Suspicion of profit runs deep. In an Atlanta Journal-Constitution op-ed, Cynthia Tucker spoke for many last summer when she wrote, “The for-profit health insurance industry is in the business of maximizing profits for their shareholders, and the only way they can do that is to hold down the payments they make for medical care” (emphasis added).

It just ain’t so. Holding down payments unreasonably or in violation of contract would give a company a bad reputation. Firms with bad reputations would have a difficult time attracting future customers in a competitive market, George Mason University economist Bryan Caplan argues. What would happen to profits then? Reputation provides a powerful incentive against the conduct Tucker fears. However, reputation would be a more potent force if people bought their insurance directly rather than through their employers. Nevertheless, the potential for profit does not lie simply in minimizing the payment of benefits.

But, Tucker argues, “There is no real competition among insurance companies, as recent research has shown.” She’s right. Competition is sparse, however, not because of any inherent market failure but because, among other things, the federal government forbids interstate competition. The purpose of the prohibition is to prevent consumers from finding better deals than those permitted by their state insurance regulators. The protectionist limit on competition is fine with the insurance companies, confirming Freeman contributing editor Steven Horwitz’s First Law of Political Economy: “No one hates capitalism more than capitalists.”

Admirably, Tucker takes Republicans to task for not doing something about competition when they could have. But the failure to repeal a bad policy hardly justifies piling a new bad policy on top of the old.

Profit: the Cure, not the Disease

Some people are repulsed that doctors and insurance companies profit from illness; indeed, Michel de Montaigne wrote a famous essay in which he argued that “the profit of one man is the damage of another.”

Illness, however, isn’t the source of profit. Rather, as FEE web columnist William Anderson points out, it’s the ability and opportunity to make someone well.

In a Freeman article last year, Horwitz went further: “Profit is not just a motive; it is also integral to the irreplaceable social learning process of the market. Critics may consider eliminating the profit motive the equivalent of giving the Tin Man from Oz a heart; in fact it’s much more like Oedipus’ gouging out his own eyes.”

Advocates of government-run health care argue that the profit-driven U.S. system is inferior to its Canadian and European counterparts. There is plenty of reason to doubt that claim, but more fundamentally, a system with government-subsidized consumption (Medicare, Medicaid, and tax-advantaged employer-based insurance) and government-constricted markets is not the system free-market advocates have in mind.

Some also argue that private for-profit insurance has higher administrative costs than the government’s nonprofit Medicare program. But lowering such costs is no free lunch. Economist Greg Mankiw points out that “Low administrative costs are not to be confused with high administrative efficiency” and cites his colleague Malcolm Sparrow, who argues that “health care fraud and abuse [cost] hundreds of billions of dollars per year. . . . The rule for criminals is simple: if you want to steal from Medicare, or Medicaid, or any other health care insurance program, learn to bill your lies correctly. Then, for the most part, your claims will be paid in full and on time, without a hiccup, by a computer, and with no human involvement at all.” If anything, this suggests that administrative costs for Medicare and Medicaid might be too low.

A Learning Process

It’s a misconception that profit is something tacked onto the price of goods and services. If that were so, why would profits change from year to year and why would companies go out of business? Profit and loss are indispensable to consumer well-being because resources are scarce and have alternative uses. How do we decide how much to devote to making people well and how much to devote to feeding, clothing, entertaining, and educating them? It isn’t merely that this is a difficult question to answer. It is literally impossible to answer in any meaningful way without market prices, profits, and losses.

Profit rewards the entrepreneur who takes a risk in transforming resources into products she correctly thinks consumers will value more than those currently being made with those resources. Entrepreneurs get needed feedback from profits and losses. If they create value, profits are the reward. If they destroy value, losses are the punishment. In a free market no entrepreneur may rest on her laurels. Profits attract competition and are competed away before long. So the incentive to innovate and economize is strong.

Contrast this with government. On several online networks I asked for examples of successful and sustainable government programs giving away 12- and 13-figure pots of money. The best examples were infrastructure and basic research, but even these aren’t disciplined by the market. Without market prices—and the possibility of profit and loss—we can’t calculate the opportunity cost of any given project. Our experiences with the Cash for Clunkers and ethanol debacles do little to inspire confidence.

Profits and losses provide crucial information that enables producers to engage in rational economic calculation in the service of consumers. Grasping this is one of the most important contributions economics has made to our understanding of the world. Thus the profit-and-loss system is as badly needed for medical services as it is for any other product or service. It is true that health care is unique in some ways, but this strengthens rather than weakens the case for subjecting it to entrepreneurial profit and loss. Health care is not “too important to be left to the market.” It is too important not to be.

Related posts:

1. Profit: Not Just a Motive
2. Health Care’s Muddled Incentives
3. Profit and Loss

This time it happened on p. 31, where Bastiat writes, “Socialists look upon people as raw material to be formed into social combinations. This is so true that, if by chance, the socialists have any doubts about the success of these combinations, they will demand that a small portion of mankind be set aside to experiment upon. . . . And one socialist leader has been known seriously to demand that the Constituent Assembly give him a small district with all its inhabitants, to try his experiments upon.”

Two things occurred to me as I read this. First, you don’t have to be socialist to believe that people are raw material to be experimented upon. And second, in modern America, doubts or no doubts about success, experiments can be run on the entire country at once. No need to try things out first on a small district.

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

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

Bastiat brimmed with controlled outrage at the French politicians and writers who so blithely presumed that other people’s lives were theirs to dispose of in grand experiment. He dissected the classical notion, popular among the pundits of his day and ours, that individuals are inert until a wise leader comes along and invests them with a principle of motion—“They assume that people are susceptible to being shaped by the will and hand of another person—into an infinite variety of forms, more or less symmetrical, artistic, and perfected,” he wrote.

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

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

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

We shall not be experimented upon!

* * *

When President Obama intervened in the bankruptcies of GM and Chrysler, longstanding financial-legal precedents went by the wayside. What consequences will this have for the future? Richard Epstein ponders this question.

The numbers are in on Cash for Clunkers. Despite the program sponsors’ and participants’ euphoria, it was a bad deal all around. Bruce Yandle has details.

New Nobel laureate Elinor Ostrom explained how people voluntarily coordinate to solve problems. Peter Boettke says every freedom-lover should rejoice in her prize.

When it opened its doors in 1914 the Federal Reserve System was supposed to bring stability to the U.S. economy. It didn’t quite work out that way. Chidem Kurdas explains why.

Why don’t we ever hear older people reminisce about how tough life was during the depression of 1920–21? Maybe it’s because that one, unlike the Great Depression, was what W. S. Gilbert might have called a short sharp shock. Robert Murphy describes the depression history forgot.

Mexico’s violent drug trade has spilled across the border, creating concern throughout the United States. There’s an easy way to stop it, Paul Armentano writes: End the war.

Belief in manmade climate change once led to large-scale economic and personal dislocation. That was in the nineteenth century. Will it happen again? Tyler Watts reminds us that we can learn from history.
Here’s what’s been on our columnists’ minds lately: Lawrence Reed recalls the influence that a movie had on him long ago. Thomas Szasz remembers those whom the criminal justice system has forgotten. Robert Higgs looks at the case for slavery. John Stossel finds it curious that big pharmaceutical and big insurance companies like Obama’s healthcare plans. Charles Baird analyzes the latest papal encyclical on labor unions. And Art Carden, confronting the claim that profit has no place in the healthcare system, responds, “It Just Ain’t So!”

Our reviewers test-drive books on the effect of higher taxes, the bloated presidency, the dollar, and Paul Krugman’s view of the economy.

It’s December, which means the issue wraps up with the year-end index, prepared by Managing Editor Michael Nolan.

Related posts:

1. Bastiat and Unionism
2. Bastiat, Socialism, and the Blank Slate
3. Bastiat, Liberty, and The Law

On November 9, 1989, the Berlin Wall effectively ceased to exist. Remember the sequence: Communist Hungary started letting people pass into Austria and to freedom. Captives of the Soviet bloc left in droves. East Germans, too—thousands of them. The Hungarian government tried to stanch the flow, but the dam had been breached. With one dictator having resigned, a panicky East German regime began making concessions, hoping to mollify the people. They would not be placated. Thousands—and in one case, a million—took to the streets, shouting, “We want out!” Things were getting out of hand. So, on November 9, the government fumblingly announced it would lift travel restrictions to West Berlin and West Germany. It was all over but the demolition.

I don’t know why it seems so much longer ago that we saw those inspiring celebrations, when East Berliners, joined by their countrymen from the western side, danced on the wall while others whacked at it with axes and sledge hammers. The crowds, the singing, the joyful cries of “Freedom!”, the sections of wall toppling—I remember watching the scenes on television with my then-six-year-old, Jennifer. If you can watch them on YouTube today without tearing up, I don’t know what to say.

It’s hard to believe that today’s 19-year-olds were born into a world without a Berlin Wall and 17-year-olds were born into a world without the Soviet Union. When my generation was growing up, the Iron Curtain and USSR seemed like permanent fixtures of life.

Yes, we really did have air-raid drills in school. (Looking back, I can see they were insidious, ridiculous propaganda stunts.) Some of us wished, at most, for what was called peaceful coexistence. Others thought “we” could roll “them” back. War—which a few, amazingly, actually welcomed—would have been catastrophic beyond imagination. We dared not hope for a bloodless dissolution of totalitarianism. Yet that, more or less, is what we got.

Those of us who believe in full individual liberty have been dismayed to learn that revulsion with dictatorship does not equate to a wholehearted embrace of freedom. None of the former Soviet-bloc countries has thoroughly foresworn state-capitalist welfarism, and some have traveled only a short distance along the road from serfdom. Central planning is dead as an ideal, but the regulatory state lives, as does what Thomas Szasz calls the Therapeutic State. This is disappointing, but it would be difficult for a resident of the United States to criticize others for failing to resist overbearing government. The longing for security, combined with the absurd notion that only ignorant and force-wielding bureaucrats can provide it, dies hard.

The fall of the Iron Curtain has been heralded as the failure of socialism, but this is a more complicated matter. Strictly speaking, there has been much less socialism in the world than it might appear since Lenin gave it up for the New Economic Policy in 1921. Remember, Marx envisioned the abolition of the market, including money and exchange. The economy was to be centrally planned—literally. But when the Bolsheviks tried it, they ended up, as Trotsky said, “staring into the abyss.” Lenin was savvy enough to back away from oblivion and reintroduce aspects of the market, including a gold ruble. What followed for the next seven decades was a heavily bureaucratized, de facto quasi-market economy, existing in a world of prices in which The Plan was adjusted ex post to reflect reality and black-market “corruption” kept things going. Ludwig von Mises could not have been surprised.

Such an economy was doomed to fail, but perhaps with a little less intervention and a dollop of political freedom, it might have muddled through a bit longer. The market can put up with a lot of harassment, which means people can resourcefully get around a lot of government obstacles when they want to. Look at the U.S. economy.

* * *

The late summer and early fall were dominated by what is prejudicially called healthcare “reform.” Statist analysts dominated the public discussion. A rare exception was Arnold Kling, who in this issue explains that our problems are caused by government’s creation of perverse incentives up and down the line.

The government owns large shares of Chrysler and General Motors, which is a sign of how things are going these days. Michael Heberling analyzes this venture into socialist ownership of the means of production. Christopher Westley follows up with the story of Cash for Clunkers, or how the government won friends by sticking it to the poor.

Most people—and politicians—have no idea what hedge funds do, but they are sure the government should control them. Warren Gibson guides us through the thick of high finance.

So you think the government can create jobs? Then Houdini must have been able to exit a locked trunk without trickery. William Allen and William Dickneider have their doubts.

If the government could shut you away without having to justify its conduct, no enumerated right would be worth a thing. That’s why habeas corpus is called the Great Writ, as Wendy McElroy explains.

Government was big on January 19, but it’s growing bigger still—in ways most people don’t even realize. Murray Weidenbaum is keeping score.

Composer Quincy Jones thinks there should be a cabinet department to promote the arts. Don’t bet against it. Bruce Edward Walker discusses this urgent “necessity.”

Our columnists have found some interesting things to tell you about. Lawrence Reed traces the end of child labor in Britain. Donald Boudreaux thinks about Star Trek. Burton Folsom pays some attention to President Rutherford B. Hayes. John Stossel shows healthcare “reform” won’t produce competition. Walter Williams explores the rule of law. And Richard Fulmer, incessantly running into the assertion that World War II ended the Great Depression, retorts, “It Just Ain’t So!”

Reviewers assay volumes on money, a neglected Antifederalist, education, and libertarian political philosophy.

—Sheldon Richman

srichman@fee.org

Related posts:

1. The Rise and Fall of England: 17. The Fall of England (Conclusion)
2. The Rise and Fall of England: 16. The Fall of England (Part I)
3. Berlin, August 1961: An Anniversary We Should Never Forget

He has since repeated this bon mot in a number of columns and television appearances. Like Keynes, Krugman lets his fondness for flippant, pithy sayings get in the way of regard for long-run economic prosperity. (Keynes famously remarked that “In the long run we are all dead,” ignoring the fact that in the long run others are alive.)

It is true, as the graph shows, that the country’s gross domestic product rose sharply during the war.

But GDP measures only the total monetary value of production while ignoring what is actually produced. It is just a number, a number that would be no different if consumer goods were produced and sold or if the government set the workforce to making mud pies and then purchased those pies for a like sum. Yet what is produced makes all the difference. The point of an economy is to improve people’s lives by producing goods and services they want and need.

During the war the P in GDP largely consisted of the munitions needed to defeat the Axis powers. While these weapons were necessary to win the war, they did nothing to provide food, clothing, and shelter. Despite all the production increases that came with the war, the American people were materially worse off while it lasted. Some 15 million American men and women, over 10 percent of the population, served in the armed forces. Living, and sometimes dying, in a foxhole was not an improvement over stateside life—even life during the worst of the Depression. Back in the States living standards also dropped (though not as dramatically) as consumer goods, including food and gasoline, were rationed.

Bridges to Nowhere But Recovery?

Krugman, however, is interested in jobs rather than production. He wants the government to spend massive amounts of money and is relatively indifferent as to how the money is spent: “Let the government borrow money and use the funds to finance public investment projects—if possible to good purpose, but that is a secondary consideration—and thereby provide jobs, which will make people more willing to spend, which will generate still more jobs, and so on.”

This indifference is a logical outcome of his belief that the war ended the Great Depression. If, as Krugman thinks, the economy was rescued then by expending huge amounts of resources to build weapons that disappeared overseas, then we would be that much better off now if the government spent a similar amount of resources on things that have even marginal utility—say, bridges to nowhere. If the bridges provide any long-term economic benefit at all, that would just be icing on the cake.

Economically, however, World War II did not spark a recovery so much as it created a financial bubble—not in Internet stocks or housing but in

munitions. Once the war was over, the bubble collapsed along with the demand for aircraft carriers and B-17 bombers.

The war’s outbreak necessitated two policy changes, though, that did aid the postwar recovery. First, President Roosevelt stopped his incessant attacks on business. As Amity Shlaes points out in The Forgotten Man, FDR needed big business to produce the tanks, planes, and ships required to defeat Hitler and his allies. Second, he ended his erratic, trial-and-error experimentation. Before the war the stated strategy of FDR and his Brain Trust was to try one program after another until they found something that worked. This resulted in perpetual market churn that made long-term planning and investment especially risky if not impossible. Another result was the creation of myriad tiny, short-lived bubbles. Jobs were created in various locations and in various crafts only to disappear when the government lost interest and shifted its gaze.

Yet Krugman elsewhere prescribes this same strategy of experimentation for today’s financial woes: “The point of all this is to approach the current crisis in the spirit that we’ll do whatever it takes to turn things around; if what has been done so far isn’t enough, do more and do something different, until credit starts to flow and the real economy starts to recover.”

The Don Ho School

World War II forced Roosevelt to concentrate on a single area of production: weapons. This focus was maintained for the duration of the war and resulted in a sustained economic bubble. Without a similar attention-focusing crisis, however, current government attempts at stimulus will simply result in economic effervescence—tiny bubbles inflating and bursting as the winds of politics shift lawmakers’ attention. Call it the Don Ho School of Economic Thought.

The inability of the Obama administration’s deficit spending to spark economic recovery may be masked for a time by the Fed’s continued expansion of the money supply. Inflation could resurrect the housing bubble, providing a brief uptick in the economy, but such policies cannot be maintained for long.

What the country needs is not more economic bubbles—tiny or otherwise. It needs sustained economic growth. That will come by strengthening the private sector, not by strengthening government. The best way to do this is to reduce government spending, which crowds out the private kind, and to enact long-term tax cuts.

Contrary to popular belief, the “public works program” known as World War II did not end the Great Depression; it ended the New Deal. The end of the war brought federal spending and tax cuts and the repeal of the Smoot-Hawley tariffs. All these changes combined to pull the nation’s economy out of its long and painful slide, and all could have been made without the war. Similar changes made now could restore the world’s economy without the massive human suffering that, in their absence, is all but inevitable. Inevitable, yet so avoidable and so unnecessary.

Related posts:

1. The Great Depression and World War II
2. The Great Escape from the Great Depression
3. The Great Depression According to Milton Friedman

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

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

That’s collectivism.

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

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

When we see problems in other important markets, most of us don’t expect televised presidential town-hall meetings, congressional committees, and omnibus legislation to give us the answer. We individually adjust our behavior in the marketplace and anticipate that entrepreneurs will cater to us. Solutions, with inevitable tradeoffs, are micro, marginal, and tailored to individual needs, not macro, holistic, and procrustean. Out of this arises an orderly marketplace–without a conscious overall plan. No one has found a better way to make masses of people better off.

Why is health care different? Must we collectively reinvent the industry? The social knowledge problem that F. A. Hayek spelled out should make us wary of any collective response.

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

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

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

* * *

Why did it take a major recession to get politicians thinking about fixing the roads and bridges? Because there is glory in starting big flashy projects, but none in maintaining them. Jim Powell documents this truth.

The debate raging over the legitimacy of intellectual property rights is about more than rock bands trying to stop kids from swapping MP3 files over the Internet. It’s about whether people are free to use their human capital to compete with entrenched dinosaur corporations looking to the State for protection. Kevin Carson assesses what’s at stake.

In the future, when government retrenches and the market is finally free, people will obtain their medical care differently from how they do now. Ross Levatter speculates on how things might look.

Political leaders are always haranguing us to volunteer in our communities. So why do they make it so darn difficult? James Payne describes the mess that awaits would-be volunteers.

In every era do-gooders condemn the consumer-credit trap and propose ways to shield supposed victims from predatory lenders. It’s happening again now with credit cards. Todd Zywicki summarizes the history of consumer credit in America and the harm done by protecting people from themselves.

Curaçao was once a popular offshore financial center. Now it’s not. Andrew Morriss explains the lessons to be learned from its rise and fall.

Here’s what our columnists have brewed up this month: Lawrence Reed commemorates Poland’s break from the Soviet bloc. Donald Boudreaux contemplates working for a state-run university. Thomas Szasz recounts the psychiatric attempt to deny General Edwin Walker a criminal trial. Stephen Davies shows that true heroes are not politicians and generals. John Stossel finds healthcare reformers arrogant. David Henderson defines privilege. And Peter Lewin, contemplating the argument that free-market advocates should welcome financial regulation, protests, “It Just Ain’t So!”

Books undergoing dissection deal with slave emancipation, the current financial turmoil, the essays of a great economist, and media freedom.

–Sheldon Richman

srichman@fee.org

Related posts:

1. Book Review: Code Blue: Healthcare in Crisis by Edward R. Annis, M.D.
2. A Health-Insurance Criminal Pleads His Case
3. Medical Competition Works for Patients

Singer proposes “three fundamental tests” for the new “regulatory infrastructure”: 1) assess and measure risks accurately, including the compounded risks of herding; 2) impose significant margin requirements on all exposures; and 3) bring all investors and traders–regardless of whether the risk holder is a hedge fund, bank, private equity fund, individual, or government agency–under the regulatory umbrella.

These are not trivial or piecemeal steps. The last especially implies a substantial expansion of government reach into all parts of the investment environment. That alone would give free marketeers extreme pause, especially since Singer wants “a global mandate.”

Perhaps his boldest assertion, however, is that “The private sector, not the public sector, is where the biggest mistakes were made.”

By saying this Singer joins the chorus that attributes the financial collapse to the “excesses” of the free market–to the lack of regulation that characterized the pre-crash environment. The Orwellian nature of this position is a source of painful–though not unpredictable–frustration for those who understand that the true cause of our current problems is, and continues to be, massive government regulation that prevented markets from working and pushed resources into investments that could not be sustained. Those who understand this also understand that if government is the problem, it cannot be the solution.

The crash of 2008 will be hotly debated for a long time to come, and the precise nature of its causes will be the subject of much historical research. Matters now somewhat obscure will emerge with greater clarity as time goes by. We do know enough right now, however, to identify with great certainty three fundamental causative factors: easy money, “innovations” in mortgage lending, and misleading credit rating. Disagreement about the precise role of easy money probably will continue. (It is not easy to know if the crash would have occurred had the Fed not been so accommodating.) But there is a compelling case about the other two.

First, what does “innovative” mortgage lending mean? According to Professor Stan Liebowitz’s in-depth examination of the mortgage industry, “[I]n an attempt to increase home ownership, particularly by minorities and the less affluent, virtually every branch of government undertook an attack on underwriting standards starting in the early 1990s” (“Anatomy of a Train Wreck: Causes of the Mortgage Meltdown”).

The huge consumer leverage in residential real estate that ensued was in fact the brainchild of those persistent and self-righteous legislators (chief among them Barney Frank), aided and abetted by progressive journalists and academics. Their much-touted agenda to increase homeownership in America, particularly among minority low-income earners, succeeded spectacularly. And it is precisely these new homeowners who have featured most prominently in the meltdown that home foreclosures triggered. These legislators and their cheering section in the press and academia have a lot to answer for in having precipitated a world financial crisis. Would that they were at least aware of their culpability.

Gold (Plated) Standards

In the meantime, of course, the run-up in housing prices attracted investors from other parts of the financial sector and encouraged experimentation with new types of financial instruments and insurance based on these high-performing mortgage assets. Absent the systematic and massive intentional degrading of mortgage-lending standards, it is hard to see how this could have occurred. Still, it is clear that the three existing credit-rating agencies systematically misread and underestimated the riskiness of these assets and misled the entire market in the process. Notably, all three agencies (Moody’s, Standard and Poor’s, and Fitch) earn their incomes from the companies whose assets they rate. They all made substantial profits from rating mortgage-backed securities. There are no independent agencies because those three are “government approved” to rate assets in which government-created financial institutions can invest. These agencies were in effect protected from competition and subject to serious conflicts of interest. The positive glow generated by their consistently high ratings, fueled in part by implicit government guarantees, obscured the darker warning signs emanating from less prominent sources.

Against this backdrop Singer’s reasoning is difficult to understand. On what basis can he possibly claim that the biggest mistakes were made by the private sector? What mistake could be bigger than the willful encouragement–even mandating–of irresponsible lending by private-sector institutions that otherwise would have continued to adhere to their time-tested standards for assessing the reliability of mortgage borrowers? In the absence of this legislative abuse, the margin requirements for which Singer calls would not be necessary because the underlying assets would be more reliably valued. And surely, in the absence of government protection, independent rating competitors would have had a much better chance of bringing some sanity to bear on the market.

The Nature of Regulation

Singer seems to misunderstand the nature of regulation itself. He calls for regulators (with the aid of the private institutions in the pay of the regulators!) to “accurately assess” risks, including the risks of herding (psychological contagion that causes markets to tank), and to use this assessment as the basis for new and enlightened regulations. We might as well pray for the Messiah to come next Thursday.

Regulators are fallible human beings whose knowledge of the present and ability to predict the future–including the future consequences of their actions–are seriously limited. The future is and will always be unpredictable. One might wonder whence even dedicated public servants are to come up with such “accurate assessments” when such assessments depend on events beyond their ability to foresee. Why should they do better than the market in this respect? After all, it is not even their own money they are regulating.

Successful regulation is rare. Market successes, on the other hand, are abundant. Bubbles may be unavoidable, but in the absence of clumsy government pushing and shoving, they are likely to be small, short-lived, and confined in scope. The housing monster-balloon is a creature of the most egregious regulation. How can we expect more regulation to be the solution?

Related posts:

1. Meltdown: A Free-Market Look at Why the Stock Market Collapsed, the Economy Tanked, and Government Bailouts Will Make Things Worse
2. Government Must Keep Track of Derivatives?
3. Bootleggers, Baptists, and Bailed-Out Bankers

Indeed.

From the setting forth of praxeology as the a priori science of human action, to the description of the market’s operation, to the explanation of the business cycle, to the proof that rational central planning is impossible, Mises’s work is nothing less than a work of art. It faithfully captures the elegant orderliness of social reality that grows out of the logic of human action. I could go on, but instead I will reprint here, slightly edited, what I wrote in these pages nine years ago. I can’t improve on it.

If I had to pick my favorite sentence in all of Mises’s Human Action (a daunting task in a 900-page book), it would be this one: “The fact that my fellow man wants shoes as I do does not make it harder for me to get shoes, but easier” (p. 673 of the Third Revised Edition). That sentence may seem rather pedestrian compared to all the sentences Mises used to establish the science of praxeology (human action) and to spin out its countless implications for economics. But it’s a perfect example of how Mises showed that untutored intuitions about social interaction are often wide of the mark.

There is an old school of thought, widely identified with the Reverend Thomas Malthus, but actually quite older, that held the opposite of Mises’s position. Beginning with the undeniable assumption of scarcity, that school believed the human race was doomed to misery. Population would grow until it strained the carrying capacity of the environment; then starvation, disease, and conflict would set in and scale back the numbers. This process was assumed to be more or less the permanent fate of mankind.

How could it not be? Growing numbers of people would be vying for limited resources. Life had to be poor, nasty, brutish, and short—though not, as Hobbes had it, solitary. Mises was surely not the first to see it otherwise, but he was second to none in spelling out why the pessimists are wrong. He first seemed to concede their point, then zeroed in on what they missed. “The characteristic mark of the ‘state of nature,’” Mises wrote, “is irreconcilable conflict. The means of subsistence are scarce and do not grant survival to all . . . . The source of conflict is always the fact that each man’s portion curtails the portions of other men.”

What saves man from the dismal existence of wild animals? The division of labor, the first topic taken up by Adam Smith in The Wealth of Nations. As Mises put it, “What makes friendly relations between human beings possible is the higher productivity of the division of labor. It removes the natural conflict of interests. For where there is division of labor, there is no longer question of the distribution of a supply not capable of enlargement.” Mises drives home the point: “Because many people or even all people want bread, clothes, shoes, and cars, large-scale production of these goods becomes feasible and reduces the costs of production to such an extent that they are accessible at low prices.”

The upshot is that because of the productivity specialization makes possible, the rest of the animal kingdom holds few lessons for mankind. Anyone who believes government’s role is to temper the market with cooperation needs to learn that lesson. The market is cooperation.

***

To celebrate the 60th anniversary of the publication of Mises’s Human Action, we’ve brought together several high-powered contributors, spanning several generations, all with a special connection to the man and the groundbreaking book: Israel Kirzner, who earned his Ph.D. under Mises at New York University and who is regarded as the dean of Austrian economics; Bettina Bien Greaves, a retired FEE staff member who was Mises’s close friend, attended his NYU seminar, and compiled a bibliography of his work; Peter Boettke, a leading member of the “third generation” of American Austrian economists and professor of economics at George Mason University, which has the most Austrian-oriented economics department in the United States; and Peter Leeson, visiting professor at the University of Chicago and one of the rising stars of Austrian economics. Finally, the Human Action tribute winds up with Henry Hazlitt’s 1949 Newsweek column about the treatise. Hazlitt had much to do with introducing Mises to American readers.

I hope you enjoy the photo spread of Mises reflecting his close association with FEE.

Also in this issue, Sanford Ikeda registers his discontent with economics reporting in the newspapers, especially the way the definitions squeeze out any place for Austrian economics.

Barack Obama would have us believe he is ushering in a post-ideological age, where preconceived notions are equated with dogmatism. Mario Rizzo cautions that to throw out ideology is to throw out something important.

The last year of Fed expansion, bank nationalizations, “stimulus” spending, and bailouts has put the American economy even deeper into the arms of the State. In fact, Randall Holcombe says, these measures and precedents have fundamentally changed the U.S. economy.

Congress has decreed that tobacco will no longer go unregulated. Unregulated? Are those folks in Washington joking? Bruce Yandle relates the long history of tobacco regulation.

Here’s what our columnists have whipped up: Lawrence Reed wants to know who bailed out whom over the last year. Robert Higgs looks at big business’s role in the emergence of American statism. John Stossel imagines what would result from a truly competitive healthcare system. Charles Baird looks at the Employee Free Choice Act. And Steven Horwitz, reading claims that saving is keeping the economy in recession, responds, “It Just Ain’t So!”

This issue’s reviewers scrutinize books on the New Deal, ownership, global economics, and debt.

Readers react to past articles in Capital Letters.
—Sheldon Richman

Related posts:

1. What Human Action Has Meant to Me: Reflections of a Young Economist
2. Human Action: The Treatise in Economics
3. Human Action: The 60th Anniversary

But the view that consumption is “stimulative” while saving is harmful is almost the exact opposite of the truth if the goal is to generate sustainable economic growth. Savings is what makes long-term growth possible. It just ain’t so that more consumption is what is needed in a recession.

An Incomplete View

This particular fallacy is essentially a version of the more general fallacy identified by Frédéric Bastiat in the nineteenth century: an inability or refusal to “see the unseen.” Consumption has easily observable effects on the economy. We see people spending on new cars or televisions, and we understand how that means larger profits for firms and more opportunities for employment. So it comes as no surprise that people would think that an increase in saving, defined as the portion of our income we do not devote to consumption, would be bad for the economy. If we are increasing our saving, we are presumably reducing our consumption, which means lower profits and fewer job opportunities in the places where we used to be spending those consumption dollars.

So far, the analysis is not necessarily wrong, just incomplete. A full analysis would then ask, “What happens to the portion of people’s income no longer being devoted to consumption?” What exactly do we mean by “saving?” If people are “saving” by simply increasing their holdings of currency (say under the storied mattress), then the critics have a point. Those resources are being withdrawn from the larger economy, and to that degree they will reduce conventional measures of economic well-being. Of course, those increased currency holdings will improve the well-being of their owner, as he or she is now holding wealth in the preferred form of currency.

This isn’t how it usually goes, though. Most saving takes the form of financial instruments, including everything from basic checking accounts to the fanciest investment tools. If people are keeping higher checking account balances or putting more in savings accounts or money market mutual funds, then that wealth is not withdrawn from the economy. It is simply channeled elsewhere than into consumer goods. Financial institutions that accept such deposits lend them to customers who invest in their businesses. This is the process of creating the capital that is the sine qua non of sustainable, long-term economic growth.

In Bastiat’s terms, we see the lost expenditures at the retail store, but we mostly don’t see the “backdoor” way the savings are channeled to other businesses. More precisely, an increase in the savings rate represents a change in consumers’ time preferences: They are saying they are less interested in current consumption and more interested in future consumption. The beauty of financial markets is that they translate that change in preferences into a change in the flow of resources. Those investments will take time to become consumption goods, but that’s what consumers want.

Saving Creates Growth

So contrary to Isidore’s arguments, restricting consumption does not hamper economic growth. In the long run, economic growth requires saving and the creation of new capital goods.

For savings to contribute to growth this way, financial intermediaries must function properly. The fallacy that increases in saving will frustrate growth finds its most recent theoretical statement in Keynes, particularly in his assumption that the financial system cannot translate savings into investment. In contrast to the classical and Austrian economists, who believed that interest rates would coordinate the supply of savings and the demand for investible funds, Keynes argued that saving was a function of income, and investment was driven by the “animal spirits”—that is, people’s psychology and expectations. As a result, there was no reason to think that increases in saving would make their way back into the economy as investment. Indeed, savings was a “leakage” from the expenditure stream made up of consumption, investment, and government spending.

But Keynes was wrong about how markets, especially financial markets, work—at least when they are left to themselves. As Isidore’s article points out, if banks are reluctant to lend out the funds that savers are supplying, increases in saving will not get translated into investment spending. He argues that is precisely what is happening right now.

If true, the fault lies not with the saving habits of the public, but with whatever is causing the banks to hesitate. Blaming the public for “saving too much” is wrong, as Isidore himself notes in claiming that “a high savings rate is not a bad thing for the economy.” The problem, he argues, is people doing it now when banks won’t lend. Why then are banks reluctant to lend?

One answer is that at the onset of the crisis the Federal Reserve System decided to pay interest on the reserves banks hold in their accounts at the Fed. Combined with very low rates of return on other assets, this made sitting on both the public’s increased savings and the Fed’s newly injected reserves a better choice than lending.

Moreover, the combination of bailouts, quasi-nationalizations, and policy zig-zagging might be making lenders more uncertain about the future and less likely to lend. What economic historian Robert Higgs has termed “regime uncertainty” was responsible for the length of the Great Depression and might be a key reason why banks might lend less than in the recent past. Isidore and others never consider that, in the words of economist Roger Koppl, “Keynesian policies can create a Keynesian world”—that is, bad policy can break the link between savings and investment. In any case, blaming the savers misses the real problem.

And there might not be a problem anyway: A number of economists have disputed the claim that banks have stopped lending. Even at the height of the crisis in October, economists at the Minnesota Fed found no evidence that banks had stopped lending to individuals or nonbank entities. More recent data from the winter show that while the rate of lending growth had slowed, the total quantity of loans to individuals and firms was steady, if not growing slightly. So theory aside, the empirical reality since September does not support the claim that savings is counterproductive.

Related posts:

1. Saving Hunky Town
2. Where Has All the Saving Gone?
3. The Social Security Trust Fund: Savings vs. Saving

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

A common form of the fallacy is rejection of the imperfect free (or freer) market in favor of (presumably) omniscient, omnipotent, and omnibenevolent government regulation. A “flawed” but achievable arrangement is set against an (alleged) ideal, though it is left unestablished whether the ideal can in fact exist. The problem here should be obvious. If the ideal is not available, then the comparison is worthless. If the rejected option were compared to other achievable—also imperfect—alternatives, it might well be judged superior.

A recent example of the Nirvana Fallacy comes from Sen. Charles Schumer of New York. Asked how the Obama administration will prevent another financial crisis, Schumer said:

“You’re gonna find a different system of regulation. . . . So like when Bear Stearns began to run into trouble, they’re gonna call the heads of Bear Stearns in and say, ‘All right fellas, you’re getting rid of those two hedge funds; you’re gonna raise more capital—even if it means you have lower profitability. . . . [Y]ou do it or we’re gonna take sanctions against you.’ . . . You need a tough, strong regulator, unified—no holes in the system— . . . who . . . sees the problem ahead of time, so they have complete transparency, they know exactly what’s going on. . . .” (emphasis added)

We see at once that Schumer assumes what he must demonstrate: namely, that the regulator can overcome the Hayekian “knowledge problem,” the limits posed by the fact that the most critical economic information is not readily obtainable statistical data but rather is diffused and often unarticulated knowledge, including know-how.

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

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

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

* * *

Advocates of big government claim they learned lots of lessons from the New Deal. But here’s something they missed: The post-1929 economy began to rebound before FDR’s programs could have taken effect and even before he took office. Jim Powell explains.

Government spending is said to be indispensable to recovery from a recession thanks to the magic of the “multiplier.” Is there really more bang from the government-directed buck? James Ahiakpor debunks the myth.

But surely the government is good at creating productive jobs when it spends money, no? Larissa Price, applying Bastiat’s lesson, throws cold water on that hope.

By now you may have bought some of those funny-looking spirally light bulbs after hearing they use less energy and save you money—only to find that they can’t hold a candle to the old incandescent bulbs. Thanks to Congress and former President George W. Bush, though, soon you won’t have a choice. Michael Heberling has the unfortunate details.

Last spring’s G-20 economic meeting called for a crusade against tax havens, places where people can protect their wealth from greedy politicians. Daniel Mitchell comes to their defense.

Can there be freedom when the state sees itself as Robin Hood? Carlos Rodríguez Braun shoots an arrow into the heart of that belief.

Land has been at the center of conflict from time immemorial. Even so-called capitalist countries have been blemished by land monopolies, government-sponsored speculation, and feudal-style interventions, such as property taxes. Joseph Stromberg conducts a tour of the great land question.

Our columnists again serve up an intellectual feast. Lawrence Reed writes about perseverance in the face of adversity. Thomas Szasz further documents psychiatric slavery. Burton Folsom takes a critical look at an economic interpretation of the Constitution. John Stossel examines the “fatal conceit” of interventionists. Walter Williams defends school choice. And Robert Murphy, encountering a free-market advocate’s case for government monitoring of derivatives, responds, “It Just Ain’t So!”

Our reviewers render verdicts on books about World War II, libertarianism, early globalization, and the Constitution.

Related posts:

1. Free-Marketeers Should Welcome Regulation?
2. The Fed: The Inside Story of How the World’s Most Powerful Financial Institution Drives the Markets
3. Bad Policy Drives Out Good

“Unlike all other property paper,” de Soto writes, “derivatives are not required by law to be recorded, continually tracked and tied to the assets they represent. Nobody knows precisely how many there are, where they are, and who is finally accountable for them.”

Hence: “Government’s main duty now is to bring the whole toxic environment under the rule of law where it will be subject to enforcement.”

I largely agree with de Soto’s diagnosis of the problem, but not his solution. When I worked in the financial sector in early 2007, my boss said his associates in New York were getting nervous because nobody knew how much leverage their trading partners had. It was thus pointless to run the standard “value at risk” and other calculations they teach finance grads, because no individual participant—even a large hedge fund or investment bank—could see the big picture in deals involving complex derivatives. Indeed, after everything blew up, I talked to one credit analyst at an insurance company who said, “Have you ever actually tried to read one of these credit default swap contracts? Nobody really knew what they did.”

Free Markets Don’t Mean Omniscient Entrepreneurs

I bring up these anecdotes to bolster my view that the market critics are probably (at least partially) correct to blame the financial bust on overextended firms that horribly miscalculated the risks they were assuming. I would be willing to go even further and say that innovative financial products that appeared to mitigate risk at the individual level might have paradoxically made the entire system more vulnerable.

But the market critics and de Soto go wrong in concluding that only governments can fix the problem. These advocates of increased regulation fail to realize that the case for the free market does not rely on omniscient entrepreneurs. Fans of the market should not be embarrassed to admit that sometimes even well-established companies screw up royally and lose billions of dollars.

Or at least, that’s what would happen in a true profit-and-loss system. The self-regulation of the market only works when profits and losses are allowed. When trying to make sense of why so many large firms were so careless with their investments, we can’t ignore the perverse incentives the government had created in a multitude of ways.

For example, the ratings agencies didn’t need to worry that they would be ruined if their AAA ratings on mortgage-backed securities turned out to be absurd. If any private-sector actors can be directly blamed for the financial debacle, it would be S&P, Moody’s, and Fitch. Yet these rating agencies are still in business because government regulations require banks and other institutional investors to hold bonds and other securities with a certain rating, and (of course) the regulations cartelize the rating industry. Specifically, SEC regulations require that institutions receive their (legally mandated) ratings from a “nationally recognized statistical rating organization” (NRSRO). But lo and behold, it is very difficult for any outsiders to attain this exalted NRSRO status. Since the big three agencies have a guaranteed demand for their services, is it any wonder that they were careless in granting the desired ratings to the complex securities being pushed by their big clients during the boom years? And let’s not forget the government-induced shaky mortgages at the foundation of those derivatives.

The fundamental problem with de Soto’s analysis is that he thinks politicians and bureaucrats can be trusted to improve financial transparency. This is the height of naiveté. Has de Soto flipped through the U.S. tax code recently? Doesn’t he realize that seemingly every week Treasury Secretary Geithner announces another convoluted plan to use tax dollars to encourage leveraged investment in precisely these “toxic” assets?

Markets Produce Laws

Apparently, de Soto thinks the virtue of Western governments over the centuries has been to create an orderly body of laws within which the free market can flourish. I would argue that it was the relative impotence of Western governments that allowed a market-driven law to emerge, which these governments then codified.

Economists such as Bruce Benson, David Friedman, and Edward Stringham have thoroughly documented the spontaneous development of legal customs and financial rules without any enforcement from the state. The entire body of English common law, too, was not centrally designed by legislatures, but instead emerged out of myriad individual rulings given by judges, as did the Law Merchant, the early modern global commercial law. 

Had the government minded its own business, the private financial sector would have learned from its mistakes during the housing boom. There is no reason to suppose that Geithner or anyone else employed by the government can come up with a solution that private analysts couldn’t discover. Quite the contrary. In fact, every move the government has taken during the crisis has expanded its power over the private sector and its ability to shower literally trillions of dollars on powerful beneficiaries. Doesn’t de Soto see the immense scope for corruption if the government gains more discretionary power over financial transactions?

Ironically, it is the government’s response to the initial crisis that has led to less transparency not more. Had the troubled firms been allowed to fail, bankruptcy proceedings would have ascertained which companies were holding which assets and how they should be valued. But at least since December 2007, the Federal Reserve has artificially propped up insolvent firms by accepting their “toxic” assets as collateral on short-term loans. In this environment, of course the most leveraged firms will string their investors along and carry derivatives on their books at inflated values.

Regardless of what caused the crisis, government efforts to regulate derivatives will only lock in undesirable aspects of the current market and ensure that politically connected players reap artificial gains. It is absurd to ask politicians to promote financial integrity and sound accounting. They are the worst violators of these principles on the planet.

Related posts:

1. Did Deregulated Derivatives Cause the Financial Crisis?
2. The Subprime Crisis Shows that Government Intervenes Too Little in Financial Markets? It Just Aint So!
3. Free-Marketeers Should Welcome Regulation?