Thus a faltering corporation may use its political connections to win a government bailout paid for by taxpayers.  Environmentalists may protect vulnerable wetlands from uses they don’t approve of, not by buying the property in question, but by using government to stop its current owner from developing it.  In today’s interventionist world one could come up with a zillion examples.

The Political Logic

It would be a mistake to pass a government program if the full economic cost would be $100 million while its full economic benefit would amount to only $1 million — there would be an economic loss of $99 million.  But if those costs were spread over 100 million taxpayers, each taxpayer would only pay $1.  On the other hand, if the $1 million benefit went to 100 beneficiaries, each would get a hefty $10,000.  In such a case a given taxpayer probably wouldn’t fight very hard against the program because doing so would save him only $1, but a beneficiary would likely make a lot of noise and spend a considerable amount (but less than $10,000) to make sure the program passes.

Many economists argue that this is the logic that drives our political system, resulting in chronically inefficient legislation and morbidly fat government budgets.  It’s sometimes pithily stated as “concentrated benefits, dispersed costs.”

If the political rules allow it, calculating and opportunistic people will game the system to their narrowly selfish benefit.  Armed with full knowledge of the consequences of their actions, they can exploit the rest of us, and we won’t bother to follow what’s going on because it’s just not worth it.

Hunting for Goodwill

When I teach my course on public policy I assign Friedrich Hayek’s famous book of 1944, The Road to Serfdom.  A passage that stands out in my mind in this context is from chapter one:

Against the innumerable interests which could show that particular measures would confer immediate and obvious benefits on some, while the harm they caused was much more indirect and difficult to see, nothing short of a hard-and-fast rule would have been effective [71].

He means that it may be desirable for people to hold certain libertarian principles even when they may not fully understand why they do.  The point that struck me, however, is how he contrasts the “immediate and obvious” benefits of a government policy with its negative consequences, which are “indirect and difficult to see.”  This is similar to but different in important ways from the “concentrate benefits . . .” idea.

Hayek dedicates The Road to Serfdom “To the Socialists of All Parties.”  Some think Hayek was mocking his opponents on the left when he wrote that, but they are wrong.  Hayek’s raison d’être for writing the book was to warn well-meaning socialists in England that, just as he had seen happen a few years before in Europe, the policies of collectivism and central planning they were advocating during World War II were essentially the same that socialists in Germany (and Russia) had implemented before the war and that eventually led to fascism and national socialism.  He warns that while socialism in theory may be internationalist, in practice it becomes violently nationalist (162).

But the logic of his argument is not that socialists are merely calculating opportunists who want to use the political rules of the game for their own personal gain.  No doubt some of his ideological opponents were indeed political opportunists and he knew this.  But his targets were the men and women of goodwill – socialists of all parties – who sincerely believed that the government interventions they sought would promote the general welfare.

Their problem from Hayek’s perspective was not that they were stupid or evil.  It was that they were ignorant and mistaken.  There were things that they didn’t know.  That is, for Hayek the central political struggle is not one of fighting evil people but of fighting bad ideas, ideas that he hoped to persuade his reasonable opponents to drop once they heard and understood his arguments.  He wanted them to look beyond the “immediate and obvious” to the consequences “indirect and difficult to see.”  He hoped that sound economics and recent experience would convince enough people to reject the collectivist doctrines that, if left unchecked, would lead Great Britain down the road to serfdom.

Be Tolerant and Criticize!

In a world of heated ideological differences and partisan political conflict, it’s tempting to paint our opponents as stupid and evil, as calculating opportunists.  Again, often they are, and from their point of view often so are we.  We need to get past that.  We need to keep learning.

Learning, though, means exposing yourself to ideas that you find strange, perhaps even repugnant at first.  Even if we end up rejecting them, we will, having been able to correctly state the opposite case, have a better idea why we reject them.  Learning through personal interactions requires dialogue, and genuine dialogue between grownups who disagree cannot begin with name-calling and smirking cynicism.  No.  Genuine dialogue means treating our ideological opponents as people of goodwill with the hope that they will treat us the same way.  Only then can we learn and grow.

As a young libertarian scholar recently summed it up, “Treat people kindly but ideas harshly.”  Exactly!

In his introductory essay editor Edward López states the core idea advanced in the book: “[I]f we want to understand why the legal system sometimes fails to perform up to our ideals and expectations we must analyze the incentives available to actors in the legal arena and the institutions that set the ‘rules of the game.’” This focus raises the question of whether Public Choice analysis differs from the “economic analysis of law” advanced by Ronald Coase, Richard Posner, and others. López maintains that while “there is little fundamental difference between” the two on methodological grounds, there seems to be a difference “in the character of the reforms they recommend.” According to López, Public Choice emphasizes constraining political actors while the economic analysis of law emphasizes “arranging institutions to minimize transactions costs.”

Benjamin Barton’s chapter on the “lawyer-judge hypothesis”—which might be the marquee contribution to this volume—argues that “if there is a clear advantage or disadvantage to the legal profession in any given question of law, judges will choose the route that benefits the profession as a whole.” Barton offers a number of examples drawn from numerous areas of the law that support the hypothesis. Charles Keckler’s outline of recent changes in the cy pres doctrine that enable judges to award unclaimed funds from class actions to “law related entities such as law schools” fits squarely within this analysis.

The other nonquantitative contributions deal with more familiar topics. Nicholas Curott and Edward Stringham do a nice job retelling the story of Anglo-Saxon law as a spontaneous order that focused on victim compensation and how it was replaced by a centralizing Norman legal order after 1066. Ilya Somin takes dead aim at the use of eminent domain by local governments bent on “economic development,” and John Bratland argues that “just compensation” in cases of government takings fails as an ethical matter. Adam Summers recounts the case against government licensure of lawyers and argues for market-based alternatives.

Three chapters that use numerical data and summary statistics all include suggestions for reform. Roger Koppl offers a strong critique of the current use of forensic science in criminal justice administration. Government-run forensic laboratories make mistakes in testing crime scene evidence—television dramas to the contrary notwithstanding. Testing at multiple labs simultaneously would reduce the number of mistakes, but money for multiple testing is unlikely to be sought by the law enforcement bureaucrats who handle the laboratories’ budget requests—in part because the bureaucrats are likely more interested in maximizing the number of convictions than in the disinterested pursuit of truth. Koppl argues for triplicate testing of fingerprint evidence on the grounds of cost savings; his most conservative estimate is that $9 million in extra testing would save taxpayers $61 million in prison costs by “eliminating over 98 percent of the false felony convictions” caused by errors in fingerprint analysis.

Jeffrey Hammond explains class-action litigation as a vehicle for rent extraction, using the government lawsuits against the tobacco companies as a strong example.

The book’s three chapters that use regression analysis all find fault with the election of judges at the state level. Russell Sobel, Matt Ryan, and Joshua Hall suggest nonpartisan elections as an alternative. They also relate overly aggressive prosecutions to the election of public prosecutors. Adrianna Cordis finds that judicial elections contribute to government corruption, but does note a 2008 article by Alt and Lassen that finds the contrary to be true. Aleksandar Tomic and Jahn Hakes explain judicial sentencing of criminals as a function of whether the judges face political pressure. While all three papers will doubtless enter the long-running debate over state judicial selection, they are unlikely to provide a knockout punch to the supporters of judicial elections.

In all, this book is an excellent contribution to the Public Choice literature.

Much of this well-written study, however, is devoted to describing the intellectual origins of the approach to political economy known today as “Public Choice”—the economics of politics. Nevertheless, its subject is the history of the analysis of nonmarket activity generally.

Modern economics offers two separate grounds for interventionism. One traces its origins to John Maynard Keynes, the other to Arthur Cecil Pigou. Both were students of Alfred Marshall; both were fellows of King’s College, Cambridge, in the 1930s; and both proposed theories of “market failure.” Pigou was probably the first to examine so-called “market failure” within a Marshallian, microeconomic framework, pointing out how self-interest can produce systematic inefficiencies. His intellectual descendants often use the framework he created to conduct “welfare analyses” of positive and negative externalities, as well as of the taxes, subsidies, and other measures that are supposed to fix them.

Steven G. Medema deals with the Pigouvian legacy in this fascinating intellectual history. But Pigou lies somewhere in the middle of the story Professor Medema tells.

The book presumes familiarity with economic theory and contemporary ideas in political economy, so I would not recommend this book for the general reader. But anyone who has taken an introductory course in microeconomics should be reasonably comfortable with the discussion. The book opens with a short overview of Adam Smith’s explanation of how self-interest promotes the general welfare via the “invisible hand,” contrasting that view with the more statist approaches of the earlier French Physiocrats and English Mercantilists. In the hands of Smith, self-interest “had finally found legitimacy.” But this is not the Smith of laissez-faire caricature. Medema offers an impressive list of interventions Smith advocated, from regulating public hygiene to taxes on liquor. For Medema, Smith’s great achievement, however, was to make laissez-faire capitalism the “default mode” of government policy.

The next two chapters trace the swing from widespread support for laissez faire among British intellectuals back to a more interventionist proclivity in the latter nineteenth century in the writings of Jeremy Bentham, J. R. McCulloch, J. E. Cairnes, and especially John Stuart Mill and Henry Sidgwick. However, despite important reservations, the default remained laissez-faire capitalism, more or less.

In chapter four we see how, beginning with the Italian La Scienza delle Finanze and the work of the Swedish economist Knut Wicksell, some economists by the mid-twentieth century were beginning to integrate political incentives into the area that we today call “public finance,” something British political economy (Keynes included) had neglected to do. This gave rise to a systematic examination of the causes and consequences of “government failure.”

Chapter five discusses the contributions of Ronald Coase, who opened inroads into the study of nonmarket phenomena. What later became known as the “Coase theorem” emerged from an explicit critique of the Pigouvian market-failure theory (though, as Medema argues, not of Pigou himself), and is the basis of the “economic analysis of law” tradition and modern theories of regulation.

Chapter six addresses the Public Choice school itself, moving in a most welcome and informative way from intellectual to institutional history. It chronicles the beginnings of Public Choice from the University of Virginia in the late 1950s, to the ideological tensions that may have scattered its most important scholars in the 1960s, to its reestablishment at Virginia Polytechnic Institute and the founding of the Center for the Study of Public Choice, as well as the journal Public Choice, in the late 1960s.

Finally, chapter seven could actually stand alone as an essay on how, largely in the masterful hands of Richard Posner, the law-and-economics tradition evolved into the “economic analysis of law.”

This book reads a bit like a “Whig interpretation of the history of political economy,” in that it gives the impression that the developments in political economy after Smith have led to Public Choice as not only the predominant but perhaps the sole market-based theory of government failure.

Thus there is only the briefest, nonsubstantive reference to F. A. Hayek and his influential book The Road to Serfdom and none at all to Ludwig von Mises, who wrote many tracts critiquing the doctrine of interventionism. While their take on government failure does appreciate the role of (perverse) incentives in the political process, its main focus is on how knowledge and calculation problems tend to thwart interventionism by systematically creating negative unintended consequences.

But these are really nits I’m picking here. I wholeheartedly recommend this informative book to anyone with a little background in microeconomics who is interested in a history of Chicago and Virginia political economy told in a clear, scholarly, and engaging way.

To think about this question, we need to avoid being either too romantic or too cynical about governance. While readers of this publication are at no risk of being romantic about government, there is a chance of excessive cynicism. Government currently works very poorly, but this doesn’t need to be so. Competition would force providers of governance to offer high-quality rules and public services at a reasonable price, unleashing institutional innovation and making the world a much better place.

So far, most libertarians have been hacking at branches, while a few come tantalizingly close to striking at the root. We’re going to try to convince you that the root at which we should be striking is a tangled mess of barriers to entry and costs of switching in the governance market. The ax we should be using is the technology to settle the ocean.

Rules Matter

Rules governing interaction and resolving disputes are an essential part of free and prosperous human life. It’s difficult to stress strongly enough the importance of good rules. There are enormous differences in living standards around the world, and affluence is largely determined by the geographical lottery of birth. The average American earns about $47,000 a year, while the average Zimbabwean gets by on a little more than $300. This doesn’t mean that Americans simply have more stuff, but also more health, security, and peace.

The difference between the United States and Zimbabwe is that the former has relatively good institutions that allow trade and specialization, while the latter does not. An even starker demonstration of the power of rules comes from the Korean peninsula. Before World War II, North and South Koreans shared a common culture, history, and set of rules. With the arbitrary division of the country based on the strategic maneuvering by the United States and the Soviet Union, this all changed. The South became more free; the North less. The result of this natural experiment is those in the South are now almost 15 times richer than those in the North.

Of course, even relatively rich countries have their problems, and libertarian policy activists have spent countless hours and pages describing areas for improvement. Patri’s grandfather Milton Friedman, for example, painstakingly laid out the problems caused by many government programs and argued that giving people greater freedom would lead to dramatic improvements. While such reforms would certainly be desirable, simply insisting that we need particular reforms ignores the incentives of the political system.

This neglect is rather odd: Libertarians are well aware of systemic incentives and unintended consequences at the policy level, but most ignore similar problems in the higher-level political system. They will chide statists for assuming they can bring about a particular social or economic outcome through top-down planning, and then go on to specify how they’ll change the rules from the top down to allow bottom-up interaction.

Policy activists are forgetting that the same problems that prevent statist policies from working as advertised also block desirable reforms. The political system is itself a spontaneous order in which the interaction of many individuals operating under various constraints and incentives determines the policy decisions that will eventually be reached. This is where Public Choice theory is helpful: It allows us to analyze the incentives of political actors and suggests a more fundamental level of intervention.

Meta-Rules Matter

Public Choice begins with a simple, indisputable, but somehow widely rejected idea: Politicians, voters, and bureaucrats are not angels. Political actors do not selflessly strive to pursue the common good but respond to incentives. James M. Buchanan describes Public Choice, a field he jointly founded, as “politics without romance.”

The theory makes a distinction between two levels of politics. At the first is the to-and-fro of everyday politics in which rules are created, amended, and repealed. This is the level at which policy activists concentrate their efforts. The behavior at this level, though, is determined by the incentives created at the constitutional level. Public Choice theorists argue that if we want to improve policy, we need to do so indirectly by changing the constitutional meta-rules (rules about rulemaking) through which ordinary rules are established.

This has led many to advocate constitutional limits on the power of government. While this approach is better than lobbying for particular policy changes, since the results are likely to be more robust, Public Choice-influenced constitutionalists have not entirely rid their analysis and approach to activism of romance.

The familiar problems of unintended consequences also arise at the constitutional level. Even if we could design the perfect constitution, we’d need to find a way of implementing and enforcing it. Given that this would need to happen through existing political channels, we’re unlikely to end up with anything good. Constitutional politics is still politics, and those drafting the new constitution have the same foibles as anyone else.

The problem of crafting better meta-rules is the same as that of crafting better rules: We know what the problems are and might even have some good ideas about how things can be improved. What we don’t have is a mechanism for improving things. The interests and passions of people do not disappear when they start drafting constitutions, and political behavior, whether at the policy or constitutional level, emerges from the interaction of various agents. We need to think about the incentives that structure all political behavior, including that of the constitutional level.

The Governance Industry Matters

An extremely useful way to think about the incentives that structure the political game is to consider the market for governance. Rules have economic value, and people would be willing to pay for them. We can think of the bundle of rules and public goods provided by government as a product, governments as producers, citizens as consumers, and taxes as prices.

This seems counterintuitive, especially to libertarians—who realize that markets provide choice whereas governments as we know them do not. There are, however, a number of benefits to this view. It allows us to analyze the industry structure for government and learn why governance quality is currently so low. The current market for governance is dominated by a series of large geographic monopolies not subject to competition. In a competitive market those organizational forms that are not conducive to producing high levels of customer satisfaction are weeded out by natural selection. Without competition, this selection mechanism is absent and we end up with what we have today: bad firms producing bad products.

This is why we have bad constitutional structures.

A number of scholars have already recognized this. The idea of market anarchism is to have governance services such as rulemaking, adjudication, and protection provided on the open market. This would force providers to compete and the incompetent would go out of business. Patri’s father, David Friedman, provided what is, in our unbiased opinion, the best description of how such a polycentric system would work in his book The Machinery of Freedom. Market anarchism is not simply a system of good rules or even a system for producing good rules. It is a system for producing good rule-making organizations.

Similarly, though less radically, some have argued that we need to geographically decentralize political power. With smaller units of governance among which citizens could move based on quality and their idiosyncratic preferences, we’d see governors constrained by the threat of exit and the quality of governance would improve. This was an important argument underlying the federalism of the U.S. Constitution: There would be competition among the several states, and Americans would enjoy better governance.

While market anarchists and decentralists are correct that we need more competition if we are to improve government, they have generally failed to address the reasons we have such an uncompetitive market for governance and therefore provide no route for getting from here to there.

The Technological Environment Matters

When we think of governance as an industry, the problem with policy and constitutional activism becomes clear: Policy advocates are demanding better products without providing a mechanism for products to improve, while constitutionalists are demanding better firms without providing a mechanism for firms to improve. The problem with the arguments of anarcho-capitalists and decentralists is less obvious but simple enough: They demand a better industry structure but have provided no mechanism for the industry structure to improve.

Think about the operating-system (OS) industry. This is one of the least competitive industries around (though it’s still orders of magnitude more competitive than the governance industry). We all know it’s uncompetitive, but simply insisting that we need to increase competition is not useful. It is uncompetitive for a reason. Creating an operating system is an expensive undertaking, and network effects and switching costs mean that consumers are reluctant to change.

If someone genuinely wanted to make the OS industry more competitive, she wouldn’t go about it by simply insisting that we need more competitors. Rather, she would attempt to change the underlying technological factors that cause the OS industry to have high barriers to entry and switching costs. We can see this happening with the open-source software movement, which does not simply create a new competitor to Microsoft, but rather opens a range of possibilities for improvement by making it easier for hackers to build custom OSes. Over time this has produced new versions of Linux that are more user-friendly and compatible with Windows, lowering the cost of switching.

This is the sort of technological activism libertarians need to engage in if they really want to change things. Some are doing this already. Crypto-anarchists aim to help people escape State control by developing more secure communication technologies; agorists aim to develop non-State institutions that would allow people similarly to avoid dealing with the State; and Julian Assange’s Wiki-Leaks project uses technology to make government more transparent. While we applaud these efforts, we don’t think they are going to get us to a radically freer world. The State is a powerful and resilient institution, and it will fight back against these internal threats to its existence. Fortunately, there is another way that has the potential to fundamentally change things.

Seasteading

Developing the technology to create permanent, autonomous communities on the ocean seems like a strange way to solve the problem of bad governance, but we’re convinced it’s the best chance we have for liberty in our lifetimes. This is why Patri established The Seasteading Institute with the mission of developing the technological, political, and economic knowledge we need to revolutionize the governance industry.

If the ultimate problem with that industry is high barriers to entry and switching costs, we need to find a way to dismantle these obstructions to competition. In the past, frontiers have provided the means for disenfranchised groups to start their own country. Unfortunately, we’ve run out of frontier on land. Every square inch of land on the planet is claimed by some existing State, and none is going to give up its claim.

The ocean is a vast frontier unclaimed by States. While they claim some jurisdiction over resources in large areas of ocean, there is much space for political experimentation within these zones and plenty of space outside any State’s practical reach. Starting your own country on the ocean will be difficult and expensive, but at least it’s possible.

The ocean is not yet ready for settlement by most people. It is harsh and unforgiving, and long-term life on the sea is currently limited to only a few pioneers in the fishing, offshore oil, and cruise industries, as well as a handful of dedicated live-aboard sailors.

Technology, though, has the potential to make the ocean a feasible alternative for more people. Early pioneers will learn lessons that will make life on the ocean easier, thus prompting previously unwilling pioneers to make the move. Over time the costs in comfort, safety, and access to civilization will fall and the ocean will be just another place to live. This is the path we see on any frontier. Living in the harsh environment of North America would not have seemed like an attractive proposition to most Europeans a few centuries ago. Eventually, the wilderness was tamed, and North Americans now enjoy higher standards of life than many in the old world.

As it happens, the ocean has another important benefit. Water makes it easy to shift large objects around cheaply. This is what allowed the global shipping industry to prosper, and it could also help make government more competitive. We normally think of buildings as being tied to land, and this has serious implications for competition. Government can do a lot of harm before it becomes worthwhile for someone to move away. The fluidity of the ocean, in contrast, allows people to vote with their house by sailing to a neighboring jurisdiction. If a seasteading government announces an unpopular policy, it could find that it rules over nothing but empty waves. This would allow bad governments to die without bloodshed and force governors to think about what people really want.

While the challenges and uncertainties in settling the ocean are large, there are only a few core problems and none are insurmountable. To make seasteading a reality we need to take a pragmatic, incremental, and business-focused approach. Rather than creating a multibillion-dollar vessel straight away without any clear way to finance it, we encourage seasteading entrepreneurs to think carefully about the business case for particular industries for which seasteading has a comparative advantage. Many industries are overregulated, and a seastead off the coast of a major U.S. city offering medical treatments not yet approved by the FDA, for example, would be a very lucrative proposition.

We know it is possible to live on the ocean; we know there are ways to make money there, and our mission is to drive down the costs of seasteading to transform the ocean from potential frontier into real frontier and eventually into just another option with some serious advantages. This will lead to experimentation and innovation in governance and force existing States to improve or wither away for a lack of residents. The challenges are large but the potential payoffs are much, much larger. By transforming the political problem of bad governance into a hard but achievable technological problem, which humans have a knack for solving, we make success possible.

This is a rather extreme statement. Are governments really so tightly bound by the beliefs of the public? Anyone versed in Public Choice theory is likely to find Mises’s statement a bit much. After all, Public Choice demonstrates how incentive structures in the political system can lead to policies that are not in fact favored by the majority of citizens but are in the interest of a powerful few.

Public Choice analysis is incredibly useful to economists and laypeople alike. It has opened our eyes to the difficulty of government reaching its own stated ends because of incentive problems within the system of government itself. It has dispelled the myth that government ineptitude is simply the result of bad leaders. However, in all this emphasis on incentives and interests, Public Choice often overlooks or minimizes the role of ideas.

We cannot forget the power of ideas to overcome the bad incentives inherent in any system of government and to act as a roadblock to the seemingly inevitable expansion of State power.

Consider a rather silly example that illustrates the inability of Public Choice alone to explain the world of policies in which we live.

A billboard says, “Kicking chickens creates prosperity.”

This is part of a campaign sponsored by the Partnership for a Chicken-Free America. The group is made up of people who have an extreme dislike for chickens, and they are willing to put vast resources into reducing the well-being of such fowl. In fact, they advocate legislation to establish national Kick-A-Chick Day.

Most voters and members of the general public do not share this distaste for chickens. Then, again, most people are relatively indifferent when it comes to chicken happiness. With a few exceptions, it is not in an individual’s interest to spend resources on a counter-campaign or to hire lobbyists to oppose the Kick-A-Chick bill; the costs of doing so simply outweigh the benefits.

This is a classic case of concentrated benefits and dispersed costs. The anti-chicken people derive tremendous happiness from harming chickens, making their campaign a worthwhile expenditure. Yet the general public gains little from preventing chicken kicking, and the cost of opposing it is very high.

On the other hand, the public loves prosperity. If they believed that punting hens created wealth, there is little reason to suspect they would not support the policy. A public-awareness campaign would be just the ticket.

Armed with Public Choice theory we can see the sad but likely result. The chicken-free association will exert its influence and get its bill. The public will either support what they believe to be a prosperity-creating policy or ignore it altogether because the cost of fighting is too high. The interests align in such a way that we can expect the anti-bird forces to get their way.

Of course this story is absurd and such a law would never be introduced, let alone pass. What makes it so obviously impossible?

Ideas.

People know there is no causal connection between kicking a chicken and enjoying a higher standard of living. That knowledge makes the campaign laughable. Regardless of how the interests are aligned, if people are educated enough to know that chicken kicking does not equal prosperity, such an absurd policy will not be enacted.

Ideas and Public Opinion

This was an admittedly silly example. You could claim that the real reason such a stupid policy wouldn’t fly is not public opinion, but the fact that no real interest group would advocate for kicking chickens. But it is not hard to imagine other instances where a real interest would benefit from marketing a false cause-and-effect relationship, but where they simply cannot because the public knows enough not to buy it. Hotdog producers would gain if the consumption of one frankfurter per day were required by government. Why don’t they promote such a law? They could run ads saying, “If you eat a hotdog, a child will be cured of cancer.” It is not hard to see that, real or imagined, interest groups cannot get away with everything, even in the face of bad incentives.

Yesterday I saw a sign on the side of a bus that I found no less absurd than the chicken-kickers campaign. It read, “Converting buses creates jobs. What are we waiting for?” The ad was sponsored by a “clean air” association, no doubt consisting of members of the natural-gas industry and people for whom a reduction in fossil fuel use would bring some great personal pleasure.

Just like our chicken story, the incentives are aligned so that the benefits of bus-conversion mandates to the members of this small group exceed the cost of their advocacy efforts, while the benefits to individual citizens of stopping the mandates fall short of the cost of opposition. As far as incentives go, the situation seems pretty dire.

Unlike our chicken story, however, most people do not know there is no magical or “free” job creation when government mandates bus conversions. The resources used to convert the buses must be taken from somewhere, and it is as likely as not that there are many other jobs destroyed or never created in the first place when the resources are redirected. Furthermore, most people do not know that there is no causal connection between more jobs and more prosperity, or a higher standard of living. In fact, if a government mandate creates jobs, it is likely that it does so precisely because it is destroying wealth by moving it from more-productive to less-productive (and more labor intensive) uses.

This lack of knowledge is actually good news.

It means things are not as hopeless as pure Public Choice theory might suggest. Bad incentives can be overcome by good ideas. In our chicken story it was clear that interests alone were insufficient to enact policy. Knowledge of the policy’s incoherence trumped the incentive structure. With a grasp of basic economics, people may find the sign on the bus just as laughable as the idea of Kick-A-Chick Day.

Special interests can only appeal to things within the realm of accepted public opinion, which is shaped by public knowledge. We can affect public knowledge.

Special interests can do much to destroy liberty given the incentive structure in our political system. Indeed, with an ignorant populace there is little they cannot do. But even the most powerful interests ultimately answer to the ideas held by a majority of citizens. Policy follows the path blazed by belief.

In emphasizing the role of ideas in limiting the expansion of the State or the power of special interests I do not mean to say Public Choice is incorrect. It is a valuable toolkit that brings a dose of realism to our efforts at reforming the State. But it is most powerful when it recognizes and incorporates the power of ideas to change and shape interests, and to help people put aside their short-term interests and understand their long-term interests.

It was recognition of the power of ideas over interests that motivated Leonard Read to start the Foundation for Economic Education. It is because of the power of ideas that FEE has tirelessly educated individuals on economic principles for these many years. It is because of the power of ideas that we must continue our educational efforts, no matter how frustrating it may sometimes be.

When we succeed, all interventionist interest groups and their ploys will be shown to be just as ridiculous as the Partnership for a Chicken-Free America. No matter how powerful an interest, how strong its incentives, or how corrupt the system, government can ultimately only do what people permit it to; and people will only permit it to do what they believe it capable of doing. Through education we can demonstrate just how incapable government is. In the end, despite the very real power of interests, ideas win.

To paraphrase Victor Hugo, “More powerful than an army of special interest lobbyists, is an idea whose time has come.”

For wealthy developed countries, however, inflation over the last few decades has in fact become a trivial source of government revenue. This outcome stems not merely from the worldwide decline in inflation rates that began in the 1980s. That disinflation was as much an effect of the way sophisticated financial systems now prevent governments from gaining much revenue from even severe inflation as it was a cause of falling inflation revenue. Yet most libertarians have overlooked this crucial development in the dynamics of government finance. They anachronistically harp on how the U.S. or European governments might cover significant fiscal shortfalls with the printing press, completely oblivious to how insignificant for such governments this hidden tax has become.

Governments can potentially gain revenue from inflation in three ways. The first is the most obvious and the one most emphasized by libertarians: by issuing fiat money the government benefits in the same way as an undetected counterfeiter. Simple fiat money, such as the Continentals issued during the American Revolution or the Greenbacks and Confederate currency issued during the Civil War, is easiest to understand. It is directly spent to cover government purchases, and the resulting increase in prices over what they otherwise would have been reduces the purchasing power of money held by the general public. The government gains by exactly the same amount the public loses in this implicit tax on real cash balances. Economists have dignified this implicit tax with the term seigniorage.

Currently nearly all fiat money is instead issued by central banks, such as the Federal Reserve. This arrangement makes seigniorage a bit more complicated, sometimes requiring a well-taught course in economics to comprehend it, but the final result is identical. One arm of the government, the central bank, creates fiat money and lends it to another arm of the government, the Treasury, which then spends it, in a process known as monetizing the debt. Legally the Fed cannot purchase securities from the U.S. Treasury directly, and must buy them on the open market from private holders, but that makes absolutely no difference since, in either case, more of the government’s deficit has been financed by new issues of fiat money.

Monetary cranks often attach undue importance to the fact that the Treasury pays interest to the central bank for these loans. Admittedly, interest earnings cover the operating expenses of the Fed, which therefore never has to go to Congress for an appropriation, and the precise incentives faced by these two separate arms of the government may differ. But the Fed ultimately rebates most of its interest earnings back to the Treasury (in 2008, for instance, $35.5 billion out of $41.0 billion, or 86 percent). If you consolidate the balance sheets of the central bank and the Treasury, the process looks exactly like simple fiat money. Even when much of the money the central bank creates is lent to private banks, as during World War I, or purchases private securities, as has been happening recently, the interest rebate to the Treasury still indirectly generates the same seigniorage as a direct purchase of Treasury securities. The new fiat money flowing into the private sector simply releases money held by others to purchase Treasuries.

Declining Purchasing Power

The second way that government can gain from inflation relates to transfers between debtors and creditors. If inflation is totally unanticipated or unexpectedly high, interest rates will not have risen enough to compensate for the decline in the purchasing power of any loans. Net debtors gain, and net creditors lose. Government is, of course, the economy’s biggest debtor. Unanticipated inflation therefore reduces the real value of government debt. During the Great Inflation of the 1970s private investors holding long-term U.S. Treasury securities actually earned negative real returns despite receiving positive nominal interest. As a consequence, from 1946 to 1982, while the nominal debt that the U.S. government owed to the general public rose from $242 billion to $925 billion, that debt in 1946 dollars had actually fallen to $201 billion.

The third way that government can gain from inflation stems from interaction with explicit taxes. Under a progressive income tax, inflation pushes people into higher tax brackets even if their real incomes remain constant. The U.S. government thus enjoyed automatic tax hikes requiring not one iota of change in the tax code throughout the 1970s. Under President Ronald Reagan the income tax brackets were indexed, but bracket creep continues with the alternative minimum tax. Moreover, indexing does not eliminate inflation’s tax on saving, both through the personal income and capital gains taxes. When interest rates rise to offset expected inflation, the tax rate applies to the higher nominal returns, which represent just inflation’s “phantom gains,” to borrow a phrase from David Henderson. Real returns quite likely remain constant. These tax interactions, along with seigniorage and real debt reduction, not only bring about transfers from the public to government, they also distort the economy’s performance, creating what economists call deadweight loss, additional losses to the general public that exceed any gains. But we are focusing here just on gains to government.

Fractional Reserve

Each of these three potential sources of inflation revenue has become attenuated in developed countries. The main factor impairing the first, seigniorage, is fractional reserve banking. Banks, as private institutions that increase the money stock, can magnify inflation but do not generate seigniorage. To the extent that bank-created money causes any inflationary fall in real cash balances, the offsetting gains remain within the economy, accruing to the banks themselves or, absent monopoly privileges, flowing back via competition to their customers. The government doesn’t just fail to realize any seigniorage, its ability to do so is diminished. We can visualize why by comparing an economy in which banks hold 100 percent reserves—in which every $10 in circulation is backed by $10 of government-issued fiat money—to an economy with fractional reserves—in which every $10 in circulation is backed up by only $1 dollar of fiat money. Now assume a $100 billion increase in the total money stock. With 100 percent reserves, government fiat money (also called the monetary base) increases by the full $100 billion, all of which constitutes seigniorage. With the 10-to-1 ratio, in contrast, the same increase in the money stock is driven by only a $10 billion increase in the fiat base, so seigniorage is only one-tenth as much. Nonetheless, in both cases, the $100 billion increase in the total money stock sets off the same price inflation.

In other words, the lower the reserve ratio in a fractional reserve banking system, the less seigniorage government gets from a given increase in the price level. Or what amounts to the same thing, the greater will be the inflation cost of any given amount of real seigniorage. Fractional reserve banking in effect lowers the demand for government-created base money, reducing the seigniorage tax base (that is, the public’s real holdings of non-interest-paying base money).

Public Choice and Seigniorage

This threat to seigniorage provided a major Public Choice motivation for the myriad government regulations of banking in the past, from the imposition of reserve requirements to the creation of central banks with a monopoly on the issue of bank notes, all of which helped hold up the demand for government base money. The financial innovations and regulatory changes of the last several decades, however, have all but swept away most of these constraints on bank-created money.

Outside of America’s two hyperinflations (during the Revolution and under the Confederacy during the Civil War), seigniorage in this country peaked during the Civil War under the Union, when it covered about 15 percent of the war’s cost. By World War II seigniorage was financing only a little over 6 percent of government outlays, which amounted to about 3 percent of gross domestic product (GDP). During the Great Inflation of the 1970s seigniorage was below 2 percent of federal expenditures, or less than half a percent of GDP. Consider today how little of your own cash balances is in the form of government-issued Federal Reserve notes and Treasury coin rather than in the form of privately created bank deposits and money market funds. Prior to the recent financial crisis, M2 (a broad measure of the money stock that includes all checking accounts, savings and small-time deposits, and retail money market funds) was more than eight times the size of the monetary base.

Partly that is because reserve requirements (which should not be confused with government-imposed capital requirements) became virtually a dead letter in the 1990s. Many countries, including Australia, Canada, New Zealand, Sweden, and the United Kingdom, abolished them outright. In the United States the Fed eliminated all reserve requirements on the forms of money M2 adds to M1 (a narrower measure of the money stock that includes only currency in circulation and certain checking accounts) and permitted banks to freely sweep customers’ money between M1 checking accounts and M2 accounts. Congress has furthermore given the Fed authority to abolish the remaining reserve requirements on M1 in 2012.

Conversion to Debt

The Fed’s response to the financial crisis has only accelerated these trends. It is true that in the three months after September 2008, the Fed doubled the monetary base, from $850 billion to $1.7 trillion, so that M1 now has over 100 percent reserves behind it. But the Fed simultaneously eliminated nearly all seigniorage from this unprecedented expansion of fiat money. It did so by starting to pay interest on bank reserves, something other major central banks, including the European Central Bank, were doing already. Essentially this converts any reserves that banks hold as deposit at the central bank into more government debt rather than proper fiat money. The Fed is now borrowing money from the banks and relending it to the Treasury or private parties. This means that the only forms of money that still provide the U.S. government full seigniorage are currency in the hands of the general public and the actual cash held in bank vaults (which are a small part of a bank’s total reserves).

And this new restraint on seigniorage will become tighter in the future as people replace currency with bank debit cards and other forms of electronic fund transfers.

What about the other two ways that governments have benefited from inflation? The unexpected inflation of the 1970s, through its reduction of the real value of the national debt, actually generated about twice as much revenue for the U.S. government as did seigniorage during the same period. That still is not a lot, and investors are much savvier these days. Globalization, with the corresponding relaxation of exchange controls in all major countries, allows them easily to flee to foreign currencies, with the result that changes in central-bank policy are almost immediately priced by exchange rates and interest rates. Add to this the ability to purchase from many governments securities that are indexed to inflation, and it becomes highly unlikely that investors will be caught off guard by anything less than sudden, catastrophic hyperinflation (defined as more than 50 percent per month)—and maybe even not then.

All Pain, Little Gain

As for inflation’s interaction with explicit taxes, while it definitely hurts taxpayers and the economy, it seems not to have helped the U.S. government much. Since the Korean War, federal tax revenue has been bumping up against 20 percent of GDP. That is quite an astonishing statistic when you think about all the changes in the tax code over the intervening half-century. Thus the Great Inflation had no obvious impact on explicit government revenues, even before the tax brackets were indexed. It would require a more complex quantitative analysis that adjusted for changes in the tax code and in the economy to determine just how much periods of high inflation boosted the tax bite, but we can safely say that the effect was not dramatic.

Because of all these factors combined, governments in developed countries have little incentive to resort to monetary expansion, which no doubt contributed to inflation’s worldwide decline after 1980. Reid W. Click, in a study of 90 countries between 1971 and 1990, finds that average annual seigniorage exceeded 5 percent of GDP in only eight countries: Egypt, Poland, Malta, Nicaragua, Argentina, Chile, Yugoslavia, and Israel. Almost none of the developed countries could boast seigniorage amounting to more than 1 percent of GDP, despite the fact that the study incorporated the inflationary years of the 1970s. Joseph H. Haslag’s smaller sample of 67 countries over a longer period, 1965 to 1994, finds that seigniorage averaged about 2 percent of total output for the entire sample, ranging from as low as 0.25 percent to as high as 9.98 percent (for Ghana). And Stanley Fischer puts the average seigniorage of industrial countries between 1973 and 1978, a period of high inflation, at 1.1 percent of gross national product. I know of no more recent studies, but with disinflation, the widespread paying of interest on bank reserves, and the consolidation of European countries under the European Central Bank, these averages should be lower for the period from 1990 to today.

How Much Would It Take?

By comparison, let us now run some numbers to estimate how much inflation might be needed to close the looming “fiscal imbalances” (as they are euphemistically styled) that face not merely the United States but most of the world’s welfare states. The 2010 report of the Congressional Budget Office (CBO) projects that in 25 years some combination of spending cuts or tax increases equivalent to no less than 12.3 percent of GDP will be needed to close the U.S. government’s fiscal gap. Assuming that revenues from explicit taxes remain capped at 20 percent of GDP, whether for structural or political reasons, and that politicians will have little incentive to cut spending, seigniorage will have to come up with the difference. Given that 10 percent inflation during the 1970s generated revenue amounting to 0.5 percent of GDP in the United States, a straight-line extrapolation suggests that covering the growing fiscal shortfall would require more than a tripling of the price level, year after year after year. Within three years the dollar would be worth only about 2.5 percent of its original value.

Such continual triple-digit inflation would be unprecedented, the highest the United States has ever experienced outside of its two hyperinflations. We admittedly have not included any short-term government gains from a reduction in the real value of its debt, which biases our inflation estimate upward, but we also have not adjusted for the loss of seigniorage on interest-earning reserves, pushing the bias downward. Moreover, seigniorage itself faces its own Laffer curve (known as the Bailey curve, after the economist Martin Bailey). To avoid higher taxes on their real cash balances, people spend money faster as inflation rises, thereby exacerbating the price increases. Higher rates of inflation thus generate proportionally ever-smaller revenue increases. Once we also acknowledge that the CBO’s projections are probably too optimistic, we can see why our estimate that financing the explosion in Social Security, Medicare, and Medicaid payments will necessitate a 246 percent annual inflation is far too low.

How likely is it that governments in the developed countries will be willing or even able to unleash such appalling currency depreciation? Recall how politically unpalatable the mere double-digit inflation of the 1970s was. Could central banks maybe cease paying interest on reserves and then reimpose or raise reserve requirements to generate more seigniorage at any given inflation rate? Although the answer is technically yes, the likelihood is slim indeed. Now that the genie is out of the bottle, any fiddling with reserve requirements (or other bank regulations) in a way that significantly increases seigniorage will destroy the banking industry as we know it. Think of reserve requirements as a tax on banks, requiring them to hold assets earning zero interest. The higher the requirement, the higher the tax rate. After ending interest on reserves, the Fed would have to multiply the current low reserve tax by a factor in the neighborhood of 15 or more, plus extend reserve requirements to money market funds, to make seigniorage truly lucrative. Given that the U.S. government has just engaged in a gigantic bailout of the banking system, I do not find this prospect probable.

I am not denying that the future may bring higher inflation, if for no other reason than expectations of a fiscal crisis could start a flight from the dollar (or pound or euro) without any immediate change in central-bank actions. But the bottom line is that inflation’s implicit tax on real cash balances will no more be able to resolve the escalating budgetary problems of the welfare states than would an excise tax on chewing gum.

The billboard is part of a campaign sponsored by the Partnership for a Chicken-Free America.  This group is made up of people who have an extreme dislike for chickens, and they are willing to put vast resources into reducing the well-being of chickens.  In fact, they advocate legislation to establish national Kick-A-Chick Day.

Most voters and members of the general public do not share this distaste for chickens as a species.  Then again, most people are relatively indifferent when it comes to chicken happiness. With a few exceptions, it is not in an individual’s interest to spend resources on a counter-campaign or to hire lobbyists to oppose the Kick-A-Chick bill; the costs of doing so simply outweigh the benefits.

This is a classic case of concentrated benefits and dispersed costs.  The anti-chicken people derive tremendous happiness from harm to chickens, making their campaign a worthwhile expenditure.  Yet the general public gains little from preventing chicken kicking and the cost of opposing it is very high.

On the other hand, the public loves prosperity.  If they believed that punting hens created wealth, there is little reason to suspect they would not support the policy.  A public-awareness campaign would be just the ticket.

Armed with Public Choice theory we can see the sad but likely result.  The chicken-free association will exert its influence and get its bill.  The public will either support what they believe to be a prosperity-creating policy or ignore it altogether because the cost of fighting is too high.  The interests align in such a way that we can expect the anti-bird forces to prevail.

Of course this story is absurd and such a law would never be introduced, let alone pass.  What makes it so obviously impossible?

Ideas.

People know there is no causal connection between kicking a chicken and enjoying a higher standard of living.  That knowledge makes the campaign laughable.  Regardless of how the interests are aligned, if people are educated enough to know that chicken kicking does not equal prosperity such absurd policy will not be proposed, much less enacted.

Bus Conversion

Yesterday I saw a sign on the side of a bus which I found no less absurd.  It read, “Converting buses creates jobs.  What are we waiting for?”  The ad was sponsored by a “clean air” association, which no doubt comprises members of the natural gas industry and people for whom a reduction in fossil fuel use would bring some great pleasure.

Just like our chicken story, the incentives are aligned so that the benefits of bus-conversion mandates to the members of this small group exceed the cost of their advocacy efforts, while the benefits to individual citizens of stopping the mandates do not exceed the cost of opposition.  As far as incentives go, the situation seems pretty dire.

Unlike our chicken story, most people do not know there is no magical or “free” job-creation when government mandates bus conversions.  The resources used to convert the buses must be taken from somewhere, and it is as likely as not they there are many other jobs destroyed or never created in the first place when the resources are redirected.  Furthermore, most people do not know that there is no causal connection between more jobs and more prosperity or a higher standard of living.  In fact, if a government mandate creates jobs, it is likely it does so precisely because it is destroying wealth by moving it from more-productive to less-productive (and more labor intensive) uses.

This is actually good news.

It means things are less hopeless than pure Public Choice theory might suggest.  Bad incentives can be overcome by good ideas.  In our chicken story it was clear that interests alone were insufficient to enact policy.  Knowledge of the policy’s incoherence trumped the incentive structure.  With a grasp of basic economics people may find the sign on the bus just as laughable as the idea of Kick-A-Chick Day.

Special interests can do much to destroy liberty given the incentive structure in our political system.  Indeed, with an ignorant populace there is little they cannot do.  But even the most powerful interests ultimately answer to the ideas held by a majority of citizens.  Policy follows the path blazed by belief.

Mises stated this plainly in Human Action: “What determines the course of a nation’s economic policies is always the economic ideas held by public opinion. No government whether democratic or dictatorial can free itself from the sway of the generally accepted ideology.”

That is why FEE has tirelessly educated individuals on economic principles for these many years.  That is why we must continue our educational efforts, no matter how frustrating it may sometimes be.

When we succeed, interest groups and their ploys will be shown to be just as ridiculous as the Partnership for a Chicken-Free America.

Why is it that spending larger sums for public education does not lead to better results while a higher price purchases a higher-quality service nearly everywhere in the private sector? And why haven’t fundamental changes to the schools been made through the political system despite long-falling student achievement? Public Choice theory and economic reasoning make it clear that, far from being contradictory, the current state of affairs in American public schools is the logical result of the processes by which they are run and funded, and that the continuance of the status quo is the result of rational choices by voters within the current democratic system.

Just how much is spent on schooling in the United States? In 2004–2005, the average expenditure per pupil was $9,266, the National Center for Education Statistics says, while the average expenditures in 1984 and 1994 were $6,219 and $7,504, respectively. This represents a 23.5 percent increase over ten years and a 49 percent increase over 20. It’s also 52 percent more than what 29 other countries spent in 2003, according to the Organization for Economic Cooperation and Development.

Yet despite the vast spending increases, the average combined SAT score dropped from 1060 in 1967 to 990 in 1980, after which it rose modestly to around 1028 in 2005. Fifteen-year-old U.S. students scored 483 on the 2003 Program of International Student Assessment, 17 points below the average of all the countries that participated. Thus by the dual standard of cost and benefit, the public school system is doing poorly.

One great difference between government-run operations (such as the public schools) and all organizations on a free market, whether for-profit or nonprofit, is that government agencies are allocated funds by political decisions, while free-market organizations must earn their revenue either through voluntary gifts or voluntary exchange. This distinction has important implications for the actions of these two groups. Free-market organizations strive to maximize profit by increasing revenue and reducing costs; these profits are then either distributed to owners or shareholders or are used to further the goals of the organization. Organizations in which costs exceed revenue earned close or go bankrupt. Thus they constantly strive to become more efficient and productive, and the inefficient producers are driven out.

As Public Choice theory tells us, however, the people who run government agencies have no such incentive to decrease costs and increase revenue because they are not subject to market competition and do not stand to benefit from any profits made. In fact, through a perverse process exactly opposite to the market process, failing schools and districts are often given more money in the desperate hope that the problem will be solved. Public Choice theory also demonstrates that for any public school or school system it is rational to waste resources because of the “use it or lose it” phenomenon. If a school were to have a budget surplus, its budget for the next period might be curtailed—something its administrators would abhor. Thus the public education system typically does not provide incentives for cost-cutting and quality-improving measures. In fact, it does the opposite.

Cost and Quality at Private Schools

Based on this reasoning, and other things equal, one would expect to see, on average, private schools providing better-quality education at lower cost (per pupil) than public schools. Indeed this is exactly what we find. Adam Schaeffer of the Cato Institute, in his policy analysis, “They Spend WHAT? The Real Cost of Public Schools,” found that in the five metro areas studied, public schools spend nearly twice the amount of money per pupil (93 percent more) than the estimated median private school does. That students were sent to these tuition-charging schools instead of to “free public” schools is further evidence the private schools were providing a higher-quality education even at lower total cost.

Instead of competing for students and donations, public schools and school systems compete for allocations from legislatures and bureaucracies. One factor in making these allocations is student performance on standardized tests. This artificial substitute for competition creates perverse incentives for all levels of the education apparatus. Individual teachers and schools, for example, knowing that funding is dependent not on general student knowledge and sharp critical thinking skills, but rather on one test, are induced to teach students only those skills which will be tested (a process known as “teaching to the test”). When schools receive money according to how many students enroll in upper-level classes, they have an incentive to spur more students to take those classes, resulting in unqualified students falling behind and advanced students being held back. In addition, states have an incentive to make standardized tests easier rather than harder so that more students will pass. Thus the perverse results are seen at all levels: individual schools, districts, and state governments.

Rational Ignorance and Bundle Purchases

Public Choice also explains why voters don’t show up en masse on election day to vote for candidates who will change the educational system. Although many citizens agree that the schools could and should be run better, few have a detailed plan of how that could best be done, and therefore few have a standard by which to judge the education proposals of candidates. This is a result of rational ignorance. To cast the smartest vote regarding education policy, a parent (for example) would have to devote an enormous amount of time to learning about the various issues related to education: the inner workings of the local school system, the broader laws of economics, Public Choice theory, the structure of the teachers’ unions, the fine print of the No Child Left Behind Act, and more. Yet after all this work, the parent would still only have one vote to cast. Thus the cost to the parent of learning about this political issue far outweighs the potential benefit of one well-informed vote.

Even more, an informed parent might still not vote for the candidate with the better schooling plan because political decisions, unlike market decisions, are “bundle purchases.” While one chooses any variety of individual goods and services on the market, one must choose a single politician with all of his policy positions. Stuck with a choice of two candidates, each of whom has some agreeable and some disagreeable views, voters are very often forced to choose the lesser of two evils. Note that such language is rarely used to describe market purchases.

Even if a parent voted for the politician who advertised the best plan for educational reform, the politician might fail to live up to his campaign promises. Candidates compete for votes and have an incentive to say or promise whatever is necessary to be elected. But dishonest campaigning is not illegal—no politician ever went to jail for breaking a campaign promise. In addition, politicians generally cannot be ejected from office during their terms; thus in the case of a lying candidate, the voter would be stuck with a representative committed to the status quo until the next election, at which time entirely new issues (apart from education) might take priority. This is the opposite of the market, where many goods can be returned immediately for full refunds, and where false advertising is punished both by the law and by consumers who withdraw their patronage. So widespread public dissatisfaction persists but the education system does not change.

A few alternatives to the current public system have been proposed, including school vouchers and charter schools. While both options stimulate a limited sort of competition on the supply side of schooling, they too are fundamentally flawed. First, the requirements and mandates that the government would impose on all schools accepting vouchers (in terms of curricula, standardized tests, and hiring policies) could create even more State control over education than already exists. Second, these proposed solutions would do nothing to address the abnormally large quantity of education that is demanded under a system of taxpayer-financed schooling.

In the final analysis, the only solution that solves all these problems is the complete separation of state and school. Only in this way can a high-quality, low-cost, diverse, and voluntary educational system be achieved.

Enacting the right regulations is somewhat simpler than electing an omni-everything being to run the world—but not by much. As evidence, consider all the bad regulations that got us into this mess in the first place. Also consider the oft-heard argument that financial regulators needed to “get out ahead of the innovators.” Clearly, a job for the omniscient. There is, after all, a reason why the Wright Brothers’ flight at Kitty Hawk preceded the establishment of the Federal Aviation Administration.

Any time government regulators try to do much more than lay out the basic rules of the game, unintended consequences and moral hazards rear their ugly heads. The following list of pitfalls, adapted from our book Energy: The Master Resource, is offered as a caution to regulatory enthusiasts.

1. Laws and regulations may institutionalize the tragedy of the commons. The rule of capture (which stated that oil belonged to whoever pumped it out of the ground) and related regulations led petroleum companies to drill as many wells as possible in order to get the oil before their competitors could. By encouraging companies to drill otherwise unnecessary wells, the rule led to wasted resources and sometimes to reservoir damage.

Groundwater in the United States is still a common-property resource. Because no one owns it, no one has an incentive to conserve it. Farmers in California, enjoying subsidized water prices, have been growing water-intensive crops such as rice and cotton in desert areas despite endemic water shortages.

2. Special interests lobby the government to get their products or services mandated by regulation. The mandated use of ethanol in automotive fuel is an example. In the United States most ethanol is made from corn. Farmers who grow corn and companies that make ethanol from it have heavily pressured Congress to require its use. As a further subsidy the government has banned imported ethanol even though it can be purchased from other countries for less than it costs to make it here. One unintended consequence has been an increase in food prices. As the price of corn has risen, so has corn-based animal feed and with it the price of beef, milk, chicken, and eggs.

3. Regulations can create (or destroy) entire industries overnight. The use of such power adds uncertainty and risk to the market. If risk reaches unacceptable levels, investors put their money elsewhere. The concentration of political power in Washington forces companies to lobby Congress and the White House for protection against its arbitrary use. Corporate lobbying, in turn, increases people’s distrust of the system.

4. Regulations are often the result of compromise. After concessions have been made to this powerful representative or that influential senator, the resulting law or regulation may be very different from the original proposal and have far different consequences. Politics may be “the art of the possible,” but what is politically possible may be neither practical nor environmentally friendly.

Compromise can also result in laws so vaguely worded that they can be interpreted in any number of ways. In the end it is left up to regulatory agencies and the courts to decide what a bill actually means. Their interpretations may be very different from the original intentions of the bill’s proponents.

The Clean Air Act Amendments of 1977, for example, stated that only new factories and power plants would have to meet the tighter emissions standards imposed by the act. Existing plants would continue to be regulated under the preexisting standards unless the old plants were “substantially modified.” Unfortunately, Congress did not precisely specify what “substantially modified” meant.

In 1998 the Environmental Protection Agency (EPA) sued the owners of a number of old plants, charging that the upgrades done over the years to these plants had cumulatively added up to “substantial modifications.” The owners responded, with some justification, that the EPA had originally approved their changes and that altering the rules after the fact amounted to passage of a retroactive law, something explicitly forbidden by the U.S. Constitution (Section 9, Article 3).

5. Lobbyists may support regulations as a way of hurting their competition. Utility companies with “old source” power plants, for example, welcomed the Clean Air Act’s 1977 amendments because they put potential competitors at a disadvantage by raising the cost of market entry.

Other amendments to the Clean Air Act required power companies to reduce sulfur dioxide emissions by installing scrubbers. A less expensive way to lower emissions would have been to switch to low-sulfur coal, but eastern labor unions and coal mining companies (which produce high-sulfur coal) successfully lobbied to get the requirement for scrubbers enacted into law. This resulted in a waste of resources since (otherwise unnecessary) scrubbers had to be built, installed, and powered.

In the United States during the twentieth century, government intervention in the energy market was commonly industry-driven. Firms often organized lobbying groups to obtain favorable regulation or special subsidies. Free-market economist Milton Friedman complained, “Time and again, I have castigated the oil companies for . . . seeking and getting governmental privilege.”

6. Regulations can eliminate or alter feedback. Feedback is an essential component of any activity. Imagine how dangerous the world would be for a person who had lost the ability to feel pain (as happens with certain forms of leprosy). Such a person could do serious damage to himself by continuing to walk on a badly sprained ankle or putting his hand on a hot stove without knowing it.

Government action can create a sort of institutional leprosy by weakening or even destroying the feedback loops that make it possible for companies to know whether their activities are of any value. For instance, by taxing productive companies in order to subsidize unproductive ones, governments perpetuate the waste of resources.

7. “Hard cases make bad law.” All too often, regulations are hastily written in response to the public’s demands that the government “do something” in the face of a crisis. Petroleum price controls during the 1970s are a case in point. Under the provisions of the rules, refiners could charge more for higher-octane fuels, so they were encouraged to increase the lead content to artificially boost octane ratings.

At the same time that crises lead to demands for action, they tend to increase the cost of any action. For instance, in response to the power shortage of 2000–2001, the state of California negotiated long-term contracts for the purchase of electricity. Within a few months market electricity prices dropped well below what, in the midst of the crisis, had appeared to be justified. California taxpayers bore the costs of this multibillion dollar mistake.

8. Regulations often have unintended side effects. New laws or regulations may change the incentives people face and encourage them to act in ways that the lawmakers had not foreseen.

Recall the 1977 Clean Air Act amendments that placed strict emissions regulations on new power plants, while grandfathering existing facilities. Those rules increased the costs of new plants relative to existing ones, encouraging power companies to keep older plants in service longer than they otherwise would have. Old plants are less efficient than new ones, and the result was more fuel used and more pollution created.

Fears of oil spills have led lawmakers to prohibit offshore drilling in many of America’s coastal areas. As a result, the nation must import more oil than would otherwise be the case. However, imported oil is delivered via tanker. Notwithstanding the recent tragedy in the Gulf of Mexico, tankers pose a greater oil spill danger than does offshore oil production. Similarly, forbidding drilling in onshore and near-shore locations forces oil companies to drill in more hostile areas, making accidents more likely. American coastlines are, therefore, actually less safe thanks to such legislative “protection.”

The Community Reinvestment Act and the American Dream Downpayment Act were supposed to merely increase home ownership. As should have surprised no one, however, they also set off a housing price bubble.

9. Regulators do not bear the costs of their regulations and have little incentive to ensure that the benefits outweigh those costs. The U.S. Forest Service does not pay the cost of building timber roads in the nation’s forests; the money is paid out of the Treasury. However, the Forest Service is allowed to keep some of the proceeds from timber sales. This practice provides an incentive to build logging roads into remote areas of the nation’s parks to allow timber companies access to trees that would otherwise be uneconomical to harvest.

The result, according to Tom Bethell (The Noblest Triumph: Property and Prosperity Through the Ages) is that “[b]y 1991, the service had constructed 360,000 miles of roads—eight times the length of the U.S. Interstate Highway System.” Because the cost of many of these roads exceeded the value of the timber harvested, resources were wasted. Because the link between costs and rewards was eliminated, damage is being done to thousands of acres of parkland through deforestation, loss of habitat, and soil erosion for no net gain.

10. Public officials are self-interested, and their self-interest may not always be in the public interest, as James Buchanan and Gordon Tullock, the main developers of Public Choice theory, pointed out.

For instance, managers with the federal government are often paid in proportion to the number of people who report to them. Their incentive, therefore, is to expand their departments. All too often they act in accordance with this incentive regardless of the cost to taxpayers.

More familiar are the politicians who purchase votes by using tax dollars to pay for projects of questionable value, or city officials who get kickbacks in return for construction contracts.

11. Once in place, regulations are difficult to eliminate—Friedman’s “tyranny of the status quo.” For example, even though the problems with ethanol have been known for years, the regulations requiring its use have yet to be repealed.

No matter how detrimental a regulation is, or how outdated it has become, there is usually someone who benefits by it. The beneficiaries of the regulation generally have a stronger interest in keeping it in place than anyone else has in getting rid of it. As a result, they are willing to spend time and money lobbying the government to support their position. While the benefits of a regulation may be enjoyed by a relative few, the costs are often spread out among many. If the per-person cost of a regulation is only a dollar or two a year, no one has a financial incentive to travel to Washington to lobby against it. Economists call this the problem of concentrated benefits and diffused costs.

Moreover, the benefits of any particular government action are usually quite visible, but the costs are often hidden. For example, if the recycling industry receives a subsidy, the new facilities and jobs are open to public view. Those gains may be more than offset by the loss of facilities and jobs in other industries because taxes raised to subsidize the recycling industry leave consumers fewer dollars with which to purchase other goods and services.

Perhaps most important, people just do not like to admit when they have made a mistake, and politicians are no exception. If the “Smith Act” causes problems, Senator Smith is unlikely to apologize and propose that his act be repealed. Instead, the senator will probably argue that his legislation was not properly funded or enforced. In the end the law is more likely to be expanded than repealed.

For example, the laws and regulations encouraging lenders to give home mortgages to people who cannot afford to pay them back are still in effect. Rather than admit their mistake, legislators create straw men (such as Wall Street “greed”), then pass regulations to battle them.

12. Industries exert enormous influence over the government agencies created to regulate them. Reformers, believing this problem is due to an imbalance of power, often seek to remedy the situation by increasing the authority of the regulatory agency. Such measures will likely serve only to solidify the positions of those companies that already dominate the regulated business.

Industry sway over government agencies is a natural result of the incentives inherent in the regulatory process. As already noted, no one has more incentive to lobby regulatory agencies than do the companies they regulate. And regulators’ self-interest gives them a powerful incentive to listen.

There is also the “revolving door” phenomenon whereby personnel leave industry for jobs with government agencies and vice versa. Some see this as proof of corruption, but there is a simpler, less sinister, explanation. When an agency is created to oversee a business, one of its first needs is employees with knowledge of that business. Where can it go for such people but to the industry itself? Similarly, when government employees retire and wish to begin second careers, where can they go other than to the business about which they have spent their professional lives learning?

13. Laws and regulations stifle innovation. Once a particular solution is written into law, there is little incentive for companies to develop a better one. Laws are notoriously difficult to change, particularly when lobbyists’ businesses depend on the mandated solution. Even if the mandated solution was cutting-edge technology when the law was signed, technology quickly becomes outdated in a free market.

14. National regulations can create nationwide problems. In 1978 the Carter administration, mistakenly convinced that the country was running out of oil and natural gas, passed the Powerplant and Industrial Fuel Use Act. Under the act existing plants were prohibited from increasing their use of natural gas, and new plants were prohibited from using either natural gas or fuel oil. This restriction left coal as the only alternative despite the fact that coal emits more pollution and CO2 than does natural gas. (While nuclear power was also an alternative, the Three Mile Island incident, which occurred the following year, made the option politically impossible.) President Reagan lifted the restrictions on existing plants in 1981 and on new plants in 1987.

15. The existence of regulations and regulatory bodies gives people a false sense of security. Bernie Madoff’s victims, for example, were reportedly as angry with the SEC for leading them to relax their guard as they were at Madoff for taking advantage of them. Consumers who believe that government watchdog and licensing agencies weed out incompetent and fraudulent service providers may be less vigilant than they would otherwise be.

This is the state on which our authors focus. They aren’t much interested in either praising or condemning the conservative movement, but seek to explain its political success over the last several decades. They do that very well indeed. Micklethwait and Wooldridge thoroughly cover the whole spectrum of conservative politics, from the ground troops of the Republican Party to the brigades of analysts and policy wonks in the various rightist and free-market think tanks. (But sorry to say, FEE doesn’t get a mention.)

Micklethwait and Wooldridge take Western Europe as a counterpoint, a sort of leftish benchmark, and note that America is conservative in a relative way—and in a bipartisan way. Even “liberal” Democrats here are “conservative” in comparison with European leftists, something that the authors attribute to the “effectiveness” of the conservative movement.

Where I take major exception with the authors is precisely that—American conservatism is “effective.” Effective, how? Maybe in slowing down the progress of government expansion a tiny bit. We aren’t quite as bad off as, say, Sweden, but the main contours of America are not much different than they were when Nixon took office. And now we have a huge new federal entitlement in prescription drugs, courtesy of a “conservative” president.

Our authors note that America is the only developed nation without a full government-supported health-care system; that it is the only Western democracy that does not furnish child support to all families; that it is ready to be the only OECD nation (of 30—Australia seems about to give up being the only other holdout) to deny paid maternity leave. In this sense are we “the right nation,” one with “conservative power,” but I’m not inclined to see any remarkable conservative power in the fact that the United States hasn’t bitten on some of the worst ideas meddlesome politicians have come up with.

When the authors talk about “conservative power in America,” I say this could well be the very power that Milton Friedman put down as “the tyranny of the status quo.” Few conservative politicians have the nerve to challenge the deeply ingrained collectivist notions that many Americans hold, ranging from “public education” to eminent domain. The great conservative movement has done precious little to shake people out of those ideas, and it’s becoming increasingly clear that many conservative leaders today don’t even care to try. It reminds one that F. A. Hayek took pains to explain why he was not a conservative.

A particular blind spot for Micklethwait and Wooldridge is the phenomenon of rent-seeking. In their index, they give 12 citations to Milton Friedman and ten to Hayek, yet none to another Nobel economist, James Buchanan. Yet it was Buchanan who, with Gordon Tullock, came up with the idea of Public Choice, the explanation for why the modern democratic state inevitably gets caught up in the favor-granting business. Here special interests press our vote-and-campaign-money-hungry politicians for favors including subsidies and manifold tax-and-import protectionism.

Micklethwait and Wooldridge correctly charge the Bush White House with kowtowing to special interests, letting federal spending (defense and nondefense) skyrocket, federalizing airport security with tens of thousands of new government employees, slapping tariffs on imported steel, signing the biggest farm bill on record, and, by the way, casting not a single veto on a spending or any other bill. What they apparently fail to see is that the federal juggernaut is a systemic problem that conservatism has done nothing to solve.

Back in 1835, Tocqueville foresaw today’s democratic state, where all too often “The will of man is not shattered, but softened, bent, and guided; men are seldom forced by it to act, but they are constantly restrained from acting; such a power does not destroy, but it prevents existence; it does not tyrannize, but it compresses, enervates, extinguishes, and stupefies a people, til each nation is reduced to nothing better than a flock of timid and industrious animals, of which the government is the shepherd.”

Dear Freeman reader, look out. Make way for more shepherded “progress.” Messrs. Micklethwaite and Wooldridge amuse and edify us on today’s Politicized America, but do so in an ephemeral way. They silently endorse government interventionism as a given and conservatism as a means of protecting the status quo. This a pity.