, because
although the late arrivals may have better products, they won™t
stand a chance in the market.

It is useful to differentiate between claims of weak path
dependence and strong path dependence. The weak case says
little more than that the future is, to some extent, dependent
on the past. For instance, the presence of nonconvertible cap-
ital goods in an economy will lead to more conservative
choices of methods of production than if they were absent.
But that is for the best, because it is only in the case where
investments in new technology more than repay the cost of
abandoning existing capital goods that they make efficient use
of society™s scarce resources. Mises points out that from our
present vantage point, we might wish that past entrepreneurs
had made different choices about production. But that is
merely an inevitable consequence of the fact that the future is
uncertain, and that humans can make mistakes. What we are
now faced with are decisions about the best way forward,
given that the past was what it was, and that it created the
present situation, which we must take as a given. It is only the
future that holds open the opportunity to replace what is with
what ought to be.
However, the strong case goes much further than the weak
one, and contends that we often get stuck using inferior prod-
ucts, even when “society” could benefit from switching to bet-
ter ones. The first product to market can win out against sig-
nificantly superior competitive products. Those forwarding the
theory contend that path dependence can lead to a situation
where the government could usefully intervene to steer the
market toward better standards.
The first flaw in this argument based on strong path
dependence is that there is no objective yardstick by which to
gauge whether some technology is “better for society,” other
than the profits and losses of the entrepreneurs who chose it.
As we saw in examining the calculation problem faced by
socialism, we cannot measure whether consumers have

received a net benefit from some macro-level change to the
technological landscape. Some consumers will gain, some will
lose, but we cannot “sum up” these changes to yield a total
for “society™s profit.”
Just because we cannot calculate or measure that society is
better off with one standard than another does not mean that
it is impossible to employ human understanding for that pur-
pose. We might, for instance, judge that society is better off
having made knives the standard cutting implement in restau-
rants, rather than axes. But even under that looser standard,
there is little evidence that the supposedly superior standards
mentioned above actually were better. Let™s examine the three
popular cases put forward by the proponents of strong path
dependence, and see how their evidence stands up under
closer scrutiny.


S (THE DEVELOPER of the Betamax format) and Mat-
sushita (one of the VHS developers) chose to give dif-
ferent weight to the importance of ease of transportabil-
ity (which meant small tape size) and recording time (which
increases with tape size). Sony thought that consumers would
want a paperback-sized cassette, even though it would limit
recording time to one hour, while Matsushita opted for a
larger tape and a two-hour recording time. Otherwise, the two
technologies were nearly identical. In essence, each side had
made a bet as to what would be more important to con-
sumers, with Sony betting on small tape size, and the VHS
folks betting on recording time.

Sony had a monopoly in the market for two years before
VHS arrived on the scene. But with the VHS format allowing
the taping of full-length movies, it quickly began to gain mar-
ket share. The two formats started a price war. Sony also
countered the VHS onslaught by increasing the recording time
of Betamax to two hours. In response, VHS upped its record-
ing time to four hours. Betamax went to five hours, and VHS
to eight. (With the larger tape size on their side, the VHS con-
tingent could always achieve a better trade-off between
recording time and quality than could Sony.)
As we all know, the ultimate outcome was that VHS came
to dominate the market for home video equipment. Betamax
hung on as a niche format in broadcasting, where its advan-
tages in editing and special effects were more important than
in the consumer market. Stan Liebowitz and Stephen Margo-
lis, the authors of Winners, Losers & Microsoft, point out that:
[T]he market [did] not get stuck on the Beta path. . . .
Notice that this is anything but [strong] path depend-
ence. Even though Beta got there first, VHS was
able to overtake Beta very quickly. This, of course,
is the exact opposite of the predictions of path
dependence. . . . For most consumers, VHS offered
a better set of performance features. The market
outcome . . . is exactly what they wanted.


T the Dvorak keyboard to the standard
QWERTY model has been taken for granted by many
writers. Yet the myth largely has been constructed
around a single study, performed by the U.S. Navy during

World War II. The study, it turns out, was conducted by none
other than the Dvorak keyboard inventor himself, August
Dvorak. He was the Navy™s top expert in the analysis of time
and motion studies during that war. The study he conducted
used inadequate controls, and allowed no real comparison
between the two training groups. The Navy study ignored the
fact that additional training on QWERTY will also increase typ-
ing speeds.
The QWERTY keyboard, far from being deliberately
designed to slow down typists, as the apocryphal story goes,
actually had to win many typing-speed contests to eventually
triumph in the market. Liebowitz and Margolis say:
The QWERTY keyboard, it turns out, is about as
good a design as the Dvorak keyboard, and was
better than most competing designs that existed in
the late 1800s when there were many keyboard
designs maneuvering for a place in the market.
(Winners, Losers, & Microsoft)

In asking whether our QWERTY-dominated world is an
inefficient outcome compared to one in which Dvorak had
won, we must keep in mind that the past cannot be undone:
bygones are bygones. We are not faced with the task of recon-
structing human society from scratch. “Society,” meaning
either the entrepreneurs of a market order or the central plan-
ners of a socialist order, must decide how best to use the cur-
rent array of resources in going forward. If we were to start
society over again, with the benefit of our current knowledge,
we would make different choices. Factories would be located
in different places, different transportation facilities would be
available, different materials chosen for construction projects,
and so on. Unless we wish to plunge mankind back to the
subsistence economy that supported only a few million

humans on the entire globe, we must make effective use of
our current resources. That means that we can only afford to
abandon older tools and techniques when the benefits gained
by the switch outweigh the cost of switching.
The proponents of strong path dependence theory contend
that in the cases we are discussing, the switch would more
than pay for itself, but we have become “locked in” to inferior
standards. If Dvorak is “infinitely superior,” as Jared Diamond
contends, switching to it as a standard would certainly be ben-
eficial. But if that were really true, why hasn™t it happened? It
doesn™t take long to recoup an investment offering infinite
The supposed superiority of the Dvorak keyboard has
been touted as so great that the extra productivity in ten days
of work would repay the cost of training typists on Dvorak.
But if that were true, it would hardly be necessary to get the
rest of the world to go along on the switch. A single entre-
preneur who employed a large pool of typists could lead the
way out of the “efficiency trap” by himself.
In fact, more recent studies show that switching to Dvorak
does not repay the cost of retraining. If a company needs to
increase typing speeds, it is better off adding training on
QWERTY keyboards.
In a world of rivalrous competition, where entrepreneurs
seek out every opportunity for profit, we have good reason to
suspect that they would not overlook an investment that they
could amortize in ten days, but which offered years of returns.
Liebowitz and Margolis, while not self-professed Austrian
economists, forward an Austrian-like critique of the static
models employed by the path-dependence theorists:
In [Paul David™s] model [of markets] an exogenous
set of goods is offered for sale at a price, take it or

leave it. There is little or no role for entrepreneurs.
. . . In the world created by such a sterile model of
competition, it is not surprising that accidents have
considerable permanence. (Winners, Losers, &
Microsoft )

Notice that the new “ergonomic” keyboards, from Microsoft
and others, belie the notion that we are locked in to a partic-
ular keyboard choice. Although they use the same key order
as the traditional QWERTY keyboard, the ergonomic models
use a very different layout for the keyboard as a whole. Yet,
despite the retraining necessary to use them, they are appar-
ently quite viable in the marketplace.


A VIRGINIA POSTREL pointed out in Reason, calling the Mac-
intosh superior to “Wintel” computers ignores many
dimensions of what users want from their machines:
expandability, a good price/performance ratio, a wide choice
of peripherals, a wealth of software, and so on.
The first Macintosh was a 128K machine with no option for
RAM expansion, no parallel port, a single floppy drive, no
hard-drive option, little available software, and a limited
choice of printers. It was simply not an acceptable business
machine. Although Apple improved on the original Macintosh
in many respects, it also continued to charge high prices.
Apple also erred in failing to realize that a large portion of
the early PC adopters were tinkerers who wanted to be able
to get inside their machine, trying to hook a piece of lab
equipment to the computer™s internal bus, for example. The

early Mac was simply not to be tinkered with. The case was
designed so that the consumer could not even open it.
That was a crucial mistake, for it is the tinkerers who
develop the peripherals and applications that a platform
needs to succeed. Tom Steinert-Threlkeld, writing in
Inter@ctive Week Online, summed up Apple™s failure: “Open
up your architecture to all comers and win”or keep it closed,
like the Macintosh, and lose.”
A common charge leveled against Microsoft is that they
used their monopoly over the operating system to attain dom-
inance in application software. It is belied by the fact that
Microsoft dominated the spreadsheet and word processing
markets for Macintosh computers, where it did not control the
operating system, several years before it achieved such dom-
inance on MS-DOS machines.
Far from stifling innovation, as the proponents of path
dependence contend will happen, Microsoft has had to inno-
vate constantly to maintain its position. Consider that just a
few years ago, “Microsoft Bob” was, according to Redmond,
the “easy-going software that everyone will use.” But it turned
out that it was actually a Web browser that everyone would
use, and Microsoft quickly switched strategies. The market
process does not rely on altruistic motives on the part of
entrepreneurs”Microsoft may have wanted to stifle innova-
tion in that case, but they were simply unable to do so.
In the beginning of the personal computer revolution, con-
sumers frequently complained about the bewildering variety
of incompatible software and hardware on the market. I
worked in technical support for a software product in 1985.
We had to keep extensive lists of different hardware and soft-
ware combinations available to us, as we found printing didn™t
work on manufacturers X™s PC, graphics wouldn™t function

with graphic card Y, and so on. Bill Gates had the vision nec-
essary to see that consumers would be much happier with
standardized products they could mix-and-match without
worry. By creating the Windows standard, Microsoft was able
to internalize many of the network externalities in the per-
sonal computer market, earning it years of high profits.


E really don™t like some market outcome, which
is what the majority of charges of market failure come
down to, we must realize that in any effort to rearrange
this outcome we must rely on opinion and guesswork, and
cannot make use of economic calculation.
Imagine again that you are the economic dictator for your
country. Usually, you let the market run its course. But once
in a while, some market outcome really ticks you off, and you
decide to act. Let™s say that you feel there are too few operat-
ing systems available for personal computers, and you™re
going to change things.
How do you proceed? Perhaps you™ll fund new operating
system development. But how much funding should you pro-
vide? Over how many different companies should you spread
the funding? If the development effort were profitable, we
might expect that someone would be funding it already.
Therefore, you will probably lose money in the venture.
But how much is it reasonable to lose? What is the right
price to set for how much the public is “suffering” from hav-
ing “too few” operating systems? And whom do you fund? The
findings of the Public Choice School tell us that policymakers

will almost inevitably be influenced by factors other than eco-
nomic efficiency in making such decisions.
Perhaps the dominant operating system manufacturer
should be penalized until it reduces its market share. What is
the right amount of penalty to compensate for what you see
as the cost of its dominance? What is the maximum market
share that should be allowed?
The plain answer is that, other than pure guesswork, it is
not possible to answer such questions other than by exchange
based on private property. It is only when confronted with
really paying the cost of something that we make choices that
reflect our true values. Furthermore, if truly inefficient stan-
dards have been adopted, then the market presents entrepre-
neurs with the opportunity to profit by moving consumers to
superior standards.

See the Pyramids Along the Nile


ago, in my home state of Connecticut,
Governor John Rowland agreed on a deal to bring the
New England Patriots to Hartford. To quote Diane Scar-
poni of the Associated Press, “At $374 million for a Hartford
waterfront stadium and amenities, it was considered to be the
richest stadium deal in National Football League history.” Car-
ole Bass of the New Haven Advocate noted: “[U]nder the deal
struck by Rowland and Patriots owner Robert Kraft, the team
will pay no rent, property tax or insurance on the stadium for
30 years.” (The deal later fell through when Massachusetts
made Kraft an offer that was, in his estimation, even better.)
While Connecticut™s deal with the Patriots would have been
expensive, the proposal just barely exceeded the $360 million
Denver agreed to spend on a new stadium for the Broncos.
Similar projects are common across the country. Writing in The
Brookings Review in 1997, economists Roger G. Noll and
Andrew Zimbalist described the then-current situation:


New facilities costing at least $200 million have
been completed or are under way in Baltimore,
Charlotte, Chicago, Cincinnati, Cleveland, Milwau-
kee, Nashville, San Francisco, St. Louis, Seattle,
Tampa, and Washington, D.C. and are in the plan-
ning stages in Boston, Dallas, Minneapolis, New
York, and Pittsburgh. Major stadium renovations
have been undertaken in Jacksonville and Oakland.
Industry experts estimate that more than $7 billion
will be spent on new facilities for professional
sports teams before 2006. Most of this $7 billion will
come from public sources.

By subsidizing sports facilities governments are taxing the
“average Joe” and increasing the earnings of some very
wealthy individuals: pro athletes and sports team owners.
What justification exists for such a practice? The usual expla-
nation is that such largesse will, in the long run, provide a
boost to the local economy, more than paying for itself. This
explanation fails to heed Bastiat™s warning to consider what is
not seen, as well as what is seen, when contemplating an
economic policy.
What is seen is the activity around the stadium on game
day. People buy tickets to the game, producing revenue for
the team. The tickets are taxed, producing revenue for the
state. Inside, they buy hot dogs and beer, with money going
to both the vendors and the state. They may go out for a meal
before or after the game, enriching area restaurants. Perhaps
they will also stop at a local museum, or see a show after-
ward. Both while the stadium is being built and after it is in
use, local construction companies will have more work, first
constructing and later maintaining the stadium, access roads,
parking lots, and so on.

When we look at what is seen, it appears obvious that the
stadium has been a boost to the local economy. It is only
when we focus on what is not seen that the picture looks less
rosy. The resources being expended around the stadium had
to come from somewhere.
“Ah,” the supporter of the stadium deal may reply, “but the
state is going to borrow most of the money”so it™s really cre-
ating the resources necessary for the project simply by being
However, Bastiat pointed out that in any loan, money is
only the intermediary. What is being borrowed is ultimately
always a currently existing good. When the government lends
money to a farmer, he spends it on a tractor. (Bastiat used a
plow in his example, but we might as well be more up-to-
date.) What the farmer has really borrowed is the tractor. And
since there are only so many tractors in existence at one time,
someone else does not have that tractor as a result.
And so it is with these stadium deals, and all similar gov-
ernment efforts to “boost industry.” If construction companies
are building the stadium, there is something else they are not
building. If steel is being used to support the structure, that
steel is unavailable for other projects. If people are spending
their money at restaurants around the stadium, there are other
places”perhaps restaurants in their own neighborhood”
where they are not spending that money. And the money
spent by the state, whether raised through taxes or borrowing,
to be repaid by later taxes, would have been spent by some-
one on something else.


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