Freeman

ARTICLE

The Free Lunch Myth

MAY 01, 1978 by E.C. PASOUR

Dr. Pasour is Professor of Economics at North Carolina State University at Raleigh.

The conventional wisdom about scarcity has changed dramatically in recent years. Only a few years ago, a fashionable view held that we had reached or were nearing the end of the age of scarcity. According to this view, popularized by Professor Galbraith, our affluent society was approaching a time when all our "basic needs" could be met. Today, the pendulum has swung in the op­posite direction. A series of events including the "environmental crisis," the "energy crisis," and the "world hunger crisis" have made clear to most people that scarcity is and will remain a fact of life. Gover­nor Brown of California describes our era as an "age of limits."

Although the public conception of scarcity may change, scarcity is a basic enduring reality and an inher­ent fact of life. Every age is and must be an age of scarcity. Scarcity of any good or service means that it has an opportunity cost. That is, in order to obtain more of any good or service other goods or services must be given up.

Scarcity is a fact of life for individ­uals as well as governments. Yet, in spite of ample evidence that all use­ful goods and services involve a cost, the myth persists that "free lunches" are attainable. The economic concept "free lunch" means that an individual or group can be provided a good or service at no cost to the individual receiving the bene­fit or to anyone else. Scarcity means that the "free lunch" is and must remain an illusion.

Consumerism and the Free Lunch

The "free lunch" myth has been responsible for much of the "con­sumer" and environmental legisla­tion of recent years. Ralph Nader and other consumer advocates led us to believe that automobiles could be made safer at little or no cost to the consumer. The results of this myth are now apparent, being reflected in higher auto costs. The mandatory air bag requirement when im­plemented will further increase the price of a new car by several hundred dollars.

The purported "free lunch" in the case of mandated safety regulations has been found to be quite expen­sive. Some people may prefer to pay a higher price as a way of reducing risk. More important, however, is that for most of us the supposedly "free lunches" turn out to be entrees which we didn’t order and don’t even wish to eat when served! Auto air bags, seat belts, shoulder harness and the interlock safety system are good examples. Public reaction against the interlock system for seatbelts was such that Congress repealed this safety requirement.

Much of the support for consumer safety legislation of recent years has been based on a lack of recog­nition by the public about the ulti­mate incidence of the legislation.

People will desire to reduce risk as long as the expected benefits exceed the costs. Public support for safer automobiles, drugs, lawn mowers, and the like has been overstated where consumers are led to believe that safety can be increased at no cost to them. Politicians contribute to this confusion with demagogic statements that any relaxation in a safety standard is a "sellout" to the industry involved, that manufactur­ers should always be responsible for safety in the use of products sold, that only drugs which are com­pletely safe should be sold, and so on. Implicit in such rhetoric is the "free lunch" myth that risk can be re­duced without cost to consumers.

Pollution and the Free Lunch

The "free lunch" myth is also re­sponsible for much of the impetus behind the environmental move­ment. We are told that clean water (or clean air) is "priceless" but we are not told what the costs will be of obtaining the clean water (or clean air). The so called "Muskie clean water bill" of 1972 declared a na­tional goal to end the discharge of pollutants into the nation’s water­ways by 1985. This amounts to a national goal to achieve a zero level of water pollution. The cost of at­taining such a standard, even if technically possible, would be as­tronomical.

In this case, the "free lunch" myth takes a slightly different form. The consumer is misled into thinking that a good or service will be pro­vided free to him at the expense of the industries providing consumer goods and services. If the apparent cost is less than the actual cost, demand will be overstated. Indeed, the fact that costs to the public were perceived to be unrealistically low is almost certain to have been respon­sible for much of the public support in the case of the Muskie clean water bill.

Excess Profits and the Free Lunch

Another interesting variant of the "free lunch" myth arises in the case of proposals to roll back oil prices or to tax "excess profits" of the oil in­dustry. As President Carter, Senator Jackson and other politi­cians castigate the excess ("obscene") profits of the oil indus­try, the erroneous idea is promoted that profits of the oil industry can be taxed away without affecting the domestic supply of petroleum prod­ucts. In other words, the public is led to believe that there is a "free lunch" involved in the sense that oil prices can be "rolled back" or profits re­duced without affecting producer in­centives and long-run oil produc­tion. (It isn’t denied, of course, that this would reduce income of the pro­ducers.)

Economic theory suggests that roll backs in price or profits will not affect production only if producers are completely unresponsive to prod­uct price (i.e., if supply is perfectly inelastic). The Carter Administra­tion’s contention that price ceilings on oil and natural gas will not affect future production is a good example of the idea that production is unre­lated to price. Producers of oil and natural gas, however, are similar to producers of other products. They do respond to economic incentives. This means that more oil and natural gas will be produced the higher the price.

Legislation which effectively re­duces price (or profits) to producers will inevitably reduce output. If "ex­cess profits" are defined (consistent with the free-lunch myth) as profits which do not affect output, there are no excess profits. There are no prof­its which can be taxed away with­out affecting future production. Thus, the relevant issue is not whether "excess profits" should be taxed away. Instead, the relevant policy issue concerns how much higher taxes or lower prices will affect output both in the short run and in the long run. The "obscene profits" rhetoric obfuscates the basic issues and, indeed, serves to per­petuate the "free lunch" myth.

World Hunger and the Free Lunch

The "free lunch" myth also plays a prominent role in current discus­sions relating to world hunger and poverty problems. The free-lunch myth is involved in several ways. A New International Economic Order (NIEO) has been approved by the UN to redistribute income from the United States and other industrial countries to the less developed coun­tries. The NIEO involves a wide range of interventionist schemes ranging from price-raising cartels for major products sold by the less developed countries to increased foreign aid by the developed coun­tries. The NIEO is fundamentally anti-market in mentality and as­sumes that arbitrarily redistribut­ing income from the West to the less developed countries will have no important effect on production. Yet, there is ample evidence that indi­viduals in the U.S. as well as other countries respond to economic in­centives. Thus, there is every reason to expect that action taken to force­fully redistribute income between countries will adversely affect out­put. There is no "free lunch" in­volved.

Individuals in the West are en­couraged to reduce waste in the use of food, gasoline, electricity and other energy sources. Citizens in the United States and other highly de­veloped countries are told that they should change their life style, reduc­ing consumption to the amount ac­tually "needed." The concept of waste implies that consumption can be reduced without any adverse ef­fect on consumer welfare, i.e., that there is a "free lunch."

There are two problems with this proposed "free lunch" approach of reducing consumption as a way of alleviating world food problems. First, a reduction in food eaten by a U.S. citizen doesn’t mean that more food will be available for the world’s hungry people. Even if the food is given as food aid, we can’t assume that the effects will be favorable. In some cases, (e.g., Tanzania) food aid permits the government to engage in collectivist social experiments which are a major cause of food problems.

Need, Waste and the Free Lunch

The second problem with the ap­proach of reducing our consumption to the amount "needed" is that the concept of "need" is meaningless as a guide to our daily activities. How much beef, housing, gasoline, heat­ing fuel, or clothing do we "need"? We as individuals respond to rela­tive price changes and consume rel­atively less of those goods whose prices increase. The higher the price, the less of any product we consume—whether it be food, cloth­ing, gasoline, heating fuel, or hous­ing.

The concept "waste" implies that there is some minimum amount of a product which is "needed" regard­less of price and that larger amounts of the product provide no additional satisfaction (i.e., that demand is per­fectly inelastic). If this were the case, amounts of the product above this minimum level could be re­moved at no loss in satisfaction to the consumer and would, in fact, be a "free lunch." Can any of us give up expenditures in food, clothing, travel, and so forth without feeling a loss in satisfaction? It is easy for us to find such "waste" only in the consumption habits of other people!

The use of the family car provides an interesting example of the im­possibility of identifying waste. It is often alleged that the typical motorist wastes gasoline by using the auto more than is "needed." We observe that a neighbor Jones drives his own car to work each day when he could form a car pool; drives his car on short trips when he could walk or ride a bicycle; takes vaca­tion trips out-of-state when vaca­tions could be taken in-state (or at home); and uses the car for a host of other "non-essential" purposes. Yet, there is no basis for us or any other outside observer to conclude that any of these uses of the auto by Jones are "wasteful" in any mean­ingful sense.

The problem is that the concept "need" has little if any meaning. We, as motorists, respond to relative prices in deciding where to live, how to get to work, where to vacation, and so on. Virtually everything we do could (and would) be done in some other way if relative costs changed. The attempts to get people to change driving habits are likely to have little effect so long as relative prices remain unchanged. On the other hand, if gasoline prices were to dou­ble, no one would have to encourage consumers to economize in the use of gasoline.

Conclusion: Beware All Free Lunches

Undoubtedly the world would be a quite different place if the "free lunch" were fact not myth. However, it is a world difficult even to im­agine. We would not be constrained by problems of scarcity to the extent that this were, in fact, the case. Then, we could provide more food, more energy, cleaner air, cleaner water, and the like without cost, i.e., without sacrificing anything valu­able. In this case, there would be no need for the Sierra Club to lobby for environmental issues, for Senator Hatfield to lobby for the world’s hungry, for President Carter’s worry about the "energy crisis," or for Ralph Nader to protect us from un­safe cars and other consumer prod­ucts.

The individual consumer can de­termine and support the kind of legislation he desires only if he knows the cost of alternative courses of action. A necessary first step is the realization that the "free lunch" idea is a myth. In the energy, environmental, and safety areas, a great deal of legislation has been enacted under false pretenses. All such legis­lation involves increases in cost. Much of this legislation would have not enjoyed public support if the costs had received equal billing with the benefits.

The fact that government fre­quently enables some people to ben­efit at the expense of other people is apparent in this age of transfer payments. Yet, the possibility of the use of the state to enrich everyone at the expense of everyone else is no less an illusion today than at the time of Bastiat.

The individual should also be wary of proposals to obtain "free lunches" by reducing "waste." Man-dated reductions in use of energy sources including gasoline and elec­tricity always involve a cost to the consumer. The consumer who is forced to use less electricity, gasoline or any other good is worse off even though price remains the same. Mandated reductions are fun­damentally different from voluntary reductions in use induced by price increases. Rationing through the price system permits much more flexibility in catering to a diversity of individual tastes and circum­stances.

In summary, the individual should be skeptical of all "free lunch" proposals. He should be espe­cially wary of those designed for him.

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May 1978

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