He claims that the Enron bankruptcy was all “about doing away with regulation” of energy prices and of financial trading. Huh? The regulatory budgets of both the Securities and Exchange Commission (SEC) and the Commodity Futures Trading Commission (CFTC) are at all-time highs, and they employ more regulatory bureaucrats than ever. If anything, the Enron debacle proves once again the ineffectiveness of SEC and CFTC regulation. Enron collapsed despite layers and layers of financial regulation.

Krugman’s claim that Enron used its “political clout” to create a “regulatory black hole” in energy markets is equally absurd. There has been very little, if any, deregulation of energy markets: oil, electric power, and natural gas remain among the most heavily regulated industries in the United States, as they have been for over a century. Radical environmentalists in and outside government continue to impose a regulatory blockade on energy development. What Krugman calls “deregulation” is really re-regulation, or a change in the form of regulation. A good example is California’s crazy electric power regulatory regime that blocks energy development while placing price controls on power, thereby guaranteeing periodic shortages and blackouts. He routinely misleads his readers by referring to this Byzantine regulatory morass as “deregulation.”

Like other anti–free-market commentators, Krugman also spreads the false tale that Enron’s chairman, Ken Lay, was a free-market disciple. This too is, well, baloney. Lay was a member of the group of extreme anti-capitalist ideologues known as the Union of Concerned Scientists. He was also a strong supporter of the Kyoto global-warming treaty. He supported this treaty (which the Bush administration refused to sign on to), because he wanted his company to profit from another Byzantine regulatory scheme concocted by the government: the trading of carbon dioxide emission permits. Lay wanted government-imposed restrictions on carbon dioxide emissions to create an artificial market for air pollution “credits” to be purchased to burn coal. A government-controlled and -supervised “market” is not a genuine market, of course, but more like the failed experiments in “market socialism” that occurred in some of the former communist countries.

Enron collapsed primarily because it made some bad business decisions. It reportedly invested billions in failed power plant, utility, pipeline, and waterworks companies in India, Brazil, and Great Britain. When the profits from these investments failed to materialize, investors got wise and dumped Enron stock. The energy-trading business is competitive and, as with all competitive industries, market leaders can expect their profits to be whittled away by new competitors.

If there was accounting fraud, that’s not a result of “deregulation” but the fact that there are sinners in all walks of life. Governments commit accounting fraud all the time; during the Clinton administration it was reported by Gene Epstein of Barron’s that the Social Security and Federal Highway Trust Funds were being plundered and the money placed into the current-year budget so that Clinton and Congress could take credit for balancing the budget. But don’t expect Krugman ever to call for smaller government whenever such fraud is uncovered.

In this respect Enron’s demise is an example of free-market success. The energy trading market in general is thriving; the fact that one firm that once had 25 percent of that market has left the industry is by no means an example of “market failure.”

Wrong on Argentina Too

Krugman is just as wrongheaded in his comments on Argentina. He blames the entire collapse of the Argentine economy on one thing: that country’s adoption of currency boards, as have been advocated by such free-market economists as Steve Hanke of Johns Hopkins University. Once again Krugman commits the post-hoc-ergo-propter-hoc fallacy (after this, therefore because of this). Yes, a currency board existed in Argentina, and yes, its economy has gone down the tubes. But Krugman never even attempts to prove causation. Anything that smells like a free-market institution must, in Krugman’s mind, be the culprit.

In reality, the fault lies with the International Monetary Fund (IMF) and the U.S. government, which have been subsidizing Argentina’s failed statist economic policies for many decades. The IMF promised to subsidize Argentina’s currency-board regime, which caused a flood of investment in Argentine bonds. The Argentine government was known to be hopelessly spendthrift and corrupt, but with the IMF’s guarantee, international investors began earning above-average returns on Argentine bonds with what they saw as virtually no risk. IMF funding created a massive moral-hazard problem.

The Argentine government used this massive influx of credit to enlarge an already bloated government sector, which always causes the private sector to shrink. Government spending doubled during the decade of the 1990s, far outstripping personal income growth. When a recession hit in the mid-1990s, the government responded in a prototypical Keynesian way by spending even more extravagantly and accumulating more debt. Private investors began shying away from Argentine bonds in 2000, at which time the IMF poured another $48 billion down the government rat hole.

The one good thing the IMF did finally was to refuse to continue to bail out Argentina’s politicians, and that is what caused the bottom to fall out of the Argentine economy.

For decades, Argentina has practiced the kind of economic statism that is championed by the likes of Paul Krugman. Its guiding philosophy has been that its economy should be centrally planned by domestic government elites with the help of the IMF bureaucracy. Its politicians were shielded from taking responsibility for the inevitable failures of these policies by IMF and U.S. government foreign aid. Now that the Argentine bubble of economic statism has burst, the Paul Krugmans of the world are frantically seeking to shift the blame to the free market. Sorry, Professor Krugman, it just ain’t so.

Thomas J. DiLorenzo – Department of Economics, Loyola College, Maryland

Callahan, the research director at a New York City public-policy organization called Demos, proclaimed that the prosperity of the 1990s left him “financially battered and psychically troubled.” His biggest complaint is the rising cost of rental housing in New York City, which he blames on prosperity. He revels in the prospect of an impending recession that will presumably moderate the rise in housing costs.

It’s true that New York City has experienced sharp increases in the price of rental housing, but the cause of those increases is government regulation, not prosperity. No city in America has used rent-control laws as widely and has had them in place as long. With over 1.1 million rent-controlled apartments, New York City is a showcase for the policy’s destructive effects: housing shortages that get worse and worse every year; deteriorating housing quality; middle-class families trapped in apartments that are too small for their needs, while affluent retirees pay a pittance for large three- and four-bedroom apartments they have lived in for decades; and virtually no new construction. Callahan mentions all of these problems, but incorrectly blames them on “prosperity.”

Because rent control makes rental apartment housing less profitable (or unprofitable altogether), the number of rental units built each year has dropped precipitously from 35,000 in 1969, the year in which rent control was expanded to hundreds of thousands of additional housing units, to a mere 8,000 units a year over the past decade, despite a burgeoning population in the city.

On top of that, zoning, environmental, and building-code regulations make it even more costly to develop apartment units in the city (and elsewhere). Regulation also stipulates that the residents of apartments have a “right” to reside in the apartments as long as they wish and can even veto a landlord’s decision to renovate the building or turn it into co-ops or condominiums. This additional abolition of property rights makes it even more unlikely that anyone would want to build apartments in New York City. In fact, it is a virtual miracle that anyone does.

Regulation has made being a landlord in New York City so unprofitable that hundreds, if not thousands, of landlords have simply abandoned their properties. The city government has taken over some 40,000 abandoned apartments.

In short, 50 years of housing-market socialism, not free-market capitalism, is the source of Mr. Callahan’s financial “battering.” There is no quick fix to the destructive effects of a half-century of interventionism in housing markets, but the elimination of New York City’s rent controls would be a necessary first step. It would go a long way to restoring the profitability of rental housing, increase its supply, improve its quality, and moderate housing prices in the city.

Mr. Callahan also complains about rising housing costs in other places, such as Silicon Valley. But that part of northern California is famous for its decades-long “growth control” policies, which have also restricted the supply of housing and escalated its costs. Some parts of nearby Marin County even imposed 100-acre-minimum-lot zoning regulations in the 1970s, which drove housing and land prices through the roof. And the same kind of environmentalist extremism that has caused the California energy crisis is also partly responsible for a housing crisis in some parts of the state because of regulatory restrictions on development.

Health-Care Costs

Mr. Callahan’s second complaint is that middle-class people are also supposedly being “wiped out” by the rising costs of health care. Well, there is arguably no other industry in America that has experienced a larger increase in the degree of government control over the past 50 years than health care. As Milton Friedman documented in a 1992 Hoover Institution study titled “Input and Output in Medical Care,” as the hospital industry was transformed from one that was primarily proprietary in the 1920s to today’s system in which most hospitals are either government-run or government-subsidized “nonprofit” hospitals, more and more spending has led to less and less quantity and quality of health care, all other things equal. The increased governmental role in health care has led to a massive bureaucratization, which, coupled with government-induced stimulation of demand through Medicare and Medicaid, has caused health-care costs to explode.

Callahan’s third complaint is that “materialistic values” supposedly “came to pervade our culture” in the 1990s. This is an unprovable assertion, although socialists of all stripes, from Marx to Mussolini to John Kenneth Galbraith, have been bemoaning increasing “materialism” for centuries. One wonders if Mr. Callahan is aware, moreover, that charitable giving in the United States was at an all-time high during the past decade when rampant materialism supposedly blossomed.

What he seems utterly unaware of is the basic economic fact that the only way to become wealthy in any capitalistic economy is to provide goods or services to very large numbers of people. If more and more people become “materialistic” and motivated primarily by the prospect of earning large amounts of money, there will inevitably be more and more entrepreneurs who become successful at providing us with more and better goods and services at lower prices. That’s the only true route to great wealth, but in his confusion Mr. Callahan cries that he is “psychically troubled” by all of this.

His “solution” to these problems is more socialism: “[U]ntil we find a way to share the country’s wealth more equitably . . . it’s hard to get too excited about surges in national prosperity,” he writes. So he celebrates the coming recession: “As I see it, the good times are coming, not going.”

How a recession, which would cause thousands of New Yorkers to lose their jobs, would help the middle class that Mr. Callahan professes to be so concerned about is not explained.

Mr. Litan claims that the antitrust laws allow companies to “gain dominant positions in their markets” only “if they do so fairly.” But the word “fairness” appears nowhere in the antitrust laws; this is a recent invention of socialist-minded policy wonks like Mr. Litan. Moreover, it is extraordinarily naïve of anyone calling himself an economist to believe that such a charge would even be a desirable part of the antitrust laws: Competitors will always whine and cry about how the price-cutting, product-improving, and customer-satisfying practices of their more successful rivals are “unfair.” This in fact is the modus operandi of antitrust: The antitrust laws provide a means by which sour-grapes competitors can achieve through politics what they fail to achieve in the marketplace.

Mr. Litan commits what Hayek called the “fatal conceit” of believing that government bureaucrats, rather than entrepreneurs and consumers, are in the best position to decide what constitutes a “legitimate business purpose.” Microsoft got into trouble, he argues, because it “ran afoul of this simple maxim.” The maxim is indeed simple, but it is unequivocally false. Neither economists nor politicians nor policy wonks are capable of deciding the most “efficient” size or configuration of any business enterprise. As Ludwig von Mises once explained, “The question to be decided is: Who should determine the size of the enterprises, the consumers by their striving to buy what suits them best or the politicians who know only how to tax away and to spend?”^*

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* Ludwig von Mises, “Small and Big Business,” Economic Freedom and Interventionism (Irvington-on-Hudson, N.Y.: Foundation for Economic Education, 1990), p. 221.

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By adhering to this false “maxim” antitrust regulators are attempting to supersede the informed judgment of millions of consumers with the opinions Janet Reno and her former antitrust sidekick Joel Klein. Just how damaging this has been to consumers is revealed by several plain facts. First, in a poll of adult computer users taken by USA Today, only 6 percent said that “reducing Microsoft’s influence” was a “major issue” to them. Most consumers love Microsoft’s products.

Second, as Stan Leibowitz and Steve Margolis have shown in their book, Winners, Losers and Microsoft, in virtually any market that Microsoft has entered (financial software, spreadsheets, etc.), the effect has been a dramatic reduction in prices and an expansion of output and innovation. Software products that do not compete with Microsoft’s products fell in price by 12 percent from 1988 to 1995, but by 60 percent where there was competition from Microsoft.

Third, the government is clearly unconcerned about consumer welfare in its prosecution of Microsoft: In Judge Thomas Penfield Jackson’s November 1999 “Statement of Fact” he devoted a mere five out of 412 paragraphs to the issue of consumer welfare.

Mr. Litan, like his former employer Janet Reno, simply ignores that Microsoft has provided incredible benefits to consumers. He rests his case on the lame notion that, in his opinion, the company’s management had “anticompetitive motives.” Economic analysis may not be Mr. Litan’s strong point, but mind-reading apparently is. He claims that such a malevolent “intent” has harmed Microsoft’s competitor Netscape by keeping it from competing in the Web browser market. In fact, Netscape has distributed more than 150 million copies of its browser since 1995.

It is typical of government, and its intellectual apologists like Mr. Litan, to assume that business practices they are incapable of understanding—such as exclusive-dealing contracts—should be outlawed in the name of “fairness” or because of presumed bad motives.

Intel Doing Well?

As alleged “proof” that antitrust regulation is not harmful, Mr. Litan notes that Intel, which recently settled an antitrust complaint, seems to be doing well. This kind of statement ignores the important but unseen effects of such regulation. What is the opportunity cost of having to spend millions of dollars in legal fees and diverting management talent away from striving to produce better and cheaper products to deal with the blizzard of paperwork typically imposed on a company that is the victim of an antitrust “complaint”? Mr. Litan ignores such important questions even though it is well known to antitrust scholars that one effect of antitrust is to induce companies to be less successful than they could be out of fear of attracting the attention of antitrust regulators. It was the official policy of General Motors for many years to never let its market share top 45 percent for this very reason.

It has been standard knowledge in the field of industrial organization for at least 35 years (more than 100 years to Austrian economists) that the mere number of firms in an industry does not necessarily have anything to do with how competitive that industry is. Industrial concentration is usually caused by the fact that one or a few firms in an industry are simply more efficient and/or have a superior product than their rivals do—at least temporarily. Mr. Litan ignores this mainstream thinking by issuing a 1950s-era call for splitting Microsoft into three companies. The free market, guided by the preferences of consumers, has given us the current configuration of the computer industry; Mr. Litan’s proposed tinkering can only be destructive to consumer welfare and an affront to the principle of private property.

He also ignores decades of research by Chicago school scholars such as the late Yale Brozen and Harold Demsetz, and Austrian school scholars such as Dominick Armentano, who have compiled thousands of pages of published, documented evidence of how antitrust regulation has been harmful to consumers and has impaired economic efficiency and reduced productivity. “Our economy has profited greatly from sound antitrust enforcement,” Litan declares, without offering a shred of evidence.

Perhaps the biggest absurdity of all is Mr. Litan’s dire warning that “If you have monopoly power in our economy, don’t abuse it.” I’ll take him seriously on this point whenever he starts criticizing the government’s own monopoly power, such as the government school monopoly, the old-age insurance monopoly, the occupational licensure monopoly, the postal express statutes, cable television franchising, and myriad other monopolistic enterprises operated by federal, state, and local governments.

—Thomas J. DiLorenzo
Loyola College in Maryland

Most Americans have probably never heard of University of Washington economist Paul Heyne, who recently passed away. That’s a shame, for Paul was arguably the most effective economic educator in America for the past 25 years.

Most free-market economists consider Heyne’s textbook, The Economic Way of Thinking, to be by far the most effective tool for teaching the principles of economics. During the 1960s and ‘70s that honor resided with University Economics by UCLA economists Armen Alchian and William Allen, whom Professor Heyne acknowledged as his inspiration. The approach of Professors Heyne, Alchian, and Allen differs significantly from the dominant mainstream approach, which is almost exclusively devoted to a mind-numbing rendition of technique after technique in which students are forced to more or less memorize hundreds of theorems, formulas, and diagrams. Students inevitably become lost in the fog of technique, and most of them are miseducated.

In contrast, Paul Heyne believed that principles of economics must be taught “as tools of analysis.” This means first picking an application of economic theory (the minimum wage, trade disputes, merger waves, price controls, exchange rate fluctuations, traffic congestion, and so on), and then explaining the unique contribution that economic theory makes to understanding the application. Once a particular economic theory is introduced in this way, The Economic Way of Thinking applies the same theory to several other applications. Heyne believed this is the only way that students can truly learn not just economics but the economic way of thinking.

His book went through nine editions over the past 20 years, but was never quite a market leader. One likely reason for this is stated by Heyne in his preface: teaching people to think like economists requires one to become familiar with both current economic events as well as economic theory, and to be able to apply that theory to myriad contemporary issues. Most academic economists are, well, too lazy for that. They prefer instead to take the easy way out and just recite a theory or two a day, accompanied by elaborate diagrams and mathematical manipulations that they long ago memorized.

Popular in the Old Soviet Bloc

The Economic Way of Thinking became enormously popular in the former communist countries in recent years, and Heyne himself spent a considerable amount of his time as an invited lecturer before audiences of Russians, Czechs, Slovaks, Hungarians, Bulgarians, Poles, and Romanians, among others. These are people who “can’t afford to spend time learning an economics that is merely intellectual aerobics,” he explained in the preface to his eighth edition; they “need to understand how markets work and what institutions are essential if effective cooperation is to occur in a society characterized by an extensive division of labor.”

That is exactly what The Economic Way of Thinking teaches and what most other textbooks fail quite miserably at. That is because Heyne’s vision of what economics is all about has its roots in Adam Smith; the Austrian school economists, most notably Nobel laureate E A. Hayek; and Nobel laureate James M. Buchanan (a fellow traveler of the Austrian school). To these men, what matters and what most ordinary people do not understand is the process of exchange: the process by which literally millions of people in society coordinate their plans through markets—as long as they possess the freedom to do so. How this process works “is the great puzzle that the economic way of thinking begins to resolve” and few people have ever done it better than Paul Heyne.

Focus on Exchange

Focusing on market exchange through social cooperation and the division of labor—as opposed to mere “economizing” behavior, which is the subject of most economics texts—forces one to learn the importance of “the use of knowledge in society,” the title of the most famous essay by Hayek, whom Heyne greatly admired. This has significant implications for the study of economic theory and policy. For example, to Heyne the corporate takeover market is a mechanism that, among other things, tells us which kinds of corporate structures succeed and which do not. Indeed, allowing corporate restructurings to take place is the only way to gain such information. By contrast, too many other economists (and especially non-economists), because they fail to understand this straightforward point, condemn the takeover market as wasteful and call for regulation.

The Economic Way of Thinking also explains why such “middlemen” as real estate agents, stockbrokers, and speculators, who are generally reviled by the politically correct, are in fact indispensable to the smooth operation of markets. The beneficial role of speculators, Heyne wrote, is to “even out the flow of commodities into consumption and diminish price fluctuations over time.”

Paul Heyne devoted the last 40 years of his life to teaching economics to students all over the world through his lectures and his outstanding textbook. His legacy to the economics profession is to have helped revive the study of markets as they should be studied: as institutions that facilitate, in Adam Smith’s words, “man’s propensity to truck, barter, and exchange” and not as an endless array of “optimization” problems and puzzles that are quickly forgotten.

It is no exaggeration to say that trade is the keystone of modern civilization. As Murray Rothbard wrote, “The market economy is one vast latticework throughout the world, in which each individual, each region, each country, produces what he or it is best at, most relatively efficient in, and exchanges that product for the goods and services of others. Without the division of labor and the trade based upon that division, the entire world would starve. Coerced restraints on trade—such as protectionism—cripple, hobble, and destroy trade, the source of life and prosperity.”^[1]

Human beings cannot truly be free unless there is a high degree of economic freedom—the freedom to collaborate and coordinate plans with other people from literally all around the world. That is the point of Leonard Read’s most famous article, “I, Pencil,” which describes how producing an item as mundane as an ordinary pencil requires the cooperation and collaboration of thousands of people from all around the world, all of whom possess very specific knowledge that allows them to assist in the manufacture and marketing of pencils. The same is true, of course, for virtually everything else that is produced.

Without economic freedom—the freedom to earn a living for oneself and one’s family—people are destined to become mere wards of the state. Thus, every attempt by the state to interfere with trade is an attempt to deny us our freedom, to impoverish us, and to turn us into modern-day serfs.

Ludwig von Mises believed that exchange is “the fundamental social relation” which “weaves the bond which unites men into society.”^[2] Man “serves in order to be served” in any trade relationship in the free market.^[3] Mises also distinguished between two types of social cooperation: cooperation by virtue of private contract and coordination, and cooperation by virtue of command and subordination or “hegemony.”^[4] The former type of coordination is symmetrical and mutually advantageous, while the latter is asymmetrical—there is a commander and a commandee, and the commandees are mere pawns in the actions of the commanders. When people become the mere pawns of their rulers they cannot be said to be free. This, of course, is the kind of “cooperation” that exists at the hands of the state.

Western civilization is the result of “achievements of men who have cooperated according to the pattern of contractual coordination” Mises wrote.^[5] The contractual state is guided by such concepts as natural rights to life, liberty, and property, and government under the rule of law. In contrast, the “hegemonic society” is one that does not respect natural rights or the rule of law. All that matters are the rules, directives, and regulations issued by dictators, whether they are called kings or congressmen. These directives may change daily, and the wards of the state must obey. As Mises wrote, “The wards have one freedom only: to obey without asking questions.”^[6]

Trade involves the exchange of property titles. Restrictions on free trade are therefore an attack on private property itself and not “merely” a matter of “trade policy.” This is why such great classical liberals as Frederic Bastiat spent many years of their lives defending free trade. Bastiat, as much as anyone, understood that once one acquiesced in protectionism, no one’s property was safe from myriad other governmental acts of theft. To Bastiat, protectionism and communism were essentially the same philosophy.

It has long been recognized by classical liberals that free trade is the most important means of diminishing the likelihood of war. Nothing is more destructive of human freedom than war. It always leads to a permanent enlargement of the state—and a reduction in human freedom—regardless of who wins. On the eve of the French Revolution many philosophers believed that democracy would put an end to war, for wars were thought to be fought merely to aggrandize and enrich the rulers of Europe. The French quickly proved this theory wrong, however, for under the leadership of Napoleon they, in Mises’s words, “adopted the most ruthless methods of boundless expansion and annexation.”^[7]

Thus it is not democracy that is a safeguard against war but, as the British (classical) Liberals were to recognize, free trade. To Richard Cobden and John Bright, the leaders of the British Manchester School, free trade—both domestically and internationally—was a necessary prerequisite for the preservation of peace; for in a world of trade and social cooperation, there are no incentives for war and conquest. It is government interference with free trade that is the source of international conflict. Indeed, naval blockades that restrict trade are the ultimate act of war. Throughout history restrictions on trade have proven to be impoverishing and have instigated acts of war motivated by territorial acquisition and plunder.

It is no mere coincidence that the 1999 meeting of the World Trade Organization—a cabal of bureaucrats, politicians, and lobbyists that favors government-controlled trade—was marked by a week of riots, protests, and violence. Whenever trade is politicized the result is inevitably conflict that quite often leads, eventually, to military aggression.

Mises summarized the relationship between free trade and peace most eloquently when he noted:

What distinguishes man from animals is the insight into the advantages that can be derived from cooperation under the division of labor. Man curbs his innate instinct of aggression in order to cooperate with other human beings. The more he wants to improve his material well-being, the more he must expand the system of the division of labor. Concomitantly he must more and more restrict the sphere in which he resorts to military action . . . . Such is the laissez-faire philosophy of Manchester.^[8]

As Bastiat often said, if goods can’t cross borders, armies will. This is a quintessentially American philosophy; it was the position of George Washington, Thomas Jefferson, and Thomas Paine, among others. “A foreign policy based on commerce” wrote Paine in Common Sense, would secure for America “the peace and friendship” of the Continent and allow her to “shake hands with the world—and trade in any market.”^[9] Paine—the philosopher of the American Revolution—believed that free trade would “temper the human mind,” help people to “know and understand each other,” and have a “civilizing effect” on everyone involved in it.^[10] Trade was seen as “a pacific system, operating to unite mankind by rendering nations, as well as individuals, useful to each other . . . . War can never be in the interest of a trading nation.”^[11]

George Washington agreed. “Harmony, liberal intercourse with all nations, are recommended by policy, humanity, and interest,” he stated in his September 17, 1796, Farewell Address.^[12] Our commercial policy “should hold an equal and impartial hand; neither seeking nor granting exclusive favors or preferences; consulting the natural course of things; diffusing and diversifying by gentle means the streams of commerce, but forcing nothing.”^[13]

The Eternal Struggle Between Freedom and Mercantilism

The period of world history from the middle of the fifteenth to the middle of the eighteenth centuries was an era of growth in world trade, technology, and institutions suited to trade. Technological innovations in shipping, such as the three-masted sail, brought the merchants of Europe to the far reaches of America and Asia. This vast expansion of trade greatly facilitated the worldwide division of labor, greater specialization, and the benefits of comparative advantage.^[14]

But whenever human freedom advances, as it did with the growth of trade, state power is threatened. So states did all they could then, as now, to restrict trade. It is the system of trade restrictions and other governmental interference with the free market, known as mercantilism, that Adam Smith railed against in The Wealth of Nations. As Rothbard has written:

Mercantilism, which reached its height in the Europe of the seventeenth and eighteenth centuries, was a system of statism which employed economic fallacy to build up a structure of imperial state power, as well as special subsidy and monopolistic privilege to individuals or groups favored by the state. Thus, mercantilism held that exports should be encouraged by the government and imports discouraged.^[15]

Classical liberals waged an ideological war against mercantilism during the eighteenth and nineteenth centuries, and scored some major victories for freedom. The French physiocrats, led by the physician and economist François Quesnay, were influential from the 1750s to the 1770s. They were among the first laissez-faire thinkers who denigrated mercantilist propaganda and called for complete freedom of domestic and international trade. Their position was based on sound economics as well as Lockean notions of natural rights. Quesnay wrote, “Every man has a natural right to the free exercize of his faculties provided he does not employ them to the injury of himself or others.”^[16]

When Anne Robert Jacques Turgot, a precursor of the Austrian school, became finance minister of France in 1774, his first official act was to free the import and export of grain. At around the same time, Adam Smith was defending trade on moral as well as economic grounds by identifying it as part of the system of “natural justice.” One of the ways he did this was to defend smuggling as a means of evading mercantilist restrictions on trade. The smuggler, explained Smith, was engaged in “productive labor” that served his fellow man (consumers), whereas if he were caught by the government and prosecuted, his capital would be “absorbed either in the revenue of the state or in that of the revenue-officer” which is an “unproductive” use “to the diminution of the general capital of the society.”^[17]

The Manchester School

Despite powerful arguments in favor of free trade offered by Quesnay, Smith, David Ricardo, and others, England (and other countries of Europe) suffered from protectionist trade policies in the first half of the nineteenth century. The British public was plundered by the mercantilist Corn Laws, which placed strict quotas on the importation of grain. By raising food prices, the laws benefited landowning political supporters of the government at the expense of consumers, especially the poor. But this changed thanks to the heroic and brilliant efforts of what came to be known as the Manchester School, led by two British businessmen (and later, statesmen), John Bright and Richard Cobden. Bright and Cobden formed the Anti-Corn Law League in 1839 and turned it into a well-oiled political machine with mass support, distributing literally millions of leaflets, holding conferences and gatherings all around the country, delivering hundreds of speeches, and publishing their own newspaper, The League.^[18]

The Irish potato famine of 1845 created great pressures for repeal of the Corn Laws, which was finally achieved on June 25, 1846. The elimination of all other import duties followed, and a 70-year period of British free trade began. Cobden was also influential in pushing through the Anglo-French treaty of 1860, which lowered French tariffs and helped put that country on the road to freer trade.

The Great Bastiat

From his home in Mugron, France, Frederic Bastiat single-handedly created a free-trade movement in his own country that eventually spread throughout Europe. Bastiat was a gentleman farmer who had inherited the family estate. He was a voracious reader, and spent many years educating himself in classical liberalism and in almost any other field that he could attain information about. After some 20 years of intense intellectual preparation, articles and books began to pour out of Bastiat (in the 1840s). His book Economic Sophisms is to this day arguably the best defense of free trade ever published. Economic Harmonies quickly followed, while Bastiat published in magazines and newspapers all over France. His work was so popular and influential that it was immediately translated into English, Spanish, Italian, and German.

Because of Bastiat’s enormous influence, free-trade associations, modeled after one he had created in France and similar to the one created by his friend Richard Cobden in England, began to sprout in Belgium, Italy, Sweden, Prussia, and Germany.

To Bastiat, collectivism in all its forms was immoral as well as economically destructive. Collectivism constituted “legal plunder,” and to argue against the (natural) right to private property would be similar to arguing that theft and slavery were moral. The protection of private property is the only legitimate function of government, Bastiat wrote, which is why trade restrictions—and all other mercantilist schemes—should be condemned. Free trade “is a question of right, of justice, of public order, of property. Because privilege, under whatever form it is manifested, implies the denial or the scorn of property rights.” And “the right to property, once weakened in one form, would soon be attacked in a thousand different forms.”^[19]

The Struggle Against Mercantilism in America

There is no clearer example of how trade restrictions are the enemy of freedom than the American Revolution. In the seventeenth century all European states practiced mercantilism. England imposed a series of Trade and Navigation Acts on its colonies in America and elsewhere; they embodied three principles: (1) all trade between England and her colonies must be conducted by English (or English-built) vessels owned and manned by English subjects; (2) all European imports into the colonies must “first be laid on the shores of England” before being sent to the colonies so that extra tariffs could be placed on them; and (3) certain products from the colonies must be exported to England and England only.

In addition, the colonists were prohibited from trading with Asia because of the East India Company’s state-chartered monopoly. There were duties placed on all colonial imports into England.

After the Seven Years War (known in America as the French and Indian War), England’s massive landholdings (Canada, India, North America to the Mississippi, most of the West Indies) became expensive to administer and police. Consequently, the Trade and Navigation Acts were made even more oppressive, which imposed severe hardships on the American colonists and helped lead to revolution.^[20]

After the American Revolution trade restrictions nearly caused the New England states—which suffered disproportionately from them—to secede from the Union. In 1807 Thomas Jefferson was president and England was once again at war with France. England declared that it would “secure her seamen wherever found,” which included U.S. ships. After a British warship captured the U.S.S. Chesapeake off Hampton Roads, Virginia, Jefferson imposed a trade embargo that made all international commerce illegal. After Jefferson left office his successor, James Madison, imposed an Enforcement Act, which allowed war-on-drugs-style seizure of goods suspected to be destined for export.

This radicalized the New England secessionists, who had been plotting to secede ever since Jefferson was elected, and who issued a public declaration reminding the nation that “the U.S. Constitution was a Treaty of Alliance and Confederation” and that the central government was no more than an association of the states. Consequently, “whenever its [the Constitution's] provisions were violated, or its original principles departed from by a majority of the states or their people, it is no longer an effective instrument, but that any state is at liberty by the spirit of that contract to withdraw itself from the union.”^[21]

The Massachusetts legislature formally condemned the embargo, demanded its repeal by Congress, and declared that it was “not legally binding.” In other words, the Massachusetts legislature “nullified” the law, just as South Carolina would nullify the 1828 Tariff of Abominations some 20 years later. Madison was forced to end the embargo in March 1809.

There has always been a collection of men in America who wanted to bring the British mercantilist system here precisely because it was so destructive of freedom. They figured to be the commanders of the system and its chief beneficiaries. As John Taylor of Caroline observed, these men “included Hamilton and the Federalists and later, the politicians of the Era of Good Feelings in the 1820s who eventually became Whigs.”^[22] These men “sought to bring the British system to America, along with its national debt, political corruption, and Court party.”^[23]

Taylor, a noted Anti-Federalist, was a lifelong critic of mercantilism, who laid out his criticisms in his 1822 book, Tyranny Unmasked. Like Bastiat, Taylor saw protectionism as an assault on private property that was diametrically opposed to the freedom the American revolutionaries had fought and died for. Taylor sought to “unmask” the tyranny of the fables and lies that the mercantilists had devised to promote their system of plunder. If one looked at England’s mercantilist policies, Taylor wrote, “No equal mode of enriching the party of government, and impoverishing the party of people, has ever been discovered.”^[24] He wrote of the “indissoluble conexions” between both “the freedom of industry and national prosperity” and also “between national distress and protecting duties, bounties, exclusive privileges, and heavy taxation.”^[25] The former produces national happiness, whereas the latter produces national misery, according to Taylor. In pointing out the folly of economic autarky (self-sufficiency) he asked:

Will Alabama want nothing but cotton, should that State select this species of labour for its staple? Can she eat, drink, and ride her cotton? Can she manufacture it into tools, cheese, fish, rum, wine, sugar, and tea? . . . . Is not Georgia a market for manufacturers, and Rhode-Island a market for cotton, in consequence of the division of labor?^[26]

Many of Taylor’s arguments were adopted and expanded on by the South Carolinian statesman John C. Calhoun during the struggle over the 1828 Tariff of Abominations, which a South Carolina political convention voted to nullify. The confrontation between that state, which was very heavily dependent on imports, as was most of the South, and the federal government over the Tariff of Abominations almost led to the state’s secession some 30 years before the War Between the States. The federal government backed down and reduced the tariff rate in 1833.

The northern manufacturers who wanted to impose British-style mercantilism on the country did not give up, however; they formed the American Whig party, which advocated three mercantilist schemes: protectionism, corporate welfare, and a central bank to pay for it all. From 1832 until 1852 the Whigs, led by Henry Clay and later by Abraham Lincoln, fought mightily in the political arena to bring seventeenth-century mercantilism to America.^[27]

The party died in 1852, but the Whigs simply began calling themselves Republicans. The tariff was the centerpiece of the Republican party platform of 1860, as it had been when the same collection of northern economic interests called itself “Whigs” during the previous 30 years.

By 1857 the level of tariffs had been reduced to the lowest level since 1815, according to Frank Taussig in his classic Tariff History of the United States.^[28] But when the Republicans controlled the White House and the southern Democrats left the Congress, the Republicans, as former Whigs, did what they had been itching to do for decades: go on a protectionist frenzy. In his first inaugural address Lincoln stated that he had no intention to disturb slavery in the southern states and even if he did, there would be no constitutional basis for doing so. But he promised a military invasion if tariff revenues were not collected. Unlike Andrew Jackson, he would not back down from the South Carolinian tariff nullifiers.

By 1862 the average tariff rate had crept up to 47.06 percent, the highest level ever to that point, even higher than the 1828 Tariff of Abominations. These high rates lasted for decades after the war.

Many of the newspapers that supported the Republican party openly called for a military invasion of southern ports to keep the South from adopting free trade, which was written into the Confederate Constitution of 1861. On March 12, 1861, for example, the New York Post advocated that the U.S. Navy “abolish all ports of entry” in the South.^[29] On April 2, 1861, the Newark Daily Advertiser in New Jersey warned ominously that southerners had “apparently taken to their bosoms the liberal and popular doctrine of free trade” and that free trade “must operate to the serious disadvantage of the North” as “commerce will be largely diverted to Southern cities.” The “chief instigator” of “the present troubles,” South Carolina, has all along been “preparing the way for the adoption of free trade” and must be stopped by “the closing of the ports” by military force.^[30]

As mentioned above, by 1860 England itself had moved to complete free trade; France sharply reduced her tariff rates in that very year; and the free-trade movement started by Bastiat was spreading throughout Europe. Only the northern United States was clinging steadfastly to seventeenth-century mercantilism.

After the war the northern manufacturing interests who financed and controlled the Republican party “ushered in a long period of high tariffs. With the tariff of 1897, protection reached an average level of 57 percent.”^[31] This political plunder continued for about 50 years after the war, at which time international competition forced tariff rates down moderately. By 1913 the average tariff rate in the United States had declined to 29 percent.

Protectionists Triumph

But the same clique of northern manufacturers was begging for “protection” and persisted until President Herbert Hoover signed the Smoot-Hawley Tariff of 1929, which increased the average tariff rate on over 800 items back up to 59.1 percent.^[32] Smoot-Hawley spawned an international trade war that resulted in a 50 percent reduction in total exports from the United States between 1929 and 1932.^[33] Poverty and misery were the inevitable result. Even worse, the government responded to these problems of its own creation with a massive increase in government intervention, which only produced even more poverty and misery and deprived Americans of more and more of their freedoms.

Since the seventeenth century all the great classical liberals have defended free trade and opposed trade restrictions. Restrictions on trade are an attack on the institution of private property, interfere with the international division of labor that is the source of our prosperity, and are nothing less than an act of theft. As Murray Rothbard remarked:

[T]he impetus for protectionism comes not from preposterous theories, but from the quest for coerced special privilege and restraint of trade at the expense of efficient competitors and consumers. In the host of special interests using the political process to repress and loot the rest of us, the protectionists are among the most venerable. It is high time that we get them, once and for all, off our backs, and treat them with the righteous indignation they so richly deserve.^[34] []

Notes

1. Murray Rothbard, “Protectionism and the Destruction of Prosperity,” found on www.mises.org/fullarticle.asp?title=protectionism&month=1.
2. Ludwig von Mises, Human Action: A Treatise on Economics, Scholar’s Edition (Auburn, Ala.: Mises Institute, 1998 [1949]), p. 195.
3. Ibid.
4. Ibid., p. 196.
5. Ibid., p. 198.
6. Ibid., p. 199.
7. Ibid., p. 819.
8. Ibid., p. 827.
9. Thomas Paine, Common Sense, p. 20, in Philip S. Foner, ed., Complete Writings of Thomas Paine (New York: 1954).
10. Ibid.
11. Ibid.
12. W.B. Allen, ed., George Washington: A Collection (Indianapolis: LibertyClassics, 1988), p. 525.
13. Ibid.
14. Nathan Rosenberg and L.E. Birdzell, Jr., How the West Grew Rich (New York: Basic Books, 1986), pp. 71-112.
15. Murray Rothbard, “Mercantilism: A Lesson for Our Times?” in his The Logic of Action II (Cheltenham, England: Edward Elgar, 1997), p. 43.
16. Cited in Henry Higgs, The Physiocrats (New York: Langland Press, 1952), p. 45.
17. Adam Smith, An Inquiry into the Nature and Causes of the Wealth of Nations (New York: Oxford University Press, 1976), p. 898.
18. Nick Elliott, “John Bright: Voice of Victorian Liberalism,” in Burton W. Folsom, Jr., ed., The Industrial Revolution and Free Trade (Irvington-on-Hudson, N.Y.: Foundation for Economic Education, 1996), p. 28.
19. Frederic Bastiat, Selected Essays on Political Economy, George B. de Huszar, ed. (Irvington-on-Hudson, N.Y.: Foundation for Economic Education, 1995), p. 111.
20. Samuel Eliot Morison, Henry Steele Commager, and William Leuchtenburg, The Growth of the American Republic (New York: Oxford University Press, 1980), pp. 112-25.
21. James Banner, To the Hartford Convention: The Federalists and the Origins of Party Politics in Massachusetts, 1789-1815 (New York: Alfred A. Knopf, 1970), p. 301.
22. John Taylor, Tyranny Unmasked (Indianapolis: Liberty Fund, 1992), p. xvi.
23. Ibid.
24. Ibid., p. 11.
25. Ibid., p. 19.
26. Ibid., p. 24.
27. Michael F. Holt, The Rise and Fall of the American Whig Party (New York: Oxford University Press, 1999).
28. Frank Taussig, A Tariff History of the United States (New York: Putnam, 1931), p. 157.
29. Howard Perkins, Northern Editorials on Secession (Gloucester, Mass.: Peter Smith, 1964), p. 600.
30. Ibid., p. 602.
31. Wilson Brown and Jan Hogendom, International Economics (New York: Addison-Wesley, 1994), p. 188.
32. Ibid., p. 192.
33. Ibid., p. 193.
34. Rothbard, “Protectionism.”

In 1978 Michael Jensen and William Meckling, writing in the Financial Analysts Journal, offered an extraordinarily gloomy prediction for the future of capitalism: “The most spectacular period of economic growth in our history is over,” they wrote, because “government is destroying two vital instruments of that growth—the system of contract rights and the large corporation.”¹ Constitutional and electoral constraints on political plunder have proven ineffective, Jensen and Meckling wrote, as the courts, politicians, and regulators have revoked or attenuated property and contract rights and have attacked freedom of association as well, “especially in the civil rights arena.”²

With regard to the stock market, Jensen and Meckling forecast that because of the instability of property rights caused by government intervention, investors have become much less certain that any contract they enter into now will be subject to the same rules and regulations in the future. An early consequence of the erosion of property rights will be a reduction in the capitalized values of corporate securities, with many corporations able to remain in business only so long as they can finance their operations from internally generated cash flow or [government] subsidy.³

As of 1999 the Dow Jones Industrial Average was about 15 times higher than it was in 1978, when Jensen and Meckling issued their dire warnings. But this doesn’t mean that they were wrong about the effects of the American regulatory state on stock prices. The Dow Jones average might be even higher yet were it not for the large degree of governmental control of the means of production that is exercised through regulation. And the stock market is surely much more volatile because of the great uncertainties created by regulation. Overzealous regulators may even cause the market to crash. As discussed below, it was proposed regulation and taxation of corporate takeovers that likely precipitated the 1987 U.S. stock market crash.

Political Entrepreneurship

Although regulators are usually blamed for the economic and social harm inflicted by regulation, it is politicians who are ultimately responsible. The U.S. Department of Labor may enforce the minimum-wage law, for example, but it is Congress that passed it. Regulation is just another form of pork-barrel politics whereby politicians dispense regulatory favors to special-interest groups, at the expense of the rest of society. Corporations are particularly susceptible to attacks by politicians pandering to special-interest groups because corporate ownership is relatively invisible, widely dispersed, and politically incohesive, as a rule. Moreover, the stock market is so volatile and complex that the owners of corporations (shareholders) would find it difficult, if not impossible, to attribute declines in their asset values to specific government actions. In contrast, special-interest groups are, by definition, more focused and politically well organized.

Politicians are not merely passive bystanders who go on “listening tours” of their constituencies and then faithfully enact the kinds of laws that the public wants. They are “entrepreneurs” who are experts at either creating genuine economic and social crises or the perception of crises, and then offering their “services” in resolving the crises. The most obvious example of this phenomenon is war. War provides politicians with myriad rationales for controlling and regulating economic activity, and few of the controls are abandoned once the war is ended.⁴

Of course, politicians never admit that they are the source of the problems. They usually blame corporations in particular, or capitalism in general. Hence, we witness a constant recitation of “crises” manufactured by the state and blamed on capitalism. In the agricultural sector, for example, it has been government policy ever since the Hoover administration to simultaneously pay farmers to grow more (with price supports) and less (with acreage allotments), and to subsidize thousands of failing farm businesses with farm welfare in the form of low-interest loans and grants. The agriculture industry is thereby made weaker and more volatile, which of course is reflected in the prices of publicly traded corporations in agriculture and agriculture-related industries. Government intervention is the source of these problems, but the blame is always placed on “agricultural markets.”

The U.S. Department of Commerce publishes fraudulent poverty statistics to make poverty look worse than it actually is and to “justify” such economically destructive policies as increases in the minimum wage or tax increases for the ostensible purpose of redistributing income to the “poor.”

In the environmental arena, countless capitalistic bogeymen have been blamed for everything from cancer to the destruction of the planet. This list of phony environmental scares is so long that any rational, thinking person should routinely assume that everything the organized, political environmental organizations say is a lie.

The federal government has been forecasting an impending energy crisis ever since the dawn of the oil industry—roughly 1866. In that year the U.S. Revenue Commission warned that the nation may run out of oil at any moment. In 1885 the U.S. Geological Survey forecast no chance of oil’s being discovered in California; some ten billion barrels have been pumped from that state since then. By 1914 the U.S. Bureau of Mines was predicting that only 5.7 billion barrels of oil were left; more than 50 billion barrels have been pumped since then. In 1947 the U.S. Department of State warned that “sufficient oil cannot be found in the United States”; in 1948 more than 4 billion barrels were found—the largest discovery in history up to that point and twice the volume of U.S. consumption. In 1951 the U.S. Department of Interior forecast that oil reserves would last only until 1964.⁵

All of these gloomy (and false) forecasts were (and are) accompanied by proposals for more government control of the energy industry to “assure” a more adequate rate of development.

The fundamental effect of this regulatory-propaganda regime on stock markets is to convince more and more investors that the right of corporate managers to use the assets of corporations in the best interests of stockholders and creditors (that is, to maximize profits) is tenuous, if not abrogated completely. The politicization of corporate decision-making via regulation causes an overall decline in capital values as corporate decisions become more and more designed to pander to the whims of politicians and bureaucrats rather than satisfying consumers and earning income for shareholders.

Government regulation is often a form of legalized extortion. For example, federal regulators routinely show up at corporate headquarters and accuse a corporation of being out of compliance with regulations that no human could possibly be in compliance with. The EPA requires that corporations which handle “hazardous materials”—which even includes Windex, according to the EPA—must keep a written record of where each and every container is located at every moment. Former New York state environmental protection commissioner Thomas Jorling described this practice as “a kind of extortion.”⁶ EPA regulators will enter a corporate office and impose huge fines on corporations that could not possibly maintain the EPA’s huge paperwork burden even if they wanted to. Threatened criminal indictments assure payment of the fines.

In a 1997 book, Cornell University law professor Fred McChesney argues that blackmail and extortion are inherent features of the modern regulatory process. In short, political “entrepreneurs” threaten legislation and regulation that will either impose price controls or increase costs (both of which would reduce profit margins) unless the targeted companies and industries compensate the politicians with campaign contributions or other kinds of private payoffs (including speaking honoraria, jobs for relatives, and subsidized travel to luxurious vacation resorts).

Politicians call legislation that is intended to extort campaign contributions from a business or industry “milker bills” or “cash cows.” As explained by one California legislator, a politician “in need of campaign contributions, has a bill introduced which excites some constituency to urge [the legislator] to work hard for its defeat (easily achieved), pouring funds into his campaign coffers.”⁷

Another name politicians have given to such legislation is “juicer bill,” since they are designed to “squeeze” cash out of corporate coffers in return for not harming the corporation with proposed legislation and regulation. So-called “fetcher bills” are also said to be capable of “fetching” gobs of campaign cash.

Examples of Political Extortion

One recent example of a proposed regulation that seems to have been designed purely to fetch perpetual campaign contributions is the battle over reducing the legal blood-alcohol content (BAC) level from .10 to .08. The federal government’s Office of Substance Abuse Prevention has declared that its goal is to eventually have .04 as the legal limit, which can be attained by an adult male who consumes one or two beers. Congress failed to pass such a law in 1998; the law that it did pass, however, creates a slush fund of highway grant money that can be used to bribe states into passing laws that reduce the legal BAC level. The law is to be renewed every year, guaranteeing that the alcoholic beverage industry will be forced to make campaign contributions indefinitely to defeat this neo-prohibitionist legislation.

In 1992 Congress authorized the Federal Communications Commission to impose price controls on cable television. Ever since then, the cable industry has poured millions of dollars of campaign contributions into Washington annually in an apparently fruitless effort to eliminate the controls.

One of the more notorious examples of political blackmail in recent years involved the Clinton administration’s proposals to impose price controls on doctors, hospitals, and the pharmaceutical industry as part of its failed plan for socialized medicine. Once price controls were proposed, reported the New York Times, members of Congress and the president were “receiving vast campaign contributions from the medical industry, an amount apparently unprecedented for a non-election year. While it remains unclear who would benefit and who would suffer under whatever health plan is ultimately adopted, it is apparent that the early winners are members of Congress.”⁸

Representative Jim Cooper, who proposed legislation that was slightly less onerous than Clinton’s, received nearly $1 million in campaign contributions in the first four months of 1994; overall, campaign contributions in 1993 were about one-third higher than in the previous non-election year of 1991.⁹ It was also widely reported at the time that the handlers of Hillary Clinton’s not-so-blind trust were selling her pharmaceutical stocks short every time she made a highly publicized speech demonizing the pharmaceutical industry, which she did quite often. During the Clinton health plan fiasco of 1993-94 the value of pharmaceutical stocks dropped by over $40 billion, according to one account.¹⁰ After the industry poured millions of dollars into the coffers of Washington politicians the price-control plan was defeated.

In his book In Defense of the Corporation, Robert Hessen documents how Ralph Nader has long engaged in the same practice as the first lady—shorting the stocks of companies that his numerous think tanks and organizations routinely demonize with highly publicized “studies” alleging corporate wrongdoing.¹¹ The “tobacco settlement” reached by the state attorneys general, the federal government, and the companies might well be considered to be the Mother of All Political Shakedowns. In return for being allowed to stay in business, American tobacco companies are being forced to pay almost a quarter of a billion dollars to trial lawyers and federal, state, and local governments. The media have already begun reporting on how the initial installments are being spent on anything and everything by state and local governments, and not only “health-care costs,” as was promised.

Even this record may someday be broken, however, if the government succeeds in destroying the Microsoft Corporation. Just a few years ago the Washington Post was writing sneering articles about how naive Bill Gates was for believing he could focus his energies solely on producing better computer products without being a “player” in Washington, that is, caving in to the Washington establishment’s legalized extortion racket. Since then, Gates has hired dozens of Washington lobbyists and lawyers and has spent the required millions in campaign contributions.

Regulation is perhaps most effectively used as a tool of extortion when it threatens to sharply increase the costs of doing business, which it always does. Again, the game is for politicians to propose regulations that would drastically increase the costs (and subsequently reduce the profits) of successful companies with “deep pockets.” For example, the banking industry spent millions in campaign “contributions” to stop a 1982 requirement that they withhold taxes on interest and dividends—a paperwork nightmare for the banks. In 1983 and 1984 the life insurance industry spent more than $2 million to defeat legislation that would have banned the granting of gender-based rates and benefits.

Perhaps the most egregious example of regulatory blackmail is enforcement of the so-called Community Reinvestment Act (CRA). The CRA was enacted in 1978 under a patently false pretense—that banks made fewer loans to residents of low-income neighborhoods not because there were fewer creditworthy borrowers there, but because of allegedly pervasive “discrimination” against the primarily black residents of those neighborhoods. Banks do—and should—“discriminate” against less creditworthy borrowers, but in doing so they run the risk of regulatory extortion.

An entire industry of sometimes federally funded “community groups” has sprung up, with names like Center for Community Change and Association of Community Organizations for Reform Now (ACORN), which essentially extort money from banks with the following ruse: Whenever a bank proposes a merger, expansion, or building of a new branch, it is subject to regulation by the Federal Reserve, the Comptroller of the Currency, and the Federal Deposit Insurance Corporation. If anyone files a complaint with any of these agencies accusing the bank of making too few CRA loans, the merger or expansion is halted. So-called community groups frequently lodge such complaints and do not withdraw them until the banks give them or other groups they designate large sums of money, sometimes in the tens of millions of dollars. The Neighborhood Assistance Corporation of America (NACA), led by self-described “urban terrorist” Bruce Marks, has “won” loan commitments totaling $3.8 billion from Bank of America Corp., First Union Corp., Fleet Financial Group, and others. That money is lent to borrowers favored by Marks, and his organization usually gets a lump-sum fee or a percentage of each loan.¹² NACA plans to operate in all 50 states by 2001, when it expects its annual budget to be in the $80 million range.

Regulation and the Stock Market Crash of 1987

Economists Mark Mitchell and Jeffrey Netter have provided powerful evidence that regulatory sneak attacks precipitated the stock market crash on October 19, 1987, when the Dow Jones Industrial Average fell 508 points (22.6 percent).¹³ Their thesis is that proposed changes in the tax treatment of corporate takeover transactions, which would have made such transactions much more costly, triggered the crash.

It is important to recognize the importance to the economy of the market for corporate control, or the takeover market. This market is a keystone of any capitalist economy, for it is the very means by which capital is continually reallocated to those who will make the best use of it. A vital and free capital market, Ludwig von Mises wrote, is the keystone of capitalism and the one thing that most distinguishes a capitalist economy from a noncapitalist one. Unfortunately, that is also why politicians are forever proposing more and more regulatory control of it.

Laws and regulations that restrict corporate takeovers are protectionist. In a corporate takeover a group of investors has determined that a particular company is being mismanaged. They seek, through a proxy battle or other means, to take over control of the board of directors and, subsequently, of management. They may fire some or all of the poorly performing managers, replace them with better ones, and make more profit for themselves and the other shareholders.

No one has perfect foresight, so many takeovers do not work out. But nevertheless, the only way to learn who can make the best use of corporate resources is to allow the free market to tell us, including the free market for corporate control.

Laws and regulations that would restrict takeovers or make them prohibitively costly are invariably the result of lobbying efforts by incumbent managers who have bribed politicians into enacting the protectionist provisions, which only benefit the incumbent managers at the expense of their shareholders and customers.

In early October 1987 the Congress waged a full-scale assault on corporate takeovers by passing several important changes in the tax code.¹⁴ Mitchell and Netter calculated that these changes would have reduced the value of acquiring a company through a takeover by about 25 percent; that would in turn cause a decline in the stock price of the acquiring company. Typically, the stock price of an acquiring company increases 25 to 35 percent as the result of a takeover. Moreover, such a dramatic anti-takeover bill would have reduced stock prices overall by generally weakening the market for corporate control, a major source of efficiency in capital markets.

The Regulatory Attack on Microsoft

Microsoft’s critics claim to believe that what is bad for Microsoft (an antitrust prosecution) is good for the rest of the computer industry and vice versa because of Microsoft’s allegedly “exclusionary” practices. Microsoft is supposedly “a threat to everybody in the industry,” according to Alan Ashton, president of WordPerfect, which has lost almost all of its market share to Microsoft Word.

In a forthcoming article in the Journal of Financial Economics, Thomas Hazlett and George Bittlingmayer expose this as a myth.¹⁵ The authors surveyed all Wall Street Journal articles from 1991 through 1997 announcing the investigations and litigation and gauged the reaction of the stock markets to it. Categorizing all news stories about the regulatory assault on Microsoft as “positive,” “negative,” or “ambiguous,” they found that:

[W]hen Microsoft receives good news, its stockholders experience average market-adjusted returns of 2.4%. But the news is also good for the industry as a whole, which sees average returns of 1.2% over the same dates. (Both returns are significantly greater than zero at standard levels of statistical significance).

During negative events . . . Microsoft stockholders incur average returns of minus 1.2% per event, while the non-Microsoft computer portfolio declines 0.6%.¹⁶

The returns of a few companies, such as Netscape, which is leading the lobbying and public-relations attack on Microsoft, enjoy increased stock prices whenever the news is bad for Microsoft, which explains why it is instigating the political assault on its rival. It is merely attempting to achieve through politics what it has failed to achieve in the competitive marketplace.

The regulatory persecution of Microsoft is yet another example of regulatory extortion. The political establishment is busy extracting “protection money” from Microsoft in return for its promise to allow the company to exist.

The Tobaccoization of Industry?

The so-called tobacco industry “settlement” has ominous implications for all industries (and consumers). The model is for a government-funded attack on specific industries, complete with volumes of junk science and taxpayer-funded lobbyists who pressure for advertising bans and other regulations that make it difficult to sell the product, along with higher excise taxes.¹⁷ The industry’s management is demonized and portrayed as corporate outlaws. The notion of individual responsibility (for smoking, drinking, reckless driving, firearm use, and so on) is abandoned as “responsibility” is socialized. Once this is done and it is established that no one is responsible for his or her own irresponsible behavior, then it is relatively easy to plunder an industry at will through the vehicle of “taxation by litigation.”

Florida, Vermont, and Maryland actually rewrote the laws to strip the tobacco industry of long-standing common law defenses, guaranteeing that those states would win their lawsuits against the industry. There is no reason to believe that politicians will not do the same to other industries now that the precedent has been set. The state governments cleverly hired private trial lawyers to bring the cases and paid them enormous sums—in the tens of millions of dollars each in some states.

Tort lawyers are now touting plans to use the tobacco litigation/extortion model against the producers of firearms, lead paint, pharmaceuticals, beer, wine and liquor, chemical additives, fatty foods, sports utility vehicles, biotechnology, and myriad other products. These industries will be demonized, more and more severe regulatory restrictions and excise taxes will be imposed on them, and their stocks will tumble. No industry is safe from the greedy hand of regulatory extortion.

Notes

1. Michael C. Jensen and William H. Meckling, “Can the Corporation Survive?,” Financial Analysts Journal, Jan.-Feb. 1978, p. 31.
2. Ibid.
3. Ibid.
4. Robert Higgs, Crisis and Leviathan (New York: Oxford University Press, 1987).
5. Ibid., pp. 142-43.
6. Phillip K. Howard, The Death of Common Sense (New York: Time Warner, 1994), p. 33.
7. Fred McChesney, Money for Nothing (Cambridge, Mass.: Harvard University Press, 1997), pp. 29-30.
8. Ibid., p. 57.
9. Ibid.
10. “Requiem for Reform,” Wall Street Journal, October 14, 1994, p. A-10.
11. Robert Hessen, In Defense of the Corporation (Stanford, Calif.: Hoover Institution Press, 1979).
12. John Hechinger, “NACA Helps Low-Income Clients, But its Tough Methods Draw Flak,” Wall Street Journal, September 13, 1999.
13. Mark Mitchell and Jeffrey Netter, “Triggering the 1987 Stock Market Crash: Antitakeover Provisions in the Proposed House Ways and Means Tax Bill” Journal of Financial Economics, vol. 24, 1989, pp. 37-68.
14. Ibid., p. 39.
15. George Bittlingmayer and Thomas Hazlett, “DOS Kapital: Has Antitrust Action Against Microsoft Created Value in the Computer Industry?” Journal of Financial Economics, forthcoming.
16. Ibid.
17. See James T. Bennett and Thomas J. DiLorenzo, Cancer-Scam: Diversion of Federal Cancer Funds to Politics (New Brunswick, N.J.: Transaction Publishers, 1997).

The students are always quick to recognize that many jobs would, in fact, be created: auto repair, glass manufacturing, street sweeping, garbage removal, and so on. But once they are introduced to the first principle of economics—opportunity cost—they realize that to think of vandalism as an economic stimulant is a farce.

Sure, such vandalism may “create” certain jobs, but only by forcing people to spend money on auto repair that would have otherwise been spent (or invested) elsewhere. The jobs that are “created” are visible, whereas the ones that never materialize are invisible; but they are a very real part of the opportunity cost of using those resources. Government statistics do not measure the jobs, economic activity, and products that never materialize.

A Principle Missed

It is disheartening that a publication as distinguished as the Wall Street Journal would fail to understand this most elementary of economic lessons. But it has. In a September 17, 1999, news article titled “Hurricane Floyd May Leave Robust Economy in its Wake,” Journal reporter Tristan Mabry wrote that Hurricane Floyd, which devastated parts of the eastern United States, “won’t likely damp economic growth and may actually have churned up some extra economic activity.” Mabry quotes Marilyn Schaja, chief economist at Donaldson, Lufkin and Jenrette Securities Corporation in New York City as saying that the storm “may actually give the economy a boost.”

Ian Shepherdson of High Frequency Economics, Inc., told the Journal that the hurricane actually accelerated GDP growth by 0.5 percent, or about $30 billion. “That could add fuel to the nation’s already revved-up economy,” stated the economically clueless Mabry. U.S. Labor Department economist Richard Rosen chimed in, “We’re sensitive to the weather.”

Continuing with the weather theme, Mabry further stated that “like meteorologists, economists are quickly trying to focus their forecasts to reflect changing conditions.” In other words, as Austrian economists have long contended, economic “forecasting” is largely a fraud. When forecasts are off base (which they almost always are), they are simply revised, after the fact, ostensibly to “reflect changing conditions.”

All this talk of Hurricane Floyd as an economic stimulant is, of course, absolute nonsense. If what these commentators say is true, we should be celebrating the occurrence of natural disasters, vandalism, and even war, and investing our life savings in places like Serbia, East Timor, and Iraq. (One wonders how much of Mabry’s own portfolio is invested in Timorese bonds.) The American Civil War should have made the southern states—vast parts of which were looted and burned to the ground—the economic dynamo of the late nineteenth century, with Charleston and Savannah overwhelming New York City and Chicago as the nation’s centers of commerce and finance.

Property destruction always makes people worse off than they were before, but because of their ignorance of economics, Wall Street and government bean counters fall for what Henry Hazlitt, building on a Frederic Bastiat fable, called the “broken-window fallacy.” Once one understands the concept of opportunity cost, which is rooted in the reality of pervasive economic scarcity, then one does not fall for other fallacious notions either, such as a government-spending “multiplier effect,” because one recognizes the destructiveness of the taxation that is necessary to finance the government’s spending.

Nor could one be so foolish as to believe that government “jobs” programs could possibly create jobs on net. The only thing that such programs can do is to create government make-work jobs by destroying more productive private-sector jobs. No matter how such jobs programs are financed—through direct taxation, borrowing, or inflationary monetary expansion—they must divert resources from the private to the governmental sectors. In so doing, they destroy private-sector jobs that had been created as a means of serving consumers in order to generate patronage jobs whose main purpose is to allow politicians to buy votes and advance their careers with taxpayers’ money. Every government program ever proposed was advanced with the help of the fallacious notion that it will somehow “create jobs”—in addition to enlightening the unenlightened, healing the ill and the lame, saving the environment, etc., etc.

Pervasive Ignorance

It is no accident that so many supposedly educated people are ignorant of the most basic concept in economics. As Ludwig von Mises wrote in Human Action, the state is perpetually at “war” with economics and economists, for economic education exposes the fraud involved in the something-for-nothing promises of politicians. “The paramount role that economic ideas play in the determination of civic affairs,” Mises wrote, “explains why governments, political parties, and pressure groups are intent upon restricting the freedom of economic thought.”

A variant of the broken-window fallacy is government “disaster relief.” The billions of taxpayer dollars spent in recent decades have subsequently created a massive moral hazard, which has made natural disasters much more economically harmful than they would otherwise have been. According to The Weather Channel, there have actually been fewer east-coast hurricanes in the past 20 years than the historical average, but the damage from them is much higher because coastal property is much more developed. An important reason why so much development has taken place in the paths of hurricanes is that the government subsidizes it with “disaster relief,” money for rebuilding, and federal flood insurance. This creates an even bigger role for government in future disasters.

The more involved the government becomes in “responding” to natural disasters, the worse will be the economic destruction caused by them. When economically illiterate journalists tell us that hurricanes and government create prosperity, we should answer resoundingly, “It Just Ain’t So!”

Reich began the decade of the ’80s writing books and articles with the Marxist economist Barry Bluestone about the “deindustrialization of America,” which, in their view, could only be stopped by the introduction of central planning, euphemistically called “industrial policy.” But America wasn’t deindustrializing. In a 1984 study published by the Heritage Foundation, I showed that the U.S. Commerce Department’s Index of Manufacturing was at an all-time high, and that manufacturing as a percentage of GDP was about the same in 1980 as it was in 1950. American industry was evolving, as it always has, but it wasn’t disappearing.

Then came the myth of the “great U-turn” in wages, with the average worker allegedly suffering a decline in wages and living standards. This myth was debunked by Richard McKenzie, who showed that if one considers total employee compensation, and not just wages, there is no “U-turn.”

Reich and Ira Magaziner also championed the view that the Japanese system of crony capitalism was the key to that country’s economic success and should be imitated by the United States. Now that the Japanese system has collapsed in a sea of corruption and bankruptcy, Reich is silent on the issue.

The late Murray Rothbard once asked Ludwig von Mises if he thought there was one single thing that designated an economy as primarily capitalist. Mises’s response was yes, a vigorous private capital market. For it is capital markets that facilitate the constant reallocation of capital, guided by consumer sovereignty, in a capitalist economy. So, naturally, Reich next wrote a book and a series of magazine articles criticizing private capital markets as essentially useless, part of a “paper economy” that supposedly adds nothing to production.

The Latest Crusade

In a May 16, 1999, Washington Post article titled “To Lift All Boats,” Reich is back to his old tricks. This time he endorses the Clinton administration’s scheme to use tax dollars to set up “Universal Savings Accounts” worth up to $2,000 for citizens with incomes under $40,000 per year. Another variant of this scheme that Reich writes approvingly of is Senator Bob Kerrey’s plan to give each newborn child $1,000 in tax money, along with $500 per year every year until age 21, to be deposited in a government-operated “savings account.” Then there’s Yale Law School’s Bruce Ackerman, who favors giving every 21-year-old $80,000 of someone else’s hard-earned income, no questions asked. This latter proposal really gets Reich excited. It can be funded, he says, with a mere “2 percent wealth tax on the wealthiest 40 percent of Americans.” That’s any family with an annual income of more than $40,000 per year, hardly what one would consider to be “wealthy.” (For those who believe the tax rate under such a scheme would remain at 2 percent, I’ve got some oceanfront property in Arizona I’d like to sell you.)

All these socialistic share-the-wealth plans are based on profound economic ignorance. The most fundamental problem is a problem of socialism generally, as Mises pointed out in his 1922 classic, Socialism: “The socialist community is characterized by the fact that in it there is no connection between production and distribution. The magnitude of the share [of income] which is assigned for the use of each citizen is quite independent of the value of the service he renders.”

Reich’s share-the-wealth plans are just another “entitlement” (to other people’s money) that will continue to destroy the work ethic by paying people for not working. Since economic reward is divorced from one’s service to consumers, the principle is the antithesis of how a market economy works. Reich, however, absurdly claims that it would expand “the benefits of a market economy.”

It would induce people to save less on their own, just as Social Security does. But once again, Reich gets everything backwards, arguing that it would “encourage saving.” In reality, the reduced savings rate would diminish the rate of capital accumulation and reduce economic growth. The annual cost of the programs, which would run in the tens of billions of dollars, would in itself depress the private sector because the opportunity cost of such programs is returning those tax dollars to their rightful owners, the people who earned them.

Static View

Reich’s case is based on a static view of the economy and the old socialist canard that there is a “lump” of wealth out there: if one person has more, others must have less. But the economy is dynamic; there is great mobility in a capitalist economy, and that mobility is driven by people’s desire to better themselves financially and materially. Giving some of them something for nothing, as Reich’s proposal does, can only diminish that incentive.

In their book, Myths of Rich and Poor, Michael Cox and Richard Alm examine a sample of more than 50,000 Americans from all socioeconomic backgrounds whose incomes have been tracked for more than 20 years. They found that those who started out in the bottom fifth of income earners in 1975 gained more than four times the income by 1991 than did the top fifth in 1975. In a dynamic, capitalist economy the “rich” may get richer, but the “poor” do even better.

Reich argues that the enormous flow of funds into the stock market in recent years doesn’t seem to have benefitted “the bottom 30 percent” very much. But those funds have financed the capital expansion and job creation that have made the U.S. economy the envy of the world. The “bottom 30 percent” has benefitted as much as anyone, if not more.

Reich’s share-the-wealth plan is nothing but another Ponzi scheme, not unlike Social Security, that is designed to help politicians buy the votes of a majority (the “bottom 60 percent”) by taxing a minority. As Rothbard wrote in The Ethics of Liberty, “the State is a coercive criminal organization that subsists by a regularized large-scale system of taxation-theft, and which gets away with it by engineering the support of a majority . . . through securing an alliance with a group of opinion-moulding intellectuals whom it rewards with a share in its power and pelf.” Professor Reich, take a bow.

—Thomas J. DiLorenzo

Professor of Economics

Loyola College, Maryland

This “market failure” supposedly justifies the political plundering of the tobacco industry through war-on-drugs–style regulation of tobacco products, extortionate tax increases, and having the government instruct jurors in tobacco liability cases that they are to assume that smokers bear no responsibility for their smoking-related health problems. To Elhauge, a free market is not really a market free of government intervention; it is a market in which antitrust regulation is pervasive and stands in the way of price-fixing, quantity-fixing, or quality-fixing conspiracies. But the history of the cigarette industry proves that Elhauge’s assertions could not be farther from the truth; the free market did lead to better quality cigarettes until the good professor’s cherished regulation put an end to decades of vigorous quality competition.

Cigarette Advertising

That the cigarette companies vigorously competed on quality before regulation impeded them has been painstakingly documented by economist John E. Calfee, a fellow at the American Enterprise Institute, in “The Ghost of Cigarette Advertising Past” (Regulation magazine, Summer 1997) and his 1997 book, Fear of Persuasion: A New Perspective on Advertising and Regulation. In the 1950s, before the Federal Trade Commission (FTC) started regulating cigarette advertising, the tobacco companies used health as an effective means of promoting one brand over another. This competition led to rapid improvements in cigarettes in light of the new research on the health effects of smoking that was being developed in the 1940s and ’50s.

According to Calfee, cigarette ads from the 1920s to the early 1950s included such slogans as “Not a cough in a carload”; “Not a single case of throat irritation due to smoking Camels”; “Smoking’s more fun when you’re not worried by throat irritation or smoker’s cough”; “Lowest tar of all low-tar cigarettes”; “Today’s Marlboro—22 percent less tar, 34 percent less nicotine”; “Why risk sore throats?” and “less tar and more taste . . . they said it couldn’t be done.” This kind of advertising was so pervasive that in 1953, Business Week wrote that the tobacco companies were “screaming at the top of their lungs about nicotine, cigarette hangovers, smoker’s cough . . . and kindred subjects.”

The industry’s claims were not just talk. Tar and nicotine levels declined by nearly 40 percent between 1957 and 1959, Calfee writes. Nothing like that has happened since. In the 1950s both Consumer Reports and Reader’s Digest published monthly health ratings on cigarettes that carefully noted which brands had improved. Epidemiological studies in later years showed that these tar and nicotine reductions led to roughly proportionate declines in death rates from smoking-related disease.

Regulation Ruins Health-Based Advertising

It was the arrogant heavy-handedness of FTC bureaucrats, not the free market, that was responsible for the decline in health-based advertising in the cigarette industry over the past four decades. In the early 1950s the bureaucrats convinced themselves that all brands of cigarettes were identical and filed numerous “deceptive advertising” claims against the tobacco companies for their ads that made reference to coughing, lung health, and the like.

Incredibly, Calfee points out, in 1950 the FTC declared that smoking cigarettes “is not appreciably harmful” and that health-based advertising was therefore fraudulent. The FTC also decided it was technically impossible to manufacture a cigarette with less tar and nicotine than another. It ordered the tobacco companies to “cease and desist” such advertising.

But the FTC rule prohibited health-based advertising claims only for existing brands of cigarettes. The tobacco companies ingeniously evaded this restriction by creating new low-tar and low-nicotine brands. That fierce quality competition came to be known in industry circles as the “tar derby.”

By the late 1950s, as scientific evidence on the link between smoking and lung cancer mounted, the tobacco companies responded by increasing the share of the cigarette market accounted for by filtered brands from 1 to 10 percent and advertised “healthier” filtered brands heavily. Individual companies sought to gain market share with their advertising by scaring smokers about their competitors’ brands.

That so-called “fear advertising” was successful for some firms, but overall cigarette sales began to fall—an outcome that the industry certainly wanted to avoid. It was free-market competition that led to that result. When the FTC further regulated cigarette advertising, it reduced the degree of competition and the amount of health-related advertising, and slowed the decline in U.S. smoking rates.

In 1960 the FTC ruled that all tar and nicotine advertising was illegal, eliminating such ads for several years. After making this declaration, Calfee writes, the FTC also deceptively announced that the industry had adopted a “self-imposed Cigarette Advertising Code.” Of course, it was not “self-imposed”; the FTC would have sued the industry had it not adopted the government-sanctioned code. Consequently, during the early 1960s all cigarette ads spoke only of flavor and pleasure.

After the Surgeon General’s Report on smoking and cancer in 1965, the FTC changed its position again and permitted advertising references to tar and nicotine—but it was illegal to link these substances to health. In 1970 Congress banned all cigarette advertising on television and radio, ending once and for all the free market in cigarette advertising.

In sum, Professor Elhauge is dead wrong. When the free market was allowed to work, there was vigorous quality competition in the cigarette industry, which produced an enormous amount of information about the health hazards of smoking. The FTC’s interventions may well have been part of a conspiracy, however: the industry’s “fear advertising” was causing a drop in the incidence of smoking, which the industry wanted to reverse. If the industry did in fact conspire with FTC bureaucrats to eliminate health-based advertising, the lesson is that such conspiracies can only work if they are organized by corrupt government regulators; they are impossible in the free market. Professor Elhauge, read your history.

—Thomas J. DiLorenzo

Professor of Economics

Loyola College, Maryland

Even the Wall Street Journal has joined in this attack; reporter Alan Murray claimed in a page-one article that Gates supposedly enjoys “monopoly power” that “even John D. Rockefeller could envy.”

Microsoft’s critics are right. There are many similarities between Bill Gates’s company and the old Standard Oil organization.

Like Gates, Rockefeller was the victim of a political assault for the “sin” of rapid innovation, a vast expansion of output, and rapidly declining prices just the opposite of what the antitrust laws ostensibly police. As with Microsoft, the political attack on Standard Oil was launched by less-efficient rivals who wanted to achieve through the political process what they failed to achieve in the marketplace.

There is indeed a lesson to be learned from Rockefeller’s antitrust ordeal, but it is not the one Microsoft’s critics have in mind.

Rockefeller’s Economic Legacy

The firm of Rockefeller, Andrews, and Flagler was formed in 1865 and was a marvel of efficiency because of Rockefeller’s penny-pinching ways and the managerial genius of his brother William.¹ Even Rockefeller’s harshest critic, the muckraking journalist Ida Tarbell (whose brother’s firm the Pure Oil Company was driven from the market by the more efficient Standard Oil), described the company as “a marvelous example of economy.”²

The efficiencies of economies of scale and vertical integration caused the prices of refined petroleum to fall from over 30 cents a gallon in 1869 to 10 cents by 1874 and to 5.9 cents by 1897. During the same period, Rockefeller reduced his average costs from 3 cents to 0.29 cents per gallon.

The production of refined petroleum increased rapidly throughout this period of increasing dominance by Standard Oil as well, as increased competition was provided by Associated Oil and Gas, Texaco, the Gulf Company, and 147 independent refineries that had sprung into existence by 1911 the year in which the government forced the breakup of Standard Oil.

Contrary to popular mythology, Standard Oil’s market share declined from 88 percent in 1890 to 64 percent by 1911. Because of intense competition the company’s oil production as a percentage of total market supply had declined to a mere 11 percent in 1911, down from 34 percent in 1898.

Moreover, Standard Oil’s decades-long price-cutting was not “predatory pricing” the theoretical practice of pricing below average cost to drive competitors from the market and establish a monopoly. Any business person would be a fool to intentionally lose money by pricing below average cost for decades. As economist John McGee concluded in his classic analysis of the Standard Oil case, “whatever else has been said about [it], the old Standard organization was seldom criticized for making less money when it could readily have made more” through other means.³

Indeed, Standard Oil never came close to cornering the market; by the time the antitrust case against it was filed in 1906, it had hundreds of competitors. Nevertheless, Standard Oil was convicted of violating the antitrust laws in 1911 and partially dissolved, despite the fact that the courts conducted no economic analysis of its conduct and performance. That is, they completely ignored the effects the company had on prices, output, and innovation in the petroleum industry, just as Microsoft’s critics tend to ignore that there are tens of thousands of software development firms in the world and that during the period of Microsoft’s rise to dominance the cost of computing has fallen spectacularly while product quality has soared.

Standard Oil was convicted because of a general anti-business animus stoked by socialist intellectuals and journalists such as Henry Demarest Lloyd and Ida Tarbell and urged on by the company’s higher-cost and higher-priced rivals. As a result the most efficient industrial organization of the time was crippled, weakening competition and pushing prices up.

The Protectionist Roots of Antitrust

From the very beginning, the antitrust laws have been a protectionist vehicle. While in theory they guard consumers against monopoly, in reality they politically protect uncompetitive (but well-connected) businesses. In a 1985 International Review of Law and Economics article, I showed that in the ten years before the 1890 Sherman Anti-Trust Act, the industries accused of being “monopolized” by trusts were all dropping their prices faster than the general price level was falling at that time and were expanding output faster than GNP was growing some as much as ten times faster.⁴ The late-nineteenth-century trusts were the most innovative and fastest-growing industries of their time, which is why they were unfairly targeted by antitrust laws.

Indeed, Congress at the time recognized the great advantages of the trusts for consumers. Congressman William Mason stated during the U.S. House of Representatives debate over the Sherman Act that the “trusts have made products cheaper, have reduced prices; but if the price of oil, for instance, were reduced to one cent a barrel, it would not right the wrong done to the people of this country by the trusts’ which have destroyed legitimate competition and driven honest men from legitimate business enterprises.”⁵ Senator George F. Edmunds added that “Although for the time being the sugar trust has perhaps reduced the price of sugar, and the oil trust certainly has reduced the price of oil immensely, that does not alter the wrong of the principle of any trust.”⁶

Thus, members of Congress acknowledged that the trusts had caused lower prices to the great benefit of consumers, but objected that higher-priced businesses many of which were political supporters had lost market share or had been driven out of business.

The Sherman Act was a protectionist scheme in more ways than one. The real source of monopoly power in the late nineteenth century was government intervention. In October 1890, just three months after the Sherman Act was passed, Congress passed the McKinley tariff the largest tariff increase in history up to that point. The bill was sponsored by none other than Senator John Sherman himself. Sherman, as a leader of the Republican Party, had championed protectionism and high tariffs since the Civil War. In the Senate debate over his antitrust bill he attacked the trusts because they supposedly “subverted the tariff system; they undermined the policy of government to protect . . . American industries by levying duties on imported goods.”⁷ That is, the price-cutting by the trusts undermined the manufacturing cartel that was created and sustained by the Republicans’ high-tariff policies.

The Sherman Act was a political fig leaf designed to deflect attention away from the real source of monopoly power the tariff and the true price-fixing conspirators Congress and protectionist manufacturers. The New York Times saw through this charade when it editorialized on October 1, 1890, that the “so-called Anti-Trust law was passed to deceive the people and to clear the way for the enactment of this . . . law relating to the tariff. It was projected in order that the party organs might say to the opponents of tariff extortion and protected combinations, Behold! We have attacked the Trusts. The Republican Party is the enemy of all such rings.’”⁸

Economists were almost unanimously opposed to the Sherman Act because they viewed competition as Austrian school economists view it as a dynamic, rivalrous process of discovery.⁹ According to historian Sanford D. Gordon, who surveyed all professional journals in the social sciences and all books written by economists regarding the late-nineteenth-century trusts, “a big majority of the economists conceded that the combination movement was to be expected, that high fixed costs made large scale enterprises economical, that competition under these new circumstances frequently resulted in cutthroat competition, that agreements among producers was a natural consequence, and the stability of prices usually brought more benefit than harm to society. They seemed to reject the idea that competition was declining, or showed no fear of decline.”¹⁰

The Myth That Antitrust “Saved” Capitalism

A popular argument made at the time was that antitrust was necessary to stave off something even worse the more extreme forms of regulation or outright socialism. Antitrust was adopted, but Americans were subjected to the more extreme forms of regulation and socialism anyway. As Milton and Rose Friedman pointed out in Free to Choose, by the 1970s the entire Socialist Party Platform of 1920 had been adopted in the United States. Socialism, F. A. Hayek pointed out in The Road to Serfdom, no longer meant nationalization of industry and central planning, but rather the institutions of the welfare and regulatory state. Antitrust did nothing to stop the spread of socialism in America.

Quite the contrary; the adoption of antitrust helped speed up the adoption of socialism. By weakening the competitive process, it has led to slower productivity growth and diminished prosperity. Government always reacts to slower economic growth, unemployment, and economic crises by adopting even greater economic interventions. The late-nineteenth-century proponents of antitrust had it all backwards. This is why it is so disingenuous, to say the least, of contemporary proponents of antitrust, such as the Wall Street Journal’s Murray, to repeat this same discredited argument, urging Bill Gates to “place trust in trustbusters,” or else “he may eventually find the Justice Department and Congress considering more-radical remedies.”¹¹

The Real Robber Barons

John D. Rockefeller, like Bill Gates, achieved his economic success by offering the best products for the lowest prices on the free market. The real “robber barons” of the late nineteenth and the late twentieth centuries are the business people who, having failed to achieve competitive success in the marketplace turned to government and asked it to enact laws and regulations granting them special privileges and harming their competitors. A century ago, such immoral special pleaders included Leland Stanford, who became wealthy by using his political connections to obtain a government-created monopoly franchise in the California railroad industry; Thomas Durant and Grenville Dodge, who pocketed millions in government subsidies to build the Union Pacific railroad; Henry Villard, who “rushed into the wilderness to collect his [government] subsidies” to build the Northern Pacific railroad; and steel industry magnate Charles Schwab, who championed the disastrous 1930 Smoot-Hawley tariff.¹² Their modern-day counterparts would include many of Bill Gates’s competitors, such as the chief executive officers of Netscape, Sun Microsystems, Novell, and other companies that have lobbied the federal government to use the antitrust laws to diminish or destroy the competitive efficiency of their most effective rival, Microsoft.

For over 100 years antitrust regulation has allowed politicians to deceitfully pose as “populists” while stifling competition with politically motivated attacks on the most innovative and progressive companies. These attacks have been supported for over a century by socialist intellectuals and journalists who have taught many Americans to hate capitalism, to envy successful people, and to support government policies that undermine or destroy them both. Being the most successful businessman in the world, Bill Gates was an inevitable target of the anti-capitalistic crusaders. It’s time we recognized antitrust for the protectionist racket that it is and repealed the antitrust laws.

Notes

1. The following information about Standard Oil is from Dominick Armentano, Antitrust and Monopoly: Anatomy of a Policy Failure (New York: Wiley, 1982).
2. Ida Tarbell, The History of the Standard Oil Company (New York: Peter Smith, 1950), pp. 240 41.
3. John S. McGee, “Predatory Price Cutting: The Standard Oil (N.J.) Case,” Journal of Law and Economics, October 1958, p. 168.
4. Thomas J. DiLorenzo, “The Origins of Antitrust: An Interest-Group Perspective,” International Review of Law and Economics, 1985, pp. 73 90.
5. Congressional Record, 51st Congress, 1st Session, House, June 20, 1890, p. 4100.
6. Ibid., p. 2558.
7. Ibid., p. 4100.
8. New York Times, October 1, 1890, p. 2.
9. Thomas J. DiLorenzo and Jack C. High, “Antitrust and Competition, Historically Considered,” Economic Inquiry, July 1988, pp. 423 34.
10. Sanford D. Gordon, “Attitudes Toward Trusts Prior to the Sherman Act,” Southern Economic Journal, 1963, p. 158.
11. Alan Murray, “It’s Time Gates Placed Trust in Trustbusters,” Wall Street Journal, March 9, 1998, p. 1.
12. Burton W. Folsom, Jr., The Myth of the Robber Barons (Herndon, Va.: Young America’s Foundation, 1991).