Failure Part II - Government

Strong believers in the Theory of Second Best who see market failure in everything and who believe it sufficient to justify state action tend to believe in perfect government. This is the high school civics version of government where an informed electorate votes for politicians who wisely draw up laws that reflect the public will and the general good. How their knowledge of markets can be so sophisticated while their knowledge of government remains so simple is not clear, but there are several forms of government failure that should be noted. Before I list them, though, there are two points worth noting.

Point 1: the decision to use state intervention to address the market failure may not always undo the underlying logic of the situation.

• Example 1: Pollution is an externality. Regulation of the polluter does not make it not an externality. A Pigovian tax imperfectly internalizes the cost to the producer and consumer, but does not relieve the sufferer.
• Example 2: Forcing all car buyers to attend classes on judging automobile quality does not give them the idiosyncratic knowledge possessed by car sellers, so education does not automatically defeat the asymmetric information problem. Regulating natural monopolies does not make them not monopolies. In fact, it guarantees their monopoly status in perpetuity.

Point 2: The decision to use state interference introduces a new set of external costs. If A & B vote to do something that benefits them but costs are spread evenly, and C votes against it because it does not benefit C (who shares in the costs), then an external cost is levied on C.

With that, here are some examples of government failure:

• Log rolling: A is in favor of policy X and indifferent to Y, B is in favor of Y and indifferent to X, and C is against both X and Y. The electorate is equally split on both X and Y, but if A and B agree to trade votes, they will get both X and Y. In fact, you might have A for, B and C indifferent, and D and E against X, while A and C are indifferent, B for, and D and E against Y, and still end up with both X and Y if A and B trade votes and then convince C to go along for some future payoff (or an actual one, such as a chairmanship -- remember Jeffords?) even though public sentiment, to the extent the makeup of the legislature reflects it, is against both by 2:1. May not always be a problem, e.g. online trading of votes between Gore and Nader in 2000.
• Rational ignorance and the concentrated interests/spread costs problem (a variant of the public goods problem from market failures). If it is worth $10 to me and every other individual to change regulation X, but the industry benefiting from the regulation accrues $10 x 300 M people = $3 B, it will only be worth a few hours of my time to learn the legislators, the regulators, their views, to draft legislation, write position papers, uncover facts, conduct studies, etc., while it will be worth a few hundred million to each of (say) ten firms within that industry to counter me.
  
• Crowding out - not sure I’m a big believer in this. It says that government borrowing crowds out capital borrowing, resulting in lower growth and lower prosperity. However, we are borrowing the money from and spending it on ourselves. So long as it goes to build capital (roads, bridges, etc.), it may still be useful.
  
• Rent seeking - firms and individuals sometimes use regulations to prevent competition. Rent control is an example in which tenants seek to expropriate the value of apartments from owners. This discourages owners from building new housing, and results in shortages. Similarly, bureaucrats will seek to increase their sphere of influence and budget in order to promote their own interests (pay and prestige).
• Regulatory capture - it is possible for the regulated industry to get enough friendly votes on the regulatory boards to substantively control them. This has been true of railroads, electric utilities, banking, insurance, and especially medicine.
• Market distortion by tax structure, regulatory ordering, subsidization, risk assumption. Any one of these things could force the market into a suboptimal choice of goods and services, including LIFO inventory management, the choice of dirty Eastern coal over natural gas or clean western coal (to appease eastern mining unions), the choice of High Fructose Corn Syrup (HFCS) over cane sugar, and the collapse of the S&L industry due to an increase in the federal insurance coupled with a regulatory push towards a mix of risky investments and into a single, undiversified market (real estate).
• Unintended consequences - conditions arising from regulatory interference in ways that were unanticipated. For example, the ban on liquor in the 20s and on drugs at present has caused a rise in gang violence. Paying farmers to stay off of good farmland means they take those payments and then use them to buy irrigation and fertilizer so they can farm suboptimal farmland, resulting in more environmental degradation than if they had simply farmed the prime land.
• Some of the market failures, too, like moral hazard (crop insurance), structure (rail and airline regulation created cartel-like oligopolies), etc.

As with market failures, there are sometimes workarounds to the government solutions. However, most of these are not open to private actors as they were for market failure.

• Log rolling: A basic remedy to this is a Constitutional requirement for a supermajority. The only option open to individuals is to vote for reform.
• Rational ignorance and the concentrated interests/spread costs problem - Political Action Committees concentrate spread interests. However, this is still a public good type of problem, so PAC activity will be underproduced.
  
• Crowding out -- vote for reform.
• Rent seeking -- you can always try capturing the regulatory body 8~). Otherwise, vote for reform.
• Regulatory capture -- vote for reform
• Market distortion by tax structure, regulatory ordering, subsidization, risk assumption - vote for reform.
• Unintended consequences -- vote for reform
  

As far as I can tell, the individual's options for countering government failure are far more limited than the individual's options for countering market failures. That is why I think we're frequently better off living with the market failures than we are when we attempt a state intervention, especially if it isn't clear which market failures are dominant. The market failure may be countered by one clever individual, whose solution may then be copied by others, whereas the government failure always requires obtaining the agreement of a majority - perhaps even an overwhelming majority - of the public. There are costs to building consensus, which is why David Friedman refers to this situation as being "on the wrong side of the public good problem [paraphrasing]."

I am indebted to James Buchanan and Gordon Tullock for their illumination of some of these problems, especially the cost of consensus building and the external costs of laws, in The Calculus of Consent.

Failure Part I - Market Failure

In economics, there are several competing descriptions of "efficiency". In Econ 101, you will usually be shown how market transactions can produce one or more of these efficient outcomes. However, that demonstration is usually conducted under ideal circumstances of atomistic competition and other constraints. Later on in your academic career, you relax those constraints and find out how the real world interferes with the nice, neat perfect market.

Things which interfere with market transactions are known as "market failures". A market failure is not the failure of the market to produce the thing you desire, like a $500 Ferrari. Rather, it is the failure of the market to produce the efficient outcome. For example, if you would be willing to purchase something for no more than $500, and someone would sell it to you for no less than $250, any transaction between $250 and $500 would be efficient. If something interferes, the market is said to fail. Market failures include (in broad categories):

• Structure (increasing economy of scale or scope, path dependency, oligopoly, monopoly) - problems in the structure of the market in which one or a few firms may come to dominate. When that occurs and oligopoly or monopoly obtain, they may attempt to restrict output artificially and thereby raise prices.
  
• Opportunism/Knowledge (asymmetric knowledge, adverse selection, moral hazard, principal-agent, specialized assets, measurement) -- problems in the distribution of knowledge where one side of a trade knows more about a key aspect than the other. Used car owners know whether or not their vehicle is a good car or a lemon, but potential buyers don't and therefore assume average quality. Owners of superior used cars will refuse to sell at average prices, so the market becomes dominated by lemons (canonical example of asymmetric information). Similarly, only unhealthy elderly consumers will be willing to buy health insurance (adverse selection). If an insurer allows an asset owner to insure the asset for far more than it is worth, he runs the risk that the insured will fail to exercise proper prevention strategies and therefore be in the position of collecting on the insurance (moral hazard). A principal who hires an agent is dependent on the agent's judgment of what constitutes due diligence. A company that invests in specialized equipment (e.g. dies) to make products for a particular buyer runs the risk that the buyer will attempt to expropriate the entire value of the investment with the threat of leaving him in the lurch. When a manufacturer sells through complex distribution channels, he is frequently unable to monitor whether customers are given adequate support at the retail level.
  
• Public good (free rider, externality, holdout, commons tragedy, merit good) -- If I broadcast a radio signal to one customer, it is impossible to prevent others from receiving that same signal. Therefore, no single customer would pay for it knowing that others will free ride. On the other hand, if I agree to broadcast only if everyone agrees to pay equally, a single holdout can scuttle the entire deal. Similarly, if I agree to provide electricity to a single customer using a coal-fired plant, I cannot help but create pollution that will affect everyone (public bad). If we all decide to use a common resource, none of us can capture the rewards of conservation, but all of us can capture the rewards of increasing our use until it collapses. Some goods are thought to have externalities so valuable that they should be provided even if nobody would buy it themselves (e.g. education, vaccinations against communicable disease).
  

The existence of such failures is often considered to be the entry point for government action. This "Theory of Second Best" has been around for a while but is usually associated with both paleoprogressives (roughly 1890-1920) and neoprogressives (roughly 1990-present). The "second best" solutions open to the government are the Pigovian tax (including negative tax for merit goods) and simple public ordering (regulation). However, this is exactly the kind of problem I suggested a couple of essays ago when I stated that our choices are not between imperfect markets and perfect government policies. There are two problems here: the first is that the policies themselves may give rise to new problems, and second that the market itself may produce solutions.

A number of private solutions are available for each of the problems identified above.

• Structural problems may be countered with substitution and/or innovation. Gort and Argawal ("First-Mover Advantage and the Speed of Competitive Entry, 1887-1986", JLE vol XIV, April 2001) found that "first to the market" status conferred a positive advantage, but that the length of that advantage had declined from 30 years in 1887-1906 to about 4.5 years in 1986. In other words, the rate of change is accelerating and the advantage of the "first to market" is declining. The danger of monopoly was never as great as it was made out to be, and becomes less important every year.
• Another solution to monopoly problems is to remove public policies that create the condition in the first place. These include patents, subsidies, and legal monopolies. Many if not most historical monopoly problems were the result of regulatory capture by so-called "natural" monopolies that were anything but natural. AT&T comes to mind. Southwest Airlines is still hampered by the Wright Amendment. The USPS still has exclusive rights to carry First Class Mail.
  
• Opportunism can be countered with contractual remedies. For example, if you see that investing money in a very specialized asset for a single customer is going to open you to a situation where they can take advantage of you by threatening to abandon you after you have made the investment, you can demand a hostage or deposit.
• You can counter knowledge asymmetry with information gathering, as Akerlof even suggested in "The market for lemons" (though his suggested private remedies are usually overlooked). These include using branding and/or franchising to create or leverage existing reputation, using guarantees, or using third-party reputation sources such as licensing and certification providers. Underwriters Labs and Orthodox Union are two of the better known 3rd party certifiers, though FairTrade and others serve the same purpose. Note that these remedies are not necessary when repeated transactions within a local market are common. I used Consumers Union and Carfax when purchasing my most recent used vehicle. Hmmm - apparently, information gathering costs money, and if someone can gather it more efficiently than you, you can both profit by it.
  
• Contractual remedies are also applicable to asymmetric knowledge problems. If you think you might have a difficult time monitoring retailers of your product, you can try bundling, setting price floors, using standard contracts (common with car rental agencies), and franchising rules that prevent quality "shading" by franchisees.
• Finally, even public good problems are not entirely insurmountable. Radio is operated by bundling the public good (music, news, etc.) with public bads (commercials). Free rider and holdouts can be captured in mutual benefit contracts (covenants, for example). Commons can be divided up and parceled out with the equivalent of barbed wire and property rights assignments (such as auctioning off the RF spectrum).

The last example may benefit from a hybrid solution of public and private remedies. By assigning property rights in an application of the Coase theorem via legislative fiat, the commons problem is removed. Pigovian taxes are strictly ruled out by this (see David Friedman, Law's Order, on problems with joining Coase and Pigou), but some minor regulation may still be beneficial. For example, cap & trade markets in sulfur & carbon are generally accepted as the proper way to address the commons problem that results in pollution.

In this respect, I am not averse to public solutions so long as it can be shown that they are better than any possible private solution. That being a nearly impossible task (because of the "any possible" requirement on something as dynamic as our sophisticated economy), I would rather see state action that attempts to align incentives and allow the market to work without dictating the outcome; well-designed cap & trade markets are preferred to Pigovian taxes which are preferred to command & control regulations, so give me the sulfur market over a carbon tax over a new CAFE rule. I would also like to see such state interference written in such a way that it is subject to review and renewal frequently. Regulations are frequently written in a toxic mix of public hysteria, rent-seeking by corporate lobbyists, and power-seeking by legislators and bureaucrats, then set in stone and milked for 3-4 generations the way railroad, trucking, airline, and natural gas regulations were.

Heck, we just recently paid off the Spanish-American War.

UPDATE: This has a follow-up, Failure Part II, Government Failure.

A diesel takes LeMans!

First there was this bit of news about a diesel dragster breaking the 8 second barrier, now (via GreenCarCongress) the news that an Audi turbodiesel took the LeMans 24 hour race with a 4 lap lead. This comes on the heels of their win at the 12 hour Sebring race.

The Audi is a twin turbocharged V12 diesel that develops a scant 650 hp (485 kW) but a jaw-dropping 811 ft-lb (1100 N-m) at somewhere around 5500 rpm. One advantage that the diesel brings is greater efficiency and therefore - since the cars' fuel tanks are limited by LeMans rules - fewer pit stops. The Audi pitted 27 times, the 2nd place car 32.

Made of an aluminum block, this is not a stock engine (damnit!), but it still sends a message that this ain't your father's nasty old diesel Oldsmobile. Audi has a history of doing this to major racing series, the last time being the damage they did with all wheel drive (the Quattro technology that finally prompted a limit on their intake manifold to even things up).

Father's Day

Today, I wish I could call my father and talk to him about the USA v. Italy game in the World Cup.

Take a pledge - no ad hominem

The ideology-free ideology is but one example of three rhetorical approaches that I have been increasingly sensitive to, lately. Those are

• Characterizing your opponent as evil
• Characterizing your opponent as insane
  
• Characterizing your opponent as mentally deficient (including being blinded by ideology)

The first hit this made on my radar was a Nick Gillespie editorial in Reason Magazine a while back. He was disappointed that blogging had not resulted in a more civil, robust conversation.

The most recent hit on my radar was the recent controversy surrounding Anne Coulter. Her point, which has some merit, is that the Left keeps using Holy Messengers to oppose Administration policies. I can't think of similar examples used by the Right, but that doesn't mean they exist. In a sense, Anne is saying that they are preemptively using an ad hominem argument since only a cad would argue with a grieving widow, and as we all know, cads are wrong. However, her own exposition on the topic is so laced with vile ad hominem arguments that it will not be taken seriously by anyone not already convinced.

The final hit on my radar was the ideology-free ideologue's incessant use of every trick on this page - a problem which he compounded by claiming, when caught in his fallacy, that you wouldn't hesitate to level such arguments against someone who had defrauded you.

So what is a better option than assuming or using any of the devices at the top? You could assume that your opponent was simply wrong without having to question his/her motives, intelligence, or sanity. That's a much more civil means of discovering common ground and truth. It confirms rather than denies their humanity.

Or you could assume that you are wrong. It happens.

The ideology-free ideology

I haven't participated in usenet in years, but I do occasionally participate in other blogs by their comments. I had almost forgotten about the ideology-free ideologue. For some reason, they always seem to turn out to be Neoprogressives, but that may simply be a problem of self-selection.

I'm not sure how they arrive at their particular politics, but it may be either or both of these paths:

• Tried socialism, kept bumping into failure, or
• believed in free market (nominal - see below), bumped into market failure

By nominal free market, I refer to the fact that the free market has never actually been completely free. Neoprogressives are quick to point this out, but as proto-progressives they seem to have been unaware of it.

Now, the person is a reformed, enlightened, passionate new convert, free of the blinders of ideology. They regard the unconverted as naive and benighted. Interestingly, rather than trying to proselytize, they frequently participate in discussions from a very condescending point of view, violating all or most of the ad hominem variants from this list (hat tip: Mike Huben).

I hereby admit guilt of having on occasion tried some of these things and promise to try not to use them anymore.

In fact, the claim to be ideology free is subject to serious question. Having an ideology means having a worldview, a conception of reality, a set of assumptions about the world. In its pejorative sense, "being ideological" or "being an ideologue" means having a narrow set of rules and forcing reality to fit them. however, lacking an ideology is possible by only two approaches of which I can think:

• Trivial: complete insanity, inability to coalesce facts into concepts, waking up in a new world every day, having no understanding of cause and effect
• Unlikely: Being free of evolutionary and cultural influences and personal experience

The second approach requires unbounded rationality; there are few such supermen (even Superman was influenced by the teaching of both Jor-El and the Kents).

Nolan Chart inadequacy

Most libertarians will probably have encountered the Nolan Chart, a graphical representation of an idea published by Lillie and Maddox about how many voters fell into a category of social liberal and fiscal conservative that was not captured by either party. The Nolan Chart is frequently accompanied by a silly quiz; the real power of the chart is in breaking the idea that everyone should be separable into either Left or Right wing politics. While useful as an example, it fails to adequately capture the entire political realm.

The Left/Right split is a metaphor used to reinforce power. We talk in terms of "the political spectrum", we make out our electoral maps in two colors, arguments are presented as have two sides, and so on. It is ridiculous to think that all questions faced by humans can be divided down the center. Where did this come from?

During the French Revolution, the National Assembly sat in order of their affiliation, from the Jacobins to the left to the monarchists on the right. Left became associated with radical change, while Right became associated with protection of the Ancien Regime. After they got a little out of hand (note: this is understatement), Napoleon put an end to the Revolution and then proceeded to overthrow the Ancien Regimes throughout Europe. Unfortunately, he also sought to establish a new one and got himself thrown out of France for attempting to win a war.

Meanwhile, in Great Britain, the landed aristocracy, who favored agricultural protectionism and mercantilism, were dealing with the Industrial Revolution. The rising merchant class wanted to trade, which put the in conflict with the aristocracy. The Mercantilist question was ultimately put to rest by the Scottish Enlightenment (Hume and Smith), giving birth to the Anti-Corn Law League. The Corn Laws were struck down, and they managed to take a great deal of power away from the monarchy and aristocracy in the process.

At the same time, in America, the Colonists had just won independence, only to discover that they couldn't pay their bills under the Confederacy. They wrote the Constitution to set up a stronger central government, but in the process (and with the return of Jefferson from abroad) set up a struggle between the Federalists, led by Hamilton, and the Democrat-Republicans, led by Madison and Jefferson. The Federalists favored a strong central government so they could build good credit and use that to promote industry. The D-Rs favored a decentralized government as well as Jefferson's theories about a nation of "yeoman farmers".

The Civil War interrupted the period of prosperity that followed the creation of the new Republic. The war pitted the northern industrialists against the southern agrarians. Each side adopted the language of States' Rights and Central Government handed down from pro-industrial Hamilton and pro-agrarian Jefferson. However, the liberals, forced to recognize the divergence between liberal principles and decentralization and agrarianism, were cut adrift and never to return to the Jeffersonian fold.

In Europe and GB after Napoleon, there generally followed a long period of peace and prosperity in all three regions until approximately 1848. At that time, the Europeans threw out the last vestiges of the old regimes and began to reap the reward of greater general wealth from the Industrial Revolution. With this wealth came a realization that they could now afford to effect social change. Robert Owen, a Welsh industrialist, noted that he got better productivity out of happy and literate factory workers and embarked upon a lifelong quest to establish a utopia. He never succeeded, but did manage to coin the term "socialism". During this time in England, the Brits passed a series of labor laws, especially the Factory Acts. Marx and Engels published the Communist Manifesto in 1848.

In the prosperous period after the two continental upheavals, a period of nearly unrivaled scientific discovery produced profound changes in the way men perceived the world. From Pasteur to Darwin, human understanding of the world seemed to multiply by the minute; they believed that soon they would be able to understand everything in its minutest operation, and therefore to scientifically manage both nature and man. This zeitgeist, coupled with the social upheavals, brought about the idea that human existence could be centrally planned and managed to bring about the maximum amount of happiness for everyone.

In Europe, then, the radicals merged with the socialists to try to bring about this change. They still used the radical language of fighting against monarchy, aristocracy, and hierarchy in general, bringing this rhetoric to bear against capitalists. There was no real defense of capitalism outside the Manchester school, Bastiat, and (later) the Austrian School. The result was the creation of an entrenched bureaucracy that, while still wearing the rhetorical trappings of radicalism, has assumed the place of the aristocracy. Pro-labor protection measures on the continent, and to a lesser extent in GB, are the new Corn Laws.

In America, liberals were cut from their decentralized, agrarian roots and put in search of a new philosophy. Social activists wanted scientific management of social problems. Business interests wanted relief from the variety of state laws rising up to regulate transcontinental trade made possible by the telegraph and railroad. The resulting alliance was known as Progressivism. The activists served as the moral cover and retained the nominal title of "liberal" while the business interests wrote legislation that enabled cartelization and captured regulatory agencies.

These are impressions of a few of the currents active in these two continents over the past 250 years. There are obvious deficiencies in that story. Trying to describe those currents in a few paragraphs is like trying to describe the ocean; you can look at a micro level and miss the big picture, or look at the big picture and miss the eddies and subtle variations, but you can't do both. So below I present two graphical depictions of the events described above.

In the first, describing the Continental experience, you see how Left and Right are associated with change and entrenched interests, but over time the Left moves into entrenchment while the Right moves toward the position of change relative to the left, but have now returned back to a center position. (yes, Virginia, the nationalists, nazis, fascists, and other such movements really did want to change things) That is why Europe is currently experiencing stagnation.
















In the second chart, we see the liberal and conservative interests start out under decentralization and centralization, respectively. After the Civil War, liberalism moves toward centralization. During the FDR era and afterwards, conservatism moves toward decentralization, but this movement saw its zenith with (pick one: Goldwater's campaign, the Sagebrush Rebellion, the "era of big government is over" speech).
















There are other interesting descriptions of possible Nolan-like charts here and here, but I haven't thoroughly vetted them. I think you'll agree that the political world deserves more than a 1D depiction.

The myth of YOYO

I came across a term that appears to be in wider use than I knew: YOYO. It stands for "You're on your own." Ironically, if it were not for the contraction, it would be YAOYO, which is Chinese for "giant man (YAO) [made] of straw (YO)."*

YOYO trumps any idea of government in the liberal tradition (note: "liberal" originally shared some etymology with "liberty" and was used to describe the tradition of Locke, Hume, Smith, Mills, Emerson, and Thoreau, and still shares that sense outside the English-speaking world and in the sense of neoliberalism). Under the YOYO argument, freedom of action (freewill) is turned on its head and implies a curse rather than a blessing.

But YOYO is a myth. It implies that government action is the only help you will get. It isn't clear how people acquire an altruistic and economical disposition when they become bureaucrats and politicians which they don't have when they're you're family, friends, and neighbors. Somehow, the otherwise stupid populace shucks their greedy or self-seeking motivations in the voting booth and elects similarly enlightened legislators who pass well-crafted acts which are enforced and enacted by wise and virtuous bureaucrats. Somehow, joining the Civil Service is thought to remove any of their lower motives and inclinations and turns them into thoughtful agents of altruism. These assumptions are completely preposterous.

YOYO has two other bogus assumptions: that no institutions exist to deliver aid if they aren't government institutions, and that government institutions are as effective as they are assumed by their proponents to be. A slightly more reasonable version of YOYO says that private institutions are always and everywhere imperfect, while government institutions are always and everywhere better. History shows that these assumptions are untrue.

Socialism, like the ancient ideas from which it springs, confuses the distinction between government and society. As a result of this, every time we object to a thing being done by government, the socialists conclude that we object to its being done at all.

We disapprove of state education. Then the socialists say that we are opposed to any education. We object to a state religion. Then the socialists say that we want no religion at all. We object to a state-enforced equality. Then they say that we are against equality. And so on, and so on. It is as if the socialists were to accuse us of not wanting persons to eat because we do not want the state to raise grain.
-- Bastiat

An important but long-forgotten example of private aid (and complete refutation of the YOYO ideal), Mutual Aid societies provided unemployment insurance, medical care (especially preventive care), catastrophic health coverage, hospital coverage, widow and orphan protection, and coverage for large swaths of minorities and the working classes, even in a less enlightened era (roughly, 1880-1920). They were arguably better than the Medicaid system available today; in fact, much of the current social safety net was based on early private institutions like unemployment insurance, and surveys of satisfaction were consistently high for the Mutual Aid societies while recipients of public health care in the US are less than satisfied by it. A large part of the problem with government interventions, though, is not what they do in static analysis, but in dynamic analysis.

Government programs have a serious competitive disadvantage in dynamic analysis. Long after the supposed rationale for an intervention has passed, the government program continues and moreover continues in its original configuration. As our experience with Mutual Aid showed, private aid is dynamic and responds to the market because it is possible for innovators to introduce new approaches. Some of those will fail, but some will not, and everyone will quickly adopt the successful approach. A government program will be defended in its original conception to the bitter end; politicians may only make the barest change because they come and go while the bureaucrats and their organization remain. As modern examples of mutual aid, I give you the hippy "communalism" ideal, cooperatives, and even Wikipedia.

I concede that privatization is a difficult case to make for those goods and services which are pure public goods, but there are three points to be made in that regard. First, few government enterprises are actually built to address market failures such as public goods problems, and in fact many public goods arguments are made up to justify existing government programs. Second, few public goods are pure public goods. Third, the fact that something is a public good does not mean that private institutions don't find a way around the barriers involved. Radio is a public good which is made available by mixing it with a public bad (commercials). Lighthouses were once thought to be an example of a pure public good until Ronald Coase showed that many if not most were privately built and funded (the only significant counter-argument to this merely bolsters a an alternative form of taxation favored by classical liberals, user fees). Roads and police are a less-pure public good whose history includes similar levels of private provision (see here for Dan Klein's extensive writing about private roads, and see here and here for but two of many articles David Friedman has written about the history of private law enforcement). National defense is just about the toughest case to make for private provision, but YOYO generally fails to defend the Army as something helpful to the individual.

That's interesting, since the army is the clearest illustration that when you aren't "on your own" due to government intervention, it is because the government is using force. In fact, force is behind every government intervention, either to effect the change in behavior or to acquire the money. "We're from the government and we're here to help" is so much more rhetorically appealing than, "We're going to jail or kill anyone who resists", so I can understand the reluctance to include that side of the question. When the opposition party seizes control of the levers and abuses them, they are demonized while the underlying structures and mechanisms are defended. Indeed, when one's own party abuses the system, even the abuses are defended. Thus, we can see the left defend the use of warrantless searches (Carnivore, Echelon), secret evidence and limitless detention for foreigners (Nasser Ahmed and the 1996 Antiterrorism and Effective Death Penalty Act), and foreign intervention (Somalia, Bosnia, Iraq, Afghanistan) under Clinton, and then both parties reverse roles under Bush, each acting as if things would be different if only they had power with no sense of irony whatsoever.

It is furthermore insulting to claim that you aren't on your own due to the largess of the government. There is no federal carwash or bake sale: they only get money by printing it or taking it from you. Thus, the claim that they are here to help is a claim that they are here to spend your money on your behalf. How is that better than spending your own money on your own behalf? The only way in which that can be helpful is if they are spending someone else's money on your behalf.

Government is the great fiction through which everybody endeavors to live at the expense of everybody else.
-- Bastiat

YOYO never examines the evidence of whether that is actually the case; they want you to assume it's someone else's money (someone they demonize as less deserving than you), and that it is being spent on your behalf. They take away $1 a penny at a time so you don't notice, give you back $0.50 worth of "benefits", demand gratitude and loyalty for the trick, and demonize those who would let you keep the $1 on the grounds that they actually intend to take the $1 and keep the $0.50, but never ask whether you are actually getting $0.50 worth of value that is spent “on your behalf”. What about

• Corporate welfare -- they are either spending your money (if you are an employee or owner of an affected business: oil, agriculture, etc.), or causing you to spend more of your own (through price supports, regulations, and taxes). But of course, it isn't advertised this way. Agricultural subsidies are for the benefit of family farms, the environment, market stability, and so on. If you own a farm, you may indeed be getting something albeit it out of your own pocket; if you don't, you are paying more than you get. Price supports for sugar are helpful to growers of corn because high fructose corn syrup is the preferred substitute. They don't help consumers and arguably lead to environmental degradation in sugar-growing regions, yet we still have them. YOYO conveniently forgets that such examples of government failure inconveniently mirror the market failures which they feel trump all argument.
  
• Social Security and Medicare -- There are costs to your employer for keeping you employed beyond the income that finds its way into your pocket. These include the employer matching for your SSI and Medicare, benefits, unemployment insurance, regulatory compliance, and paperwork. It is not clear how you are better off when money your employer would otherwise pay to you is diverted on your behalf to purchase goods and services that you could buy yourself. At retirement, it's tempting to think that your SSI is a free lunch, but it isn't. It's your own damn money, coming back to you at less than market rates (actually, it's your grandchildren's money, but that argument is only valid when used to describe government spending, and more specifically, only when used by Democrats when Republicans control Congress, or Republicans when Democrats control Congress, but never by the same party that controls Congress).
• In fact, it's worse than not being a free lunch. SSI is thought to be progressive, but is in fact regressive. In order of strength of effect: (A) People with lower incomes retire later and don't live as long, so they pay longer and receive fewer lifetime benefits. (B) People with lower income don't defer entry into the workforce to go to college, so they start paying earlier. (C) The tax is assessed against the first $90,000 of income, so the rate falls as your income rises above that (the definition of regressiveness). You would in most cases be better off on your own, especially if you are a post-Baby Boomer, since your lifetime returns are estimated to be between negative 1% and 3%.
• Many of your personal costs are higher thanks to regulations that protect businesses from competition. Beneficiaries include the steel industry, doctors, utility companies, and insurance companies. But, without these, YOYO argues that doctors might be incompetent, the steel industry might fail, and insurance companies might charge more. YOYO makes the absurd claim that by protecting them from competitors, they are protecting us from competition on the basis of the equally absurd claim that competition in a private good or service leads to higher costs and lower quality.

I concede that these goods will be underprovided for those who can't afford them in the private system. Yet, as the actual but largely unknown history of Mutual Aid shows, they will still be provided. I challenge any YOYO believer to acknowledge the corollary: that they are equally underprovided in the state system. Here's proof that they are: no politician or activist has ever said, "Stop! We have enough funding! We don't need any more;" in fact, quite the opposite is the case.

The alternative is not between a society where the government provides things perfectly and one in which a market provides them not at all (the YOYO argument). It is also not between a society where government provides them badly and a market provides them perfectly (the lazy libertarian's argument). It is between a society where government provides such goods and services imperfectly and one in which private parties provide them imperfectly. The significant advantage of the latter, however is that change is made slowly if at all, politicians use the system to acquire and maintain power at the expense of the intended beneficiaries, and the means of preventing opportunism (fraud and abuse) are expensive in the state provision case, while in the private system change is comparatively rapid, the system is transparent and largely free of power abuse, and the creative fraud and abuse prevention mechanisms are much less expensive.

* If it is not true, which it likely isn't, it should be.

The same thing ... only different

I recently came across a post with a point in it that I considered to be irresponsible, especially coming from environmental economist John Whitehead. In it, he claimed that "Electric utilities are natural monopolies -- business firms that must operate on a massive scale in order to bring costs down so that the product can be priced affordably." What on earth does "affordably" mean, exactly? That's a forgivable error if made by a laymen, but not by a practicing economist, especially an environmental economist interest in conservation.

The entire argument surrounding electric utilities and natural monopoly seem to be circular when "affordability" is taken as the reason. From what he's saying, it was recognized that electric utilities realize economies of scale, in other words, that marginal costs fall as the scope of the organization gets larger. It's true that coal-fired plants are extremely efficient on a large scale, and a single centrally planned distribution system is cheaper. So then why do they want them to change (the focus of the rest of the article)? Apparently because the system of franchised electric delivery has external costs like forced global warming, pollution, and the like, bringing into question whether the existing system is cheaper when comparing social cost instead of private cost.

But, focusing on private cost, the current system is "cheaper" in comparison to what, exactly?

The alternative to the current organization of the electric industry is not "the same thing but without regulatory controls on the prices". John even comes close to touching on this when he says, "The natural inclination of monopolies is to raise prices so that profit is maximized ... but electric utilities are heavily regulated in return for government's gift of monopoly status." If the government has given them monopoly status, it may not be a natural monopoly at all. Yet everyone treats the subject as if they are a natural monopoly and that regulation was necessary.

What is the purpose of regulation? Assuming no self-interest, we could say that suppliers favor it because there are increasing returns to scale, that politicians prefer it because they are looking out for the common good, and that consumers prefer it because energy is cheaper. It is true that the current scheme for generating and delivering electricity would be more expensive if there were no regulations. However, if there were no regulations, the industry would not be so organized. This reduces to the argument that if the existing system were different, than it would not be the existing system.

Further, what happens when we relax the assumption of no self-interest from above? We understand that suppliers favor regulation because they are rent-seekers and politicians prefer it because they are power-seekers. I don't have any source for these conclusions, but it seems easy to extrapolate from Gabriel Kolko's findings in the railroad, banking, and other regulated industries.

How does such regulation work? Competitors aren't banned outright, but rather are thwarted by "public benefit" clauses. If I decide to start my own utility -- let's say I'm going to use a solar system -- I must first obtain a license. At the hearings, the license will be opposed by someone (a lawyer for existing utilities) who will argue that because my method of generating electricity is more expensive, then it will not benefit consumers and therefore my license should be denied. In fact, arguing only on private cost, this will be correct because solar costs about $0.20/kW-h to generate, compared to about $0.02/kW-h to generate from a nuclear plant and $0.03/kW-h to generate from a coal-fired plant. But if that is the case, I will fail on my own without need for a regulatory agency to interfere -- what purpose do they serve? If it is redundant to prevent high cost competitors from entering competition, it seems obvious to conclude that the purpose of the regulatory agency is to prevent lower cost competitors from entering competition, which largely undermines the argument that regulated monopolies are the low cost method of providing energy.

I have now asserted that the current organization of energy utilities is the low-cost method, but that the method by which they protect the organization undermines the claim about being low cost. What gives?

Electricity generation was pioneered by Thomas Edison and underwent significant innovation by Westinghouse and his genius engineer, Nikola Tesla, in the late 1880s and early 1890s. Urban areas were the first to be electrified because of the population density. Rural areas were electrified by a distributed system (windmills) until the advent of the REA. I propose that the following alternative history may have shaped the industry if natural monopoly regulation never appeared in the lexicon: Competitors would set up on opposite sides of each town and begin building distribution systems until they hit the territory supplied by other producers. The redundant generation and distribution systems would indeed have been more expensive to producers. If you were in the neighborhood supplied by a less well managed producer, your electricity would be more costly and/or less reliable. People in the marginal neighborhoods could entice the better supplier to build inroads, so prices would be tempered by competition. Businesses would relocate to the better-supplied neighborhoods, depriving the higher cost suppliers of revenue and opening them to bankruptcy, failure, and takeover. Weaker competitors would have reason to combine efforts, for example by sharing lines as well as by merging. Some companies might sell generation capacity and specialize in distribution while others did the opposite. The market for electricity would tend toward consolidation, but would also be tempered by new entrants and competition between large rivals in much the same way as the auto industry is.

Electricity would in fact have been more expensive to the consumer as well as the producer. But that does not necessarily leave consumers worse off than they are now for two reasons: first, more expensive electricity means less generation and less pollution, and second because of the increased importance of conservation measures.

Some measures were already available to consumers with the technology available to them at that time, but there can be no doubt that consumer technology would have taken a different course. Electrical heating is just about the least efficient method of heating a house, but it grew in popularity because the price of electricity was held artificially low compared to natural gas until deregulation in 1980. Passive methods for cooling and heating were largely abandoned because fans, air conditioners, and central heating were so cheap and convenient. Fluorescent lights were invented by Tesla and displayed at the 1893 World's Fair and were in wide use by 1938, but were not made compact and inexpensive enough for household use until the 1990s. Would there have been more emphasis on developing them if incandescent lighting were more expensive? Skylights are an easy alternative, but only recently exploited by Wal-mart in the design of their stores. Low ambient lighting and focused task lighting might have come into vogue earlier instead of the high levels of ambient lighting now almost universally used.

Furthermore, consider what might have been the case if we had developed distributed methods of generation. Currently, about 2/3 of the energy that goes into electric generation is lost as waste heat. Windmills already existed and are currently the favored method of renewable energy, but only in large windfarms. What if every household had one of those old Aermotor windmills like they used to? Surely, a method for sharing my excess power with my neighbors would have grown up, even if it meant that we paid someone to run lines and then run interconnection and backup systems. In such an environment, it would be more feasible for the average homeowner and business to install solar on the roof in order to decrease costs or even improve profitability.

I propose that all of the methods currently advocated for lowering household energy bills would have been more highly developed had there been no public utility regulation. The current organization is the low cost method of delivering energy, but not of consuming it, its uses (lighting, heating and cooling, etc.), or its substitutes (passive design, renewable sources). It's even arguable whether the current system is the low cost of delivering energy given the potential benefits of distributed generation (heat loss, land lost to powerlines, lower susceptibility to system-wide failures). Yes, the centrally planned public utility has an efficient generation and distribution system, but the alternative is not the same system with unconstrained pricing. The alternative is a collection of substitutes, distributed and competitive generation, innovative distribution schemes, and so on.

These are the same outcomes for which advocates of fuel, gas, or other energy taxes implicitly hope. More expensive gasoline is thought to both push consumers toward more efficient vehicles, mass transportation, and different living circumstances (denser communities), while simultaneously coaxing suppliers into developing the more efficient vehicles as well as alternative forms of energy.

The use of energy on roads was made possible by the Progressive "Good Roads" movement of the early 20th century as a direct assault on the supposed market power of the railroads (which, at that time, were ironically almost all in bankruptcy because of the pressure of competition, hence their interest in the Interstate Commerce Commission and its ability to act as a cartelizing agency). The substitution of electricity for passive lighting, cooling, and heating was made possible by the Progressive public utility regulation movement of the early 20th century as a direct assault on the supposed market power of the electric utilities. We are suffering as a result of both of these attempts to scientifically organize society from that era, but the central planners never seem to learn their lesson.

It is arguable that had this regulation not been adopted, we would have seen slower economic growth over the last century. We would not have the same magnitude of environmental concerns that we have now, nor would we have the same means to address them. However, growth would not be so slow as we would calculate if we simply increased the price of electricity over the past century because the pace and direction of consumer technology would have been different, too. In this way, central planning is focused on short term outcomes and market solutions are more flexible in the long term, which is exactly opposite to what central planners will tell you.