Demsetz considers a wide array of topics, all presented verbally so that the discussion can be followed without any formal economics training. They include fascinating discussions of Richard Dawkins’s selfish-gene hypothesis, how capitalism solved the Malthusian population trap, why it took so long for the market order to develop, and why political parties act differently from firms. But his greatest contributions are his defenses of the spontaneous coordination of markets against attacks grounded in logical confusion. Three are of particular note.

Demsetz devotes a chapter to Robert Frank’s Luxury Fever. Frank argues, following Veblen and Galbraith, that the wealthy seek higher stature by acquiring more luxury goods than their peers, but that the attempt is self-defeating, supposedly justifying progressive consumption taxes to control that wasteful market failure. Demsetz responds, “My objection is to those who believe that we are so locked into serious decision errors that we must be coerced into doing that which we knowingly choose not to do.” He reveals holes in Frank’s logic, then adds several societal advantages Frank did not consider, including the fact that status-seeking through consumption is far more benign than status-seeking through power over others, which history has shown to be both bloody and massively destructive of liberty. He concludes that “Free choice is much too precious to surrender just because the wealthy buy more expensive goods than some of us think they should. . . . [T]he free society does not entitle [anyone] to coerce them into submission to his idea of what is good for them.”

Similarly powerful is Demsetz’s discussion of how transaction costs are misunderstood. He refutes the conclusion, tracing it to Ronald Coase, that “positive transaction costs can make the competitive economic system function inefficiently.” That idea has spawned almost uncountable assertions of market failure, backed by proposals for “corrective” government coercion. Demsetz shows that courts can make errors in the assignment of rights, but that markets efficiently respond to those errors: “Legal error has caused the problem, not positive transaction cost. There is no inefficiency in the way the market accommodates to the court’s mistake.”

Perhaps most powerful is Demsetz’s analysis of the supposed “separation of ownership and control” in large corporations, particularly relevant when blaming out-of-control management for everything is in vogue. Demsetz shows that it is not a market failure and that government “fixes” will make matters worse. In a nutshell, the separation-of-ownership-and-control “story” is that large corporations have so many small shareholders that no one monitors management carefully and managers routinely benefit themselves at shareholder expense. Demsetz shows how that story works only by ignoring several market mechanisms that address it. For example, if shareholders know management will mistreat them, they protect themselves by paying less for shares. Takeover possibilities triggered by low share prices also restrict misbehavior. And managers will not ignore how misbehavior will undermine their advancement and future incomes as managers, typically their greatest financial asset.

Demsetz shows that “separation” claims arise from ignoring that one cannot delegate authority without agents (managers) facing different incentives from their principals (stockholders). Principals, however, would not willingly bear such costs except to capture even greater benefits. So where “separation” critics see only deviations from efficiency, Demsetz recognizes that self-interested owners would only choose the corporation form, warts and all, when they expect the gains to exceed the costs, increasing efficiency. Therefore, corporate governance does not demonstrate market failure.

Demsetz further traces these confusions to a mistaken understanding of economists’ standard model of competition, which causes many errors in antitrust and regulation. It is actually a model to explain why beneficial spontaneous coordination will emerge in markets, even in the complete absence of central planning. However, its assumption that no individual has power over any choice, useful for understanding decentralized market coordination, makes it an inappropriate standard for judging real-world competitive behavior within or between firms.

Demsetz’s understanding of real individual and institutional behavior and his defense of the market order make From Economic Man to Economic System well worth reading for those committed to defending freedom.

“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.

In 1969 economist Harold Demsetz identified an important flaw in much public policy analysis, the “Nirvana Fallacy.” We would do well to keep it in mind as we think about solutions to the current economic problems.

The rest of TGIF is here.