Sowell Basic Economics A Citizen's Guide to the Economy
.pdfBy infringing or negating property rights, affluent and wealthy property owners are able to keep out people of average or low incomes and, at the same time, increase the value of their own property by ensuring its growing scarcity relative to increasing employment in the area. Some even acquire a sense of moral superiority in doing so, demonizing the intermediaries who seek to transfer land to new uses. "Developer" is as much of a dirty word among those protecting the status quo in California as "profits" were to India's socialist Prime Minister Nehru.
While strict adherence to property rights would allow landlords to evict tenants at will, the economic incentives are for them to do just the opposite-to try to keep their apartments as fully rented and as continuously occupied as possible, so long as the tenants pay their rent and behave themselves. Only when rent control or other restrictions on their property rights are enacted are landlords likely to do otherwise. Under rent control and tenants rights laws, landlords have been known to try to harass tenants into leaving, whether in New York or in Hong Kong.
Under stringent rent control and tenants rights laws in Hong Kong, landlords were known to sneak into their own buildings late at night to vandalize the premises, in order to make them less attractive or even unlivable, so that tenants would move out and the empty building could then be torn down legally, to be replaced by something more lucrative as commercial or industrial property. This of course was by no means the purpose or intention of those who had passed rent control laws in Hong Kong. But it illustrates again the importance of making a distinction between intentions and effects-and not just as regards property rights laws. In short, incentives matter and property rights need to be assessed economically in terms of the incentives created by their existence, their modifications, or their elimination.
The powerful incentives created by a profit-and-loss economy depend on the profits being private property. When government-owned enterprises in the Soviet Union made profits, those profits were not their private property but belonged to "the people"-or, in more mundane terms, could be taken by the government for whatever purposes higher officials chose to spend them On. Soviet economists Schmelev and Popov pointed out and lamented the adverse effects of this on incentives:
But what justifies confiscating the larger part-sometimes 90-95 percent-of enterprises' profits, as is being done in many sectors of the economy today?
What political or economic right-ultimately what human right-do ministries have to do that? Once again we are taking away from those who work well in order to keep afloat those who do nothing. How can we possibly talk about independence, initiative, rewards for efficiency, quality, and technical progress?
Of course, the country's leaders could continue to talk about such things, but destroying the incentives which exist under property rights meant that there was a reduced chance of achieving these goals. Because of an absence of property rights, those who ran enterprises that made profits "can't buy or build anything with the money they have" which represent "just figures in a bank account with no real value whatever without permission from above" to use that money. In other words, success does not lead to expansions of successful enterprises or contraction of unsuccessful ones, as it does in a market economy.
While government officials in the United States cannot arbitrarily confiscate profits as directly as Soviet officials could, American legislators can pass laws imposing costs on private enterprises, thereby causing profits to be reduced-and incentives to be changed. In California, for example, the state legislature passed a law requiring landlords to give elderly tenants a year's notice before evicting them and to pay up to $3,000 to each tenant evicted, to help with relocation costs. This legislation was intended to deal with the danger of mass evictions by
landlords who were losing money under rent control in places like San Francisco, and who wanted to stop renting.
Since this legislation went into effect on January 2, 2000, owners of cheap hotels in San Francisco evicted many elderly tenants during December 1999, in order to escape these impending costs of shutting down their hotels. Here again, the goals of the law were very different from the consequences which, in this case, caused many poor and elderly single men to be thrown out on the streets during the Christmas season, in a city with a severe housing shortage and the highest rents in the country. Far more anger and indignation were directed at the hotel owners than at those who had passed such legislation. Yet, in the absence of attempts to confiscate profits through both rent control laws and laws on evictions, the ordinary incentives of property rights and a free market would have caused the hotel owners to want to keep all the tenants they could.
Social Order
Order includes more than laws and the government apparatus that administers laws. It also includes the honesty, reliability and cooperativeness of the people themselves. Honesty and reliability can vary greatly between one country and another. As a knowledgeable observer put it: "While it is unimaginable to do business in China without paying bribes, to offer one in Japan is the greatest faux pas." Honesty and reliability can also vary widely among particular groups within a given country, and that also has economic repercussions. Some insular groups rely upon their own internal social controls for doing business with fellow group members whom they can trust. One such group are the Marwaris of India, whose business networks were established in the nineteenth century and extended beyond India to China and Central Asia, and who "transacted vast sums merely on the merchant's word." But "doing business among strangers," as The Economist puts it, "is not easy" in India. Yet that is an essential part of a successful modern mass economy, which requires cooperation among far more people than can possibly know each other personally. As for the general level of reliability among strangers in India, The Economist reported:
If you withdraw 10,000 rupees from a bank, it will probably come in a brick of 100-rupee notes, held together by industrial strength staples that you must struggle to prise open. They are there to prevent someone from surreptitiously removing a few notes. On trains, announcements may advise you to crush your empty mineral-water bottles lest someone refill them with tap water and sell them as new. . . . Any sort of business that requires confidence in the judicial system is best left alone.
Where neither the honesty of the general population nor the integrity of the legal system can be relied upon, economic activities are inhibited. At the same time, groups whose members can rely on each other, such as the Marwaris, have a great advantage in competition with others, in being able to secure mutual cooperation in economic activities that extend over distances and time-activities that would be far more risky for others in such societies and still more so for strangers.
Like the Marwaris, Hasidic Jews in New York's jewelry business often give consignments of jewels to one another and share the sales proceeds on the basis of verbal agreements among themselves. The extreme social isolation of the Hasidic community from the larger society, and even from other Jews, makes it very costly for anyone who grows up in that community to disgrace his family and lose his own standing, as well as his own economic and social relationships, by cheating on an agreement with a fellow Hasidim.
It is much the same story halfway around the world, where the overseas Chinese minority in various southeast Asian countries make verbal agreements among themselves, without the sanction of the local legal system.
Given the unreliability and corruption of some of these post-colonial legal systems, the ability of the Chinese to rely on their own social and economic standards gives them an economic advantage over their indigenous competitors who lack an equally reliable and inexpensive way of making transactions.
The costs of doing business are thus less for the Chinese than for Malay, Indonesian or other businesses in the region, giving the Chinese competitive advantages. This ability to rely on others within the group or family has likewise been a factor in the remarkable success of the Palanpuri Jains in India, who are the leading diamond suppliers there and who also control half the world's supply of uncut diamonds. Indeed, these Jains have begun to displace Jews in Antwerp, where about 90 percent of the world's uncut diamonds and half of its polished diamonds are sold.
Although businesses in some American communities must incur the extra expense of heavy grates for protection from theft and vandalism while closed and security guards for protection while open, businesses in other American communities have no such expenses and are therefore able to operate profitably while charging lower prices. Rental car companies can park their cars in lots without fences or guards in some communities, while in other places it would be financial suicide to do so. But, in those places where rare car thefts from unguarded lots cost less than paying guards and maintaining fences would cost, then rental car agencies-and other businesses-can flourish in such communities.
In short, honesty is more than a moral principle. It is also a major economic factor. While government can do little to create honesty, in various ways it can either support or undermine the traditions on which honest conduct is based. This it can do by what it teaches in its schools, by the examples set by public officials, or by the laws that it passes. These laws can create incentives toward either moral or immoral conduct. Where laws create a situation where the only way to avoid ruinous losses is by violating the law, the government is in effect reducing public respect for laws in general and rewarding dishonest behavior. Advocates of rent control, for example, often point to examples of villainy among landlords to demonstrate the need for both rent control itself and related tenants' rights legislation. However, rent control laws can widen the difference between the value of a given apartment building to honest owners and dishonest owners. Where the cost of legally mandated services is high enough to equal or exceed the amount of rent permitted under the law, the value of a building to an honest landlord can become zero or even negative. Yet, to a landlord who is willing to violate the law and save money by neglecting required services, or who accepts bribes from prospective tenants, the building may still have some value.
Where something has different values to different people, it tends to move through the marketplace to its most valued use, which is where the bids will be highest. In this case, dishonest landlords can easily bid apartment buildings away from honest landlords, some of
whom may be happy to escape the bind that rent control puts them in. Landlords willing to resort to arson may find the building most valuable of all, if they can sell the site for commercial or industrial use after burning the building down, thereby getting rid of both tenants and rent control. As one study found:
In New York City, landlord arsons became so common that the city responded with special welfare allowances. For a while, burned-out tenants were moved to the top of the list for coveted public housing. That then gave tenants an incentive to burn down the buildings in which they lived-which they did, often moving television sets and furniture out onto the sidewalk before starting the fire.
Those who create incentives toward widespread dishonesty by promoting laws which make honest behavior financially impossible are often among the most indignant at the dishonesty-and the least likely to regard themselves as in any way responsible for it. Arson is just one of the forms of dishonesty promoted by rent control laws. Shrewd and unscrupulous landlords have made virtually a science out of milking a rent-controlled building by neglecting maintenance and repairs, defaulting on mortgage payments, falling behind in the payment of taxes, and then finally letting the building become the property of the city, while they move on to repeat the same destructive process with other rent-controlled buildings.
Without rent control, the incentives facing landlords are directly the opposite-that is, to maintain the quality of the property, in order to attract tenants, and to safeguard it against fire and other sources of dangers to the survival of the building. In short, complaints against landlords' behavior by rent control advocates can be valid, even though few of these advocates see any connection between rent control and a declining moral quality in people who become landlords. When honest landlords stand to lose money under rent control, while dishonest landlords can still make a profit, it is virtually inevitable that the property will pass from the former to the latter.
Rent control laws are just one of a number of severe restrictions which can make honest behavior too costly for many people, and which therefore promote widespread dishonesty. Bureaucratic delays in many countries such as India virtually ensure that bribery will become widespread when the costs of these delays become greater than the costs of the bribes. The Prohibition era in the United States during the 1920s made widespread violation of the bans against alcoholic beverages so common as to become almost respectable among the general public, quite aside from the boost that it gave to organized crime. It is common in Third World countries for much-sometimes most--economic activity to take place "off the books," which is to say illegally, because oppressive levels of bureaucracy and red tape make legal operation too costly for most people to afford.
When laws and policies make honesty increasingly costly, then government is, in effect, promoting dishonesty. Such dishonesty can extend then beyond the particular laws and policies in question to a more general habit of disobeying laws, to the detriment of the whole economy and society.
EXTERNAL COSTS AND BENEFITS
Economic decisions made through the marketplace are not always better than decisions that
governments can make. Much depends on whether those market transactions accurately reflect both the costs and the benefits which result. Under some conditions, they do not.
When someone buys a table or a tractor, the question as to whether it is worth what it cost is answered by the actions of the purchaser who made the decision to buy it. However, when an electric utility company buys coal to burn to generate electricity, a significant part of the cost of the electricity generating process is paid by people who breathe the smoke that results from the burning of the coal and whose homes and cars are dirtied by the soot.
Cleaning, repainting and medical costs paid by these people are not taken into account in the marketplace, because these people do not participate in the transactions between the coal producer and the utility company.
Their costs are called "external costs" by economists because such costs fall outside the parties to the transaction that creates these costs. External costs are therefore not taken into account in the marketplace, even when these are very substantial costs, which can extend beyond monetary losses to include bad health and premature death.
While there are many decisions that can be made more efficiently through the marketplace than by government, this is one of those decisions that can be made more efficiently by government than by the marketplace. Clean air laws can reduce harmful emissions by legislation and regulations. Clean water laws and laws against disposing of toxic wastes where they will harm people can likewise force decisions to be made in ways that take into account the external costs that would otherwise be ignored by those transacting in the marketplace.
By the same token, there may be transactions that would be beneficial to people who are not party to the decision-making, and whose interests are therefore not taken into account. The benefits of mud flaps on cars and trucks may be apparent to anyone who has ever driven in a rainstorm behind a car or truck that was throwing so much water or mud onto his windshield as to dangerously obscure vision. Even if everyone agrees that the benefits of mud flaps greatly exceed their costs, there is no feasible way of buying those benefits in a free market, since you receive no benefits from the mud flaps that you buy and put on your own car, but only from mud flaps that other people buy and put on their cars and trucks. These are "external benefits." Here again, it is possible to obtain collectively through government what cannot be obtained individually through the marketplace, simply by having laws passed requiring all cars and trucks to have mud flaps on them.
Some benefits are indivisible. Either everybody gets these benefits or nobody gets them. Military defense is one example. If military defense had to be purchased individually through the marketplace, then those who felt threatened by foreign powers could pay for guns, troops, cannon and all the other means of military deterrence and self-defense, while those who saw no dangers could refuse to spend their money on such things. However, the level of military security would be the same for both, since supporters and non-supporters of military forces are intermixed in the same society and exposed to the same dangers from enemy action.
Given the indivisibility of the benefits, even some citizens who fully appreciate the military dangers, and who consider the costs of meeting those dangers to be fully justified by the benefits, might still feel no need to spend their own money for military purposes, since their individual contribution would have no serious effect on their own individual security, which would depend primarily on how much others contributed. In such a situation, it is entirely possible to end up with inadequate military defense, even if everyone understands the cost of effective defense and considers the benefits worth it.
By collectivizing this decision and having it made by government, an end result can be
achieved that is more in keeping with what most people want than if those people were allowed to decide individually what to do. Even among free market advocates, few would suggest that each individual should buy military defense in the marketplace. In short, there are things that government can do more efficiently than individuals because external costs or external benefits make individual decisions, based on individual interests, a less effective way of weighing costs and benefits to the whole society.
INCENTIVES AND CONSTRAINTS
Government is of course inseparable from politics, especially in a democratic country, so a distinction must made and kept in mind between what a government can do to make things better than they would be in a free market and what it is in fact likely to do under the influence of political incentives and constraints. The distinction between what the government can do and what it is likely to do can be lost when we think of the government as simply an agent of society or even as one integral performer. In reality, the many individuals and agencies within a national government have their own separate interests, incentives, and agendas, to which they may respond far more often than they respond to either the public interest or to the policy agendas set by political leaders. Even in a totalitarian state such as the Soviet Union, different branches and departments of government had different interests that they pursued, despite whatever disadvantages this might have for the economy or the society. For example, industrial enterprises in different ministries avoided relying on each other for equipment or resources, if at all possible. Thus an enterprise located in Vladivostok might order equipment or natural resources that it needed from another enterprise under the same ministry located in Minsk, thousands of miles away, rather than depend on getting what they needed from another enterprise located nearby in Vladivostok that was under the control of a different ministry.
Thus materials might be needlessly shipped thousands of miles eastward on the overburdened Soviet railroads, while the same kinds of materials were also being shipped westward on the same railroads by another enterprise in another ministry.
Such economically wasteful cross-hauling was one of many inefficient allocations of scarce resources due to the political reality that government is not a monolith, even in a totalitarian society. In democratic societies, where innumerable interest groups are free to organize and influence different branches and agencies of government, there is even less reason to expect that the government will follow one coherent policy, much less a policy that would be followed by an ideal government representing the public interest.
Under popularly elected government, the political incentives are to do what is popular, even if the consequence are worse than the consequences of doing nothing, or doing something that is less popular. As an example of what virtually everyone now agrees was a mistaken policy, the Nixon administration in 1971 created the first peacetime nationwide wage controls and price controls in the history of the United States. Among those at the meeting where this fateful decision was made was internationally renowned economist Arthur F. Burns, who argued strenuously against the policy being considered-and was over-ruled. Nor were the other people present economically illiterate. The president himself had long resisted the idea of wage and price controls and had publicly rejected the idea just eleven days before doing an about-face and accepting it. Inflation had created mounting pressures from the public and the media to "do
something." With a presidential election due the following year, the administration could not afford to be seen as doing nothing while inflation raged out of control.
However, even aside from such political concerns, the participants in this meeting were "exhilarated by all the great decisions they had made" that day, according to a participant. Looking back, he later recalled "that more time was spent discussing the timing of the president's speech than how the economic program would work." There was particular concern that, if his speech were broadcast in prime time, it would cause cancellation of the very popular television program Bonanza, leading to public resentments. Here is what happened:
Nixon's speech-despite the preemption of Bonanza-was a great hit. The public felt that the government was coming to its defense against the price gougers . . . During the next evening's newscasts, 90 percent of the coverage Was devoted to Nixon's new policy. The coverage was favorable. And the Dow Jones Industrial Average registered a 32.9 point gain-the largest one-day increase up to then.
In short, the controls were a complete success politically. As for their economic consequences:Ranchers stopped shipping their cattle to the market, farmers drowned their chickens, and consumers emptied the shelves of supermarkets.
In short, artificially low prices led to supplies being reduced while the demands of consumers increased. For example, more American cattle began to be exported, mostly to Canada, instead of being sold in the price-controlled U.S. market. Thus price controls produced essentially the same results under the Nixon administration as they had produced in the Roman Empire under Diocletian, in the Soviet Union under the Communists, in Ghana under Nkhrumah, and in numerous other times and places where such policies had been tried before. Nor was this particular policy unique politically in how it was conceived and carried out. Veteran economic adviser Herbert Stein observed, 25 years after the Nixon administration meeting at which he had been present, "failure to look ahead is extremely common in government policy making." Another way of saying the same thing is that political time horizons tend to be much shorter than economic time horizons. Before the full economic consequences of the wage and price control policies became widely apparent, Nixon had been re-elected with a landslide victory at the polls. There is no "present value" factor to force political decision-makers to take into account the long-run consequences of their current decisions.
One of the important fields neglected as a result of the short political time horizon is education. As a writer in India put it, "No one bothers about education because results take a long time to come." This is not peculiar to India.
With fundamental educational reform being both difficult and requiring years to show end results, it is politically much more expedient for elected officials to demonstrate immediate "concern" for education by voting to spend increasing amounts of the taxpayers' money on it, even if that leads only to more expensive incompetence.
The constraints within which government policy-making operates are as important as the incentives. Important and beneficial as a framework of rules of law may be, what that also means is that many matters must be dealt with categorically, rather than incrementally. The application of categorical laws prevents the enormous powers of government from being applied at the discretion or whim of individual functionaries, which would invite both corruption and arbitrariness. However, there are many things which require discretionary incremental adjustments, as noted in Chapter 4, and for these things categorical laws can be difficult to apply or can produce counterproductive results. For example, while prevention of air pollution and water pollution are widely recognized as legitimate functions of government, which can
achieve more economically efficient results than those of the free market, doing so through categorical laws can create major problems. Despite the political appeal of categorical phrases like "clean water" and "clean air," there are in fact no such things, never have been, and perhaps never will be.
Moreover, there are diminishing returns in removing impurities from water or air. A study of environmental risk regulation cited a former administration of the Environmental Protection Agency on this:
A former EPA administrator put the problem succinctly when he noted that about 95 percent of the toxic material could be removed from waste sites in a few months, but years are spent trying to remove the last little bit. Removing that last little bit can involve limited technological choice, high cost, devotion of considerable agency resources, large legal fees, and endless argument.
Reducing truly dangerous amounts of impurities from water or air may be done at costs that most people would agree were quite reasonable. But, as higher and higher standards of purity are prescribed by government, in order to eliminate ever more minute traces of ever more remote or more questionable dangers, the costs escalate out of proportion. Even if removing 98 percent a given impurity costs twice as much as eliminating 97 percent, and removing 99 percent costs ten times as much, the political appeal of categorical phrases like "clean water" may be just as potent when the water is already 99.9 percent pure as when it was dangerously polluted.
Depending on what the particular impurity is, minute traces mayor may not pose a serious danger. But political controversies over impurities in the water are unlikely to be settled at a scientific level when passions can be whipped up in the name of non-existent "clean water." No matter how pure the water becomes, someone can always demand the removal of more impurities. And, unless the public understands the logical and economic implications of what is being said, that demand can become politically irresistible, since no public official wants to be known as being opposed to clean water.
It is not even certain that reducing extremely small amounts of substances that are harmful in larger amounts reduces risks at all. For example, although high doses of saccharin have been shown to increase the rate of cancer in laboratory rats, very low doses seem to reduce the rate of cancer in these rats.
This is similar to research findings that, although a large intake of alcohol shortens people's lifespan, very modest amounts of alcohol-like one glass of Wine or beer per day-tend to reduce life-threatening conditions like hypertension. If there is some threshold amount of a particular substance required before it becomes harmful, that makes it questionable whether spending vast amounts of money to try to remove that last fraction of one percent from the air or water is going to make the public safer by even a minute amount. It also raises questions about basing categorical policies on laboratory tests which conclude, for example, that saccharin is dangerous to humans because great amounts of it cause cancer in laboratory rats.
The same principle applies in many other contexts, where minute traces of impurities can produce major political and legal battles-and consume millions of tax dollars with little or no net effect on the health or safety of the public. For example, one legal battle raged for a decade over the impurities in a New Hampshire toxic waste site, where these wastes were so diluted that children could have eaten some of the dirt there for 70 days a year without any significant harm-if there had been any children playing there, which there were not. As a result of spending more than nine million dollars, the level of impurities was reduced to the point where children could have safely eaten the dirt there 245 days a year. Moreover, without anything being done at
all, both parties to the litigation agreed that more than half the volatile impurities would have evaporated by the year 2000. Yet hypothetical dangers to hypothetical children kept the issue going.
With environmental safety, as with other kinds of safety, some forms of safety in one respect create dangers in other respects. California, for example, required a certain additive to be put into all gasoline sold in that state, in order to reduce the air pollution from automobile exhaust fumes. However, this new additive tended to leak from filling station storage tanks and automobile gas tanks, polluting the ground water in the first case and leading to more automobile fires in the second. Similarly, government-mandated air bags in automobiles, introduced to save lives in car crashes, have themselves killed small children.
These are all matters of incremental trade-offs to find an optimal amount and kind of safety, in a world where being categorically safe is as impossible as achieving 100 percent clean air or clean water. Incremental trade-offs are made all the time in individual market transactions, but it can be politically suicidal to oppose demands for more clean air, clean water or automobile safety. Therefore saying that the government can improve over the results of individual transactions in a free market is not the same as saying that it will in fact do so. Among the greatest external costs imposed in a society can be those imposed politically by legislators and officials who pay no costs whatever, while imposing billions of dollars in costs on others, in order to respond to political pressures from advocates of particular interests or ideologies.
By the same token, while external costs are not automatically taken into account in the marketplace, this is not to say that there may not be some imaginative ways in which they can be. In Britain, for example, ponds or lakes are often privately owned, and these owners have every incentive to keep them from becoming polluted, since a clean body of water is more attractive to fishermen or boaters who pay for its use. Similarly with shopping malls: Although maintaining clean, attractive malls with benches, rest rooms and security personnel costs money that the mall owners do not collect from the shoppers, a mall with such things attracts more customers, and so the rents charged the individual store owners can be higher because a location in such malls is more valuable than in a mall without such amenities.
In short, while externalities are a serious consideration in determining the role of government, they do not simply provide a blanket justification or a magic word which automatically allows economics to be ignored and politically attractive goals to be pursued without further ado. Both the incentives of the market and the incentives of politics must be weighed when choosing between them on any particular issue.
Just as we must keep in mind a sharp distinction between the goals of a particular policy and the actual consequences of that policy, so we must keep in mind a sharp distinction between the purpose for which a particular governmental power was created and the purposes for which that power can be used. For example, President Franklin D. Roosevelt took the United States off the gold standard in 1933 under presidential powers created during the First World War to prevent trading with enemy nations. Though that war had been over for more than a dozen years and we no longer had any enemy nations, the power was still there to be used for wholly different purposes.
Powers do not expire when the crises that created them have passed. Nor does the repeal of old laws have a high priority among legislators. Still less are institutions likely to close up on their own when the circumstances that caused them to be created no longer exist. For example, during the depths of the Great Depression of the 1930s, when money was in short supply, the Reconstruction Finance Corporation was created to lend money to American banks and
businesses, in order to try to maintain production and employment. Yet the RFC continued in existence for years after the depression was history and the economy was going through a boom, with money in such abundant supply as to create inflation.
When the RFC was finally closed down by Congress in 1953, the blow was softened politically by creating a "temporary" agency called the Small Business Administration to do some of the things that the RFC had been doing, but only for small and presumably struggling enterprises. Just a few years later, however, the SBA was made permanent--and then grew by leaps and bounds in the decades ahead. Despite its rationale of helping small "mom and pop" businesses, SBNs loans seldom went to such businesses and in fact concentrated on businesses of some substantial size-in one extreme case, a business with 30,000 employees and annual sales of nearly a billion dollars. Far from helping small businesses get started, it was helping a failed big business to drag out its death throes for a few more years with the taxpayers' money. Whatever Congress or the voters may have thought when they supported the creation of this agency, once it was in existence it responded to an ever-changing variety of political pressures and opportunities, taking on roles never contemplated when it was created.