Walking through the home of a very rich American man from the early 1970s, I was struck by how much the quality of life for average people now exceeds what was available only to wealthy Americans 40 years ago. Let’s compare Elvis’s Graceland with how ordinary Americans live today.

Graceland began life in 1861 as a 500-acre cattle farm on the outskirts of Memphis, originally owned by S. E. Toof, a printer, who named the farm for his daughter Grace. Toof’s niece, Ruth Moore, and her husband eventually acquired the portion of the property where the house now sits, as well as surrounding acreage, completing the mansion in 1939.

It was planned as a showcase for their daughter’s musical talents, so acoustics were as important as aesthetics. (Their daughter went on to play with the Memphis Symphony Orchestra.) A 1940 article in the Memphis Commercial Appeal raved about the house’s “subtle beauty” and the architectural details, including the white marble in the fireplace. Even before Elvis acquired the property, the house had been recognized as being at the upper end of Memphis society homes.

Being a significant home in Memphis meant something beyond Tennessee. Memphis in the mid-twentieth century was no backwater. It was home to important military facilities, including the Memphis Army Depot, the Millington Naval Air Station, and a World War II prisoner of war camp. The first national motel chain, Holiday Inn, was founded there in 1952. The city was a cultural center as well, home to Stax Records, Sam Phillips’s Memphis Recording Service, and the nation’s first African-American-format radio station, WDIA. The city had a serious side too: The Commercial Appeal won a Pulitzer Prize for its 1920s coverage of the Ku Klux Klan.

When the Moores divorced they put the property (now reduced to 13.5 acres) on the market. Memphis realtor Virginia Grant had met Elvis’s mother, Gladys, by simply marching up to her pink Cadillac and rapping on the window when Grant spotted it outside a department store. Elvis’s fame was beginning to cause problems for the neighbors of the Presley house on Audubon Drive. Near-riots at his concerts and other appearances were worrisome. At the famous Gator Bowl “riot” in Jacksonville, Florida, in 1955, hundreds of screaming girls chased Elvis into his dressing room and tore his clothes. They also scratched messages on his car and wrote on it in lipstick. In 1957 the Presleys were looking for a more private and secure location. (Besides the deluge of fan mail to Elvis, his parents were getting over 500 letters a week accusing them of fostering juvenile delinquency.) Although Grant initially thought the Presleys wanted a farm, she recommended Graceland when she learned they just wanted a house on a large lot.

By the end of a day of shopping the Presleys had made an offer on Graceland, closing on the deal for $102,500—about $800,000 in today’s dollars. (Gladys died a year later.) At the time of purchase the house was 10,266 square feet; by Elvis’s death it had expanded to more than 17,000 square feet. Elvis redecorated and remodeled it extensively, adding features for himself (a swimming pool and a custom eight-foot square bed) and his parents (a chicken coop for his mother).

Presley lived at Graceland until his death there in 1977. Until 1981 the family continued to live in the house, although the neighborhood deteriorated as scores of souvenir shops opened to sell memorabilia, including vials allegedly of Elvis’s sweat, to the tourists who came to see the home from the road. In 1981 Elvis’s ex-wife, Priscilla (who became one of the executors of Elvis’s estate after his father, Vernon, passed away in 1979), hired a consultant to explore opening the house to the public as a way of generating the income necessary to maintain it. (Upkeep and taxes cost more than half a million dollars per year in the late 1970s.) After studying other famous houses open to the public, Priscilla and her advisers crafted a business plan that included purchasing the strip mall across the street to control the environment and, like San Simeon in California, from which visitors would be bused to the property. Hundreds of thousands of people now visit annually.

Comparing Our Lives to Elvis’s

In many respects Elvis Presley’s life looks to have been that of a wealthy individual with access to resources most of us lack. His two jets are parked across from Graceland; of course the vast majority of Americans lack any sort of plane. Elvis owned dozens of expensive cars and motorcycles, far more than most Americans are likely to own during their lives. But owning planes and cars is not the only measure of quality of life. If we think about the services Elvis was buying when he purchased his airplanes and cars, many Americans today come closer to living like Elvis than we might think.

Today firms such as NetJets make it possible for many more people to have access to travel by private plane. (NetJets offers shares as small as 1/16th, or about 50 hours of flying, according to the company’s website). For the rest of us air travel has become more convenient and cheaper since airline deregulation in 1978. One study in 1997 found that even after adjusting for changes in amenities, passengers were saving more than $19 billion per year. Average roundtrip fares have fallen by more than a third in real terms.

Of course even flying business class on a major airline is hardly the same thing as flying on Presley’s Lisa Marie, a Convair 880 that Elvis bought for $250,000 and spent $600,000 refurbishing, using the same design team that decorated Air Force One. Elvis’s plane had a bar, conference room, and bed (with seat belts); our commercial airliners do not. And undoubtedly if Elvis were alive today, he would have upgraded his plane to an even more luxurious model. But in terms of the ability to get from one place to another quickly and conveniently, today’s commercial passenger comes closer to Elvis’s lifestyle than most thought possible in 1977. Elvis might still need a private jet today to avoid the fans, but he wouldn’t need it to get where he wanted to go or ship off a new recording master to RCA from Memphis, whose airport is a hub for both Delta Airlines and Federal Express.

Cars

Similarly, Elvis’s many cars continue to set him apart from noncelebrities. But none of Elvis’s cars have a stereo equal to the one in my 2011 Subaru Outback, which synchs automatically with my Bluetooth-enabled iPhone, giving me access to more music in my car than Elvis had even back in the Jungle Room at Graceland. Moreover, my Subaru has tires, an engine, and safety features far better than were available even on Elvis’s 1973 Stutz Blackhawk, 1971 Mercedes, or 1975 Dino Ferrari. And Bluetooth isn’t the only technology Elvis could not have bought in the 1970s for any amount of money. My car has multiple airbags, a continuous variable transmission, and all-wheel drive.

Of course, Elvis wouldn’t likely be driving something as mundane as an Outback (unless his manager, Col. Tom Parker, had negotiated a contract for him to do so at a hefty fee), but even if Elvis were driving a top-of-the-line Mercedes today, the gap between his car and mine would be much smaller than the gap between his Ferrari and my parents’ 1970s Toyota Corolla. In part that is because items like cars have improved in quality, but it is also because improvements in finance have made it possible for ordinary people to have access to them. Elvis would still be able to turn up at a dealer and buy a car without a credit check; the difference is that this past summer I was able to buy my Subaru via the Internet without ever meeting the dealer and without the hours of paperwork and haggling that were a routine part of the car-buying experience as recently as the 1990s.

Everything from the selection of options to the financing was arranged by email, the web, or phone. The dealer had access to financing from investors via asset securitization of its loans; it was able to check my credit in seconds using online services; and I paid the deposit with a credit card over the phone (racking up frequent flier miles since I don’t have my own plane). Aside from a test drive, the only time a member of my family set foot on a dealer’s lot was when my daughter picked up the car.

Elvis could buy a car with a similar lack of personal effort in the 1970s because he had a staff to do things like wait in line at the bank to get a cashier’s check or cash, fill out forms, and negotiate details of the purchase. He was able to get excellent service because he was a celebrity. Today all of us have access to similar levels of service, thanks to entrepreneurs like Sam Walton, whose Sam’s Club brokered my Subaru purchase.

Televisions

One of the best-known features of Graceland is Elvis’s arrangement of three televisions (there were only three networks) in several rooms. Inspired by Lyndon Johnson’s use of three TVs to monitor the three network news broadcasts simultaneously, Elvis had a more sensible reason—so he could watch multiple football games. Here our lives really shine compared to his. In the mid-1960s, console TVs cost over $5,000 in today’s dollars. When Elvis was watching football on his three color TVs, my parents had a single black-and-white television, whose screen could not have been larger than 20 inches. My grandmother, who lived with us, splurged and bought herself a 24-inch-screen console color analog television (with a remote control!), around which we gathered on Sunday evening to watch All in the Family on CBS.

Today my living room has a 60-inch digital flat-screen TV, capable of much higher resolution than anything Elvis (or my grandmother) owned but which cost considerably less than just one of Elvis’s sets. Moreover, it features technology like a “picture in picture” display that makes it unnecessary to have three side-by-side televisions if I want to monitor more than one program. Elvis had to remodel his bedroom to have two TVs positioned so he could see them from his bed. I streamed video to my iPad while lying in bed the first night after I moved into my current home without having to summon a contractor.

Stereos

Another feature of Graceland is the top-of-the-line stereo presented to Elvis by RCA Records in gratitude for the benefits it reaped from his efforts. My music system sounds better than Elvis’s expensive stereo (and can play from the TV as well). Some audiophiles might disagree, since the gold standard for many is still a tube-based amplifier like Elvis had. But not only did I have a choice of sound systems, even an audiophile system would be cheaper, better, and smaller than anything in Graceland. Of course the rich still have better systems, yet the rest of us live better than they did in the 1970s. I tried unsuccessfully to find cost figures for Elvis’s system but I have no doubt that the combination of my iPhone, a networked hard drive, and a wireless music system provides me with many times the quantity of music available to even an avid collector like Elvis—with far greater convenience and at a fraction of the cost.

If we look at the more mundane parts of Graceland, the improvement in our lives is even more striking. Elvis was proud of the chandelier that hung in the foyer; lighting fixtures (aside from government-mandated CFL bulbs) are vastly superior in illumination, efficiency, and variety to what was available to him when he decorated Graceland. In the kitchen sits a massive early microwave oven; these are now compact and virtually disposable. (In 1981 a Sears microwave cost almost $500—over $1,100 in today’s dollars—but today it is just $119.) A feature worthy of comment in the original news accounts of Graceland was its marble fireplace. Granite countertops and similar features are now present even in apartments marketed to college students. If we dig into the support systems, the differences are even more dramatic. Home Depot sells furnaces more efficient and quieter than what Elvis had in the 1970s; windows today are dramatically superior in their construction and energy efficiency; and appliances such as washing machines and dryers have options unimaginable to even the wealthiest in the 1970s.

In his classic 1945 American Economic Review article, “The Use of Knowledge in Society,” F. A. Hayek termed the price system “a marvel” for its ability to improve the quality of life without any central direction. That’s just the right word. My family (along with yours) lives a quality of life most of us could hardly imagine in 1957 or 1977. It is a marvel that we have come so far so fast. Contrary to Harvard professor (and Massachusetts senate candidate) Elizabeth Warren’s recent claim that we owe a good deal of our success to government, the improvements are the results of innovations by engineers, business people, and others striving to create their own success and to find the resources to achieve their own dreams.

Today most Americans live lives that approach and in some cases exceed the material well-being available only to rich celebrities just 40 years ago. Given how much Elvis Presley loved his fans, I think that’s something he would be happy to know.

Curious about what is so bad about gasoline that it was necessary to warn children, I bought it and found myself in an alternative universe of dreary ecological disasters. This was a far cry from the world of the classic picture books, such as what is undoubtedly today considered the criminally polluting tale of Mike Mulligan and His Steam Shovel by Virginia Lee Burton. Nor did it resemble the brightly colored and fantastic world in the books I read to my kids in the early 1990s. Even more depressing, when I dug further it turned out that What’s So Bad About Gasoline? is part of a series of “science” books aimed at elementary school kids that tell a tale of ecological catastrophe. These include Oil Spill! by Melvin Berger and Where Does the Garbage Go? by Paul Showers.

If these books are what kids grow up with today, we should hope they spend their time on video games instead of reading. The books are troubling because by ignoring economics and by focusing on eco-politics, they get the solutions to environmental problems wrong.

Worse, in the world these books present things don’t get better. We must always do more to repent for our environmental sins. As economist Robert Nelson observes, environmentalism in America has evolved into “environmental Calvinism.” Even worse, Nelson notes, it is “Calvinism without God,” as bleak a vision as one can imagine since we’re left only with an impersonal environment as the object of veneration. (Nelson’s The New Holy Wars: Economic vs. Environmental Religion is a great read.) Presenting consumption as ecological sin without showing the vast improvements in people’s lives produced by growing wealth ignores the great success of market economies and entrepreneurs.

Finally, the vision of the world these books present lacks human agency as anything other than motivating the mindless consumption that leads to ecological catastrophes. Not only is this a world missing entrepreneurs and inventors, there’s also no excitement to its vision of the future. Although I am still waiting for my personal jetpack, the world of the The Jetsons promised a future of excitement and fun rather than a grim time in which we merely replace our cars with hybrids. The optimism that prompted Julian Simon to term humanity “the ultimate resource” is missing from this literature.

Oil Spill! was first published after the Exxon Valdez event. It opens with a dramatic scene of the tanker hitting the reef in Prince William Sound. Missing from the story are the broken sonar system that should have alerted the crew to the impending collision, the overtired third mate in the wheelhouse because the union-protected captain was sleeping off a drinking binge, and the lack of sufficient crew. The spill just happens. Indeed, humans are a minor presence in the book—appearing on just eight of 29 pages of illustrations, only as a cleanup crew hosing down a beach, a family on a beach, people using energy, and a child writing her congressman. Oil Spill!’s solution to the devastation of nature is political action.

Kids reading Oil Spill! aren’t likely to be ready for a fact-heavy discussion of oil-transportation risks versus the benefits of energy consumption, the natural underwater oil seeps that could be reduced by offshore drilling, or whether using less electricity will really reduce oil spills, as the book suggests (oil-fueled sources account for under 2 percent of U.S. electrical generation).

Children do not learn that the profit motive is what drives inventors and manufacturers to improve products to reduce energy consumption. The U.S. economy has steadily become more energy-efficient: Per dollar of real GDP, energy use dropped by more than a third from the late 1970s to 2000. Compared to 1900 each unit of energy input in 2000 could provide four times as much useful heat, move a person 550 times farther, provide 50 times more illumination, and produce 12 times as much electricity. Moreover, oil spills like the Exxon Valdez or the BP disaster are exceptions rather than the rule and are more likely due to failures in regulatory schemes than to a lack of laws.

Where Does the Garbage Go? isn’t a new book, first appearing in 1974. Comparing the 1974 and 1994 editions reveals an interesting shift in environmental thinking. Originally, Where Does the Garbage Go? centered on a girl who went through her own trash to see what her family threw away. She found worn sneakers, potato peels, cans, bottles, and her old yoyo. She then visited her uncle on a farm, discovering that food scraps could be fed to pigs. The book generalized to the collection of garbage and its disposal in the ocean (showing children swimming in a polluted ocean), incinerators (children grimacing and rubbing their eyes from the smoke), and dumps (“a dirty place,” “a great big mess” with rats and “millions of flies”). After explaining recycling and showing crowds making more trash, the 1974 book concluded with the child narrator asking what the reader thought “we should do” about trash as she took her old yoyo from the trash and fixed it.

By 1994, however, the narrator was gone and the story was now presented as a school lesson. Dumps and ocean dumping were history. But, just as in 1974, “Waste never stops piling up.” Recycling and waste-to-energy plants could handle some of our trash, but “we must do more. We must stop throwing so many things away.” By the end children are depicted walking home from the grocery store holding string bags that “we never throw away” and use “over and over again.”

Set aside whether or not recycling makes economic sense, particularly in the forms advocated in Where Does the Garbage Go? No second-grader wants to read a cost-benefit analysis of curbside recycling programs. Let’s even forget whether there is a market for recycled products large enough to absorb our trash. The big problem in this book—and in the others as well—is the focus on making people feel bad about consuming goods because it creates “waste.”

Conspicuous Underconsumption

Consumption isn’t bad—it is how we are made better off by the goods and services we purchase. The great success of market societies is precisely that they make it possible for virtually everyone in them to consume at a rate greater than even kings and emperors did in even the recent past. It was Boris Yeltsin’s 1989 visit to a Houston supermarket, not a visit to a recycling center, that convinced him of the superiority of free markets.

Moreover, the bounty of a market economy is a relatively recent discovery. There was little change in consumption of calories anywhere in the world until about 1800 in western Europe. Only after the Industrial Revolution did the human condition experience a dramatic change for the better. The world’s most pressing problem is that there is too little consumption not too much. People living in poverty in societies that lack basic market institutions across the developing world need to increase their consumption not reduce it.

Simultaneously the worst and best thing about What’s So Bad About Gasoline? and its ilk is that they are excruciatingly boring. Boring is bad because energy isn’t a boring topic, and making it boring turns kids off to thinking about science and technology. To their credit the book’s author and illustrator try hard to make it interesting. The pictures are lively: glaciers melt and houses tumble into the ocean. But they aren’t enough because the eco-catastrophist version of energy is one in which people are passive and events inevitable.

That’s not how the world actually works, of course. Energy isn’t boring even for elementary school kids because it is crammed full of interesting discoveries, larger-than-life characters, and exciting events. The transformation of gasoline from a waste product into a valuable commodity is a series of exciting discoveries made by entrepreneurs and scientists who raised our standards of living and health. In transforming oil into gasoline, scientists repeatedly accomplished tasks no one believed they could—turning crude oil into hundreds of different products. Brilliant and interesting characters abound.

Unfortunately What’s So Bad About Gasoline? misses all this. There are no individuals in the story. A cast of anonymous people from the Middle East to China to the United States finds things to do with petroleum and gasoline, and then bad things happen because we’re using too much carbon-based fuel.

Presumably HarperCollins publishes books like Where Does the Garbage Go?, Oil Spill!, and What’s So Bad About Gasoline? because earnest parents want their kids to grow up with green values. They are just a small part of a large series from one publisher, and my search for these books soon had Amazon recommending dozens of other similar titles. Worse, it is not just in these books that a future of ecological gloom and doom is being taught. Michael Sanera and Jane Shaw’s Facts Not Fear: A Parent’s Guide to Teaching Children About the Environment documented the extent of the problem of teaching children to fear the future environmental catastrophe. For kids between kindergarten and 12th grade the dominant message in schools is: “The earth is badly polluted, the rain forest is about to disappear, and global warming will submerge New York City with floods—to name a few of the imminent catastrophes,” all problems caused by their parents, who “have brought the earth to the edge of doom.” Scientists and engineers are not problem solvers who make life better but evil exploiters of the environment. Congressmen solve problems.

How do people who believe humanity is indeed the ultimate resource rescue the future? We’ve got two key advantages over the prophets of doom. First, our stories are more interesting. Free societies have room for people to do things—to discover new ideas and invent new products. Children are engaged in a process of discovery about the world around them and the narrative of discovery is more exciting than one of catastrophes. Active beats passive for almost everyone, and free markets are active. Freedom and free enterprise are just much more interesting than the alternatives.

Second, “environmental Calvinism” is even less fun than the original Swiss version. Given a choice, kids’ dreams are not going to be about sorting trash into recycling bins but about personal jetpacks. Because we’ve got a more interesting story, we’ve got a chance to capture young people’s attention. If you spot a neighbor’s or relative’s young kids glumly reading Oil Spill!, slip them a life of Thomas Edison or a even Mike Mulligan and His Steam Shovel (still in print!) and most will opt for the excitement of markets, invention, and action over the gloom of environmental pessimism. If parents read stories of action, invention, and excitement, they might even think twice about their own gloomy outlooks.

If we substitute “the federal government” or “the United Nations Environment Programme” or “the European Union” for “you” and change the email to a proposed law, however, we discover that politicians from Washington to Brussels are embracing measures to “green” the economy and create “green jobs” with an almost religious fervor, despite weak empirical support for these proposals. The Obama administration included billions of spending and tax incentives for green initiatives in its budget, and last spring’s “stimulus” bill poured $62 billion in transfers plus $20 billion in tax cuts into “green initiatives.”

Unfortunately, the rhetoric about “greening the economy” or creating “green jobs” is just political window-dressing for some of the same central-planning measures proposed by the left for years. Behind that rhetoric are proposals built around government subsidies for favored technologies, measures to limit trade, and a great deal of wishful thinking about alternative energy measures not quite ready for prime time.

What Counts as Green?

The first problem in untangling the claims made by green-economy proponents is determining what counts as a “green” job or technology. Many times no definition at all is provided; even when the term is defined, different groups pick quite different definitions. For example, the U.S. Conference of Mayors’ report Current and Potential Green Jobs in the U.S. Economy defines a green job as

any activity that generates electricity using renewable or nuclear fuels, agriculture jobs supplying corn or soy for transportation fuels, manufacturing jobs producing goods used in renewable power generation, equipment dealers and wholesalers specializing in renewable energy or energy-efficiency products, construction and installation of energy and pollution management systems, government administration of environmental programs, and supporting jobs in the engineering, legal, research and consulting fields.

Interestingly, the mayors count jobs in existing nuclear power plants but not in new ones.

In contrast the United Nations Environment Programme’s Green Jobs: Towards Decent Work in a Sustainable, Low-Carbon World excludes all nuclear jobs, but includes all jobs said to “contribute substantially to preserving or restoring environmental quality.”

If we take politics into account we can explain these definitions. The Conference of Mayors is concerned with building a coalition for spending to benefit its members. Those mayors with nuclear power plants in their cities want to claim credit for greening their economy through nuclear plants (which also pay lots of local taxes). The U.N. report, on the other hand, was aimed at gaining support from an international environmental movement that detests nuclear power, which explains why it didn’t count any nuclear jobs.

Neither applies any objective criteria to the problem of defining which industries will gain and which will lose. For example, both define as “green” any jobs related to nonfossil-fuel technology, even if these energy sources (such as wood) release as much carbon dioxide per BTU of energy generated as fossil-fuel sources—or more. (Wood is much less efficient in terms of carbon emissions than either natural gas or gasoline on a per-BTU basis.) Moreover, burning many renewable fuels produces considerable particulate pollution, both inside homes and outside—a serious problem particularly for women and children in developing countries.

Green-economy proponents also disagree about how green hydroelectric plants are. Many who advocate government spending on alternative energy also want to dismantle existing hydro projects to restore rivers and improve fish habitats. (And many of those dams were built with subsidies by the Bureau of Reclamation and Army Corps of Engineers and would have flunked any serious cost-benefit analysis.) But small hydro, their preferred alternative, is by definition “small.” As a result, it would take quite a few small hydro plants to produce sufficient energy to replace even a single large dam or coal-fired power plant. Not surprisingly, there is no evidence of a large-scale building boom in small hydro projects or even a serious effort to identify where such projects might be located.

Even more interestingly, both definitions are expansive enough to include “supporting jobs in the engineering, legal, research, and consulting fields.” Indeed, the Conference of Mayors found that the top two U.S. jurisdictions for current green jobs are New York City and Washington, D.C., suggesting that the investment in green technology so far is producing a lot of consultants, lawyers, and lobbyists rather than engineers or factory workers. Another estimate found more secretaries, management analysts, bookkeepers, and janitors among “green jobs” than environmental scientists.

Defining terms is essential to a rational policy debate; without clarity we end up with a division between favored and disfavored technologies driven by interest groups rather than by either market forces or logical thinking. Unfortunately, so far the green-economy literature has mostly produced lists of “technologies we like” and “technologies we don’t like” based on politics. We certainly shouldn’t be spending billions of dollars promoting what we can’t define.

Where Do Estimates Come From?

Even if we don’t quite know what a green economy looks like, its advocates assure us there will be lots of jobs and other benefits from converting to it. Not surprisingly, most green-economy proposals predict huge benefits at low cost, making them politically appealing. Jobs will appear in economically depressed areas, and energy efficiency will soar, saving firms, consumers, and governments billions. Unfortunately these benefits are largely due to inappropriate economic forecasting methods. In particular, most estimates are produced via “input-output analysis,” the same technique used to produce outlandish claims for the benefits of municipal stadium projects.

In an input-output analysis a vast matrix is calculated from economic data as they exist today, tracing connections between firms in different industries. For example, an automobile plant uses steel, aluminum, plastic, batteries, paint, tires, and other materials to produce cars with a particular amount of labor per car under current technology. If we thought that the plant would begin producing more cars, the input-output matrix could be used to calculate how much more steel, aluminum, and other inputs would be demanded by the car industry and how many more workers would be hired to work in it.

There is a role for such calculations in industry forecasts (predicting steel demand from auto production helps steel plants decide about investing in new capacity, for example). But using them to predict the impact of government programs to green the economy is problematic because the method rests on two assumptions that green proposals violate: constant prices and constant technology.

By definition, efforts to change energy technology are going to change technology and prices. The relationships in an input-output matrix based on using coal to generate electricity and gasoline to fuel cars simply aren’t applicable to an economy where substantial amounts of energy come from high-cost sources like wind and solar and the cars are hybrids or run on ethanol.

Worse, the green-economy predictions rest on extremely optimistic estimates of the impact of spending on new technologies. Almost no advocates of these policies deduct the jobs lost from replacing existing technologies with the new, green ones. Refinery workers, coal miners, fossil-fuel power plant workers, and many others will all lose their jobs if the proposed shift to nonfossil fuels takes place. Some of those workers may find jobs insulating public buildings or bolting together windmills, but many will not. Because all that public spending to produce these new technologies comes from taxes (whether today or in the future), it reduces private spending and so eliminates the jobs that would have been created by the higher private spending displaced by the taxes.

Any estimates of major changes are likely to be imprecise even if all these factors are taken into account because of the considerable uncertainty surrounding these relationships. Ignoring all the downsides, as green-economy proponents do, suggests that they are less interested in accurate predictions than in creating political pressure for policies regardless of their impact.

Labor Productivity

Even if we set aside these technical issues, however, there are still some serious problems with green-economy plans. Perhaps most important, the literature mistakenly glorifies low-productivity jobs on grounds that more employment is better. For example, the UN Environment Programme criticizes modern agriculture because “labor is extruded from all points in the system,” argues wind and solar are better technologies because producing each BTU of energy requires more labor than in fossil-fuel industries, and argues that the steel industry has evolved to use too little labor.

To see why this is a problem, let’s consider ethanol. Although even many environmentalists now recognize ethanol’s problems, it was the darling of alternative-energy proponents for many years, and hundreds of millions of dollars in subsidies have produced a substantial corn-based ethanol industry in the United States. (Despite these subsidies, the fuel remains uncompetitive with gasoline at current gas prices.) Corn-based ethanol requires more labor to produce than gasoline does, largely because growing and processing corn is more labor-intensive than pumping and refining oil. As a result, green-economy advocates score ethanol higher than gasoline since each BTU of energy in ethanol takes more labor to make than a BTU of gasoline.

But lower labor productivity is a bad thing not a benefit. Not only does more labor mean higher costs, but higher-productivity jobs (generally those that involve working with greater amounts of capital) can pay higher wages precisely because they are more productive. Low-productivity jobs are low-paying jobs because employers cannot afford to pay their employees more than the employees generate. If more labor were the metric, we’d all be better off using quills and parchment in place of computers.

Rejecting Trade

The advocates for greening the economy reject more than basic labor economics. They also believe that a green economy is one with relatively little trade. The literature emphasizes buying locally produced goods over those from other areas, both to save the transportation costs and to promote self-sufficiency. Not surprisingly, the UN Environment Programme criticizes Walmart for its global supply chain:

Companies like Wal-Mart (with its policy of global sourcing and especially its policy of searching for cheap products, with potential negative impacts for labor and the environment) are major drivers and symptoms of [increased global trade]. . . . Ultimately a more sustainable economic system will have to be based on shorter distances and thus reduced transportation needs. This is not so much a technical challenge as a fundamental systemic challenge.

To be fair, the benefits of trade are sometimes hard to understand. Nobel Prize-winner Paul Samuelson said the theory of comparative advantage was a contribution of economic theory that was both “nonobvious and nontrivial,” and generations of Econ 101 instructors have proved his point by struggling to get students to understand it. But the libertarian case for trade is remarkably simple and clear: Voluntary exchanges must make people better off or they wouldn’t occur, so a world with more voluntary exchange is preferable to one with less. Even the person most confused by trade theory can understand that autarky (producing everything locally) is a recipe for disaster by examining the record of Albania under communist dictator Enver Hoxha or North Korea today, two examples of societies where the rulers reject virtually all trade.

Moreover, the idea of locally grown food (a key component of the green economy) is hard to accept for those of us living far enough north to lack a year-round growing season. From my home in rural Illinois, I can see miles of soybean and corn fields. I am delighted that my neighbors can trade their corn and soybeans to people living elsewhere and that people in countries from France to Honduras to Israel to New Zealand send agricultural products here in return. I can buy French wine, Honduran bananas, Israeli citrus, and New Zealand lamb in my local grocery store because of trade, enriching both the variety and healthfulness of my diet. Even if it didn’t make us better off, the freedom to trade would be an important liberty. Since it does, it is indispensable to the vastly better lives we live today compared to our ancestors.

Ignoring Incentives

Those advocating for a green economy often appear to believe that no one will undertake any measures to improve environmental quality or conserve resources without a government program to show them the way. We know this is false because we have over a hundred years of experience with market incentives for both providing environmental quality and reducing resource use.

Studies of income levels and environmental quality have found what is termed the “environmental Kuznets curve,” a U-shaped relationship between national income and environmental quality. As very poor countries begin to develop, environmental quality often falls as energy production and use increase, factories appear, and people begin to consume more. But once per capita gross domestic product (GDP) reaches about $5,000, people can afford to spend more on improving the environment. Not surprisingly they do, and environmental quality improves after that point with respect to most pollutants for which we have data. In short, richer is greener.

The Environmental Kuznets Curve

Environmental quality also improves because market incentives spur firms to reduce energy and resource use. Any firm that cuts its energy use can devote the savings to undercutting its competitors’ prices. This has happened on an economy-wide basis. For example, from the 1970s to 2000, energy use per dollar of real GDP fell by 36 percent as firms economized on energy without reducing output.
Each unit of energy input yielded four times as much useful heat, moved people 550 times farther, provided 50 times more illumination, and produced 12 times as much electricity in 2000 compared to 1900—a stunning success story. Major energy-using industries like steel, aluminum, and paper have all become more energy- and resource-efficient, while consumer goods like refrigerators have become larger, more feature-rich, and cheaper to operate. It doesn’t take a government program to make firms more efficient, but it does take a market economy.

According to its proponents, the green economy will run on biofuels, wind, and solar power, ushering in a new age of clean energy. Unfortunately, this is mostly wishful thinking. The Department of Energy (DOE) says wind currently contributes less than 0.6 percent of total U.S. energy production. (Usually green-energy advocates note that it contributes 7 percent of renewable electricity generation, ignoring the less flattering total energy numbers.) Moreover, wind is both expensive and unreliable, as wind turbines produce energy only when the wind blows. Plus the massive wind farms green-energy advocates envision would require building what DOE estimates are $60 billion of new transmission lines (which many environmentalists oppose) and offshore wind farms like the Cape Wind project (blocked for years by the late Sen. Ted Kennedy, who objected to its impact on the view from his sailboat). There are also important questions about wind turbines’ effects on bird populations and the impact of “shadow flicker” from the turbine blades on neighbors. Similarly, solar power (mostly solar thermal and hot-water production) currently produces only 0.05 percent of U.S. energy consumption and is projected by DOE to rise to just 0.13 percent by 2030. Solar panel arrays take a great deal of land, usually in sensitive desert environments where endangered-species issues have already blocked some proposed photovoltaic sites. And both solar and wind power require expensive backup plants for when weather conditions aren’t right (such as at night and on days without wind).

None of these problems are insurmountable, and it is quite possible (and perhaps likely) that as the prices of natural gas and oil rise in the future, an entrepreneurial inventor will find ways to make these technologies viable. The problem is that they are not viable today and will not become so in an environment of subsidies.

In the late 1970s virtually every major U.S. corporation had a subsidiary in the Dutch Caribbean island of Curaçao, which was used to obtain cheap capital from the vast Eurodollar bond market. By 1982 the Eurobond market reached $48.9 billion, compared to the U.S. corporate bond market’s $33.5 billion, and more than half was likely issued through Curaçao-based subsidiaries of U.S. firms. Many early hedge funds (including George Soros’s) were also domiciled there.

A few years later Curaçao’s offshore finance business collapsed almost overnight. How did an obscure Dutch possession in the Caribbean come to be so important to the U.S. economy and why did its finance business collapse so quickly? As the United States and European Union ramp up their war on offshore finance, a look back at the history of Curaçao provides a cautionary tale about the conflict between onshore tax authorities and offshore financial centers (OFCs).

The discovery of oil in Venezuela launched an economic boom in Curaçao beginning at the start of the 1920s. Venezuelan political instability made the Anglo-Dutch oil company Royal Dutch Shell unwilling to refine oil there, and so the company built a major refinery in Curaçao. Along with prosperity, the refinery brought accountants, lawyers, and other professionals to the Dutch islands, a crucial ingredient for the development of the OFC. Even more came after Nazi Germany invaded the Netherlands and Dutch multinationals shifted their legal domiciles there. An entrepreneur, Anton Smeets, created the Curaçao International Trust Company (CITCO) to manage overseas Dutch firms for their owners.

While most of the multinationals returned to the Netherlands after the war, the companies had learned how to operate in Curaçao, and Smeets seized the opportunity to persuade them to locate subsidiaries there by convincing the Antillean government to create a special low-tax regime with rates of 2.4–3.0 percent for foreign companies legally resident in Curaçao but not physically doing business there. Curaçao OFC was born.

The Dutch islands were able to seize the opportunity Smeets provided because the restructuring of the Kingdom of the Netherlands after the war left them considerable autonomy over their domestic affairs. In an unsuccessful attempt to persuade Indonesia to remain part of the kingdom, the Dutch offered their non-European possessions equal status within a federal structure. Indonesia left anyway, but the remaining territories saw considerable advantages to remaining. However, the five smaller Dutch islands (Aruba, Bonaire, Saba, Sint Eustatius, and Sint Maarten) resisted being lumped together with Curaçao in a single entity, fearing the larger island would dominate the shared government and grab most of the development assistance expected from the Dutch. A compromise brought the six together into a federal unit (the Netherlands Antilles) within the larger kingdom and solved that problem, but left the islands without enough politicians to effectively run three levels of government. To solve the staffing problem, kingdom institutions were scaled back, with the Dutch Parliament and cabinet serving as the Kingdom Parliament and cabinet when augmented by overseas members.

The refinery-driven economy slowed after the war as automation began to reduce labor needs and Venezuelan demands for a share of the refining business prompted Royal Dutch Shell to shift capacity to the mainland. This provided Smeets with a ready audience for his proposals for economic development through financial services. The island’s relationship with the Dutch gave it the remaining two things it needed to attract international businesses. First, since they could appeal to the highly regarded Dutch courts in The Hague, investors did not need to fear that local prejudice would influence cases. Second, the Netherlands’ postwar tax treaty with the United States allowed for a routine extension to Dutch overseas territories, making the Antilles attractive for U.S. firms. With these elements in place, Curaçao began to attract offshore business despite the twin handicaps of an unfamiliar (to Americans) civil law legal system and the requirement of Dutch-language legal documents.

The Growth of the Finance Subsidiaries

In the 1960s the combination of social spending and Vietnam war financing strained U.S. capital markets. The Treasury pressed U.S. multinationals to raise funds outside the United States to finance their foreign operations, encouraging firms to tap into the growing market of dollars deposited in non-U.S. banks. Rising U.S. interest rates in the 1960s led companies to seek Eurobond issues to fund their domestic operations as well. A major obstacle was the 30 percent “withholding tax” the United States imposed on interest payments to foreigners. Since corporate bonds were typically issued on a net basis, a U.S. issuer would have to “gross up” the interest payments to make up for the tax, raising the cost of borrowing and eliminating the advantage of borrowing from the Eurocurrency markets.

The U.S.-Antilles tax treaty exempted interest payments to Antillean entities from this tax. Thus if a U.S. firm established a subsidiary in the Antilles, the subsidiary could sell Eurobonds in the London market and relend the money to its American parent. Interest payments to the subsidiary by the parent would be exempt from the tax under the treaty, and the Antilles imposed no tax on the subsidiary’s payments to the third-country bondholder.

As Americans and foreigners alike became accustomed to the use of Antillean entities, creative entrepreneurs began to find new uses for them. Moreover, like most civil-law jurisdictions the Antilles permitted the use of anonymous bearer shares, making the ownership of Antillean entities an effective means of concealing the identity of the owner.  For foreign investors nervous about domestic reaction to their ownership of U.S. assets, particularly Middle Eastern investors worried about a backlash from the Arab oil embargo in the early 1970s, this provided additional security for foreigners’ investments in the United States.

However, as use of Antillean entities grew, so too did opposition within Treasury and law enforcement agencies. Treasury discovered that the tax treaty with the Antilles was becoming what it termed a “treaty with the world,” as individuals from countries without tax treaties with the United States created Antillean companies to conduct business here. A newfound concern with “treaty abuse” became a major policy matter at Treasury, although the Antilles insisted that this “abuse” was just a relabeling of long-standing practices consistent with international law. Most important, Treasury found many countries uninterested in negotiating tax treaties with the United States, as their citizens could avoid the 30 percent withholding tax simply by routing their U.S. investments through the Antilles. By undermining Treasury’s biggest carrot, the Antilles treaty hampered efforts to persuade countries to sign on to information-sharing agreements with the United States. In addition, Treasury worried that Americans were opting for Antillean vehicles to hold U.S. investments, illegally but undetectably evading U.S. income taxes via the anonymous bearer shares. Law enforcement authorities had similar concerns about money laundering.

By the end of the 1970s the Treasury (which handled U.S. tax treaties) was determined to do something about the Antilles. In 1982, it canceled the tax treaty with the British Virgin Islands; this was intended to send a signal to the world that the United States was serious about closing what it saw as “loopholes” in treaties. This and other measures persuaded the Antilles to open negotiations, and for a time it appeared that a new agreement would be reached. Ultimately this proved impossible, as American demands for information on ownership of Antillean entities and limitation of benefits to entities formed by Antillean residents could not be accommodated without destroying the Antilles’ business model and changing fundamental international legal principles about corporate citizenship. Unable to conclude a new treaty, Treasury announced cancellation of the tax treaty in July 1987, effective six months later.

Curaçao’s financial sector never recovered from this blow. As a result of the loss of revenue, the Antilles became more dependent on Dutch subsidies, and internal disputes among the six islands led to an ongoing reorganization of their relationship with the Netherlands. Aruba pulled out of the Antilles, but not the kingdom, in the 1980s; Curaçao and Sint Maarten are scheduled to assume similar status in the near future; and the remaining three islands will become overseas municipalities within the Netherlands. The result was the loss of a major funding source, increased emigration to the Netherlands, and greater dependence on Dutch subsidies. Almost half the Antillean population now lives in the Netherlands, including a significant number of young people. In addition, Dutch money has come with strings, and the Netherlands is more involved in Antillean government today than in the past, reducing Antillean sovereignty in practice if not in theory.

Lessons from the Antilles

Curaçao’s rise and fall has three lessons for the rest of the world. First, the fragility of even a robust financial services industry is a cautionary tale in an era when government regulators are assuming unprecedented powers over financial institutions. Curaçao lost a thriving financial sector in an instant because of policy changes in the United States. Once gone, it has proven remarkably difficult to get back.

Second, the Antillean finance industry illustrates how international financial transactions benefit both parties. The Antilles obtained economic development and government revenue; the United States lowered its firms’ cost of borrowing, making them more competitive.

Third, Curaçao lost its leading position because it was not sufficiently flexible to adapt to changed circumstances. The dominant OFCs today–Barbados, Bermuda, the Cayman Islands, the British Channel Islands, Hong Kong, Singapore–have prospered because they have adapted to the changing international climate by inventing new products and services. The creation of captive-insurance laws in Bermuda, Cayman, and Guernsey, for example, brought those jurisdictions considerable business by providing business structures initially unavailable elsewhere. Curaçao had a chance to seize the lead in a number of areas–George Soros located his hedge funds there and a number of others followed–but the island did little to provide specialized services or laws for the nascent funds industry, which is now largely in Cayman.

Curaçao’s government was unable to respond to new opportunities as quickly for several reasons. The government paid less attention to the financial sector than its rivals’ governments did, in part because of internal divisions over access to Dutch subsidies. Moreover, the Netherlands is itself a financial center, and the Dutch-controlled kingdom government has been less responsive than the governments of independent jurisdictions (like Barbados) or U.K. overseas territories (like Cayman). As a result, the Netherlands has a more favorable tax arrangement with its fellow EU member Malta than it does with the Antilles. Finally, government business in the Antilles is conducted in Dutch, requiring everything from corporate documents to statutes to be translated. This introduces uncertainty, cost, and delay. This is a significant handicap in an era when some Caribbean OFCs are now allowing the filing of corporate documents in Chinese.

The United States and many European nations are putting new pressures on OFCs through measures like the Stop Tax Haven Abuse Act in the United States and the European Union’s Savings Directive. These measures risk harming both sides. Today’s OFCs depend on the international financial services industry, but the United States and Europe also benefit from these jurisdictions. For example, a heavy-handed regulatory approach is likely to increase costs for the many U.S. nonprofit hospitals that use the Cayman Islands for their insurance needs, divert investment capital from the United States by making it harder to organize investment funds in tax-neutral jurisdictions, and raise the cost of everything from air travel to televisions by harming the structured finance and shipping registry businesses that enable firms to cut costs. Perhaps the most important lesson for onshore governments has something to do with avoiding cutting off of one’s nose to spite one’s face.

Friedman’s evaluation corresponds to Hong Kong’s consistent ranking at the top of both the Heritage Foundation’s Index of Economic Freedom and the Fraser Institute’s Economic Freedom of the World reports. In the 2008 Index, for example, Hong Kong scored 90 percent or better on seven of the ten measures of economic freedom. Impressively, Hong Kong’s weakest score (freedom from corruption, where it ranks 13th of the 180 countries rated in 2006 by Transparency International) put it well ahead of the United States (fifth most free overall, 20th on freedom from corruption).

Why has Hong Kong been so free?

Hong Kong never would have become the economic powerhouse it is today if either British or Chinese senior politicians had had any say in the matter. Britain acquired Hong Kong island in 1842 (additional territory came later) through a deal between the British representative, Captain Charles Elliot, and the Chinese negotiator, the Marquis Ch’i-ying, to settle a small war that had broken out over trade issues. (Compensation for a Chinese seizure of British opium was one issue, but the dispute was broader than the issue of opium, and recent scholarship tends to cast doubt on the conventional labeling of the dispute an “opium war.”)

The resulting deal was unpopular both with the Chinese Imperial Court and the British government. The Chinese authorities disliked any cession of territory to the British and worried about the impact on tariff revenues of creating a British-controlled port. Moreover, the Chinese disdained the British obsession with trade. The British government thought Hong Kong a poor location compared to the possible alternatives, such as Formosa. Nonetheless, the limits to communication in the nineteenth century had forced the two governments to delegate the authority to resolve the dispute to their representatives on the scene, so they were left with what Frank Welsh’s excellent one-volume history, A History of Hong Kong, terms “a source of embarrassment and annoyance to its progenitors since it first appeared on the international scene.” (Unless otherwise indicated, quotations are from Welsh’s book.)

Early History

Early assessments of Hong Kong’s potential were pessimistic. Lord Palmerston, in possibly the worst prediction ever made by a British diplomat, concluded that it was “a barren island, which will never be a mart of trade.” The colonial treasurer, Robert Montgomery Martin, a prolific writer on Britain’s overseas possessions (including a five-volume History of the British Colonies published in 1840), echoed Lord Palmerston’s assessment in 1844, finding that “there is no trade of any noticeable extent in Hong Kong. . . . There is scarcely a firm in the island but would . . . be glad to get back half the money they have expended in the colony and retire from the place. . . . There does not appear the slightest probability that, under any circumstances, Hong Kong will ever become a place of trade.”

Some trade did begin, however, as a result of the establishment of British merchants’ warehouses. But early British policies concerning their new territory did little to promote economic growth. An 1847 Parliamentary investigation of the economic situation in Hong Kong found that British rule had initially brought with it a government bent on raising “as large a revenue as possible” and that this had damaged trade, concluding that the restrictions on trade instituted by the early British administration to raise revenue meant that “[f]rom this time may be dated the reverses of Hong Kong.”

Hong Kong physically expanded twice during the nineteenth century. Territory on the mainland opposite Hong Kong island, Kowloon, was acquired in a “casual way” for 500 taels during a Sino–British conflict in 1859 in a deal between a British Consul and a Ch’ing official. And in 1898 Britain leased for 99 years the New Territories, additional mainland territory plus some islands. In both cases, the rationale for expansion was to protect the harbor from the range of guns located on the mainland. Although the British hoped to eventually make the New Territories lease a more permanent arrangement, their agreement to the lease rather than a permanent cession of control played an important role in the eventual return of the entire territory to the People’s Republic of China in 1997.

Britain did relatively little with its new colony, beyond establishing public order and extending the rule of law. The result was essentially a treaty port, much like those that European powers established on the mainland under the Treaty of Nanking in 1842–43. One reason for Britain’s relatively hands-off policy was the persistence of the view formed by early colonial officials that the Chinese residents did not want or appreciate British lawmaking. This attitude is clear in the testimony to a mid-nineteenth-century Parliamentary committee looking into administration of the colony by Col. John Malcolm, an aide to the governor, who told the British M.P.s that “the Chinese are a peculiar people, and they do not like being interfered with. They do not understand us; they cannot understand our ways; and when they are told that they are to do first one thing and then another, they get frightened and will not come to us.” Whether it was a characteristic “peculiar” to the Chinese to dislike arbitrary government or not, the avoidance of conflicting mandates and general tendency to leave people alone—policies adopted in pursuit of trade—gave the colony the benefit of the rule of law from the start.

A Natural Trading Center

What did Britain create in Hong Kong? The combination of the excellent harbor and the rule of law meant Hong Kong was a natural trading center. But it was not the best place to trade in China, and by the early twentieth century Shanghai was successfully winning trade away from Hong Kong. Shanghai offered a more educated population, a more convenient location, access to European protection under treaty concessions by the Chinese government, and relatively little Chinese-government interference due to the decline of imperial power. By the 1910s Shanghai had become a significantly more important center of trade than Hong Kong. With the British choosing the more defensible Singapore as the center of British naval power in the region, Hong Kong also lost importance for the British government. As a result, the colony languished as a backwater, becoming known as a center for prostitution and gambling rather than the economic powerhouse it is today.

One thing Britain did not create in Hong Kong was a democratic government. No local democratic institutions were permitted to develop, as were allowed in most other British colonies, because the British were unwilling to give the Chinese majority a real voice in administration. As a result, as Welsh concludes, “Hong Kong was to continue as authoritarian an administration as any Chinese government, but the final authority was to be the law, rather than individual whim.”

China’s imperial central government rarely favored economic freedom, and the late nineteenth and early twentieth centuries were no exceptions. As the central government’s power ebbed away, regional warlords began to establish rival, but equally predatory centers of power. European, American, and Japanese power in China also expanded, focusing on access to the Chinese market for their nationals, but not creating economic freedom for the Chinese within their spheres of influence. Hong Kong’s stability increasingly drew migrants from elsewhere in China. Population grew from 600,000 in 1920 to over a million in 1938. As conditions worsened in China with the Japanese invasion and fighting between regional warlords, the Kuomintang (Nationalists), and communists, 5,000 migrants a day began to pour into Hong Kong. By March 1950 the city had 2.3 million people, which brought Hong Kong both a significantly increased workforce and the human capital of Chinese entrepreneurs who escaped ahead of Mao’s armies. Moreover, the communist victory on the mainland meant that Shanghai ceased to be a serious competitor.

Finding Freedom in Hong Kong

Life on the edge of communist China was not easy. During the Korean War, embargoes on trade hurt the city’s entrepot business, forcing many Hong Kong traders to reinvent themselves as manufacturers. The continuing influx of refugees from the mainland strained the colony’s infrastructure. But the flood brought refugees like Jimmy Lai, one of the millions of penniless individuals who sought freedom in Hong Kong.

While working in the Shanghai railway station as a porter, Lai was given his first chocolate bar by a traveler. Hungry, Lai immediately ate it. Running after the man, he asked where this wonderful food came from and the answer was “Hong Kong.” Determined to get to the place where such wonders were available, Lai eventually persuaded his mother to allow him to escape and was smuggled out of China in the bottom of a fishing boat. On his arrival in Hong Kong, he went to work the same night in a garment factory. Today, Lai is a billionaire, owner of one of the most successful media companies in Asia. His drive and entrepreneurial skills played a major role in his success, of course. (Lai movingly tells his story in the Acton Institute’s documentary The Call of the Entrepreneur.) But it was the freedom available in Hong Kong that allowed him to put his talents to work. That freedom took many forms, including an absence of the currency restrictions in force at the time in the United Kingdom and much of Europe, and few laws regulating businesses. As a result, Hong Kong began to flourish.

Why? As Hong Kong’s last British governor, Christopher Patten, wrote in his memoir, East and West, the refugees from communism who flooded into Hong Kong arrived in China’s only free city; it was indeed (in the words of Chinese journalist Tsang Ki-fan) “the only Chinese society that, for a brief span of 100 years, lived through an ideal never realized at any time in the history of Chinese society—a time when no man had to live in fear of the midnight knock on the door.” Hong Kong had a competent government, pursuing market economics under the rule of law. It was a government that fully met the Confucian goal—“Make the local people happy and attract migrants from afar.”

The laissez-faire attitude of the Hong Kong government on economic matters was cemented by Sir John Cowperthwaite, the colony’s financial secretary from 1961 to 1971, whom Welsh called a “political economist in the tradition of Gladstone or John Stuart Mill” and the personification of “unreconstructed Manchester-school free traders.” Cowperthwaite had almost complete control of Hong Kong government finances and used it to implement his policy of “positive nonintervention.” Friedman gave Cowperthwaite a great deal of the credit for Hong Kong’s success, citing approvingly Cowperthwaite’s refusal to collect most economic statistics on the grounds that “[i]f I let them compute those statistics, they’ll want to use them for planning.” Jimmy Lai has a bronze bust of Cowperthwaite at his company’s entrance (as well as ones of Friedman and F. A. Hayek).

Cowperthwaite deserves the accolades he has received. During his decade as financial secretary, real wages rose by 50 percent and the portion of the population in acute poverty fell from 50 to 15 percent. What is remarkable is that Hong Kong accomplished this with no resource other than its people. The colony had no real agricultural land, no natural resources, and even the one resource it did have—people—lacked much education. Indeed, few at the time thought that the masses of refugees who reached Hong Kong during the 1950s would amount to anything other than a burden for the state.

Most remarkably, Hong Kong’s transformation occurred when social democrats ruled Europe and Lyndon Johnson’s Great Society dominated American politics, both reflecting the consensus among the political elites in Europe and North America that the welfare state and interventionist economic policies were the only sensible direction for advanced societies. Even in the developing world, interventionist economic policies like industrialization through import substitution, which relied on high tariff walls to protect domestic industries, were widely accepted. Tiny Hong Kong thus managed to adopt and hold to free-market and free-trade policies that ran counter to the policies of the British government and the consensus of policy analysts and development economists everywhere, and did it while perched precariously on the edge of a massive communist dictatorship in the midst of self-destructive policies like the Great Leap Forward and the Cultural Revolution.

No Libertarian Paradise

While consistently freer than most places, Hong Kong has never been a libertarian paradise. Government-subsidized housing has long dominated Hong Kong’s residential market, with 60 percent of residents living in it at one time. And the government manipulated (and continues to do so) the land market to maximize sales revenues for public coffers, which plays an important role in causing the housing shortages that required the public housing “solution.” Medical care has also long been socialized. Moreover, Hong Kong had serious corruption problems even during the height of the Cowperthwaite era, with the police in the 1960s and early 1970s “riddled with corruption,” according to former Governor Patten.

Then there is Hong Kong’s persistent “democratic deficit.” Hong Kong managed to escape the post-World War II wave of democratization in the rapidly dwindling British Empire because, as one British official put it in a radio interview in 1968, “the electorate of Britain didn’t care a brass farthing about Hong Kong.” Indeed, Britain showed almost no interest in expanding representative government in the colony until it became clear that Hong Kong would “return” to China in 1997 when the lease on the New Territories expired.

In some sense this democratic deficit served Hong Kong well, for men like Cowperthwaite and Patten held classical-liberal ideas on economic freedom and so largely refrained from actions that might have won popular approval (and certainly would have in Britain). But the lack of representative government also allowed Britain to treat Hong Kong’s residents shamefully when Britain rejected allowing Hong Kong passport holders the right of residence in Britain, fearing a flood of refugees in advance of the return to China. (The rest of Europe behaved no better.)

“One Country, Two Systems”

Hong Kong returned to China in 1997 under an agreement negotiated between Britain and the People’s Republic which provided a guarantee that for at least 50 years Hong Kong and China would be “one country, two systems.” (Formally, Hong Kong and the former Portuguese colony of Macau are both “Special Administrative Regions” of China.) The return itself was inevitable, as was China’s willingness to preserve capitalism in its midst. Not only were Hong Kong island and Kowloon unsustainable without the leased New Territories, where much of the water supply was located, but British voters still didn’t care a farthing for Hong Kong in the 1990s. China’s interest in the preservation of the goose that laid the golden eggs was also clear. The People’s Republic had long made use of Hong Kong—which it could have seized by force at any time—as a means of accessing foreign markets and sources of capital. At times 80 percent of China’s foreign income came through Hong Kong. China also wanted to demonstrate to Taiwan that peaceful reunification was possible.

The danger was that China’s leadership would not understand what Patten, in his book, termed “the relationship between Hong Kong’s hardware—a capitalist economy—and its software—a pluralist society—and yet it was the latter that enabled the former to function so well.” Thus far Hong Kong’s new rulers have shown themselves remarkably adept at continuing the smooth functioning of both the hardware and the software. Whether that will remain true in the long run is still an open question, of course.

Chinese Emperor Tao-kuang’s initial reaction to the British had been that “these barbarians are wanting in any high purposes of striving for territorial acquisition; they always look on trade as their first occupation.” Frank Welsh concluded his history by noting that Hong Kong “proved the Emperor’s point.” It is not just the British who made Hong Kong a success. It is the people of Hong Kong, from factory workers to entrepreneurs, who turned Hong Kong from a barren island to an economic powerhouse. They were able to do so because the Hong Kong government generally left them sufficiently alone. Hong Kong is far from perfect, and far from a libertarian dream world. But it remains a dramatic example of how far human ingenuity and entrepreneurial talent can take a society.

Why has Hong Kong been so free? Partly, Hong Kong has been fortunate to be ruled by men who understood their role as quite limited. Not quite the classical-liberal ideal, even under Cowperthwaite, but nonetheless significantly closer than any other twentieth-century society. And the combination of Britain’s failure to provide any real democratic institutions and its lack of interest in Hong Kong allowed those men to hold to those policies, even as Britain herself experienced economic disaster under the socialism of the 1950s–70s. Hong Kong also benefited from the example of China’s disastrous 1960s economic policies. With so many residents having come as refugees from communism, demand for freedom in Hong Kong was high. Freedom made possible the success of Jimmy Lai, and that of the millions who did not become billionaires but who had a higher standard of living than most of the world through their own efforts.

Hong Kong was lucky that freedom was tried. But Hong Kong’s people proved that freedom worked.

Responding to the increased demand, private entrepreneurs funded the development of cracking technology. This method of transforming one set of hydrocarbons into another increased the proportion of the most-valuable products. On average 100 barrels of crude yielded 75.2 barrels of kerosene and 10.3 barrels of gasoline in 1880. By 1940 those same 100 barrels of crude produced an average of 5.5 barrels of kerosene and more than 40 barrels of gasoline. An equally dramatic example of technological progress occurred in the early 1930s and 1940s. The development of higher-performance engines prompted growing demand for higher octane gasoline, kicking off what came to be known as the “octane race” among refiners in the 1930s. Then World War II created demands for large quantities of high-performance 100-octane aviation fuel. Millions of gallons a year of this fuel, which had only been produced in tiny quantities as a reference chemical at a cost of $25 per gallon in the 1930s, became available at a cost of just over 25 cents per gallon in the early 1940s.

As a result, gasoline has been the subject of multiple regulatory efforts since the early twentieth century. (What? You thought they might produce public acclaim for an industry that had turned a waste stream into a valuable commodity and then upgraded the quality and reduced the price of its products to fuel the war effort?) These regulations have severely distorted the market for gasoline, increasing costs for consumers and diverting investment into political maneuvering. The government meddling produced a transportation-fuel network that is dangerously fragmented and at risk from natural disasters, accidents, terrorist attacks, and just plain old stupidity. Even worse, each time the fragile nature of the gasoline market is exposed, the reaction in Washington and state capitals is to layer on yet more bureaucracy and regulations, worsening the problem.

Aside from comparatively lightly regulated periods in the 1920s, 1950s, and 1980s, American governments have rarely left the oil business alone. Politicians use four different, and often mutually contradictory, rationales for their interventions.

• Antitrust. Since the Standard Oil litigation in the early twentieth century, politicians regularly invoke antitrust issues in support of claims that oil companies are conspiring against the public. When prices go up, you can be sure that politicians will call for antitrust investigations, windfall-profits taxes, and other measures to keep “greedy oil companies” from profiting “too much.”
• Destructive competition. When prices go down, however, domestic oil producers suffer reduced revenue, and less-efficient refiners and retailers lose market share. This spurs calls for investigations into measures to stop “destructive competition.” The governors of Texas and Oklahoma declared martial law in the oil fields during the Great Depression as part of their efforts to stop unregulated “excessive” pumping. Creating an oil “industry code” to reduce competition was a key element in the New Deal. Later regulatory programs have been filled with exemptions and special treatment for “small” players in the energy business in an attempt to protect inefficient firms from the ravages of competition.
• National security. From the time oil proved its worth as a naval fuel in World War I, the military has worried about adequate oil supplies. Domestically, national security concerns led to the creation of petroleum reserves after World War I (which later played a role in the Teapot Dome scandal) and these reserves have served as a fig leaf for import quotas and other restrictions on several occasions. You can count on the federal government to trot out national security as a justification almost every time it unveils a new subsidy or some other barrier to trade.
• Environmental protection. Governments at all levels take a keen interest in fuel formulation, inclusion of renewable fuels, and the location and operation of refineries, terminals, and filling stations. Since the appearance of the modern environmental statutes in the early 1970s, federal, state, and local governments have increasingly involved themselves in gasoline markets on environmental grounds. The actual regulations and laws enacted in pursuit of these goals often do not advance the stated purpose, which frequently serves as convenient window-dressing for interest groups looking for favors. (The definitive source on energy markets through the 1980s remains Robert Bradley’s monumental 1996 study, Oil, Gas, and Government.) To see how these interventions have disrupted gasoline markets, let us consider three of the largest regulatory programs: the Mandatory Oil Import Program (MOIP), the 1970s era of price and allocation controls, and the current mishmash of “boutique” fuel requirements.

MOIP

After World War II the refinery capacity built up to serve the military’s needs quickly refocused on producing gasoline for the booming domestic market. Freed from wartime scarcity and price controls, people bought cars and drove them, sending gasoline sales soaring. Many of the major oil companies invested heavily in developing new sources of crude oil in the Persian Gulf, Latin America, and elsewhere. These investments included construction of tanker fleets and oil terminals and acquisition of oil rights around the world. Production costs in the newly opened fields overseas were low enough that it was soon cheaper to import crude oil and refine it in U.S. refineries than it was to use domestic oil. As oil imports rose during the 1950s domestic producers and refiners who had not invested in access to the cheap foreign oil worried (correctly) that they were losing market share to foreign oil producers and the refiners who had made those investments.

Rather than playing catch-up in the marketplace, however, the disgruntled domestic oil producers and smaller and inland refiners headed to Washington, where they began a relentless lobbying campaign for restrictions on oil imports, citing the detrimental effects of competition from abroad and national-security concerns. At first the Eisenhower administration resisted the idea of quotas, then it experimented with “voluntary” quotas, but the administration ultimately gave in to the political pressure and created the Mandatory Oil Import Program. The program was in effect from 1959 to April 1973.

MOIP was simple in theory. Each refiner received a permit to import crude oil. The total number of barrels authorized was set below the amount that would have been imported in a free market. Refineries’ allocations of the permits started with a proportional share of this smaller total based on their prior level of imports, but these amounts were then adjusted in attempts to achieve various policy goals and reward particular interest groups. Crucially, every refinery got some permits, even if it had not imported any oil previously, and smaller refineries received a disproportionately large share of the permits. The permits were made tradable, making it possible for refiners that received permits, but did not need imported oil, to trade or sell them.

This system had five important effects. First, domestic oil producers got their reward as domestic crude prices were higher than they would have been in the absence of the quota system.

Second, because domestic prices were artificially above the world market price, the right to import the cheaper foreign crude granted by the permits became quite valuable.

Third, the major oil companies that had invested in tankers and terminals learned their lesson and shifted their investment dollars to lawyers and lobbyists who could find profits in the pages of the Federal Register. Within a few years they had learned to play the game well enough that they no longer opposed the MOIP.

Fourth, anyone who could slap together something that could pass as a refinery now had an incentive to do so, leading to a rapid expansion in the least expensive and least sophisticated refinery sector as new entrants built “teakettles” to get quotas. As a result U.S. refineries tended to lack the capacity to handle high-sulfur crudes, which have become an increasingly large proportion of the crude supply.

Finally, because independent ownership of refineries maximized quota allocations, consolidation in the industry was discouraged, leading to lower operating efficiency. (A group of refineries can often be operated more efficiently than an individual plant, because joint management allows operators to use equipment at one plant to prevent a bottleneck from developing at another.)

All that is bad enough, but the MOIP also proved to be a classic example of the unintended consequences of regulation. When the MOIP was enacted it allowed imports only under the permit system. Almost immediately, however, the Canadian government objected that limiting oil imports from Canadian oil fields through pipelines to refiners in the northern Great Plains was counterproductive. Not only would the limits hurt Canada, since the oil had no other export route, but the Canadians argued that it made no sense on national-security grounds to reduce imports from a loyal ally across a secure land pipeline. This argument proved persuasive and regulations exempted land imports.

When the exemption was granted, however, no one remembered to retract the permits that had been issued to the “Northern Tier” refiners. These refiners had no access to any other source of crude—there being no crude oil pipeline connection between Minnesota and the Dakotas and no port where tankers could unload Persian Gulf or Latin American oil. As a result, these refiners now found themselves with both access to the Canadian oil and valuable import permits that they physically could not use. So they sold and traded the permits to other refiners and pocketed the proceeds. On discovering the mistake, the federal government attempted to take back the permits. The “Northern Tier” refiners fought back with the aid of valuable allies like Minnesota Sen. Hubert Humphrey and succeeded in retaining what became known as the “double dip” for years.

That was just the first level of unintended consequences, however. Mexico soon came knocking on the State Department’s door, complaining of the special treatment Canadian oil was getting. True, Mexican oil was not imported via a land route, but wasn’t the Caribbean virtually as safe? And wasn’t Mexico vulnerable to communist subversion? Didn’t national security dictate that some accommodation be found for a key ally and neighbor?

To mollify Mexico, the State Department lawyers found what was termed a “crevice” in the MOIP regulations on overland imports launching the “Mexican Merry-Go-Round.” Tankers of Mexican crude sailed to Brownsville, Texas. The crude was unloaded into tank trucks, but remained outside the United States in the eyes of the law by being placed in customs bond, which prevented its transfer to Americans. The tank trucks were then driven across the border into Mexico, released from the customs bond, driven around a traffic circle, and then driven back into the United States, importing their cargo “by land.” The trucks returned to the port, and the oil was loaded into tankers headed to the east-coast refineries. Since the oil had entered the United States via a land route, it was eligible for exemption from the MOIP quotas. This strategy boosted Mexican exports to the United States from 7,000 barrels to 40,000 barrels per day.

The next complaint came from Venezuela, which pointed out that it too was an important Latin American ally and that there was a limited market for its heavy, sour crudes outside of U.S. refiners. An exemption for “resid,” or “residual fuel oil,” a minimally refined product, followed and industrial users in the northeastern United States began using Venezuelan resid largely because it was exempt from the quotas. The result was that the ratio of domestic resid production to resid imports fell from 1.42 before the MOIP to 0.46 during it, demonstrating a clear substitution of the foreign product for the domestic one. The exemption basis for the success of Venezuelan resid became clear when the end of the MOIP triggered a massive conversion to natural gas and distillate fuels by U.S. resid users.

Perhaps most ironically, it was the oil-rich countries’ concern over the impact of the MOIP on their ability to export to the United States that proved to be a key factor in spurring the formation of the organization now known as OPEC, surely one of the most counterproductive impacts of a policy in history.

Price and Allocation Controls

The proliferation of exemptions and special provisions by 1970 made the MOIP more of a sieve than an effective regulatory barrier, and the Nixon administration considered abolishing it. But Nixon was worried about energy prices as a factor in inflation, and the price controls imposed in August 1971 froze domestically produced and refined oil product prices. The price freeze had no impact on world prices, of course, and as these continued to rise, refiners dependent on crude imports were required to sell their products at a loss. The federal government continually modified the price controls, attempting to address the growing problems that this massive interference in the operation of the free market produced. Politics dictated the adjustments, however, with Nixon refusing to allow increases in politically sensitive commodities like home heating oil and gasoline. By 1973, when the Arab oil producers declared an embargo on shipments to the United States in retaliation for U.S. support for Israel in the Yom Kippur War, there had already been calls for a government allocation scheme to control crude supplies and distribution of refined products. A series of proposals created in response to these special-interest demands were cobbled together into a “response” to the oil embargo and passed as the Emergency Petroleum Allocation Act (EPAA) in 1973.

Not surprisingly the EPAA made the embargo’s impact worse. Mistaken assumptions that consumption patterns would not change and bad weather predictions, together with politically driven decisions about the appropriate product mix, left some regions awash in gasoline while shortages caused long lines elsewhere. But because the government dictated distribution patterns, the federal government ensured that areas with surplus gasoline could not send them to areas experiencing shortages and so exacerbated the initial misallocation problems.

Each misstep led to further expansions of controls—the Nixon administration even instituted a price freeze dubbed “Phase III1/2” to give the bureaucracy time to catch up on the flood of problems caused by Phases I to III.The crowning misstep in the program was Phase IV’s introduction of a distinction between new and old domestic oil supplies. Old supplies were price-controlled to prevent “windfall” profits; new ones were allowed higher prices to provide an incentive to expand supply. Of course, the distinction also meant that there was considerable money to be made if an oil well could be reclassified from “old” to “new,” and an industry sprang up doing exactly that.

The 1976 presidential campaign put pressure on both the new Ford administration and the Democratically controlled Congress to demonstrate that it had done something about energy issues. Desperate for a showpiece for voters, the administration and Congress produced the incoherent Energy Policy and Conservation Act (EPCA) of 1975, which managed to include both measures that would lead to price increases and others that would push prices down. Economic opinion of the EPCA was that it was “infinitely worse” than the prior programs because it left out the market-based quota-trading provisions of the MOIP and instead allowed transfers of quotas only at government-set prices.

The regulations issued under the EPCA granted entitlements to fuel to anyone with a refinery; energy analyst Daniel Yergin concluded in his massive history The Prize that “the result was the bringing out of mothballs any piece of ‘refining junk’ that could be found—leading to the return of hopelessly inefficient ‘tea kettle’ refineries of the kind that had not been seen since the flood of oil in the East Texas field in the early 1930s.” It also tilted allocations toward small refiners, ensuring that large refineries ran at less than maximum efficiency and so increased costs and rewarded the least efficient players in the market. Economists Kenneth Arrow and Joseph Kalt calculated in 1979 that the EPCA was worth $17 billion to special interests in 1979. The Carter administration began the move toward decontrol of oil prices, but these efforts were impeded by concerted special-interest pressures.

It took the election of Ronald Reagan to speed up the phase-out of energy price and allocation controls. The Reagan administration brought in a period of relatively relaxed regulation of energy markets, and the results confirmed what economists had predicted. The small, inefficient refineries set up to obtain quotas quickly closed (23 in 1981 alone), while refining technology improved as the more efficient refineries expanded capacity.

Boutique Fuels

When drivers fill up their tanks they rarely notice anything different about their gasoline whether they are in Denver or Detroit. But gasoline has evolved from the “straight run” distilled from crude by early refiners to a highly complex fuel whose characteristics vary widely from location to location. For example, fuels sold at higher altitudes (Denver) are less volatile than those sold in lower altitudes (Detroit). Many of these variations are the result of refiners adapting gasoline to optimize performance under different altitude and weather conditions. Gasoline retailers have also spent millions on advertising campaigns aimed at convincing drivers that there is a difference in the mixture of additives that should lead the buyer to prefer a “tiger in the tank” (Exxon) to “the detergent gasoline” (Mobil). (Of course, Exxon and Mobil then merged into ExxonMobil, presumably giving drivers a cleaner tiger in their tanks.)

Beginning with the mandate to remove octane-enhancing lead additives from gasoline in the 1970s, however, the federal, state, and local governments have exerted increasing control over the formulation of gasoline—in the name of improving environmental quality and increasing (you guessed it) national security by substituting locally produced ethanol for a portion of the gasoline. As the number of formulation requirements increased they came to be known as “boutique fuel requirements” because they made it impossible to sell gasoline formulated for Tucson in Phoenix.

There is no question that some measures can make gasolines burn cleaner. Removing lead octane enhancers from gasoline, for example, produced major environmental quality improvements, although the replacements for lead brought their own environmental problems. What is questionable is whether the particular mandates imposed by various regulators actually accomplish that goal and what the cost of splitting the gasoline market into an assortment of boutique markets is. And many of these mandates (particularly the use in the 1990s of MTBE and the current mania for ethanol) have little or no benefit and actually can be harmful to the environment.

Three things should make us worry about boutique-fuel mandates. First, by fragmenting markets, they are raising the cost of gasoline in the same ways as the 1970s allocation programs. The best statistical evidence suggests that they have increased prices in many instances, although EPA denies this. Second, limiting the sources for fuel for many regions to a small number of refineries set up to produce particular blends leaves those markets’ supplies vulnerable to refinery closures from accidents, natural disasters, and routine maintenance. Finally, boutique requirements reduce the availability of gasoline imports from foreign refineries. For example, European refineries produce more gasoline than is needed to satisfy European demand for gasoline (which is lower because of the much higher proportion of diesel-powered passenger cars in Europe). Because those refineries are primarily concerned with producing diesel for their home markets, however, the gasoline they make is not compatible with some U.S. fuel requirements. Since there are other buyers for this gasoline (like China), the refineries have little reason to make the large investments necessary to produce a U.S.-boutique fuel. But because U.S. refineries lack sufficient capacity to meet U.S. demand, any shift away from exports of European gasoline to the U.S. market will cause shortages and price hikes here.

Energy markets have demonstrated the power of private enterprise each time they have been permitted to function freely. A waste product, gasoline, became a valuable commodity, and production yields soared. Better engines required higher octane, and the quality of gasoline increased dramatically. But as this brief account describes, the American gasoline market has moved away from a national market and toward a series of fragmented regional markets. Further, domestic refining capacity is well below what a free market in gasoline would have produced in the absence of the pervasive government interference of the 1960s and 1970s. The combination leaves the market fragmented and vulnerable to price spikes caused by everything from hurricanes to refinery fires. If we want to fix gasoline markets, the first step is to take the bureaucrats out of the process.

Miners

When gold was discovered in California in 1848, just days before the territory was transferred by Mexico to the United States, what had been the Mexican province of Alta California had few inhabitants and little government. Located far from Mexico City and the centers of power in Mexico, Alta California’s economy focused on the hide and tallow trade between the California ranchers and passing sailing ships. Property boundaries were poorly delineated, both because Mexican law allowed “floating land grants” whose precise boundaries were to be located later and because land in California was rarely worth the cost of completing the grant process and securing full title to a specific parcel. Moreover, the government of Alta California during the 1840s had distinguished itself primarily by its corruption, with several governors spending much of their time drawing up large grants of dubious legitimacy to award to friends and family members.

When control passed to the United States, only a small military force was present in the territory and Gen. Bennett Riley, the officer in charge, quickly made clear that he considered himself lacking in jurisdiction over civil matters. Moreover, Congress took no action to organize a government for the new territory because of an inability to agree on whether the new territory would be slave or free. California was thus effectively without a government after it became American territory.

As word of the discovery of gold at Sutter’s Mill spread, people from around the world began to head for California and their chance at riches. The new arrivals quickly swamped the existing population and institutions. Faced with an almost total absence of government and the opportunity to get rich by, almost literally in many cases, picking up gold off the ground, the new arrivals had little time for politics. As most intended to stay only long enough to make their fortune, they had no reason to invest their time in anything but searching for gold or running businesses catering to the miners. (It was the latter who profited the most from the gold rush.)

Under these conditions, one might expect violence to be endemic. Such expectations could only be increased by the demographics of the mining boom: primarily armed single young men, from a wide variety of cultures and nations, sharing only a desire for wealth. Rather than violence, however, the California gold-rush miners chose contract time after time. Virtually every major mineral find in California, and throughout the West, was organized by the locators into a mining district with rules agreed on, property rights established and respected, and violence kept to a minimum.

On locating a promising site, the first group to arrive would designate one member record-keeper, establish rules governing claim size (roughly the amount of property that could be worked in a single season by the current technology), set down minimal regulations (primarily tort-based rules forbidding such things as theft, assault, and murder), and establishing boundaries. Later arrivals had a choice of accepting the rules or moving on. Because miners quickly found that there was profit to be had in selling claims, early rules restricting claim transfers were done away with rapidly and free transfer of claims became the norm. So secure were property rights that miners could leave their claims marked in the agreed fashion while fetching supplies from larger camps several days away and rarely suffer theft of the valuable tools and goods they kept in their camps.

In addition to the general conditions of peace and order that prevailed—something true of the west generally, where the stereotypical gunfights of movie fame rarely took place and where overall levels of violence were below contemporary levels in the large cities of the east—mining camps were noted for their minimalist approach to law. In a society where the opportunity cost of collective action is giving up the chance to pick up gold from the ground, miners had little incentive to devote their time and resources to anything but creating wealth. As a result, their legal codes forbade the use of force against others and theft—and little else. No one wanted to be in charge of prisoners, so punishments were generally limited to banishment; physical punishments such as ear cropping and flogging, which left criminals marked as prior offenders; and death. Record- keeping was done by an elected registrar, who was paid a fee by those using his services to compensate him for time away from mining.

Only as the population of non-miners grew did specialists in “mining the state” appear and seek to enrich themselves through the use of the state’s power. Corrupt official judges, for example, plagued the west while there are virtually no claims of corruption from the miners’ tribunals.

Miners’ law was far from perfect, but it was no worse than, and often superior to, contemporary state law. Anti-Chinese prejudice led many camps to bar Chinese miners, but the Chinese were able to organize their own mining camps in many areas and secure their rights to the property they established there. What they could not avoid were California’s official laws, which included discriminatory taxes and other restrictions.

Vigilantes

Located far from official law enforcement, western communities attacked by criminal elements were forced to defend themselves. Two vigilante efforts in Montana Territory shed some light on how property rights can be defended in the absence of the state.

Montana’s first gold rush occurred in the Bannack-Virginia City area in 1863–64, bringing hundreds of miners to the remote region. Among them was a Californian named Henry Plummer, who soon organized a criminal gang that proved efficient at separating miners from their money. Using a spy in the stage office, secret codes chalked on stagecoaches, and Plummer’s unofficial position as “sheriff” of the two communities, the gang robbed and killed over a hundred men.

At first the miners were helpless to resist the well-organized criminals since no one was willing to stand alone against the force the Plummer gang could muster. The ability to resist the gang’s depredations was further reduced by the lack of long-term reputations, which would have fostered trust among the miners in the area. With little social capital and unsure who was involved in the gang and who was not, those outside the gang did not know whom to trust and so could not organize against it.

This problem was solved by the chance discovery that there were several Masons in the area. The bonds between Masons provided the basis for the organization of a vigilance committee to counter the Plummer gang. The Masons discovered one another when a man dying of natural causes gave a Masonic sign to his friends and discovered that two were also Masons. The dying man asked his friends for a Masonic funeral and they agreed to attempt to find enough fellow Masons to bury him with full rites. After canvassing additional miners, they located three more Masons and planned the funeral. Word spread, and on the day of the funeral 77 Masons were present.

Because the Masons trusted one another they were able to overcome the problems that had prevented an earlier response. (The vigilantes adopted 3-7-77 as their symbol and the best guess today as to the symbol’s meaning is that it commemorates the number of Masons at each of these first meetings. The numbers adorn the shoulder patches of Montana state troopers today.) Although the Plummer gang attempted to infiltrate the vigilance committee, it was never able to do so because the Masons excluded all those of whom they had suspicions. After a winter campaign 22 members of the gang, including Plummer, were captured and hanged; the remainder fled the territory.

One of the most remarkable things about the first Montana vigilance committee was its failure to use its power to settle personal or political scores. Most historians agree that the committee made at most two “mistakes.” One was the hanging of the notorious “Captain” Joseph Slade, a larger-than-life figure who was featured in Mark Twain’s account of his time in Nevada and whose regular exhibition of ears he had cut off in barroom fights earned him free drinks. After Slade repeatedly made threats against the committee, it preemptively hanged him to prevent his promised attack.

The other mistake was wrongly identifying a Mexican as part of the Plummer gang. This record is remarkable compared to contemporary state legal systems in the more “civilized” portions of the United States. It is all the more so because Montana was riven with factional disputes between Confederate and Union sympathizers, whose antipathies ran so deep that they lived on opposite sides of the creek that ran through Bannack. There is no evidence of sectional score-settling in the operation of the vigilance committee.

The second Montana vigilance committee operated 20 years later, stopping a gang of rustlers in eastern Montana and western Dakota Territory. Led by Granville Stuart, a Montana rancher, this committee operated more quietly and left fewer records. As Stuart later wrote, “The civil law and the courts had been tried and found wanting. The Montana cattlemen were as peaceable and law-abiding a body of men as could be found anywhere but they had $35,000,000 worth of property scattered over seventy-five thousand square miles of practically uninhabited country and it must be protected from thieves. The only way to do it was to make the penalty for stealing so severe that it would lose its attractions.”

Again, however, the historical consensus is that it fought only against a gang of rustlers that raided ranches across the area in the mid-1880s. Certainly their contemporaries had no problems with the vigilantes’ activities: The vigilantes won praise from most Montana newspapers at the time; Granville Stuart was elected president of the Montana Stockgrowers Association in the midst of the committee’s operations; and James Fergus, a strong defender of extra-legal activities, was elected president of the Montana Pioneers Society and had a new county named after him in 1885. Moreover, despite numerous contemporaneous conflicts over access to the range between ranchers and homesteaders, there is no evidence that this group attacked any of the ranchers’ political opponents.

Vigilantism today has a bad name, largely due to the higher-profile vigilance committees that in effect conducted a coup d’état in San Francisco in 1856 and the southern white-supremacist vigilantes. Both groups’ activities undermined rather than reinforced property rights. The important lesson from the Montana vigilante experience is that the absence of state authority does not have to produce a Hobbesian war of all against all.

Why did the Montana vigilantes succeed? Three factors made them successful examples of private
law enforcement. First, everyone involved in both committees had high opportunity costs for their time. Just as the gold miners in California had to give up time gathering gold (and perhaps finding the big strike that all miners dreamed of), so the Montana miners and ranchers who made up these efforts could profit more from engaging in mining and ranching than they could by stealing their neighbors’ property. The incentive to institutionalize their power into a means to confiscate rivals’ property didn’t exist.

Second, the general problem with private law enforcement is not that there will be too much of it but that there won’t be enough. Economists refer to this as the “free rider” problem because of the temptation we have to “free ride” on others’ efforts. If my contribution to the vigilante effort isn’t going to determine its success or failure, I might as well stay home (where I am safe and warm) and let the rest of the group risk death and injury chasing vicious bandits in the snow. If everyone feels that way, of course, the effort does fail. Indeed, one participant said, “The people bore with crime until punishment became a duty and neglect a crime.” The Montana vigilantes overcame this problem by drawing on preexisting groups. In the 1863–64 committee the Masons formed the core group and the loyalty the group inspired in its members was enough to overcome the individual incentive to free ride. The 1884 committee was formed out of the regional cattlemen’s association, a group that was bearing the brunt of the attacks. Small-group cohesion provided the means to overcome the free-rider problem.

Third, these two vigilance committees, unlike the southern white supremacists or the San Francisco 1856 committee, were organized to defend life, liberty, and property. The clear mission in support of widely accepted natural rights served to both motivate the members and to constrain the exercise of their power. Men drawn into hazardous volunteer activities, such as chasing criminals, by the need to defend their property and lives could not be easily persuaded to continue such work in pursuit of personal gain.

Cattlemen and Homesteaders

Western cattlemen found their own version of gold on the Great Plains. The buffalo hunters’ slaughter left a sea of grass ideal for cattle. The end of the Civil War, the expansion west of the railroads, and the creation of the Chicago stockyards combined to create a vast new market for beef in the 1870s and 1880s. Cattlemen began to trail range cattle up from Texas onto the plains in Wyoming, Montana, and Dakota Territories. Millions of dollars in both domestic and foreign investment poured into the range-cattle industry, with vast ranches springing up in Texas. The XIT, whose brand stood for “ten in Texas” because it covered parts of ten counties, was created by investors who received three million acres in return for construction of the $3 million state capitol building in Austin.

The problem for the cattlemen on the Northern Great Plains (Wyoming, Montana, and the Dakotas) was that federal land policy prevented them from acquiring equivalent tracts there. Texas was happy to sell its state land to anyone who wanted to buy it, enabling Texas ranchers to buy large tracts and fence them with the newly invented barbed wire. Northern Plains ranchers, by contrast, were faced not only with federal refusal to sell them land but also the federal homestead acts, which gave farmers the ability to obtain crucial tracts around water sources, effectively controlling wide areas of rangeland. Even the railroads, the other large land owners on the Plains, couldn’t sell sufficient land for a cattle ranch because their federal grants alternated tracts along the rail to prevent the railroads from gaining a “land monopoly.”

Rather than sell land to willing buyers, the approach Texa and most states took, the federal government’s homestead policies in the west prevented the rise of a property-rights solution. There are a variety of explanations for the shift from land sales to homesteading during the nineteenth century, ranging from the desire of congressmen from the manufacturing areas to maintain support for tariffs by denying the federal government the revenue from land sales, to the use of settlers on the frontier as an adjunct to army operations in dispossessing Native Americans from western lands. There is general agreement, however, that homesteading’s impact on the homesteaders was to, as Richard Stroup put it, allow them to buy land with misery. Homesteading brought settlers to frontier regions before settlement was economically viable and forced them to endure five years of near starvation in many cases to prove up their claims.

One reason that homesteaders paid such a high price in misery for their land was the federal government’s refusal to provide adequately sized tracts. Even allowing for some of the mistaken nineteenth-century beliefs about weather (rain would “follow the plow” as farming released moisture from the soil), the federal government’s refusal to follow the advice of its own experts doomed many homesteaders to failure. Major John Wesley Powell, for example, clearly explained to Congress in his reports that the acreage limits set with humid eastern conditions in mind allowed farmers far too little land for the arid west’s environment. Although the homesteaders were often ultimately unsuccessful in making their homesteads into viable farms, their impact on the cattle range was problematic. In sum, the result of federal land policy was to preclude a property-rights solution on the Northern Plains.

The contrast between the Texas ranches and the Northern Plains cattle operations, often operated by the same partnerships and companies, could not have been clearer. In Texas the ability to fence property induced investment in better quality stock, windmills to provide water, and advances in range management. Northern Plains cattlemen managed to control the open range for a time, relying on institutions such as cooperative roundups and cattlemen’s associations to allocate range rights. But these organizations were ineffective against the claims of homesteaders and sheep herders, who increasingly competed with the cattlemen for the grass and water.

In Texas the large plains ranches welcomed the arrival of farmers, for the ranches profited by selling the newcomers land and supplies. In Wyoming, conflict between homesteaders and cattlemen led to the “Johnson County War,” an attempt at mass murder of opponents of the cattlemen in northern Wyoming by a troupe of imported gunmen. The cattlemen also managed to seize control of the territorial and state governments in Wyoming, placing allies in the governor’s mansion and both U.S. Senate seats as well as controlling both houses of the legislature.

The cattlemen’s quite different experiences in Texas and Wyoming highlight the important role property rights play in creating the conditions for peace and good order. It was the existence of property rights in Texas that ensured a peaceful transition from range cattle to mixed farming and ranching. Texas cattlemen’s investments in their range and herds improved both. The Northern Plains, by contrast, saw more conflict and more violence, both caused by the imposition of institutions that prevented the development of property rights.

Lessons

What does the frontier experience have to teach us today? There are three kinds of lessons that can be drawn from property rights on the frontier. First, Hernando de Soto refers to the role of property rights as among “the missing lessons of U.S. history” in his analysis of why North America has prospered while Latin America has not. Recovering the lessons of the frontier can remind us of why our society is both free and wealthy.

Second, the evolution of property-rights institutions on the frontier—in the mining camps, on the range, and among the vigilantes—can teach us about the importance of evolutionary institutions. Allowing experience to instruct the law’s development, a hallmark of the common-law process, allows the legal system to grow institutions that meet the needs of the society in which they operate. Imposing planned solutions from outside, as the federal government did with the homestead acts, risks falling for the fallacy of central planning.

Most important, the experience of the frontier teaches us that a society built around property rights is one in which peace and good order can prevail. In the mining camps, contract prevailed over violence time and again in a society of armed young men drawn from disparate cultures and lacking any of the social institutions we normally rely on to promote alternatives to violence. The Montana vigilantes showed that individuals could protect their lives and property without provoking a Hobbesian war of all against all. On the Plains the presence of property rights solved the commons problem and eased conflict between farmers and cattlemen, while the absence of property rights led to open warfare.

A simple example illustrates the evolution of property rights in land. The basic form of property in land in the United States is called the fee simple absolute. The owner of a fee simple absolute has the maximum extent of rights possible in the land under the law; most privately held American land is in this form.

An owner of a fee simple absolute in a plot of land in 1800 and an owner of a fee simple absolute in the same plot in 1900 had different sets of rights because of changes in the law. Between 1800 and 1900 the federal government abandoned a claim it had in mineral rights in private land. Most national governments in 1800 claimed a share of any minerals produced from any land within their boundaries. (Indeed, most national governments still make such a claim today.) Although American law was not completely clear on the subject in 1800, many thought that the federal government had inherited the English government’s claim of a share of mineral rights, and such claims were asserted by the federal government a number of times during the first part of the nineteenth century. By 1900, however, the United States had effectively abandoned its general mineral-rights claim and recognized that private landowners with fee simple title had property rights to both the surface and subsurface of their land. Indeed, the U.S. government went further and through a series of laws in the 1860s and 1870s, culminating in the General Mining Law of 1872, recognized individual claims of ownership of mineral rights and surface rights by those who discovered valuable mineral deposits on federal land.

Now compare the rights held by today’s owner of this land with the rights held in 1900. Over the past century or so, various governments took important parts of the property-rights bundle from many landowners. Local governments passed zoning laws, reducing landowners’ freedom to use their property as they see fit. State governments adopted a wide range of land-use restrictions. Some, such as Florida, adopted statewide land-use planning programs that imposed major restrictions on how property could be used. Others simply increased taxes on land. The federal government significantly reduced landowners’ rights through regulatory statutes such as the Endangered Species Act and the assertion of jurisdiction over a wide range of “wetlands” under the Clean Water Act. As a result, an owner of a fee simple absolute in that same property today has many fewer rights than the 1900 owner did.

At the same time, the rights that remain in that fee simple absolute have evolved in ways that make them potentially more valuable today through private efforts at rebundling rights. For example, one of the fastest-growing forms of property ownership today is ownership in communities in which a developer has rearranged the property rights through covenants, easements, and servitudes. One of the best known such communities is the town of Celebration in Florida, constructed by Disney. There restrictions in the deeds govern a multitude of details of the houses constructed on the property. Houses must conform to a particular architectural style, have front porches and white window hangings fronting the street, be painted a color from a specified range, and so forth. While the deeds to the properties Disney sold were notable for the number and detail of restrictions, they were by no means unique. In fact, millions of Americans now own property in which they paid a premium price to receive a deed with many more restrictions on use than was common even 30 years ago. Why?

The solution to this seeming paradox of paying more for less lies in the relative values of the rights lost and gained. Property owners in Celebration did not just give up property rights; they also acquired negative rights in their neighbors’ property.

A homeowner in Celebration is limited in her choice of colors for her house—but so are her neighbors. A homeowner in Celebration is limited in the color of blinds she can hang in the windows facing the street—but so are her neighbors. The success of Celebration in boosting property prices in the development over the prices for property in surrounding areas that lack the restrictions tells us that property owners are more concerned with limiting their neighbors’ ability to create aesthetic annoyances than they are with maintaining their own ability to do so. Reallocating the property rights among the property owners in Celebration increased the value of the bundle of rights each person purchased because it added rights worth more (the ability to prevent an aesthetic disaster down the street) than those it took away (the ability to create one’s own aesthetic disaster).

Not everyone wants to live in Celebration, or even in a community with fewer restrictions, such as the one in Yuma, Arizona, where my parents live and all houses must be painted a shade of sand color. Enough people do, however, that property owners and entrepreneurial developers have discovered that they can increase the value of some properties by incorporating such restrictions into their deeds. Property law makes such transactions possible by providing a mechanism for embedding such reallocations in deeds and so binding future purchasers of the property. It also provides a way out of deed restrictions that become obsolete, as a future entrepreneur could change or abolish restrictions by reuniting the parcels benefited and burdened by them.

There’s an important difference in how property rights changed in these examples. In the expansion of property rights to include subsurface rights between 1800 and 1900, rights became more secure as the result of government’s limiting its claims against individuals. In the rearranging of rights involved in creating developments with a particular aesthetic, private entrepreneurs used contracts and deeds to increase their property values through voluntary transactions. In the contraction of property rights from 1900 to the present through regulatory statutes, however, interest groups used the power of the state to forcibly redistribute property rights. (Anyone who doubts the “forcibly” portion of the preceding sentence need only speak to one of the landowners criminally prosecuted for violating federal endangered-species or wetlands laws and regulations.) Unfortunately, the value created by the combination of property rights and voluntary transactions all too often makes property rights a tempting target for expropriation.

Property Rights Evolve

The first key economic insight is thus that property rights are not static. They evolve. How does this evolution work? As a type of property becomes more valuable, people are willing to invest more in efforts to define rights to it. Property rights thus naturally evolve in response to changes in technology, changes in costs, changes in tastes, new discoveries, and other changes in individuals’ preferences. A critical role in this evolution is played by entrepreneurs who identify opportunities to increase value by rearranging property rights.

How do property rights evolve? It is useful to think about five different ways in which they regularly change:

1. The subject of property rights changes, making new things property that were not previously considered property.
2. The bundle of rights changes, making it possible to divide property rights in new ways and trade those rights.
3. The method of establishing property rights changes, making the cost of establishing property rights different.
4. The method of protecting property rights changes, making the cost of securing property rights different.
5. The method of stealing property rights changes, making property rights more or less secure.

Property rights can evolve to include new subjects. A classic example is the development of water rights in the nineteenth-century American west. Settlers from the more humid east found that the water-law institutions they brought with them, derived from English law and custom, were inadequate. Eastern water law gave riparian rights to landowners adjacent to bodies of water. These rights generally included the right to use water but not to diminish its flow for downstream users. In the west, where water was scarcer, however, the right to divert water for irrigation or mining was valuable. Western states and territories quickly recognized a doctrine of prior appropriation, whose essentials came out of the practice of early miners and farmers in the region. Under prior appropriation, water users had the right to divert water, with users’ rights ranked in the order in which it was originally appropriated.

Unfortunately, western water rights subsequently became the subject of a massive resource grab by the federal and state governments. Wyoming initiated the process by asserting a claim of state ownership to all surface water in its 1889 state constitution and placing the state engineer’s office in charge of water allocations. The federal Bureau of Reclamation built massive water projects across the west with tax dollars, further distorting water rights. The combination made western water rights less secure and limited their evolution in response to changes in technology and demand for water. Today, however, many states have loosened their control of water rights and are beginning to allow markets to emerge.

Rights also evolve into different bundles through voluntary transactions that benefit both parties. As discussed earlier, entrepreneurs in the United States discovered that reallocating the rights to make aesthetic decisions about the appearance of homes could increase the value of properties in some cases. Other examples include sale of easements to neighbors that allow an adjacent property owner to guarantee the preservation of a desirable view and conservation easements that allow a property owner to sell development rights to a preservation group while continuing to use his land.

The method of establishing rights also evolves in response to demand. Creation of an easy-to-use title system increases the value of all property, facilitating transactions by making it inexpensive to determine who owns a particular piece of land. The development of title insurance facilitated property transactions by reducing the risks for buyers. More recently, the securitization of mortgages in the United States has vastly increased the financial resources available to prospective property owners by making it possible for investors to buy diversified portfolios of mortgages. What all these examples share is that they are the result of entrepreneurs identifying an opportunity for profit and using the tools provided by the law to create a means of earning that profit.

Finally, property rights evolve in response to changes in how they can be defended. Property owners often play a critical role in physically defending their rights, as anyone knows who has seen the broken-glass-topped walls, gates, and razor wire routinely used by property owners in countries where land is vulnerable to invasion. New technologies can repeat the role of barbed wire on the American Great Plains, making it possible to cost-effectively control access to resources that cannot be safeguarded today. For example, in the not-too-distant future we may see a combination of GPS and DNA-testing technologies provide a means to create property rights in migratory sea animals, such as whales.

The evolution of property rights is a remarkable phenomenon. In the United States and elsewhere, positive developments have produced better-defined, more secure, and more valuable bundles of rights over time. That evolution has occurred as the result of individuals’ seeking to fulfill their own plans, to earn profits, and to use their property to serve their own needs. In short, the voluntary transaction-driven evolution of property rights is a Hayekian spontaneous order.

At the same time, however, there have been value-destroying, liberty-restricting developments in property law. The widespread adoption of central-planning methods for land-use control, the seizure of private property to redistribute it to favored interest groups masquerading as “economic development,” and regulatory restrictions on property owners in pursuit of special interests’ agendas, as has happened with laws such as the Endangered Species Act and Clean Water Act, are the result of the combination of an unconstrained state and the attraction of the wealth individuals create through the trade made possible by property rights.

Property Rights Solve Problems

There are two fundamental problems solved by property rights: (1) how to exchange goods in the course of trade and (2) the commons problem.

The problem of how to exchange goods in trade is a serious one, although not one we often consider today. If goods belonged to whoever happened to pick them up, there would be little reason for me to trade with you. I could simply wait until you fell asleep or were distracted and take the goods without giving you anything in return. Even if you and I agreed between ourselves, or if all the people in our neighborhood or even our town agreed on who owned what, we would still not be close to unlocking the potential value made possible by a system of well-defined property rights.

To take but one example, many new businesses in the United States are started by entrepreneurs using their homes as collateral. If a bank could not be sure who owned the property offered as collateral, it would not be willing to lend the money. Similarly, if the bank thought that it could not collect on the collateral, it would be unwilling to lend. When banks can rely on clear titles, however, they are willing to advance money, holding the titles as collateral. When property rights are sufficiently clear and markets well-enough developed, bundles of security interests in land can be combined and turned into new investment securities. These securities then make it possible to expand the pool of money invested in real estate, and so enabling even more, even cheaper loans. The economic power of property rights in such cases is so extraordinary that they almost seem to be alive with energy. Indeed, Peruvian economist Hernando de Soto refers to property in societies where rights are so poorly specified that using it as collateral is impossible as “dead capital” because it cannot be used to produce new value in this way.

This critical feature of property rights—that they permit trade and so permit the creation of wealth—is central to the economic case for them. It provides the solution to some thorny philosophical issues as well. Philosopher David Schmidtz suggests that the solution to the problem of the Lockean Proviso—the requirement that “enough and as good” be left for others in a just system that includes original appropriation—is that allowing the original appropriation produces more for those who come after by permitting trade to take place. In his essay “The Institution of Property,” Schmidtz points out that “Philosophers are taught to say, in effect, that original appropriators got the good stuff for free. We have to pay for ugly leftovers. But in truth, original appropriation benefits latecomers far more than it benefits original appropriators. Original appropriation is a cornucopia of wealth, but mainly for latecomers. The people who got here first never dreamt of things we latecomers take for granted.”

The second important problem property rights solve is the tragedy of the commons. Made famous by Garrett Hardin in his 1968 article in Science, a tragedy of the commons occurs when there is no means to exclude others from a resource. Under these conditions, the resource will be overused to the point of destruction so long as each user gains more benefits than the costs he bears as a result of his actions. In Hardin’s example, villagers shared access to a common field. Each could put as many cattle on the field as he desired since no one had the right to exclude another. As a result, each villager added cattle so long as the last cow he added benefited him more than it cost him. Since a portion of the cost created by the additional cow was the reduction in grass available to the cows owned by others, no villager took into account the total cost to the village of the additional cows. Unsurprisingly in Hardin’s example, the field ended up with so many cattle grazing on it that it was overgrazed and destroyed. All the villagers were worse off, yet no one had had an incentive to stop the overgrazing. Why?

Without the power to exclude, any grass left for tomorrow would be eaten by someone else’s cow today. Even if the villagers had all recognized that there were too many cows on the land, no one would rationally agree to reduce his herd because any grass “saved” would be eaten by someone else’s cow.

As Hardin recognized, in a passage rarely cited by those eager to use his work as an excuse for state intervention, the commons is a problem only for societies that lack property rights. The tragedy, Hardin declared, is solved by “private property, or something formally like it.” And in fact there was no tragedy of the commons in medieval English common fields, the case Hardin used as his example, precisely because there were property rights in them, known as “stinting,” that limited the ability to add animals. Stinting rights were based on the amount of property in the private fields each villager held.

By making it possible for a property owner to gain from good stewardship, private property creates an incentive to invest in maintaining and improving resources. Just as important, if someone is not engaged in good stewardship, whether due to ignorance, indolence, or idiocy, private property rights make it possible for someone who is able to engage in good stewardship to offer a premium over the value of the property to the current owner. By buying the property and improving its management, the new owner can generate enough income to pay the higher price. (Of course, not every owner will sell when offered more money than he is getting from his property, but many will.)

Government-Caused Problems

Economics can also shed light on how governments can cause problems with property rights. Two problems are particularly acute today. The first is that governments may impede efforts to create tradable property rights by attempting to steal resources for themselves. The second is that governments may fragment property rights into so many small bundles that the cost of reassembling them into useful arrangements is too high to be worthwhile.

The problem of predatory states is as old as the state itself. Simply taking property without compensation is of course possible, but predators that engage in such naked aggression kill the goose that lays the golden egg. More common are efforts to chip away at property rights on the margin, transferring specific rights from property owners to favored interests. For example, local governments often attempt to condition construction permits on grants of easements or restrictions on use of the property in question. Similarly, “regulatory takings” are a major area of concern, as property rights become entangled in a web of regulatory restrictions. Unfortunately, the American courts have been even less protective of property rights in the face of regulatory takings than they have been with respect to outright takings.

The problem of fragmentation of property rights is particularly acute in countries attempting to privatize state-owned property. In some instances, rather than decide to whom to award a particular property, officials simply gave it to everyone. As a result, there were multiple “owners” able to veto any particular use of a property. Professor Michael Heller termed this the “tragedy of the anticommons” after observing it in post-Soviet Russia. Heller wondered why so many Moscow storefronts were empty while businesses occupied kiosks on the sidewalks in front. He discovered that the reason was that granting of rights to the former employees of the stores so fragmented ownership that reaching an agreement on a use of the property was virtually impossible. The tragedy of the anticommons is a creature of the state. Overcoming it is largely a matter of preventing fragmentation of property rights in privatization efforts.

In his history of property rights and civilization, The Noblest Triumph, Tom Bethell concludes that private property makes possible liberty, justice, prosperity, and peace. Secure property rights make liberty possible because they fence off a private domain out of the reach of the grasping hand of the state. They make justice possible because property owners reap the rewards and suffer the losses caused by their actions, linking reward to merit. They make prosperity possible because they allow trade. Finally, secure private property rights make peace possible because they enable each individual property owner to pursue his or her own plan, free from the interference of others and without interfering with others.

One of the most enduring myths of the pre-European Americas is that the cultures were a kind of property-less Eden, in which various peoples existed in harmony with one another and with nature. Even a brief survey of the major pre-Columbian civilizations of the Inca, Aztec, Maya, and North American tribes quickly demonstrates that such a view neglects well-established customs that included recognizable forms of property in scarce resources, from weapons to hunting territories, as well as conflicts among tribes and other groups over control of territories.

Native Americans encountering Europeans may have been unfamiliar with their particular forms of property ownership, but such unfamiliarity did not long survive extended contact between Europeans and Native Americans. In part these differences were the result of the differences between Europe and the Americas. For example, Europe was more crowded than the eastern seaboard of North America, and so land was scarce. Population estimates of the pre-contact populations vary wildly, but it seems clear that even the highest estimates put the population density well below contemporary European levels. As a result, land was more abundant than it was in Europe, so its allocation was less likely to be worth the effort to make boundaries and claims precise. But the scarce resources in any particular area, such as good hunting grounds, were the subject of property rights.

In short, many if not all of the pre-contact residents had their own well-developed systems of property rights before the arrival of Europeans. Those property rights evolved in response to European contact, with new rights delineated as trade with the Europeans made previously undelineated rights valuable. Harold Demsetz’s classic 1967 article, “Toward a Theory of Property Rights,” for example, showed how rights to beaver pelts developed among North American tribes in response to the European demand for fur.

The Europeans added a wide range of ideas about property to the mix. The European feudal tradition made property contingent on grants from the monarch. Vassals held their land, known as a “feud,” on condition of providing service and homage to the lord above him. William the Conqueror brought feudalism to England, redistributing English estates to his supporters in 1066. (Nine of these received almost all the land in England.) The king could reclaim his property if the feudal tenant failed to comply with his obligation, committed treason, or died. In some parts of Europe this absolutist conception of property rights as dependent on the state survived relatively unchallenged. In Property and Freedom historian Richard Pipes ties the lack of political and economic liberty in tsarist Russia to the weakness of property rights in that society.

A second tradition, more friendly to liberty, also existed in Europe, one which saw property as independent of the monarchy and the state. Particularly in England, but also among groups of thinkers ranging from the Spanish Scholastics to those in the Dutch Republic, many Europeans saw property as a natural right. While Americans are most familiar with John Locke’s statement of this argument in his Second Treatise, continental writers including Hugo Grotius and Samuel Pufendorf also developed influential natural-rights theories of property. Among the colonies in America this idea took strongest root in the North American English colonies. In particular, the Puritans argued that land was held not of the king but as a gift from God alone. As a result, the owners of these “allodial” (the opposite of feudal) land holdings owed no service to any lord.

American colonists from Britain brought with them both this natural-rights heritage and a significant set of common-law principles dealing with property in general and property in land in particular. In his 1765 essay “A Dissertation on the Canon and Feudal Law,” for example, John Adams argued that American land titles were not feudal. And Thomas Jefferson, in his 1774 instructions to the Virginia delegation to the Continental Congress, “A Summary View of the Rights of British America,” went even further, linking the colonists’ allodial titles to Americans’ “Saxon ancestors” who had held their land “in absolute dominion . . . disencumbered with any superior.” For Jefferson and many others, the Norman Conquest had produced only a temporary exception to the English tradition of liberty and allodial ownership rather than a permanent reduction in rights.

Further, even with respect to the feudal institutions introduced by William the Conqueror, British land law had evolved—and the point that it evolved rather than developing through pronouncements from on high is important—into a complex set of arrangements that enabled individuals to engage in a wide range of property transactions. Land originally held “of” the king and transferred from generation to generation only by the king’s grace became a commodity that the owner could sell and leave to his heirs without permission of the Crown. By the 1700s the evolution of English property toward more marketable forms had reached the point that the idea of an individual having a freehold estate in land independent of the government was both philosophically well grounded in natural law and practically established in property law.

Evolution Was Not Inevitable

How did English property law come to evolve in this direction? There was nothing inevitable about an evolution toward property rights, as Russia demonstrates. Pipes has documented how Russian property rights withered under the sustained assault of the tsarist autocracy, leaving Russians dependent on the central government’s forbearance rather than independent of the state.

There was no grand liberal design by the English aristocracy behind the evolution of property rights in England. Rather, two factors appear critical. First, the English crown was relatively poor and so dependent on the aristocracy for regular support. Even successful English monarchs like Elizabeth I struggled for funds. Elizabeth, for example, left her successor, James I, a virtually empty treasury containing only £200 and 3,000 dresses. Crucially, it was not England that was short of resources but the monarchy. Indeed, James, coming from impoverished Scotland, termed his arrival in England “a Christmas time” because of the far greater wealth he found there. This dependence forced even absolutist English monarchs such as the Stuarts to summon Parliaments and to regularly concede power to them simply to obtain the resources necessary to rule.

Second, England had a competitive system of courts. Multiple jurisdictions existed, including common-law and equity courts, merchant courts, and canon-law courts, each seeking business from litigants. This competition bred independence, giving litigants a fairer chance against the Crown in litigation than in many other European states. Further, the competition among courts allowed lawyers opportunities to develop tactics that brought their clients greater security of property rights. Indeed, legal historians agree that the primary focus of medieval common law was land law, what William Camden, a Stuart-period historian, summed up, saying, “[T]he declaring of the meum and tuum [mine and thine] . . . is the very object of the laws of England.”

The result of this combination was supremacy of law. Parliament, courts, and lawyers regularly pushed the boundaries of royal power back, expanding liberty by protecting property rights in the pursuit of the resolution of private conflicts. The monarchy’s need for cash forced England’s kings and queens to repeatedly acquiesce in limits on their power. In both cases, because land was the key form of wealth, the result was strengthening of property rights and steady evolution toward higher estates.

The highest estate, and the form in which American land came to be held almost universally, was the fee simple. It included rights we often take for granted today but that were hard-won rights of Englishmen: the descent of land to the heir without reversion to the state, perpetual tenure, complete freedom to transfer by contract or will, the ability to change the use of the property, and freedom from “incidents uncertain,” making the state of title known at the time of transfer. The ultimate result was, as Jonathan Hughes has written, to turn the American understanding of property “inside and out” by making property rights so complete that the Fifth Amendment did not even bother to specify the content of the rights it guaranteed.

Of course, Europeans brought not only natural-law justifications of property rights but also philosophical critiques of them. Both the Jamestown colonists and the Plymouth colonists initially attempted to hold property in common. In Jamestown land was to be held and managed collectively and each colonist was to receive an equal share of the colony’s production regardless of his contribution. Two-thirds of the initial 104 colonists died of starvation and disease before the first winter, and the population, after soaring as hundreds of new colonists arrived from England, plummeted to 60 after the winter of 1609. When Governor Thomas Dale visited the colony in 1611 he found living skeletons bowling in the streets while fields went untended. After Dale partially converted the communal lands to individual three-acre tracts in 1614, productivity increased seven-fold. The remainder of the communal land was privatized by 1617.

Similarly, the Plymouth colonists began in 1620 with communal land and were near starvation when land was privatized in 1623. As William Bradford noted, the change “made all hands very industrious, so as much more corn was planted than otherwise would have been.” Taken together, natural-rights theories, legal doctrines, and practical experience combined to give the American colonists a strong sense of the role of private property rights in ensuring their survival and prosperity.

Competing Claims to Property

The problem of establishing property rights in the New World rested not only on the relationship between individual and monarch but also on the relationship between monarchs. As Europeans began exploring the continent, competing claims to property in the Americas quickly appeared. Not only did various Native American tribes hold claims to different areas (and sometimes more than one had a claim to a particular area), but the European monarchs had conflicting claims to various territories. Individual European settlers also began to assert claims based on both the fact of their settlement or their own contracts with native peoples. Desiring to avoid conflicts over the new territories, the European powers reached an accord dividing much of the Americas among them. Spain and Portugal negotiated a partition of territory (based on a division by Pope Alexander VI). European powers more generally recognized a rule of discovery, granting to the European power that first found a new land the right to determine how to acquire the territory from the native inhabitants, whether by conquest or contract. The implementation of this principle varied from country to country. Britain generally prohibited individuals from making their own bargains with the native peoples, while France permitted such bargains.

Despite the claim to rights based on discovery, British colonists often acquired land by contract. For example, almost all of Massachusetts was acquired by purchase from local tribes. The primary exceptions there, Salem and Boston, were uninhabited areas, having been depopulated earlier by the diseases the colonists unwittingly brought with them. Although the British crown claimed the sole right to negotiate transfer of land rights from the Native Americans, many colonists thought otherwise and regularly made individual arrangements with various tribes to secure land. Such contracts led to one of the seminal cases in American land law, Johnson v. M’Intosh, an 1823 Supreme Court opinion by Chief Justice John Marshall that is still a foundation stone of law-school property classes. Although Marshall unfortunately sided with the state over the individual in that case, the principle of self-initiated land transactions proved hard to eradicate and continued as a means of establishing private property rights well into the nineteenth century as the frontier moved westward.

As noted, while European settlers brought their ideas about property to America, they also encountered something new here: vast tracts of fertile land. To acquire a parcel, one needed only to head west past the settled edge, find a desirable spot, possibly contract with a local tribe, and then build a farm. Instead of Europe’s scarcity, America offered abundance. In 1800 an English laborer had to spend a third of his income to rent ten acres, while an American farm laborer could rent the same amount with only 1 percent of his income.

This abundance was not costless even if no cash had to change hands. Property-law casebooks used in the first year of law school often begin with a quote from John Locke’s Second Treatise—“In the beginning all the world was America”—most often as a way of introducing the question of how property rights are initially established. However, Locke’s point was not that America was unowned but that property’s value depended on there being a means of storing value to encourage trade. In a world without money, he asked, what value would there be even for the best land? “[W]hat would a man value ten thousand, or an hundred thousand acres of excellent land, ready cultivated, and well stocked too with cattle, in the middle of the inland parts of America, where he had no hopes of commerce with other parts of the world, to draw money to him by the sale of the product? It would not be worth the enclosing, and we should see him give up again to the wild common of nature, whatever was more than would supply the conveniencies of life to be had there for him and his family.”

Only then did Locke say, “Thus in the beginning all the world was America, and more so than that is now; for no such thing as money was any where known. Find out something that hath the use and value of money amongst his neighbors, you shall see the same man will begin presently to enlarge his possessions.”

Locke’s grasp of Native American societies was questionable, for as noted earlier there is ample evidence that Indians had both well-developed property systems and measures of value. However, his central point that property was valuable only to the extent it was embedded in a market economy, where the goods produced on it could be exchanged for other goods, is critical to understanding the role of property in the economy.

The economic impact of secure property rights comes about because property makes possible positive-sum transactions between individuals. Those who own property will hire labor from those who do not, enriching both parties through trade. Likewise someone with property suited to growing apples will exchange with another whose property is suited for growing corn and is likely to do so on the property of a third person that is situated at a convenient crossroads between the apple orchard and cornfield.

Land’s abundance in America also offered an important limit on the power of government. Fixed assets such as land have traditionally been vulnerable to expropriation and confiscatory taxation because it is hard
for their owners to escape the state’s grasp. In colonial America, excessive taxes could be readily evaded by moving west. Because property owners could move more readily than they could in Europe, American governments were constrained in their ability to tax.

America’s vastness also offered enormous opportunities for land speculation. In Our Enemy, The State, libertarian writer Albert Jay Nock wrote that “land-speculation may be put down as the first major industry established in colonial America.” While speculation can serve an entrepreneurial role, rewarding those who see possibilities in undeveloped land, it can also all too often become yet another exercise in political rent-seeking. Unfortunately, in many cases, land speculators in the New World were able to turn to governments to gain access to land resources or to locate valuable state institutions in such a way as to increase the value of their lands.

Property on the Frontier

English property concepts and law thus survived their transplant to American soil. Indeed they did more than survive; they thrived. As settlers pushed further west into new territories, they were faced with the problem of establishing property rights far from “civilization.” They did so repeatedly, expanding first the colonies and ultimately the United States westward, as Jonathan Hughes put it, cutting settlements “into the wilderness primarily by privately motivated frontiersmen making small family farms acquired by purchase or homesteading.”

After the Revolution, the new federal government faced the problem of determining how to govern the western territories the states ceded to it. Although it took until after the War of 1812 to finally settle all the U.S. land claims with Britain, even before then, American territory was advancing through the 1803 Louisiana Purchase.

Jefferson devised a system for the new lands, embodied first in the Ordinance of 1784 and then in the Northwest Ordinance of 1787. Not only did the ordinance create the mechanism by which territories could become states, it also explicitly guaranteed property rights. Following English law, the Northwest Ordinance provided for intergenerational land transfers both by will and by contract, with provisions that took into account the frontier difficulties in registering deeds with distant officials. The Ordinance also promised “the utmost good faith” toward the Indians, including within that term “that their lands and property shall never be taken from them without their consent; and, in their property, rights, and liberty, they shall never be invaded or disturbed, unless in just and lawful wars authorized by Congress. . . .”

Like many other aspirations of the new nation, the Northwest Ordinance’s promises of fair treatment for Native Americans were ultimately unfulfilled, and the division of land in the Northwest Territory had its share of fraud and corruption. Ultimately, however, the combination of European notions of natural rights, the transformed and transplanted English common law of property, and American conditions led to the land’s distribution into private hands with secure titles, forming the basis for the expansion of a free society westward.

When the modern Peruvian economist Hernando de Soto set out to discover why some nations were rich and some were poor, he found that the legal and economic experts he consulted could not satisfactorily explain the success of the West. One reason, he determined, was what he termed the “missing lessons of U.S. history.” These lessons are not simply American, however, but universal lessons from history. What de Soto discovered was that the experts had failed to recognize the centrality of secure property rights in the development of the United States and the West in general. Rather, they mistakenly believed that prosperity grew out of the thicket of regulations and rules that exist today. Recapturing those missing lessons is important if we are to avoid inadvertently destroying the foundations of our freedom and prosperity. What then are the lessons of the colonial experience with property rights?

The first is simple: property matters. The second is the power of ideas. Property rights derived from British law and natural-rights philosophy developed into stronger, more effective guarantees of liberty over time. First in Britain and then in America, ideas introduced into the law evolved beyond their original, limited scope. Though gradual, this expansion of property rights ultimately produced a significant force for liberty.

Third, institutions that facilitate positive-sum transactions flourish. Such institutions produce peaceful and prosperous societies, a combination that is no accident. Property rights instantiate no particular vision of how property is to be used, leaving that to individual property owners to determine through voluntary transactions and so reducing social conflict over resources. Individual ownership in turn creates a powerful incentive for entrepreneurs who, envisioning a new, more valuable use for a piece of property, may purchase it and realize the gain. Change occurs peacefully in such circumstances because it is a byproduct of trade rather than the result of the decision of an autocrat. That peace and prosperity flow from property is the ultimate lesson, one that too few remember today.

What does it mean to have the rule of law? Adams’s opposition of “a nation of laws” to one of “men” suggests part of the answer. A “nation of men” would be one governed by the desires and whims of the rulers, unconstrained in their impositions on those they ruled. Disputes would be decided according to the rulers’ preferences, not principle, leaving individuals dependent on having a protector among the rulers. A “nation of laws,” on the other hand, would substitute principle for preference.

Consider a simple question of whether John must repay a loan from Mary. In a “nation of men,” the fact of the loan would be irrelevant; what would matter was whether John’s patron outranked Mary’s. In a “nation of laws,” on the other hand, if Mary could establish that John had borrowed money from her and not repaid it, the principles of contract law would require John to repay the loan regardless of whether John had more powerful friends than Mary.

In other words, societies without the rule of law would be Hobbesian states of nature, with escape possible only through the intervention of the Leviathan. That escape would be purchased with the surrender of liberty to the Leviathan and the acceptance of his exactions as the price of preventing the greater losses of the war of all against all. In the society with the rule of law, on the other hand, individuals would not fear their neighbors, since disputes would be settled through the application of principles known in advance. These individuals would have no reason to submit to the local Leviathan. (What we know about a variety of primitive” societies suggests that the rule of law was far more common than was once believed. Bruce Benson’s The Enterprise of Law, for example, documents the widespread existence of the rule of law in a variety of pre-modern societies.)

In a society governed by the rule of law, we should expect to observe two key features. First, the principles by which disputes will be resolved are known in advance. John knows before he borrows the money from Mary that promises to repay loans are enforceable. Second, the result of the application of those principles to a dispute does not depend on who the parties are. Powerful people are governed by the same rules as the weak, the rich by the same rules as the poor.

These are necessary but not sufficient conditions for the rule of law.While we sometimes take these components of the rule of law for granted today, they have often been absent under tyrannical rulers. For example, the Roman Emperor Caligula had imperial decrees written in small letters and posted so high up on pillars that the decrees could not be read, ensuring that citizens could not know whether or not they had violated the law.

These conditions are enough to exclude arbitrary tyranny like Caligula’s, but not enough to get us to a free society. We need to constrain the content of laws for two reasons. First, for there to be the rule of law, both John and Mary must be secure enough in their property rights to have accumulated sufficient assets to make their transaction possible. Second,we need to be able to eliminate orderly tyrannies such as fascism and communism, which oppress people with laws adopted in accordance with “proper procedures,” as well as merely arbitrary ones such as Caligula’s.

The German Nazi regime, for example, had many well-known, well-understood, and equally applied rules. The infamous Nuremberg laws, for example, outlawed marriages between “citizens of German or some related blood” and Jews. The law was known and understood by the public, and applied equally. As in most dictatorships, of course, enforcement of the law was sometimes arbitrarily waived — but our primary objection to the Nazi regime as violating the rule of law cannot be that its hideous laws were imperfectly enforced. Some restraint on substance of what lawmakers can do seems necessary.

Of course, the Nuremberg laws were built on the distinction between those of “German or some related blood” and Jews, a distinction we today recognize as having no validity whatsoever. Germany is not unique in having introduced such distinctions: much turned on minute distinctions of the degree of “African blood” under pre-Civil War and segregationist American laws, and similar nonsense continues today, from the United States (over “native Hawaiian” and American Indian status) to New Zealand (over Maori status). It is also present in nonracial distinctions—employment-discrimination laws treat people differently depending on whether they are large or small employers, employers or employees, or disabled or able-bodied, to name but a few such distinctions. Indeed, one of the fundamental problems in today’s legal system is that our rights often depend on how the law categorizes us, an issue to which we will return below. The problem of treating individuals differently is thus not merely a relic of past tyrannies but a real problem in today’s legal system.

Constraining Content

Constraining the content of rules requires that we constrain the power of the bodies that create them. Any reasonable theory of the rule of law ought to be able to distinguish the Nazi legal system from the legal system of a free society. Indeed, this seems like a minimal requirement. There are lots of closer cases where we want our theory to do much harder work in drawing distinctions. We thus need to add some kind of substantive constraint to our initial set of conditions. This is where things get tricky.

The notion that the rule of law requires a constraint on the reach of lawmaking powers is far from universally accepted. For example, Hans Kelsen, one of the twentieth century’s major legal theorists, does not accept it. Kelsen (who was forced to flee Germany when Hitler came to power) thought the Nazi racial laws met the definition of law precisely because he defined law in terms of the ability of a state to back a command with the threat of force and did not impose substantive constraints on the content of the law. His theories are still taught throughout the world, particularly in civil-law countries, and he numbers among the fans of his jurisprudential theory Judge Richard Posner, one of the most influential figures in American law today. (Fortunately, given his position, Posner’s own jurisprudence is considerably better than Kelsen’s.)

We also have the problem of where to find the constraints we will impose. In his book A Brief History of Time, Stephen Hawking relates an anecdote of a scientist who, after delivering a lecture on the structure of the solar system and galaxy, was approached by a little old lady. She told him that his talk was rubbish because everyone knows that the earth is a flat plate balanced on the back of a giant turtle. The scientist responded by asking her what the turtle stands on. She replied, “You’re very clever, young man, very clever. But it’s turtles all the way down.” Unfortunately many attempts to locate substantive constraints on the legal system devolve into resting our premises on ever-increasing numbers of turtles.

As F. A. Hayek perceptively noted in 1973, the problem is the legal system’s refusal “to recognize as binding any rules of conduct whose justification had not been rationally demonstrated or ‘made clear and demonstrative to every individual,’ ” a problem that has been an “ever recurring theme” since the nineteenth century (Law, Legislation and Liberty, vol. 1, p. 25; subsequent page numbers are from this book). Just as central economic planning intruded on the spontaneous order of the marketplace throughout the twentieth century, central legal planning displaced ever more of the spontaneous order of the common law. As a result it is turtles all the way down for most modern legal theorists. As they seek to impose their ever-more complex, planned, rational legal orders on society, they stack turtle on turtle in trying to locate a plausible source for the legislation they write.

External Sources of Constraints

One possible source for substantive constraints is to look outside the legal system for a set of principles to guide the law. There are an infinite variety of possible sources: feminism, Marxism, fascism, divine law, or whatever ideology is the current favorite. All of these suffer from the turtle problem, of course, since we’ve simply substituted the problem of justifying feminism, Marxism, and so on for the problem of justifying the constraints on the legal system. Adherents to these various worldviews recognize the fundamental truth of their particular views, but convincing the rest of us has generally come down to using state power to coerce compliance. Of course, the next turtle down is the problem of how to resolve conflicts over which theory to use. For those who identify law only as the command of the sovereign, this is not a problem. The ism with the most guns gets to tell the rest of us what to do, and we should just be thankful if it doesn’t turn out to be the Khmer Rouge or the Taliban running the show. This is not to suggest that my religious or philosophical beliefs shouldn’t play a major role in shaping my conduct, just as yours do in shaping your conduct. The issue is whether my beliefs get to play a role in shaping yours and vice versa.

The records of societies that looked outside the legal order to religious, political, or other moral codes as the source of legal constraints are neither libertarian nor particularly happy ones. The Soviet Union, Puritan Massachusetts, and the Taliban regime in Afghanistan are just a few of the failed societies that relied on an external set of beliefs as the source of rules in the legal system. Unfortunately, they are also societies more famous for witch trials (political as well as religious) or mass killings than for flourishing economies or freedom. The lesson is that if we are to have a society in which people are free to hold diverse opinions about religious and ethical issues, we cannot rely on such sources to constrain power without igniting conflict over which religion or ethical system on which to rely.

Another possible source of constraints is to limit the subjects about which laws can be written. Disputes over the morality of consensual behavior between adults, for example, can be left to the pulpit and water cooler if the state is not authorized to legislate about such matters. The U.S. Constitution takes this approach by carefully enumerating the subjects over which the national government has authority. Through such limits, the Framers hoped to constrain the national government to a relatively narrow sphere.

Unfortunately, however, this strategy proved insufficient to permanently prevent the expansion of government power. Once the federal government was in place, it became a permanent lobby for enhancing its own powers and over time, bit by bit, many of the constraints imposed by the Constitution were worn away. For example, the Supreme Court allowed a steady expansion of congressional power under the Constitution’s Commerce Clause (Article I, section 8, clause 3), ultimately holding in a 1942 opinion (Wickard v. Filburn) that Congress could rely on its interstate commerce power to punish a wheat farmer for growing wheat on his own land for his own consumption. (Sadly, the Court again endorsed this approach this year in Gonzales v. Raich,
upholding federal rules barring the medical use of marijuana.)

Although more recently the Court has attempted to revive the notion of enumerated powers as a meaningful constraint on the federal government, the extent of its powers today would surely shock even the most ardent proponents of a strong national government among the Founders. While imposing as many constraints on state power as possible through a written constitution is worthwhile, what must be recognized is that such constraints are vulnerable to erosion from the ever-present pressures from governments and interest groups.

Hayek’s Solution

Where, then, can we find a source of limits that will constrain state power and enable us to live under the rule of law rather than men? Hayek wrote extensively about law, applying the insights of Austrian economics to the study of legal institutions in The Constitution of Liberty (1960) and a three-volume work Law, Legislation and Liberty (1973, 1976, and 1979, respectively). Although there are certainly ambiguities and inconsistencies in his analysis, Hayek provided at least a partial solution to the problem of securing the rule of law, neatly addressing how to permanently constrain the domain of law-making and locating a mutually acceptable source of the constraint.

Central to Hayek’s theory of law is the distinction between law and legislation: law is a spontaneous order that came largely from custom; legislation is a planned order created by human institutions such as legislatures. The distinction seems at odds with common usage. We often talk of “laws” passed by Congress and state legislatures. Few modern statutes would meet Hayek’s definition of law, however. (Hayek did recognize the need for organizational statutes to structure the state, and transaction-cost-reducing measures that offered focal points such as clear rules on the formalities necessary to conclude a binding contract.) By introducing this distinction, Hayek pointed us toward a solution to the problem of constraining legislative power. Because it comes from custom and is the result of a decentralized process of dispute resolution, Hayekian law is not vulnerable to the interest-group pressures that bias the legislative process. (Hayek did not entirely exclude the legislature from contributing to the production of law. He allowed for intervention to save the legal system from conceptual “dead ends” (p. 100), although he never fully specified how one can distinguish a solution to a “dead end” from special-interest legislation.)

In a Hayekian legal order the judge “serves, or tries to maintain and improve, a going order which nobody has designed, an order that has formed itself without the knowledge and often against the will of authority, that extends beyond the range of deliberate organization on the part of anybody, and that is not based on the individuals doing anybody’s will, but on their expectations becoming mutually adjusted.” (pp. 18–19) Crucially, “[t]he question for the judge here can never be whether the action in fact taken was expedient from some higher point of view, or served a particular result desired by authority, but only whether the conduct under dispute conformed to recognized rules” (p. 87). As a result of limiting the production of law to the outcome of dispute resolution, a Hayekian legal order’s rules focus on making “it possible at each moment to ascertain the boundary of the protected domain of each. . . .” (p. 107)

Legal rules, Hayek argued, must satisfy a principle of generality; that is, they must be general, non-arbitrary, and applied equally to all. Legal rules produced by common law courts and ultimately rooted in custom meet these criteria; most of the product of legislatures does not. Hayek’s generality principle solves the problem of constraint without resting on a turtle. We avoid the problem of treating the Nazis’ Nuremberg laws as valid because a law that distinguishes between those of “German or related blood” and Jews violates the requirement of generality by introducing a distinction. We avoid the problem of special-interest legislation in the same fashion: special interests can’t be “special” if they cannot distinguish themselves from everyone else. As a result, they cannot confiscate our assets for their benefit.

What kinds of laws pass Hayek’s test of generality? Rules that allow individuals to make and keep private agreements, resolve conflicts, and structure their dealings meet the test. The essentials of property, tort, and contract pass unscathed.

What kinds of laws fail? Not much of the modern administrative welfare state would survive. Among the casualties:

• Environmental laws that prescribe differential treatment for different interests (such as the distinction between point and nonpoint sources under the Clean Water Act, which leads those who emit the exact same amount of the exact same pollutant from a field treated with fertilizers and from a factory to be treated radically differently).

• Employment laws that treat different groups of employees and employers differently.

• Regulatory laws that limit individuals’ freedom to enter occupations.

Indeed, all the many statutes that take the property rights of one person and indirectly award them to another (so-called regulatory takings) would fail Hayek’s test. (Hayek introduced some ambiguity on this point in volume three of Law, Legislation and Liberty, by suggesting there might be exceptions to the principles set out in the book for employment, environmental protection, and a surprising number of other areas. This is one of the rare occasions when I feel comfortable saying he was simply wrong.)

Why We Need the Rule of Law (and Not Much Else)

This would not leave us helpless, however. As Richard Epstein has eloquently written, simple rules turn out to be remarkably robust for resolving the problems of a complex world (Simple Rules for a Complex World, 1997). The principles of tort, property, and contract are enough to enable market forces to produce solutions to problems that bedevil regulators trying to write comprehensive regulations, while avoiding the special-interest problems inherent in government action. Indeed, this relatively small set of laws is all we need for the same reason that we do not need state assistance in making markets “work.” In fact, Hayek’s legal theory is rooted in his economics, particularly his understanding of the critical role dispersed knowledge plays.

Just as Hayek showed in his 1945 essay,“The Use of Knowledge in Society,” that attempts to “fix” specific problems in the marketplace by bureaucratically altering prices damage the market’s ability to reconcile the diverse needs and resources of the millions of individuals, so too does he explain how attempts to “fix” legal problems through special-interest legislation damage the legal system’s ability to provide law. Once courts move beyond enforcing the expectations of the parties in an attempt to produce specific distributional outcomes, the legal system’s ability to reconcile the actions of individuals pursuing their diverse aims is damaged. No longer able to rely on the enforcement of their voluntary arrangements, people turn to Leviathan for protection, competing for recognition of their status as “deserving” and the special treatment such status brings. The result is a never-ending cycle of special-interest lobbying, bringing ever-increasing numbers of laws doling out favored status to clients of the powerful.

We can see this dynamic illustrated in the ever-increasing list of protected classes in employment law. The list of prohibited bases for employment decisions has expanded in some American jurisdictions to include sexual orientation, appearance, weight, and use of tobacco. With such an extensive list of prohibited bases for discrimination, of course, employers can no longer simply hire and fire employees. To avoid lawsuits, employers must invest in expensive compliance programs and vet their advertisements to avoid the appearance of impropriety.

Why No One Else Cares

Are classical liberals alone in caring about the rule of law? Increasingly it appears so. A nominally conservative administration in Washington seems more intent on outcomes than principle, abandoning federalism whenever it sees an opportunity to impose a desired outcome nationally. Some special-interest legislation is to be expected from any politician as the price of politics (the 2002 steel tariffs were a particularly clear example of such a measure), but the widespread abandonment of principle in areas as diverse as environmental regulation and tort “reform” makes clear the lack of commitment to the rule of law. At the same time, a nominally liberal opposition articulates its challenges to judicial nominees not in terms of their qualifications but based on whether they are “in the mainstream” of political discourse —in other words, whether the nominees will take the “correct” political position while on the bench.

Supreme Court Justice Antonin Scalia recently noted that the bitter fights over judicial confirmations are a sign that the courts are no longer about interpreting legal texts but about political decision-making.

If we are selecting lawyers, if we are selecting people to read a text and give it the fair meaning it had when it was adopted, yes, the most important thing to do is to get a good lawyer. If on the other hand,we’re picking people to draw out of their own conscience and experience a new constitution with all sorts of new values to govern our society, then we should not look principally for good lawyers.We should look principally principally for people who agree with us, the majority. . . . And that is why you hear in the discourse on this subject, people talking about moderate, we want moderate judges. What is a moderate interpretation of the text? Halfway between what it really means and what you’d like it to mean? There is no such thing as a moderate interpretation of the text. Would you ask a lawyer, “Draw me a moderate contract?” The only way the word has any meaning is if you are looking for someone to write a law, to write a constitution, rather than to interpret one.

Politics has captured the American legal system, an inevitable consequence of the judicial activism that flowed from the New Deal-era capitulation of the courts to legislative and executive power. As a result, interest groups from business lobbies to “public interest” groups see the courts as simply one more battlefield on which to seek special treatment. Many profit from this state of affairs — lawyers, lobbyists, regulators, and the interest groups themselves. They are not interested in ceding this profitable arena by acquiescing in the reinstitution of the rule of law.

All is not lost, however. Old constraints have revived. Richard Epstein’s book Takings (1989) launched a revival of the federal takings doctrine that promises to yield some limits to special-interest legislation. (The current Supreme Court’s determination not to follow Epstein’s analysis through to its logical conclusions is limiting the impact Takings ought to have. Unfortunately the decision in Kelo v. City of New London is only the most recent example of this.) Last year the Michigan Supreme Court reversed its pernicious Poletown decision and reinvigorated its state constitutional takings jurisprudence (County of Wayne v. Hathcock). Restoring the rule of law will be a long hard road, but articulating the benefits can help create the atmosphere in which it is possible. Ideas matter—and on this issue classical liberals have the better idea.