As we see in Moore’s new movie, Capitalism: A Love Story, Moore is offended by some truly offensive things: banks engaging in wild speculation without concern for the risk, taxpayer bailouts for banks and other businesses, cozy relations between Wall Street and Washington, politicians getting favors from companies that want benefits from government, and big institutions pushing less powerful individuals around. True, he’s offended by some inoffensive things as well, such as the cut in the 90 percent top income-tax rate nearly 30 years ago. But by and large, what he rails against should be railed against.

(Update: Moore gets the tax-rate story wrong, and I let it get by me. The 91 percent top marginal rate fell to 77 in 1964 and 70 in 1965; this was the Kennedy tax cut — I wonder why Moore didn’t say that Democrats John Kennedy and Lyndon Johnson were the rate cutters. Under Republican Ronald Reagan, whom Moore wishes to demonize for cutting taxes for the rich, the rate dropped to 50 and eventually to 28 percent. HT: Gary Chartier.)

Had he called his movie State Capitalism: A Love Story, I might be applauding (with some reservations). But he’s targeting the more ambiguous “capitalism,” which he uses interchangeably with “the free market.” He can be forgiven for this, however. Most people would say that the current U.S. economic system is capitalist. Moore has probably heard that all his life. He’d hear if he watched a Fox financial program. Would Ben Stein or Lawrence Kudlow disagree? Moore has also heard Republican politicians, George W. Bush, for example, praise the existing system, with all its deep government interventions, as capitalist. He did this even as he and Treasury Secretary Henry Paulson, former chief of Wall Street behemoth Goldman Sachs, stampeded Congress into passing the $700 billion TARP bailout last year. Moore takes such people at their word: The free market is capitalism, and capitalism is what we have today.

Can we blame him for thinking this way?

Yes, it’s sloppy thinking, and had he been more curious and read beyond the confines of “Progressive” literature, he could have gotten the straight story. But many knowledgeable advocates of the free market contribute to the confusion by exhibiting what Kevin Carson calls “vulgar libertarianism,” or what Roderick Long describes as “the tendency to treat the case for the free market as though it justified various unlovely features of actually existing corporatist society.” How often have you heard a free-market advocate condemn pro-business intervention in one breath, then defend existing dominant corporations in the next — as though they did not arise in the interventionist environment just condemned? Pro-market is not the same as pro-business. If some market advocates don’t understand that, why should Moore? Vulgar libertarianism is a disconnect that makes the free-market philosophy look like a corporate apologetic. It’s done incalculable damage to the cause of freedom, in part by alienating potential allies. Who knows, maybe even Michael Moore.

Aversion to Profit

This may go a long way in explaining Moore’s aversion to profit — at least other people’s. He associates profit with business, which he associates with (state) capitalism. So for him, profit per se is suspect. But he should see a problem here. Does he think he’s exploiting moviegoers when his production company ends up with a profit? Do the co-ops and worker-owned firms he loves exploit their customers when they sell their products for more than their money costs? When two people barter, are they mutually exploiting each other because each gets more value than he gives up? To consistently oppose profit, one would have to oppose all human action, since every action aims at a surplus of subjective benefit over subjective opportunity cost.

Cornered like this, Moore might say he’s only the against excessive profits that capitalist market power permits. But now we’re back where we started. To the extent that intervention hampers competition by erecting barriers to entry — which is the usual effect, intended or not — protected firms are free to charge higher prices and reap more profits than would have been the case in an open market. Corporate power and privilege derive from political power and can’t exist without it. In contrast to existing capitalism, the truly free market would have no legal barriers to competitive entry, assuring that prices and returns are economically justified and not the fruits of privilege. Strictly speaking, entrepreneurial profit in a true market gets competed away because the very process of capturing them reveals valuable information to others and invites imitation. It takes innovation and efficiency — that is, superior service to consumers — to create new profits. Only the State permits business to make profits by withholding benefits from consumers.

But Moore doesn’t know this. What he “knows” is that the choice is between the current corrupt system — and it is corrupt — and some vaguely defined scheme of control by benevolent politicians, which he calls socialism and democracy.

In his movie Moore expresses affection for socialism, but he’s not clear what he means. He never advocates collectivization of the means of production or the abolition of markets. Instead he suggests that socialism means workers having a say in how the companies they work for are run. But why assume that’s anti-free market? He praises worker-owned companies and notes that hundreds of them exist in the United States today. He might be surprised to learn that these things are entirely compatible with the free market. In fact, it’s a perfectly libertarian intuition to abhor being subject to the arbitrary whim of anyone — yes, even a private employer. If government regulatory and tax obstacles to new competition and self-employment did not exist, workers would have their maximum bargaining power and widest array of alternatives. I imagine we’d see more departures from the traditional firm. People used to get their “social insurance” from mutual aid societies. Maybe in a true free market, we’d see a bigger role for the employment counterpart to these public, yet not governmental, organizations.

What would Moore think about a system in which no one could collude with politicians to legally plunder the rest of us for their own benefit and everyone was free to enter into any cooperative arrangements to produce and offer goods to others in voluntary exchange? Michael, that’s the free market!

FDR’s Second Bill of Rights

Of course, Moore naively looks to government to provide things. His movie laments that FDR died before he could see his Second Bill of Rights enacted. Roosevelt wanted government to guarantee everyone a good education, job, home, health care, and so on. Has Moore ever wondered where government would get the resources for this? He can’t really believe that somewhere there’s a massive pot of collective wealth waiting to be distributed. He must realize that the tax system would provide the money. But how can he not know that if government appears to penalize wealth creation with confiscation, less wealth will be created?

Moore is unaware that he commits the “Nirvana fallacy.” This is the erroneous idea that our choice is between the admittedly imperfect world we’re bound to live in if government leaves us alone and an imagined utopia in which benevolent and all-wise rulers oversee and regulate everything. Of course that is not the choice. Moore’s preferred system, whatever he calls it, would be run by individuals whose insight into the public interest would be no sharper and whose motives no purer than other people’s. However, since they would wield political power — which is the legal authority to compel obedience– they would be far more dangerous than anyone in a free market could ever be. He knows how corrupt politicians are. Why does he think different people would run things in his utopia? Does he really want them in charge of everyone’s job, education, health care, housing, pension, and the rest? It’s hard to understand why he isn’t uncomfortable with the idea of the people being tenants and employees of the State.

Whether he realizes it or not, Moore favors a system in which an elite necessarily would make critical decisions for the rest of us. He’d be incredulous to hear that, but if he ever comes to understand it, libertarians might end up with an unlikely ally.

In his op-ed column Monday, Brooks imagines how Bentham and Hume would each approach global warming and health care. Bentham, he says, would display a policy wonk’s command of the nuts and bolts and come up with detailed government programs for imposing solutions to the problems.

“Mr. Hume, I’m afraid, wouldn’t be so impressive,” Brooks writes. He imagines that Hume — whining, head in hands, or weeping while in the fetal position — would confess his ignorance about solving the problems and then would propose just enough government intervention, such as a carbon tax and health-insurance exchanges, to “set off a decentralized cascade of reform, instead of putting all the responsibility on us here.”

Brooks then gets to his point:

This country is about to have a big debate on the role of government. The polarizers on cable TV think it’s going to be a debate between socialism and free-market purism. But it’s really going to be a debate about how to promote innovation.

The people on Mr. Bentham’s side believe that government can get actively involved in organizing innovation….

The people on Mr. Hume’s side believe government should actively tilt the playing field to promote social goods and set off decentralized networks of reform, but they don’t think government knows enough to intimately organize dynamic innovation.

Brooks predicts that Bentham will win because he serves the lobbyists interests.

Leaving aside Brooks’s defamation of Hume as a pathetic, sniveling character — David Hume? — we can take issue with his picture of Hume on a couple of other counts. I am no Hume expert (and I disagree with him on many issues), but I know enough to point out some important things Brooks missed in his effort to be cute.

Note that Brooks presents the debate over the role of government in fairly narrow terms. It’s between a government that actively organizes innovation and a government that actively sets social goals then arranges the carrots and sticks in order to induce people to achieve those goals.

In either case, government is the active party. Hume would not be comfortable with either team.

Stability of Possession

For one thing, Hume thought that society depends on, more than anything else, secure property. But how secure can property be if politicians of limited knowledge and perspective (not the impliedly lofty government) have the power to set goals for the rest of us and to impose incentives and penalties in the service of those goals?

Let there be no mistake about where Hume stood on the matter of property. In A Treatise of Human Nature (Book III, 1740) he writes of “the three fundamental laws of nature, that of the stability of possession, of its transference by consent, and of the performance of promises” and adds:

’Tis on the strict observance of those three laws, that the peace and security of human society entirely depend; nor is there any possibility of establishing a good correspondence among men, where these are neglected. Society is absolutely necessary for the well-being of men; and these are as necessary to the support of society.

“Stability of possession” is a favorite phase of Hume’s. Indeed, he emphasized that property should be respected even when in particular cases we do not like the outcome:

Property must be stable, and must be fix’d by general rules. Tho’ in one instance the public be a sufferer, this momentary ill is amply compensated by the steady prosecution of the rule, and by the peace and order, which it establishes in society. And even every individual person must find himself a gainer, on ballancing the account; since, without justice, society must immediately dissolve, and every one must fall into that savage and solitary condition, which is infinitely worse than the worse situation that can possibly be suppos’d in society.

These “three fundamental laws of nature” were not the conscious inventions of some Benthamite social engineer, but rather elements of an undesigned social order that produces benefits for the general population. Indeed, Hume along with Adam Smith, was a leading philosopher of the Scottish Enlightenment.  Its defining characteristic was the historic liberal appreciation that society was not constructed consciously but rather emerged spontaneously from the peaceful pursuit of self-interest and the social cooperation it generates. “[T]he rule concerning the stability of possession,” he wrote, “… arises gradually, and acquires force by a slow progression, and by our repeated experience of the inconveniences of transgressing it.”

He goes on to draw a parallel that will be familiar to students of Menger, Mises, and Hayek: “In like manner are languages gradually established by human conventions without any promise. In like manner do gold and silver become the common measures of exchange….”

Thus law, language, and money are institutions that are, in the words of Hume’s friend Adam Ferguson, “the result of human action, but not the execution of any human design.“

Public Good as Byproduct

Hume emphasized that, as spontaneously emergent institutions, the laws of justice and property were not intended to promote the good of the public, having grown out of “self-love,” but they nevertheless do so. This process is what Adam Smith would liken to an “invisible hand.” In fact, Hume wrote, the public good wouldn’t have been achieved had it been aimed at directly and consciously. He writes,

[I]f men had been endow’d with such a strong regard for public good, they wou’d never have restrain’d themselves by these rules; so that the laws of justice arise from natural principles in a manner still more oblique and artificial. ’Tis self-love which is their real origin; and as the self-love of one person is naturally contrary to that of another, these several interested passions are oblig’d to adjust themselves after such a manner as to concur in some system of conduct and behaviour. This system, therefore, comprehending the interest of each individual, is of course advantageous to the public; tho’ it be not intended for that purpose by the inventors.

Is belief in spontaneous social order and stable property consistent with the two forms of rationalistic discretionary government Brooks gives us? I think not.

One final word from Hume in light of today’s fiscal affairs: “The source of degeneracy, which may be remarked in free governments, consists in the practice of contracting debt, and mortgaging the public revenues, by which taxes may, in time, become altogether intolerable…” (Of Civil Liberty).

Has any group of professionals ever been so spectacularly wrong? Pre-Copernican astronomers and cosmologists, I suppose, and for the same reason, really: They had an entire, internally consistent, theoretically rich system that described the universe. They were wrong — the sun and other celestial bodies save the moon didn’t actually revolve around the Earth, as they insisted — but no matter. It was a thing of beauty, their cosmic order. A vast faith was sustained in part by their pseudo-science, a faith from which such free thinkers as Galileo deviated at their own risk.

As it was with the pre- (or anti-) Copernicans, so it is with today’s mainstream economists. Theirs is an elegant system, a thing of beauty in itself…. It just fails to jell with reality. And unlike the pre-Copernicans… their latter-day equivalents in the economic profession pose a clear and present danger to the well-being of damned near everyone.

Meyerson elaborates on the problems with the mainstream:

[It] is not simply that it failed to predict the near-collapse of the world financial system last year. The problem is that it believed such a collapse could not happen, that all risk could be quantified by mathematical models and that these quantifications could help us correctly price just about everything. Out of this belief arose the banks’ practice of securitization, which put a value on all manner of mortgages and enabled buyers to purchase and swap them with the certainty that such transactions reflected an accurate judgment of the value of the properties and the risks associated with them.

Except, they didn’t. So long as economists insisted that they did, however, there really was no need to study such things as bubbles… Under mainstream economic theory, which held that everything was correctly priced, bubbles simply couldn’t exist.

Judging by these excerpts, you might suspect that Meyerson would have some sympathy toward Austrian economics. His characterization of mainstream economics could easily have come from an Austrian. But I admit I left some things out. Alas, Meyerson isn’t an Austrian. Nor has he any sympathy with the free market. In fact, he curiously labels mainstream economists, pejoratively, as “free market” economists, though he conflates two separable, indeed conflicting, things: belief in the virtues of the market and fascination with mathematical modeling. (To speak strictly, Austrian economics is not free-market economics. It is a particular, value-free approach to the discipline. It requires a moral judgment, which no economic theory can supply, to pronounce the market process, as described by the Austrians, good. To be sure, if one values freedom and prosperity, Austrian economics will be attractive and promising, though of course that is not the test of its validity.)

Meyerson reveals his leanings at the top of the column: “‘The worldly philosophers’ was economist Robert Heilbroner’s term for such great economic thinkers as Adam Smith, Karl Marx, John Maynard Keynes and Joseph Schumpeter. Today’s free-market economists, by contrast, aren’t merely not philosophers. They’re not even worldly.”

The mainstream economists he has in mind are those “at least with the purer strain of free-market economics associated with the University of Chicago.” Despite the financial turmoil they still have not learned their lesson, he says. “The quants at the banking houses say that they simply failed to sufficiently factor some risks into their mathematical models. Once they do, their system will be corrected, and banks can resume their campaign to securitize everything (as some banks are already doing by establishing a secondary market in life insurance policies).”

Then he tips his hand fully: “The one economist who has emerged from the current troubles with his reputation not only intact but enhanced is, of course, Keynes.” (That’s too big a topic to address here.)

Uncertainty and Risk

Interestingly from an Austrian perspective, part of what Meyerson likes about Keynes is his grasp “that an uncertainty attends human affairs that transcends quantifiable risk.” Any Austrian can say something similar. Austrians eschew mathematical economics precisely because human action doesn’t fit into equations and the knowledge presumed by mathematical modeling is denied real human beings.

People are not molecules or planets or rats or bloodless calculators reacting to outside forces or instinct. They are entrepreneurial actors who form preferences and plans based on expectations about the uncertain future, none of which can be quantified. Moreover, these factors manifested in action are not fixed and known in advance; people don’t behave according to predetermined utility functions or indifference curves. Plans and preferences emerge when people choose among alternatives in the hustle and bustle of life, and can change unexpectedly and unpredictably as new situations arise (that is, as other people do unanticipated things.) Value preferences are subjective ordinal rankings of utility, or satisfaction, lacking a unit to which cardinal numbers can be attached and manipulated mathematically. Real costs are subjective utilities forgone and thus unobservable to outsiders. There are no constant quantitative laws in human action, according to which, say, doubling the price of commodity guarantees a predictable quantitative response.

In other words, as the preeminent Austrian economist  Ludwig von Mises asked, “How can economic action that always consists of preferring and setting aside, that is, of making unequal valuations, be transformed into equal valuations, and the use of equations?”

In short, Austrians — Mises, Hayek, Rothbard, Kirzner, and those who have followed — stand second to none in rejecting scientism, the application of the methods of the physical sciences to the social “sciences.” They have relentlessly critiqued the mainstream’s out-of-touch preoccupation with mathematically describing the Neverland of general equilibrium, while ignoring real-world entrepreneurial action under uncertainty. No wonder Austrian economics has often been dismissed by the mainstream for rejecting the mathematicization that Meyerson properly ridicules.

Unfortunately, Meyerson seems oblivious of the Austrian school. If that were not the case, he would not imply that only the Keynesians are skeptical about neat mathematical models that claim to account for all eventualities. Nor would he identify the free market only with the Chicago school. He’d know that the Austrians were not among those economists who were “spectacularly wrong” as the financial fiasco approached. (It is surely inaccurate to say that all Chicago economists were unconcerned.) And he’d know that many prominent mathematical economists dislike the free market.

Austrians have long opposed the Federal Reserve’s price-distorting power over banking and money, the government’s intervention in the market for housing finance, and the too-big-to-fail doctrine that licenses unjustifiable speculation and rescues failing firms from the consequences of their actions. (That’s the free market?) Therefore, Austrian economists were not surprised by the housing bubble or the miserable aftermath of its bursting. Indeed, they have longed warned of a crash.

Where Are Fannie and Freddie?

Meyerson, unsurprisingly, never mentions the Fed, Fannie Mae and Freddie Mac, or the other agents of intervention that set the economy up for recession and other system-wide failure. To him the culprits are irrational animal spirits, no doubt with a big dollop of greed. Since he is blind to government’s responsibility for the crisis, he can write, “Thus the state must ensure against periodic madness in the markets with regulations and social insurance, because madness is a potential threat in markets just as it is in other human endeavors — because the market is a human endeavor, not reducible to a mathematical construct.”

Since the State is a human endeavor, too, why should we assume that government officials, who are plagued by ignorance, political incentives, and the lack of feedback, are immune to the “psychology” that Meyerson says the mainstream economists leave out of their models? Where is his rebuttal of the mountain of evidence that regulation and social insurance (such as federal deposit insurance) create “madness” through the construction of perverse incentives and moral hazard?

The mathematical economists might have been too busy with their models to notice that in the real world intervention was, and remains, rampant. Meyerson dislikes some of the right things. But his ignorance of Austrian economics keeps him from seeing the full picture. The free market didn’t fail — because there was no free market.

I was honored to be a part of the event, and I warmly thank my hosts, especially  Paweł Toboła-Pertkiewicz and Jan Malek, for their kind hospitality. They are most eager to bring FEE to the attention of the Polish public, so they arranged for me to be interviewed by an Internet television host, a radio reporter, and a business-newspaper reporter. They also arranged for me to speak to a gathering of students who were eager to hear the libertarian perspective on the financial turmoil. A lively discussion followed. All this occurred immediately after my overnight flight and arrival in Warsaw, but the enthusiasm was a tonic for this weary traveler. (Pawel’s pictures of the events are here.)

It was certainly a pleasure to see such enthusiasm for Bastiat and his work in Poland. The two-day conference drew 90 highly motivated people. I learned, among other things, that Bastiat was first translated into Polish in the 1860s. So the Poles are not newcomers to the great French liberal economist, who lived from 1801 to 1850. American and French fans of Bastiat have long been amused by the fact that he is better known in the United States than in France. Apparently he is better known in Poland too. Paweł, who organized the conference, explained that when he asked the French Institute in Warsaw about holding the conference there to honor a French economist, the official was delighted by the request. He had just one question: Who is this Bastiat?

The passion for liberalism (libertarianism), Bastiat, and Austrian economics that I saw during my brief visit bowled me over. After Bastiat’s, the most common picture at the conference was Ludwig von Mises’s. The conference audience couldn’t have been more eager to exchange ideas and ask questions of the speakers. Thanks to Pawel, the great liberal works are being translated into Polish, including FEE founder Leonard Read’s I, Pencil and FEE president Lawrence Reed’s Great Myths of the Great Depression. The latest to be translated are the collected works of Bastiat, in two beautifully produced volumes.

Lack of Respect

Although I’ve read a lot about Bastiat over the years, I learned much from the lectures. Professors Jan Klos of John Paul II Catholic University  and Witold Kwasnicki of Wroclaw University spoke about Bastiat’s place in the modern world and in economic education. Unfortunately Bastiat has not gotten the respect he deserves in surveys of the history of economic thought. Joseph Schumpeter, for example, dismissed him as a mere journalist. On the other hand, Murray Rothbard had glowing praise for Bastiat’s work, though it lacked critical insights related to subjectivism and marginalism later developed by Carl Menger, founder of the Austrian school. (See Henry Hazlitt’s two-part discussion here and here. For an interesting discussion of what is missing from Bastiat’s theoretical framework, see Roderick Long’s article here.)

Robert Gwiazdowski, a lawyer and economist, and Mateusz Machaj of the Institute of Economic Sciences and a policy analyst with the Polish Mises Institute spoke on Bastiat’s economic theories, particularly his emphasis on the economic harmony of all “classes” in the free market. Kris Mauren of the Michigan-based Acton Institute for the Study Religion and Liberty, drawing on unpublished correspondence, discussed Bastiat’s struggle and eventual coming to terms with his Catholic faith. Jaroslaw Romanchuk, president of the Scientific Research Mises Center in Belarus, spoke about the nature of pro-freedom reform in the former Soviet-bloc countries, offering a radical program including free banking and competitive courts.

My own lecture covered Bastiat’s classic The Law, in which he argued that the only legitimate function of law is the protection of life, liberty, and property. When law is used in opposition to those things — when it authorizes “legal plunder” — it is destructive of the good and prosperous society, regardless of motives. I applied Bastiat’s thinking to some current issues, including the housing-financial turmoil and the push for government-run medicine. I also participated in a spirited panel with Romanchuk and activist-blogger Janusz Korwin-Mikke on the nature, role, and future of government. In response to comments by Korwin-Mikke, I emphasized that the first modern peace movement was launched by the liberals, such as Bastiat (who sat on the left side of the French Assembly with “socialist” Pierre-Joseph Proudhon), and his free-trade counterparts in England, Richard Cobden and John Bright.

The conference concluded with a summation by Jacques de Guenin, founder and president of the Circle Frédéric Bastiat in France. I was gratified to hear Jacques twice praise FEE for its long-time promotion of Bastiat’s ideas.

A high point of the conference was the screening of the Acton Institute’s latest film, The Birth of Freedom, a sweeping and stirring look at the historical evolution of individual liberty. Kris Mauren led an energetic discussion at its conclusion.

Scant Economic Reform

The former communist countries have made only halting progress in the transition to freedom since 1989. They have more political freedom but have made much less headway in reforming their economies. State businesses have often been privatized more in appearance than fact. The same goes for Poland, where the government holds life-and-death control over business through the central bank and licensing power. In a long dinner discussion with a Polish businessman, I learned that 20 years after the fall of communism there, the government still pervades the economy, dispensing favors and burdens in order to reward and cultivate friends and punish opponents. The economy is far from free. In some cases, the same people who ran businesses under the communist regime run them today. They’ve simply changed hats.

The lesson here is that firms’ outward forms are of secondary importance. What matters is who controls them. Nominal private ownership under political control is essentially the same as direct state ownership. Regular people are still victimized — by being denied economic opportunity and a chance for a better standard of living. All the while, they are told the regulation is for their own good. This leads me to conclude that politics is the art of seducing people into cooperating in their own exploitation.

This is why it is a hopeful sign that Bastiat is being promoted in Poland. If his essays, which are so effective at conveying basic economic lessons in terms accessible to everyone, can be disseminated and discussed widely, perhaps people will understand the damage done by government and demand that the politicians stop the legal plunder.

It happened again. On page 31 I came across this:

Socialists look upon people as raw material to be formed into social combinations. This is so true that, if by chance, the socialists have any doubts about the success of these combinations, they will demand that a small portion of mankind be set aside to experiment upon. . . . And one socialist leader has been known seriously to demand that the Constituent Assembly give him a small district with all its inhabitants, to try his experiments upon.

Two things occurred to me as I read this. First, you don’t have to be socialist to believe that people are raw material to be experimented upon. And second, in modern America, doubts or no doubts about success, experiments can be run on the entire country at once. No need to first try things out on a small district. When Americans appreciated the virtue of decentralizing power — “federalism” — grand experiments at worst could be done only in individual states because according to the consensus, the national government was supposed to be limited by the Constitution. (As I’ve written before, such a reading of the Constitution, a political document full of compromises and deliberate ambiguities, is at best a loose construction. However, I’m glad it was the dominant interpretation for some years after Thomas Jefferson’s election in 1800, and I would love to see it become dominant again.) That consensus essentially died in the War Between the States, and Alexander Hamilton’s revived vision of a consolidated nation has endured fairly continuously ever since.

As for point one, I have in mind the current administration. The word “socialist” (as well as “fascist”) is thrown around too glibly today, and everyone ought to be more careful. Lots of bad things are being proposed that would interfere with the market process, but no one in power is calling for replacement of the market with central planning. Ludwig von Mises called the philosophy behind the mixed economy “interventionism, and we ought to be working to make that word the pejorative we know it deserves to be.

Point two, of course, refers to the Obama administration’s experiments for the health-insurance, financial, and energy industries. Without getting into details here, I want to emphasize the sheer presumptuousness of those experiments. Those are our lives they are fooling with.

Bastiat brimmed with controlled outrage at the French politicians and writers who so blithely presumed that other people’s lives were theirs to dispose of in grand experiment. He dissected the classical notion, popular among the pundits of his day and ours, that individuals are inert until a wise leader comes along invests them with a principle of motion.

[T]hese writers on public affairs begin by supposing that people have within themselves no means of discernment; no motivation to action. The writers assume that people are inert matter, passive particles, motionless atoms, at best a kind of vegetation indifferent to its own manner of existence. They assume that people are susceptible to being shaped — by the will and hand of another person — into an infinite variety of forms, more or less symmetrical, artistic, and perfected….

These socialist writers look upon people in the same manner that the gardener views his trees. Just as the gardener capriciously shapes the trees into pyramids, parasols, cubes, vases, fans, and other forms, just so does the socialist writer whimsically shape human beings into groups, series, centers, sub-centers, honeycombs, labor-corps, and other variations. And just as the gardener needs axes, pruning hooks, saws, and shears to shape his trees, just so does the socialist writer need the force that he can find only in law to shape human beings. For this purpose, he devises tariff laws, tax laws, relief laws, and school laws.

This superior attitude is palpable throughout the Obama administration. One sees it in the words and tone of the president, Geithner, Summers, Emanuel, Sebelius, Clinton, and their allies in Congress. In a profound way, they are the anti-egalitarians. They know better than we. They exercise powers that we mere individuals out of government can never possess. They dictate to us, but we can’t dictate to them. They get to determine our lives in important ways — which means that in those respects we don’t.

Yes, they claim they are our representatives. It’s a baseless claim! They are not our representatives. They don’t know us, and they can’t really care about us. They are our rulers, gratifying their ambitions to “make a difference” — whether we want it made on our lives or not. If we don’t comply, they can take our liberty, our property, even our lives.

Depriving them of that power is a long and arduous intellectual process, requiring a philosophical sea change. In the meantime, those of us who know that we, and not they, own our lives, need a battle cry. In dedication to Bastiat, I propose this:

We shall not be experimented upon!

Economist William Niskanen writes, “We did not have a health care crisis in 1940 when few people had health insurance.”  In fact, that year only 10 percent of Americans had such insurance (henceforth imagine ironic quotation marks). But World War II was a bonanza for the industry, especially Blue Cross Blue Shield. Government economic controls prohibited firms from attracting or keeping workers with higher wages. So someone hit on the idea of supplementing wages with noncash compensation, specifically, health insurance. The government said okay and the rest is history. Employee insurance was untaxed, creating a bias toward employer-provided health plans. If an employer bought a $5,000 plan for a worker, that worker got the full $5,000 benefit. But if the employer paid the worker $5,000 in cash, the worker would pocket $5,000 minus federal and state taxes. He’d need more than $5,000 to buy a $5,000 policy.

The government intervened in another way. According to Niskanen, “[T]ax and regulatory preferences for the Blues displaced the older form of commercial indemnity policies with policies providing cost-based reimbursement.” This act of social engineering — arrogant politicians and bureaucrats always think they know better than the collective wisdom stimulated by the free market — had huge (and presumably) unintended consequences that account for many of our current problems. Under the old-style indemnity plans (which individuals shopped and bought for themselves), contracting a catastrophic disease triggered a fixed insurance payment — to the policyholder – according to an agreed-on predetermined schedule. The money was hers. If she could find services that cost less than the insurance payment, she pocketed the difference. Of course, this provided an incentive to be cost-conscious in buying medical care. Homeowners’ and other types of insurance still works like this.

In contrast, under the Blue Cross Blue Shield model pushed by government — which began not as insurance but as a prepayment plan for doctors and hospitals — the policyholder never sees a dime. Treatment simply sets in motion a process in which the insurance company sends a check to a hospital, lab, or doctor. No treatment, no payment. The individual has no reason to shop around (there can be great variation in prices), or to question whether a test or procedure is necessary, or to even ask what anything costs. What’s the point? It would seem only to save the insurance company money.

The insurance companies take this into account when negotiating with providers and employers who buy coverage on behalf of their workers. A key problem here is the disconnect between cost and benefit (which would be aggravated by the Obama plan). In most cases employers pay for their workers’ coverage with money that otherwise would have largely gone into cash wages. To the workers, it looks like free (or pretty cheap) coverage. Because of competition among employers and the rigged tax laws, coverage has become more luxurious, including services for situations that are not even insurable. A good example is maternity benefits. Pregnancy is not a disease, is largely preventable, and usually results from a volitional act.  From a true insurance perspective, it’s ridiculous to expect coverage. (It would be like insurance against gaining weight.) The same could be said for many other “conditions” that are covered today. Well-baby care? Is that insurance against a baby’s being well? (Orwell was right: corrupt the language and one can get away with anything.)

State Mandates

To make matters worse, state governments have mandated that all “basic” policies include coverage for situations that are either uninsurable or unlikely to affect most people. Most people shopping for insurance in a free market would never buy this coverage because it would unnecessarily increase their costs. If they decided later on that they wanted, say, chiropractic or acupuncture, they would pay for it out of savings.

Writing in The Freeman, John Seiler reported that the Congressional Budget Office estimated that “for every 1 percent increase in the cost of insurance, 200,000 to 300,000 people nationwide lose their insurance.” He adds, “State mandates keep about one quarter of Americans from getting health insurance, according to John C. Goodman, president of the Dallas-based National Center for Policy Analysis, a free-market think tank.”

In 2007 the average number of mandates in the United States was 36, with a high of 62 (Minnesota) and a low of 13 (Idaho). Might this have something to do with the size of the uninsured population? The Great Humanitarians in Washington seem strangely incurious about that.

You and I could evade the mandate plague somewhat if we were free to buy policies offered in low-mandate states. But — under the federal McCarran-Ferguson Act — we aren’t free. That 1945 decree shelters the states — and the insurance companies — from the interstate competition that might have reined in their regulatory regimes.

Do we have mandates because we are too dumb to know we need coverage for chiropractic, acupuncture, social workers, alcoholism and drug-abuse treatment, marriage counseling, hearing aids, toupees, contraceptives, and so on, ad infinitum? No. We have mandates because the providers of those products and services wined and dined enough state legislators to get these special-interest bills enacted. The insurance companies don’t mind: They can recover the cost from people who don’t realize they are paying for the “free” (or cheap) “services” because they think their bosses are paying for the coverage.

State regulation also sets up barriers to entry in the insurance industry. As a result, each state is a walled fortress that protects established insurance companies from competition. This doesn’t make their profits spectacular (see this), but it creates safety and stability, which are worth something.

No Free Market

So no sympathy here for these state creatures of privilege and protection. We can safely guess that today’s companies look nothing like companies would look in a free insurance market. The federal and state governments — to some extent haphazardly — have almost completely determined the nature and shape of the industry, giving us a classic government-sponsored cartel.

But…

None of this justifies what President Obama and his ilk call healthcare “reform.” They merely propose more of what we already have: more “free” insurance for more people, more coverage for more uninsurable situations, lower out-of-pocket costs — all of which means less cost-consciousness and higher prices, which seeds the ground for price controls and rationing. In the name of creating competition, Obama would further suppress it, rather than dismantling the current anticompetitive regime.

The solution to the problems caused by what I’ve described above cannot be to encourage people to believe, childishly, that they have a right to health care — that is, a right to other people’s labor — or that resources are not scarce. Yet that is what Obama & Co. are doing. A core principle of their scheme is that no one could be turned down for insurance because they are already sick. That’s not insurance; it’s welfare, with the costs to all of us disguised and the politicians unaccountable.

The other night Obama also demanded that insurance companies cover preventive services — physical exams, colonoscopies, mammograms, etc. — for free. He also insists on low caps on out-of-pocket expenses and unlimited lifetime payouts.

But none of this is free. Someone will have to pay the doctors, clinics, and hospitals. Who? The answer is: the insurance companies. Where will they get the money?

One need not sympathize with the insurance companies to see that it it sheer demagoguery for Obama & Co. to rail sanctimoniously against them for not giving away their shareholders’ and employees’ money on demand. They’re businesses not charities. If the “reformers” think they can run a better company, let them try –  in the free market. (That company executives favor most of Obama’s plans tells us that forcing people to buy insurance is worth more to them than the coverage mandates.)

By all means, strip the insurance companies of the privileges governments now provide. Throw them into the free market and let them fend for themselves. Open the gates to new entrepreneurs and innovators. But do not expand the rotten system that increases and hides costs while leading people to believe that medical care is manna from heaven. Pandering to people’s wish for free services ought to get a politician — even a president — hooted off the stage.

Orwell, a man of the “left,” could not remain silent in the face of the horrors of Stalinism. Twice — during the Spanish Civil War and again at the dawn of the Cold War — he refused to permit his comrades to blind themselves to where their collectivism had led and could lead again. For his favor he was called a conscious tool of fascism, a stinging accusation considering he had gone to Spain to fight fascism. (But for a few inches, the bullet that penetrated Orwell’s neck in Spain would have denied us the latter warnings, Animal Farm and Nineteen Eighty-Four. We would have never known what the fascists had cost us.)

Hayek, a man of the “right,” risked ostracism and worse in 1944 by publishing The Road to Serfdom, in which this Austrian-turned-Briton, writing in England at the height of World War II, warned that central economic planning would, if pursued seriously, end in a totalitarianism indistinguishable from the Nazi enemy. That couldn’t have been easy to write at that time and place — central planning was much in vogue among the intelligentsia. While a good deal of the reception was serious and respectful, a good deal of it was not. Herbert Finer, in Road to Reaction, called Hayek’s book “the most sinister offensive against democracy to emerge from a democratic country for many decades”; it expressed “the thoroughly Hitlerian contempt for the democratic man.”

Not surprisingly, it was The Road to Serfdom that brought Orwell and Hayek together in print. Orwell briefly reviewed the book along with Konni Zilliacus’s The Mirror of the Past in the April 9, 1944 issue of The Observer. The man who would publish Animal Farm a year later and Nineteen Eighty-Four five years later found much to agree with in Hayek’s work. He wrote:

Shortly, Professor Hayek’s thesis is that Socialism inevitably leads to despotism, and that in Germany the Nazis were able to succeed because the Socialists had already done most of their work for them, especially the intellectual work of weakening the desire for liberty. By bringing the whole of life under the control of the State, Socialism necessarily gives power to an inner ring of bureaucrats, who in almost every case will be men who want power for its own sake and will stick at nothing in order to retain it. Britain, he says, is now going the same road as Germany, with the left-wing intelligentsia in the van and the Tory Party a good second. The only salvation lies in returning to an unplanned economy, free competition, and emphasis on liberty rather than on security. In the negative part of Professor Hayek’s thesis there is a great deal of truth. It cannot be said too often — at any rate, it is not being said nearly often enough — that collectivism is not inherently democratic, but, on the contrary, gives to a tyrannical minority such powers as the Spanish Inquisitors never dreamed of.

This is a significant endorsement, for no one understood totalitarianism as well as Orwell. Indeed, in Why Orwell Matters, Christopher Hitchens points out that Nineteen Eighty-Four impressed Communist Party members behind the Iron Curtain. He quotes Czeslaw Milosz, the Polish poet and Nobel laureate, who before defecting to the West was a cultural attaché for the Polish communist government: “Orwell fascinates them [members of the Inner Party] through his insight to the details they know well…. Even those who know Orwell only by hearsay are amazed that a writer who never lived in Russia should have so keen a perception into its life.” (An audio interview with Hitchens about Orwell is here.)

But true to his left state-socialism, Orwell could not endorse Hayek’s positive program:

Professor Hayek is also probably right in saying that in this country the intellectuals are more totalitarian-minded than the common people. But he does not see, or will not admit, that a return to “free” competition means for the great mass of people a tyranny probably worse, because more irresponsible, than that of the State. The trouble with competitions is that somebody wins them. Professor Hayek denies that free capitalism necessarily leads to monopoly, but in practice that is where it has led, and since the vast majority of people would far rather have State regimentation than slumps and unemployment, the drift towards collectivism is bound to continue if popular opinion has any say in the matter.

…Capitalism leads to dole queues, the scramble for markets, and war. Collectivism leads to concentration camps, leader worship, and war. There is no way out of this unless a planned economy can somehow be combined with the freedom of the intellect, which can only happen if the concept of right and wrong is restored to politics.

Short Shrift

It’s disappointing to see Orwell give such short shrift to Hayek’s positive thesis. He is glib and dogmatic, which is unbecoming a serious intellectual such as Orwell. His ignorance of economics leaps from the page.

“[A] return to ‘free’ competition means for the great mass of people a tyranny probably worse, because more irresponsible, than that of the State.” It’s hard to believe that someone so familiar with Stalinism could have written that. Even without knowing much economics, could he really have thought that what goes on in market-oriented societies, even during depressions, could be worse than the famine Stalin inflicted on the Ukrainians, the show trials and executions, or the labor camps in Siberia?

“The trouble with competitions is that somebody wins them.” In a market producers compete to better serve consumers. The losers in that competition are not exiled or executed. They find other ways to serve consumers, just as producers are trying to serve them.

“Professor Hayek denies that free capitalism necessarily leads to monopoly, but in practice that is where it has led….” Where has monopoly arisen without the aid of the State? We find no market-generated monopoly in England or the United States. There, major business interests actively promoted protectionism and other interventions precisely to tamp down competition and protect their market shares. Of course, for many people, Orwell presumably among them, that is capitalism, a topic I return to below. (I should note that Hayek forswore laissez faire in his book, but that is a topic for another day.)

“[T]he vast majority of people would far rather have State regimentation than slumps and unemployment….” But that’s a false choice. Slumps and unemployment, as Hayek and his mentor Ludwig von Mises taught, are products of central-bank manipulation of money and interest rates, that is, of government not of the free market. The Great Depression, which must have been on Orwell’s mind, was no exception. The real choice is between freedom and security (including mutual aid) on the one hand, and State “regimentation,” slumps, and unemployment on the other.

I must pause here to focus on Orwell’s disgraceful use of the word “regimentation.” I say “disgraceful” because he committed the sin he himself so eloquently condemned in his justly famous essay “Politics and the English Language”: the sin of euphemism. In that great essay he wrote:

In our time, political speech and writing are largely the defence of the indefensible. Things like the continuance of British rule in India, the Russian purges and deportations, the dropping of the atom bombs on Japan, can indeed be defended, but only by arguments which are too brutal for most people to face, and which do not square with the professed aims of the political parties. Thus political language has to consist largely of euphemism, question-begging and sheer cloudy vagueness. Defenceless villages are bombarded from the air, the inhabitants driven out into the countryside, the cattle machine-gunned, the huts set on fire with incendiary bullets: this is called pacification. Millions of peasants are robbed of their farms and sent trudging along the roads with no more than they can carry: this is called transfer of population or rectification of frontiers. People are imprisoned for years without trial, or shot in the back of the neck or sent to die of scurvy in Arctic lumber camps: this is called elimination of unreliable elements. Such phraseology is needed if one wants to name things without calling up mental pictures of them. Consider for instance some comfortable English professor defending Russian totalitarianism. He cannot say outright, “I believe in killing off your opponents when you can get good results by doing so”. Probably, therefore, he will say something like this:

“While freely conceding that the Soviet regime exhibits certain features which the humanitarian may be inclined to deplore, we must, I think, agree that a certain curtailment of the right to political opposition is an unavoidable concomitant of transitional periods, and that the rigors which the Russian people have been called upon to undergo have been amply justified in the sphere of concrete achievement.”

Regimentation is the least of what goes on under a totalitarian regime.

Capitalism versus the Free Market

“Capitalism leads to dole queues, the scramble for markets, and war.” I think that part of the problem for Orwell is that a truly free market is not among the possible options. For him and many others, the choice is between a system run for employers and one run for workers. (The preferable alternative is not obvious.) In this view, the former is capitalism, sometimes dressed up as “the free market,” and the latter is socialism. We shouldn’t be too hard on Orwell for thinking this way, for many defenders of the market are just as careless when they write about mixed economies such as the one in the United States. Despite pervasive government intervention, we often hear business conduct defended because “under capitalism” consumers have the power to punish firms that ill-serve them. Tell that to consumers who chose not to buy GM and Chrysler cars. Tell that to people who lost land through eminent domain so that a big-box chain might prosper. Generations of business-inspired intervention to some extent must have rigged the market against consumers and workers. If not, what are the economists complaining about?

As for his inclusion of war in his list, let it be said that the scramble for markets and other economic objectives cannot be a sufficient condition for war. War requires the State, that is, the socialization of costs through taxation and conscription.

One wonders how Orwell avoided despair. He couldn’t accept (state) capitalism, and he saw the totalitarian tendencies of socialism up close. Yet he could write, “There is no way out of this unless a planned economy can somehow be combined with the freedom of the intellect, which can only happen if the concept of right and wrong is restored to politics.” (Emphasis added.)

Hadn’t he just read Hayek’s Chapter 11, “The End of Truth,” in which Hayek described how a serious commitment to central planning must produce “contempt for intellectual liberty”?

The word “truth” itself ceases to have its old meaning. It describes no longer something to be found, with the individual conscience as the sole arbiter of whether in any particular instance the evidence (or the standing of those proclaiming it) warrants a belief; it becomes something to be laid down by authority, which has to be believed in the interest of unity of the organized effort and which may have to be altered as the exigencies of this organized effort require it.

The general intellectual climate which this produces, the spirit of complete cynicism as regards truth which it engenders, the loss of the sense of even the meaning of truth, the disappearance of the spirit of independent inquiry and of the belief in the power of rational conviction, the way in which differences of opinion in every branch of knowledge become political issues to be decided by authority, are all things which one must personally experience — no short description can convey their extent.

But of course Orwell had experienced those things in Spain and knew how it was in Russia. He certainly put a heavy burden on that word “somehow.” How restoring the concept of right and wrong to politics would make central planning either decent or practical is a mystery no one has solved. (Of course, Mises had long before shown that socialism could not be practical because without prices arising out of the exchange of privately owned means of production, the socialist planner could not make rational calculations with respect to what should be produced, in what manner, and in what quantities.)

To end on a partly optimistic note, though Orwell presumably would not agree, central economic planning is not on the modern agenda. The threat today is not state socialism. It’s bureaucratic corporatism dressed up as progressive democracy.

The media spotlight on the late Sen. Edward Kennedy is the latest example. Admittedly, it’s an extreme case because of his family history. Nevertheless, when was the last time a cable news channel celebrated the life of a recently deceased entrepreneur or founder of a great company? It doesn’t happen, and that should offend our sense of justice. Producers make things they think we will value and offer them for a price they think we’ll be willing to pay. All they can do is proffer, persuade, and cajole. Free exchange is win-win. But we, individually, can say no. We can buy from a competitor or not buy at all. And guess what? Nothing happens to us. We don’t get threatening letters. We don’t find our wages garnished or our bank accounts frozen. We don’t get sent to prison. We’re left alone. This is only contradicted when companies are close to government. You don’t get to say no to helping to bail out Chrysler, GM, or too-big-to-fail financial companies.

Now contrast what happens in a market with what happens in the political sector. Politicians talk all the time about making us better off, but they are thwarted by an iron fact they prefer to ignore: Government provides no net benefits. What it gives away it has first taken from others under threat of punishment. It has to break windows in order to bestow benefits. Politicians simply move scarce resources around, defying consumers, who in a free market would direct them to uses that they believe would better serve their purposes. Government is the antonym for choice.

This means the politicians truly can do good only by doing what they abhor: giving up power. That happens only on rare occasions. To his credit, in the late 1970s Kennedy helped divest the government of the power to regulate the commercial airline and trucking industries. Except for those who lost State privileges, everyone has benefited from competition and lower prices. (Deregulation didn’t go nearly far enough, but it was a start.) That’s right: The “Reagan years” preceded Reagan. Ironically, today “deregulation” is a dirty word to most people who adore Kennedy.

Unfortunately, Kennedy never let himself see that the healthcare industry needs the same approach he applied to air travel and trucking.

So why do mere distributors of wealth — politicians — get so much more flattering attention in death (and life too) than producers of wealth?

I see several reasons, only a few of which I’ll mention. One is that for many people the market deals in material goods, while government is thought to be concerned with (social) justice. But this isn’t true. The market is built on justice: self-ownership, self-determination, social cooperation, and mutuality — all of which are undermined by the corporatist welfare state we labor under.

Ignorance of Economics

Another reason is that most people do not understand the marketplace. Bryan Caplan analyzes this ignorance in The Myth of the Rational Voter. The common view is that trade is zero-sum (a loser for every winner) and that profit is added to the price of goods rather than squeezed out of the costs. Such an attitude leads, at best, to a lack of appreciation for the efforts of entrepreneurs, who take risks to bring us new things in new ways. Besides this, many people take today’s vast array of accessible goods and services for granted, as though it’s a fact of nature rather than the product of ingenuity, foresight, and risk-taking. Another factor is that improvements in living standards tend to be incremental and undramatic. Even a big innovation, such as the personal computer or mobile phone, soon seems commonplace. (See Donald Boudreaux’s take on this.)

For most people an understanding of how markets work is not intuitive. It requires the grasp of such elusive ideas as unplanned order, entrepreneurial profit, and prices as capsules of (imperfect) information. These concepts can’t be conveyed in a television sound bite or editorial cartoon. In contrast, government “solutions” are simple. Total health insurance is too expensive? Pass a bill decreeing it to be universal and affordable. Next problem.

A politician who makes a career of proposing such “solutions” is likely to win admiration not only from the public but also from the news media, whose reporters and commentators know as little economics as their readers and viewers. The dynamic leader who gives impassioned speeches and sponsors legislation on behalf of social justice appears heroic in part because few people can find the logical flaws in the program. Observers see only his presumed motives. But motives divorced from understanding are worthless — even dangerous. In a more sensible world, proposing ends while being oblivious to means would be a sign of irresponsibility, the intellectual equivalent of drunk driving. Maturity lies in understanding that, as Steven Horwitz reminds us, ought implies can. That’s where economic logic enters the picture.

During the endless hours of television coverage of Kennedy’s death, someone mentioned that when he was stricken with brain cancer, he received the quality of medical care that “he wanted for everyone.” But such things don’t come from wishing, proposing, or decreeing.

There’s a moral side here also. Business is for profit. Government is not. At least that’s how it looks on the surface. Apart from ignorance of the economics of profit (see Horwitz on this), there is a moral prejudice against profit — that is, against the pursuit of self-interest. People who do things for profit do not get the respect of those who seem to act from other motives. This is a big subject that can only be touched on here. Suffice it to say that 1) if life is a value, then the pursuit of self-interest is praiseworthy; 2) as Adam Smith taught, given the right institutions general good grows out of its pursuit; and 3) politicians are as self-serving as anyone else. What makes them different is that because they have power their incentives are out of alignment with the public’s well-being.

Nevertheless, for most people government, despite its occasional scandal and atrocity, is generally trusted (despite what they say), while business, despite its routine creation of benefits, is generally distrusted. (I acknowledge that the unholy alliance of business and state — corporatism — justifies a good deal of mistrust, but it doesn’t account for all of it.)

Let us hope for the day when the passing of a politician gets little more than an inch or two in the obituary section of the newspapers.

Who could be against those things?

Well, Obama for one, followed by House Speaker Nancy Pelosi, House member Barney Frank, and everyone else who favors what is question-beggingly called reform. The word reform suggests not just change but improvement. Therefore, to call the proposals to nationalize the medical-insurance industry reform is to assume precisely what is in dispute and must be proved. The argument is — or should be — over whether the proposed changes indeed are reform. To call them reform before the debate has even begun is to rig the discussion. It’s an old — and sadly effective — bit of sophistry.

But let’s get back to competition and choice. I contend that what Obama favors would produce the opposite of competition and choice: cartel and restriction. This is so clear that it’s hard to believe an intelligent person surrounded by economic advisers wouldn’t know this.

We’ll use HR 3200 as our guide. Most of the provisions of this bill are likely to be in any final legislation, with the possible exception of the government-operated insurance program, or “public option.”

The bill begins with a provision “to establish standards to ensure that new health insurance coverage and employment-based health plans that are offered meet standards guaranteeing access to affordable coverage, essential benefits, and other consumer protections.” No insurance policy would be deemed qualified unless it satisfied the conditions imposed by the government. This is important because under the bill, every individual would be mandated to have a “qualified” health plan. A sub-standard plan that nevertheless satisfied a particular consumer — such as low-cost high-deductible catastrophic coverage — would be forbidden.

According to the bill, a plan would be accepted as qualified only if, among other things, it:

• covered preexisting conditions without limit;
• accepted all applicants;
• guaranteed renewal;
• charged everyone, regardless of health status, the same premium within an area, with the exception of age and family variations defined either by the legislation or by state law;
• had achieved the medical loss ratio defined by the Health Choices Commissioner (the ratio refers to the percentage of revenues paid in benefits; companies that fell short would have to give policyholders rebates);
• imposed no annual or lifetime limit on coverage; and
• was “equivalent … to the average prevailing employer-sponsored coverage.”

The “essential benefits package” would have to cover:

• hospitalization;
• outpatient and emergency services;
• professional services;
• incidental services, supplies, and equipment;
• prescription drugs;
• rehabilitative and habilitative [?] services
• mental-health and substance-use disorder services
• preventive services (Obama has specified physical exams, mammography, and colonoscopy);
• maternity care; and
• well-baby and well-child care

The bill would also set up a Health Benefits Advisory Committee, a public-private panel of “experts,” “to recommend covered benefits and essential, enhanced plans.”

Government Definition

There are other requirements but we need not go into them. The point of this tedious recitation is to convey to the reader how precisely the government would define private insurers’ business practices and products. To varying degrees state governments already define these things; this is part of the corporate-state bargain in which companies get cartel rents through protection against new competition in return for complying with various regulations that they take a hand in writing. But this would be the first time that the national government would dictate what minimum health coverage would include and other company practices. For that reason, such a law would effectively create a national health-insurance cartel. Big Insurance, which has been working with the Obama administration behind the scenes, has no problem with any of this.

Now let’s look at the “public option.” This would be a government-operated insurance plan that would be offered in a “Health Insurance Exchange,” which the government would establish “to facilitate access of individuals and employers, through a transparent process, to a variety of choices of affordable, quality health insurance coverage.”

Apparently members of Congress and the administration don’t know about the Internet, which performs the same function for every other good and service. If there’s no health-insurance market on the Internet, it may be because government forbids interstate competition, in order to protect the states’ ability to burden their residents with coverage mandates for hair transplants, in vitro fertilization, and other things offered by privileged businesses.

In case there is any doubt about the nature of the “competition” that is to take place in the exchange, the bill states, “The Commissioner shall specify the benefits to be made available under Exchange-participating health benefits plans during each plan year.” No company may offer so-called enhanced, premium, and premium-plus plans unless it also offers a basic plan. (These are defined in the bill.) State mandates would continue to apply if a state and the commissioner work up a suitable agreement.

According to the bill, the public option would be a “low-cost” high-quality plan that would have to follow the same rules as private exchange-participating plans. The secretary of Health and Human Services would set premiums adequate to cover benefits and administrative costs. However, the government plan would get a $2 billion starter loan from the Treasury (no interest rate mentioned), along with enough money to cover claims for the first 90 days.

To avoid the charge that the public option would have continuing access to the Treasury, the bill states, “Nothing in this section shall be construed as authorizing any additional appropriations to the Account, other than such amounts as are otherwise provided with respect to other Exchange-participating health benefits plans.” (That’s right — private companies will get subsidies.)

The secretary would be authorized to set reimbursement rates for providers, generally using Medicare rates, except for a three-year “initial incentive period,” in which more would be paid. What happens if a doctor thinks the bureaucratically set rates are too low and refuses public-option patients? I couldn’t find an answer in the 1,000-plus bill, but I don’t think I’d want to be in his white coat. The licensing power is awesome.

The immediate question that should arise about the public option is why — if it must support itself through premiums  — the government needs to set it up in the first place. What’s the point of having one more entity selling the same thing private insurers must sell under the same pricing constraints?

Advocates of the public option would say that since it would be a nonprofit enterprise run by public-spirited personnel, it would keep the private firms honest. We’ll get to this in a minute. I’ll just point out here that “The Secretary may enter into contracts for the purpose of performing administrative functions.” That should allow for plenty of favoritism and rent-seeking.

We are entitled to some skepticism toward the bill’s limitation on subsidies to the public option. Based on experience — the Postal Service, Fannie Mae, Freddie Mac, and the federal flood-insurance program, among others — we can expect that the public option will be bailed out by Congress when it runs into trouble. The language of the current bill can always be amended later. The starter loan could be forgiven (see the flood program). Only naïveté or disingenuousness could prompt one to insist otherwise.

That’s a small part of what the bill would do. But remember, the stated objective is competition and choice. So we must ask: What relation does the bill have to those objectives? If we understand the nature of competition, the answer must be: no relation at all.

Instead of competition the bill would create a newer, bigger insurance cartel, directed from Washington. Calling Obama’s exchange a “competitive market” is like calling a graveyard a “bazaar.”

Discovery through Competition

As Ludwig von Mises and F. A. Hayek elaborated, competition is valuable not primarily as a contest among producers of known goods and services using known methods of production and business practices. Rather, to use Hayek’s phrase, competition is a discovery procedure. (I believe “process” would have been the better word.) What it does is teach us things we didn’t know before the competition took place and might not learn otherwise. What kind of things? Things such as: which hitherto-unknown products best serve consumers’ interests as they see them, at what price, and through which low-cost methods. Such things can’t be known in advance; computers can’t give us the answers after data entry. The most relevant “data” do not exist as such! The information is decentralized and much of it, such as nuanced consumer preferences, is rarely articulated. Rather, it is revealed as would-be producers and consumers go about their business, improvising on the spot in their efforts to improve their conditions. It certainly is not available to a bureaucracy or panel of experts.

The importance of this discovery process should be clear for any good or service, but how much more so for medical services, where the potential for variation in individual needs and preferences is virtually infinite!

Obama’s plan shows no appreciation for competition’s discovery role. He and his experts claim already to know — or will later decide — what insurance products should be offered and what business practices should be used. The bill would permit no variation — that is, no competition. There would be none of the free market’s entrepreneurial trial and error, in which firms offer competitive products, and consumers render verdicts on them.

The public option would not increase competitiveness. On the contrary, because of its implicitly privileged position it could engage in predatory pricing and force private firms out of the market or prevent new ones from entering. The record of the federal flood-insurance program is instructive.

The tipoff that Obama can’t really be interested in competition is his disparagement of profit. Yesterday he said that a good thing about the public option is that “there wouldn’t be a profit-motive involved.” Apart from this revealed bias against self-interest and his failure to understand that mutual benefit can be achieved through its pursuit, Obama shows no sign of grasping the communications role performed by profit and loss in a market. (See Steven Horwitz’s “Profit: Not Just a Motive.”) At any time scarce resources and labor could be used in a large variety of ways to produce a large variety of things. Some of those uses and methods would serve consumers better than others. Tradeoffs are unavoidable. How are consumers to make their subjective preferences known? In the market they do so by, in effect, rewarding profits and imposing losses through their decisions about what to buy and what not to buy. Profit indicates that producers are doing what consumers want: turning lower-valued inputs into higher-valued outputs. The profit-loss system, to the extent it has been allowed to work, has consistently produced more for less. As Mises and Hayek showed, there is no alternative to market prices and profit-loss for directing productive efforts and resources to where we most want them. No bureaucratic approach can solve this “knowledge problem.”

For all his talk about choice and competition, what Obama proposes is more of what we already labor under: corporate-state bureaucratic decision-making. The status quo is not the free market. It is a system of government-business collusion that, among other things, welds workers to their employers. Obama’s scheme would simply be more of the same. The reason Big Pharma and Big Insurance favor the scheme is that everyone would be forced to buy their products or coverage for their products, with the taxpayers picking up most of the tab.

Obama offers no radical break with the present but only a further application of the statism that brought us the current morass.

This is most obvious when the advocate of a State solution says, as President Obama said, “The scary thing is to do nothing.” Anyone who thinks that the free-market solution means doing nothing is either ignorant or dishonest. Sorry, I see no other alternative. It doesn’t take much looking to see that we have nothing like a free market in medical services and insurance. Insisting we do is an effective way to assure that the free market is never considered as an alternative to the current State-ridden system.

The statist also shows his lack of understanding (or of honesty) by loosely accusing the free-market advocate of “being in the pocket of the insurance and drug companies.” Is it impossible that someone could sincerely believe that the market solution is just and efficient? Those who throw this charge around miss a perhaps subtle point. A free-market advocate and big entrenched insurance companies could oppose the same proposal — say, a government-run insurance program — without having any other positions in common. The market advocate rejects not only the so-called public option; he also favors dismantling the entire protectionist-regulatory-monopoly-privilege system the insurance companies have enjoyed for generations. No insurance company favors that. Similarly, libertarians and pharmaceutical companies oppose government’s negotiating drug prices. But no Big Pharma company is likely to favor repealing the FDA, the monopolistic patent system, and other privileges because these interventions protect it from upstart competition.

There’s a deeper barrier keeping the honest advocate of nationalized medical care from truly hearing what the libertarian says: the (implicit) belief that medical care is a right, and its corollary, that no one should have to pay (very much) for these services.

This is where the discussion needs to be but usually isn’t, which accounts for the mostly unsatisfying outcome. There is no meeting of the minds on what is in dispute, much less on what ought to be done.

Someone who believes that medical care is a right will never accept that consumption of medical services should have anything at all to do with one’s income or wealth. That’s just wrong, he will think. What’s more, he’ll think there’s something deeply wrong with the market advocate for thinking this way. “What’s the market got to do with it?” he’ll wonder in horror. “We’re talking about medical care!”

The libertarian may never convince the statist, but the first (and perhaps the last) thing to be discussed should be whether medical care is a right. Of course, it can’t be a right. In the absence of a contract, no one can have a right to anything that must be provided by someone else’s labor. It really is that simple. The alternative proposition is in essence a slave proposition. Most people will never be persuaded by the excellent efficiency arguments against nationalized medicine — the fact that bureaucratic rationing and triage are inevitable with government in charge — if they cling to the medical-care-is-a-right theory. So we may as well have the debate there.

No Right, No Service?

The libertarian must also head the statist off at this pass: the inference that if you don’t believe health care is a right, you must believe that people of modest means would be — and even should be — without adequate medical attention.

Of course, this is ridiculous. Opposition to nationalized agriculture or housing doesn’t imply that people of modest means should starve or go homeless. When you consider how concentrated wealth was throughout history, it is astonishing how competent market-oriented society — despite all the State’s efforts to cripple it  — has been at delivering necessities and one-time luxuries to the masses. From the Industrial Revolution onward, to the extent people have been free to engage in enterprise, it was regular people whose living standard increased by orders of magnitude.

The point is that markets deliver, and medical care has been no exception. If the price of basic care has soared since World War II, we can largely thank all the ways government has unhinged demand from cost considerations. Much medical care is optional or marginal, and  if government, by disguising the true cost, makes it possible for people to overconsume it, those of modest incomes who don’t qualify for handouts will suffer the consequences.

It is simply wrong to believe that in a “freed market,” as Charles Johnson calls it, large numbers of people would  go without medical attention. A free society would be richer at all levels than our semi-free society because it would have none of the barriers that today impede economic self-advancement. (See Johnson’s article on the matter.) A freed medical system would be competitive, entrepreneurial, and innovative in getting services to greater numbers of people at reasonable prices. How do we know? We’ve see the same pattern in other industries that are far less straitjacketed than the medical industry. In case after case, what began as luxuries for the rich have become commonplace items for nearly everyone. A government-free medical industry would have no income-preserving professional licensing, no paternalistic drug prescriptions, no competition-inhibiting patents, no monopolistic certificates of need, no protectionist medical guild. In their place would be competition and entrepreneurship, the discovery process that serves consumers in ways we cannot imagine in advance

Demand-Side Innovation

Innovation would also emerge on the demand side. Again we can refer to history. In an earlier time Americans (and Britons and Australians) of modest means, including new immigrants, obtained medical care through sophisticated mutual-aid societies and in particular the institution called lodge practice. Exemplifying what Tocqueville identified as an American penchant for setting up associations, early Americans established “friendly societies” not only for social contact but for the safety net later provided, in coercive and much inferior form, by the welfare state. One member benefit of these societies was access to a family physician with whom the group contracted on an annual basis. “Lodge practice,” historian David Beito writes, “became particularly extensive in urban and industrial centers. In 1915, for example, Dr. S.S. Goldwater, Health Commissioner of New York City, went so far as to assert that in many communities it had become ‘the chosen or established method of dealing with sickness among the relatively poor.’” Lodge practice flourished until State-empowered organized medicine, whose members’ incomes were threatened by this unorthodox competition, put the screws to the “lodge doctors” it reviled. Who knows how mutual-aid would have evolved had it not been crowded out by “Progressives” aping Bismarck and wielding the power of taxation? What we do know is that people found a way to make medical care “universal and affordable,” that holy grail the politicians still haven’t located.

Free people are resourceful even when their resources are modest. The key is to keep government out of the way.

Admittedly, the sick and destitute would have had trouble joining a mutual-aid society. But a free and prosperous society would also be a generous society. History demonstrates it. As in the past, philanthropic foundations, charity hospitals, teaching hospitals, and pro bono medicine would all combine to provide for those who truly could not make it on their own. Government intervention undoubtedly makes these things less common. If laws mandate that all hospital emergency rooms treat whoever shows up with whatever ailment, we can anticipate that charitable efforts will be less abundant than in a free society.

We will never achieve the medical system — indeed, the society — worthy of free people as long as we are trapped in the juvenile mindset that someone owes us medical care. It is an absurd doctrine — is that someone also owed medical care? But worse, it is fodder for political opportunists, who will exploit this demand to increase State power at the expense of freedom and therefore dignity. If we follow this path, rationing of medical care might be the least of our worries.

But some defenders of government control acknowledge that rationing is the logical consequence of their ambition. They parry objections by saying in effect: “So we’ll have to ration. Big deal. We already have rationing — by the market.”

For example, Uwe Reinhardt, an economics professor and advocate of government-controlled medicine, writes, “In short, free markets are not an alternative to rationing. They are just one particular form of rationing. Ever since the Fall from Grace, human beings have had to ration everything not available in unlimited quantities, and market forces do most of the rationing.”

Sadly, interventionist economists are not the only economists who talk this way. Most free-market economists would agree that where there is scarcity there must be rationing and that the most efficient way to ration is by price, that is, through the market.

This is factually wrong and strategically ill-advised. As we’ll see, markets do not ration. Thus the healthcare debate is not about which method of rationing — State or market — is superior.

Let me be clear about what I am not denying. I am not denying that economic goods are by definition scarce and that at any given time we must settle for less of them than we want. I am also not denying that the marketplace is relevant in determining who gets how much of those scarce goods.

I am denying that this is appropriately called “rationing.”

Markets Don’t Do Anything

To see that the market does not ration one need only see that “the market” doesn’t do anything. To talk as if it does things is to reify the market — worse, it is to anthropomorphize the market, ascribing to it attributes — purposes, plans, and actions — that only human beings possess. We may also see this as another instance of literalizing a metaphor, which, as Thomas Szasz has so often warned, is fraught with peril.

I’m not saying that economists don’t realize this diction is a metaphor. Of course they do, and there’s no harm in using this shorthand among those who understand it as such. The problem, as I see it, is that the general public doesn’t fully grasp the metaphorical nature of these statements. For the sake of public understanding, free-market advocates should not welcome a debate in which they begin by saying, “Our method of rationing is better than your method of rationing.”

Better to respond to the interventionists this way: The market does not ration or allocate. The market does not do anything. It has no purposes or objectives. It is simply a legal framework in which people do things with their justly acquired property and their time in order to pursue their own purposes.

This is squarely in the Austrian conception of the market as set out by Ludwig von Mises and F. A. Hayek. The market order “has no specific purposes but will enhance for all the prospects of achieving their respective purposes,” Hayek wrote in volume two of Law Legislation, and Liberty.

The market was never set up by people to achieve a purpose. It is not a device or an invention aimed at satisfying an intention. “Market mechanism” is a metaphor. The market — as a set of continuing relations among people — emerged, unplanned and unintended, from exchanges, initially barter, in which the parties intended only to improve their respective situations. Lecturing at FEE this week, Israel Kirzner recalled that one of the first things Mises said to him as a graduate student was, “The market is a process,” by which he meant “a series of activities.” This is similar to what the French liberal economist Destutt de Tracy (1754–1836) wrote in A Treatise on Political Economy, “Society is purely and solely a continual series of exchanges.”

Mises, Hayek, and Tracy help us to sort out the rationing question. I submit it makes no sense to say that an undesigned series of exchanges rations goods. If we were to observe a free market (wouldn’t that be nice?), what would we see? Rationing? Allocation? Of course not. We would see people exchanging things — factors of production, services, and consumer goods — for money. Where would they have gotten those things? From previous exchanges or original appropriation from nature.

When a person buys five apples in a grocery store rather than ten because he wishes to use the rest of his money for other purposes, it seems entirely wrong to say the market (or even the grocer) has rationed the apples. The customer makes his choice on the basis of his preferences and the money available (which is the result of previous transactions).

It is true that as a result of market exchanges, goods and resources change hands and (except for land) locations. But in no sense is this rationing or allocation. The resulting arrangement of resources is simply a product of many transactions. Of course, people’s choices of what and what not to buy and sell at which prices create an arrangement of goods and resources that tends to be intelligible in terms of consumers’ subjective priorities. But that does not warrant calling the process rationing or allocation.

Those words — especially ration, which shares its root with rational – suggest conscious decision-making — as part of a plan — by an agent. In a free market there is no consciousness overseeing this “distribution” — another inappropriate word when it comes to describing the market process.

I am not saying anything that a good economist or thoughtful person doesn’t know. I am merely pointing out that we can be more effective in the healthcare debate if we are more precise in our language. We do not face a choice between methods of rationing medical services. We face a choice between rationing according to a bureaucratic plan and being freed to engage in mutually beneficial exchanges.

The scariest word in that sentence is not something. It’s we.

The first-person plural form is not merely a convenience, as in “We’re in for a cold winter.” It indicates that decisions about “the healthcare system” are to be made collectively, with one decision binding everyone.

That’s collectivism.

So why is virtually everyone a collectivist when it comes to heath care? I do not exaggerate. Every prominent participant in the current debate over how to “reform” the medical and insurance industries — regardless of party — approaches the issue in collectivist terms. They have differences at the margin — tax increases versus tax credits, a government-run “public option” versus subsidized nonprofit cooperatives — but there is no disagreement that we must have a policy.

But why must we do anything about health care? Why can’t you do what you want, I do what I want, and he and she do what they want? Isn’t that what’s supposed to happen in a free society? Reformers would say that costs are rising too much and some people can’t afford insurance. But that is no answer. It tells us only that possibly ameliorable conditions exist, not that collectivism is a good approach.

When we see problems in other important markets, most of us don’t expect televised presidential town-hall meetings, congressional committees, and omnibus legislation to give us The One Answer. We individually adjust our behavior in the marketplace and anticipate that entrepreneurs will cater to us. Solutions are micro, marginal, and tailored to individual needs, not macro, holistic, and procrustean.  Out of this arises an orderly marketplace — without a conscious overall plan. That’s why it works so well. No one has found a better way to make masses of people at all income levels better off.

Health Care Is Different?

Why is health care different? Must we collectively and consciously reinvent it? The social knowledge problem that F. A. Hayek spelled out should make us wary of any such response. All of us together acting in the market are wiser than any group of congressmen. (Did I really need to say that?)

The reformers’ stock answer is that this is something only we, working through the “democratic process,” can handle. That’s an assertion. Where’s the proof? What if earlier collectivist decisions gave us rising medical and insurance costs?

In fact they did. Nearly every aspect of medicine and health insurance that the politicians say needs fixing is the result of politicians’ previous attempts to fix something. Much of the escalation of prices comes from consumer demand that is freed from normal cost constraints thanks to third-party payers: government-privileged insurance companies, Medicare, and Medicaid. While that intervention boosts demand by eliminating cost consciousness, others constrict supply: occupational licensing, insurance mandates and barriers to entry, patents on drugs and devices, FDA regulations, certificate-of-need requirements, and more.

Making Things Worse

With each so-called reform, we (in reality, they, the politicians) made things worse. It’s time we — collectively — stopped trying to reinvent the medical and insurance industries.  Instead that task should be left to us individually — acting, transacting, competing, and cooperating in the marketplace. Only then will solutions emerge from people’s — not politicians’ —  choices, as entrepreneurs (neither aided nor impeded by the State) pursue profit by producing goods and services that make us better off.

Notice that entrepreneurship is missing from the public debate over medical care. Typical of the politicians’ arrogance, they can’t appreciate the role entrepreneurs— without privileges of any kind — play in bettering our lives. In a free market they look for unmet or poorly met consumer demand and devise ways to meet it. To do that job well, they need price signals that convey accurate information about consumer preferences and resources — which means prices undistorted by government policy. The successful entrepreneur’s payoff is profit, the result of transforming lower-value inputs into higher-value outputs.

Profit is the key, but “profit” is a dirty word in the current debate, one more arrow against freedom in the demagogues’ quiver. Insurance company profits are condemned not because the corporate state bulks them up through anticompetitive regulation, but rather in principle. The politicians are always ready to exploit people’s deep suspicion that profit is added to the price rather than extracted from the costs. If government interferes with profit-making, it suppresses entrepreneurship, which in turn cripples the market’s ability to serve us. To paraphrase Hayek, profit-seeking is a discovery procedure. The government condemns profit at our peril — especially in the medical industry.

Let’s hear no more about what we — collectively and coercively — must do about health care. If government would get out of the way we — individually and cooperatively — would figure out what to do. Collectivism and government planning trample freedom and foster social stupidity. Individualism and free markets respect each person’s dignity and liberty while getting the most out of the “wisdom of crowds” in the marketplace.

To begin, the “reformers” want to compel insurers to cover people who are already sick for the same price healthy people pay. But if someone is already sick, no government plan to pay his medical bills can be accurately called “insurance.” Insurance is a voluntary way to spread risk. Risk comes from uncertainty. But someone already sick doesn’t face a risk that he might need medical attention for his ailment. He is certain to require the attention. There’s a reason you can’t buy homeowner’s insurance after your house has burned down or life insurance for a deceased person. Why should one expect to be able to buy insurance to cover medical treatment for a disease one already has contracted? When private donors voluntarily pay the bills, we call it charity or philanthropy or benevolence. When government pays them after extracting money by force from taxpayers or by requiring insurance companies to overcharge healthy people who are compelled to buy coverage, we should call it (at the very least) welfare.

If someone wants to defend medical welfare, let him do so. But don’t let him get away with calling it insurance. He not only does violence to the language; he also clouds the discussion. This is another application of the tacit premise that no one should have to pay for his own medical care. Bastiat’s line about the state being the means by which we all try to live at everyone else’s expense comes to mind.

President Obama says he will finance “reform” by shifting Medicare reimbursement decisions from Congress to an independent board of experts. Too bad he is unaware of the Austrian critique of central planning. Outside the marketplace, no one can know how much doctors and hospitals should be paid. Bureaucrats can’t tell what is too much or little compensation because they can’t have the relevant knowledge. Markets are good at setting prices because that knowledge is communicated through people’s buying and abstention from buying.

This is not just an academic discussion. Prices are information, and when they are “wrong” there are consequences. If the bureaucrats pay too little, costs will be shifted to others and providers will leave the market, creating shortages. If the bureaucrats pay too much, resources and labor will drawn away from other needed areas. With the collapse of the Soviet Union and the continuing examples of Cuba and North Korea, we should all know that government doesn’t know how to set prices.

Obama promises overall “cost containment.” But government has only two ways to accomplish this: rationing or price controls. The drawback to the first is obvious. People are forbidden to buy the services they want, even when they are willing to pay for them themselves. Bureaucrats — rather than individuals and their doctors — decide what tests and procedures are necessary. The drawback to the second is that services will disappear from the marketplace. Price ceilings create shortages.

On the other hand, the market has a method for containing costs. It’s called economizing, and people practice it naturally when they face the costs and consequences of their decisions. People are less likely to buy unnecessary services if they have to pay for them. And if they were buying their own insurance, they wouldn’t typically buy policies that covered smaller, routine expenses. The administrative overhead would make such policies a bad buy.

Conflicting Goals

The New York Times points out that the reformers have two conflicting ostensible goals: “to expand health coverage to nearly all Americans while reducing the growth of health spending.” How can they do both? Obama goes back and forth between stressing universal coverage and cost containment, but he doesn’t discuss one in relation to the other. Newly subsidized coverage will bring new demand for medical services and put  more upward pressure on prices. As noted, higher prices can be counteracted only by denying service (say, hip replacements for octogenarians) or by imposing price controls, overtly or covertly.

Why is it government’s business how much we spend on medical services anyway? Government’s only concern should be to eliminate the ways it interferes with and influences our choices. The aggregate cost of our freely chosen actions is our concern alone, not the government’s.

But of course, government interferes with and influences our choices in many ways, and by doing so raises the costs. As Obama said the other night, “[T]he biggest driving force behind our federal deficit is the skyrocketing cost of Medicare and Medicaid.”

For once Obama was conceding that the government is at fault. Medicare and Medicaid are two ways the government forces the taxpayers to pay for medical care. Those who obtain their medical care through those programs have no incentive to economize because it’s free to them. That’s why the budgets are out of control — people act rationally according to the incentive system they are in — and why Obama is looking for ways to control costs. As long as those programs exist, he won’t be able control costs without bureaucratic rationing of services one way or another.

If the “reformers” get their way, something much like this failed system will be extended to the general public.

Ending Waste

Obama says two-thirds of the estimated cost of “reform” — at least $1.5 trillion over a decade — will be paid for “by reallocating money that is simply being wasted in federal health care programs.” I wouldn’t take seriously any of the reformers’ numbers. The safe bet is that cost of the program will far exceed what they project, and the most of the savings will never materialize. When Medicare was being put together, the pooh-bahs projected that by 1990, hospitalization coverage would cost only (!) $9 billion. When 1990 arrived, the price tag read $66 billion.

The final third of cost would likely come from surtaxes on upper-income earners. Are high earners likely to stand still when targeted for new taxes? No. They will adjust their income-earning activities to minimize the tax take, and that will mean lower-than-projected revenues. Then what? Taxes on the middle class, perhaps. Or more debt and inflation.

Competition and Choice

Does anyone else laugh when politicians promise that government will bring competition, choice, and efficiency to the medical industry? Government routinely can’t account for millions, even billions, of dollars. And competition and choice? As a compulsory monopoly, government is the enemy of those things.

Competition and choice are what you get when the government backs off. You don’t get them by having government interject itself even further in an area of life.

Finally, the way to rig a debate over public policy is to never acknowledge the only genuine alternative to your proposal. Obama says, “I’m confident that when people look at the costs of doing nothing they’re going to say, we can make this happen.” Why is “doing nothing” the alternative to a conscious attempt to reinvent the healthcare industry? While it is true that doing nothing would be preferable to what Obama and his congressional allies want to do, it is not the best alternative. The best alternative is the free market. But have you ever heard the advocates of government control offer an argument against the free market? The answer is no, and the reason is that to argue against it would be to acknowledge it as an alternative. And that they cannot afford to do. Better to have the people think we already have a free market in medicine and that it has failed. That way they will be more likely to win support for government control. The “reformers” task would be more difficult if people understood that what has created the problems is government, not the free market.

This effort to ignore the market solution is abetted by an alleged limited-government party that is unwilling or unable to speak the truth. That helps explains the predicament we are in.

Leoni (1913-1967) was a professor of legal theory and a lawyer in Italy. He was also an eminent liberal scholar and champion of individual freedom, who served as president of the Mont Pelerin Society. Freedom and the Law has a provenance worth describing. In 1958 Leoni, F. A. Hayek, and Milton Friedman each gave a series of lectures at the Fifth Institute on Freedom and Competitive Enterprise at what is now Claremont McKenna College in California. To say this meeting was consequential would be a gross understatement. Hayek’s lecturers were incorporated into The Constitution of Liberty. Friedman’s grew into Capitalism and Freedom, and Leoni’s were collected as Freedom and the Law. (Readers of this column will know that I previously wrote about Leoni’s essay “Voting Versus the Market,” which appears in Freedom and the Law.)

Leoni’s work was critical in helping to launch the multidisciplinary movement known as Law and Economics, in which these two areas of knowledge are applied to each other in order to achieve an otherwise impossible depth of understanding of society.

His work is highly relevant to the Judiciary Committee’s hearing on Sotomayor. In speeches she has suggested that because of sex and ethnicity, judges either can’t or shouldn’t try to be impartial in their rulings. Moreover, President Obama said he wanted a Court nominee with empathy based on life experience, as well as knowledge of the law. However, under questioning by adversarial senators, Sotomayor seemed to back away from both approaches. At one point, she said, “They [judges] don’t determine the law. Congress makes the laws. The job of a judge is to apply the law. And so it’s not the heart that compels conclusions in cases. It’s the law. The judge applies the law to the facts before that judge…. I look at the law that’s being cited. I look at how precedent informs it. I try to determine what those principles are of precedent to apply to the facts in the case before me and then do that…. We apply law to facts. We don’t apply feelings to facts.”

This is clearly what the conservative senators wanted to hear, but observers of varying ideological stripes were disappointed that Sotomayor stooped to feeding the television audience such pablum. She more than implied that a judge’s job is mechanistic: The facts plus the law plus precedent equals a ruling.

Nothing in human affairs is that simple. Judgment and interpretation are required every step of the way. This is why, contrary to popular fable, the line between the rule of law and the rule of men and women is so fine as to be nonexistent. (See John Hasnas’s important papers The Myth of the Rule of Law and the Depoliticization of Law [pdf]). Laws, which are intended to be applied to an unlimited number of unforeseeable future circumstances, do not speak for themselves. Human beings must interpret them. This does not mean language is inherently impenetrable. (I could hardly write if I believed that.) However, there is a broad middle ground between impenetrability and perfect clarity. As libertarian legal scholar Randy Barnett noted,  “While I do not share [the] view of law as radically indeterminate, I sure think it is a whole lot more underdeterminate than Judge Sotomayor made it out to be in her testimony today.”

If the law is underdeterminate–if there is scope for interpretation and more than one competing interpretation can be reasonable–what is an advocate of liberty to do?

Enter Leoni

Leoni offers us hope. Let’s start at the beginning. Why do we care who is on the Supreme Court? We care because down the street from the Court is the legislation factory we call the U.S. Congress. It has virtually nothing to do but churn out bills. In fact, most “serious” pundits judge congresses by how many bills they churn out. All the incentives faced by members of Congress push in one direction: to legislate (that is, meddle in people’s affairs).

Furthermore, we know that much of this legislation, since it interferes with what people want to do, will spawn litigation. Eventually some of these cases will wind up before the Supreme Court, the rulings of which will become the law of the land. Hence the interest in Supreme Court nominees.

Thus it would matter far less who is on the Supreme Court if there were little or no legislation.

But we need legislation, don’t we?

Without legislation there would be no law, right?

Where did we get the idea that a group of mostly undistinguished men and women–absurdly claiming to be our representatives and sitting in what is surely the ultimate ivory tower–should make blanket rules for everyone (except perhaps for themselves), regardless of time, place, and circumstance? It certainly has not protected liberty. Why don’t more people realize how poorly this simpleminded procedure serves a complex society?

Law versus Legislation

Most of us are badly in need of reminding that what is admirable about the Western legal tradition–that which has made our progress and prosperity possible–is the product not of legislatures but of something rather different. This fact compels us to distinguish law from legislation. As Hayek wrote in the first volume of Law, Legislation, and Liberty,

Unlike law itself, which has never been “invented” in the same sense, the invention of legislation came relatively late in the history of mankind….  Law in the sense of enforced rules of conduct is undoubtedly coeval with society; only the observance of common rules makes the peaceful existence of individuals in society possible. Long before man had developed language to the point where it enabled him to issue general commands, an individual would be accepted as a member of a group only so long as he conformed to its rules…. To modern man … the belief that all law governing human action is the product of legislation appears so obvious that the contention that law is older than law-making has almost the character of a paradox. Yet there can be no doubt that law existed for ages before it occurred to man that he could  make or alter it.

Or as Leoni put it, “[F]ewer and fewer people now seem to realize that just as language and fashion are the products of the convergence of spontaneous actions and decisions on the part of a vast number of individuals, so the law too can, in theory, just as well be a product of a similar convergence in other fields.”

He goes on, “The paradoxical situation of our times is that we are governed by men, not, as the classical Aristotelian theory would contend, because we are not governed by laws [legislation], but because we are.”

The question for Leoni is not how can we get good legislation and avoid bad legislation. The matter is much deeper than that: “It is a question of deciding whether individual freedom is compatible in principle with the present system centered on and almost completely identified with legislation.”

He tells us that in order to imagine an alternative to governance by legislatures, we need not visit Utopia. Rather, we may study Roman and English history: “Both the Romans and the English shared the idea that the law is something to be discovered more than to be enacted and that nobody is so powerful in his society as to be in a position to identify his own will with the will of the land.” This was law that judges discerned when resolving specific disputes brought before them by specific individuals; it was law based on custom and the expectations it gave rise to. (See Hasnas’s “Toward a Theory of Empirical Natural Rights” [pdf].)

Leoni lists three differences between judges in the sense just described and legislators:

1. “[J]udges or lawyers or others in a similar position are to intervene only when they are asked to do so by the people concerned, and their decision is to be reached and become effective, at least in civil matters, only through a continuous collaboration of the parties themselves and within its limits.”

2. “[T]he decision of judges is to be effective mainly in regard to the parties to the dispute, only occasionally in regard to third persons, and practically never in regard to people who have no connection with the parties concerned.”

3. “[S]uch decisions on the part of judges and lawyers are very rarely to be reached without reference to the decisions of other judges and lawyers in similar cases and are therefore to be in indirect collaboration with all other parties concerned, both past and present.”

Thus, “the authors of these decisions have no real power over other citizens beyond what those citizens themselves are prepared to give them by virtue of requesting a decision in a particular case.”

Free Markets versus Central Planning

Leoni draws important parallels between judge-discovered law and the free market on the one hand and legislation and central planning on the other: “[A] legal system centered on legislation resembles … a centralized economy in which all the relevant decisions are made by a handful of directors, whose knowledge of the whole situation is fatally limited and whose respect, if any, for the people’s wishes is subject to that limitation.”

He exposes the posturing of self-styled “representatives” with a refreshing bluntness not often encountered today:

No solemn titles, no pompous ceremonies, no enthusiasm on the part of applauding masses can conceal the crude fact that both the legislators and the directors of a centralized economy are only particular individuals like you and me, ignorant of 99 percent of what is going on around them as far as the real transactions, agreements, attitudes, feelings, and convictions of people are concerned…. The mythology of our age is not religious, but political, and its chief myths seem to be “representation” of the people, on the one hand, and the charismatic pretension of political leaders to be in possession of the truth and to act accordingly, on the other.

Finally, to bring this back to Judge Sotomayor and the job she will assuredly be awarded, Leoni noted that judiciary law can become like legislation “whenever jurists or judges are entitled to decide ultimately a case.” But isn’t that what a Supreme Court is entitled to do when it makes law for everyone everywhere?

“In our time,” Leoni wrote, “the mechanism of the judiciary in certain countries where ‘supreme courts’ are established results in the imposition of the personal views of the members of these courts, or of a majority of them, on all the other people concerned whenever there is a great deal of disagreement between the opinion of the former and the convictions of the latter.”

Thus the assertion that the Supreme Court must not become a legislature is wishful thinking. It must and it will–no matter who sits on it.

So what’s an advocate of liberty to do? Leoni concluded that we must limit legislatures to as few matters as possible. That in itself is a tall order. But it is a start in the right direction.

It takes some sophistication to follow Henry Hazlitt’s economics lesson and trace the consequences. Under the new supply and demand conditions, if prices cannot rise beyond a certain arbitrarily set level, supplies will run short, since people have no incentive to conserve and entrepreneurs have no incentive to divert goods from where they are relatively plentiful to the stricken area where they are relatively scarce.

Similarly, most people think the minimum-wage law is a good thing because they dislike that unskilled workers are paid very low wages. What could be more humanitarian than to set a floor beneath which wages cannot fall? If they thought like economists, they would realize that a mandatory minimum wage set above the marginal productivity of unskilled labor creates unemployment or less-desirable jobs for the workers it is intended to help.

But lately an idea has been floating around that anyone should be able to see through because it has no superficial logic whatsoever. It goes like this: The government hasn’t been able to spend $500 billion fast enough to stimulate the economy, so the only thing to do is . . . give the government even more money.

Huh? How does that make sense?

The Obama administration, for now, seems to grasp the weakness of this reasoning, but the same cannot be said for some members of Congress. There is talk of a second “stimulus” package. We shouldn’t discount the possibility that the congressional backers of a new bill know it’s a ridiculous idea but that they stand to benefit from passing it anyway. That’s how incentives work in the political system.

The first “stimulus” package under Obama was no such thing. As has been noted many times, any money the government spends must be acquired from somewhere in the economy first through borrowing or taxation. While moving money around may stimulate a given activity, it comes at the price of the other activities to which that money would have been directed. And since bureaucrats, not entrepreneurs, direct the “stimulus” projects, this redirection of scarce capital is detrimental to consumer welfare. If the projects served consumers and thus were profitable, they would have been undertaken privately and more efficiently than bureaucracies could have accomplished them.

The money in the earlier bill was supposed to be used for what we were assured were “shovel-ready projects.” But the truth seems to be that precious few were shovel-ready. They won’t get started for a year or more.

Edward Lazear writes in the Wall Street Journal, “By June 26, about $56 billion [out of about $500 billion] was spent on the stimulus from the American Recovery and Reinvestment Act of 2009, passed Feb. 17. A large proportion of that actually reflects mere transfers from the federal government to state governments, so the amount that has gotten into the economy is significantly lower.”

What Were They Thinking?

Thus even if the “stimulus” plan had been sound in theory, back-loading the spending to such an extent undermined its stated purpose: immediate job creation. It makes you wonder what the bill’s architects had in mind. Did they actually believe what they were saying? If so, their actions make no sense. When the bill passed in February, the unemployment rate was 8.1 percent, Today it is 9.5 and rising. That doesn’t seem terribly stimulating. Obama might claim he saved some number of jobs, but he wouldn’t be able to prove that.

Administration spokesmen are now asking for patience, but they are the ones who created a public expectation of quick stimulus. They have only themselves to blame for the disappointment showing up in the popularity polls.

Outside advocates of stimulus, such as Paul Krugman, will say the unabated rise in unemployment only proves what they said all along: The spending package was too small. But that is not a satisfying rebuttal. First, as noted, if government agencies can’t disburse a half-trillion quickly enough to jolt the economy, logic compels us to conclude that they can’t disburse a trillion. Should they fly around in helicopters and drop the money? (That wouldn’t work — people would do unpatriotic things like save or pay off debts.)

Second, economic theory refutes the Krugmanian claim. Since government can spend only what it has first taken from someone else (by borrowing or taxation), the spending can’t create jobs on net. So even if the government-created jobs were real jobs — in the sense that they ultimately contributed to consumer well-being according to consumers’ own priorities — they were created at the cost of other productive jobs that would have been created in the absence of government intervention. Resources are scarce; government spending displaces private economic activity. There is no way around that.

If the Stimulus I was a bad idea, Stimulus II is even worse.

The timing of the Declaration is significant. The Battles of Lexington and Concord had taken place in April 1775, Bunker Hill in June 1775. As the Declaration stated:

General Gage, who in the course of the last year had taken possession of the town of Boston, in the province of Massachusetts Bay, and still occupied it as a garrison, on the 19th day of April, sent out from that place a large detachment of his army, who made an unprovoked assault on the inhabitants of the said province, at the town of Lexington, as appears by the affidavits of a great number of persons, some of whom were officers and soldiers of that detachment, murdered eight of the inhabitants, and wounded many others. From thence the troops proceeded in warlike array to the town of Concord, where they set upon another party of the inhabitants of the same province, killing several and wounding more, until compelled to retreat by the country people suddenly assembled to repel this cruel aggression…. The inhabitants of Boston being confined within that town by the General, their Governor, and having, in order to procure their dismission, entered into a treaty with him, it was stipulated that the said inhabitants, having deposited their arms with their own magistrates, should have liberty to depart, taking with them their other effects. They accordingly delivered up their arms, but in open violation of honor, in defiance of the obligation of treaties, which even savage nations esteemed sacred, the Governor ordered the arms deposited as aforesaid, that they might be preserved for their owners, to be seized by a body of soldiers; detained the greatest part of the inhabitants in the town, and compelled the few who were permitted to retire to leave their most valuable effects behind.

Foreshadowing another declaration that Congress would pass later, this Declaration listed serious charges against Empire. The Parliament, it said,

have undertaken to give and grant our money without our consent, though we have ever exercised an exclusive right to dispose of our own property; statutes have been passed for extending the jurisdiction of courts of admiralty and vice-admiralty beyond their ancient limits; for depriving us of the accustomed and inestimable privilege of trial by jury, in cases affecting both life and property; for suspending the legislature of one of the colonies; for interdicting all commerce to the capital of another; and for altering fundamentally the form of government established by charter and secured by acts of its own legislature solemnly confirmed by the crown; for exempting the “murderers” of colonists from legal trial and, in effect, from punishment; for erecting in a neighboring province, acquired by the joint arms of Great Britain and America, a despotism dangerous to our very existence; and for quartering soldiers upon the colonists in time of profound peace. It has also been resolved in Parliament that colonists charged with committing certain offenses shall be transported to England to be tried.

Thus, “We are reduced to the alternative of choosing an unconditional submission to the tyranny of irritated ministers, or resistance by force. The latter is our choice. We have counted the cost of this contest and find nothing so dreadful as voluntary slavery. …With hearts fortified with these animating reflections, we most solemnly, before God and the world, declare that, exerting the utmost energy of those powers which our beneficent Creator hath graciously bestowed upon us, the arms we have been compelled by our enemies to assume we will, in defiance of every hazard, with unabating firmness and perseverance, employ for the preservation of our liberties; being with our [one] mind resolved to die free men rather than live slaves.”

However, the document declared, “We have not raised armies with ambitious designs of separating from Great Britain establishing independent states.”

George III was unpersuaded. A month after the Declaration was issued, writes historian Gordon Wood, the king “proclaimed the colonies in open rebellion. In October he publicly accused them of aiming at independence.”

July 4, 1776

Then, almost a year to the day after Congress forswore independence while justifying taking up arms against the Empire, it issued an explanation for why, just  two days earlier, it approved the final language explaining why it had moved for independence. That explanation is what we call the Declaration of Independence.

July 4, 1776, was roughly six months after Thomas Paine published Common Sense, the pamphlet that moved a people. In it Paine wrote, “For God’s sake, let us come to a final separation…. O ye that love mankind! Ye that dare oppose, not only the tyranny, but the tyrant, stand forth! Every spot of the old world is overrun with oppression. Freedom hath been hunted round the globe. Asia, and Africa, have long expelled her. Europe regards her like a stranger, and England hath given her warning to depart. O! receive the fugitive, and prepare in time an asylum for mankind.”

That the resolution on independence and then the Declaration itself should have followed that stirring call seems entirely natural.

The Declaration of Independence was, and remains, an extraordinary document — self-conscious in its embrace of the radical liberal tradition developed by the Levellers during the seventeenth-century English Civil Wars and “Cato” (John Trenchard and Thomas Gordon), whose pamphlets, first published in England in the early 1720s, were repeatedly reprinted in the colonies, bringing a radicalized version of John Locke to the Americans.

To appreciate the connections, read the words of Leveller Richard Overton: “[B]y natural birth all men are equally and alike borne to like propriety, liberty and freedom.” And “Cato”: ‘[L]iberty is the unalienable right of all mankind….[T]he nature of government does not alter the natural right of men to liberty, which is in all political societies their due.”

As historian Bernard Bailyn has shown, it was “Cato” and other radical liberals who seeded the ground for the American Revolution, which was an intellectual event every bit as much as a military one.

This does not undercut Jefferson’s accomplishment — and let us not forget John Adams’s role in promoting the states’ own crucial (though forgotten) moves for independence or in floor-managing the Declaration in Congress. Jefferson never claimed the ideas were original. Natural rights, including the right of revolution, had been “in the air” for years, in America and Europe. Assertions “that it [the Declaration] contained no new ideas, that it is a commonplace compilation, its sentiments hacknied in Congress for two years before … may all be true,” Jefferson later wrote. “Of that I am not to be the judge…. I know only that I turned to neither book nor pamphlet while writing it. I did not consider it part of my charge to invent new ideas altogether and to offer no sentiment which had ever been expressed before.”

He may not have come up with anything not expressed before, but he was certainly in the right place at the right time. Thus Jefferson’s words have taken their proper place among liberty’s greatest writings.

Yet Catherine Rampell, economics editor for nytimes.com, reports there has been “no sea change in public opinion” about healthcare reform. She cites Nolan McCarty of Princeton University, who shows that public support for a government overhaul of the medical industry was higher in 1993, when the Clinton plan failed, than it is today.

Of course, we always have reason for suspicion about public opinion polls, since pollsters can get the results they want by how they frame the questions, especially the all-important preliminary questions. People aren’t laboratory rats, and some respondents may be as interested in impressing the pollster as in speaking their minds. Definitive proof of the case for suspicion was provided some years ago by an episode of the satirical BBC television program Yes, Prime Minister, the key scene of which is here.

So What?

But let’s not stop there. We may grant that “the public” want (as the British would say) the government to set up an insurance program to compete with private insurers and are even willing “to pay higher taxes so that all Americans have health insurance that they can’t lose no matter what.”

So what? By asking this question, I am not displaying naïveté. Politicians of course will use a favorable poll for cover when they do what they want to do anyway.

I mean something else: Why should the people get something through government–that is, at the point of a gun–simply because they want it? We make that assumption reflexively, but why? Fifty-seven percent may be willing to pay higher taxes for universal health insurance, but let’s not overlook what else they are willing to do: tax the 37 percent who aren’t willing to pay higher taxes. (Six percent don’t know if they are willing or not. Sigh.)

H. L. Mencken long ago defined democracy as the “the theory that the common people know what they want, and deserve to get it good and hard.” The problem is that those who don’t want it get it, too. When it comes to government programs, there’s no opt-out provision. Alas, what distinguishes “free” from unfree countries is the freedom to speak out, not to opt out. In the latter respect, all are unfree.

What about that 37 percent who would be ignored? If they don’t count, they needn’t have had their time wasted by the pollster. As Bruno Leoni wrote, “[I]n assuming that 51 voters out of 100 are ‘politically’ equal to 100 voters, and that the remaining 49 (contrary) voters are ‘politically’ equal to zero (which is exactly what happens when a group decision is made according to majority rule) we give much more ‘weight’ to each voter ranking on the side of the winning 51 than to each voter ranking on the side of the losing 49.” (See my article  “The Crazy Arithmetic of Voting.”)

Well, it might be said, in our system the majority rules. Standing alone, this principle sounds rather ominous, so the speaker usually hastens to add, “but the rights of the minority are protected.” But really now, which is it? Do the majority rule or are the rights of the minority protected? I really don’t see how you can have it both ways.

Misrepresentatives

Our “representatives”–more aptly, our “misrepresentatives”–are supposed to sort out all this complicated stuff, but don’t bet on their squaring the circle any time soon.

The upshot is that they will decide what kind of healthcare system we will have. To the extent they take into consideration what some of the people whom they “represent” want, it is only because they are looking to the next election.

All of which leads me to the question of why we even see these decision-makers as our representatives rather than as our rulers. Think about this: The average congressional district has a population of well over 600,000 people. In Montana, one congressman allegedly represents the state’s entire population of 967,440. The populations of the states range from about half a million (Wyoming) to 36.7 million (California).

Honestly now, who really believes that anyone can actually represent such large and diverse groups of people? (Credit the Antifederalists, or anti-Rats, with another legitimate concern about centralized power.) Are we playing games when we talk about representation under those circumstances?

The Fiction of Representative Government

What got me thinking about this the other day is an essay by the highly respected historian Edmund Morgan, emeritus professor of history at Yale University and prolific author of books on America’s colonial and revolutionary era. His latest book is a collection of previously published papers with the self-explanatory title American Heroes: Profiles of Men and Women Who Shaped Early America. (Hat tip: Jeffrey Rogers Hummel.) But Morgan departs from that theme in a couple of chapters, including Chapter 15, “The Founding Fathers’ Problem: Representation.”

Morgan begins by noting that all governments rest on consent; specifically, the governors are few and the governed are many and thus potentially more powerful than the governors. Therefore the governed must be persuaded to believe that obeying the government is the right thing to do. This is the role ideology plays: It constitutes “opinions to sustain their consent.”

“The few who govern take care to nourish those opinions, and that is no easy task, for the opinions needed to make the many submit to the few are often at variance with the facts,” Morgan writes. “The success of government thus requires the acceptance of fictions, requires the willing suspension of disbelief, requires us to believe that the emperor is clothed even though we can see that he is not.” (Emphasis added.)

In democratic countries such as the United States, those fictions include the idea of representation, as well as the idea that our “representatives” are mere members of the governed like the rest of us. It doesn’t take a lengthy visit to Washington, D.C., or even a state capital, to be disabused of that latter fiction.

Fictions endure only as long as they are useful, and the one regarding representation is quite useful. Morgan writes, “And just as the exaltation of the king could be a means of controlling him, so the exaltation of the people can be a means of controlling them. …In locating the source of authority in the people, they ["the men who first promoted popular government"] thought to locate its exercise in themselves. They intended to speak for a sovereign but silent people, as the king had hitherto spoken for a sovereign but silent God.”

Morgan is unequivocal: “Representation from the beginning was a fiction. If the representative consented [to the king's taxes or laws], his constituents had to make believe that they had done so.” The problem was not only that often a perfect stranger deigned to represent individuals he knew little about, but also that he had a conflicting mandate: to represent his district while also looking out for the welfare of the whole country. This second part was useful in making representative bodies into modern aristocracies. (We leave aside the further problem that for much of the history of representative government, many people were not allowed to vote.)

“The sovereignty of the people was an instrument by which representatives raised themselves to the maximum distance above the particular set of people who chose them,” Morgan adds. “In the name of the people they became all-powerful in government, shedding as much as possible the local, subject character that made them representatives.”

Morgan connects these considerations to the American Revolution, the Articles of Confederation, and the goals of the Constitutional Convention. But bear in mind that he is not a radical critic of the American political system. He’s no anti-Rat. Yet he concedes that centralization of power under the Constitution was intended to restore representation to its fictive status, since it had become more real in the small legislative districts within the states during the Confederation period. As he writes, “The fictions of popular sovereignty embodied in the federal Constitution may have strained credulity, but they did not break it.”

Alas, that topic must be left for another time. For now, as the Senate and House of “Representatives” deliberate whether to give even more control over your health care to bureaucrats, ask yourself what taxation with representation has wrought.

So he must persuade us that this freedom will be safe under his plan.

But can he make a truly persuasive case? No, he cannot, for reasons I will outline. Either Obama knows this and is lying to the American people, or he does not know it because he is shamefully ignorant of economics. You decide.

First, here’s what he said in his speech to the AMA this week:

We know the moment is right for health care reform. We know this is an historic opportunity we’ve never seen before and may not see again. But we also know that there are those who will try and scuttle this opportunity no matter what – who will use the same scare tactics and fear-mongering that’s worked in the past. They’ll give dire warnings about socialized medicine and government takeovers; long lines and rationed care; decisions made by bureaucrats and not doctors. We’ve heard it all before – and because these fear tactics have worked, things have kept getting worse.

So let me begin by saying this: I know that there are millions of Americans who are content with their health care coverage – they like their plan and they value their relationship with their doctor. And that means that no matter how we reform health care, we will keep this promise: If you like your doctor, you will be able to keep your doctor. Period. If you like your health care plan, you will be able to keep your health care plan. Period. No one will take it away. No matter what. [Emphasis added.]

Obama will not be able to keep his promise if he gets the “reform” he wants. He favors a “public option,” which is a euphemism for a government insurance plan. Obama says a government plan will keep private insurers “honest” through competition. But what will keep it from being a predatory competitor? After all, it will have a guaranteed source of revenue that no private insurer has: captive taxpayers. So the public option would be able to price its policies below market level and put the squeeze on the private companies.

It is strange that those folks who are always warning about predatory pricing and cutthroat competition in the free market never fret when the government provides services in “competition” with private firms. (See the “public” schools, for example.) But government is the only entity that can truly price predatorily because it can hold down explicit prices to consumers while recouping its costs implicitly through taxation or Fed-monetized debt.

Let’s not forget that Obama favors having a government bureau define the contents of the basic insurance coverage — that is, the state will dictate to insurers what services they must sell to their customers. Plus, the emerging reform plan would outlaw a premium schedule based on risk or existing illness. People who are sick or more likely to get sick could not be charged more than healthy people. (By that logic, the owner of a simple wooden house would pay the same fire-insurance premium as the owner of a brick house.)

Moreover, people would be compelled to have insurance (and then pay taxes on their employer-originated coverage). This will give the government the incentive to impose price controls — “guidelines,” no doubt –  to keep insurance “affordable” and “universal.”

If the private insurers protest that these terms make profitable operations impossible, Obama and his allies will accuse them of profiteering and proclaim that the free market has once again failed to deliver medical care.

At that point insurers may choose to leave the medical policy market. Meanwhile, when reimbursements to doctors and other providers shrink in the name of cost-cutting and red tape mounts, doctors may choose to take early retirement or find other ways to make a living. (Some doctors have stopped accepting Medicare patients.)

But when that happens, what about all those people who are “content with their health care coverage”? Despite Obama’s solemn pledge, they will not be able to keep it. What recourse will we have for the broken promise? A vote at the polls in 2010 and 2012?

Inject Competition

Obama says the public option is needed to “inject competition into the health care market so that [we can] force waste out of the system and keep the insurance companies honest.” But who is limiting insurance competition today?

Government, of course.

Interstate competition in medical insurance is illegal. There is no national market. Americans living in Texas are not free to buy coverage from a firm operating in Maine. (When John McCain proposed legalization during the presidential campaign, he was pilloried for wanting to do to medical insurance what was done to banking.)

One reason interstate competition is not allowed is that states throughout the country, to different degrees, force insurers to provide coverage for all kinds of services that most people might never buy on their own. Mandated coverage results from service providers’ lobbying state legislatures – a truly corrupt rent-seeking system. (See John Seiler’s Freeman article here.) Interstate competition could nullify the mandate system, as people bought policies from companies in states with fewer requirements. Opponents of interstate competition say this would set off a race to the bottom. What they mean is that it would permit people the freedom to tailor policies to their personal requirements.

That the government is the biggest obstacle to full competition in health insurance is also the rebuttal to another idea emerging from the “reform” factory: state exchanges, or federally subsidized insurance “marketplaces.” Imagine that! The government would set up markets. As though there is no market now, hampered as it is by idiot rules from the brains of clueless politicians.

When Obama promises to  make health care and insurance “affordable,” he means he will impose price controls, overt and covert, on providers and insurers. Promises of cost-cutting should get the same credit as past such promises: exactly none. Cost-cutting is not a bureaucracy’s strong suit.

We know where price controls lead: to shortages, decline in quality, queues, rationing, and regimentation. Welcome to healthcare reform.

Obama and John Stuart Mill

Obama’s belief that government can control the distribution of health services according to his personal preferences without effecting production of those services brings to mind John Stuart Mill’s fatal move in his famous economics treatise, Principles of Political Economy (1848 and beyond). Driving a theoretical wedge between production and distribution, Mill wrote:

The laws and conditions of the Production of wealth partake of the character of physical truths. There is nothing optional or arbitrary in them. Whatever mankind produce, must be produced in the modes, and under the conditions, imposed by the constitution of external things, and by the inherent properties of their own bodily and mental structure.

It is not so with the Distribution of wealth. That is a matter of human institution solely. The things once there, mankind, individually or collectively, can do with them as they like. They can place them at the disposal of whomsoever they please, and on whatever terms. [Emphasis added.]

Obama and Kennedy et al., like Mill before them, foolishly believe that government intervention in the distribution of medical services will have no effect on their production. “The thing once there, mankind …. can do with them as they like.” How absurd. Goods and services are never “there” once and for all.  They must be continuously produced — but the producers could decide to stop producing. Didn’t Ayn Rand write a novel about this?

Contrary to the brain trust running Washington and attempting to run the economy, distribution affects — can discourage or render impossible — production. That’s what the American people need to realize as they listen to Obama’s sugared — but fundamentally misleading — words. The people are right to be concerned.

None of this is meant to sanction the system of privilege that the medical and related professions enjoy through licensing, patents, and other interventions. On the contrary, that system must be dismantled if we are to have a free and competitive healthcare system — for that is the only way to make medical care really universal and affordable.

IP isn’t merely about rock bands preventing kids from sharing MP3s over the Internet. (See “Weird Al” Yankovic’s musical commentary, “Don’t Download This Song,” here.) It’s about crusty incumbent firms trying to preserve market share by stifling competition, domestically and in the developing world.

The crux of the issue is this: Do IP laws protect legitimately ownable things? One’s view of the laws will proceed from one’s answer to that question, and that’s what I will concentrate on here. I leave for another time the issue of incentives. I do so because the justice of a claim must be decided before we consider the specific incentives and disincentives that flow from our decision. (No, this does not make me a “nonconsequentialist.” Consequences figure in our basic conception of justice.) Suffice it to say that the existence of disincentive effects from the abolition of IP cannot furnish proof that it is legitimate. That question must be decided on its own terms. (On incentives and many other related issues, see Michele Boldrin and David Levine’s Against Intellectual Monopoly; also online. The authors, along with Alessandro Nuvolari, contributed Freeman articles on IP here and here.)

What does IP refer to? What exactly is owned? It is not ideas per se that are owned, according to the law. But what is owned seems problematic. Stephan Kinsella (pdf) points out that “Copyright gives [the creators of original works] the exclusive right to reproduce the work, prepare derivative works, or to perform or present the work publicly.” However, “Copyrights protect only the form or expression of ideas, not the underlying ideas themselves” (emphasis added). Patents, Kinsella continues, grant exclusive use in “devices or processes that perform a ‘useful’ function…. A patent effectively grants the inventor a limited monopoly on the manufacture, use, or sale of the invention. However, a patent actually only grants to the patentee the right to exclude (i.e., to prevent others from practicing the patented invention); it does not actually grant to the patentee the right to use the patented invention.” Importantly, “laws of nature, natural phenomena, and abstract ideas” cannot be patented (emphasis added). But, Kinsella notes, “Reducing abstract ideas to some type of ‘practical application,’ i.e., ‘a useful, concrete and tangible result,’ is patentable….”

Note that in both cases ideas are said not to be the object of intellectual property. And yet, ultimately, it is ideas that are at issue. For what is a “form or expression of ideas” if not an idea? And what is a “practical application” of an idea if not an idea? When someone holds a copyright to a novel, she does not own all copies of the book in the world. And when someone holds the patent to the widget, he does not own every widget in the world. There’s no escaping that IP is about ideas.

There is another way to look at IP, but it is even harder to square with traditional property rights. When one acquires a copyright or a patent, what one really acquires is the power to stop other people from doing certain things with what is indisputably their own property. One can say that a copyright holder doesn’t actually own anything but the legal authority to stop other people from using their own equipment to copy a book or CD they purchased. And one who holds a patent on the widget actually only has permission to call on the state to stop others from manufacturing and selling widgets in factories they own.

IP is a peculiar form of property, indeed.

Tangible Versus Intangible

There’s another peculiarity. Property rights in land and other tangible, finite, and scarce things emerged among human beings to facilitate cooperation and flourishing. Society can be a setting in which people trade and go about their business only if they generally know in advance what they can and cannot do with the material objects around them. Ludwig von Mises, F. A. Hayek, Bruno Leoni, Bruce Benson, and John Hasnas are just a few of the many scholars who have elaborated this point from a multidisciplinary perspective.

That prompts the question: Why assume that rules which emerged to avert social conflict over tangible objects are also appropriate to intangible things? I need not labor the point that ideas, or what Tom Palmer calls “ideal objects,” are different from material things. Two or more people cannot consume the same Coca Cola or develop the same parcel of land at the same time, but two or more people can possess and use the same idea at the same time. No one has put the issue better than Thomas Jefferson:

If nature has made any one thing less susceptible than all others of exclusive property, it is the action of the thinking power called an idea, which an individual may exclusively possess as long as he keeps it to himself; but the moment it is divulged, it forces itself into the possession of every one, and the receiver cannot dispossess himself of it. Its peculiar character, too, is that no one possesses the less, because every other possesses the whole of it. He who receives an idea from me, receives instruction himself without lessening mine; as he who lights his taper at mine, receives light without darkening me. That ideas should freely spread from one to another over the globe, for the moral and mutual instruction of man, and improvement of his condition, seems to have been peculiarly and benevolently designed by nature, when she made them, like fire, expansible over all space, without lessening their density in any point, and like the air in which we breathe, move, and have our physical being, incapable of confinement or exclusive appropriation. Inventions then cannot, in nature, be a subject of property.

But aren’t ideas scarce in the sense that if I exploit one commercially, your opportunity to do so is reduced? This mixes up two issues: the “thing” and its economic value. You can never own economic value. A falling market price for your house is not proof you’ve been robbed. Likewise, if your income from a book or CD falls, that also is not proof you’ve been robbed.

Kevin Carson (pdf) elaborates:

It is sometimes argued, in response to attacks on patents as monopolies, that “all property is a monopoly.” True, as far as it goes; but tangible property is a monopoly by the nature of the case. A parcel of land can only be occupied and used by one owner at a time, because it is finite. By nature, two people cannot occupy the same physical space at the same time. “Intellectual property,” in contrast, is an artificial monopoly where scarcity would not otherwise exist. And unlike property in tangible goods and land, the defense of which is a necessary outgrowth of the attempt to maintain possession, enforcement of “property rights” in ideas requires the invasion of someone else’s space.

To Create Is Not to Own

Why is this approach resisted by so many advocates of freedom? A key reason is the importance attached to the act of creation. If someone writes or composes an original work or invents something new, the argument goes, he or she should own it because it would not have existed without the creator. I submit, however, that as important as creativity is to human flourishing, it is not the source of ownership of produced goods.

So what is the source? Prior ownership of the inputs through purchase, gift, or original appropriation. This is sufficient to establish ownership of the output. Ideas contribute no necessary additional factor. If I build a model airplane out of wood and glue, I own it not because of any idea in my head, but because I owned the wood, the glue, and myself. If Howard Roark’s evil twin trespassed on your land and, using your materials, built the most creatively original house ever seen, would he own it? Of course not. You would–and you’d have every right to tear it down.

Thus ceasing to treat ideas like property would not jeopardize real property. On the contrary, it would affirm it. Protection of intellectual “property” requires the violation of real property rights, since it forbids you to do certain things with your own CD or DVD burner and blank disks, your own copier and paper, and your own knowledge of production techniques and processes that are protected by state patents.

The last example is most crucial today, Kevin Carson writes, because of “[t]he growing importance of human capital [i.e., the ideas in people's heads], and the implosion of capital outlay costs required to enter the market….” In other words, the free society and competitive economy require an end to intellectual “property.”

Cashing in on the common notion that anything unregulated is bad, advocates of government regulation argue that an unregulated market is to be abhorred. This view is captured by twin sculptures outside the Federal Trade Commission building in Washington, D.C. (One is on the Constitution Ave. side, the other on the Pennsylvania Ave. side.) The sculptures, which won an art contest sponsored by the U.S. government during the New Deal, depict a man using all his strength to keep a wild horse from going on a rampage.

The title? “Man Controlling Trade.”

Since trade is not really a wild horse but rather a peaceful and mutually beneficial activity between people, the Roosevelt administration’s propaganda purpose is clear. A more honest title would be “Government Controlling People.” But that would have sounded a little authoritarian even in New Deal America, hence the wild horse metaphor.

What’s overlooked—intentionally or not—is that the alternative to a government-regulated economy is not an unregulated one. As a matter of fact, “unregulated economy,” like square circle, is a contradiction in terms. If it’s truly unregulated it’s not an economy, and if it’s an economy, it’s not unregulated. The term “free market” does not mean free of regulation. It means free of government interference.

Ludwig von Mises and F. A. Hayek pointed out years ago that the real issue regarding economic planning is not: To plan or not to plan? But rather: Who plans (centralized state officials or decentralized private individuals in the market)?

Likewise, the question is not: to regulate or not to regulate. It is, rather, who (or what) regulates?

All markets are regulated. In a free market we all know what would happen if someone charged, say, $100 per apple. He’d sell few apples because someone else would offer to sell them for less or, pending that, consumers would switch to alternative products. “The market” would not permit the seller to successfully charge $100.

Similarly, in a free market employers will not succeed in offering $1 an hour and workers will not succeed in demanding $20 an hour for a job that produces only $10 worth of output an hour. If they try, they will quickly see their mistake and learn.

And again, in a free market an employer who subjected his employees to perilous conditions without adequately compensating them to their satisfaction for the danger would lose them to competitors.

Market Forces

What regulates the conduct of these people? Market forces. (I keep specifying “in a free market” because in a state-regulated economy, market forces are diminished or suppressed.) Economically speaking, people cannot do whatever they want in a free market because other people are free to counteract them. Just because the government doesn’t stop a seller from charging $100 for an apple doesn’t mean he or she can get that amount. Market forces regulate the seller as strictly as any bureaucrat could—even more so, because a bureaucrat can be bribed. Whom would you have to bribe to be exempt from the law of supply and demand?

It is no matter of indifference whether state operatives or market forces do the regulating. Bureaucrats, who necessarily have limited knowledge and perverse incentives, regulate by threat of physical force. In contrast, market forces operate peacefully through millions of participants, each with intimate knowledge of his or her own personal circumstances, looking out for their own well-being. Bureaucratic regulation is likely to be irrelevant or inimical to what people in the market care about. Not so regulation by market forces.

If this is correct, there can be no unregulated, or unfettered, markets. We use those terms in referring to markets that are unregulated or unfettered by government. As long as we know what we mean, the expressions are unobjectionable.

But not everyone knows what we mean. Someone unfamiliar with the natural regularities of free markets can find the idea of an unregulated economy terrifying. So it behooves market advocates to be capable of articulately explaining the concept of spontaneous market order—that is, order (to use Adam Ferguson’s felicitous phrase) that is the product of human action but not human design. This is counterintuitive, so it takes some patience to explain it.

Order grows from market forces. But where do impersonal market forces come from? These are the result of the nature of human action. Individuals select ends and act to achieve them by adopting suitable means. Since means are scarce and ends are abundant, individuals economize in order to accomplish more rather than less. And they always seek to exchange lower values for higher values (as they see them) and never the other way around. In a world of scarcity tradeoffs are unavoidable, so one aims to trade up rather than down. The result of this and other features of human action and the world at large is what we call market forces. But really, it is just men and women acting rationally in the world.

The natural social order greatly concerned Frederic Bastiat, the nineteenth-century French liberal economist. In Economic Harmonies he analyzed that order, but did not feel he needed to prove its existence—he needed only to point it out. “Habit has so familiarized us with these phenomena that we never notice them until, so to speak, something sharply discordant and abnormal about them forces them to our attention,” he wrote.

…So ingenious, so powerful, then, is the social mechanism that every man, even the humblest, obtains in one day more satisfactions than he could produce for himself in several centuries…. We should be shutting our eyes to the facts if we refused to recognize that society cannot present such complicated combinations in which civil and criminal law play so little part without being subject to a prodigiously ingenious mechanism. This mechanism is the object of study of political economy….

In truth, could all this have happened, could such extraordinary phenomena have occurred, unless there were in society a natural and wise order that operates without our knowledge?

This is the same lesson taught by FEE’s founder, Leonard Read, in I, Pencil.

Most people value order. Chaos is inimical to human flourishing. Thus those who fail to grasp that, as Bastiat’s contemporary Proudhon put it, liberty is not the daughter but the mother of order will be tempted to favor state-imposed order. How ironic, since the state is the greatest creator of disorder of all.

Those of us who understand Bastiat’s teachings realize how urgent it is that others understand them, too.

With the nomination of Judge Sonia Sotomayor to the Supreme Court, we will be hearing that a lot in the coming weeks. The nomination of a Supreme Court justice occasions much public debate over exactly what judges are supposed to do—and not do. Thus we will hear that it’s Congress’s job to make the laws and the Supreme Court’s job to interpret them, along with the Constitution. Or, to put it in the shorthand: judges should not make the law.

It seems like a tidy division of labor, but there is a certain problem—namely, that the line between making and interpreting law is exceedingly fine—if it exists at all. Indeed, interpreting the law is tantamount to making it. Interpretation is a creative act.

Since in our society it is men and women who write and interpret the laws (and the Constitution), the rule of law is necessarily the rule of men and women.

I realize this is a heretical thought among advocates of individual freedom, but facts are facts and it’s better to face them. A weak argument for liberty is harmful to the cause, so let’s mount the best case we can.

Constitutions and laws do not speak for themselves. People must decide what they mean. This is by nature a controversial truth from which there is no escape. Seemingly clear language is often argued about for years, indeed decades and centuries. As I’ve written elsewhere, “[I]t’s not as if the proper interpretation (whatever that may be) can be hardwired somehow to guarantee that legislators, presidents, and judges will act in certain ways, or that the public will demand it. At every point people will be making the interpretive decisions, including the decision over which interpretation is right.”

Or as Ludwig Wittgenstein wrote in Philosophical Investigations, “[A]ny interpretation still hangs in the air along with what it interprets, and cannot give it any support.”

John Hasnas, a visiting professor at Duke University Law School and a first-rate legal philosopher, has taken up this matter in a paper explosively titled “The Myth of the Rule of Law.” (He has developed his thesis further in “The Depoliticization of Law” [pdf]. Quotations are from the earlier article.)

Hasnas argues that laws can never be determinate because no language is exempt from interpretation. The First Amendment to the Constitution is about as plain as language gets, but after more than 200 years its meaning is still subject to disagreement. Or, the Commerce Clause, which says Congress shall have the power to “regulate … commerce among the several states,” was initially interpreted as limited to interstate commerce, although that meaning is by no means obvious from the text. The framers were perfectly capable of writing “between citizens of different states” when they wanted to and as they did in Article III on the powers of the judiciary.

Thus to interpret law is to make law.

Contradictory Rules

Moreover, in a legal system such as ours, Hasnas writes, there is inevitably a host of “incompatible, contradictory rules and principles…. This means that a logically sound argument can be found for any legal conclusion.” (Hasnas gives several examples.) “Because the law is made up of contradictory rules that can generate any conclusion,” Hasnas writes, “what conclusion one finds will be determined by what conclusion one looks for, i.e., by the hypothesis one decides to test. This will invariably be the one that intuitively ‘feels’ right, the one that is most congruent with one’s antecedent, underlying political and moral beliefs. Thus, legal conclusions are always determined by the normative assumptions of the decisionmaker…. [I]t is impossible to reach an objective decision based solely on the law. This is because the law is always open to interpretation and there is no such thing as a normatively neutral interpretation. The way one interprets the rules of law is always determined by one’s underlying moral and political beliefs.”

The upshot is that interpreting the law is an intrinsically political act.

Hasnas points out that the necessity for interpretation does not mean that the law will be acutely unstable. There is indeed a large degree of stability. The law changes over time, but not day to day. Yet, he writes, “The stability of the law derives not from any feature of the law itself, but from the overwhelming uniformity of ideological background among those empowered to make legal decisions…. [T]o assume that the law is stable because it is determinate is to reverse cause and effect. Rather, it is because the law is basically stable that it appears to be determinate. It is not the rule of law that gives us a stable legal system; it is the stability of the culturally shared values of the judiciary that gives rise and supports the myth of the rule of law.”

Hasnas (who advocates competition in the production of law) concludes, “The fact is that there is no such thing as a government of law and not people. The law is an amalgam of contradictory rules and counter-rules expressed in inherently vague language that can yield a legitimate legal argument for any desired conclusion.”

This need not lead us to pessimism or cynicism. As Thomas Paine recognized, the fundamental order that defines any society—indeed, the order without which we would call a group of people a mob rather than a society—originated not with top-down legislatures but from bottom-up custom, contract, and common-law processes. The great liberal legal scholar Bruno Leoni wrote in Freedom and the Law that a legislature is analogous to a central planner, with all the knowledge problems that plague it, while a common-law system is more like the free market, with far better access to the knowledge of time and place that is scattered throughout society and unavailable to a central authority. Better to progressively shrink the sphere in which legislators can operate so that people are free to govern themselves through voluntary exchange.

Advocates of liberty will ultimately carry the day not by invoking impossible standards like “the rule of law not of men,” but rather by directly upholding the standard of freedom and justice.

Barack Obama says, “[T]he most significant driver — by far — of our long-term debt and our long-term deficits is ever-escalating health care costs. If we don’t reform how health care is delivered in this country, then we are not going to be able to get a handle on that.”

Very clever, indeed. Enlist the budget-deficit hawks in the effort to further bureaucratize decision-making in medical care. Obama has already recruited the competitiveness lobby, claiming that more centralized control of medical care will lighten (!) the burden on American business, enabling it to better compete against companies in countries with socialized medicine.

Another strategy is to blame “private”-sector medicine for the out-of-control Medicare program, which has a $35 trillion unfunded liability and is helping to break the federal budget. In the 1960s the national government took over funding of medical care for the elderly. Critics warned that, as a welfare program, Medicare would explode beyond all official budget estimates. When it did so, the advocates of Medicare (and fully nationalized medicine) blamed the (semi-)private providers of services, and now Obama threatens more control than they already endure.

Once again, we see an important principle at work: No matter how much the government controls an industry, when something goes awry, economic freedom will get the blame.

If the price of a particular set of services rises faster than other prices year after year —and there is no free market in those services—there are two things you can do: 1) give bureaucrats greater power to control costs—this is called “reform—or 2) look for the ways that existing policies create price inflation, then repeal those interventions.

For medical care the juggernaut is heading toward option 1, with the insurance companies and providers climbing aboard fast in order to cut their deals early.

This is too bad, because the solution lies with option 2.

Prices in the medical industry today, no matter what the advocates of government control believe, are not arbitrary numbers plucked out of the air, or the result of sheer profiteering and greed. Rather they are the product of a government-manipulated, semi-competitive, supply-and-demand process. Prices emerge from this tangled system that is result of decades of government intrusion. If the planners ignore the real determinants of rising prices and attempt to get them “under control,” it will make things worse by creating shortages and other problems. If, for example, price controls are imposed, supply will shrink relative to demand, and when the shortages become acute, the bureaucracy will step in to ration medical services.

Or the policymakers might go directly to rationing as a way to control costs. The easiest way for the government to lower society’s overall medical bill would be for it to engage in triage, dictating who gets what kind of service. In some ways, this already happens in Medicare, which refuses to cover certain services out of budgetary concerns. It could also license medical technology to avoid “wasteful duplication,” another form of rationing. Such an approach might lower total money expenses, but so what? The point shouldn’t be to cut the total bill regardless of the consequences. Waiting months for surgery or doing without because the government won’t pay for it is a cost, although it doesn’t show up in the budget. This in part is how other countries seem to spend less on medical care than we do. In fact, our semi-statist system uses resources more efficiently than fully nationalized systems in other wealthy countries—with equal if not superior results. U.S. per capita spending growth is below the OECD average, writes John Goodman of the National Center for Policy Analysis.

Savings through Modernization

The Obama administration promises savings will come through modernization not interference with consumer choice. Imagine government modernizing a sector of the economy! The grounds for skepticism are abundant. We can be confident that when the benefits don’t materialize, the politicians will resort to more draconian methods—while blaming greed and profiteering for the policy failure.

You know an industry is heavily regulated when politicians exhort providers to lower costs and they pledge to do so. No competitive industry would require exhortations or pledges. Competition would drive innovative providers to minimize costs while maximizing quality and making even exotic services more and more accessible.

It is not the free market that has failed. It is government.

Therefore, the second approach to cost-cutting is in order: Eliminate all the ways that government causes medical price inflation. These range from supply-side interventions—including occupational licensing, certificates of need, the FDA, and patents—to demand-side interventions—including tax favoritism toward employer-based insurance, Medicare, and Medicaid. Third-party payment that makes medical services appear free or nearly so encourages overconsumption and raises costs indirectly for everyone, with particular hardship to those not participating in the programs.

To set things right, consumer prices and true costs must be aligned through the market process. People would then become cost-conscious buyers of services and would most likely reserve insurance for truly insurable catastrophic events. Of course, some who need medical attention wouldn’t be able to afford it. That would be less frequent in a real free market, but when it occurred, the answer would be voluntary charity rather than clumsy bureaucratic intervention.

For decades government policy has conveyed the message that no one should have to pay for medical care. Bastiat’s aphorism has never been more true:

The state is that great fiction by which everyone tries to live at the expense of everyone else.

But of course medical services and products are not really free, and we can’t all live at everyone else’s expense. Someone has to pay. There are only two choices: free exchange (including mutual aid and charity) or bureaucratic diktat— and all its negative externalities.

The government should get out of the way. How much we spend on medical care is none of its business. The medical industry is not destroying the government and the country. On the contrary, the government is destroying the medical industry and the country.

On the other hand, trusting one’s representatives — “misrepresentatives” is a more precise term — to watch over things is pointless: They don’t read the bills they vote on; deal-cutting is a higher priority anyway. In recent years they’ve voted to bail out Wall Street banks, “stimulate” the economy, invade countries, and inflate the power of government to violate civil liberties—all without reading the relevant materials. (Not that the executive always waited until Congress blindly passed the requested authorization.)

By what criterion are we entitled to call this “representative government”? Periodic elections are a necessary condition for that label to apply, but they are hardly a sufficient condition.

A government of self-defined powers is  hardly new in the United States; nor is it the monopoly of any one party. But it has accelerated in the last decade through the exploitation of fear: fear of economic calamity, fear of terrorism, fear of the unfettered market. From the beginning, fear has propelled the growth of the state. H. L. Mencken saw this more clearly than most –“The whole aim of practical politics is to keep the populace in a continual state of alarm (and hence clamorous to be led to safety) by menacing them with an endless series of hobgoblins, all of them imaginary.” — and Robert Higgs has spent a career explaining it.

Using powers the origins of which predate the New Deal, government has now extended its tentacles to encircle the entire economy. Bureaucrats exercise wide-ranging discretion with, at best, murky authority. The unaccountable Federal Reserve System creates money in order to buy not only government securities, but also “troubled” assets from investment banks and other favored firms. The FDIC now insures all bank debt, not just deposits, and guarantees government loans to hedge funds that buy the kinds of securities Treasury Secretary Timothy Geithner prefers. The Treasury last fall asked for $700 billion for one purpose (buying worthless mortgage-backed securities) but uses it for other things instead, such as buying stock in banks and bailing out insurance and auto companies that have earned the right to fail. As George Will writes, “TARP’s $700 billion, like much of the supposed ‘stimulus’ money, is a slush fund the executive branch can use as it pleases.” This points to another unsettling practice: congressional blank-check authorizations to the executive branch: “Here’s some money; do something good with it.” (Of couse it is not only in domestic policy that blank checks are handed out.)

All told, such government-run-amok financial undertakings have the hapless taxpayers on the hook for an amount of money rivaling the gross domestic product. The Fed has created trillions in funny money—portending a horrendous price inflation—and the current deficit is nearly half the entire budget. When Congress is asked to rubberstamp executive activities — as occasionally it is — most of our misrepresentatives faithfully comply. The news media call this being “responsible.” Dissenters, such as those in the House last fall who voted down the first TARP bill, are stigmatized as fringe characters unworthy of serious attention, and quite possibly nihilists.

The Chrysler Intervention

The latest example of government run amok is the Obama administration’s interference with the bankruptcy of Chrysler. Under the administration’s plan the UAW will get 43 cents on the dollar and a majority of the stock shares, while secured nonbank bondholders are offered about 30 cents and have their contractual rights nullified. When they balked in an attempt to fulfill their legal responsibilities to their investor clients, Barack Obama denounced them as greedy speculators. Where does the White House occupant get this authority? Does he know or care that he is engaged in the destruction of wealth? Does the public even wonder about these questions?

It is taken for granted that government can do whatever it wants so long as those doing it seem to be acting in good faith and aren’t benefitting too overtly. This trusting attitude is a far cry from the “jealousy” toward government that Thomas Jefferson prescribed for a free people.

Government has been exercising such power so long that people are accustomed to it. It’s normal. They don’t expect modest government in either domestic or foreign matters. If we think government runs amok in the economy, look at what it’s doing in Central Asia and the Middle East. Foreign policy not only gives government great scope for unmonitored mischief, it also efficiently drains the taxpayers. Like domestic intervention, foreign intervention is madly expensive—not to mention dangerous to innocents and those only suspected of crime but not yet proved guilty. Yet many people  who are distrustful of carte-blanche power over domestic affairs apply a different standard to government’s powers in foreign matters. It’s as though Foggy Bottom the Pentagon, and the CIA weren’t departments of the government — as though war,  intervention, and the resource-eating military budget had no effect on the marketplace. Freedom’s greatest advocates, including Adam Smith, Richard Cobden, and Frederic Bastiat, knew better. There could be no laissez faire at home and continuous war-making abroad.

Thus Rep. Ron Paul wisely writes, “We need to rein in our overseas empire, as quickly as possible. We need to bring our troops home, and get our economy back into the business of production, not destruction. The smartest thing we could do is admit we don’t know all the answers to all the world’s problems. If the new administration can take a closer look at real free trade and no entangling alliances, we would be much better off for it…. But unfortunately, it is not likely to happen.”

So those who understand had better get to work.

No one familiar with the origins of the Fed, or the other Progressive Era reforms, should be surprised. Those who have not studied the Progressive Era in any depth, however, are likely to believe those reforms were imposed by enlightened politicians to end abuses by big business. That is one of many fairy tales we learn in school. It’s not so, but it serves its purpose, which is to protect the left and right wings of the ruling party from the radical laissez-faire alternative. Those reforms, though of course cheered on by European-educated American intellectuals attracted to power and ambitious Progressive politicians, were in fact the brainchildren of the corporate elite. Its members disliked the vigorous market competition of the late nineteenth century because it cost them market share, and their efforts to stifle competition through mergers had failed miserably. So the elite turned to the state for protection. (See Roy Childs’s classic “Big Business and the Rise of American Statism” here.)

In no industry was this more true than in banking. There has hardly ever been anything we could call genuine free banking in America, even when a gold standard was in effect. States and the national government regulated the banks by, among other things, tying the issuance of currency to the holding of government bonds and banning interstate and intrastate branch banking.

“The banking system of the United States after 1865 was, therefore, a halfway house between free and central banking. Banking was subsidized, privileged, and quasi-centralized under the aegis of a handful of large Wall Street banks,” wrote Murray Rothbard (pdf), economist and historian. “Even at that, however, the large national banks and their financial colleagues were far from satisfied. There was no governmental central bank to act as the lender of last resort.”

The problem, Rothbard explained, was that when an inflationary boom went bust, the banks “were forced to contract and deflate to save themselves.” This was a problem of “inelasticity” of the money supply. “Translated into plain English, ‘inelasticity’ meant the inability of the banking system to inflate money and credit, especially during recessions.”

So, concerned about “inelasticity” and the rivalry of state and private banks and private trust companies, the national banks (Wall Street), led by J. P Morgan, turned their attention at the end of the nineteenth century to the establishment of a central bank.

Growing Consensus

To make a long story short, Rothbard writes in The Mystery of Banking: “The growing consensus among the bankers was to transform the American banking system by establishing a central bank. That bank would have an absolute monopoly of note issue and reserve requirements and would then insure a multilayered pyramiding on top of its notes. The Central Bank could bail out banks in trouble and inflate the currency in a smooth, controlled, and uniform manner throughout the nation.”

Essentially it would be a cartel that would allow concerted action free from competition. A cartel unsupported by government is vulnerable to independent competitors. To succeeded in defiance of market forces, a cartel needs government help, either to force everyone into it or to hamper outsiders.

While the New York bankers’ interest in central banking went back to the late nineteenth century, the Panic of 1907 provided the final impetus for action. Meetings were held, reports were issued, and legislation was drafted—all in the campaign for a European-style bank. Rothbard shows that the principals in this effort were associates of the most important groups in New York banking, particularly “the Morgans, the Rockefellers, and Kuhn Loeb.” Their point man in Congress was Sen. Nelson Aldrich, father-in-law of John D. Rockefeller, Jr.

Several men associated with these interests, including Aldrich, gathered on Jekyll Island, Georgia, in late 1910 “in a top secret conclave to draft a bill for a central bank.” As Rothbard commented, “There is no clearer physical embodiment of the cartelizing coalition of top financial and banking interests that brought the Federal Reserve System into being than the sometimes allied, often clashing Rockefeller-Kuhn, Loeb and Morgan interests, aided by economic technicians.” A plan for a central bank was drafted and, after modification, “introduced … as the Aldrich Bill, which in turn became in all essentials the final Federal Reserve Act passed in December 1913.” (With some technical changes, it later was known as the Glass bill.)

Rothbard added, “[T]he main difference between the draft and the eventual legislation is that in the former the national board of directors was largely chosen by the banks themselves rather than by the president of the United States. This provision was so blatantly cartelist that it was modified for political reasons to have the president name the board.” (The board of the New York Fed is dominated to this day by the Wall Street banking establishment. For an indication of its current difficulties see this.)

At a big conference in 1911 in Atlantic City, bankers from around the country embraced the draft legislation. As historian Gabriel Kolko summed things up: “[T]he real purpose of the conference was to discuss winning the banking community over to government control directed by the bankers for their own ends…. It was generally appreciated that the [Aldrich plan] would increase the power of the big national banks to compete with the rapidly growing state banks, help bring the state banks under control, and strengthen the position of the national banks in foreign banking activities.”

Rothbard added, “[T]he nation’s bankers, and especially the big bankers, were overwhelmingly in favor of a new central bank. As A. Barton Hepburn of the Chase National exulted at the annual meeting of the American Bankers Association in August 1913, in the course of his successful effort to get the bankers to endorse the Glass bill: ‘The measure recognizes and adopts the principles of a central bank. Indeed, if it works out as the sponsors of the law hope, it will make all incorporated banks together joint owners of a central dominating power.’”

Thus, summing up the thinking of Edward Hurley, vice chairman of the Federal Trade Commission in 1915, Rothbard wrote, “The railroads and shippers had the ICC [Interstate Commerce Commission], the farmers had the Agriculture Department, and the bankers had the Federal Reserve Board.”

Why does this matter now? The major banks wanted to inflate in unison and with impunity, reaping the profits of the perpetual boom they thought they could create. That, they understood, required a central bank. But fiat money inflation is the people’s nemesis. It knocks the economy out of alignment with their preferences, allocates incomes politically, robs people of their purchasing power, and throws them out of work when the inevitable bust comes. In this libertarian “class struggle,” the special interests prevailed. The people’s best interests lie in free banking and hard money.

The story, titled “Geithner, Member and Overseer of Finance Club,” chronicles Treasury Secretary Timothy Geithner’s close and repeated contacts with Wall Street moguls when he was the president of the Federal Reserve Bank of New York and on his way to becoming the “leading architect of [the financial] bailouts.” The Times story did not quite suggest corruption on Geithner’s part. Rather, its orientation is more systemic, the point being that whoever regulates banks, especially those on Wall Street, is bound to be caught up in a particular culture in which regulators and regulated tend to see things from the same perspective. It’s not that Geithner would knowingly put the interests of Wall Street ahead of those of the people in general. It’s that he would tend to equate those interests, even when they objectively diverge.

As the Times put it, “His actions, as a regulator and later a bailout king, often aligned with the industry’s interests and desires, according to interviews with financiers, regulators and analysts and a review of Federal Reserve records.”

In fact, as the New York Fed is structured, the line between regulator and regulated is quite fine. The bank, the Times notes, oversees “many of the nation’s most powerful financial institutions.” At the same time, “The New York Fed is, by custom and design, clubby and opaque. It is charged with curbing banks’ risky impulses, yet its president is selected by and reports to a board dominated by the chief executives of some of those same banks. . . . [T]op executives of global financial giants fill many seats on the board. In recent years, board members have included the chief executives of Citigroup and JPMorgan Chase, as well as top officials of Lehman Brothers and industrial companies like General Electric” (emphasis added).

As to be expected, Geithner’s contact — personal and professional — with “bankers, hedge fund managers and others” was hardly infrequent. His meal and meeting partners were top people from Goldman Sachs, Citigroup, Morgan Stanley, and JPMorgan Chase. Some of these get-togethers were at the executives’ homes.

Geithner began his career with Kissinger and Associates, an international consulting firm founded by former Secretary of State Henry Kissinger, a Rockefeller family confidant. Geithner worked in various capacities for Treasury beginning in 1988, spent some time at the Council on Foreign Relations, then moved to the International Monetary Fund. His mentor is Robert Rubin, who was Treasury secretary under President Clinton. Before that, Rubin had been a top executive at Goldman Sachs. After leaving Treasury he went to Citigroup, “the largest bank under his [Geithner’s] supervision” at the New York Fed.

Thus before he took over the New York Fed at age 42, he was a man with deep connections to the financial establishment. Rubin was on the search committee that recommended Geithner for the job. Sanford Weill, a major Goldman Sachs figure, was on the board of the bank. “He didn’t have a lot of experience in dealing with the industry,” Weill said of Geithner. Thanks to what Weill calls “his willingness to listen to people,” however, he apparently quickly learned the ropes from the people he was monitoring.

Financial Meltdown

When Wall Street’s mortgage-related problems, which Geithner did not foresee, began to surface, he worked behind the scenes for a plan favored by Citigroup and others to reduce their capital requirements. Around this time, late 2007, when the company was looking for a new CEO (after Rubin became chairman), Weill proposed Geithner for the job. (Of course, he didn’t take it.)

As the government-built financial house of cards began to tumble, Geithner was a key designer of the bailouts, along with then-treasury secretary Henry Paulson (another Goldman alumnus) and Fed chairman Ben Bernanke. Geithner helped get JPMorgan Chase to assume control of Bear Stearns – with the aid of a $29 billion government check in exchange for Bear’s toxic paper.

When AIG (American International Group) started tottering, Geithner, again, was there. While looking for private money to save the insurance giant, he enlisted Goldman Sachs to assist in the rescue, even though AIG thought that would involve a conflict of interest. When the government took on the rescue itself, “A.I.G.’s trading partners, including Goldman, were compensated fully for money owed to them by A.I.G.”

As New York Fed chief, it was Geithner’s idea to have the FDIC guarantee the debt of banks and investment companies. “Mr. Geithner’s program was enacted and to date has guaranteed $340 billion in loans to banks,” the Times wrote. (The government has collected about $7 billion in fees from the banks.)

Finally, Geithner raised eyebrows by awarding three no-bid contracts, worth about $71 million, to the BlackRock financial company for help in managing the iffy assets bought by the Fed bank. “Mr. Geithner socialized with Ralph L. Schlosstein, who founded the company and remains a large shareholder, and has dined at his Manhattan home. Peter R. Fisher, who was a senior official at the New York Fed until 2001, is a managing director at BlackRock” reports the Times. Geithner says no other company had the expertise to handle the contracts.

Since becoming Treasury secretary in the Obama administration, Geithner has continued to devise ways to help struggling giant financial companies. For example, he launched a program to provide FDIC-backed loans to hedge funds for the purchase of consumer-debt-backed securities. Thanks to Geithner and others, the U.S government has committed the taxpayers to $12.8 trillion in various forms of assistance to the financial industry. That’s almost equal to the country’s GDP.

Geithner also advocates comprehensive new powers that would permit the government to take over (“rescue”) not only banks, but insurance and other financial companies, such as hedge funds, whose failure would allegedly pose a systemic risk.

The extent of Geithner’s connections are startling — but only until one understands the origins of the Federal Reserve System. Seen in that context, the Geithner saga seems more like business as usual. You’ll see why next week when we look at the Fed’s origins.

Last month the Treasury announced a “Framework For Regulatory Reform,” which “focuses first on containing systemic risk.” The release said: “While we strengthen prudential oversight for all firms, we must also create higher standards for all systemically important financial firms … to account for the risk that the distress or failure of such a firm could impose on the financial system and the economy.”

The Treasury is not alone in talking about this. Rep. Barney Frank, among others, wants Congress to create a “systemic-risk regulator,” perhaps within the Federal Reserve. Fed chairman Ben Bernanke also sees the need for the government to regulate systemic risk. In a speech to the Council on Foreign Relations in March titled “Financial Reform to Address Systemic Risk,” Bernanke said, “Any firm whose failure would pose a systemic risk must receive especially close supervisory oversight of its risk-taking, risk management and financial condition, and be held to high capital and liquidity standards.”

There is something bizarre, indeed, about government assuming the role of protector against systemic risk. Knowledge problems aside, is there any entity in our society that presents a greater systemic risk than the U.S. government, including the Federal Reserve?

That the central government is systemically risky in the extreme hardly needs demonstration. It borrows trillions of dollars to cover profligate spending, shouldering future generations with heavy debt and taxes. Its tentacles reach into every nook and cranny of the marketplace. Regulation of the critical financial industry is pervasive and has been for years. When rules, such as inflexible capital requirements and cartelized securities-rating procedures, emanate from a central bureaucracy, the financial system is vulnerable to mistakes that the bureaucracy will inevitably commit. Competition is a discovery process, as Hayek taught, which means that a monopoly central regulator deprives the market of important discoveries that would have been made in its absence. Mistakes are thus more likely and the vulnerability of the entire system is magnified.

One need only study the genesis of the current financial crisis for the most recent example. When the federal government imposed housing and lending policies on the market, it set everyone up for the disaster that ensued. Now even people who did not take out mortgages or buy homes are suffering for the policymakers’ mistakes.

The Fed

The biggest single creator of systemic risk is the Federal Reserve. It manages the money supply, and money is part of virtually every transaction that occurs. Its monetary conduct also influences the most important set of prices: interest rates, key signals that coordinate the allocation of scarce resources over time. By tampering with those signals the Fed is in a position to make huge mistakes that can harm everyone–which is exactly what it has done throughout its history.

“Manages the money supply” doesn’t quite capture what the Fed really does. It creates money out of thin air to carry out macroeconomic objectives and, most recently, to bail out firms deemed too big to be permitted to fail.

What could be a bigger systemic risk than a legal counterfeiter whose handiwork is legal tender? Here is a true weapon of mass destruction.

No private bank or other company has ever come close to causing the damage the Fed has caused. Its inflations robbed people of purchasing power while twisting the economy out of shape with artificial booms that inevitably ended in unemployment and other hardship. It was the Fed that gave us the Great Depression and the depression within a depression several years later. The same Fed is at least partly responsible for the late housing boom that has brought so much misery (and expanded government power). And the Fed now multiplies risk by buying up trillions of dollars in toxic bank assets, exposing the people to future crushing tax liabilities and inflation.

Besides creating bigger risks than private firms (without government privileges) could ever create, government agencies also encourage banks and other financial companies to take more risks than they could possibly take in a free market. Any hint that the government will bail out big companies increases the likelihood of reckless behavior on a scale that couldn’t be imagined otherwise. Last month Bernanke said, “[T]he Federal Reserve, other federal regulators, and the Treasury Department have stated that they will take any necessary and appropriate steps to ensure that our banking institutions have the capital and liquidity necessary to function well in even a severe economic downturn. Moreover, we have reiterated the U.S. government’s determination to ensure that systemically important financial institutions continue to be able to meet their commitments.”

What is that if not a invitation to undertake systemically risky conduct in the future?

The idea that the U.S. Treasury, the Federal Reserve, and Barney Frank will save us from systemic risk sounds like a “Saturday Night Live” sketch. For some reason, no one is laughing.

At some point the nonlibertarian interlocutor will think he’s figured things out: “I get it. You are biased against government. When you spot a public problem, you assume that government is at fault.”

This is a charge to which I have to plead guilty. I am biased against government, specifically the people who make and carry out its policies. It is to them that I look first for the cause of social or economic problems, although it may not be the last place I look. There, I’ve confessed.

It’s a bias but not a prejudice. A prejudice, as the word suggests, is a judgment made before consideration of evidence. A bias is an inclination, and there’s no reason an inclination against the State can’t be the result of detailed knowledge of its nature.

What’s puzzling is that anyone thinks there’s something wrong with this. What could be more natural than a suspicion of the only organization in society that has the legal authority to initiate force? Initiate force. That means using it against people who have not aggressed against anyone. Two days after tax day I shouldn’t have to elaborate this point. Not paying taxes is a perfectly nonviolent activity, a victimless act. But that will not stop government agents from using whatever violence deemed necessary to obtain what they believe is their due, including imprisonment and lethal force should the tax nonpayer appear to “resist arrest.” Monty Python hit the bullseye when their Holy Grail peasant implored, “Come and see the violence inherent in the system!” (Follow the link for the best summation of political philosophy in the history of the cinema.)

Whether or not one thinks the power to initiate force is necessary for some worthwhile end, the point is, as George Washington may or may not have said, government is (legitimized) force. That is its essence, the thing that distinguishes it from anything else. Government is in a class by itself, and that warrants a unique attitude toward it.

Since no one else may use force nondefensively, a question arises for which liberals (in the original sense) have long been awaiting an answer: Where do the State’s officers get their authority? In democratic republics we say the people delegate certain powers through constitutions to those hold who hold government office. The obvious problem here is a logical one: The people can’t delegate what they don’t possess.

Why should force summon such apprehension? Because it is the chief means by which a person may be kept from living the life of reason in accordance with his nature and thereby flourishing. Isn’t it curious that so many people who proclaim their commitment to peace and human rights also adore expansive government?

Interferer with Spontaneous Order

There’s another, though related, reason to begin with a bias against government. When one grasps the beneficent nature of human action, peaceful exchange, and spontaneous market order, one is naturally wary of an organization that appears designed to interfere with those things.

Sound economic theory furnishes grounds for this wariness, while the world around us furnishes abundant examples to illustrate the theory. We see that government policy achieves the opposite of its stated goals virtually every time. (Its real goals may be something else.) When it sets price ceilings to make things more affordable, it drives those things from the market, whether it’s milk, apartments, or medical care. When government sets price floors to ensure a living wage, it drives jobs from the market or reduces other forms of compensation. When it tries to bring homeownership within the reach of people with no income and bad credit, it shakes the foundations of the economy. When it sets out to make money more abundant, it robs most people of their wealth before plunging them into depression. And when it embarks on fixing up the mess it has made, things get even worse. If you need an example, see the goings-on in Washington. At a time when people are sensibly consuming less and saving more — permitting a market reallocation of politically misallocated resources – the government is borrowing astronomical sums in their name and consuming resources like mad. (Meanwhile the news media portray the reduction in consumer spending as a problem not a solution.)

So behold the organization that bullies and coerces while disrupting the best form of social organization ever discovered by mankind. (We haven’t even touched on the offenses committed under the rubric “defense.”)

Who wouldn’t harbor a bias against “the coldest of all cold monsters”?

“The view that now pervades much public policy economics implicitly presents the relevant choice as between an ideal norm and an existing ‘imperfect’ institutional arrangement. This nirvana approach differs considerably from a comparative institution approach in which the relevant choice is between alternative real institutional arrangements.”

A common form of the fallacy is rejection of the imperfect free (or freer) market in favor of (presumably) omniscient, omnipotent, and omnibenevolent government regulation. A ”flawed” but achievable arrangement is set against an (alleged) ideal, though it is left unestablished whether the ideal can in fact exist. The problem with this form of analysis should be obvious. If the ideal is not available, then the comparison is invalid and yields no practical information. If the rejected arrangement were compared to other achievable—that is, imperfect—alternatives, it might well be judged superior.

A recent example of the Nirvana Fallacy comes from Sen. Charles Schumer of New York. Earlier this week Schumer, appearing on MSNBC’s “Morning Joe,” explained how Congress and the Obama administration will prevent a recurrence of our financial troubles. Schumer said:

You’re gonna find a different system of regulation. The real problem—and this is government’s fault …—when the financial world changed, the system of regulation didn’t…. That will change. There will be a strong, quiet, hopefully more unified federal regulator…. And he’s gonna be tough–or she. But they’re gonna be quiet. So like when Bear Stearns began to run into trouble, they’re gonna call the heads of Bear Stearns in and say, “All right fellas, you’re getting rid of those two hedge funds; you’re gonna raise more capital—even if means you have lower profitability. We’re not gonna tell anyone you’re doing this, but you do it or we’re gonna take sanctions against you.” … You need a tough, strong regulator, unified—no holes in the system— … who … sees the problem ahead of time, so they have complete transparency, they know exactly what’s going on … and they come in and say ‘straighten up even if your … profitability is lower and your stock has to go down.

We should be grateful to Schumer for providing such a detailed answer because it affords an excellent opportunity to see how the Nirvana Fallacy underpins the regulatory approach to economic problems.

We see at once that Schumer is engaged in question begging, a key feature of the fallacy. He assumes what he must demonstrate—namely, that a regulator would have the characteristics he supposes. Several problems plague Schumer’s objective, but I’ll focus on one: the knowledge problem, which stems from that fact that the most critical economic knowledge is not readily obtainable statistical data. (The other problems involve incentives and mission creep.) Reread Schumer’s description with my emphasis:

So like when Bear Stearns began to run into trouble, they’re gonna call the heads of Bear Stearns in…. You need a tough, strong regulator, unified—no holes in the system— … who … sees the problem ahead of time, so they have complete transparency, they know exactly what’s going on.

Now ask yourself what Schumer apparently has not asked himself: How will the regulators “know exactly what’s going on”? Spotting Bear Stearns’s specific hedge-fund problems “ahead of time” (!) would have required insights and hunches that only entrepreneurs with money at risk could be expected to have—and even those might not have been enough. Fortune-telling is not a widely distributed skill. It’s not a matter of toughness or access to Bear’s books. At the very least, it’s a matter of entrepreneurship (not to mention luck), which is profit-driven. Bureaucratic regulators bring no such talent to their jobs. More likely, they’d enforcing formal (possibly outdated and irrelevant) rules, looking for a repeat of the last problem, while missing the next one entirely. As Nassim Nicholas Taleb might say, it’s the next black swan, not the last one, that bites you.

Schumer apparently assumes these insurmountable obstacles away. Worse, he shows no awareness of them. As a result, he perpetuates misconceptions that give people a false sense security about regulation, thereby making them more vulnerable to risk than otherwise. Bernard Madoff’s Ponzi pigeons thought they were protected by the SEC. Would they have been better or worse off without that “protection”?

Schumer’s fallacy is actually worse than the standard Nirvana Fallacy. He doesn’t compare his unrealizable regulatory vision to the free market but rather to the corporatist economy, replete with government bailouts, moral hazard, easy credit, and all the other ways of disabling market forces that lured big financial firms into trouble in the first place.

The closest we can get to what Schumer says he wants is through the discipline—that is, the regulation—imposed by the unfettered market. That includes bankruptcy’s Sword of Damocles and the freedom of traders to sell short, that is, to profit by betting that a company’s stock is overvalued and acting to communicate that information to the market early. Predictably, the government is planning to restrict short-selling. Bad regulation drives out good.

When you don’t understand how the economy got into a mess, you are not likely to understand how it can get out. Politicians either can’t or won’t graps the key fact: “the free market” did not cause our problems. How do we know this? It’s logic: the nonexistent cannot be the cause of anything. I’d like someone to show me this free market that brought on all the current turmoil. Please. The banking industry gets most of the blame, but banking has been part of a formal government-sponsored cartel since 1914 and is regulated, as well as privileged, by multiple layers of authorities, among them the Federal Reserve, the Federal Deposit Insurance Corporation, and the Comptroller of the Currency. An international agreement among the major central bankers, the Basel Accord, controls capital requirements and related matters. (Before 1914 a patchwork of regulations existed.) And let’s not forget the regulators in the states. With perhaps a local or exception or two, there has never been an unregulated banking industry in America (or most anywhere else).

This only scratches the surface of the corporate state’s stewardship of the economy. But politicians, who wield power and spend coercively acquired money for a living, have no incentive to see this. How could they? That’s not how the game of politics is played. They have no reason to see things in a way that would counsel against their exercising authority.

So, with complete predictability, the Gang of 20 promised to spend over a trillion dollars they don’t have to “stimulate” the world economy, to help struggling countries through the IMF (its record is so good at that), and other noble purposes. The G-20 also endorsed worldwide inflation by central banks and promised—I love this one—to “take action against” tax havens.

“The era of banking secrecy is over,” said the communiqué, as though that were a good thing. “We stand ready to deploy sanctions to protect our public finances and financial systems.”

The Obama administration led us to believe it was standing firm against a world regulatory authority, which was pushed by French President Sarkozy. But you be the judge. Here’s what the communiqué says:

“We each agree to ensure our domestic regulatory systems are strong. But we also agree to establish the much greater consistency and systematic cooperation between countries, and the framework of internationally agreed high standards, that a global financial system requires…. In particular we agree: … to establish a new Financial Stability Board (FSB) with a strengthened mandate, as a successor to the Financial Stability Forum (FSF), including all G20 countries, FSF members, Spain, and the European Commission…; to reshape our regulatory systems so that our authorities are able to identify and take account of macro-prudential risks; to extend regulation and oversight to all systemically important financial institutions, instruments and markets. This will include, for the first time, systemically important hedge funds; to endorse and implement the FSF’s tough new principles on pay and compensation and to support sustainable compensation schemes and the corporate social responsibility of all firms….”

And more—as if the regulators could have the requisite knowledge to manage economic affairs. This is a regulatory cartel, and to the extent it squelches competition among jurisdictions, it will produce all the evils of a coercive monopoly. That of course is the point. There is to be no safe haven where people can protect their wealth from the grasping politicians.

Economies Aren’t Run

The presumptuous and undistinguished assembly in London—why are they regarded by the media as wise men and women of accomplishment?—aspire to run the world economy, and they know that out-and-out nationalization is not necessary to that end. Of course, they disclaim any such objective. The current White House occupant, Barack Obama, said in his post-conference news conference that he believes in the free market—he did say that!—but that government must set rules to keep it from running “off the rails.”

Well, of course, an economy is not a locomotive and there are no rails. It’s people engaging in exchanges. “Society is purely and solely a continual series of exchanges,” said the eighteenth-century French liberal economist Destutt de Tracy. So Obama’s idea translates into politicians regulating our peaceful, consensual conduct in order to bring about or to avoid certain outcomes. The current economic turmoil has politicians convinced that they must limit risk taken by financial firms. This, pardon me, is a bad joke. It is none other than government itself that has systematically socialized risk in the financial industry and therefore encouraged individuals and firms to undertake greater risks than they would have taken otherwise. The irony is that the more the politicians strive for a risk-free society, the greater the danger to us all. That’s moral hazard, the largest manufacturer of which is the state.

If banks, hedge funds, and other sorts of operations (including government-sponsored enterprises) assume the Federal Reserve or the Treasury will bail them out in a crisis, they will be less risk-averse than they would have been without that guarantee. If depositors see an FDIC sticker on every bank they encounter, they won’t be too particular about which one they entrust with their money. Safety will not be a competitive factor because deposit insurance makes them all appear equal. The bankers know this.

Full Market Discipline

If politicians were really interested in reducing reckless financial activity with the potential for external harm, they would want to see the full force of market discipline at work. The full force. But remember the point about political incentives. Letting market forces discipline banks, insurance companies, automakers, and other firms would leave politicians and bureaucrats little to do. Market discipline—the threat of loss and bankruptcy—is the product of laissez faire, and, loosely translated, that means: “Politicians, keep your cotton-picking hands off peaceful voluntary exchange.”

We face a serious challenge. On the one hand, people who understand markets realize that government regulation—which includes the corporate safety net—was the essential cause of the economic failure. Any seeming irrationality by bankers and financial managers must be grasped in the context of well-understood government guarantees, including the implied promise by the Federal Reserve—the Great Counterfeiter—to buy toxic assets and provide fiat liquidity in a crunch. This was the indispensable underpinning of the government housing policy that encouraged the making and securitizing of dubious mortgage loans (prime and subprime) and the underwriting of those who invested in them.

On the other hand, people who don’t understand markets or who dislike markets can always blame them for any problem that arises. After all, government regulators, no how much power they have, can’t be everywhere watching everything, can they? So as I’ve written elsewhere, “No matter how much the government controls the economic system, any problem will be blamed on whatever small zone of freedom that remains.” (I modestly acknowledge that Laurence Vance has dubbed this, Richman’s Law. I have no objection.) And the “solution” will be—of course—more regulation. Just ask Obama and Treasury Secretary Timothy Geithner. Don’t think of regulation as being imposed. Think of it as the modest price for government privileges and protection.

So the market’s opponents can rely on demagogic sound bites and pervasive economic ignorance, while the market’s defenders must ask people to think. Sad to say, this puts the freedom philosophy at a disadvantage. And so we press on.

In the past few years, the cartels and other drug trafficking organizations have extended their reach across the United States and into Canada. Law enforcement authorities say they believe traffickers distributing the cartels’ marijuana, cocaine, heroin, methamphetamine and other drugs are responsible for a rash of shootings in Vancouver, British Columbia, kidnappings in Phoenix, brutal assaults in Birmingham, Ala., and much more.

United States law enforcement officials have identified 230 cities, including Anchorage, Atlanta, Boston and Billings, Mont., where Mexican cartels and their affiliates “maintain drug distribution networks or supply drugs to distributors,” as a Justice Department report put it in December.

In response the Obama administration says it will send nearly 500 additional agents to reinforce the Border Patrol, Immigration and Customs Enforcement, and Bureau of Tobacco, Firearms and Explosives.  Millions of dollars and military equipment, including three Black Hawk helicopters, will be given to the Mexican government. “If anything, this is really the first wave of things that will be happening,” said Homeland Security Secretary Janet Napolitano. She’s also considering requests by the governors of Texas and Arizona to deploy the National Guard.

These events are also fueling sentiment for new control of guns, especially so-called “assault weapons” (a bogus category dreamed up by gun controllers) since it has been reported that the cartels are entering the United States to buy guns to take back to Mexico.

Does anyone still think the “war on drugs” is a good idea?

That may strike some people as an odd question under the circumstances, so let’s take it from another direction. Have you seen the news stories about the violence on the border being perpetrated by the Mexican whiskey and cigarette cartels?

No? That’s probably because there was no such violence and are no such cartels.

So why are there violent cartels in the marijuana, cocaine, and heroin trades but not in the whiskey and cigarette trades?

All together now: prohibition.

Of course the politicians blame everything and everyone but themselves for this spreading violence. “Our insatiable demand for illegal drugs fuels the drug trade,” Secretary of State Hillary Clinton said. “Our”? Including hers? “Our inability to prevent weapons from being illegally smuggled across the border to arm these criminals causes the deaths of police officers, soldiers and civilians.” Her answer, in addition to sending the Mexican government taxpayer money, is to go after consumers of drugs and manufacturers and dealers of guns she doesn’t like.

Excuse me? Drug users and gun dealers are to blame for drug-cartel violence? That makes no sense. If it did, then drinkers and smokers, along with gun dealers, would be creating violence, too. What’s missing?

Once again in unison: prohibition. Who brought us prohibition?  Politicians. Every politician, bureaucrat, and agent who facilitates or enforces prohibition is an accomplice in the violence because he or she helps to create the conditions in which thugs have a comparative advantage in dealing drugs.

Variety of Evils

For years advocates of free trade in drugs—that is, basic rights to life, liberty, and property for drug consumers, producers, and merchants—have pointed out that prohibition, in addition to being an immoral invasion of liberty by the State, sets in motion a variety of concrete evils that harm innocent people. (No one has been more consistent and rigorous in this than Thomas Szasz). These evils include the corruption of law enforcement, violent crime, and the expansion of intrusive government. Besides these domestic evils, the U.S. government has alienated farmers in foreign lands by helping to destroy their crops and livelihoods. If that’s not terrorism, nothing is. Crop destruction has been a recruiting tool for guerilla organizations, while black-market profits finance them and others with malign intent.

Few listened to these Cassandras against the anti-drug crusade. Maybe they will listen now.

While violent gangs that make their money selling drugs in the black market are murdering and kidnapping people, invading homes, and committing other atrocities, the politicians have nothing to say but the same bromides they’ve been repeating for years. Thinking we’re either simpletons or amnesiacs, they expect us to be comforted by their words. (Will they be right?) They promise to defeat the cartels, crack down on drug use, and disrupt the gun trade. It won’t work. It’s never worked. It can’t work. Black-market operators are always steps ahead of the plodding bureaucrats. Break up one gang and another emerges. The drugs keep flowing (there’s plenty of bribe money), and consumers will have what they want when they want it. The profits made possible by the black market are powerful incentives to keep the industry going. Government is impotent.

Out of Business

Yet the gangs could be put out of business overnight. How? By removing the criminal penalties for the production, trade, and consumption of all drugs; by bringing the black market into the open, so disagreements can be resolved through civil channels and the talent for violence is no longer an advantage; by dissolving the extraordinary profits that illegal industries always reap.

Yes, it is that easy.

People will recoil. We can’t do that! No? Then accept as normal the unspeakable violence that is starting to spread from city to city, because that is the alternative to the stubborn refusal to end the “war on drugs,” which is really a war on people. Even full police-state tactics will not be able to control it, though that won’t stop demagogic politicians from giving them a try. (They can’t keep drugs out of prisons!)

I don’t expect the multitude of officials who depend on the drug war for their livelihoods and power to endorse an end to prohibition. They have shown themselves more than willing to accept the violence (against others) as the price of their ambition. The new threat to us is an opportunity for them to amass more power, bigger budgets, and higher salaries.

But the rest of us have no reason to support the complex of government and “private” tax-financed agencies that grow fat prosecuting this detestable war. The worn-out rationalizations can’t stand examination. Prohibition keeps no one from getting any drug he wants at an affordable price. On the contrary, it encourages the creation of cheaper, more potent drugs, just as alcohol prohibition replaced wine and beer with hard liquor. (More bang in a more compact form.) Prohibition doesn’t keep our children safe. It makes drugs into enticing forbidden fruits and pushes the trade into less visible channels. Drugs aren’t “dangerous,” though people are capable of doing harmful things with drugs and many other things. (Jacob Sullum’s  Saying Yes is an eye-opening book that I highly recommend.) Addiction is not a disease; it’s a choice.

Everything the drug warriors have said is wrong—and often a conscious lie.

Drugs are to our society what Eurasia and East Asia were to Oceania in Orwell’s 1984: a convenient conjured-up demon to justify expansion of power and the usurping of liberty—in the name of keeping us safe.

What will it take, if not the current violence from Mexico, to make people see through the scam?

Look around. It’s our self-proclaimed protectors from whom need we protection most.

Sweep aside the phony expressions of “outrage” over AIG’s government-financed $165 million in bonuses (the information was in black and white) and ask yourself this:

Who supplied the money?

When politicians hand out other people’s money to businesses, they have no right to complain about the results. The politicians are primarily at fault. The bonuses couldn’t have been paid without them.

Adam Smith wrote in The Wealth of Nations, “People of the same trade seldom meet together, even for merriment and diversion, but the conversation ends in a conspiracy against the publick. . . . It is impossible indeed to prevent such meetings, by any law which either could be executed, or would be consistent with liberty and justice. But though the law cannot hinder people of the same trade from sometimes assembling together, it ought to do nothing to facilitate such assemblies; much less to render them necessary.”

You’ll find no sympathy for the mostly nationalized AIG here, but let’s have no more sanctimonious pronouncements from the facilitators on Capitol Hill. What should happen now? Unless the money goes right back to those it was borrowed from, it hardly matters. We and our children will have to repay the debt one way or another. Nevertheless, ex-post-facto tax increases, bills of attainders, and executive-branch abrogation of contracts would indeed be worrisome.

The facilitators say they had to bail out AIG or another Dark Age would have descended on the world. But of course they would say that. Other firms would have salvaged the profitable parts of the company. The rest would have been renegotiated. As for AIG’s counterparties in mortgage-related securities, perhaps they could better weather the storm of an AIG bankruptcy if they weren’t hogtied by inflexible, arbitrary capital requirements imposed by unaccountable government authorities who can’t possibly know the nuanced particulars of time and place.

On the other hand, have the bailout proponents tried calculating the consequences of the AIG rescue in terms of moral hazard? Will future counterparties exercise more or less diligence in light of this episode?

Leading Inquisitors

Predictably, the leading inquisitors into the causes of the financial turmoil are themselves among the most culpable: Rep. Barney Frank, Sen. Chris Dodd, and New York Attorney General Andrew Cuomo. AIG got into trouble because it in effect wrote insurance policies (credit default swaps) against the failure of securities based on mortgages, too many of which were waiting to blow up when the housing bubble burst. Who created the housing bubble? Who created the incentive environment in which writing bad loans paid off handsomely?

It may be hard to tell from the news coverage, but politicians and bureaucrats deserve the lion’s share of the blame, particularly for their government-sponsored enterprises Fannie Mae and Freddie Mac, which bought up and securitized a slew of bad mortgage loans, thereby encouraging lenders to write more of them. This was only the tip of the policy iceberg.

Enter Frank, Dodd, and Cuomo. There were no bigger boosters of Fannie and Freddie in Congress than Frank and Dodd. (The GSEs were vigorous lobbyists and campaign donors.) Every time someone questioned the GSEs’ fiscal integrity, these guys assured us everything was fine.

And then there’s Cuomo, Bill Clinton’s last secretary of housing and urban development and close friend of the Mortgage Bankers Association, which likes any policy that makes writing mortgages safer—for its members. According to the Village Voice, Cuomo pushed the GSEs to buy more and more dubious mortgages, while requiring them to report less and less. “In other words,” Wayne Barrett writes, “HUD wanted Fannie and Freddie to buy risky loans, but the department didn’t want to hear just how risky they were.” Cuomo also “took to reshape the Federal Housing Administration, which guarantees millions of mortgages. These actions, too, sought to maximize homeownership—this time by opening the FHA’s door to borrowers unable to qualify in the past, a lofty goal that has also helped spur an FHA delinquency rate that exceeds its subprime competitors. . . . Cuomo even supported down-payment and closing-cost assistance programs that allowed FHA borrowers to buy a home without spending a cent of their own money up front.”  (If you want to appreciate what a sewer Washington is, read the Barrett’s article.)

Are these guys pursuing AIG out of guilty consciences? Most likely. Will they ever have their day in the hot seat? Not likely.

More Regulation?

The received wisdom is that we need more regulation now, perhaps a Food Drug Administration for the financial industry. This would be foolish and pernicious. We already have regulators falling over themselves. Moreover, the FDA kills thousands of people a year by delaying the marketing of new drugs. Some would like a financial regulatory regime that would prohibit anyone from executing a transaction before a bureaucratic overseer understands its consequences. Such a regime may not actually kill people, as the FDA does, but it would make us poorer. In the miasma of crisis it’s easy to overlook the benefits of financial innovation. By shifting risk to willing parties and increasing liquidity, innovative investment instruments make products and services available we would otherwise not see. For this to work properly, however, government must never blunt the market’s discipline with guarantees and even implicit promises of bailouts. Regulation doesn’t protect us. It merely encourages innovators to take less transparent and perhaps more risky paths. The innovators will always be a step ahead of the regulators. The only true protection we can have is market discipline–the threat of bankruptcy. Government regulation is a shoddy, ineffective substitute that only creates a false sense of security. (Ask Bernie Madoff’s victims.)

Many companies, bedazzled by computer risk models that presume to measure the immeasurable or rewarded for abolishing lending standards, engaged in reckless and even reprehensible conduct leading up to the current crisis. But never forget that only one institution could have created the housing bubble, which made that conduct widespread, lucrative, and substantially free of market discipline: the State. We should hardly look to it for salvation.

“You never want a serious crisis to go to waste. And what I mean by that is an opportunity to do things you think you could not do before.” –Rahm Emanuel

Has President Obama’s chief of staff read Robert Higgs’s Crisis and Leviathan? Probably not, and he wouldn’t have had to. Higgs’s classic is a history of political opportunism during crises. Throughout American history, economic and foreign upheaval has been used to justify expansion of government power. When the crisis subsided, government never shrunk back to its pre-crisis dimensions. Some “emergency” powers were retained, while others were shelved but nevertheless available for quick retrieval thanks to precedent and the public’s reinforced belief that only government can manage a crisis. Moreover, the rate of government growth was faster after the crisis than before.

What’s noteworthy about Emanuel’s statement is its candor. A crisis without an expansion of government would be a tragic waste in his view. It presumably is Obama’s view also. (Secretary of State Hillary Clinton made a similar remark.)

The new administration is certainly living up to the sentiment. The economy is in bad shape primarily because of some combination of housing and monetary policy over the last two decades. Government intervention created incentives for behavior that misallocated scarce capital and distorted the structure of production relative to how things would have been had politicians and bureaucrats not tampered with prices and interest rates. The only real path to sustainable recovery, therefore, is the painful one of market-driven reallocation and restructuring so that the economy can be aligned with the true preferences of consumer-savers.

But that is not the path the policymakers are taking. Instead, they are intent on not wasting the crisis. That is, they are using the economic disarray as an excuse to expand government power and further limit freedom in a host of areas unrelated to the recession. The misnamed “stimulus” bill is the most obvious example. Any government spending can be touted as economic stimulus via an increase in “aggregate demand.” If all the bureaucracies doubled their purchases of paperclips, that would put (borrowed and printed) money in the hands of paperclip makers. Paperclip factories might add a shift and hire workers. This activity would be shown on the evening news, and optimism would spread. Of course, as Bastiat might be saying, the news channel can’t show the jobs that won’t be created because the government has commandeered purchasing power from the private sphere. That capital would have been devoted to consumer-driven projects as soon as entrepreneurs were relatively confident the government wouldn’t launch some absurd scheme that would undermine their prospects or confiscate their profits. It’s so like government to chill the economic environment and then claim it must step in to make up for the lack of activity in the private sector.

Larger Agenda

But seizing advantage during the current crisis goes beyond monstrous spending. Obama is also moving on medical care and education in the name of fixing the economy. To justify this, he must convince us that the economic crisis is partly caused by the current medical and educational systems. These government-dominated sectors do need changing, but Obama’s case is a stretch. What do they have to do with the housing bubble, the result of deliberate social policy?

I sense an opportunistic wish not to waste a good crisis.

The Obama line on the medical system is that if health care didn’t cost so much, American companies would be more competitive with their foreign rivals. But expensive health care didn’t cause the recession, which began in late 2007. Recessions are the price of artificial booms induced by government policy. So justifying healthcare reform as a way to end the recession is disingenuous.

For one thing, employer-provided health insurance is a form of compensation, not an addition to compensation. Bosses don’t give their employees gifts. If we assume that wages are roughly set by supply and demand (hampered as the market is), cheaper insurance may not reduce the total cost of employing workers because they would tend to acquire the premium savings in cash. (At least to some extent. This would certainly be the case in a fully free and competitive economy.)

So even if Obama could lower the cost of medical care and hence insurance, it would not lower companies’ costs overall and make them more competitive. (Government could transfer the cost of medical care for their pre-65 retirees to the taxpayers, but while that may help the firms in one respect, the required higher taxes, borrowing, and/or inflation would harm them in other respects.)

Government Can Lower Costs?

But who believes Obama’s bureaucracy can really lower those costs?

Bureaucrats have only one thing the rest of us don’t have: the legal power to coerce and plunder. How can that power lower the real costs of a service like medical care?

Illusions abound. The Obama plan promises to save $80 billion a year by designing and compelling use of electronic medical records. Whatever the benefits of a computerized network—why wouldn’t the private economy create it?—the promise has met with skepticism. (See this by two physicians and Harvard medical professors.) Moreover, as the Institute for Health Freedom points out, as long as the government legally ignores patients’ privacy rights, electronic records will be a threat not a boon.

In truth, lower costs come from innovation, capital investment (saving), and entrepreneurial risk-taking. And one more thing: competition, that is, freedom on the supply and demand sides. The only relationship government has to those things is its propensity to suppress them. Suffice it to say that government and efficiency are not commonly found in the same place. Government-run medical care would be as efficient as the post office or Pentagon (which routinely misplaces millions of dollars every year.)

This is not to say that government can’t make costs appear lower. It can do this in two ways. First, it can shift and disguise costs. It’s been doing that with medical care for generations. Something like 75 cents out of every dollar spent is paid by either government or insurance companies. Most people do not pay the full price of even predictable, routine checkups. (Tax advantages make paying even small amounts through an employer-provided insurance policy preferable to paying out of pocket, although this adds astronomically and unnecessarily to administrative costs. Policies that cover predictable events subvert the very idea of insurance) The link between service and price has long been broken. That’s a major part of the problem with the system because artificially low prices inflate demand. This drives up real costs, but the burden is hidden and diffused among the larger population.

The other way government can control medical costs is to limit and ration services. Countries with even more regulation of health care than we have achieve this through global budgeting. So much is budgeted for service X, and that is it—even if the money runs out before the year does. Too bad if you need the care.

This may reduce the amount a society spends on medical care, but why is that in itself desirable? If we spend less because fewer services are available, that would only be trading one kind of cost for another (pain, for example). One reason Americans spend more than other people is that, thanks to innovation, there is more care to buy than previously and we can afford it. Not long ago, no money was spent on knee or hip replacements because there were no such things. Their availability strikes me as good even if it means our overall bill is higher. The issue shouldn’t be how much “we” spend altogether but whether costs are imposed on others against their will. As the proverb has it, “Take what you want and pay for it.” (Or  find willing a donor to help you out.)

Government can’t directly reduce costs, but it can stop making medical care more expensive than it needs to be. As public policy inflates demand, it simultaneously suppresses supply—through occupational licensing, regulation, the FDA, patents, medical-school accreditation, certificate-of-need laws, and myriad other ways of centrally planning healthcare.

As in so many other things, if the politicians really want to help people and not just augment their own power, they will get out of the way. That will be a good thing. But don’t expect it to end the business cycle. That will require laissez faire across the board, starting with abolition of the central bank.

Why aren’t we buying more? If it’s because we don’t have the money, then why aren’t we borrowing more? Don’t we realize that people will lose their jobs, and companies will go out of business if we don’t start buying stuff? And since we aren’t spending, the government is going to do it for us. Hence, the huge spending bill passed by Congress recently. We have only ourselves to blame.

Well, excuse me, but something is screwy here. In my naiveté I’ve long been under the impression that an economic system is supposed to serve consumers and not the other way around. I thought that producers cater to them and not vice versa. If producers and consumers are out of sync—for whatever reason—it isn’t up to consumers to adjust themselves to suit the producers. It is the producers’ job to realize they forecasted the future incorrectly, learn from their mistakes, try again. So I thought. Boy, was I wrong.

That’s what I get for not studying economics in college. Had I done so, I would know what all those television commentators and editorialists seem to know: that consumers exist for the sake of business owners and workers. Shame on us for letting them down.

Not!

Let’s get something straight. We produce so that we may consume. We don’t consume so that we may produce. Jobs aren’t ends in themselves. If we could have what we wanted by twitching our noses Samantha-style, then great! Jobs would be lost, but that would be something to celebrate not mourn.

If goods aren’t moving off shelves or car lots, maybe the wrong products are being offered. Maybe the prices are too high. It’s up to producers to figure out what’s wrong and do it right.

Or maybe unwise government policies have made us nervous about the future, prompting caution about spending. If so, the answer is not for us to rush out and spend anyway. Rather, the government should stop creating the conditions that make us nervous, such as prompting asset bubbles, which eventually burst, or inflationary booms, which must eventually bust.

Let It Be

When these things do happen, the only smart thing to do is to let the marketplace readjust to consumers’ real preferences, that is, their preferences undistorted by government social engineering. That adjustment is not painless or costless, but it’s necessary given the earlier distortions. Government can try to delay the reallocation of resources, but it can’t obviate the need for it. Delay only makes the adjustment more severe later.

This misunderstanding of the consumer-producer relationship is pervasive. We’re constantly reminded that consumer purchases are 70 percent of economic activity. The implication is that if we buy at a slower pace than producers expected or if we change our minds about what we want, we have failed the country and are doomed to long-term depression. But let’s take a closer look at that.

First, that percentage is misleading. Even if final consumer purchases are 70 percent of GDP, in fact all private economic activity is ultimately for the sake of consumers. (I’m excluding production for government purchase.) Every stage of the structure of production gets its value according to its contribution to a final consumer good. Carl Menger, the first “Austrian” economist, taught us that. No one would bother to build a bagel maker and no baker would buy it if no consumers wanted bagels. When producers buy machines, raw materials, and semi-finished goods in order to add value to them, they are in fact buying consumer-goods-in-process so they can advance them toward a form in which consumers will find them useful.

The Right to Buy Less

Second, it’s the consumers’ business how much they buy. If for years they bought X million new cars a year but one day decided they didn’t want a new car so often and reduced that number by half, what of it? True, car prices would fall; some autoworkers would have to find new jobs; and some dealerships and factories would close. Should the government do something about this? Of course not. Producers—that includes workers—have a responsibility to try to forecast future demand. No one said it would be easy. If consumer tastes change, then those who took an entrepreneurial risk on their not changing will lose. Those who guessed right will profit. The last thing we should want is a government bailout for the struggling firms. If they are turning scarce capital into something consumers don’t want, the firms are destroying value. Capital is too scarce to tolerate that. Better that it be released to more competent entrepreneurs for purposes more preferred by consumers. That’s what bankruptcy accomplishes.

So courage, my fellow reluctant consumers. Withstand the pressure to borrow and buy. Holding money—not spending—is no shame if that best suits your perceptions and plans. It’s not an irrational impulse that wise government must overcome. Money is not just for spending. It renders services other than simply bringing goods into our possession. It provides security and opportunities to consume more in the future. We have no need to apologize for partaking of those services. And if it makes you feel any better, saving is a form of spending that will create the demand for labor.

Admittedly, producers have it tough. They have to anticipate what we consumers will want–and we ourselves often don’t know what we want. Government can’t make things easier on producers (by, say, pushing us one way or another) without creating regrettable consequences. But it can stop making things harder: by ceasing to debauch the currency and otherwise distorting investment and production.

We consumers can take care of ourselves, thank you.

That’s what the economic turmoil is all about for many people. Too many of us were greedy, and now everyone is paying the price.

Luckily this belief is wrong, because if it were right we’d be up the creek. Greed, however defined, presumably has always been and will always be with us in an unvarying amount. Schemes to change human nature have all failed dismally. Better to assume it won’t change any time soon. So if having a sound economy depended on eliminating or diminishing greed, we’d have trouble.

I see people blaming greed for our problems everywhere. Bob Woodward, the famous journalist, was on “Larry King Live” the other night, laughing derisively at the idea that cutting taxes would help revive the economy. How could that help, he asked, when the cause of the debacle is “greed”? Cutting taxes just feeds greeds, he implied. Dee Dee Myers, former President Bill Clinton’s one-time press secretary, nodded in approval.

Closer to home, I got into a debate with a religion professor who was sure that the housing bubble and recession were market, not government, failures. Why was he so sure, considering that he professed no knowledge of economics? Because people are greedy, he said. Of course the market failed. How could it not when greed is its foundation?

This line of thinking is worth exploring because it’s more common than we might suspect. I will avoid the semantic issue. I suspect many people use the word as a synonym for self-interest: To be greedy is to be “selfish.” If so, Ayn Rand had it right–as long as self-interest is held to be morally corrupt, the market order will be suspect.

For the sake of discussion, however, let’s take the least flattering definition and go from there. This approach has the advantage of showing how mistaken the interventionist is without getting him to reconsider his definition of greed. (For the record, the word has no objective referent. It only applies to others, never oneself. The best I can make out, A is greedy when he wants more of something than B thinks he should want. B, on the other hand, wants just the right amount.)

Institutions Matter

It shouldn’t take much consideration to see that greed will have different effects in different institutional settings, that is, different political-economic-legal systems. The problem is that most people don’t think about institutions. Being part of the landscape, they escape notice. But they are crucial.

An institutional setting in which people know they will bear the negative consequences of their own actions can be expected generally to elicit conduct markedly different from one in which those consequences can be passed on to others without their consent, namely, through taxpayer bailouts and the like. Everyone sees this in concrete terms at the individual level. The religion professor recognized it in when I presented these two scenarios:

Scenario A: He goes to Las Vegas knowing that the winnings are his and the losses are his.

Scenario B: He goes to Las Vegas knowing that the winnings are his, but the losses will be covered by someone else.

I asked him if his behavior would differ in the two scenarios? Of course, he replied. But he refused to extend the principle to the political-economic context.

More Not Less

Greedy people by definition want more not less. So they will be as concerned to hold on to what they have as they will be to increase their wealth. Risky investment is a way to get more but also a way to end up with less. Greed, therefore, will tend to restrain recklessness if people know their profits and losses belong to them. The corollary is that the restraints on recklessness will be weakened to the extent that people expect the losses to be absorbed by others. Market discipline is the key.

For large financial institutions in the United States, Scenario B is far closer to reality than Scenario A. As Gerald P. O’Driscoll Jr.writes, “Deposit insurance, access to the Fed’s lending, and the implicit (now explicit) government guarantee for banks ‘too big to fail’ all constituted a system of financial corporatism.” What these interventions have in common is the potential to shift losses forcibly from those who should be responsible for them to someone else—making reckless behavior and losses more likely than they would be. That’s the definition of moral hazard.

Greed is an easy target. But blaming greed gets us nowhere. As Lawrence White says, it’s like blaming gravity for a plane crash. It certainly doesn’t suggest any sensible policy response. The religion professor said we need more regulation. But if people are greedy, how do more regulators promise to improve matters? They are people too.

If we can’t trust people with freedom, how can we trust them with power?

I hope the story is not apocryphal, because it perfectly sums up the government’s proper role in managing the economy: none. The misnamed stimulus law is now on the books. While nearly everyone believes the government has to do something to get the economy out of the recession, those who understand markets insist that we’d be better off if the government did nothing at all. Of course, politicians are incapable of doing nothing when there is harm to be done, but the “stimulus” critics intrepidly insist that anything the government does will be worse than doing nothing at all.

This is certainly true. Unquestionably, doing nothing is better than borrowing nearly $800 billion from the credit markets (to be repaid through inflation and taxation) and spending it on pet political projects, from food stamps to bridge repairs to subsidies for favored energy forms. (Remember opportunity cost!) Doing nothing is indeed is an attractive option. For example, it would avoid re-stimulating parts of the economy shouldn’t have been stimulated in the first place, such as housing and autos. As economist Mario Rizzo said recently, “Trying to prop up housing prices or injecting capital into areas of misallocation is a bad idea. It prevents the market’s corrective mechanisms from working. Wealth should not continually be destroyed after the errors of the bubble have been revealed. This is the proverbial practice of throwing good money after bad.” (Watch Rizzo’s presentation  here. The written remarks are downloadable here.)

But, frankly, doing nothing is only the second-best option. We can do better. We need the government to do less than nothing. It should undo many things.

Government-Inflated Bubble

Let’s remember that government created the housing bubble through a constellation of policies that made borrowing for home mortgages — prime and subprime — artificially attractive. Because of the securitization of mortgages (in itself a good risk-spreading device), the consequences of government housing policies spread far beyond the housing and banking industries. When home prices seemed to be perpetually rising, people were encouraged to refinance their homes and withdraw equity so they could spend the money on cars, trips, and other big-ticket items. Government-stimulated demand touched everything. When the bubble popped — when interest rates rose and the housing glut became apparent — things turned around. People now had costly mortgages they couldn’t refinance;  homes bought on the expectation of early profitable resale were now money losers. The party was over.

It was a party that couldn’t have been thrown without politicians eager to do things for us and, not coincidentally, to boost their reelection prospects as well.

The upshot is that if the economy is to thrive again, the reigning philosophy of government as a social service center will have to change. Many things will have to be undone.

These things will strike most people as politically impossible, but if no one ever talks about them, that’s what they will remain. We have to start somewhere. The first thing we need is a monetary system that is beyond the reach of manipulative politicians and political appointees. Whatever the Fed Reserve’s role in the housing bubble — even if it was only the Alan Greenspan’s promise to provide liquidity to overextended lenders — the central bank has again proven itself hazardous to our economic well-being. When will we cease to tolerate this continuing threat in our midst? When will we realize that the mortals who run it cannot know how much money the economy needs or what interest rates should be? Market-rooted money — most likely gold — and free banking are long overdue. How can we afford to wait any longer?


No More Housing Policy

Also on the list of things to go is every manifestation of housing policy. In a free society there would be no such thing. The alphabet soup of agencies — from HUD to FHA to FHLB, and the rest — should be abolished at once.

The same goes for those privileged cartoon characters Fannie Mae, Freddie Mac, Ginnie Mae, and any I may have overlooked. They exist to circumvent the market in order to carry out the agendas of politicians, who must dispense goodies to favored constituencies in order to keep their hold on power. Because the agencies are backed by captive taxpayers, they are can do things no free-market institution can do, such as obtain special low-interest loans and guarantees. These bureaucracies have no place in a free market. If we haven’t learned that by now, what will it take? (We haven’t learned it. The Obama administration wants to give them more billions.)

While we’re at it, let’s get rid of the income tax if for no other reason than because it would end the mortgage deduction. We must stop thinking of home-ownership as something worthy of government privilege. There’s nothing magic about housing. It’s one more thing we need. Yet it gets special treatment in the law, and economy-watchers give it special attention. Why do news agencies report housing starts faithfully each month as though the fate of the planet hangs in the balance? They never tell us how many computers, Coca-Colas, or boxes of Cheerios were produced.

Other taxes should be cut or abolished too, including the payroll tax, which is a tax on hiring. But — this is often overlooked — tax cuts without spending cuts require more borrowing and more inflation. It’s a bad bargain in the tradition of Keynes. We must cut government spending along with taxes.

If government really wants to make it easier for people to own homes, let it give up control of money and banking, divest itself of the land it holds off the market, and generally relieve society of its endless burdens.

The biggest favor the state can do for us is to stop doing us favors!

In light of the resurrection of the at least twice-interred Keynes (1946 and some time in the 1970s, the long run and the longer run), I decided to revisit some of the gentleman’s writings. It occurred to me that before people started tattooing Keynes’s name on their forearms, they might like to become better familiar with what he actually believed. I realize that many who profess Keynesian views on the economy may not feel obliged to embrace his political or social views. But the categories may not be as distinct as they think. Keynes, at least, didn’t seem to think so. Let us recall that in 1936 he introduced the German edition of The General Theory of Employment, Interest, and Money by noting that “[T]he theory of output as a whole, which is what the following book purports to provide, is much more easily adapted to the conditions of a totalitarian state [emphasis added], than is the theory of the production and distribution of a given output produced under conditions of free competition and a large measure of laissez-faire.” My translation: your system and mine are made for each other.

For the purposes of today’s symposium, I chose Keynes’s 1926 essay, “The End of Laissez-Faire,” which was based on lectures he had given around that time. I’ll skip his synopsis of the intellectual history of individualism and cut to the chase.

One of the revealing passages of the essay is where Keynes explains why he rejects “State Socialism.”  But first he enumerates those features which he does not find  objectionable: “I criticise doctrinaire State Socialism, not because it seeks to engage men’s altruistic impulses in the service of society, or because it departs from laissez-faire, or because it takes away from man’s natural liberty to make a million, or because it has courage for bold experiments. All these things I applaud. [Emphasis added.] I criticise it because it misses the significance of what is actually happening; because it is, in fact, little better than a  dusty survival of a plan to meet the problems of fifty years ago, based on a misunderstanding of what someone said a hundred years ago.”

In other words, the problem with State Socialism is only that it’s out of date and confused. Other than that, it has much to recommend it. It engages our altruistic impulses, and it isn’t hung up on the freedom to make lots of money. Best of all, it isn’t afraid to experiment. To fully appreciate Keynes’s sentiment, take a moment and remind yourself what was going on around this time in the Bold Socialist Experiment taking place to the east.

Keynes prefers the “semi-socialism” of “semi-autonomous corporations.” (We might call this fascism.) He writes, “It is true that many big undertakings, particularly public utility enterprises and other business requiring a large fixed capital, still need to be semi-socialised. But we must keep our minds flexible regarding the forms of this semi-socialism. We must take full advantage of the natural tendencies of the day….” Like his fellow Progressives, he had nothing against giant monopoly firms; quite the contrary — as long as they are directed at the public interest and not private profit. What he disliked was decentralization and money making.

“I suggest, therefore, that progress lies in the growth and the recognition of semi-autonomous bodies within the State-bodies whose criterion of action within their own field is solely the public good as they understand it, and from whose deliberations motives of private advantage are excluded, though some place it may still be necessary to leave, until the ambit of men’s altruism grows wider, to the separate advantage of particular groups, classes, or faculties — bodies which in the ordinary course of affairs are mainly autonomous within their prescribed limitations, but are subject in the last resort to the sovereignty of the democracy expressed through Parliament.

“I propose a return, it may be said, towards medieval conceptions of separate autonomies.” Now that sounds progressive.

Deliberate Control

Keynes proposes to cure the great economic evils that are “the fruits of risk, uncertainty, and ignorance.” These are what create disparities in wealth and unemployment. “I believe that the cure for these things,” he writes, “is partly to be sought in the deliberate control of the currency and of credit by a central institution, and partly in the collection and dissemination on a great scale of data relating to the business situation, including the full publicity, by law if necessary, of all business facts which it is useful to know. These measures would involve society in exercising directive intelligence through some appropriate organ of action over many of the inner intricacies of private business, yet it would leave private initiative and enterprise unhindered.”

Keynes was a master euphemist. For him, government, which at its foundation is nothing but legalized aggressive force, is simply “society . . . exercising directive intelligence through some appropriate organ of action.” This organ will centrally control money and credit, determining who does and doesn’t have access to capital. (He endorses this idea again ten years later in The General Theory.) Yet initiative and enterprise will be “unhindered.” Keynes was a magician as well.

Keynes elaborates: “I believe that some coordinated act of intelligent judgement is required as to the scale on which it is desirable that the community as a whole should save, the scale on which these savings should go abroad in the form of foreign investments, and whether the present organisation of the investment market distributes savings along the most nationally productive channels. I do not think that these matters should be left entirely to the chances of private judgement and private profits, as they are at present.”

We are to presume that leaving these matters to politicians and bureaucrats entails no chance. Unlike the money-motivated, they are not moved by “animal spirits.” Can you imagine a man being taken seriously after proposing that the government — “some coordinated act of intelligent judgement” — dictate how much the population should save? (Bear in mind that Keynes thought saving was antisocial.)

The Scary Part

As he nears the end of his essay, Keynes gets downright scary in thinking of things for the state to do that “at present are not done at all.” I shall simply quote him:

“The time has already come when each country needs a considered national policy about what size of population, whether larger or smaller than at present or the same, is most expedient. And having settled this policy, we must take steps to carry it into operation. The time may arrive a little later when the community as a whole must pay attention to the innate quality as well as to the mere numbers of its future members.”

Well, no surprise here. If we can intelligently design an economy, why not the human race itself? The eugenics movement once teemed with Progressives, although after the program’s gory bold experiment in totalitarian Germany, some biographies were airbrushed to obscure that fact.

Keynes could speak like a politician whose last intention was to frighten anyone. He winds up by saying that “These reflections have been directed towards possible improvements in the technique of modern capitalism by the agency of collective action. There is nothing in them which is seriously incompatible with what seems to me to be the essential characteristic of capitalism, namely the dependence upon an intense appeal to the money-making and money-loving instincts of individuals as the main motive force of the economic machine.”

Remember that when he says “capitalism,” he does not mean the free market. He means the sort of state-regulated economy then in practice in both Britain and the United States, complete with central bank. The laissez-faire whose end he foresaw and favored was not an existing system but a philosophy. He laments that the Great War, with its “centralised social action on a great scale,” had not turned the old stalwarts into reformers despite its impressive record. “War socialism unquestionably achieved a production of wealth on a scale far greater than we ever knew in peace, for though the goods and services delivered were destined for immediate and fruitless extinction, none the less they were wealth [!].” He concedes, however, that the waste and obliviousness to cost were “disgusting.” Minor details.

For Keynes, capitalism is the system driven by the “money-motive of individuals.” There must be a better way, but most of us are too reactionary to see this.

“A preference for arranging our affairs in such a way as to appeal to the money-motive as little as possible, rather than as much as possible, need not be entirely a priori, but may be based on the comparison of experiences.. . . On the other hand, most men today . . . do not doubt the real advantages of wealth. Moreover, it seems obvious to them that one cannot do without the money-motive, and that, apart from certain admitted abuses, it does its job well. In the result the average man averts his attention from the problem, and has no clear idea what he really thinks and feels about the whole confounded matter.”

Not to worry. The Enlightened, such as Keynes, will show the way to a new world.

“Confusion of thought and feeling leads to confusion of speech. Many people, who are really objecting to capitalism as a way of life, argue as though they were objecting to it on the ground of its inefficiency in attaining its own objects. Contrariwise, devotees of capitalism are often unduly conservative, and reject reforms in its technique, which might really strengthen and preserve it, for fear that they may prove to be first steps away from capitalism itself. Nevertheless, a time may be coming when we shall get clearer than at present as to when we are talking about capitalism as an efficient or inefficient technique, and when we are talking about it as desirable or objectionable in itself. For my part I think that capitalism, wisely managed, can probably be made more efficient for attaining economic ends than any alternative system yet in sight, but that in itself it is in many ways extremely objectionable. Our problem is to work out a social organisation which shall be as efficient as possible without offending our notions of a satisfactory way of life.” (Emphasis added.)

He sought to assure us that with him and like-minded people at the helm, we were in good hands. His spiritual descendants do the same today. Who will protect us from our protectors?

Now maybe we shouldn’t be so sure. The monetary contraction still seems unlikely, but Messrs. Smoot and Hawley have apparently returned from the netherworld along with Keynes. These are three guys I had hoped were gone for good. (By the way, Paul Krugman favors the protectionism: “[T]hese are not normal conditions…. [P]rotectionism can make the world as a whole better off.” Yikes!)

The House version of the sabotage bill mandates that all infrastructure projects use American iron and steel. The Senate’s first version had even more inclusive language. It required that all “manufactured goods” bought under the program be American-made. (Some exceptional circumstances are allowed.)

While this aspect of the bill hasn’t gotten the big headlines that others have, it has created a firestorm among America’s trading partners. Europe, Canada, and Australia voiced concern, enough to make President Obama appear to back away. “We can’t send a protectionist message,” he said. This couldn’t have pleased his party members in Congress who got into power on the wings of populist, protectionist rhetoric.

Now it looks as though the White House and Senate have reached a compromise in the usual Washington manner. They fudged the issue. The Washington Post reported, “[T]he Senate voted unanimously … by voice vote to tone down a controversial ‘Buy American’ provision that had sparked an uproar among foreign leaders who warned that it could lead to a trade war. The new language would add the caveat ‘applied in a manner consistent with U.S. obligations under international agreements’ to a requirement that public works projects funded by stimulus money use only American-made materials.”

Does this really take protectionism out of the bill? Who knows? The U.S. government is a party to several trade agreements with which the “Buy American” provision would seem to be in conflict. On the other hand, why have the provision at all if it may not be carried out in violation of trade agreements? In Washington there is always wiggle room, and this is especially true with so-called trade agreements. As the New York Times points out, “Buy America” is hardly a new idea — Congress has passed similar requirements for seven decades — and in many cases it is not considered a violation of trade treaties.”

If that’s the case, then the language added by the Senate is a ruse. The bill remains protectionist, and even if there were no other reason, that would be grounds to hope for its defeat.

Protectionist Fallacies

Of course the industries and unions that want the provision say it will create more American jobs than if foreign-made products are purchased. But it’s a mistake to think that protectionism creates or protects jobs overall. While it may protect certain jobs, it does so at the expense of others.

This is a classic case of the “broken window fallacy,” or ignoring the “unseen” secondary effects of government policy. When Americans buy imports, foreign sellers obtain dollars with which they can buy American-made products or invest here. Either way, Americans and foreigners benefit through trade.

When laws prohibit or limit the purchase imports, foreigners have fewer dollars and therefore fewer opportunities to buy American exports or to invest. The Americans who would have benefitted from those transactions lose out. So while protectionism is defended as a way to help the American economy (at the expense of foreigners), in fact it is special-interest legislation that helps only a small well-defined interest group at the expense of many other Americans. If people generally understood this, they would not fall for protectionist appeals.

The damage to Americans will be even worse if the “Buy American” provision sets off a trade war. The effected countries have already said they will complain to the World Trade Organization. If the WTO finds the provision a violation and if it is not rescinded, this will give other countries the legal cover to retaliate against American products.

The last thing we need now is a trade war, a contraction in world trade, and an inflammation of national rivalries. Congress is playing with fire. Every one of them should Google “Smoot Hawley” and read for a while.

None of what I’ve said should be taken as approval of trade agreements or the economic sabotage bill. We should practice free trade unconditionally, and government spending should be radically cut, not increased. Nevertheless, adding protectionism to the bill is a pretty stupid thing to do.

Let me see if I have this straight. The U.S. government is going to borrow $819-$??? billion, largely from the Chinese (if they’ll lend it, which they may not) and put that money into people’s pockets in a hundred different ways, from paying workers for filling potholes, to extending unemployment benefits, to expanding Medicare, to weatherizing buildings, to enlarging the National Endowment for the Arts, and on and on and on. This is going to make us all richer. What would we do without those folks in Washington, D.C.?

I like to know the theory behind things. The theory behind this alleged stimulus idea is the Keynesian principle that economic depressions result from inadequate aggregate demand. We’re not buying enough stuff–either because we don’t have the money or we’re anxious about the future–and this reduces employment and incomes, which in turn further reduces demand, employment, and incomes. The economy spirals down.

If (the theory continues) the government borrows or creates money and gives it to people who are likely to spend it, such as the poor and unemployed (not those more-affluent folks who are likely to save it), the economy can recover, that is, unemployment will decline and idle resources will be pressed into service. The new recipients of the largess will drive the economic recovery by buying things, increasing the incomes of the sellers, who will then buy things, increasing the incomes of those sellers, etc. All this will stimulate investment. Now the spiral is upward. For every dollar the government spends this way, so we’re told, GDP will go up by more than a dollar. But when money is simply left in private hands, say, through tax cuts, the effect is …  bupkis. This apparently is because the money will be saved, and in this story saving is the devil’s handiwork. It is nonspending, nonconsumption, which means it’s income deprivation. No one will invest the savings (so it is argued) if consumption is flagging. Keynes famously wrote that just because someone saves by abstaining from eating dinner today doesn’t mean he will be eating dinner tomorrow. So why would anyone invest? (If you reply that people typically save for a reason, you have too much common sense to play this game. Go back and take Economics 101.)

Don’t Just Stand There–Spend!

There’s been a good deal of wrangling over how the government should spend the “stimulus” money. But to a good Keynesian this must be frustrating because it really doesn’t matter how the money is spent, as long as the government spends it–and quickly. For a long while I thought the Keynesian theory was surely more nuanced than that. But I was wrong. I recently listened to a podcast conversation between Russell Roberts and Keynesian Professor Steve Fazzari of Washington University during which Fazzari said that paying people to dig and fill holes would be just as effective as any other spending program. The point, he emphasized, is to increase aggregate demand. (Don’t take my word for it.  Listen for yourself.)

Aggregate demand is obviously down these days. We aren’t buying as much as we used to. This didn’t happen out of the blue. When housing values plummeted, many people cut back their spending because, for example, they had no housing equity to borrow against or their mortgage payment ballooned and they couldn’t refinance. As the adverse effect on institutions holding mortgage-backed securities rippled out, people became anxious about the future and reined in spending, which sent the ripples out further, resulting in more reining-in, and so on.

The question is what do we do about it. The dominant view, embodied in the “stimulus” package, is that it doesn’t matter what caused demand to collapse–we must do everything we can to build it back up, along with housing values and other macroeconomic variables. The more intelligent approach is to understand why things are the way they are so that causes and not just symptoms can be addressed.

Fixation of the Macro

As economist Mario Rizzo points out, fixation on the macro takes our eyes off the ball, namely, the micro policies and actions that brought us to this state of affairs. In other words, Rizzo writes, “Too many resources went into the housing market,” thanks to government programs. The solution, then, is not demand management through government spending or contrivances to raise home prices back to their old unsustainable, government-induced levels. Rather, “Markets should be allowed to equilibrate.” That is, housing prices must find the level at which they reflect economic reality, which in turn will reveal the value of mortgage-backed securities and the condition of the financial institutions holding or insuring them. Only when markets have sorted this out can the capital structure and prices be reconfigured in ways appropriate to real conditions and consumer preferences. That is the recovery phase.

But what about the meantime? For the government the injunction should be: do no harm. Unfortunately, harm is what government does best. As Roger Garrison says, it’s a net producer of macro instability. One way it does harm is by creating an environment of uncertainty. Will it nationalize the banks? Will it buy toxic assets? Will it bail out company X? Okay, it didn’t do it this week, but how about next week? Will taxes be raised or lowered? How will the debt be paid? Political uncertainty is not good for long-term planning. Those who insist that the private economy cannot regenerate itself ought to pay more attention to the manifold ways they help make that a self-fulfilling prophecy. Stop giving entrepreneurs and investors reasons to shrug.

Government borrowing does not inject money into the economy. It was already there. But it can and does reduce the amount of capital available for private investment. To the extent the government borrows, the economy serves politicians not consumers. This is the broken-window fallacy exposed by Bastiat. Moreover, since the Federal Reserve will monetize the debt by continuing to expand the money supply, it will set in motion all the evils that accompany inflation: investment and price distortions, wealth transfers, and calculational chaos. Any short-term illusion of recovery will be paid for with a new crisis up the road.

That said, it is unrealistic to expect politicians, who live short-term, to pay any heed to sound economic theory. The public has been taught for years that the government is the steward of the economy. If things slow
down, our “leaders” are expected to do something. A politician with both the understanding and courage to resist that expectation is as rare as a dodo bird.

If we’re going to change politicians’ thinking about the economy, we’ll first have to change the public’s thinking. We have our work cut out for us. But we have to start somewhere.

Government “countercyclical” spending is notorious for kicking in after the recession has passed. The planners’ information is necessarily dated, and their capacity to act quickly is overestimated. The Congressional Budget Office says most of the $355 billion in discretionary spending being planned wouldn’t be used before 2011. Paul Krugman, the loudest cheerleader for trillion-dollar government spending, says that’s okay because we’re in for a long recession. We certainly are if we’re counting on his kind of thinking to get us out of it.

We shouldn’t be surprised that government can’t get the timing right. It’s a political not an economic institution. That’s allegedly its advantage, but we know deep down it’s a handicap. Political incentives are not in sync with the public interest.

Magical Infrastructure

“Infrastructure” has again become a magical word. Who can object to spending on it? Do you want bridges to fall down? You want to bend your rims in potholes? It says something about government management of roads and bridges that politicians don’t talk about them until the economy slows down and they want more money to spend. Private businesses don’t do that. Competition forces them to maintain their properties for the comfort of their customers. Governments have no competition.

Politicians want us to believe they select infrastructure projects on the basis of objective need, even scientifically. But we shouldn’t be so naive. The Public Choice economists are right when they suggest we ignore the civics textbooks and look at how politicians actually behave. The New York Times shed some light last fall. In an article on infrastructure spending, reporter David Leonhardt wrote,

A lack of adequate financing is part of the problem, without doubt. But the bigger problem has been an utter lack of seriousness in deciding how that money gets spent…..

It’s hard to exaggerate how scattershot the current system is. Government agencies usually don’t even have to do a rigorous analysis of a project or how it would affect traffic and the environment, relative to its cost and to the alternatives — before deciding whether to proceed. In one recent survey of local officials, almost 80 percent said they had based their decisions largely on politics, while fewer than 20 percent cited a project’s potential benefits.

Government decisions are based largely on politics? Shocking! (We might ask whether the 20 percent were merely less honest than the 80 percent.)

Think how magnified this problem will be when federal, state, and local politicians are under intense pressure to spend hundreds of billions of dollars as quickly as possible. The little care they may take now will be dispensed with completely. Indeed, judiciousness will be tarred as obstruction. I can imagine the news stories a few years from now describing the pointless projects, the shoddy work, the corruption, and the horrendous waste of resources. We’ve seen it many times before. As Leonhardt noted:

There are monuments to the resulting waste all over the country: the little-traveled Bud Shuster Highway in western Pennsylvania; new highways in suburban St. Louis and suburban Maryland that won’t alleviate traffic; all the fancy government-subsidized sports stadiums that have replaced perfectly good existing stadiums. These are the Bridges to (Almost) Nowhere that actually got built.

They help explain why our infrastructure is in such poor shape even though spending on it, surprisingly enough, has risen at a good clip in recent decades.

That’s something you don’t read every day. The government isn’t starved for tax money. It’s just lousy at spending it intelligently. “Spending is up 50 percent over the last 10 years, after adjusting for inflation. As a share of the economy, it will be higher this year than in any year since 1981,” Leonhardt writes.

So the suggestion that government spending as it happens in the real world will restore the economy is a bad joke. You’ve got to wonder about how people win Nobel Prizes while thinking such ludicrous thoughts.

We’re likely to see some attempt to convince the taxpayers that the money will be well spent. Watch for lots of references to cost-benefit analyses. But keep in mind that deft bureaucrats and staff economists can reach any conclusion they want. You just have to have the “right” assumptions. Garbage in, garbage out. This was confirmed in a refreshingly candid moment reported by the wire services: “Even the president-elect’s own economists acknowledge their two-year  [job-creation] estimates could be wrong. The analysis, posted online, says estimates are ‘subject to significant margins of error’ — because of the assumptions that went into the economic models and because it is not known what might pass Congress.”

Politicized TARP

If you’re still not convinced, realize that the decisions about which banks get money under TARP is heavily politicized. The Wall Street Journal reports that “Bankers, regulators and politicians complain of a secretive and opaque process for deciding which banks get cash and which don’t. The goal of aiding only banks healthy enough to lend — laid out by the Treasury when the program began — clearly seems to have shifted, but in a way that’s hard to pin down and that the Treasury has declined to explain. Part of the problem is that some powerful politicians have used their leverage to try to direct federal millions toward banks in their home states” (Emphasis added.)

Government will be government. As Russell Roberts says, expecting a stimulus bill not to have pork is like expecting a ham sandwich not to have pork.

But even if we make the heroic assumption that good projects can be identified, that won’t mean the spending will fix the economy. As Michael Boskin writes,

While we have legitimate infrastructure needs, public-works spending historically has been too slow, has delayed private and local government spending, and created few jobs for the unemployed. The programs are not labor-intensive and require skills few unemployed have. Public works did not end the Great Depression. Even FDR’s treasury secretary, Henry Morgenthau, said in 1939, “We have tried spending money . . . and it does not work . . . we have just as much unemployment . . . and an enormous debt to boot.” Nor did a decade of infrastructure spending help the Japanese escape three recessions and a decade of stagnation. It did, however, saddle Japan with a national debt burden four times ours.

To this point we’ve been assuming that government spending could work in theory, just not in practice. But it can’t work in theory either. Even omniscient, omnibenevolent beings couldn’t pull it off. Political  interference with economic activity is the problem; it can’t be the solution.

Whatever the government does, it isn’t a stimulus in the way that jump-starting a car is a stimulus. Government borrowing merely moves around money that is already inside the economy. Inflation injects demand into an economy, but increased demand without additional goods is just another way to move existing wealth around. (See my elaboration, “Inflation as Income Distribution,” here.)

Government policies distorted asset prices and induced people to behave differently from how they would have behaved under an honest price system. For example, banks lent mortgage money to people who shouldn’t have been borrowing it. This set off a political shift in the structure of production. (More business for builders and mortgage lenders.) Instead of worrying about aggregate demand, the policymakers ought to get out of the  way and let the market re-price assets according to economic reality. Financial institutions could then be evaluated accurately and treated accordingly. We  need a market rearrangement of scarce  resources to align them with consumer preferences. That will require savings — not artificially stimulated consumption spending — and market-guided investment. Government borrowing and inflation is exactly what we don’t need. No politician, however charismatic, is capable of creating wealth by creating money.

Is there a role for the politicians? By all means. They must radically reduce the burden of government at all levels and in all ways. This includes spending, taxing, borrowing, regulating, subsidizing, and inflating. An economy cannot serve consumers if politicians, pretending to know what they are doing, insist on interfering.

His subject and its relation to freedom and prosperity were certainly worth capturing in such a clever, pleasing, and illuminating essay, which is why it is one of the best-known works in the popular free-market literature.

But there’s another lesson in “I, Pencil” that has been largely overlooked, perhaps by Read himself. “I, Pencil” is also an excellent primer in the Austrian approach to capital theory. It’s worth looking at Read’s essay in that light.

Early on, Read’s pencil describes his family tree, beginning with the cedars grown in northern California and Oregon that provide the wooden slats. But he doesn’t really start with the trees. He notes that turning trees into pencils requires “saws and trucks and rope and the countless other gear used in harvesting and carting the cedar logs to the railroad siding,” and those things have to be produced before a pencil can be produced. “Think of all the persons and the numberless skills that went into their fabrication: the mining of ore, the making of steel and its refinement into saws, axes, motors; the growing of hemp and bringing it through all the stages to heavy and strong rope; the logging camps with their beds and mess halls, the cookery and the raising of all the foods. Why, untold thousands of persons had a hand in every cup of coffee the loggers drink!”

What emerges here is what Austrian economists call a structure of production. This structure is characterized by two closely related elements: multiple stages (distinguished by their “distance” from the consumer) and time. The pencil that eventually emerges at the end of the process must first proceed, in various states of incompleteness, through a series of stations at which components are transformed in ways consistent with making pencils. The stations themselves have to be prepared through earlier stages of production. Thus before trees can be cut down and turned into wooden slats, saws, trucks, rope, railroad cars, and other things must be produced first. Before steel can be used to make saws, trucks, and railroad cars, iron ore must be mined and processed. And so on. The same kind of description can be provided for each component of the pencil: the paint, the graphite, the compound that comprises the eraser, the brass ferrule that holds the eraser.

Tracing the pencil’s genealogy back to iron, zinc, copper, and graphite mines; hemp plants; rubber trees; castor beans; and much more demonstrates the “roundaboutness” of production, the term of the early Austrian economist Eugen von Böhm-Bawerk. Much time and effort are spent not on making pencils but rather things that will–sooner or later–help to make pencils. Without central direction, entrepreneurs set up production this way because more, better, and cheaper pencils can be made more profitably than by some more direct process.

Price Communication

Several things are worth pointing out about the structure of production. First, while no central planner is responsible for pencil production overall, entrepreneurs and workers at each stage do have plans and expectations, which they strive to coordinate with one another across stages and time periods. The key to coordination is the price system. If there’s a brass shortage, rising prices will communicate that information to the ferrule and pencil makers. The downstream entrepreneurs will have to adjust their plans in response to the new conditions–say, by finding a substitute material. The demand for a substitute material will in turn set appropriate processes in motion as entrepreneurs react. In the real world of disequilibrium, change is the rule, so plans are always undergoing revision.

Moreover, a quantity of a resource cannot be used both at an early stage of production and a later stage simultaneously. A unit of iron could be devoted to making ferrule machines or it could be used to make a machine for mining more iron–or many other things in between. Tradeoff is the rule, and consumer welfare depends on having things arranged appropriately. Time-preference and the market for loanable funds–that is, interest rates–govern coordination across time and maximize consumer satisfaction. It all works marvelously well when government stays out of the way, but alas there are many opportunities for mischief by the central bank and the Treasury. For example, artificially depressing interest rates can shift resources from later to earlier stages in defiance of consumer preferences and resource scarcity.

Second, capital equipment wears out. Machines, engines, vehicles, saw blades, ropes and the rest need to be replaced. That requires money, which requires saving–that is, deferred consumption. Saving is also necessary to finance research and development so that better and cheaper machines, tools, materials, and writing implements might be created. Remember this when Keynesian politicians and economists who aspire to stimulate the economy deride saving as inimical to economic growth and increased consumption. Such derision invariably ignores the need for capital at stages of production remote from the final consumer level. That’s what inappropriate aggregation gets you.

Third, the stages of the capital structure consist in discrete, specific, scarce, and complementary things–buildings, machines, tools, materials, and more–in particular places at particular times. They were put in place, as part of an entrepreneur’s plan, to work together with labor to produce other specific things. In keeping with Austrian subjectivism, the plan gives meaning to the capital goods. A change in plan, for example, might convert equipment that was once complementary to the rest of the equipment into something of little or no value (besides scrap).

Menger and Value

This leads to the final point. Carl Menger, founder of the Austrian school, taught that capital goods get their value ultimately from the final consumer goods they help to produce. If there were a machine that could only make pencils and if people stopped wanting pencils, the value of the machine would drop to its scrap value. Capital goods are not a lump of Play-Doh. They are specific things, which means they cannot be adapted to any use whatever. Even when they can be adapted, the conversion will likely not be costless and certainly not instantaneous. Moreover the goods are in particular places. Equipment in the wrong place is not as valuable as equipment in the right place.

These facts have implications for booms and busts, which are much on people’s minds today. If government policy (monetary or other) artificially induces investment in unsustainable projects that are out of alignment with true consumer preferences, the realignment that will have to be undertaken later can be neither instantaneous nor costless. Equipment that was suitable for the now-liquidated projects may not work as well–or at all–in other endeavors. Much “investment” will be seen now as waste, and time and money will have to be spent putting things right. That’s the recession.

This description of the structure of production should raise no eyebrows. We see such things all around. But anyone who has taken a standard economics course will know that capital is usually discussed as though it were a lump of malleable and homogenous Play-Doh (“K”). If you assume this about capital and think in terms of aggregates and averages, you may underrate the need for the market process, which has no rival in its ability to coordinate the plans of strangers in order to raise living standards. The Play-Doh conception of capital may fit in mathematical equations, but that’s a case of the tail wagging the dog. Economics should be a way of thinking about the world we actually confront.

The Federal Reserve has been pumping hundreds of billions of newly created dollars into “the economy.” Much of that money has been sent to Wall Street to bailout large, struggling firms. But that’s just the beginning. President-elect Obama says that since he needs to “stimulate the economy” we can look forward to trillion-dollar budget deficits for years to come. Even before the financial turmoil began, the deficit had approached $500 billion. (Not to worry, though–Obama says deficit spending will impose “fiscal discipline” in the future.)

Of course, when the federal government spends more than it taxes, it has to get the extra money somewhere. Therein lies the treachery. The government’s vendors and other beneficiaries demand to be paid on time. So it borrows from the credit markets by selling Treasury securities to investors. The Federal Reserve in turn monetizes the debt by buying Treasury securities in the marketplace. It pays for those securities by creating bank reserves–money–from nothing, or as John Maynard Keynes suggested, by performing the “miracle … of turning stone into bread.”

Since we, like the rest of the world, have long lived with a fiat-money system–that is, a system in which the paper money is not backed by anything–there is nothing remarkable about this for most people (if they are aware of the procedure at all). But before long, they will pay a steep price whether or not they know who the culprit is.

The central bank’s expansion of money and credit used to be called inflation. Today that word is used mostly for one of the consequences of monetary expansion: generally rising prices. That’s unfortunate because that definition papers over the most important effects of deficit spending and monetary inflation.

To think of inflation as generally rising prices is to miss the real point. If an increase in the money simply raised the “price level” uniformly, it would be little more than an inconvenience. Prices might outrun wages at first, reducing real incomes, but soon wages would catch up and, in real terms, we’d be back where we started. The dollar values would larger, but without real consequence.

That’s not how  it works, though. Ludwig von Mises explained the process in a lecture he gave in Paris in 1938 and again in New York in 1945. It was later published under the title “The Non-Neutrality of Money.” (It appears in Money, Method, and the Market Process: Essays by Ludwig von Mises, edited by Richard M. Ebeling.)

Barter Economy

In this lecture Mises was determined to disabuse his listeners of their belief in the neutrality of money–that is, the idea that changes in the money supply leave real factors undisturbed. He understood why economists have held this erroneous belief. They began thinking of exchange in the admittedly simplified terms of a barter economy in which goods exchange for other goods. When they added money to this unrealistic picture, they assumed nothing of importance changed. As Mises put it, they believed “The functioning of the market mechanism as demonstrated by the concept of pure barter was not affected by monetary factors.”

These economists acknowledged that money prices can vary, but “they believed–and this is exactly the essence of the fallacy of money’s neutrality–that these changes in purchasing power were brought about simultaneously in the whole market and that they affected all commodities to the same extent.” Thus according to this view, the price level changes, but relative prices do not.

Here’s the problem. There really is no price level, except for ones constructed by averaging the prices of an arbitrary basket of goods and services. What really exist–and therefore what really count–are millions of prices for goods and services that are constantly subject to change in relation to one another. These prices emerge from the decisions of potential buyers and sellers who pursue their ends according to their subjective priorities.

You’d hardly know this by reading mainstream economics, but economic phenomena happen on the ground–where human action and interaction take place–and not at the level of statistical aggregates and averages that no real person ever encounters..

“Monetary problems are economic problems and have to be dealt with in the same way as all other economic problems,” Mises continued. He meant that when analyzing inflation and other monetary issues, our focus should not be “the economy” holistically conceived. As he put it, “Changes in the quantity of money and in the demand for money for cash holding do not occur in the economic system as a whole if they do not occur in the households of individuals. These changes in the households of individuals never occur for all individuals at the same time and to the same degree and they therefore never affect their judgments of value to the same extent and at the same time.”

In the economists’ lingo, macroeconomics is, or should be, rooted in microeconomics.

Inflation and Its Consequences

Take inflation. When the government expands the supply of money, it does not do so by dropping Federal Reserve notes evenly across the land from the proverbial helicopter. In the old days government would print money or filch precious metals to make coins, then spend the money as it liked. A few select people received the money first, and they could then enter the market and buy what they liked at prices still unaffected by the inflation. the late receivers were the losers.

These days the process is more complicated. The Treasury borrows money from private lenders by selling securities. With that cash it pays contractors and welfare-state beneficiaries. Meanwhile, the Federal Reserve creates money in the form of bank reserves by buying government securities. It’s called monetizing the debt. Banks then pyramid loans on these new reserves, expanding the money supply and lowering interest rates. Among the consequences is the depreciation of the monetary unit (rising prices) and the boom-bust trade cycle described by Mises and F.A. Hayek. (Hayek won his Nobel Prize in 1974 partly for his work on the trade cycle.).

Whichever method is used, the point is that the newly created money enters the economy at specific points rather than blanketing society evenly. The result is a diversion of the economy from the path it would have taken in the absence of the disturbance. A new pattern emerges the details of which cannot be predicted. Why not? Because people are people not robots. If your cash balance doubled tomorrow you wouldn’t mechanically double the quantities of everything you buy now . Instead, you would change the proportions–buy more of this and less of that–and even buy things you don’t buy today. You yourself can’t predict exactly what you would do in these circumstances.

“The additional quantity of money does not find its way at first into the pockets of all individuals; not every individual of those benefited first gets the same amount and not every individual reacts to the same additional quantity in the same way…,” Mises summed up. “The additional amount of money offered by them on the market makes prices and wages go up. But not all the prices and wages rise, and those which do rise do not rise to the same degree.”

Income Distribution

Now things get interesting. We begin to see that inflation is a form of government distribution of income. (I don’t say “redistribution” because in a true market economy income is not distributed but rather acquired through exchange.)

“If [for instance] the additional money is spent for military purposes,” Mises wrote, “the prices of some commodities only and the wages of only some kinds of labor rise, others remain unchanged or may even temporarily fall. They may fall because there are now on the market some groups of men whose incomes have not risen but who nevertheless are obliged to pay more for some commodities, namely for those asked by the men first benefited by the inflation. Thus, price changes which are the result of the inflation start with some commodities and services only, and are diffused more or less slowly from one group to the others. It takes time till the additional quantity of money has exhausted all its price changing possibilities.”

Make no mistake about it. This is a government-engineered transfer of resources, that is, a violation of property rights. And by the way, the distribution is not from rich to poor. If anything, the distribution is upwards.

As Mises explained, “But even in the end the different commodities are not affected to the same extent. The process of progressive depreciation has changed the income and the wealth of the different social groups. As long as this depreciation is still going on, as long as the additional quantity of money has not yet exhausted all its possibilities of influencing prices, as long as there are still prices left unchanged at all or not yet changed to the extent that they will be, there are in the community some groups favored and some at a disadvantage…. As long as the inflation is in progress, there is a perpetual shift in income and wealth from some social group, to other social groups.”

We have seen that government expansion of the money supply rearranges resources in society and interferes with the market’s natural tendency to serve consumers according to their own priorities. Thus inflation would be objectionable even if it did not cause malinvestment and seed the ground for a subsequent depression, that is, even if it did not spawn the trade cycle.

It is incumbent on the inflationists–specifically, the incoming government officials–to explain why income distribution is a proper function of government.

The New Deal did not end the Great Depression. This statement will come as no shock to FEE supporters, but it will to the many people who never encountered it before. Now people are encountering it — in newspaper columns and news-talk shows.

Why, after years of being taught that Franklin Roosevelt’s economic intervention saved the country from disaster, is the general public now being told — by FDR fans, not critics — that this is not the case?

It’s the Rooseveltians’ way of helping President Obama get over any fear he has of deficit spending. Paul Krugman, the newest Nobel laureate, a Keynesian, and a New York Times columnist, is explicit about this. “[H]ow much guidance does the Roosevelt era really offer for today’s world?” Krugman asks. “The answer is, a lot. But Barack Obama should learn from F.D.R.’s failures as well as from his achievements: the truth is that the New Deal wasn’t as successful in the short run as it was in the long run. And the reason for F.D.R.’s limited short-run success, which almost undid his whole program, was the fact that his economic policies were too cautious.”

By “too cautious” Krugman means that FDR’s deficits were too small. Roosevelt ran deficits (except for one year), but they were about the same size as those run by his predecessor, Herbert Hoover. Roosevelt’s biggest deficit, in 1936, was “only” 4.4 percent of GDP, Jim Powell points out in FDR’s Folly. Both Hoover and Roosevelt were big spenders — FDR doubled spending by 1940 — but they were also big taxers, which kept the deficit from growing. This is confirmed by University of Arizona economist Price Fishback, who wrote, “Once we take into account the taxation during the 1930’s, we can see that the budget deficits of the 1930’s and one balanced budget were tiny relative to the size of the problem….”

Roosevelt was quite a tax enthusiast. He levied or raised taxes on liquor, tobacco, gasoline,  corporate dividends, estates, incomes (top rate 75 percent versus Hoover’s 63), “excess” profits, and undistributed profits. (The last tax was repealed in 1939.) And then there was the payroll tax that came in with Social Security. All in all, the New Deal more than tripled the tax burden from 1933 to 1940: $1.6 billion to $5.3 billion. Serious deficit-spenders don’t raise taxes. But Roosevelt did. Is it any wonder that net investment dropped $3.1 billion during the decade or that unemployment was about as high in 1939 as it was in 1932?

Would Bigger Deficits Have Worked?

This raises the question of whether big-time deficit spending would have ended the Depression. Krugman and others think so. But how could it? Deficits are financed either by borrowing or by creating money out of nothing. When the government borrows money, that’s money no one else can borrow and invest. Where’s the gain? Moreover, the money is put to purposes selected by politicians, not entrepreneurs trying to please consumers.

When the government creates money, three things happen. First, the new money lowers interest rates below the level justified by society’s time preference; that produces perverse incentives to invest in longer-term projects far from the consumer-goods level. Second, the money early on changes relative prices (rather than raising prices evenly) because particular economic interests get it sooner than everyone else. Third, prices later rise generally, reducing everyone’s purchasing power. The result is a distorted structure of production and a boom that is unsustainable because it’s based not on real savings but on fiat money. When the inflation stops, the bust follows.

Since the New Deal didn’t end the Depression and a New Deal on steroids wouldn’t have done so, President Obama should pay no heed to Krugman and his Keynesian economic advisers. The way to wake up the economy is reduce the total government burden on producers and consumers by, among other things, slashing spending, taxes, and borrowing.

Another presidential election has come and gone, only this time the results are astoundingly and, yes, satisfyingly historic. In light of our racial history and leaving aside political philosophy, I am overjoyed at what Barack Obama’s election means. I cannot put it better than Will Wilkinson did at The Fly Bottle, “It means something profound that a black man was elected to the most visible, high-status position our society offers. The mere fact that Obama won truly does make our society a better place.” I also share Wilkinson’s reservations. In a truly free society, the presidency would not be the most visible high-status position our society offers. That designation would be reserved for a variety of private-sector roles. Unfortunately, however, the presidency does have that status today, and Obama’s election must be appreciated from that perspective. Relatedly, I am uneasy about, though understanding of, the public displays that followed John McCain’s concession Tuesday night. Again, Wilkinson: “[F]rankly, I hope never to see again streets thronging with people chanting the victorious leader’s name.” Amen.

President-elect Obama’s many supporters and well-wishers have great confidence in his ability to solve the economic problems that vex American society. That ability is said to lie in his cool judgment, his good intentions, and his eloquence. Let us grant that he possesses all three. Valuable as they are, they will be useless if he attempts to solve our economic problems directly by an exercise of power. That’s because there is something he does not have — something no man or woman can have: the power to repeal the laws of economics.

Until about 200 years ago hardly anyone understood that there are implacable laws of economics, or human action. This ignorance permitted rulers to believe they could impose their will more or less efficiently. If something went wrong, the fault lay in the flaws of others. Then, in the late eighteenth century, something changed.  As Ludwig von Mises wrote in Epistemological Problems of Economics: :

When men realized that the phenomena of the market conform to laws, they began to develop catallactics and the theory of exchange, which constitutes the heart of economics. After the theory of the division of labor was elaborated, Ricardo’s law of association enabled men to grasp its nature and significance, and thereby the nature and significance of the formation of society. The development of economics and rationalistic sociology from Cantillon and Hume to Bentham and Ricardo did more to transform human thinking than any other scientific theory before or since. Up to that time it had been believed that no bounds other than those drawn by the laws of nature circumscribed the path of acting man. It was not known that there is still something more that sets a limit to political power beyond which it cannot go. Now it was learned that in the social realm too there is something operative which power and force are unable to alter and to which they must adjust themselves if they hope to achieve success, in precisely the same way as they must take into account the laws of nature. This realization had enormous significance for men’s action. It led to the program and policies of liberalism and thus unleashed human powers that, under capitalism, have transformed the world.  [Emphasis added.]

Not that rulers and state-worshipers embraced economics and liberalism. But they sensed that the liberal economists had identified the natural limits of power. Finding that knowledge threatening, those enamored with power had no choice but to attack and deny economics as a scientific discipline. Yet economics survived.

Lesson Unlearned

Somewhere along the line the fundamental lesson taught by the economists was unlearned. Political “leaders” lost whatever humility liberalism had instilled in them and assumed a pre-modern hubris in which they believed that nothing but lack of will could keep them from accomplishing their goals. This hubris was described by Mises in “Social Science and Natural Science”: “[T]he belief prevailed that in the field of human action no other criterion could be used than that of good and bad. If a policy did not attain its end, its failure was ascribed to the moral insufficiency of man or to the weakness of the government. With good men and strong governments everything was considered feasible.” (Emphasis added.)

Sound familiar? Today’s political leaders, regardless of party and including, alas, Barack Obama, operate with this pre-modern mentality. We saw it throughout the presidential campaign, and heard its words when Obama said, “There is nothing we can’t do, nothing we can’t accomplish if we are unified.”

This is opposite of the classical-liberal insight, which can be summed up with this bumper-sticker slogan: Economics. It’s not just a good idea. It’s the law.

Because there are economic laws, there are limits to what “we” can do and how we can do it. (By we, of course, Obama doesn’t mean the spontaneous social order; he means the state and deliberate planning.) We cannot raise wages or create jobs or eliminate poverty or make medical care cheap and widely available — or do any of the other things politicians promise — by decree. But we can move toward those goals by freeing the market, the undesigned yet orderly process that distills the knowledge and wisdom of the people and rewards entrepreneurs for solving problems.

Government cannot do those things directly. If it tries, it will fail and make us worse off. The key to understanding this lies in the nature of human action. We live in a world of scarcity, and the list of scarce resources includes time and knowledge. At any moment demand exceeds supply. Under these conditions, we adapt means to achieve chosen ends. We face opportunity costs and make tradeoffs according to our subjective preferences. The perception of costs prevents us from achieving lesser values at the expense of greater values. Respect for other people and their property, backed by law, prevents us from shifting costs to them without their consent. The result is the market — that emergent order which serves the general welfare and encourages personal responsibility as each person pursues his or her private interests.

If government, which, recall, is force not eloquence, intervenes — to raise or lower costs, to increase or reduce rewards, to tamper with prices or interest rates — we will modify our behavior, knocking self-interest and the general welfare out of alignment. A subsidy for medical insurance will increase the demand for services and raise prices. A price ceiling will make those services less available. A floor under wages will make jobs for unskilled workers more scarce, as employers find it a losing proposition to hire them. A tax on production will mean less produced. A subsidy to production will mean too much produced relative to something else consumers want. A trade restriction will lower living standards at home and abroad.

The Road to Serfdom?

All the good will and all the unity in the world won’t change the laws that make these things happen. Government might try to overcome the “recalcitrant” market by issuing more and wider decrees and by firmly demanding compliance. But it would be for naught. We’ve seen this sort of thing fail time after time in systems no American would want to embrace. F.A. Hayek’s The Road to Serfdom demonstrates that the democratic process is not necessarily a barrier to the creeping despotism of a government intent on having its commands obeyed and its utopia carried out. I am not suggesting that this is where Obama wants to take us. But if he insists on using political means to achieve his ends, that is where logic will take him.

It’s the law.

True, government can take the more subtle route of manipulating incentives through the tax system. But this amounts to having politicians and bureaucrats substitute their preferences for ours. Moreover, taxation is force and all such programs have unintended consequences.

Intentions do not build their own bridges to results. We know this from our own day-to-day actions. It is even more true in the political world. No bridge can be built in defiance of economic logic.

The difference between accepting and rejecting this truth is the difference between humility and hubris. We shall see which describes the Obama administration. Let us hope he chooses wisely.