Just one day later, September 20, the Bush administration announced a price tag: It would ask Congress for what the Times described as “unfettered authority for the Treasury Department to buy up to $700 billion in distressed mortgage-related assets from the private firms.” News reports noted that $700 billion amounts to more than $2,000 for every man, woman, and child in the United States. Secretary Paulson released a three-page draft of the legislation he wanted. It did not specify how the money would be spent, but did say that no court could review the Treasury’s decisions about spending the money. Paulson warned of dire consequences should Congress not approve the legislation quickly and as proposed.

In asking for huge sums and unrestrained power for government to intervene in financial markets, Bernanke and Paulson discarded any pretense of adhering to free-market principles. The Times reported that an attendee at a strategy meeting quoted Bernanke as justifying the abandonment of principles by declaring that, “There are no atheists in foxholes and no ideologues in financial crises.” The aim of avoiding a deeper crisis, in other words, rationalizes whatever seems expedient. We should flee from the threat of a “financial meltdown” even into the arms of a constitutional meltdown. Surprisingly, many “free-market” commentators and economists echoed this sentiment. Some of them pledged to reaffirm free-market principles in the future even while calling for their abandonment for the duration of the financial turmoil. Their questionable judgment seems to have been that more government intervention was needed to offset—and would offset rather than compound—the previous interventions that had created financial chaos.

Few in Congress questioned the figure of $700 billion. Some House Republicans proposed a nominally less-interventionist plan that would have had the federal government not purchase—“only” guarantee—home-mortgage assets. Instead of putting an explicit price tag on the taxpayers’ burden for the bailout, government guarantees of mortgages and mortgage-backed securities would have obliged taxpayers to pay lenders and bond holders whenever and wherever borrowers or security issuers defaulted, implying off-balance-sheet taxpayer exposure on an unspecified scale. A blank check rather than a $700 billion check—some improvement.

After congressional wrangling for nine days over what to add to the three-page Treasury proposal, a bill of 110 pages emerged. A deal had been struck. The Treasury’s authority to purchase had grown beyond mortgage-related assets to include “any other financial instrument that the Secretary, after consultation with the Chairman of the Board of Governors of the Federal Reserve System, determines the purchase of which is necessary to promote financial market stability.” In other words, whatever the two wanted.

Shock in the House

On Monday, September 29, the House of Representatives shocked political pundits by voting down the bailout bill 228–205. With constituent email and phone messages to Congress running heavily against the bailout (some estimates said 30–1), the majority that day disregarded dire warnings that Congress had “no time” to put any more careful thought into what it was doing.

Two days later, however, the U.S. Senate approved a further-revised bailout bill 74–25. Although they had not taken time to put a lot of additional thought into it, senators had nonetheless added a lot of text: The bill had now grown to 422 pages. The Emergency Economic Stabilization Act of 2008 now not only provided $700 billion for a Troubled Assets Relief Program, but also included sections and subsections on Renewable Energy Incentives, Carbon Mitigation and Coal Provisions, Transportation and Domestic Fuel Security Provisions, a grab-bag of tax-credit extensions, a subtitle for Mental Health Parity and Addiction Equity, another for Heartland and Hurricane Ike Disaster Relief, an increase in federal deposit insurance, and authority for securities regulators to relax accounting rules that financial firms facing mortgage-related losses were finding inconvenient. The height of special-interest absurdity was reached in Section 503 of the Act which, according to the official Library of Congress summary, “Exempts from the excise tax on bows and arrows certain shafts consisting of all natural wood that, after assembly, measure 5/16 of an inch or less in diameter and that are not suitable for use with bows that would otherwise be subject to such tax (having a peak draw weight of 30 pounds or more).”

Two days after the Senate vote, on Friday, October 3, the once-reluctant House approved the bailout bill 263–171. In the second House vote 33 Democrats and 25 Republicans switched from no to yes. One congresswoman unashamedly explained to National Public Radio that she had switched because the new bill included solar-energy tax credits. President Bush immediately signed the bill. Prices on the New York Stock Exchange, which had closed way down the day the first bill had failed to pass, closed down again on the day the revised bill passed and was signed into law.

“Plan” A

The “plan” for how to spend the $700 billion bailout has always been extremely vague, from its inception in the Bernanke-Paulson phone call, through the case Paulson made before Congress, to the passage of the enabling legislation. Improvisation continued up to the date this account was written in late November. The Treasury originally announced an intention to buy troubled mortgage-related assets, and hence the bill refers to a Troubled Asset Relief Program, or TARP. But on what terms would they buy these assets? More than a month after passage, that had yet to be made clear. American Public Media’s Marketplace program reported on November 7 that, “A securities industry trade group just came out with a survey, and it found that financial players are so unclear about how TARP would work, they aren’t sure they want to participate.” The Treasury had to schedule a meeting with banking industry representatives on November 10 to fill them in on the evolving specifics of TARP.

The “troubled” assets to be purchased are mortgage loans, bundles of such loans (“mortgage-backed securities”), and apparently any other financial assets the Treasury wants to include. What makes them “troubled” is basically that financial institutions can’t sell them for what they paid for them. The basic reason is that an unexpectedly huge share of mortgages has gone bad: Mortgage-default rates have skyrocketed. Further, the secondary market for mortgage-backed securities has dried up. A firm trying to sell some of its holdings would fetch only fire-sale prices.

There is a basic problem with having the Treasury buy assets that the market won’t buy except at fire-sale prices. Either the Treasury outbids the market and overpays for the assets—which benefits financial institutions at taxpayer expense—or the government pays the current market price, which would compel banks to mark other assets down accordingly and book the losses they’ve been trying to avoid booking.

In arguing for the bailout, Bernanke proposed that an “auction” of troubled assets for taxpayer-provided dollars would enable accurate “price discovery,” even though the Treasury would be the only bidder, and thereby would restore an active market. How such an auction would work, how it could be designed to arrive at hoped-for prices—above current market prices but not above what the assets would supposedly be worth in a normal market—was never spelled out. In mid-November “Plan A” appeared to have been more or less officially shelved. Never mind that Paulson had told Congress that hundreds of billions for troubled-asset purchases were urgently and immediately needed to avoid financial Armageddon.

On November 25 the idea of troubled-asset purchases made a dramatic comeback under the auspices of the Federal Reserve, which is discussed below.

“Plan” B

On October 13 the Treasury announced a new way to spend $250 billion of the $700 billion: It would inject equity capital into banks, buying newly issued preferred shares. It soon thereafter injected $125 billion into nine major banks: Citigroup, Bank of America, Wells Fargo, JPMorgan Chase, Bank of New York Mellon, State Street, Merrill Lynch, Morgan Stanley, and Goldman Sachs. The last-named is the former investment bank, recently converted into a commercial bank, previously headed by Paulson. From the group of nine banks the Treasury took “preferred shares” with fixed 5 percent dividends (increasing to 9 percent if the shares have not been repurchased in five years).

On November 23 the Treasury announced it would inject an additional $20 billion of equity into Citigroup. For this second injection it took preferred shares with an 8 percent dividend. The Treasury together with the FDIC also provided an off-balance-sheet guarantee against losses on about $300 billion of Citibank’s troubled real estate assets, in exchange for which the Treasury and FDIC took additional preferred shares.

The federal government is now part-owner of the nine banks. The banking system has been partially nationalized. The preferred shares are ownership claims of a type falling between debt obligations (bonds) and common stock shares. They are riskier than bonds because preferred shareholders must stand behind bondholders in the line to get paid in the event that the bank can’t pay everyone.

To compensate for its risk the Treasury also took stock warrants—contracts that give it the right to buy shares in the future at a specified price so that it can make a profit should the banks’ stock prices someday rise higher than that price. “Recapitalizing” a firm normally leads to lower share prices, however, because it means more shares dividing ownership of the same asset portfolio. The infusion dilutes existing shares. For this reason two of the nine banks reportedly objected to participating in the Treasury’s capital infusion with attached strings. The Treasury explained that it did not make participation voluntary because it did not want to stigmatize as weak the banks that chose to participate. A financial analyst’s report in late November named Bank of America, Citigroup, Goldman Sachs, JPMorgan, Morgan Stanley, and Wells Fargo as the weakest institutions.

The other half of the Treasury’s $250 billion has been designated for assignment to smaller banks to be named later. Among other things, the Treasury reportedly hopes these capital injections will enable recipient banks to buy up other, weaker banks. An anonymous Treasury official told reporters: “One purpose of this plan is to drive consolidation.” Thus taxpayer money is being allocated to influence the shape of the banking market.

“Plan” C?

What will “Plan” C be? As the Treasury continues to improvise, everything and anything is possible. So says Neel Kashkari, the former Goldman Sachs employee under Paulson who is now the Treasury’s chief bailout administrator under Paulson. Asked whether funds might go to insurance companies, other financial firms, and even nonfinancial firms like automakers, one news story reported, “Kashkari indicated that everything was on the table. ‘We are looking at everything,’ he said. ‘We are trying to figure out what will provide the most benefit to the financial system.’”

House Speaker Nancy Pelosi, Senate majority leader Harry Reid, and other congressmen have urged the Treasury to use some of the $700 billion to inject capital into the leading U.S. automakers. These same lawmakers specified no such authority in the bailout bill. Some $1.5 billion of the $700 billion will go to local governments for reasons unrelated to the financial system.

Insurance executives have reportedly lobbied for the bailout to include troubled insurance company assets. There is now a precedent: The Treasury has given $67.5 billion of the bailout to AIG, the failed insurance giant brought down by its imprudently massive guarantees on mortgage-backed securities, in exchange for troubled assets and preferred shares. AIG was already on an $85 billion life-support loan from the Federal Reserve.

Second Bailout

The Treasury’s $700 billion bailout is actually the second federal bailout program underway. The press has widely reported on the Treasury bailout bill and the post-bill spending improvisations. Columnists and the public have openly debated the dubious wisdom of that program. Congress has held hearings and has voted on the bailout bill, even if it has left it to the Treasury to decide how the $700 billion will be spent. But flying under the radar, attracting much less public attention and almost zero congressional scrutiny, have been the Federal Reserve’s ongoing efforts that in mid-November added up to a $1.7 trillion shadow bailout program for favored financial institutions, more than double the size of the Treasury’s bailout. On November 25 the Fed announced two new lending lines that will add another $800 billion, bringing the total to $2.5 trillion—more than triple the size of the Treasury’s bailout. (This section draws heavily on my paper for the November 2008 Cato Institute monetary conference, “Federal Reserve Policy and the Housing Bubble.”)

The Fed’s bailout efforts began back in March 2008 with the Fed putting up $29 billion to sweeten a deal in which the commercial bank JPMorgan Chase would take over the teetering investment bank Bear Stearns. A new Fed-owned subsidiary (“Maiden Lane LLC”) was set up to cleanse the Bear Stearns balance sheet by acquiring troubled mortgage-backed securities for the $29 billion. The transformation of the Federal Reserve’s balance sheet, which used to hold virtually nothing but safe Treasury securities, had begun. Between March and November, as the Fed improvised new interventions into financial markets, the dollar amounts of the Fed’s commitments grew and grew.

The interventions are visible among the assets on the Fed’s balance sheet for November 5, where many new entries appear that were absent one year ago. The list begins with “Term Auction Credit” at $301 billion, representing 28-day and 84-day loans to banks. Previously loans to commercial banks were limited to overnight loans for meeting reserve requirements. Banks were expected to attract longer-term funds from depositors or private institutional investors in the money market. Next on the list is “Primary Dealer and other Broker-Dealer Credit” of $72 billion—that is, loans to securities dealers. A year ago the Fed did not lend to securities dealers. Third is the “Asset Backed Commercial Paper Money Market Mutual Fund Liquidity Facility”—loans to banks or bank holding companies to allow them to purchase assets from money-market mutual funds. Previously money-market funds that needed to liquidate commercial paper holdings were expected to sell them in the money market. “Other credit extensions,” a catchall fourth new entry, amount to $81 billion.

The fifth new entry is “Net portfolio holdings of Commercial Paper Funding Facility LLC,” $243 billion. A memo to the Fed’s balance-sheet release explains: “On October 27, 2008, the Federal Reserve Bank of New York began extending loans . . . to Commercial Paper Funding Facility LLC. This LLC is a limited liability company that was formed to purchase three-month U.S. dollar-denominated commercial paper from eligible issuers and thereby foster liquidity in short-term funding markets and increase the availability of credit for businesses and households.” That is, the Fed has formed a new subsidiary for directly allocating funds to a particular segment of the financial system, the commercial paper market. Previously the Fed purchased only Treasury securities, and let private banking and financial markets allocate the funds it thus injected to their best uses.

Sixth is “Net portfolio holdings of Maiden Lane LLC,” $27 billion, representing the troubled assets acquired from Bear Stearns. Note that the assets have been marked down from their acquisition price of $29 billion: the Fed has suffered a loss of $2 billion. By holding the assets the Fed is speculating that the market for selling them will be better later on. Previously the Fed did not get involved in financial takeovers by absorbing troubled assets to sweeten the deal. The FDIC sometimes did, but only in mergers between two insured commercial banks. Bear Stearns was an investment bank, not an insured commercial bank.

Last September the Federal Reserve began buying federal agency notes—short-term IOUs of Fannie Mae, Freddie Mac, and the Federal Home Loan Banks—from securities dealers. As of November 5 the Fed was holding $13 billion of such notes, where it held zero one year ago, though it has held small amounts of agency debt in the past. The Fed’s “primary” (overnight) loans to commercial banks are currently at $110 billion, up from only $1.4 billion a year ago. In total the Fed’s assets have more than doubled, from $889 billion a year ago to an astounding $2.08 trillion in mid-November. Further increases are on the way.

Two items make the Fed’s bailout loan program even larger than the $1.2 trillion increase in its total assets. First, the Fed has funded $303 billion of its new loans by selling off Treasury securities from its portfolio. Second, off its balance sheet (but recorded as a “memorandum item”), the Fed also runs a “Term Securities Lending Facility” that has lent $197 billion of its Treasury securities to broker-dealers, giving them something liquid to sell in exchange for IOUs collateralized by less liquid securities like mortgage-backed securities. As of November 5 the Fed’s new loans and purchases had extended $1.7 trillion in new credits to financial institutions over the past year.

On November 25 the Federal Reserve announced that in the following week it would begin purchasing up to $600 billion in securities issued or guaranteed by Fannie Mae, Freddie Mac, and the Federal Home Loan Banks. It would buy them from its primary securities dealers through “a series of competitive auctions.” It also announced the creation of a $200 billion Term Asset-Backed Securities Lending Facility to make new term loans to financial institutions, loans to be collateralized by nonmortgage pools of consumer and small-business loans. In both cases the Fed is engaged in price-setting, trying to drive interest spreads (the differential yields over Treasury bills required to attract purchasers) on riskier securities back into their historical ranges. Thus the Fed is second-guessing the risk premiums set in competitive financial markets. As of Thanksgiving, the new facilities had not yet appeared on the Fed’s balance shee

Unprecedented Credit Expansion

From $1.2 trillion of added bank reserves, the late-November lending programs (if not somehow offset) will push added bank reserves to $2 trillion. The Fed has no clear exit strategy from its unprecedented credit expansion. It has too few Treasury securities left to sell in order to pull the credits back in, the traditional method for contracting bank reserves. No doubt the Fed hopes that the new loans will be repaid (and not re-extended) as financial market conditions improve. But borrowing firms whose ability to repay depends on the prices of their mortgage-backed securities recovering may be unable to repay any time soon because the effects of overbuilding during the housing bubble will depress the price of real estate and thus of mortgage-backed securities for a long while. Moreover, they may be unwilling to repay. Nonbank financial firms that are now enjoying the Fed’s below-market lending rates will have no incentive to wean themselves and every reason to lobby for keeping the new bargain lending windows open indefinitely. “Temporary emergency” government subsidies have a way of living on and on. Just ask the recipients of federally subsidized farm loans.

The Fed’s new activities deserve to be called a bailout program because they seek to channel credit selectively at below-market interest rates, or purchase assets at above-market prices, in hopes of rescuing, or enhancing profits for, favored sets of financial institutions. The Fed’s new lending facilities are not parts of a central bank’s traditional “lender of last resort” role. A lender of last resort injects reserves into the commercial banking system to prevent the quantity of money from contracting—and thereby to protect the economy’s payment system—when there is an “internal drain” of reserves (bank runs and the hoarding of cash). There has been only one bank run (on IndyMac) and no contraction in the money stock. Investment banks do not issue checking deposits, are therefore not subject to depositor runs, and are not part of the payment system. Neither are securities dealers. Money-market mutual funds play a limited payment role, but because they do not issue demandable debt, they are not subject to runs. The Fed’s expansions of its own activities therefore had nothing to do with protecting the payment system or stabilizing the money supply.

The “lender” in “lender of last resort” has long been an anachronism. Central banks in sophisticated financial systems discovered decades ago that they can inject bank reserves without lending by purchasing government securities in the open market. By doing so, the central bank supports the money stock while avoiding the danger of favoritism associated with making loans to specific banks (or nonbanks) on noncompetitive terms. It also avoids the potential favoritism in purchasing other securities. The Fed’s new activities, by contrast, extend an array of loans to various financial institutions and purchase securities from nonbank issuers and holders. These activities pose the risk of favoritism—of substituting the Fed’s judgment for the market’s about what kinds of institutions and what particular firms should survive. They have nothing to do with replenishing the reserves of the banking system or preventing contraction in the stock of money. The Fed’s activities seem rather to aim at protecting financial institutions from the consequences of imprudent portfolio decisions.

The Federal Reserve’s new interventions into financial markets over the past year have proceeded at its own initiative and without precedent. They seem to be enjoying the complete freedom from oversight that Secretary Paulson unsuccessfully sought for the Treasury’s bailout program. The Fed’s program has attracted little attention mostly because it has not required a congressional appropriation. The Fed is “self-financing”: It can “print up” any funds it needs to make loans or purchase assets by simply expanding the quantity of unbacked claims on itself. This does not mean that Fed credit expansion provides a free lunch. When the Fed increases the stock of dollars, it levies an implicit tax on holders of existing dollar balances by creating an inflationary depreciation of the dollar.

An Evaluation of the Bailouts

The financial turmoil of 2008 was the result of what may be briefly described as a government-policy-induced cluster of entrepreneurial errors by financial-market participants. Paulson’s and Bernanke’s bailout programs are disabling the key market mechanisms for correcting entrepreneurial errors: price adjustments and bankruptcies. Delays in the correction of mortgage asset prices, and delays in the necessary resolution of insolvent financial institutions, do not promote but rather hinder a sound economic recovery. As ABC News commentator John Stossel has written: “We do need protection from reckless businessmen. But there is only one way to provide that: market discipline. That means no privileges and no bailouts.”

When government does not intervene with taxpayer-financed bailouts, private market participants will recapitalize banks (as Mitsubishi Bank recently did for Morgan Stanley) and buy distressed assets in genuinely price-discovering market transactions, to the extent that those risking their own money think warranted. The resolution (sale or liquidation) of firms that are not worth recapitalizing makes room in the market for better-run institutions to take their place. As the United States discovered in the savings-and-loan fiasco of the 1980s, and as Japan discovered in the 1990s, a government policy of keeping insolvent financial firms open beyond their expiration date makes survival more difficult for healthy firms.

Along these lines, the eminent monetary historian Anna J. Schwartz candidly criticized the bailout programs in an interview with the Wall Street Journal on October 18. To promote recovery the Fed and Treasury “should not be recapitalizing firms that should be shut down,” Schwartz said. Rather, “firms that made wrong decisions should fail. You shouldn’t rescue them. And once that’s established as a principle, I think the market recognizes that it makes sense. Everything works much better when wrong decisions are punished and good decisions make you rich.”

Schwartz observed that “Lending freezes up when lenders are uncertain that would-be borrowers have the resources to repay them.” Removing the uncertainty by enforcing the usual rules requiring insolvent firms to exit the market promptly would provide greater clarity to financial markets. The economist Pedro H. Albuquerque has drawn out the implications of this insight: bailout plans make “the information problem worse by keeping unhealthy banks afloat,” which “endangers the entire economy through planned obfuscation.” A hypothetical used-automobile market in which buyers are reluctant to buy because they fear that sellers are trying to palm off unreliable vehicles is known to economists as a “lemons” market. Albuquerque observes that “The government is artificially creating a lemon market when it does not allow discrimination between healthy and unhealthy banks to occur via bank failures.”

Some editorial and op-ed writers have claimed that many financial institutions have been “unregulated” too long and must now become regulated. But financial institutions have never been unregulated. They have been regulated by profit and loss. The failure of Lehman Brothers and the near-failure of Merrill Lynch raised the interest rate at which profit-seeking lenders were willing to lend to highly leveraged investment banks. The market thereby forced Goldman Sachs and Morgan Stanley to change their business models drastically and to convert to commercial banks. If that isn’t effective regulation, what is? Protecting firms from failure (Bear Stearns, AIG, Fannie Mae, Freddie Mac, Goldman Sachs, Citibank) and mitigating their losses with bailouts renders this most appropriate form of regulation much less effective.

The eagerness of Ben Bernanke and Hank Paulson to substitute their own judgment for the dispersed judgments of a freely competitive financial market may reflect simple intellectual error. Or, less innocently in the case of former Goldman Sachs CEO Paulson, it may be error compounded with partiality. In an open letter to Congress on the eve of the bailout bill’s passage, John A. Allison, CEO of the large and successful regional bank BB&T, pointed out that “There is no panic on Main Street and in sound financial institutions. The problems are in high-risk financial institutions and on Wall Street.” The bailout seemed designed, in his view, to benefit a select group of Wall Street firms: “The primary beneficiaries of the proposed rescue are Goldman Sachs and Morgan Stanley.. . . [T]his is primarily a bailout of poorly run financial institutions.” This design, Allison continued, was not an accident but the result of partiality in the designers’ interests and perspective: “Treasury is totally dominated by Wall Street investment bankers. They do not have knowledge of the commercial banking industry. Therefore they cannot be relied on to objectively assess all the implications of government policy on all financial intermediaries.”

Related posts:

1. The Subprime Crisis Shows that Government Intervenes Too Little in Financial Markets? It Just Aint So!
2. The Fed Should Inflate to End the Financial Crisis? It Just Ain’t So!
3. Transforming America: The Bush-Obama Stimulus Programs

The dangers discussed in the Report are all threats to democracy. Government payrolls are taxpayer expenditures. Basic principles of democracy call for government expenditures to be determined in the open by duly elected legislators. Moreover, taxpayers must be able to testify in open legislative hearings regarding such expenditures. This is not how government-sector collective bargaining (GSCB) works. For example, in Washington state a legislator’s only role in the GSCB process is to vote yes or no on government-employee compensation bargained by the governor and the government-employee unions. Those bargaining sessions are closed to the public. The unions are a de facto fourth branch of government empowered to ignore both the legislature and the taxpayers. Unions are not ordinary special-interest groups, like the Sierra Club, that try to affect government policy. They actually get to codetermine government policy with the governor.

As described in the Report, GSCB in Washington state is an egregious special-interest game. The governor, who gets in-kind and financial campaign support from the unions, “bargains” with them. This is government of the taxpayers by the unions for the unions. It is taxation without representation.

Because the unions are permitted to force government employees to pay union dues and agency fees as a condition of continued employment, they are able to buy the loyalty of the governor and to bribe enough legislators to vote yes on the bargains. The Report gives details of this pay-to-play game in Washington state from 2004 to July 2008. It reveals the specific amounts paid by unions to various politicians in direct campaign contributions and the resulting union-friendly votes those politicians cast. The unions spent a total of $1,128,425 buying political votes. According to the Wall Street Journal, Colorado government unions assembled over $13 million of forced dues and fees to fight a ballot measure that would have prohibited them from collecting forced dues and fees.

Sign This Card or Else!

Unions are not content with the money they take from ordinary government employees. Some unions are now bribing politicians to vote for laws that will force individual private-sector workers—such as home healthcare workers, daycare providers, and even foster parents—who are paid with any taxpayer funds to submit to union representation and forced fees.

In private-sector collective bargaining the employer and the union sit on opposite sides of the table. The employer is playing with his own money, and he is constrained by the market competition he faces. The union represents the interests of employees under the constraint that if the enterprise loses out to competitors, there will be fewer employees to represent. If the workers of a private enterprise go on strike, its customers can take their business elsewhere. In GSCB both parties sit on the same side of the table. They are playing with other people’s (taxpayers’) money and are unconstrained by competition. Taxpayers cannot legally refuse to pay taxes. If the employees of a government agency go on strike, its customers (taxpayers) have no place to turn.

Notwithstanding this crucial difference, government unions often argue successfully that strikes in the government sector must be legal simply because they are legal in the private sector. Strikes take place even in many jurisdictions where government-sector strikes are illegal. When such strikes are settled, the strikers and their unions usually are granted amnesty.

Some states, such as Iowa, have tried to avoid government-sector strikes by imposing binding arbitration in collective-bargaining impasses. But that is an unacceptable alternative. An arbitrator in government-sector labor disputes is unelected but has power unilaterally to determine the size of government payrolls and thus significantly affect state fiscal priorities. Some states have been forced to raise taxes to pay arbitrators’ awards. In the words of the Report, binding arbitration in the government sector “could place an arbitrator in the position of single-handedly raising government expenses (and thus the taxes to cover the costs.)” If this isn’t taxation without representation, the Founders gave George III a bad rap.

The Report also tells of an attempt by the California legislature to prevent private-sector employers who receive more than $10,000 of state funds from speaking out against unionization during certification election campaigns. Only unions would have free-speech rights. In June 2008, in Chamber of Commerce v. Brown, the U.S. Supreme Court struck down the California law on the grounds that the National Labor Relations Act (NLRA) preempts state law in private-sector collective bargaining. According to the Court, Congress is free to give states the power to restrict employer free speech simply by amending the NLRA.

I expect this issue soon to be moot because the new Congress and the new president are poised to abolish secret-ballot certification elections. Under the Employee “Free Choice” Act employers will be forced to recognize and bargain with unions if a majority of their respective employees have signed union cards. Signatures will be collected in face-to-face encounters between union organizers and individual employees. Free speech and free choice be damned. Sign this card or else!

What Can Be Done?

The Report offers four suggestions to improve the situation. I think the first two make sense, and the others are too weak to make any difference. It proposes that all states subject government-sector collective bargaining to open-meeting laws that guarantee the opportunity for individual citizens to be heard on the subject of government-employee compensation and that force public disclosure of all collective-bargaining agreements. Currently only 11 states have such laws. It further recommends that states adopt legislation to force unions fully to disclose their financial information to workers and the general public. If people knew how much unions spend for political and ideological purposes rather than bargaining and representation, they would be appalled.

It also recommends that all states adopt “paycheck protection” legislation, which would force unions to get permission from each individual union member before any of his dues could be used for political purposes. Paycheck protection already exists in 16 states. While this is better than doing nothing, unions are skilled at obfuscating the difference between what is and what isn’t political spending. A more effective remedy would be for all states to forbid unions to collect any forced dues or fees from any workers. Finally, the Report recommends that all government-employee strikes be prohibited by law. Unfortunately, where that proscription already exists it has proven to be feckless.

I expect all the problems discussed in the Report to get worse during the next four years. In 1985 the U.S. Supreme Court, in Garcia v. San Antonio Metropolitan Transit Authority, gave Congress a free hand in setting the rules for state and local labor relations. Congress can override any measures enacted by the states. It can even force states that do not now allow government-sector bargaining to do so. The only change we can expect here will be dictated by the unions.

Related posts:

1. Congress and Public Safety Unionism
2. Government-Sector Unionism
3. Worker Freedom in Peril

Responding to the increased demand, private entrepreneurs funded the development of cracking technology. This method of transforming one set of hydrocarbons into another increased the proportion of the most-valuable products. On average 100 barrels of crude yielded 75.2 barrels of kerosene and 10.3 barrels of gasoline in 1880. By 1940 those same 100 barrels of crude produced an average of 5.5 barrels of kerosene and more than 40 barrels of gasoline. An equally dramatic example of technological progress occurred in the early 1930s and 1940s. The development of higher-performance engines prompted growing demand for higher octane gasoline, kicking off what came to be known as the “octane race” among refiners in the 1930s. Then World War II created demands for large quantities of high-performance 100-octane aviation fuel. Millions of gallons a year of this fuel, which had only been produced in tiny quantities as a reference chemical at a cost of $25 per gallon in the 1930s, became available at a cost of just over 25 cents per gallon in the early 1940s.

As a result, gasoline has been the subject of multiple regulatory efforts since the early twentieth century. (What? You thought they might produce public acclaim for an industry that had turned a waste stream into a valuable commodity and then upgraded the quality and reduced the price of its products to fuel the war effort?) These regulations have severely distorted the market for gasoline, increasing costs for consumers and diverting investment into political maneuvering. The government meddling produced a transportation-fuel network that is dangerously fragmented and at risk from natural disasters, accidents, terrorist attacks, and just plain old stupidity. Even worse, each time the fragile nature of the gasoline market is exposed, the reaction in Washington and state capitals is to layer on yet more bureaucracy and regulations, worsening the problem.

Aside from comparatively lightly regulated periods in the 1920s, 1950s, and 1980s, American governments have rarely left the oil business alone. Politicians use four different, and often mutually contradictory, rationales for their interventions.

• Antitrust. Since the Standard Oil litigation in the early twentieth century, politicians regularly invoke antitrust issues in support of claims that oil companies are conspiring against the public. When prices go up, you can be sure that politicians will call for antitrust investigations, windfall-profits taxes, and other measures to keep “greedy oil companies” from profiting “too much.”
• Destructive competition. When prices go down, however, domestic oil producers suffer reduced revenue, and less-efficient refiners and retailers lose market share. This spurs calls for investigations into measures to stop “destructive competition.” The governors of Texas and Oklahoma declared martial law in the oil fields during the Great Depression as part of their efforts to stop unregulated “excessive” pumping. Creating an oil “industry code” to reduce competition was a key element in the New Deal. Later regulatory programs have been filled with exemptions and special treatment for “small” players in the energy business in an attempt to protect inefficient firms from the ravages of competition.
• National security. From the time oil proved its worth as a naval fuel in World War I, the military has worried about adequate oil supplies. Domestically, national security concerns led to the creation of petroleum reserves after World War I (which later played a role in the Teapot Dome scandal) and these reserves have served as a fig leaf for import quotas and other restrictions on several occasions. You can count on the federal government to trot out national security as a justification almost every time it unveils a new subsidy or some other barrier to trade.
• Environmental protection. Governments at all levels take a keen interest in fuel formulation, inclusion of renewable fuels, and the location and operation of refineries, terminals, and filling stations. Since the appearance of the modern environmental statutes in the early 1970s, federal, state, and local governments have increasingly involved themselves in gasoline markets on environmental grounds. The actual regulations and laws enacted in pursuit of these goals often do not advance the stated purpose, which frequently serves as convenient window-dressing for interest groups looking for favors. (The definitive source on energy markets through the 1980s remains Robert Bradley’s monumental 1996 study, Oil, Gas, and Government.) To see how these interventions have disrupted gasoline markets, let us consider three of the largest regulatory programs: the Mandatory Oil Import Program (MOIP), the 1970s era of price and allocation controls, and the current mishmash of “boutique” fuel requirements.

MOIP

After World War II the refinery capacity built up to serve the military’s needs quickly refocused on producing gasoline for the booming domestic market. Freed from wartime scarcity and price controls, people bought cars and drove them, sending gasoline sales soaring. Many of the major oil companies invested heavily in developing new sources of crude oil in the Persian Gulf, Latin America, and elsewhere. These investments included construction of tanker fleets and oil terminals and acquisition of oil rights around the world. Production costs in the newly opened fields overseas were low enough that it was soon cheaper to import crude oil and refine it in U.S. refineries than it was to use domestic oil. As oil imports rose during the 1950s domestic producers and refiners who had not invested in access to the cheap foreign oil worried (correctly) that they were losing market share to foreign oil producers and the refiners who had made those investments.

Rather than playing catch-up in the marketplace, however, the disgruntled domestic oil producers and smaller and inland refiners headed to Washington, where they began a relentless lobbying campaign for restrictions on oil imports, citing the detrimental effects of competition from abroad and national-security concerns. At first the Eisenhower administration resisted the idea of quotas, then it experimented with “voluntary” quotas, but the administration ultimately gave in to the political pressure and created the Mandatory Oil Import Program. The program was in effect from 1959 to April 1973.

MOIP was simple in theory. Each refiner received a permit to import crude oil. The total number of barrels authorized was set below the amount that would have been imported in a free market. Refineries’ allocations of the permits started with a proportional share of this smaller total based on their prior level of imports, but these amounts were then adjusted in attempts to achieve various policy goals and reward particular interest groups. Crucially, every refinery got some permits, even if it had not imported any oil previously, and smaller refineries received a disproportionately large share of the permits. The permits were made tradable, making it possible for refiners that received permits, but did not need imported oil, to trade or sell them.

This system had five important effects. First, domestic oil producers got their reward as domestic crude prices were higher than they would have been in the absence of the quota system.

Second, because domestic prices were artificially above the world market price, the right to import the cheaper foreign crude granted by the permits became quite valuable.

Third, the major oil companies that had invested in tankers and terminals learned their lesson and shifted their investment dollars to lawyers and lobbyists who could find profits in the pages of the Federal Register. Within a few years they had learned to play the game well enough that they no longer opposed the MOIP.

Fourth, anyone who could slap together something that could pass as a refinery now had an incentive to do so, leading to a rapid expansion in the least expensive and least sophisticated refinery sector as new entrants built “teakettles” to get quotas. As a result U.S. refineries tended to lack the capacity to handle high-sulfur crudes, which have become an increasingly large proportion of the crude supply.

Finally, because independent ownership of refineries maximized quota allocations, consolidation in the industry was discouraged, leading to lower operating efficiency. (A group of refineries can often be operated more efficiently than an individual plant, because joint management allows operators to use equipment at one plant to prevent a bottleneck from developing at another.)

All that is bad enough, but the MOIP also proved to be a classic example of the unintended consequences of regulation. When the MOIP was enacted it allowed imports only under the permit system. Almost immediately, however, the Canadian government objected that limiting oil imports from Canadian oil fields through pipelines to refiners in the northern Great Plains was counterproductive. Not only would the limits hurt Canada, since the oil had no other export route, but the Canadians argued that it made no sense on national-security grounds to reduce imports from a loyal ally across a secure land pipeline. This argument proved persuasive and regulations exempted land imports.

When the exemption was granted, however, no one remembered to retract the permits that had been issued to the “Northern Tier” refiners. These refiners had no access to any other source of crude—there being no crude oil pipeline connection between Minnesota and the Dakotas and no port where tankers could unload Persian Gulf or Latin American oil. As a result, these refiners now found themselves with both access to the Canadian oil and valuable import permits that they physically could not use. So they sold and traded the permits to other refiners and pocketed the proceeds. On discovering the mistake, the federal government attempted to take back the permits. The “Northern Tier” refiners fought back with the aid of valuable allies like Minnesota Sen. Hubert Humphrey and succeeded in retaining what became known as the “double dip” for years.

That was just the first level of unintended consequences, however. Mexico soon came knocking on the State Department’s door, complaining of the special treatment Canadian oil was getting. True, Mexican oil was not imported via a land route, but wasn’t the Caribbean virtually as safe? And wasn’t Mexico vulnerable to communist subversion? Didn’t national security dictate that some accommodation be found for a key ally and neighbor?

To mollify Mexico, the State Department lawyers found what was termed a “crevice” in the MOIP regulations on overland imports launching the “Mexican Merry-Go-Round.” Tankers of Mexican crude sailed to Brownsville, Texas. The crude was unloaded into tank trucks, but remained outside the United States in the eyes of the law by being placed in customs bond, which prevented its transfer to Americans. The tank trucks were then driven across the border into Mexico, released from the customs bond, driven around a traffic circle, and then driven back into the United States, importing their cargo “by land.” The trucks returned to the port, and the oil was loaded into tankers headed to the east-coast refineries. Since the oil had entered the United States via a land route, it was eligible for exemption from the MOIP quotas. This strategy boosted Mexican exports to the United States from 7,000 barrels to 40,000 barrels per day.

The next complaint came from Venezuela, which pointed out that it too was an important Latin American ally and that there was a limited market for its heavy, sour crudes outside of U.S. refiners. An exemption for “resid,” or “residual fuel oil,” a minimally refined product, followed and industrial users in the northeastern United States began using Venezuelan resid largely because it was exempt from the quotas. The result was that the ratio of domestic resid production to resid imports fell from 1.42 before the MOIP to 0.46 during it, demonstrating a clear substitution of the foreign product for the domestic one. The exemption basis for the success of Venezuelan resid became clear when the end of the MOIP triggered a massive conversion to natural gas and distillate fuels by U.S. resid users.

Perhaps most ironically, it was the oil-rich countries’ concern over the impact of the MOIP on their ability to export to the United States that proved to be a key factor in spurring the formation of the organization now known as OPEC, surely one of the most counterproductive impacts of a policy in history.

Price and Allocation Controls

The proliferation of exemptions and special provisions by 1970 made the MOIP more of a sieve than an effective regulatory barrier, and the Nixon administration considered abolishing it. But Nixon was worried about energy prices as a factor in inflation, and the price controls imposed in August 1971 froze domestically produced and refined oil product prices. The price freeze had no impact on world prices, of course, and as these continued to rise, refiners dependent on crude imports were required to sell their products at a loss. The federal government continually modified the price controls, attempting to address the growing problems that this massive interference in the operation of the free market produced. Politics dictated the adjustments, however, with Nixon refusing to allow increases in politically sensitive commodities like home heating oil and gasoline. By 1973, when the Arab oil producers declared an embargo on shipments to the United States in retaliation for U.S. support for Israel in the Yom Kippur War, there had already been calls for a government allocation scheme to control crude supplies and distribution of refined products. A series of proposals created in response to these special-interest demands were cobbled together into a “response” to the oil embargo and passed as the Emergency Petroleum Allocation Act (EPAA) in 1973.

Not surprisingly the EPAA made the embargo’s impact worse. Mistaken assumptions that consumption patterns would not change and bad weather predictions, together with politically driven decisions about the appropriate product mix, left some regions awash in gasoline while shortages caused long lines elsewhere. But because the government dictated distribution patterns, the federal government ensured that areas with surplus gasoline could not send them to areas experiencing shortages and so exacerbated the initial misallocation problems.

Each misstep led to further expansions of controls—the Nixon administration even instituted a price freeze dubbed “Phase III1/2” to give the bureaucracy time to catch up on the flood of problems caused by Phases I to III.The crowning misstep in the program was Phase IV’s introduction of a distinction between new and old domestic oil supplies. Old supplies were price-controlled to prevent “windfall” profits; new ones were allowed higher prices to provide an incentive to expand supply. Of course, the distinction also meant that there was considerable money to be made if an oil well could be reclassified from “old” to “new,” and an industry sprang up doing exactly that.

The 1976 presidential campaign put pressure on both the new Ford administration and the Democratically controlled Congress to demonstrate that it had done something about energy issues. Desperate for a showpiece for voters, the administration and Congress produced the incoherent Energy Policy and Conservation Act (EPCA) of 1975, which managed to include both measures that would lead to price increases and others that would push prices down. Economic opinion of the EPCA was that it was “infinitely worse” than the prior programs because it left out the market-based quota-trading provisions of the MOIP and instead allowed transfers of quotas only at government-set prices.

The regulations issued under the EPCA granted entitlements to fuel to anyone with a refinery; energy analyst Daniel Yergin concluded in his massive history The Prize that “the result was the bringing out of mothballs any piece of ‘refining junk’ that could be found—leading to the return of hopelessly inefficient ‘tea kettle’ refineries of the kind that had not been seen since the flood of oil in the East Texas field in the early 1930s.” It also tilted allocations toward small refiners, ensuring that large refineries ran at less than maximum efficiency and so increased costs and rewarded the least efficient players in the market. Economists Kenneth Arrow and Joseph Kalt calculated in 1979 that the EPCA was worth $17 billion to special interests in 1979. The Carter administration began the move toward decontrol of oil prices, but these efforts were impeded by concerted special-interest pressures.

It took the election of Ronald Reagan to speed up the phase-out of energy price and allocation controls. The Reagan administration brought in a period of relatively relaxed regulation of energy markets, and the results confirmed what economists had predicted. The small, inefficient refineries set up to obtain quotas quickly closed (23 in 1981 alone), while refining technology improved as the more efficient refineries expanded capacity.

Boutique Fuels

When drivers fill up their tanks they rarely notice anything different about their gasoline whether they are in Denver or Detroit. But gasoline has evolved from the “straight run” distilled from crude by early refiners to a highly complex fuel whose characteristics vary widely from location to location. For example, fuels sold at higher altitudes (Denver) are less volatile than those sold in lower altitudes (Detroit). Many of these variations are the result of refiners adapting gasoline to optimize performance under different altitude and weather conditions. Gasoline retailers have also spent millions on advertising campaigns aimed at convincing drivers that there is a difference in the mixture of additives that should lead the buyer to prefer a “tiger in the tank” (Exxon) to “the detergent gasoline” (Mobil). (Of course, Exxon and Mobil then merged into ExxonMobil, presumably giving drivers a cleaner tiger in their tanks.)

Beginning with the mandate to remove octane-enhancing lead additives from gasoline in the 1970s, however, the federal, state, and local governments have exerted increasing control over the formulation of gasoline—in the name of improving environmental quality and increasing (you guessed it) national security by substituting locally produced ethanol for a portion of the gasoline. As the number of formulation requirements increased they came to be known as “boutique fuel requirements” because they made it impossible to sell gasoline formulated for Tucson in Phoenix.

There is no question that some measures can make gasolines burn cleaner. Removing lead octane enhancers from gasoline, for example, produced major environmental quality improvements, although the replacements for lead brought their own environmental problems. What is questionable is whether the particular mandates imposed by various regulators actually accomplish that goal and what the cost of splitting the gasoline market into an assortment of boutique markets is. And many of these mandates (particularly the use in the 1990s of MTBE and the current mania for ethanol) have little or no benefit and actually can be harmful to the environment.

Three things should make us worry about boutique-fuel mandates. First, by fragmenting markets, they are raising the cost of gasoline in the same ways as the 1970s allocation programs. The best statistical evidence suggests that they have increased prices in many instances, although EPA denies this. Second, limiting the sources for fuel for many regions to a small number of refineries set up to produce particular blends leaves those markets’ supplies vulnerable to refinery closures from accidents, natural disasters, and routine maintenance. Finally, boutique requirements reduce the availability of gasoline imports from foreign refineries. For example, European refineries produce more gasoline than is needed to satisfy European demand for gasoline (which is lower because of the much higher proportion of diesel-powered passenger cars in Europe). Because those refineries are primarily concerned with producing diesel for their home markets, however, the gasoline they make is not compatible with some U.S. fuel requirements. Since there are other buyers for this gasoline (like China), the refineries have little reason to make the large investments necessary to produce a U.S.-boutique fuel. But because U.S. refineries lack sufficient capacity to meet U.S. demand, any shift away from exports of European gasoline to the U.S. market will cause shortages and price hikes here.

Energy markets have demonstrated the power of private enterprise each time they have been permitted to function freely. A waste product, gasoline, became a valuable commodity, and production yields soared. Better engines required higher octane, and the quality of gasoline increased dramatically. But as this brief account describes, the American gasoline market has moved away from a national market and toward a series of fragmented regional markets. Further, domestic refining capacity is well below what a free market in gasoline would have produced in the absence of the pervasive government interference of the 1960s and 1970s. The combination leaves the market fragmented and vulnerable to price spikes caused by everything from hurricanes to refinery fires. If we want to fix gasoline markets, the first step is to take the bureaucrats out of the process.

Related posts:

1. Book Review: Those Gasoline Lines And How They Got There by H. A. Merklein and William P. Murchi-son, Jr.
2. Gasoline Prices : Why So High Last Spring?
3. High Gasoline Prices Are Your Fault? It Just Aint So!

Thus far the typical libertarian response to the growing clamor has been to challenge the science behind it. Now it really is the scientific consensus that global warming occurred during the twentieth century. What is not so obvious is that (1) humans caused this warming and (2) this warming is necessarily bad.

Although it is interesting to explore the question of whether science has been perverted in the cause of environmentalism, there is a danger for libertarians in pinning their entire case on this strategy. After all, every serious student of science knows that when it comes to empirical claims, we never achieve certainty. For example, even if today one thinks that there are insurmountable problems facing the theory of manmade global warming, one still must accept the possibility that new evidence or theoretical advances could indicate that the environmentalists are perfectly right. Another possibility is that there is some other, similar disaster lurking unsuspected.

For these reasons, I believe it is crucial to accept provisionally, for the sake of argument, the scientific claims behind the case for manmade global warming. In the present article I will demonstrate that it still would not follow that the taxes and other regulations typically proposed by greens are the best way to address the problem. Just as the free market is still the optimal economic arrangement, regardless of how many citizens are angels or devils, so too does the free market outperform government intervention, regardless of the fragility of Earth’s ecosystems.

When trying to determine if the free market is to blame for possibly dangerous carbon emissions, a logical starting point is to list the numerous ways that government policies encourage the very activities that Al Gore and his friends want us to curtail.

The U.S. government has subsidized many activities that burn carbon: it has seized land through eminent domain to build highways, funded rural electrification projects, and fought wars to ensure Americans’ access to oil. After World War II it played a key role in the mass exodus of the middle class from urban centers to the suburbs, chiefly through encouraging mortgage lending.

Every American schoolchild has heard of the bold transcontinental railroad (finished with great ceremony at Promontory Summit, Utah) promoted by the federal government. Historian Burt Folsom explains that due to the construction contracts, the incentive was to lay as much track as possible between points A and B—hardly an approach to economize on carbon emissions from the wood- and coal-burning locomotives. For a more recent example, consider John F. Kennedy’s visionary moon shot. I’m no engineer, but I’ve seen the takeoffs of the Apollo spacecraft and think it’s quite likely that the free market’s use of those resources would have involved far lower CO2 emissions. While myriad government policies have thus encouraged carbon emissions, at the same time the government has restricted activities that would have reduced them. For example, there would probably be far more reliance on nuclear power were it not for the overblown regulations of this energy source. For a different example, imagine the reduction in emissions if the government would merely allow market-clearing pricing for the nation’s major roads, thereby eliminating traffic jams! The pollution from vehicles in major urban areas could be drastically cut overnight if the government set tolls to whatever the market could bear—or better yet, sold bridges and highways to private owners.

Of course, there is no way to determine just what the energy landscape in America would look like if these interventions had not occurred. Yet it is entirely possible that on net, with a freer market economy, in the past we would have burned less fossil fuel and today we would be more energy efficient.

Even if it were true that reliance on the free-enterprise system makes it difficult to curtail activities that contribute to global warming, still the undeniable advantages of unfettered markets would allow humans to deal with climate change more easily. For example, the financial industry, by creating new securities and derivative markets, could crystallize the “dispersed knowledge” that many different experts held in order to coordinate and mobilize mankind’s total response to global warming. For instance, weather futures can serve to spread the risk of bad weather beyond the local area affected. Perhaps there could arise a market betting on the areas most likely to be permanently flooded. That may seem ghoulish, but by betting on their own area, inhabitants could offset the cost of relocating should the flooding occur. Creative entrepreneurs, left free to innovate, will generate a wealth of alternative energy sources. (State intervention, of course, tends to stifle innovations that threaten the continued dominance of currently powerful special interests, such as oil companies—for example, the state of North Carolina recently fined Bob Teixeira for running his car on soybean oil.)

Private insurers have a strong incentive to assess the potential effects of global warming without bias in order to price their policies optimally—if they overestimate the risk, they will lose business to lower-priced rivals; if they are too sanguine about the dangers, they will lose money once the claims start rolling in. Individuals finding their homes or businesses threatened by rising sea levels will find it easier to relocate to the extent that unfettered markets have made them wealthier. Industrial manufacturers, as long as they are held liable for the negative environmental effects of their production processes—a traditional common-law liability from which state policies intended to “promote industry” have often sought to shield manufacturers—will strive to develop technologies that minimize the environmental impact of their activities without sacrificing efficiency. Government interventions and “five-year plans,” even when they are sincere attempts to protect the environment rather than disguised schemes to benefit some powerful lobby, lack the profit incentive and are protected from the competitive pressures that drive private actors to seek an optimal cost-benefit tradeoff.

If the situation truly becomes dire, it will be free-market capitalism that allows humans to develop techniques for sucking massive amounts of carbon out of the atmosphere, and to colonize the oceans and outer space. Beyond these futuristic possibilities, the obvious responses to global warming—such as more houses with AC, sturdier sea walls, and better equipment to evacuate flooded regions—are again only feasible when the free market is unleashed.

It is the poorest people and nations that stand to suffer the most if the worst-case scenario for global warming is realized, and the only reliable way to alleviate their poverty, and thus help protect them from those effects, is the free market.

Can the Market Meet the Threat Head-On?

In the first section I summarized some of the ways governments inadvertently contribute to the very activities that allegedly cause dangerous global warming; in the second I sketched some of the ways that free markets allow humans to better adapt to climate change. However, I haven’t really tackled the problem directly. Am I conceding that with a worldwide problem the market—which is just dandy for one-on-one interactions—can’t match the concerted “will of the people” working through their elected representatives for a common solution?

Of course not. Even when economic transactions generate so-called negative externalities (activities that shower harms on third parties), I still contend that the free market is the best institution for identifying and reducing the problems.

One way negative externalities can be addressed without turning to state coercion is public censure of individuals or groups widely perceived to be flouting core moral principles or trampling the common good, even if their actions are not technically illegal. Large, private companies and prominent, wealthy individuals are generally quite sensitive to public pressure campaigns.

To cite just one recent, significant example, Temple Grandin, a notable advocate for the humane treatment of livestock, asserts that McDonald’s is the world leader in improving slaughterhouse conditions. While many executives at the fast-food giant genuinely may be concerned with the welfare of cattle, pigs, and chickens, undoubtedly a strong element of self-interest is also at work here, as the company realizes that corporate image affects consumers’ buying decisions.

But that self-interest does not negate the laudable outcome of the pressure McDonald’s has applied to its suppliers to meet the stringent standards it has set for animal-handling facilities. Similarly, to the degree that the broad public regards manmade global warming as a serious problem, companies will strive to be seen as “good corporate citizens” that are addressing the matter. And this isn’t ivory-tower speculation on my part—I can see the “green friendly” ads already.

Critics of libertarianism sometimes denigrate it as a political program of “market fundamentalism” that, if put into practice, would reduce all human values to the price they can fetch as mere commodities. But that is a caricature of the social arrangements advocated by any sensible libertarian. The great figures of classical-liberal and libertarian thought have always recognized the vital contributions that nonmarket institutions, such as churches, families, charities, social clubs, communities of scholars and their students, art foundations, conservation groups, neighborhood associations, and youth athletic leagues, make to the healthy functioning of a free society. What libertarians offer as an alternative to statism is not a social order that judges every human interaction solely on a miserly calculation of profit or loss, but a society in which every desirable form of voluntary association is allowed to flourish, free from coercive interference by the state.

Customary Law

Besides the samples listed above, most libertarians recognize private or customary law as another important, nonmarket source of social order. A historical case in point is the Anglo-American common-law tradition in which legal norms evolved spontaneously from the customs of the people to whom it applied, rather than through legislation and state planning deliberately aimed at achieving some “public good.” The many centuries during which the common law sustained civic order in the face of inevitable divergences between individual citizens’ own interests demonstrate that a successful legal order does not inevitably require state sponsorship. The common law has shown itself to be fully capable of dealing with a number of issues that, while not exhibiting the worldwide scope of global warming, are still similar to our present concern in arising from the cumulative effects of many individual actions, each of which, regarded in isolation, appears to be unproblematic and not subject to legal sanction. For instance, the salmon-fishing streams of Scotland are a valuable natural resource, and the communities along them have developed quite successful institutions for ensuring the value of the streams is maintained, including private policing and legal penalties for overfishing and for polluting the water.

The many cases in which voluntary solutions to problems of collective choice have worked pose an empirical embarrassment for those who argue that “public goods” must be provided by the government. Most advocates of compulsory solutions to pollution abatement, for example, would assert that voluntary efforts will be vitiated by “free riding.” If individuals are not forced to contribute their fair share toward addressing these problems, this argument runs, each person rationally will hold back and hope others will pay for the proposed solution, since any free riders would gain the benefits (such as clean air) anyway. Since almost no one likes to be “the sucker,” it follows that the amount of resources devoted to the provision of the public good will fall woefully shy of the total that would be available if each person gave the amount he’d be willing to give if only he could count on everyone else pitching in equally. The sole solution that can be imagined is for the members of a society to create a “social contract” by which they are forced to pay for pollution abatement.

However, Anthony de Jasay notes in his book The State that this argument is severely flawed. If people cannot solve public-goods problems through voluntary cooperation, how can they rely on politicians’ promises to do so? There is no external authority to enforce those promises. There is only public opinion, the same thing that would enforce voluntary solutions. Moreover, government is itself a “public good” in the sense that free riders benefit from the efforts of those who try to get the government to produce public goods such as clean air.

Is Temperature a Public Good?

Another consideration is that the earth’s temperature isn’t such a public good after all. That is, certain people really do have more at stake, particularly if the warming is moderate. For example, if Manhattan became submerged because of rising sea levels, that calamity would not affect every human being equally. The residents of Manhattan and the owners of its skyscrapers would be hurt far more than people living in inland China. Because all the various potential dangers of global warming affect particular people more intensively than others, it is these groups that (in a free market) would have the incentive to reduce CO2 concentrations. For example, if rising sea levels would cause $10 trillion in damage to a comparatively small group of wealthy individuals, that’s a huge “pie” that the wealthy can offer others to motivate them to reduce emissions.

Despite my optimism about the potential to deal with environmental problems through voluntary means, I don’t wish to be misunderstood: If the official global-warming story is true, it presents a serious problem that humanity will find difficult to solve through voluntary means. But this isn’t a strike against voluntarism—of course a difficult problem will be difficult to solve! By the very same token, the government doesn’t do a terrible job at collecting stray dogs, because that’s a very simple task. When it comes to harder assignments, such as stopping terrorism or reducing teen pregnancy, the government’s record is quite a bit worse.

The very features of the official global-warming scenario that hamper purely private solutions would apply equally to government efforts. For example, even if the U.S. government passed draconian measures at home, that alone wouldn’t be enough if China and Indiadon’t follow suit. And just as private companies in a free market may have an incentive to pollute if they can get away with it, so the state, under the influence of special-interest groups and run by leaders always tempted to ignore the public good in favor of increasing their own power and wealth, can have incentives to allow more pollution than is optimal. (It should be clear the “best” amount of pollution is not zero, because even using fire to cook generates some pollutants, and I doubt that anyone but the most misanthropic, fanatical nature worshippers want to reverse all of the last 40,000 years of human progress.)

As in all debates over public versus private choice, it’s inappropriate to measure a realistic free-market response to global warming against an idealized government program. We must try to envision what real people would do if their property rights were respected and compare that scenario with the probable outcome of actual politicians in today’s world being given a blank check in the name of saving the earth.

Government programs don’t ameliorate world poverty or sickness, and no libertarian would deny that these are serious problems. So even if manmade global warming is a real threat, why should we expect governments to get it right on this issue?

Related posts:

1. Global Warming Revisited
2. Higher CO2, More Global Warming, and Less Extinction?
3. Global Warming and the Layman

Richard Weaver’s observation that “ideas have consequences” is especially valid when we study the growth of government in America. If we compare the attitudes of Woodrow Wilson and Calvin Coolidge on the Constitution and the Declaration of Independence we can see how their views on government intervention were a logical outcome of their conceptions of these documents.

The Declaration of Independence reflected a generation of thinking on the subject of natural rights—“that all men are created equal, that they are endowed by their Creator with certain unalienable rights, that among these are life, liberty, and the pursuit of happiness.” The Constitution later separated the powers of government to protect life, liberty, and property from future encroachments by potential tyrants.

Woodrow Wilson had only limited use for the Founders and the Declaration. “If you want to understand the real Declaration of Independence,” Wilson urged, “do not read the preface.” Government did not exist merely to protect rights. Instead, Wilson argued that the Declaration “expressly leaves to each generation of men the determination of what they will do with their lives. . . . In brief, political liberty is the right of those who are governed to adjust the government to their own needs and interests.” “We are not,” Wilson insisted, “bound to adhere to the doctrines held by the signers of the Declaration of Independence.”

The limited government enshrined in both the Declaration and the Constitution may have been an advance for the Founders, Wilson conceded, but society had evolved since then. The modern state of the early 1900s was “beneficent” and “indispensable.” Separation of powers hindered modern governments from promoting progress. “[T]he only fruit of dividing power,” Wilson asserted, “was to make it irresponsible.”

A better “constitutional government,” Wilson urged, was one “whose powers have been adapted to the interests of its people.” A strong executive was needed, he believed, to translate the interests of the people into public policy. The president was the opinion leader, the “spokesman for the real sentiment and purpose of the country.” And what the country needed was “a man who will be and who will seem to the country in some sort of an embodiment of the character and purpose it wishes its government to have—a man who understood his own day and the needs of his country.”

In the White House, Wilson intended to be a strong president working with a “living Constitution.” He promoted the expanding of “beneficent” government into new areas. In his second year as president he concluded that shipping rates were too high, and he blessed his secretary of treasury’s plan to regulate overseas shipping rates and the companies doing the shipping. Later he promoted a plan to make loans to farmers at federally subsidized rates. Then he pushed through Congress a bill fixing an eight-hour day for railroad workers.

Article 1, Section 8, of the Constitution gives no power to the federal government to regulate the prices of trade, the hours of work, or to make special loans to farmers or any other group. But Wilson said he was operating with a “living Constitution” and that increased government in these cases reflected appropriately the greater will of the people. Likewise, when Wilson helped centralize banking with the Federal Reserve system and when he further restricted trade by promoting the Clayton Antitrust Act, he believed that this work for the general good outweighed any loyalties to the rigid construction set up by the Founders in the original Constitution.

Not all Americans agreed with Wilson ’s evolving Constitution. The Adamson Act, which required the eight-hour day for railroad workers, was challenged and went to the Supreme Court. It was sustained by a 5–4 majority, but Justice William Day was appalled at the constitutional violations in the bill. “Such legislation, it seems to me,” Day said, “amounts to the taking of the property of one and giving it to another in violation of the spirit of fair play and equal right which the Constitution intended to secure in the due process clause to all coming within its protection.”

Such growth of government came with a cost, but Wilson was ready with the progressive income tax to pay for his new programs. World War I clearly influenced Wilson’s use of the tax and his centralization of power—he promoted an increase in the top tax rate from 7 to 15 percent in 1916; then, during the war, Wilson secured an increase to a 77 percent marginal rate on the country’s largest incomes.

Where Wilson supported an evolving Constitution that gave him authority to increase the power of government and centralize power, President Calvin Coolidge, who was on the ticket that succeeded Wilson, believed that the Declaration and the Constitution should be accepted as the Founders wrote them.

In July 1926, on the sesquicentennial of the signing of the Declaration, Coolidge gave a speech reaffirming the need for limited government. “It is not so much then for the purpose of undertaking to proclaim new theories and principles that this annual celebration is maintained, but rather to reaffirm and reestablish those old theories and principles which time and the unerring logic of events have demonstrated to be sound.”

Coolidge added that “there is a finality” about the Declaration. “If all men are created equal, that is final. If they are endowed with inalienable rights, that is final. If governments derive their just powers from the consent of the governed, that is final. No advance, no progress can be made beyond these propositions. If anyone wishes to deny their truth or their soundness, the only direction in which he can proceed historically is not forward, but backward toward the time when there was no equality, no rights of the individual, no rule of the people. Those who wish to proceed in that direction can not lay claim to progress. They are reactionary.”

Coolidge’s attitude as president reflected his belief in the ideas of the Declaration. He was not always consistent—for example, he signed the Fordney-McCumber Tariff in 1922, which slapped high and uneven taxes on some needed imports. But his efforts were largely in the direction of reducing the size of government to increase liberty. For example, Coolidge cut the size of government and was the last president to have budget surpluses every year of his presidency. Also, when the Harding-Coolidge administration came into office in 1921, the tax rate on top incomes was 73 percent; when Coolidge left the presidency eight years later it was 25 percent. The rates on the lowest incomes were also slashed.

Attacked Special Interests

Furthermore, Coolidge often attacked special interests. He vetoed a bill to give a special cash bonus to veterans; and, through President Harding, he was part of the administration that shut down a government-operated steel plant set up by Wilson, which had lost money each year of its operation.

Not once but twice Coolidge courageously vetoed the McNary-Haugen farm bill, which was popular with farmers because it promised federal price supports for them. “I do not believe,” Coolidge wrote, “that upon serious consideration the farmers of America would tolerate the precedent of a body of men chosen solely by one industry who, acting in the name of the government, shall arrange for contracts which determine prices, secure the buying and selling of commodities, the levying of taxes on that industry, and pay losses on foreign dumping of any surplus.”

When presidents are faithful to America ’s founding documents, limited government has a chance to flourish. But when presidents emote over a “living” Declaration and Constitution, then the growth of government is upon us.

Related posts:

1. Two Presidents, Two Philosophies, and Two Different Outcomes
2. Book Review ~ Star-Spangled Men: Americas Ten Worst Presidents by Nathan Miller
3. Our Presidents and the National Debt

The depression of the mid-1890s had been the most severe macroeconomic bust prior to 1929, but despite appeals for government assistance to suffering farmers, unemployed workers, and others, Grover Cleveland’s administration staunchly resisted, insisting that the federal government lacked constitutional authority to intervene in that fashion and that the public ultimately stood to benefit the most by upholding free markets.

By the late 1920s, however, many reputable observers had come to believe that the economy had entered a “new era” in which government and business leaders understood how to counteract any recession that might occur before it became severe. Unfortunately, the knowledge they imagined themselves to possess in this regard was for the most part nothing more than an instance of what F. A. Hayek later called the pretense of knowledge—the conviction that government planners, including the monetary authorities, know how to make the world a better place than it would be if people were simply left to their own devices.

So, although in previous economic downturns hardly anyone had expected the government to take vigorous action to bring about recovery, by 1929 the dominant ideology had changed substantially. Many opinion leaders and large segments of the general public had embraced the Progressive faith in activist government. To make matters worse, the economics profession for the most part had come to believe that the government could and should intervene actively in economic life.

These ideological and intellectual changes came as music to the ears of many politicians, who welcomed a plausible excuse to enlarge their powers and to turn the exercise of those enlarged powers to their own advantage. Organized special interests also seized on the new ideas and attitudes as pretexts for the creation of pensions, subsidies, insurance benefits, bailouts, barriers to competition, and other privileges they sought from government.

As officials at all levels responded to the newly strengthened demands that government “do something” in late 1929 and afterward, the government carried out an enormous number and variety of interventionist measures, spanning every industry, region, and demographic group in the country. Many of these schemes simply reestablished under new names the measures that had been used during the recent war, on the ill-considered ground that since these policies and programs had proved successful in a previous emergency (war), they would prove successful again during the existing emergency (economic depression). As President Herbert Hoover declared, “We used such emergency powers to win the war; we can use them to fight the depression.” So, for example, the defunct War Finance Corporation was revived in 1932 and called the Reconstruction Finance Corporation.

Because the government’s economic-rescue programs often worked at cross purposes or impaired the operation of the private competitive economy, they exacerbated the downturn between 1929 and 1933, making it deeper than it otherwise would have been, and they slowed the economy’s recovery after 1933, so that even when the government began to shift the economy onto a war footing in mid-1940, full recovery had not yet been attained—the official unemployment rate in 1940 was 14.6 percent (if persons enrolled in government emergency employment programs are counted as employed, the unemployment rate was 9.5 percent). In short, the government’s cures made the disease much worse and slowed the patient’s natural recovery.

The dimensions of the disaster were shocking. For nearly four years, with only brief and abortive reversals, the economy fell deeper and deeper into the trough. By 1933 real gross domestic product had declined 30 percent. Production of consumer durables fell 50 percent, producer durables 67 percent, new construction 78 percent, and gross private domestic investment almost 90 percent. The real value of U.S. exports and imports dropped nearly 40 percent. The unemployment rate reached almost 25 percent, and perhaps one-third of those still employed in 1933 were working only part-time. Prices fell on average about 23 percent. Banks failed in waves, and by the end of 1933 nearly 10,000 of them had gone under.

In 1931, 1932, and 1933 the after-tax profits of all corporations added up to less than zero each year. Rental and proprietary income dropped more than 60 percent. The stock market hit bottom in 1932, having lost more than 80 percent of its value. Farm-product prices fell more than 50 percent; net income of farm operators declined nearly 70 percent, and thousands of farmers surrendered their homes and farms to mortgage lenders and tax collectors. Three states—Arkansas, Louisiana, and South Carolina —and approximately 1,300 municipalities defaulted on their debts, and many other states and local governments verged on default.

Smoot-Hawley Act

Among the most harmful of the counterproductive policies implemented during the Great Contraction was the Smoot-Hawley Act in 1930, which lifted import taxes to an all-time high and set in motion a tariff war, a trade-constricting sequence of action and reaction around the trading world. In late 1929 President Hoover urged employers to maintain real wage rates despite the plummeting demand for their products. Many of the largest employers did so in 1930 and into 1931 and, as a result, unemployment increased much faster than it otherwise would have. The Revenue Act of 1932, which became fully effective in 1933, raised taxes by a greater percentage than any previous peacetime tax act, administering a stunning blow to already-struggling households and businesses.

Perhaps worst of all, at the Federal Reserve System, which had been created in 1913 to provide emergency liquidity to commercial banks during financial panics, officials stood by while banks failed by the thousands, bizarrely convinced that in the circumstances they had done all that they could and should do to prevent the banking system’s collapse. As a result, the money stock (M2 measure) fell by 32 percent between June 1929 and June 1933. As banks failed and depositors clamored to draw down their bank deposits and to augment their cash holdings, financial stringency took an enormous toll on households and businesses throughout the country.

Owing to the foregoing policies and many others that might be mentioned if space permitted, the economic downturn that began in 1929 turned out to be not simply another recession, quickly reversed, but a catastrophe that persisted for more than a decade. As the emergency spread across the entire trading world, it fostered takeovers by aggressive collectivist governments in several important countries, including Germany, where the ascendancy of the Nazis hastened the onset of World War II.

Related posts:

1. The Great Duration, 1929-41
2. The Great Escape from the Great Depression
3. Great Myths of the Great Depression

In light of these tendencies, it is easy to overlook the fact that a large portion of the welfare state is devoted to the rich. Although couched in altruistic language and billed as serving the public interest, much of the government’s redistribution of wealth is from the hapless taxpayer to the pockets of large corporations. This may seem paradoxical to naïve observers whose political views are shaped largely by political campaigns between Democrats (the ostensible friends of the poor) versus Republicans (the ostensible opponents of welfare). But anyone familiar with political economy can quickly recognize that it makes far more sense for politicians to funnel tax dollars into the hands of powerful (not to mention rich) special interests. Big business learned long ago that the easiest way to handle taxes and regulations is to divert “public” money into its own hands and to influence the regulators to enforce measures that disproportionately burden upstart competitors.

I hope to redress the rhetorical imbalance by outlining the numerous ways rich individuals and big businesses manage to siphon off taxpayer money into their own pockets. To keep the article manageable, I’ll focus mainly on actual subsidies, that is, cases where wealthy rent-seekers literally receive cash flows (directly or indirectly) from the government. Beyond these fairly obvious examples there are dozens of clever ways in which rich and unscrupulous special interests use their political influence to enrich themselves at the expense of the public without actually receiving tax dollars. (These would include licensing restrictions and import quotas.) Because of space constraints, an extensive analysis of these subtler shenanigans will have to wait for a future article.

One of the most blatant examples of corporate welfare is the bloated system of agricultural price supports, which started in the 1920s and was institutionalized during the New Deal. The rationale behind the program is straightforward: Under pure laissez faire, agricultural markets would (allegedly) prove extremely volatile. In good times with high prices farmers would borrow money to expand their operations and plant more crops. But this would soon lead to a glut on the markets, forcing farmers to slash prices and go into foreclosure. This tremendous uncertainty, as well as the wild swings in crop supply, could (allegedly) be rectified if the federal government stepped in to purchase surplus crops when the market’s demand proved insufficient. Such policies would presumably stabilize crop prices and the food supply, providing more rational and orderly markets in agriculture.

As with other forms of government intervention, a pure policy of surplus acquisition would lead to disaster. If farmers were assured that whatever quantities of a crop they grew the government would buy it from them at remunerative prices, they would plant the most cost-effective crops with reckless abandon. (Indeed, at the close of 2000 the Commodity Credit Corporation [CCC], a branch of the U.S. Department of Agriculture, held stockpiles of 97 million bushels of wheat, eight million bushels of corn, and five million bushels of soybeans, according to the Food and Agricultural Policy Research Institute. The CCC spent $133.5 million to purchase over a million metric tons of wheat on a single day in 1999.) To avoid the accumulation of stockpiles and yet maintain price supports for certain crops, the government hit on the absurd notion of paying farmers not to grow the crops in question. It is possible to qualify for such subsidies even if an owner of arable land had never intended to grow the crops in the first place.

From 1995 to 2004 the federal government provided agricultural subsidies of over $143 billion, according to the Environmental Working Group. The recipients of these subsidies are not exactly Dust Bowl migrants from a Steinbeck novel, either. Over $104 billion (72 percent) of the loot during this period went to the top 10 percent of the recipients, which were large farming organizations or cooperatives that each received an average of $33,000 in subsidies every year. To further illustrate the phenomenon, in October 2005 the House Agricultural Committee rejected a proposal by President Bush to place a cap on annual farm subsidies of $250,000 per person.

Another classic example of how the well-to-do fleece the taxpayers is the multiplicity of “joint ventures” between the government and big business. Projects such as sports stadiums, railroads, or even amusement parks are deemed “too big for the private sector.” Besides being silly—after all, any money that the government spends on such projects was taken from the private sector—these pork-barrel expenditures represent a transfer from the poor (and middle class) to the rich.

For example, the fiscal 2006 Transportation/Treasury/Housing and Urban Development (TTHUD) Act contained $350,000 for the Yucaipa Valley Regional Sports Complex (in California) and $100,000 for renovations to the National Orange Show Stadium in San Bernardino. The Act also contained $50,000 for the Capitol Hill Baseball and Softball League. Beyond its support for sports fans, the government also subsidized art lovers and conference attendees (not typically drawn from the downtrodden of society). Citizens Against Government Waste points out that this same Act contained $325,000 each for renovations to the Seattle Aquarium and the Fox Theater, $200,000 for renovations to the Fredonia Hotel and Convention Center in Texas, and $100,000 for D.C.’s Friends of Carter Barron Foundation for the Performing Arts.

These anecdotes, though outrageous, are whimsical when compared with other types of corporate welfare. For example, the federal government provides enormous funding for energy research, which attempts to develop alternative supplies and technologies as well as discover better methods of using existing sources. The Cato Institute estimates that in fiscal year 2003, the Energy Department spent $670 million on such projects. Inasmuch as struggling single mothers are not designing ethanol engines, this largess represents yet more welfare for the rich.

In a similar vein, the government spends billions funding scientific research. In FY2005 the National Institutes for Health alone spent over $24 billion on all awards, and over $20 billion of this consisted in research grants. Large pharmaceutical companies certainly benefit from this convenient assistance.

We close this section with the epitome of a failed government/business partnership, the classic case of Amtrak. In 2005 alone Amtrak lost $1.2 billion, according to the Heritage Foundation, a shortfall made up by the hapless taxpayer. What makes this waste even more despicable is that Amtrak doesn’t even fulfill its ostensible purpose, namely, to provide affordable passenger rail service across the nation. In particular, Amtrak doesn’t offer service to Phoenix, Las Vegas, Columbus, Nashville, Louisville, Dayton, Tulsa, or Colorado Springs, even though each of these cities has over 500,000 residents. And as anyone who has ridden Amtrak knows, it is far from cheap. For example, its cheapest roundtrip fare from New York City to Washington, D.C., is currently $135 before taxes, compared to $69 for a similar ticket on an admittedly slower bus.

Government Contractors

Even government projects that might be deemed legitimate—such as expenditures on military vehicles or renovations to the Statue of Liberty—represent hidden subsidies to the extent that the contracts are awarded corruptly. The economic principles behind the cost overruns are straightforward enough. Unlike the shareholders of a private firm, if government departments are careful to award contracts to the lowest bidder (who can still get the job done), the politicians and bureaucrats don’t pocket the savings, for that would be sheer theft of public funds. On the other hand, by awarding generous contracts, officials stay in the excellent graces of the beneficiaries. This comes in handy when officials retire from government work and look for consulting jobs.

Another source of systematic welfare is the “cost-plus” method of payment. Here, the government doesn’t settle on an actual price for goods or services delivered, but rather agrees to meet the contractor’s expenses plus some markup. Naturally, this type of arrangement puts no incentive on the contractor to watch costs, and hence represents a hidden subsidy.

We should also consider the effect of timing and the different outcomes in private versus government settings. Congress can agree to spend, say, $20 billion on a space station that will take ten years to complete. Five years into the contract the suppliers can complain that they will require an additional $10 billion to finish the project because of “unexpected” expenses. By this point the voters don’t remember the previous expenditures, and it would seem a terrible waste not to finish such a grand project. Thus the government often ends up funding boondoggles that would never have been approved had the actual price tag been known all along.

When it comes to welfare for contractors, no other agency can match the Pentagon, with its classified programs and aura of necessity. Besides the notorious $600 toilet seats uncovered in a 1983 audit, probably all the major purchases of hardware occur at inflated prices. (The difference is, nobody knows how much a B-2 Stealth bomber “should” cost, so its 2001 price tag of $530 million isn’t as shocking.) No outsider can really be sure of the exact amount of the hidden subsidy, or what the corporate beneficiary does to win it, but we can be fairly sure that the recipients do not reside in the inner city.

On this topic we must mention the case of Halliburton, for this is one issue on which the leftist conspiracy theorists make a decent case. Regardless of the motivations for the invasion of Iraq, it cannot be denied that Halliburton benefited greatly from it. According to a report by the Center for Public Integrity (which required six months and 70 Freedom of Information Act requests to assemble the data), Halliburton received over $2.3 billion in reconstruction contracts in Iraq and Afghanistan. In second place was the engineering and construction firm Bechtel Group, Inc., with just over $1 billion. International American Products, Inc., finished third with a nonetheless-respectable $526 million in contracts. (For those interested in conspiracies, Halliburton and Bechtel contributed roughly $2.38 million and $3.3 million to President Bush, respectively, while International American Products only contributed $2,500.)

The “War on Terror” has been a bonanza for defense and related contractors. According to Robert Higgs, Department of Defense outlays excluding payments to military personnel rose from $217 billion in FY2001 to $366 billion in FY2006. In this same period the number of companies with federal homeland-security contracts grew from nine to a whopping 33,890, a jump so large that it renders typical percentage figures—in this case, a growth of 376,456 percent—rather meaningless.

Small Business Administration

The Small Business Administration (SBA) is another agency with an apparently noble mission that nonetheless acts in reverse-Robin Hood fashion. In 2005 the SBA announced that $79.6 billion in federal contracts were awarded to “small businesses.” However, according to the New York Times, some of this money went to mom-and-pop organizations such as Northrop Grumman, Boeing, Bechtel, and General Dynamics. Indeed, the Christian Science Monitor reports that almost $5 billion of the contracts classified as “small business” were for the 13 largest government contractors.

Beyond winning contracts theoretically intended for small businesses, there is another way big business benefits from the SBA. In a scheme that Doug French (himself a Las Vegas banker) calls “welfare for bankers,” the SBA guarantees loans for qualifying businesses. Banks are then able to pool such loans and sell them in secondary markets. Now in a simple model of perfect competition, the SBA guarantees would benefit only the loan recipients, because they would acquire funding at lower interest rates. But in the real world, savvy banks acquire “PLP status,” meaning they are preferred lenders. This allows them to issue SBA-guaranteed loans without as much paperwork and other hassles as other banks would need to suffer, and so allows these privileged banks to earn a net income from the entire process. To the extent that PLP status represents a hurdle that has nothing to do with merit or business performance, the process is a form of subsidy to certain (rich) bankers.

The Government National Mortgage Association (GNMA or “Ginnie Mae”) is a public corporation in the Department of Housing and Urban Development. Ginnie Mae boosts the secondary mortgage market by guaranteeing principal and interest payments on mortgage-backed securities. In a typical case, a bank or other institution will acquire dozens of individual mortgages from homebuyers and place them into a single pool, then issue securities to other investors based on the cash flows from the mortgage payments. In the event of unexpected defaults by the homebuyers, Ginnie Mae would step in to guarantee the payments to the secondary investors.

This pledge obviously makes the guaranteed securities more attractive, lowering their promised rate of return. This in turn lowers the mortgage rates faced by the original homebuyers, but also provides liquidity in the secondary mortgage market and no doubt higher commissions for politically savvy middlemen. (As Ginnie Mae’s Wikipedia entry puts it in an unintentionally humorous line, “This arrangement seemingly benefits everyone involved.”) Naturally the loser is, as always, the U.S. taxpayer, who must assume the losses from mortgage loans made at rates that do not reflect the true risks involved. Although in recent years Ginnie Mae has itself earned more in service fees than it paid out on defaults (and thus did not use any public funds), this is only possible because the taxpayers are ultimately liable for the outstanding collection of guaranteed mortgage-backed securities; total potential exposure in 2004 was $453.2 billion.

Other Guarantees and Bailouts

The same analysis applies to other government loan guarantees. For example, suppose the federal government guarantees that it will make good on bonds issued by the Mexican government in the event of a default. Such a pledge undoubtedly showers benefits on both the Mexican government and the (typically wealthy) investors in its bonds, while the source of these benefits is undoubtedly the American taxpayer. This is true even if the Mexican government does not default on its bond payments. After all, if the taxpayers pledged to pay all costs associated with a fire at any of General Motors’ factories, this would certainly be a subsidy to GM, even if no such fire ever occurred. (This is obvious; with the federal guarantee, GM would save the money it otherwise would have spent on fire-insurance premiums.) In a similar fashion, even if the Mexican government doesn’t default, it still benefits from borrowing money at lower interest rates than would otherwise be the case.

Of course, if and when the U.S. government has to make good on these types of pledges, the transactions involve funneling taxpayer dollars to wealthy investors both at home and abroad. Sometimes these subsidies are particularly subtle. For example, during the Mexican “peso crisis” of 1994, the Clinton administration contributed some $20 billion to the international bailout effort by providing loan guarantees and currency swaps. This latter move, executed by the Treasury’s Exchange Stabilization Fund, swapped cash flows denominated in dollars with those denominated in pesos. Inasmuch as the dollar flows originated (at least partly) with the government Fund, and also because the whole purpose of the intervention was to engage in currency swaps that the private market considered unprofitable, President Clinton’s decision used U.S. tax dollars to shield the Mexican government from its irresponsible monetary policies. In short, yet another example of welfare for the rich and powerful.

The celebrated fate of Long Term Capital Management (LTCM), a huge hedge fund that had Nobel laureates Myron Scholes and Robert Merton on its board, presents yet another case of corporate welfare. Because its trading strategy took advantage of slight (but theoretically “irrational”) overvaluations of newly issued bonds (versus older “off-the-run” bonds), LTCM was highly leveraged, sometimes with a leverage ratio of over 30. When the Russian government defaulted on its bonds in 1998, this set in motion a chain of events that proved catastrophic to LTCM’s positions. In the course of a few months the amazing success story had lost over $4.6 billion. Citing the potential disruptions to the entire financial community if LTCM itself defaulted, the New York Federal Reserve Bank intervened. Though it technically did not use public money in the bailout, the Fed nonetheless used “moral suasion” (backed perhaps by implicit pressure?) to get LTCM’s major creditors to allow for an orderly liquidation. Supporters of the move claimed that it prevented a financial meltdown, while critics pointed out that the “too big to fail” mentality would only encourage large institutions to take risky positions in the future, and that the ultimate fallback to the government-sponsored rescue allowed LTCM to reject a private-sector bailout effort led by Warren Buffett. (Under Buffett’s plan, the managers of LTCM would have been fired and the shareholders would have fared much worse than they did under the “necessary” Fed-brokered arrangement.)

We cannot leave this section without mentioning the post-9/11 federal bailout of the airlines. The Air Transportation Safety and System Stabilization Act (signed on September 23, 2001) gave $10 billion in loan guarantees, as well as $5 billion in direct “relief,” to the airlines. Now even libertarians may differ on the justification for this bailout. After all, the federal government hampered the ability of the airlines to prevent 9/11 (through gun bans and other interventions) and also forced them to lose business by the mandatory flight ban immediately after the catastrophe. Nonetheless, the entrepreneurs involved in the airline industry certainly did not live up to their task of anticipating the future better than others. In a truly free market the consequences of poor preparation are losses. When the critics ask, “If the free market is so good, why did the government need to take over airline security?” the defender of laissez faire can reply, first, that government was involved in security before 9/11 and, second, that airline executives did not actually face the full pressures of the profit-and-loss test. When their inadequate security measures allowed disaster, they didn’t bear the full brunt of these shortsighted decisions.

Government Deficits and the Federal Reserve?

Though not as clear cut as some of the other examples in this essay, the annual issuance of hundreds of billions of dollars in new government bonds may qualify as welfare for the rich. If one agrees that the federal guarantee of Mexican bonds represents goodies to the wealthy at the expense of the taxpayer, then by consistency one must also condemn massive federal deficits for the same reason. This is because all Treasury bonds are “guaranteed” by the full faith and credit of the U.S. government as a matter of course. This practice allows the Treasury to obtain loans at low rates of interest and undoubtedly showers income on politically connected banks and other financial brokers. As always, the losers are the taxpayers (who must ultimately pay off the Treasury’s debts) and the smaller banks that do not enjoy the privileges of Fed membership.

When it comes to the “moral hazard” of federal relief, the standard illustrations are the Federal Deposit Insurance Corporation and federal checks to property owners after natural disasters, such as hurricanes and earthquakes. By insuring checking deposits (up to $100,000), the FDIC provides an incentive for banks to invest in riskier projects because on the margin the (expected) costs of doing so are reduced. In a similar manner, when the government provides massive relief to owners of beachfront condos and hotels after a hurricane, this encourages more development in disaster-prone regions than would otherwise occur (if the owners had to pay full market insurance premiums). To the extent that owners of banks and beachfront property tend to be above-average income earners, these programs represent yet more examples of subsidies to the rich.

The final example we shall discuss is one of the most blatant and economically unjustified: the Export-Import Bank. It is worth quoting the Bank’s own mission statement in its entirety:

The Export-Import Bank of the United States (Ex-Im Bank) is the official export credit agency of the United States. Ex-Im Bank’s mission is to assist in financing the export of U.S. goods and services to international markets.

Ex-Im Bank enables U.S. companies—large and small—to turn export opportunities into real sales that help to maintain and create U.S. jobs and contribute to a stronger national economy.

Ex-Im Bank does not compete with private sector lenders but provides export financing products that fill gaps in trade financing. We assume credit and country risks that the private sector is unable or unwilling to accept. We also help to level the playing field for U.S. exporters by matching the financing that other governments provide to their exporters.

Ex-Im Bank provides working capital guarantees (pre-export financing); export credit insurance; and loan guarantees and direct loans (buyer financing). No transaction is too large or too small. On average, 85% of our transactions directly benefit U.S. small businesses.

With more than 70 years of experience, Ex-Im Bank has supported more than $400 billion of U.S. exports, primarily to developing markets worldwide.

As with most descriptions provided by the agencies themselves, the Ex-Im Bank’s statement seems innocuous enough. Yet Henry Hazlitt, in his wonderful Economics in One Lesson, long ago exploded the myth that subsidizing exports is good for the economy. For example, when the Ex-Im Bank “levels the playing field” by “matching the financing that other governments provide to their exporters,” what does this really mean? It means that the federal government gives money to foreign governments or companies which they then use to purchase products from American exporters. To clearly see what is going on, it would be simpler if the U.S. government first bought the products from domestic producers (using tax dollars, of course) and then handed them over for free to the foreign organizations. Yes, this practice benefits the workers and shareholders of the privileged exporting firms, but these gains are more than offset by the losses to the taxpayers. After all, as Hazlitt pointed out, the country as a whole doesn’t get rich by giving goods away.

Similar to the Ex-Im Bank is foreign aid in general, to the extent that the recipient governments spend the money on U.S. exports. For example, according to the Cato Institute, in FY2003 $3.7 billion in federal money was used to finance weapons purchases for foreign governments.

Free-market enthusiasts often rail against welfare for the poor, and rightly so. However, as both experience and political economy suggest, the welfare state also redistributes wealth into the hands of the rich and politically powerful. To offer a consistent message—as well as attract support among more-egalitarian observers—advocates of laissez faire should condemn the billions of dollars in annual subsidies for the rich.

Related posts:

1. Book Review ~ Take the Rich Off Welfare by Mark Zepezauer and Arthur Naiman
2. The Never-Ending Welfare Debate
3. Ax Business Welfare and Privatize Social Security

There are two extreme views of American government and the political process. One is that policy is the result of special interests rigging the system in their favor and exploiting the ignorant or at least impotent masses. The other is that government pretty much gives the people what they want.

My own view is much closer to the second claim than the first. While I recognize the depressing frequency of pork-barrel legislation and numerous regulations that are structured to benefit special interests rather than the so-called public interest, I believe that the broad thrust of policy responds to the desires of the general public. Given this view, I believe that the road to greater freedom in America is to encourage a broader consensus for freedom that will in turn get translated into more limited government via the political process.

While reasonable people may disagree on these differing perceptions of the nature of the American political process, I think it’s undeniable that the average American is considerably more comfortable with an activist role for government rather than a more limited role. Why is this the case? Why don’t my fellow citizens prefer more limited government?

At first glance, liberty should be wildly popular. Each of us loves it and expects it for ourselves. Few of us want to be bossed around or treated like a child. There is a strong human urge to have our own way without restraint, and it starts young. As a parent, I see this desire in action constantly. Simply tell a baby “no” to any desire, be it for more food or something as simple as climbing the stairs, and you can see the desire for freedom in action. If anything, this resentment of authority grows stronger with time. I don’t have teenagers yet, but I hear they’re pretty willful. How do these creatures of desire, these babies and adolescents, mature into voters who support candidates who constantly advocate and implement restrictions on freedom—from drug laws to labor regulations to high tax rates?

There are many explanations for why activist government is not only prevalent in our times but popular. But one answer lies within each of us, working to counteract that same internal force working for liberty. There is one urge that may be equally strong as the desire to have your own way, and that’s the urge to impose your will on others. Again, parenting gives us insight into this urge, but from the other side of the highchair. We want our children to do what we tell them. Parental discipline may be weaker and punishment less corporal today than in past times, but we as parents still spend a great deal of time bossing our kids around or at least trying to.

When our children obey us, we feel good for two reasons. The first is altruistic, but the second is a little less attractive. Yes, we tell our children to stop playing in traffic for their own good. Yes, we refuse them the second ice-cream cone for reasons of health or the creation of self-discipline. But we also try to manipulate our children for our own benefit. We ask our children to quiet down because we’d like a more peaceful home. We tell them to sit rather than roughhousing with each other. We tell them to read this book or that because we want them to be more like us. We send them to bed earlier than they’d like because they need a good night’s sleep, yes, but also because we like a little private time with our spouses.

Power is an intoxicating elixir. One of the secrets of good parenting is restraining the urge to impose authority on our children simply because it is gratifying to have obedient children.

I’m not suggesting that we should indulge our children in order to let them enjoy freedom. I’m arguing that even the best of parents resents a child’s disobedience. We don’t like having our will thwarted as adults any more than we did as children. One challenge of being a parent is not to impose our will on our children just for the sake of being in control. This desire for control and the seductiveness of power can conflict with what is best for our children.

And of course, this phenomenon of imposing our will on others doesn’t stop at our children. We want our spouse to act in ways that we deem desirable, our co-workers to recognize our wisdom and act in ways that we feel is best for the organization, and so on. We even want people to vote the way we do and support the policies we think are best for the country and the world.

The Public Arena

The conflict between the desire to be free and the desire to impose our will on others plays itself out in the public arena. We want our Scotch, but think it right to make cocaine illegal. We want to go skiing, but we force others to wear their seatbelts. We want to eat our ice cream, but think it’s okay to ban smoking.

Mencken defined Puritanism as the haunting fear that someone, somewhere may be happy. A paternalistic government plays into the Puritanism most of us harbor somewhere deep inside. Not content with mere disapproval, we use force via the political process to restrain others.

Next time you’re in the grocery and you see a stressed-out mom or dad screaming at the kid who naturally wants to play with the candy at the check-out line, you’re seeing the roots of big government.

For normal human beings and decent parents, those grocery-store-type moments are few and far between. Love restrains us from indulging our urge to boss our children around for our good rather than theirs. Love for our children encourages us to let them begin to make their own choices as they grow up and head toward adulthood.

I long for a world where we show the same restraint in the political arena. One way to get to that world is to remind our fellow citizens of the virtues of adulthood. As an adult, I make my own decisions and deal with the consequences. Why do we want a political system that treats us like children?

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Since the early 1990s, and even through the collapse of the stock-market bubble, the American economy has continued to experience remarkable increases in worker productivity, both in manufacturing, which now accounts for 14 percent of the nation’s output, and in many service sectors as well. By the third quarter of 2003, the U.S. economy was growing at 8.2 percent, the highest rate in decades.¹

Yet in retrospect, we notice that the efficiencies that propelled the American economy for more than a decade have evaded an important segment of the workforce: high-level professionals, including those employed in education, medicine, and public administration. As a result, tuition at the average four-year private college in the United States nearly doubled from 1990 to 2000, going from $10,348 to $19,312.² During that same period, state universities imposed an 85 percent increase on their students. Similarly, with the exception of a brief respite from the implementation of managed care in the late 1980s, health-care costs for business are rising at 9.6 percent annually, simultaneously increasing the net price of labor while reducing what could be available for wage increases.³

As we shall see, professionals are adept at manipulating the political process, inflating the cost of many services with direct and indirect government subsidies. But to really understand how certain groups of highly educated workers can command ever higher compensation in an otherwise efficient economy, we must first go back to a management concept that has traditionally helped to define the very meaning of the word professional: “collegial self-regulation.”

 This means that the nature of the service is so sophisticated and intricate that the quality of its rendering can only be judged by someone else educated in the same field. Unlike the factory worker, whose job is sufficiently easy to understand that it can sometimes be automated or outsourced to less-educated labor in developing countries, the professional is deemed to have a labor function that only he and his colleagues, speaking through their professional associations, can comprehend and therefore regulate, either through a shared code of conduct or through their influence over the writing of relevant legislation.

 The result is that, while many professionals technically have bosses—college presidents and deans, hospital administrators, or simply private-sector clients—a large part of their daily behavior is governed by rules and expectations of their own making.

 Like industrial workers, most professionals are paid for the time they work, but with little incentive to improve productivity in the classical sense: output per hour. Instead, they are expected to add value by “doing their best.” And while there are certainly many people in every profession whose personal ethics hold them to the most exacting standards, it has been the historical tendency of every self-regulating elite to promote legislation that reduces competition, to preserve special privilege, and to insulate its members from the consequences of error and even negligence.

 Stephen Moore, president of the Club for Growth, has cogently observed that the two most inflated service sectors in the American economy, public-school education and Medicare, are both characterized by a system of third-party payments—which is to say that the cost of educating a child or of treating a sick senior is not borne directly by the consumer, but by a large and faceless pool of taxpayers.⁴ The result is that the consumers of these services have no personal incentive to insure that they are provided at the best possible price.

 Third-party reimbursement is not the only way that professional elites thwart competitive pricing, but it does suggest a more universal truism: that the power of a profession to preserve its high-priced inefficiency lies in its political ability to blunt competitive pressure through subsidy or regulation, and especially through licensing requirements that limit the number of people who can practice in its field. At the same time, every profession promotes a stereotype of competence that precludes any rigorous evaluation of the service it actually performs.

 An obvious example is the case of tenured professors at state universities, whose compensation is completely detached from the number of students taught, the success of former pupils, the quality of their research, or any other measure of effectiveness. Come time for the annual review of university staffing budgets by the appropriate committee of the state legislature, politicians are treated to the usual platitudes about the need for an independent faculty to guarantee students a quality education.

 The fact that professional lobbying may seriously harm consumers does not seem to restrain its influence. In the 1990s orthopedic surgeons actually went so far as to persuade the U.S. Congress to punish the federal Agency for Healthcare Research and Quality for correctly concluding that spinal fusion surgery for back pain produces no real improvement. Wall Street Journal science reporter Sharon Begley remembers that the surgeons were so successful they “crippled for years the very idea of evidence-based medicine.” ⁵

Political Arm-Twisting

The ability to create an economic privilege through a combination of political arm-twisting and public relations means that even professionals who claim to compete aggressively for business—architects, engineers, and many lawyers—have, in reality, only a rudimentary idea of what it means to work productively. Their businesses “are ridden with inefficient processes and unstructured behavior,” says Albert Bitton, director of business development for Tenrox, a California company that develops management software for service professionals. “Resources are not utilized at the optimal capacities, collaboration is less than ideal, billing cycles are lengthy, project status is based on out-of-date information, and project costs are not managed or known with certainty. . . .”⁶

Ronald Goldsmith, North American editor of The Service Industries Journal, agrees. He points out that Federal Express, McDonald’s, and many other large corporations have developed powerful techniques for streamlining their services—delegating low-level and repetitive tasks, for example, and using price incentives to control work flow—that the vast majority of professionals could also employ, but believe they can safely ignore. “Unfortunately, [these] highly educated people continue to resist the idea that they have anything to learn from people who deliver packages or flip hamburgers for a living,” Goldsmith says.⁷  Allowing professionals to regulate themselves through the political process may have been a tolerable way to manage knowledge workers in times past, when the American economy was dominated by manufacturing and consumers lacked sufficient education to evaluate complicated services. But the number of professionals in America has multiplied to the point where low productivity has begun to create serious economic distortions. As a result of the spiraling cost of a college education, for example, 39 percent of graduates with student loans are carrying a debt load that the Public Interest Research Group’s Higher Education Project classifies as “unmanageable.”⁸ And although there is honest disagreement about exactly how many families have been priced out of affordable health insurance, medical costs are clearly accelerating at many times the rate of inflation.⁹

As in the case of orthopedic surgeons, even the most expensive and critical professional services come with little guarantee of quality. Widely publicized research by Dr. Jack Wennberg and his colleagues at the Dartmouth Medical Center shows that a typical physician’s decisions are just as likely to be determined by idiosyncratic local customs and financial self-interest as by any knowledge of best medical procedures.¹⁰ George Halvorson, chairman of California’s Kaiser Permanente hospital chain, often cites a study where 135 physicians were presented with the same patient and came up with 82 different treatments.¹¹

 Most worrisome of all is that professional services are expected to dominate the American economy in the years to come. Between now and 2010, according to Daniel E. Hecker, an economist with the Bureau of Labor Statistics (BLS), employment in the professions is projected to add more workers—seven million—than in any other occupational grouping.¹² Indeed, every one of the top 25 jobs expected to grow the fastest between now and 2010 is a professional occupation.

Demand for Services

This startling “professionalization” of the American economy is caused in part by an increasing demand from aging baby boomers for services such as medical care, financial planning, and adult education, as well as by an increase in manufacturing efficiency, which has led to a worldwide reduction in the need for industrial workers. But even without the boomers, as author Irving Kristol first observed in a famous 1975 essay, “Business and the ‘New Class’,” the very nature of industrial society requires more—and more varied kinds of—college-educated professionals whose skills go hand in hand with a modern economy: scientists in fields such as genetic engineering, systems analysis, and medical-device design; special-education teachers; higher-education administrators; ecologists; international-marketing experts; public-policy analysts; family counselors; city planners; foundation officers and their research staffs; government managers; human-resource managers; and of course journalists, who can make clear to the public what all the other specialists actually do.¹³

“Knowledge workers are rapidly becoming the largest single group in the workforce of every developed country,” says management expert Peter Drucker. However daunting it may seem, he warns that the real economic challenge for developed countries in the 21st century will be to achieve the same 3.5 percent average annual rate of productivity improvement in the professions as manual workers achieved in the last century: “In no other way can [advanced countries] hope to maintain themselves, let alone to maintain their leadership and their standards of living.”¹⁴

The good news is that advances in information technology and management science are beginning to make it possible for nearly every profession to become more efficient. Consider income-tax preparation, a job once considered sufficiently complicated to require the services of an accountant. Today, many people do their own tax returns with the help of TaxCut or Turbo Tax. In the field of law, sophisticated documents, such as wills and basic business contracts, are readily available on programs such as Family Lawyer and E-Z Personal Law Library.

Even sophisticated services, such as teaching a college-level course, can be refined and packaged in a more economical manner. Supported by an $8.8 million grant from the Pew Charitable Trust, Carol A. Twigg at Rensselaer Polytechnic Institute has worked with professors from 30 colleges and universities around the country to fine-tune the design of large-enrollment courses, using sophisticated feedback techniques to reduce instructional costs while improving the quality of teaching.¹⁵ “[Our] preliminary results show that all thirty [colleges and universities] reduced the costs of course delivery by 40 percent on average, with savings ranging from 20 to 86 percent,” says Twigg. At the same time, the redesigned courses produced “increased course-completion rates, improved retention, better student attitudes toward the subject matter, and increased student satisfaction.”

All this is not to suggest that the majority of professionals are ready to let the market forces help them be more productive. They are certainly not ready to let private rating services supplant government licensing, a basic reform that would make all professions more efficient overnight. Unfortunately, no group of workers that gets comfortable with the way it earns a living, be it manual laborers in bygone factories or today’s white-collar professionals, ever likes to be forced to innovate, even for its own long-term benefit.

A century ago the pioneer of industrial automation, Frederick Winslow Taylor (1856–1915), earned the undying enmity of labor unions by inventing the scientific study of worker productivity, a discipline that led to an improved standard of living for all Americans, but especially for workers themselves. Today’s professional elites are just as resistant to calls for efficiency, only, being better educated, they are far more adept at using the political system to suppress the most important catalyst for higher labor productivity: the consumer’s freedom to shop for value.

They Are the Government

The ability of professional elites to lobby government for special privilege is strengthened by the fact that, to a large extent, these elites have become the government. Not only do lawyers dominate state legislatures and Congress; but politicians have also extended their oversight of education, health care, the environment, transportation, and commerce to such a degree that the rules under which many professionals operate are increasingly written by colleagues inside some government bureau or department. Not surprisingly, these regulations tend to reinforce the notion of professionals as high-priced hourly labor, perhaps burdened with obligations “to society,” but with little responsibility or incentive to improve their own productivity.

And when any program which the government itself directly manages begins to falter, the legislative response is typically to employ even more professionals to provide supplemental services on the same inefficient basis—effectively spreading the government’s largess among an interlocking web of diverse knowledge workers. Hence, the political answer to the failure of public education is the subsidy of remedial classes for incoming college freshmen; the cure for inefficient public hospitals is to place them under the administration of a new bureaucratic department; and the solution for prisons that fail to rehabilitate is to hire a staff of psychologists at the department of corrections.

Still, for all their collective ability to shape state and federal legislation—and to do so under the guise of doing good—today’s professionals must confront the paradox that their rapidly expanding numbers will inevitably force them to become more efficient. In the end, the ability of any elite to secure an unproductive economic advantage is based on the fact that it is elite, not simply in terms of education, but as a percentage of the population. When the number of Americans in professions and related occupations reaches 20 percent of the workforce, as the Bureau of Labor Statistics predicts it will by 2010, the only alternative to making knowledge workers more productive will be economic stagnation.¹⁶

This coming confrontation with reality will likely be accelerated by the research power of the Internet, which has emboldened consumers to make informed demands on teachers, lawyers, accountants, and especially doctors. In one of the most ambitious consumer-empowerment plans to date, 28 large employers, including Sprint, Lowe’s, BellSouth, J. C. Penney, and Morgan Stanley, are teaming up to develop online “scorecards” to help employees choose doctors based on how well—and cost effectively—they care for patients. Using claims data provided by their insurance carriers to measure how well individual physicians stack up against each other, these companies aim to make it possible for employees to instantly check ratings for all the doctors in their area who treat a specific illness and then pick the one who scores best for quality and efficiency.¹⁷

Already there are signs that some professionals see the need to make their respective disciplines more responsive to market forces. One of the fastest growing trends among family physicians in private practice is drastically discounting the cost of their services to patients who pay out of pocket. Pay-as-you-go medicine is “a phenomenon that certainly isn’t in the mainstream yet,” says William Jessee, president of the Medical Group Management Association in Englewood, Colorado, “but it seems to be becoming more visible and perhaps more common.”¹⁸

The July/August 2003 issue of Change magazine reported that university faculties are increasingly becoming peopled by what it terms “instructional entrepreneurs,” full- and part-time faculty who see that the future of education lies in designing, marketing, and delivering more cost-effective programs, especially to students who can no longer afford the traditional four-year curriculum. Among two-year community colleges, the most successful schools are those that excel at rapidly and efficiently accommodating the training needs of regional employers.¹⁹

What is certain is that the nature of what it means to be a professional must change radically in the years to come if the American economy is to sustain its historic rate of growth. Success and prestige will have to flow from those who are content to earn a credential and game the political system to a newer breed of knowledge workers who are more willing to be challenged and more eager to innovate.

Notes

1. Rea S. Hederman, “Tax Cuts Boost Business Investment,” Heritage Foundation WebMemo #412, February 3, 2004, www.heritage.org/Research/Taxes/wm412.cfm.
2. Allan Carlson, “The Anti-Dowry,” The Weekly Standard, December 16, 2002, p. 14.
3. Vanessa Fuhrmans, “Employers Say They Can Slow Rate of Health-Care Cost Gains,” Wall Street Journal, August 27, 2004, p. A2.
4.  Stephen Moore, “The Case for Tax Cuts in Washington and Hartford,” lecture sponsored by the Shelby Cullom Davis Endowment at Trinity College, April 1, 2003.
5.  Sharon Begley, “Too Many Patients Never Reap the Benefits of Great Research,” Wall Street Journal, September 26, 2003.
6. Albert S. Bitton, “Professional Services Automation,” Tenrox White Paper; Pasadena, Cal., 2001, p. 2.
7. Interview by author, April 1, 2004.
8. Carlson, p. 13.
9. Fuhrmans.
10. Michael Doonan, David Schactman, and Stuart Altman, “Regional Disparities in Health Spending,” Policy Brief, Council on Health Care Economics and Policy, May 2003.
11. George Halvorson, “The Future of Productivity,” in Productivity in the 21st Century (Washington, D.C.: Department of Labor, 2002), p. 141.
12. Daniel Hecker, “Occupational Employment Projections to 2010,” Monthly Labor Review, November 2001, p. 58ff.
13. Irving Kristol, “Business and the ‘New Class,’” in Irving Kristol, ed., Neoconservatism (New York: Free Press, 1995), pp. 205–10.
14. Peter Drucker, Management Challenges for the 21st Century (New York: HarperBusiness, 2001), pp. 141, 157.
15. Carol Twigg, “Improving Quality and Reducing Cost: Designs for Effective Learning,” Change, July/August, 2003, pp. 23–29.
16. Hecker, pp. 64–65. Laura Landro, “Doctor Scorecards Are Proposed in a Healthcare Quality Drive,” Wall Street Journal, March 25, 200
17. 4, p. A1.
18. Rhonda Rundle, “Pay-as-You-Go Medicine: The Doctor Is In, But the Insurance Is Out,” Wall Street Journal, November 6, 2003, p. A1.
19. Patricia Gumport and Robert Zemsky, “Drawing New Maps for a Changing Enterprise,” Change, July/August 2003, p. 34.

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What friends of freedom need to remember is that trends can change, that they have in the past and will again in the future. If this seems farfetched, place yourself in the position of a socialist at the time that Marx died in 1883, and imagine that you are an honest and sincere advocate of socialism. As a socialist, you live in a world that is predominantely classical liberal, with governments in general only intervening in minimal ways in commercial affairs. Most people—including those in the “working class”—believe that it is not the responsibility of the state to redistribute wealth or nationalize industry and agriculture, and are suspicious of government paternalism.

How could socialism ever be victorious in such a world so fully dominated by the “capitalist” mindset? Even “the workers” don’t understand the evils of capitalism and the benefits of a socialist future! Such a sincere socialist could only hope that Marx was right and that socialism would have to come—someday—due to inescapable “laws of history.” Yet within 30 years the socialist idea came to dominate the world. By World War I the notion of paternalistic government had captured the minds of intellectuals and was gaining increasing support among the general population. Welfare-statist interventionism was replacing the earlier relatively free-market environment. And the socialist ideal of government planning was put into effect as part of the wartime policies of the belligerent powers beginning in 1914.

Socialism triumphed during that period because while socialists advocated collectivism, they practiced a politics of individualism. They understood that “history” would not move in their direction unless they changed popular opinion. And implicitly they understood that this meant changing the minds of millions of individual people. So they went out and spoke and debated with their friends and neighbors. They contributed to public lectures and the publishing of pamphlets and books. They founded newspapers and magazines, and distributed them to anyone who would be willing to read them. They understood that the world ultimately changes one mind at a time—in spite of their emphasis on “social classes.”

They overcame the prevailing public opinion, defeated powerful special interests, and never lost sight of their long-term goal of the socialist society to come, which was the motivation and the compass for all their actions. .

The Superiority of Freedom

What do friends of freedom have to learn from the successes of our socialist opponents? First, we must fully believe in the moral and practical superiority of freedom and the free market over all forms of collectivism. We must be neither embarrassed nor intimidated by the arguments of the collectivists, interventionists, and welfare statists. Once any compromise is made in the case for freedom, the opponents of liberty will have attained the high ground and will set the terms of the debate.”

FEE’s founder, the late Leonard E. Read, once warned of sinking in a sea of “buts.” I believe in freedom and self-responsibility, “but” we need some minimum government social “safety net.” I believe in the free market, “but” we need some limited regulation for the “public good.” I believe in free trade, “but” we should have some form of protectionism for “essential” industries and jobs. Before you know it, Read warned, the case for freedom has been submerged in an ocean of exceptions.”

Each of us, given the constraints on his time, must try to become as informed as possible about the case for freedom. Here, again, Read pointed out the importance of self-education and self-improvement. The more knowledgeable and articulate we each become in explaining the benefits of the free society and the harm from all forms of collectivism, the more we will have the ability to attract people who may want to hear what we have to say.”

Another lesson to be learned from the earlier generation of socialists is not to be disheartened by the apparent continuing political climate that surrounds us. We must have confidence in the truth of what we say, to know in our minds and hearts that freedom can and will win in the battle of ideas. We must focus on that point on the horizon that represents the ideal of individual liberty and the free society, regardless of how many twists and turns everyday political currents seem to be following. National, state, and local elections merely reflect prevailing political attitudes and beliefs. Our task is to influence the future and not allow ourselves to be distracted or discouraged by who gets elected today and on what policy platform.”

Let us remember that over the last hundred years virtually every form of collectivism has been tried—socialism, communism, fascism, Nazism, interventionism, welfare statism—and each has failed. There are very few today who wax with sincere enthusiasm that government is some great secular god that can solve all of mankind’s problems. Statist policies and attitudes continue to prevail because of institutional and special-interest inertia; they no longer possess the political, philosophical, and ideological fervor that brought them to power in earlier times.”

There is only one “ism” left to fill this vacuum in the face of collectivism’s failures. It is classical liberalism, with its conception of the free man in the free society, grounded in the idea of consent, peaceful association, and individual rights. If we keep that before us, we can and will win.

Richard Ebeling is the President of FEE .

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