From its origin as a distinct secular scientific discipline with the French Physiocratic school in the middle of the eighteenth century, and the British classical school that followed, economics had a pro-market, limited-government orientation. Indeed, intellectual historians and political philosophers often refer to it as “economic liberalism,” in contrast with the classical liberal political philosophy of natural rights, human equality, and constitutionally limited government, which emerged somewhat earlier. Complementing that political philosophy, the teachings of the economists are known to have helped institutionalize liberal regimes and policies based on private property and voluntary exchange.

The effects of such regimes and policies were startling, first in Britain and then in America. Centuries of medieval stagnation gave way, and for the first time in recorded history, continuing economic growth with rising real incomes for ordinary persons became the norm. In the eighteenth century, real income had stagnated in the American colonies under British mercantile policy. Over the nineteenth century, however, closely following ratification of the Constitution in 1788, real incomes in America grew at an average annual rate 50 times above that experienced in the Old World during the sixteenth and seventeenth centuries. Average life spans rose rapidly, and life-changing inventions and innovations of all kinds emerged at a dazzling pace.

Fairly early in the twentieth century, however, most economists in America succumbed to the interventionist perspective of political progressivism and welfare liberalism. In this “public interest” perspective, the regime of private property and voluntary exchange was and is believed to be subject to massive and frequent market failures—externalities, monopolies, corporate exploitation of workers, and so on—which are assumed to require interventions by public-spirited government officials in the form of taxation, subsidies, or administrative regulation.¹ For decades economic analysis focused strongly on the nature of market failures and on regulatory prescriptions. Government intervention expanded apace, progressively restricting economic freedom.

However, a reversion of opinion by many economists back toward the classical-liberal roots of the profession began in the 1960s and accelerated in the 1970s due to three developments. The first was the increased professional influence of Milton Friedman and the Chicago school of economics, which had a strong free-market orientation. The second factor was that economists had, by that time (the 1960s), several decades of regulatory practice to observe and analyze. The picture emerging from careful studies was not one of social problems being cured by beneficent regulators. The third factor was the resurgence of the Austrian school, which had always defended free markets and opposed statist interventionism, but which had almost disappeared in the 1940s.

Oddly (or perhaps not so oddly), this resurgence of skepticism among economists about the political motivations for and beneficial character of government intervention overlapped a new burst of regulatory activity in the late 1960s and early 1970s. In that period the Johnson and Nixon administrations established the EPA, OSHA, NHTSA, CPSC, and many additional regulatory agencies with enormous budgets and vast powers. Since then, evidence has continued to accumulate that regulation normally does more harm than good. If regulatory activities were in fact solving social problems and overcoming market failures by acting to end racial discrimination, business monopoly, labor exploitation, externalities, unsafe working conditions, and the like, they should have increased productivity and economic growth.² Instead, after 1972, productivity growth fell below its historic 2 percent long-run annual average, and stayed below it for over 20 years, in an episode economists termed the Great Productivity Slowdown. Richard K. Vedder has shown empirically that increasing regulation was a primary cause of the slowdown and that we suffered staggering losses in real income as a result.³

Politics of Intervention

Suspicion among economists over the motives for regulatory intervention emerged not only because the forms and effects of regulation diverged from economists’ models and predictions, but also because firms were often observed seeking regulation, rather than opposing it. Major firms in the trucking industry, for example, had lobbied for passage of the National Motor Carrier Act of 1935, bringing the industry under regulatory control of the Interstate Commerce Commission, which had been created in 1877 to regulate the railroads. And in 1938 the airlines lobbied Congress to pass the Civil Aeronautics Act, establishing a government-enforced cartel over the air-passenger industry.⁴

George Stigler was among the first economists to wonder whether, given that economic agents often demand regulation, something like market exchange was occurring between those parties and legislators. He was a pioneer in attempting to model supply and demand in such a market.⁵ A student of industrial organization and cartels, Stigler was aware that private cartels are unstable: The fixing of a price above the competitive level motivates members of the cartel to undercut the fixed price for personal gain. Also, the high price attracts outside competitors into the market, adding to supply and making it impossible to maintain the cartel price. He also knew that entry can be prevented, and cartel arrangements enforced, if the cartel can persuade the government to use its coercive legislative and police powers in those efforts.

Political officials will not grant and enforce such a legal cartel arrangement for nothing, however. Private interests seeking monopoly or cartel gains at the expense of their competitors and the public will have to pay the politicians for granting them. The payments assume diverse forms, such as campaign contributions, wining and dining by lobbyists, literal bribes, speaking fees, and the promise of jobs after their political careers end. In essence, the politicians operate an auction market where various interests bid for redistributive legislation. Obviously, this may take many forms beyond the literal regulatory cartelization legislation stressed by Stigler. Examples include efforts by firms and other private interests to obtain such things as targeted income transfers, farm price supports, tariffs on imports competing with domestic products, and so on.

The key social problem associated with private efforts to obtain redistributive legislation (termed “political rent-seeking”) was made clear by Gordon Tullock, in another breakthrough paper.⁶ Scarce resources (money and lawyers’ and lobbyists’ time, among other things) that are used in such efforts are diverted from more productive uses, and the real output they would have otherwise generated is lost. Indeed, Tullock demonstrated that when rent-seeking is competitive, the entire discounted present value of the prospective future gains being sought through redistributive legislation will be expended as rent-seeking costs. Redistributive politics is thus a negative-sum game. There are winners and there are losers, but the sum of the losses exceeds the sum of the gains, and the members of society as a whole are made poorer than they otherwise would be.⁷

Recently there has been another breakthrough in describing the interaction between political authorities and private interests. Economist Fred S. McChesney of Northwestern University noticed that many payments by private parties to legislators could not be explained as efforts to obtain economic rents at public expense through legislation. Instead, the parties making the payments were simply attempting to protect wealth and income they already possessed from being reduced or eliminated by costly legislation targeted at them. The basic insight here seems obvious: Politicians who have the power to grant special benefits, and can generate payments from private interests seeking to be the beneficiaries, will also have the power to impose legislative harms and can generate payments from private parties by threatening to do so.⁸ McChesney calls this process “rent extraction,” or legislative extortion.

This can take many forms, including threats to impose excise taxes or costly regulation (including price controls), or even threats to deregulate industries previously cartelized through regulation. Officials in federal, state, and local regulatory agencies can also engage in rent-extraction by such practices as threatening to withhold licenses required to do business or to initiate antitrust prosecutions. It is notable, for example, that Bill Gates gave little in political contributions before the Microsoft prosecution and has given very much since it began.

McChesney stresses that, just as with political rent-seeking, there are real costs associated with rent extraction. First, the risk that government officials will use their legislative or administrative power to reduce private returns on invested capital diminishes the incentive private entrepreneurs have to invest in the first place. In addition, there are transactions costs (including bargaining and information gathering) incurred in the process. Also, risks of rent-extraction motivate some economic agents to hide their resources to avoid political extortion, and there are deadweight costs associated with doing so.

Public Choice economists have long argued that minimizing rent-seeking behavior and its associated costs requires constitutional reforms restricting the power of legislators to grant special favors. Few people will waste time or money trying to influence a legislator who has no power to grant them a subsidy or protected position in the market. McChesney likewise recognizes that limiting government authority to its minimum legitimate functions would minimize rent-extraction. Who would make extortion payments to politicians lacking power to carry out their threats?

A Look Back

The immediate question becomes whether such constitutional reforms are feasible. History provides a fairly unambiguous answer, because such reforms have been applied, and have worked, in the past. The fact that the U.S. Constitution placed so many prescriptive (Article I, section eight) and proscriptive (including Article I, section 9, and the Bill of Rights) limits on the legislative power of Congress is a primary reason so little interventionist activity was engaged in at the federal level before the Civil War. State officials, in contrast, were under much less constraint and engaged in a great deal of rent-seeking and rent-extracting economic intervention. When the effects of such activities became clear to the public, however, constitutional reforms were applied at that level of government also. Oddly, this history is little known.

One of the first political parties in the United States, the Federalists, was a mercantilist party advocating central banking, internal excise taxes, and federal funding of the building of canals and turnpikes.⁹ Its Jeffersonian opponents in Congress, citing a lack of constitutional authority, predicting that fraud and collusion would result, and stressing the regional redistributions likely to be generated by any particular transportation subsidy, largely frustrated the Federalist program of “internal improvements.” At the state level, however, constitutional provisions were less restrictive and the case for canal and turnpike subsidies seemed initially more compelling.¹⁰

State officials wanted to subsidize grandiose canal and turnpike projects precisely in such instances where market entrepreneurs were unwilling to venture because of likely unprofitability. The officials easily assumed—usually falsely—that subsidies would make those projects profitable. In some cases, such as the Erie Canal, built by New York state with borrowed money and revenue from an excise tax on salt between 1817 and 1825, that appeared to be true. The Erie made money, though its profitability was mostly due to the state’s suppressing of competition from other canals and railroads built along segments of its route.

The apparent success of the Erie, however, motivated New York and other states to subsidize many other projects. These subsidies, often in the form of state stock or bond purchases to capitalize franchised private builders, were associated with massive and repeated rent-seeking corruption, generating political scandals that outraged the public in state after state. Worse, most of the projects lost money, and the financial conditions of the states heavily involved in such projects consequently deteriorated, putting many of them in serious trouble.

Problem Exacerbated

The development of the steam railroad engine and rapid expansion of the railroad industry after 1830, though an enormous stimulus to economic growth through reduced transport cost between locales not capable of being connected by waterways, in some ways exacerbated the problems of the state governments. For one thing, the railroads, like the turnpike and canal corporations before them, had to obtain incorporation charters or permits from the governments. In return, state authorities frequently extracted rents. Canal and turnpike companies lobbied state legislators to prevent competing railroads from being built. This motivated counter-lobbying from the railroads, further enriching the legislators, but wasting scarce resources.¹¹ In many cases, the legislators offered subsidies to the railroad bidding highest for the legislative franchise to build a particular route. Consequently, many railroads were built to obtain the subsidies not to profit from operations. Such roads were often not completed, or otherwise lost money, leaving the states further in debt.

By the early 1840s the citizens in many states had had enough of scandals and financial crises generated by “internal improvement” subsidies. Around 1842, under pressure from angry citizens led by Jacksonian reformers, Indiana, Illinois, and Michigan all amended their constitutions to forbid or restrict their legislatures from providing subsidies to private corporations. They were followed in 1845 by Louisiana, in 1846 by New York, in 1850 by Kentucky, in 1851 by Maryland and Ohio, and in 1857 by Missouri and Pennsylvania. On top of this, under the same public pressures, many states had begun passing general incorporation laws, allowing virtually any group of aspiring business associates to incorporate. This removed state power to extract rents from private parties to obtain or retain incorporation, and also made corporations truly private, rather than quasi-public, business entities.¹²

These events significantly contracted the boundaries of the public sector relative to the private sector, providing crucial conditions for rapid economic growth to occur in the remainder of the nineteenth century.

This massive public revulsion and wave of constitutional and legal reform had important national implications. Mercantilist interventionism had been dealt an enormous blow, and, with it, so had a major political party. Since 1834, the mercantilist party in the United States had been the Whigs, who favored public infrastructure subsidies, paper money, and high tariffs. Their opponents were the Jacksonian Democrats, who had a classical-liberal ideology favoring low tariffs, hard money, and opposition to government economic interventions. The rejection of mercantilism by the public was to no small extent a rejection of the Whigs. This and other factors caused the Whig party to break up and be replaced by the Republican party after 1854.¹³

What followed then, we all know: a civil war over tariffs and slavery that badly injured the South and, with the Southern Democrats out of Congress, a new wave of statist and mercantilist policy under the Republicans, including the corrupt and unnecessary federal subsidization of the first transcontinental railroads.¹⁴These traumatic events seem to have overshadowed and reversed an enormous victory for those who favored limited government and opposed corrupt rent-seeking and rent-extraction, which occurred over the two decades prior to the war.

Notes

1. See, for example, Leverett S. Lyon and Victor Abramson, Government and Economic Life: Development and Current Issues of American Public Policy (New York: Brookings Institution, 1940).
2. For the logic of this claim, see James Rolph Edwards, Regulation, the Constitution, and the Economy: The Regulatory Road to Serfdom (Lanham, Md.: University Press of America, 1998), pp. 166 and 169–70.
3. Richard K. Vedder, “Federal Regulation’s Impact on the Productivity Slowdown: A Trillion Dollar Drag,” CSAB Policy Study Number 131, July 1996.
4. See William A. Jordan, Airline Regulation in America: Effects and Imperfections (Westport, Conn.: Greenwood Press, 1979 [1970]).
5. George Stigler, “The Theory of Economic Regulation,” Bell Journal of Economics and Management Science, Spring 1971, pp. 3–21.
6. Gordon Tullock, “The Welfare Costs of Tariffs, Monopoly, and Theft,” Western Economic Journal, June 1967, pp. 224–32. For a description of rent-seeking see Sanford Ikeda, “Rent-Seeking: A Primer,” Ideas on Liberty, November 2003.
7. This is so not just because of the rent-seeking cost, however, but also because of the overhead costs of administering the transfers or regulating the cartel, the deadweight costs of taxation to finance such activities, and so on.
8. Fred S. McChesney, Money for Nothing: Politicians, Rent Extraction, and Legislative Extortion (Cambridge Mass.: Harvard University Press, 1997).
9. It is important to know that the late medieval European monarchies were mercantilist, rent-seeking societies, replete with franchised monopolies, cartels, and trade restrictions. Mercantile practices had to be largely eliminated for free societies with efficient market systems to emerge. The motives for mercantile policies never quite disappear, however.
10. The standard source here is Carter Goodrich, Government Promotion of Canals and Railroads (New York: Columbia University Press, 1960). Goodrich’s bias, however, is easily shown. Repeatedly implying that state and federal subsidies were beneficial on net, he never once even mentions James J. Hill, who built the Great Northern Transcontinental railroad in the 1890s without a cent of either federal or state subsidy, an achievement that dwarfs the building of the Erie Canal.
11. Stewart H. Holbrook, The Story of American Railroads (New York: Crown Publishers, 1947), p. 231, describes these conditions well.
12. Robert Hessen, In Defense of the Corporation (Stanford Cal.: Hoover Institution, 1979), pp. 29–30.
13. The failure to recognize the nature and importance of these events leads historians to vague and convoluted explanations for the demise of the Whig party. See, for example, Michael F. Holt, The Rise and Fall of the American Whig Party (New York: Oxford University Press, 1999), chapter 26.
14. See Burton W. Folsom, The Myth of the Robber Barons (Herndon, Va.: Young America’s Foundation, 1991), chapter 2.

Despite the enormous gains this form of social organization generated for ordinary people, particularly in America, a political and ideological reaction began after the Civil War, when industrialization was proceeding rapidly, and lasted more than a century. A key claim of the partisans of this view–who originally called themselves Progressives–is that large corporations not only dominate capitalist society economically, essentially abolishing market competition, but also dominate the political system. So most, if not all legislation, serves the wealthy corporate interests. Karl Marx may have originated this argument, but to this day, shorn of its Marxist metaphysics, it is the majority perspective among the intellectual and political classes in America. Even many conservatives, and a few libertarians, adhere to this perspective.

Most staunch free-market advocates and political libertarians argue, to the contrary, that the dominant political and ideological impulse of the twentieth century in America and the West has been statist and anti-capitalist. In this view the “corporate domination” argument is simply a key element in that statist ideology, used to justify legislation enhancing governmental power and reducing human freedom. In an essay published several decades back, Ayn Rand made the connection clear when she wrote: “Every movement that seeks to enslave a country, every dictatorship or potential dictatorship, needs some minority group as a scapegoat which it can blame for the nation’s troubles and use as a justification of its own demands for dictatorial powers. In Soviet Russia, the scapegoat was the bourgeoisie; in Nazi Germany, it was the Jewish people; in America, it is the businessmen.”¹ Rand went on to claim, with some justification, that businessmen, big businessmen in particular, were America’s most persecuted minority, using the inequities of the antitrust laws to illustrate her argument.

Certainly, things are somewhat more complicated than Rand claimed in that essay. One need not believe that an all powerful conspiracy of international bankers and wealthy capitalists lies behind the statist movements of our day to recognize that businessmen have often supported extensions of state power. This was particularly so in the decades after World War I. Woodrow Wilson had centralized power in Washington during the war and exercised regulatory command and control over the economy. He drew many corporate executives into the government to operate the bureaus he created, and many of them found they preferred issuing and enforcing orders over attempting to motivate and manage voluntary, contractual employees, who could quit at will.

Thus some big-business executives came to the same elitist, technocratic view held by most intellectuals and academics: that ordinary people are too ignorant to run their own lives, much less largely determine, through their consumption and employment choices, the allocation of resources in society. It follows, in this view, that experts should run things by fiat, maintaining only a thin veneer of democracy and free markets. Franklin Roosevelt drew heavily on this pool of statist business executives to staff his administrations during the Great Depression.

Economists have also found reason to recognize that businessmen often act to extend government power and attenuate market competition. George Stigler developed the economic theory of regulation in the late 1960s, arguing that, instead of regulation being imposed on industries in genuine democratic response to the desires of oppressed and abused consumers, firms often actually seek government regulation in an effort to gain monopoly or cartel powers they cannot obtain by market methods. The historian Gabriel Kolko, in a detailed study of the Progressive era, made a similar argument a few years before Stigler. Rand herself, in many of her works, recognized the existence of such corrupt businessmen. Thus statist and corporate interests and ideology may converge at least to some degree, leaving a limited-government, free-market perspective as the only logical opposition.

Temporary Allies

Still, businessmen and statists can at best be temporary and uneasy allies. The majority of businessmen are honest, and unlike the intellectual, academic, and bureaucratic classes in America, where a statist view dominates, business interests are too diverse to generate a consistently statist legislative impulse. Some import-competing businesses, for example, will lobby for government to pass a tariff to raise the price of a product they sell domestically. Other businesses that use that product as an input, however, will oppose the tariff. Also, attitudes of firms toward regulation sometimes reverse. The airline industry sought the creation of the Civil Aeronautics Board and the airline cartel in the 1930s. But when their profits were absorbed by airline unions in the 1970s and many airlines were frustrated by the CAB in their efforts to compete on particular routes, much of the industry supported deregulation. Business groups donate to all influential parties and political groups, unlike labor unions, which donate exclusively to statist groups. Much business lobbying is essentially defensive, aimed at staving off oppressive and costly regulation, often unsuccessfully.

Most of the basic legislative structure in America conflicts with the view that legislation is dominated by wealthy corporate interests. Consider the tax structure. If such interests dominated, would the Sixteenth Amendment ever have been adopted? Would the personal income tax it allowed Congress to establish have become progressive, with a top rate that at times has been as high as 90 percent? Would over 70 percent of all revenue collected through the personal income tax come from the top 20 percent of income-earning families, as it has since the mid-1990s?

Again, if the wealthy corporate interests dominated government and legislation, would there ever have been a corporate income tax? Such a tax, levied on the net income of firms before distribution to investors, actually taxes the incomes of stockholders twice. That is because all the net income of the firm is generated by capital supplied by those investors, whose incomes are then taxed again, through the personal income tax, after distribution through stock dividends. As a result, the actual tax rate on investor income is enormously higher than the stated personal income tax rate. Certainly, rational capitalists would not have allowed such a grossly unfair and costly law to pass had they the power to stop it. The corporate income tax disadvantages corporations relative to other forms of business organization, such as partnerships and proprietorships, which suffer no such double taxation. If wealthy corporate interests dominated our political system, would they ever have allowed such a thing?

Similarly, would they have accepted a law compelling businesses to withhold the taxes of employees? Income-tax withholding forces firms to act as tax collectors for the government at their own expense. This is done without compensation of any kind, in violation of the Fifth Amendment takings clause of the Constitution, and against their wills, in violation of the Thirteenth Amendment injunction against involuntary servitude. Withholding imposes an economic burden that corporate or other business interests would not have willingly accepted had they the power to prevent it. Do not such policies in fact reflect an anti-capitalist animus?

Corporate Control?

The notion that a corporate elite dominates the nation politically presumes also that large corporations are able to control prices, output, and entry in their industries on an enduring basis, as John Kenneth Galbraith has long claimed. Though in some industries this has clearly occurred, precisely through corporate lobbying to secure franchises and monopoly or cartel protection (the electric utilities are a good example), there is precious little evidence of any successful system-wide abolition of competition. Precisely the opposite seems to be the case. The turnover of dominant firms in particular industries is far too high, and the market shares of firms in concentrated markets far too unstable year to year, to support any view that being top dog guarantees continued dominance. Add to this the rapid and constant innovation we observe, and such turnover and market-share instability indicates that most firms gain large market shares by satisfying customers with lower priced and/or higher quality products than their competitors, and lose share when they stop doing so.

The evidence regarding macro concentration points to the same conclusions. Any simple comparison of the Fortune 500 lists of the largest industrial corporations in 1980, 1990, and 2000, for example will impress an observer with the impermanence of corporate domination. Likewise, Gary Quinlivan recently compared the Wall Street Journal lists of the world’s top 100 firms ranked by market value for 1990 and 1999, and found that there were 66 new firms in the 1999 list. He also reports that the United Nations, comparing lists of the top 100 nonfinancial multinational corporations for 1990 and 1997, found a 25 percent turnover. This is less impressive than the Wall Street Journal comparison, but still an enormous turnover of top firms in just a few years.²

Using data available in the 1986 to 1996 editions of the Statistical Abstract of the United States, I recently found some remarkable changes in U.S. macro concentration between 1980 and 1993. The 500 largest industrial corporations in the United States employ a large fraction of American workers, embody a large part of our productive assets, and produce a large share of our aggregate output. Over those 13 years, however, the assets of the top 500 industrial firms, as a share of total corporate assets, fell by over 20 percent. Employment in the top 500 firms, as a share of total employment in the country, fell even more, by 29 percent. And most amazing of all, the share of gross domestic product generated by those firms fell by an astonishing 39 percent over that short period.³

Clearly, the turnover in any list of the largest corporations is inconsistent with the naïve view that large firms are able to abolish competition and insure their continued dominance. So is the evidence on the output, employment, and assets of large firms in the aggregate. Assets, employment, and market share have clearly shifted significantly to small- and medium-sized firms in the last two decades. Such firms have competed with increasing success against larger corporations in a computerized and internationally integrated economic environment. Would any economically and politically dominant class of wealthy capitalists in big corporations have allowed such an enormous decline in their relative wealth and power to occur if they could have stopped it?

In fairness, it should be noted that these economic events are also not entirely consistent with the view that the statist and anti-capitalist ideology held by most members of the intellectual, academic, bureaucratic, and media elites still dominates the legislation process. Certainly that was true for most of the twentieth century, as illustrated in the graph showing both federal government expenditures (FGE) as a fraction of gross national product and the sum of federal and state expenditures as a fraction of GNP from 1929 to 1990. The data come from various volumes of The Economic Report of the President, which is issued annually by the President’s Council of Economic Advisers. The growth in FGE/GNP, from about .025 (or 2.5 percent) in 1929 to .233 in 1990, nearly ten times as large, clearly, if imperfectly, documents the size and growth of the leviathan state.

Since about 1980, however, the ideological and political grip of statism has begun to loosen. Statist policies of regulation and income redistribution have visibly failed. Slowly, some of the statist fetters have been lifted from the economy, allowing entrepreneurship and economic growth to continue. Federal outlays actually fell from 21 percent of gross domestic product in 1994 to only 18.8 percent in 1999 (GDP replaced GNP in the National Income and Product Accounts after 1990). This nearly 10.5 percent decline in the relative size of government, and commensurate release of resources to the private sector, more than any other thing, accounted for the rapid economic growth of the late 1990s. Many statist policies still advance, of course. Things hang in the balance, but the tide seems to have incrementally turned toward restoration of a freer society. Whether that trend will continue or be deflected in a statist direction again by the terrorist attack of September 11 remains to be seen.

James Rolph Edwards is an associate professor of economics at Montana State University-Northern in Havre, Montana.

Notes

1. Ayn Rand, “America’s Persecuted Minority: Big Business,” in Ayn Rand, ed., Capitalism: The Unknown Ideal (New York: Signet, 1967), p. 45.
2. Gary Quinlivan, “Multinational Corporations: Myths and Facts,” Religion and Liberty, November and December 2000, pp. 8-10.
3. James Rolph Edwards, “The Myth of Corporate Domination,” Liberty, January 2001, pp. 41-42.

Overbeek, professor of economics at the University of the Virgin Islands, divides the book into historical periods and for each one presents writings by the most prominent writers on both sides of the issue. He gives a short history of the periods regarding international trade and the public debate over the issue, and discusses how government policies were affected. He also provides a biography of each author and a summary of his arguments.

In his choice of material, I give Overbeek an A-plus. The most important writers are included, from Thomas Mun through Alexander Hamilton, Friedrich List, Mussolini, John Maynard Keynes, and Robert Reich on the protectionist side, and from David Hume and Adam Smith through John Stuart Mill, Ludwig von Mises, Gottfried Haberler, Melvyn Krauss, and Paul Krugman on the free trade side. Moreover, the extracts Overbeek has selected are all readable by anyone with even a rudimentary familiarity with economics. Abstruse mathematics is thankfully absent. My only criticism is that some of the readings are longer than necessary to make the author’s argument, while others seem too short. In an apparent attempt to shorten the book to its still-daunting 656 pages, the writings of some key economists (Henry Hazlitt and Milton Friedman chief among them) have been left out in favor of summaries by Overbeek.

The book’s virtue is that it clearly presents the arguments of both sides on the free trade debate. One cannot read both with any objectivity without seeing that the free traders have by far the stronger arguments. Interestingly, the reader observes that the brilliant breakthroughs occurred early on and that the principles established have never been overthrown. Particularly crucial are Ricardo’s demonstration of the principle of comparative advantage and David Hume’s demonstration of how monetary flows through international payments imbalances alter exports and imports to bring equilibrium to those balances and generate a natural distribution of specie. Those arguments destroyed the rationales of the mercantilists for trade barriers.

From then on, the case for free trade evolves only in detail and sophistication. The point of production is consumption, not vice versa, and the point of trading internationally is the imports we can thus obtain more cheaply (literally using fewer domestic resources) than if we produced them ourselves. Exports are simply the way we pay for imports. What is more, international trade has little effect on domestic employment, except to allocate labor from less efficient to more efficient uses.

Just as important as the compelling arguments in favor of free trade, the readings also illuminate the sordid history and motives of the protectionists. They never grasp the truly anti-social nature of their project, which is characterized by blind nationalism, chauvinism, and xenophobia. Even otherwise democratic and “liberal” protectionists must be made uneasy when they see their association with dictators and authoritarians of every stripe, all of whom adhere to the same protectionist doctrines they do.

The book contained many surprises for me. I was amazed at the brilliance of Nicholas Gerard Pierson, arguing for free trade in the late nineteenth century, whose work was unknown to me. On the other hand, I was disappointed to read the unwarranted concessions made to protectionism by such eminent free traders as F. W. Taussig, A. C. Pigou, and Lionel Robbins.

The biggest surprise for me was historical. It is common knowledge that the reaction against classical liberalism that eventually generated the totalitarian states and world wars of the twentieth century began in Germany in the nineteenth century. But without Overbeek’s book, I would not have known that Friedrich List, the father of German protectionism, lived in the United States and was heavily influenced by American protectionists such as Alexander Hamilton and Daniel Raymond, by whom he became convinced that protectionism had been vital to American economic development. List returned to Germany and spread that erroneous view with great and catastrophic effect. Hamilton has always been my least favorite among the Founders, and now I see that he and his ilk have even more to answer for than I had previously supposed.

There is far more in this book than can be described in a short review. It is costly to be sure, but you definitely get what you pay for.

James Rolph Edwards is professor of economics at Montana State University.

The ADA is a perfect example of the harmful character of coercive morality legislation that harms society at large without even benefiting, on net, those it seeks to help.

Someone once said that the world is not only a stranger place than we know, it is a stranger place than we can know. Whether that is true or not, upon close examination it often turns out to be quite different in crucial respects than we had previously believed. Consider the theory of externalities, in which a distinction is made between the social costs and private costs of human actions and transactions. Normally, the voluntary trades that characterize production and exchange activities in market economies are mutually beneficial to the parties involved a priori because each exchanges something they want comparatively less for something they want comparatively more. Each bears the private costs of his actions generated by alternate uses forgone in the decision to use the resources employed in the way that they were. A meaningful difference between the social costs generated by these actions and the private costs exists, however, when unintended costs (often termed external costs) are imposed on third parties. In such cases, too many resources will be employed in the industry or activity involved, because only the private costs and benefits are being considered by the parties generating the externalities, and the private costs are by definition less than the true social costs.

The quintessential examples are air and water pollution, which affect the environment adversely and often pose human health hazards. It has come to be accepted by many economists that in such cases the government is justified in imposing some sort of coercive regulatory policy to reduce the external costs generated and to obtain a more correct resource use. Other observers—including many leaders of the environmental movement—extend this logic to a more radical conclusion. They believe that pollution and waste are so pervasive and threatening that government must either socialize the economy, taking full control of industry to end pollution, or force an end to industrial/technological market society itself in order to save the human race.

A variety of arguments can be marshaled in opposition to these views. First, solutions more consistent with the maintenance of a free society, such as specification of private property rights (since externalities are a common-property problem) and tort law (in which those harmed sue for compensation) can often be applied to solve or reduce externality problems.

Second, industry and technology—in the forms of such things as medicine and sewage, and water treatment—have often been intentionally employed to improve human health.[1] Indeed, as measured by mean life expectancy—the single best summary indicator of environmental risks faced by human beings—people face fewer such risks now than ever before in human history, and do so as a direct result of technical and economic progress in the market economy.

Third, the whole externality effects of industrial market society are being mischaracterized. As industry and technology develop, some forms of pollution are generated and others are eliminated. The electric stove largely ended the breathing of wood smoke in the home. The automobile ended the scourge of horse manure in cities, which would otherwise constitute a terrible source of pollution and a public health threat. As an inherent element of technological development, firms have progressively discovered and employed more and more efficient sources of fuel and power generation in order to reduce costs under competitive market pressures. This caused pollution per unit of output generated to decline steadily long before the EPA and the 1970 Clean Air Act were created. Indeed, according to economist Paul MacAvoy, there is no evidence that those regulatory mechanisms improved on that record.[2]

A closely related point constitutes the central argument of this paper. While it is true that market activities often generate externalities, and new technologies often have unintended side effects, nobody has ever offered a convincing reason why such external effects should more frequently be detrimental than beneficial. Creation of the automobile generated traffic and mobility problems that Henry Ford and other developers of the technology never foresaw, but it also eliminated local monopolies and monopsonies by integrating markets (as well as eliminating horse manure pollution), which was also no part of their intent. Environmental ideology, however, and the regulatory policy it drives, are biased toward finding the detrimental side effects of market industrial activity, and ignoring or mischaracterizing the beneficial effects. The example of industrial CO₂ emission is striking.

Carbon dioxide is quantitatively the largest single emission of free market industrial/ technological society, and over time these emissions have begun to add substantially to atmospheric CO₂ concentration. Automobiles contribute heavily by emitting carbon monoxide, which is unstable and quickly mixes with atmospheric oxygen to form carbon dioxide. Most economists and all environmentalists treat CO₂ as an unqualified pollutant; that is, a substance which generates only external costs. As one of the primary greenhouse gases, industrial CO₂ emission is accused of being a primary factor generating global warming, that is, raising lower atmospheric temperatures over time. Such rising temperatures are asserted to be eventually capable of melting the ice caps and causing deserts to expand, threatening disastrous loss of land area and increasing famine. Consequently, the argument goes, massive government controls and interventions must be employed to reduce industrial CO₂ emission.

Actually, the evidence that global warming is even occurring, much less that human CO₂ emission is generating such warming, is very weak. Most ground station atmospheric temperature time series show no warming in the last forty or fifty years, though one data series does show a very slight temperature rise.[3] Tyros N satellites, in orbit since 1979, may eventually settle the matter. They use an extremely sensitive system of microwave radiometers to measure lower atmospheric temperature. The satellite observations cover a large area at a time (a circular “footprint” 110 km in diameter) and are not restricted to land, as are most surface based temperature recording systems. Over this period in which, by global warming theory, temperatures should have risen more rapidly than ever before in human history, since industrial CO₂ emission has been larger than ever before, the satellite data show no upward trend in global temperature at all.[4]

If the effect of industrial CO₂ emission on lower atmospheric temperature is obscure and debatable, however, certain other effects are not, or at least should not be. CO₂ is the primary nutrient that plants use in transforming sunlight into plant matter (carbohydrates) through photosynthesis. That is, plants grow by transforming CO₂, other nutrients, and sunlight into plant matter. For various natural reasons, many of which are unknown, atmospheric CO₂ concentration has varied widely over the earth’s history. The last Ice Age seems to have reduced the CO₂ level far below concentrations existing in earlier historic periods. Indeed, it may have reached a level within 100 parts per million (PPM) of being too low to sustain life on earth.[5]

The significance of this is that industrial CO₂ emission is correcting what is, in terms of the Earth’s geological and ecological history, an imbalance of atmospheric CO₂ on the low side. In particular, as Sylvan Wittwer, Professor Emeritus of Horticulture at Michigan State University explains, at current atmospheric concentrations (about 365 PPM), CO₂ is the limiting nutrient in plant growth, the one plants cannot obtain in adequate amounts. Increasing atmospheric CO₂ concentration increases plant growth. Wittwer explains that it also makes plants healthier and tends to benefit common food plants more than it does common weeds.[6] The beneficial effects of CO₂ are well established in the scientific literature, and the knowledge is so common in some circles that nursery owners have been deliberately enriching the CO₂ content of the atmospheres in greenhouses to as much as 1,000 PPM for decades.

In economic terminology, the point is that, at current atmospheric concentrations, industrial enrichment of atmospheric CO₂ has a positive marginal product for plant growth. Many hundreds of scientific experiments have been conducted to determine CO₂ productivity effects on particular plants, which often yield startling results. Recently, for example, Sherwood Idso, a well known soil physicist at the U.S. Water Conservation Laboratory in Phoenix, Arizona, planted two groups of orange trees in the ground in identical soil and climate conditions. In similar experiments the plants are usually grown in laboratory pots, so Idso’s experiment more closely approximated real world conditions. Then he enriched the atmospheric CO₂ content around the second group of trees by 75 percent and observed the two groups over time. Trees in the CO₂ enriched group bore fruit a year earlier than the control group, and after three years were 2.8 times as large on average. Their fruit yields were enormously larger, and by every measure of plant vitality they exceeded the control group.[7]

A Greener World?

Evidence is accumulating that industrial CO₂ emission is increasing plant growth around the world. For example, scientists at the Finnish Research Institute, in a recent study of European forests, discovered that there had been a 25 to 30 percent increase in the growth and growing stock of those forests between 1971 and 1990, which they attribute at least partly to the increase in atmospheric CO₂ over the period.[8] They strongly hinted that this process is probably operating world wide. Other data indicate so. At Mauna Loa recording station in Hawaii, scientists measure the amplitude of the oscillation in atmospheric CO₂ concentration between summer, after spring plant growth has reduced the concentration, and winter, after much vegetation has died and returned CO₂ to the atmosphere. The scientists report that this oscillation, which is known as the “breath of the biosphere,” has increased by 15 percent since 1959, indicating that plant sequestration of CO₂ has risen that much in the northern hemisphere over this period.[9] If so, this CO₂ “fertilization” effect must be more than offsetting deforestation in the tropics, indeed, it may automatically compensate as rain forest trees are cut and stop sequestering atmospheric car bon through growth, leaving more in the atmosphere to generate and be removed by plant growth elsewhere.

The world is actually getting greener, then, due to the beneficial effects of industrial CO₂ emission, contrary to the dismal projections of the environmental apocalyptics. On the basis of the Mauna Loa data, Patrick Michaels computes that the probability that the world is not getting greener is only 3 percent. Consumers driving their automobiles, instead of feeling guilty for using depletable fossil fuels, as environmental apocalyptics so ardently wish them to, might justifiably take satisfaction in helping to feed the world’s billions, since that is exactly what they are doing. It is safe to say that economic models which exclude such a systematic, beneficial externality, cannot generate accurate estimates of the costs or benefits of CO₂ emission abatement, and must systematically overstate the amounts of such emission abatement that is economically justified. They may even get the justified direction of change wrong.

Blinded by Ideology

How can economists studying environmental issues and other effects of technical change and industrial development miss all this? It seems odd that they would, since the theory of externalities makes specific reference not just to external costs but also to external benefits possibly resulting from human actions. Environmental ideology seems to blind most analysts to those benefits. In a recent paper on the issue of global warming policy, William Nordhouse makes the following amazing admission in a discussion of the costs and benefits of CO₂ emission abatement:

In contrast to the cost function, we know little about the shape of the damage function . . . We suspect that higher levels of greenhouse gases will hurt the global economy, but because of the fertilization effect of CO₂ or the attractiveness of warm climates, the greenhouse effect might on balance actually be economically advantageous.[10]

Later in that paper, following a discussion of the various factors that must be considered in assessing the impacts of CO₂ emission and of emission abatement on the global economy, Nordhouse adds the following:

These remarks lead to a surprising conclusion. Climate change is likely to produce a combination of gains and losses with no strong presumption of substantial net economic damages. This is not an argument in favor of climate change, or a laissez-faire attitude to the greenhouse effect. Rather, it suggests that a careful weighing of costs and damages will be necessary if a sensible strategy is to be devised.[11]

Unfortunately, though Nordhouse is among the fairest and most moderate of modern economic analysts dealing with such issues, these observations appear to be unrepresentative of his general philosophy. In an even more recent paper on the same subject, Nordhouse not only completely fails to mention the “fertilization effect” of CO₂, but expresses a highly pessimistic perspective on the risks associated with human industrial activity. That paper begins with a statement, phrased in the best apocalyptic style, that mankind is playing dice with the natural environment through a multitude of interventions. The usual bleak list follows, with none of the potential beneficial effects or side effects of scientific/ industrial progress mentioned.

This attitude carries through to the last section of Nordhouse’s paper, titled, symptomatically, Uncertainties and Anxieties. lie remarks on the relatively small amount of coercive governmental controls for emission abatement his and other economic models justify, with some apparent disappointment, which becomes clear as he then writes the following:

Yet, even for those who downplay the urgency of the most likely scenarios for climate change, a deeper anxiety remains about future uncertainties and surprises. Scientists raise the specter of shifting currents turning Europe into Alaska, of mid-continental drying transforming grain belts into deserts, of great rivers drying up as snow packs disappear, of severe storms wiping out whole populations of low-lying regions, of surging ice sheets raising ocean levels by 20 to 50 feet, of northward migration of old or new tropical pests and diseases decimating the temperature (sic) regions, of environmentally induced migration overrunning borders in search of livable land. Given the potential for catastrophic surprises, perhaps we should conclude that the major concern lies in the uncertainties and imponderable impacts of climate change rather than in the smooth changes foreseen by the global models.[12]

Nordhouse clearly reads different scientists than I do. Most of the elements in this list of potential disasters seem highly unlikely. But notice his uniform concentration on catastrophic surprises, with no hint that beneficial surprises might be equally possible. Nordhouse goes on to point out that society often has to make decisions in the absence of complete information, and that a reasoned decision process lists events that may occur, assigns them probabilities, and weighs the expected values of costs and benefits under alternate courses of action in such a way as to maximize the expected value or utility of the outcome. This standard neoclassical economic argument is difficult to deny. But any society whose intellectual opinion makers and governmental decision makers—like Nordhouse—only presume disasters to be likely, and never beneficial surprises, would arrive at incorrect and harmful policy decisions with unnecessary frequency. Indeed, the progressive extension of controls such myopic disaster prevention policies entail would eventually end the very freedom that has been a precondition of modern human well-being. []

1.   See Steven Gold, “The Rise of Markets and the Fall of Infectious Disease,” The Freeman, November 1992, pp. 412415.
2.   Paul W. MacAvoy, Industry Regulation and the Performance of the American Economy (New York: W. W. Norton & Company, 1992), pp. 96-103.
3.   The data and surrounding issues are discussed clearly and exhaustively in Patrick J. Michaels, Sound and Fury: The Science and Politics of Global Warming (Washington, D.C.: The Cato Institute, 1992). Michaels was Virginia State Climatologist for several years, and was President of the American Association of State Climatologists, 1957—1988.
4.   See Roy W. Spencer and John R. Christy, “Precise Monitoring of Global Temperature Trends from Satellites,” Science 247, March 30, 1990, pp. 1558-1562.
5.   Michaels, Sound and Fury, p. 10.
6.   Sylvan Wittwer, “Flower Power,” Policy Review, Fall 1992, pp. 4-9.
7.   Idso’s experiment is reported both in Michaels, Sound and Fury, pp. 109-110, and Wittwer, “Flower Power,” p. 7.
8.   Pekka E. Kanppi, et al., “Biomass and Carbon Budget of European Forests, 1971 to 1990,” Science 256, April 3, 1992, pp. 70-74.
9.   Michaels, Sound and Fury, p. 12.
10.   William Nordhouse, “To Slow or Not to Slow: The Economics of the Greenhouse Effect,” The Economic Journal
11.   July 1991, pp. 920-937. The quotation is from page 933. I1. Nordhouse, “To Slow or Not to Slow,” p. 933.
12.   William Nordhouse, “Reflections on the Economics of Climate Change,” Journal of Economic Perspectives 77, Fall 1993, pp. 11-26. The quotation is from page 23.

As a professor of economics who wishes to convince his students of the importance of economic insights without overselling economic knowledge, I have always taught my students that even the best economic models have only heuristic value and cannot be expected to explain everything. The proper question to ask about such models is whether we understand more by having the model than we would without it. I argue that this is particularly true of the theory of perfect competition, with its numerous small firms, homogeneous product, and perfect information. It is, at best, a useful analytic device for illustrating, in a simple form, certain things about business decision-making and how economic profits and losses motivate firms to shift resources from lower to higher valued employments. However, there are many important features of the real world that are abstracted from the model. Austrian economists are correct in asserting that real states of market structure and competition which deviate from the model are not necessarily inferior, and may even be superior in crucial respects.

Assuming away such differences is sometimes useful for allowing clear focus on the relationships between a single pair of variables, or the effect of a single change, such as in demand or supply. The real world, however, is not only characterized by variation, but benefits enormously from it. Such variation cannot be ignored if economic and other social phenomena are to be understood.

Consider, for example, the fact that minerals and metals are not spread evenly throughout the earth’s crust, but are distributed randomly with concentrated lodes in some places, and almost none in others. Clearly, if such resources were spread evenly in the earth’s crust it would not have been economically feasible to mine any of them with primitive technologies. Note also, that in the history of economic thought, this uneven distribution of such resources has been one of the prime factors in the theory of comparative advantage used to explain trade flows.

Analogous to resource variability is climate, an under-represented factor in explanations of comparative advantage and trade. How often do we stop to think of the great variety of products that exists as a consequence of the variety of weather and temperature (in combination with soils, minerals, and other factors) around the world? Many types of plants and animals, which flourish in climates a standard deviation or so away from the mean, would not exist if the mean temperature prevailed everywhere. The variety of our consumption options would be greatly restricted as a consequence.

Now consider human variability. The two most crucial dimensions here are in abilities and tastes. Most of us go through life lamenting our apparently low endowment in one or more human abilities, even though we usually have above average endowments in some others. Consider certain obvious consequences that would follow from everyone having the same endowment, equal to the present mean value, of every human quality. For one thing, there would have been no Galileo and no Copernicus to advance knowledge of the universe, and no Edison to create practical products. The basic point here is crucial: The mean intellect is inadequate to make the kinds of discoveries such individuals make, but, amazingly, it is adequate to understand their basics once they are discovered and taught. The existence of individuals with extreme intellectual abilities therefore results in enormous advance in the knowledge of the general public. The absence of variation in such abilities would leave humanity in a perpetual primitive state, at best.

Variation in human abilities also has pervasive economic and social effects. It is another prime source of the comparative advantage that results in specialization, division of labor, and exchange which so greatly increase the aggregate production, wealth, and income of society’s members. Associated differences in knowledge and attitudes give rise to civilized discourse and communication, the arts, and so on, without which life would be much less interesting. In addition, each of us can gain pleasure from the mere observation of abilities we lack being applied. Who among ordinary mortals does not thrill at the sight of Michael Jordan leaping from near the foul line and sailing through an army of defenders to make a left-handed behind the back layup? In the absence of variation in human abilities there would be no Einsteins, Rembrandts, or-Michael Jordans, and I suspect we would all die of boredom posthaste. Such variation also gives rise, however, to differential attainment within all fields of human endeavor, hence differential acquisition of wealth and income. Some resentment results on the part of those who regard themselves as disadvantaged in terms of their endowment of human (or other) resources, or whose accomplishments seem meager. It is easy to argue, however, that under at least some institutional arrangements, specifically private property, limited government, and free markets, there are large social benefits that result from differential attainment of assets and wealth.

Consider, for example, differential skills and attainment in business activities. One of the abstractions of the theory of perfect competition already mentioned is that it assumes away differences in managerial and entrepreneurial ability among the decision makers of the firms in the market. It is often noted that in many real world markets the bulk of assets are concentrated in the hands of a relatively few firms, who also do the bulk of sales. But given the natural variation in managerial ability and entrepreneurial talent, and the great scarcity of extreme abilities of these types, how could things be otherwise?

With a normal statistical distribution of such abilities among corporate decision makers within an industry, there will be a distribution of costs among the firms, with some being high, a few very low, and most in between. But the highest cost firms will lose market share and leave the industry, while the low cost firms will gain market share, increasing both sales and assets. In essence, assets will be transferred within the industry from inefficient, high cost firms to efficient, low cost firms. That means not only that assets and sales in the industry will tend to concentrate in the low cost firms, which will make larger profits than others in the industry, but that industry total output (and hence market supply) will be larger and price will be lower than would be the case under an even distribution of managerial and entrepreneurial talent at the mean value. The consuming public will be enriched. This common, real world market condition is not inferior to the state described by the perfectly competitive model, but superior to it, from the crucial perspective of human well-being.

Human well-being is also enhanced by product differentiation, in which firms in the same industry produce different versions of the same product. This is another variability phenomenon that is omitted from the theory of perfect competition. Product differentiation has at least three sources. The first is that the perfect information assumption of the model does not hold in the real world. Information is an economic good which is costly to obtain, not a free good. In particular, the optimal specification of esthetic and utilitarian properties of the product, which best satisfies consumer taste, is not known a priori or by divine revelation. It must be discovered, and the only available method is to try various specifications on the market. Hence firms do so, each competing to be first to find what consumers regard as the best form of the product.

The second source of product variation is that consumer tastes vary. If consumer preferences were all the same, product variation would be transitory at best. Early in an industry’s history firms might try different specifications, but unsuccessful versions would be eliminated from the market, successful versions would be copied, and product variants would tend to converge over time on the single optimal specification. In reality, however, human tastes often vary widely with regard to the desirable characteristics of a particular product, hence there frequently is no single optimal product specification. Different versions, satisfying various subsets of the product’s consumers, will continually be produced. The third factor generating product variation is that consumer tastes change over time, so that experimentation in product specification is an ongoing necessity.

In this process as in others, participants in the market are continually responding to relative price changes and profit and loss signals in ways that shift scarce resources from the lower to the higher valued of diverse human ends. Here as in so many other ways, humans benefit from variation. The world really would not be a nicer place if all fast food chains produced identical hamburgers, and all cars were the same, as some economists seem to claim. As the Frenchman said, more wisely than he knew, “Vive la différence !”