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Why Free-Market Advocates Are Not Obligated to Defend the Economic Status Quo – Video by G. Stolyarov II

Why Free-Market Advocates Are Not Obligated to Defend the Economic Status Quo – Video by G. Stolyarov II

The New Renaissance Hat
G. Stolyarov II

Many on the political left today equate advocacy of free-market capitalism with an “anything goes” support for the economic status quo. Many on the political right give credence to this perception by, indeed, seeking to defend the status quo just because it happens to be so. Yet this is neither an obligatory nor an advisable approach for characterizing a genuinely well-considered free-market outlook.

Suppose that you are a free-market advocate and also an engineer, well-versed in the principles and methods for constructing durable, safe structures. Suppose you also identify severe deficiencies in a bridge proposed to be constructed by a completely private enterprise. Mr. Stolyarov explores the implications of this dilemma and the appropriate responses in a free society.


– “Why Free-Market Advocates Are Not Obligated to Defend the Economic Status Quo” – Article by G. Stolyarov II

Why Free-Market Advocates Are Not Obligated to Defend the Economic Status Quo – Article by G. Stolyarov II

Why Free-Market Advocates Are Not Obligated to Defend the Economic Status Quo – Article by G. Stolyarov II

The New Renaissance Hat
G. Stolyarov II

Many on the political left today equate advocacy of free-market capitalism with an “anything goes” support for the economic status quo. Many on the political right give credence to this perception by, indeed, seeking to defend the status quo just because it happens to be so. Yet this is neither an obligatory nor an advisable approach for characterizing a genuinely well-considered free-market outlook.

Suppose that you are a free-market advocate and also an engineer, well-versed in the principles and methods for constructing durable, safe structures. You hold that individuals and businesses should have the freedom to be able to build structures which would improve human well-being, in exchange for the opportunity to earn a profit (or not, if they wish to build structures for a charitable purpose). Now suppose that you are tasked with evaluating the integrity of a particular structure constructed by a private business – perhaps a bridge. This particular bridge happens to be fully privately funded – no subsidies, no exclusive rights, no barriers to competitors’ entry. The business undertaking the construction intends for the bridge to be used as part of a major new toll road that is intended to carry massive amounts of traffic.

Unfortunately, upon deploying your technical skillset and studying the bridge design carefully, you find that the bridge, while it is represented as being able to withstand one thousand cars at a time, would in fact collapse under the weight of only five hundred cars. You also find that, in your basic repertoire of engineering techniques, you have knowledge of construction techniques and superior materials which would rectify these design flaws and enable the bridge to be as safe and as durable as originally represented. The trouble is that the business owners want to hear none of it. They are attached to their original design partly out of cost considerations, but mostly because they simply cannot understand your findings or appreciate their significance, no matter how many different ways you have attempted to communicate them. The business owners have almost no engineering knowledge themselves and are generally contemptuous of overtly mathematical, “nerdy” types (like you). They are skilled salespeople who have capital from a previous venture and are eager to make additional money on a high-profile project such as this bridge. Suppose that you know that you have all of the technical knowledge of your discipline firmly on your side, but it is the owners’ money on the line, so, unconvinced by your arguments, they build the bridge according to their original specifications. They still advertise it as highly durable, but in a sufficiently nebulous way that the advertisements do not truly make any specific promises or technical claims. (This business is short on technically knowledgeable professionals, but spares no expense in hiring attorneys to litigation-proof its marketing materials.) The driving public’s impression from the marketing campaign is expected to be, “It is an incredibly sturdy, state-of-the-art, daring new bridge that you will enjoy driving on in safety and style.” The business owners contend that there is no problem. After all, were this a truly free market, the public could choose to pay to use their bridge or to find some alternative in getting from point A to point B. And competitors could build their own bridges, too, if they could buy the land, purchase the tools and materials, and hire the labor to do it.

Of course, on most days, this bridge would not collapse, since it is rare for five hundred cars to be on it simultaneously. The owners could well be reaping profits from their bridge for years and convince the lay public to drive on it with no visible ill consequences during that time. The bridge is, however, vulnerable to high winds, earthquakes, freezing damage, and gradual deterioration over time (exacerbated by substandard construction). As time passes, the risks of collapse increase. No bridge is invulnerable, but this particular bridge is about 30 years farther along the path to decay than other bridges that you know could easily have been built in its place, had the owners only listened to you. As a free-market advocate, you have some sympathies with the owners’ view that the construction of the bridge should not be forcibly prevented, as they are using their own property for their own chosen purposes, and they are not forcing anyone to use it. However, as an engineer who knows better when it comes to quality of bridge design and construction, what do you do?

This dilemma illustrates a question at the core of how free-market advocates approach the world in which they find themselves – a world, of course, which is far from free in an economic sense, but where many people still use their own property for their own purposes. There are some who will assert that the very fact of private, voluntary use of property renders such use inherently above criticism, provided it is a manifestation of free choice. (We can overlook, for the sake of this argument, the fact that, in the real world, many incentives and constraints upon human action are routinely distorted by the effects of political influences in favor of one group or set of outcomes and/or in opposition to others.) In this argument’s more typical instantiation in today’s world, some would assert that any outcome of “private enterprise” in today’s world must be acceptable for free-market advocates, since it was (ostensibly) somebody’s use of private property for a private purpose. For example, mass corporate layoffs (virtually unheard of until the 1970s), raising the price of a life-saving, long-generic drug by 5,556 percent (as pharmaceutical executive Martin Shkreli did with Daraprim in 2015), listening to or creating brutal “gangsta rap” (virtually unheard of until the 1990s), teaching of creationism in private schools (common throughout history, but increasingly untenable in the face of over 150 years of mounting evidence), and many other behaviors of questionable rationality and/or taste are defended as being the decisions of private entities – so what could be wrong about them?

The problem with reflexively defending any and every behavior, just because a private entity undertakes it, even in the absence of market distortions, is that it misses an essential point. The market is nothing more than the sum of the choices and actions of its participants. A market outcome is not a Panglossian “best of all possible worlds” scenario. Even in the absence of compulsion or restraint, some people will be mistaken, irrational, overconfident, immoral, confused, or all of the above. Ex ante, they may expect that the transactions and behaviors they engage in will benefit them – much like a tribal shaman might believe that his rain dance would bring forth water for the tribe’s crops – but, ex post, they may well find themselves regretting their behavior, or even if not, they may have still become materially, intellectually, or emotionally worse off from it compared to the alternatives. In addition to choice, there is also truth – which comes in the form of scientific, mathematical, historical, and philosophical principles and facts. Truth is an outcome of combining induction from the empirical facts of reality with deduction from the application of logical reasoning to known facts and incontrovertible first principles. It is entirely possible for a person – including a wealthy, powerful, influential person whose decisions affect thousands or millions of others – to completely miss what the truth is, or even to be ignorant of the correct methods of arriving at the truth. In other words, if the external reality is objective and governed by comprehensible natural laws – and if morality is also objective in the sense that some outcomes are incontrovertibly more beneficial to human well-being than others – then it must be the case that somebody who is thinking in a rational, well-informed manner can truly “know better” than a particular decision-maker who is not.

Does that mean that the market could be replaced by some “superior” system of decision-making? Ultimately, no. We have no guarantee that any substitution of decision-making for that of private actors could lead to a necessarily preferable result from those decision makers’ free choices. If Person A is irrational and mistaken, we have no guarantee that leaving Person B in charge of A’s life would not lead to even more irrational and mistaken choices, compounded by the knowledge problem that B will necessarily have in relation to A’s situation. The possibility that B could be not simply misguided but nefarious, and seek to sacrifice A’s genuine interests in favor of B’s own, is a further argument against this kind of command-and-control approach. More devastating, however, would be an outcome in which a different person, C, really is doing his best to act in a truthful, rational, and just manner, but the controller B does not see it. Or perhaps B does see it and thinks it is all well and good, but B needs to set uniform standards that would keep the lowest common denominator in check, and C’s scrupulous, innovative, and principled way of living could never be generalized to a society-wide system of controls.

But getting back to you, the engineer: How to address the dilemma that you are in? Has the “market” not “decided” that the bridge of substandard technical quality is just fine? Not so fast. We must never forget that we are the market, and that the market does not only consist of the first decisions and inclinations of some small group of wealthy, powerful, or connected individuals. Quite the contrary: We are what a truly free market consists of. A truly free market consists not only of our affirmative choices, but also of our negations and criticisms of certain other choices. It consists of our knowledge, including those situations where we truly “know better” than certain others. You, the free-market engineer, could not force the bridge owners to change their design. However, you could fully publicize its flaws in a fully free society, one characterized by robust protections of free speech and lack of a climate of frivolous litigation with regard to libel laws. If today such professional criticism is difficult, it is because many larger, politically connected enterprises will hire legions of attorneys to squelch sufficiently specific assertions in meritless litigation that is too costly for ordinary people to counter. But a truly free society would lack this obstacle and would include a legal system that is designed with speed, simplicity, affordability, and protections for peaceful natural persons in mind. A corporation would not be able to sue you for publicizing detailed criticisms of its products; the judge would be empowered to simply throw out such a lawsuit at first glance. A truly free market of goods and ideas is not an indiscriminate stew of anyone’s and everyone’s plans. Any such plans also would get tested, scrutinized, refined, and ultimately accepted or rejected by the other market participants. To the extent that one owns property that could sustain the perpetuation of a plan, one might counter even strongly held prevailing opinions – but only temporarily and only if one has other means of replenishing that property if the plan causes it to be depleted.

Moreover, in a truly free market, barriers to entry exist only on the basis of the constraints of the physical world, not on politics and special behind-the-scenes influence. Thus, competitors can always arise with a superior business model. Perhaps if you, the engineer, criticize the existing bridge sufficiently, another business enterprise will learn of its defects, purchase another piece of land, and construct a parallel, sturdier bridge that takes your suggestions into account. The misguided owners of the first bridge might eventually find themselves out of business because travelers will discover that safer, more convenient routes are available. And if the bridge ever does fail, a free-market system of civil liability will penalize those businesses who, through negligence, failed to take reasonable precautions to protect the health and safety of their customers. If the bridge ever becomes an imminent danger to travelers, it would be proper for public warnings to be issued and for the law-enforcement entity (be it a minarchist government or a private dispute-resolution agency) to order that traffic to the bridge be discontinued until the immediate danger is averted (perhaps through structural improvements at that time). A free market does not permit the reckless endangerment of unwitting, non-consenting others.

But always, in a hypothetical free-market society or in our own, a free-market-oriented engineer – or any professional, really – should have no compunction about expressing the truth about the soundness and validity of any party’s decisions or proposals, be they private or governmental. Just as a private party may well propose building a substandard bridge, so might a government today actually develop a decent bridge, especially if the incentives of a given political system are conducive to that particular outcome. The free-market engineer should not hesitate to praise the technical design of a good bridge, no matter what its source – because truth is true, and a bridge that could support two thousand cars at a time would, indeed, support those cars no matter who constructed it (provided the methods and materials used are identical in each case). A free-market perspective is a political and economic position which is compatible with completely rigorous, objective views of matters of science, technology, mathematics, history, metaphysics, epistemology, ethics, psychology, and any other conceivable discipline. Free-market advocates should respect people’s right to make choices, even when those choices are mistaken, but can maintain their own right to criticize those mistakes using as high a set of standards as they consider justified. If your values include striving for truth and justice, then those values are a part of the market as well, and you can improve market outcomes by working to instantiate those values in reality.

This essay may be freely reproduced using the Creative Commons Attribution Share-Alike International 4.0 License, which requires that credit be given to the author, G. Stolyarov II. Find out about Mr. Stolyarov here.

Venezuela Is Facing Runaway Financial Catastrophe – Article by Emily Skarbek

Venezuela Is Facing Runaway Financial Catastrophe – Article by Emily Skarbek

The New Renaissance HatEmily Skarbek

Debt, capital flight, food shortages, and hyperinflation take hold

Often, economists want to isolate questions of public debt and analyse these issues as if public choice considerations weren’t at play. Perhaps less studied are the ways in which debt practices can systematically exert pressure on formal political institutions.

But if you want to understand what is going on in Venezuela today, you can’t do so without looking at this political-economy nexus.

For regular people living in Venezuela, the situation is bleak. As the Economist reports, food queues start at 3 am, with the real possibility there won’t be anything for those at the end of the line. And the queues are growing longer and violent.

Real wages fell by 35% last year, 76% of Venezuelans are now poor, supplies of medicines have fallen to 1/5 of their normal level.

The government has admitted that in the 12 months to September 2015 the economy contracted by 7.1% and inflation was 141.5%. Even Nicolás Maduro, Chávez’s hapless heir and successor, called these numbers “catastrophic”.

The IMF thinks worse is in store: it reckons inflation will surge to 720% this year and that the economy will shrink by 8%, after contracting by 10% in 2015. The Central Bank is printing money to cover much of a fiscal deficit of around 20% of GDP.

In a case study of Venezuela from 1984 to 2013, Reinhart and Santos examine the relationship among domestic debt, financial repression, and external vulnerability. The paper begins with a narrative of the evolution of domestic and external debt in Venezuela over the period.

Despite soaring oil prices from 2006 to 2013, net consolidated external debt of Venezuela rose from US $26.9 to US $104.3 billion. The central government, however, only accounted for roughly a fifth of that increment.

The difference, US $60.9 billion (78%), owed to standard practices of the Bolivarian revolution, and was issued by state owned enterprises and the relatively new Fondo Comun China-Venezuela (FCCV). The FCCV is a special-purpose vehicle that allows Venezuela to withdraw from a rolling line of credit at the Chinese Development Bank in exchange for future shipments of oil.

Domestic debt in local currency also climbed, rising from 36.298 million bolivares (VEF) in 2006 to 420.502 million in 2013. The nominal increase of 1,060% (an average annual rate of 42%) was partially offset by an accumulated price increase of 528% (or an average annual rate of 30%), reducing the cumulative increase in real domestic debt to about 85% (or 9% per annum).

During much of this period, the combination of exchange controls and interest ceilings created a captive domestic audience for domestic government debt despite markedly negative real ex post interest rates. The significant losses imposed on domestic bondholders escalated over time, owing to accelerating inflation.

Unlike foreign currency-denominated debt, debt in domestic currency may be reduced through financial repression (i.e., taxes on bondholders and savers producing negative real interest rates). Reinhart and Santos find the financial repression “tax rate” is significantly higher in years of exchange controls and legislated interest rate ceilings. In Venezuela, the “haircut” on depositors and bondholders via negative ex post real interest has exceeded 30% per annum on several occasions.

Confiscating the wealth of those responsible for capital savings can partially ameliorate the existing stock of domestic debt in the short run, but at the expense of encouraging capital flight and undermining any semblance of trust in crucial economic institutions.

The paper documents that capital flight has been a chronic feature in the Venezuelan economy, “representing on average of 4.7% of GDP at the official exchange rate and 7.1% of GDP at the parallel market exchange rate, while siphoning away 17.2% of total exports.”

By all measures, exchange controls proved ineffective at reducing capital flight. In fact, “when measured as percent of GDP at the average parallel market, rate capital flight turned out to be significantly higher in years of controls (8.0% vs 5.2%).

Hayek would not be surprised. Over his professional career he argued disastrous monetary policy commits the state to taking measures that weaken the proper functioning of the market. In order to combat inflation, states will attempt to impose further controls that “would not only make the price mechanism wholly ineffective, but also make inevitable an ever-increasing central direction of all economic activity.”

In Venezuela, Chávez turned the would-be checks and balances of the state — the Supreme Court and the electoral authority — into extensions of executive power. He packed the court and they then threw out those legislators necessary for the opposition to get the two-thirds majority needed to change the constitution.

President Nicolás Maduro seems prepared to continue the repression and price controls, calling the owner of Venezuela’s largest privately-held company a thief and publicly blaming him for the country’s dire economic condition.

It is perhaps fitting that it was at a Mont Pèlerin Conference in Caracas where Hayek famously quipped:

We now have a tiger by the tail: how long can this inflation continue? If the tiger (of inflation) is freed he will eat us up; yet if he runs faster and faster while we desperately hold on, we are still finished!

I’m glad I won’t be here to see the final outcome…

Emily Skarbek is Lecturer in Political Economy at King’s College London and guest blogs on EconLog. Her website is Follow her on Twitter @EmilySkarbek.​

This article was published by The Foundation for Economic Education and may be freely distributed, subject to a Creative Commons Attribution 4.0 International License, which requires that credit be given to the author.

Why Trump and Sanders See Losers Everywhere – Article by Steven Horwitz

Why Trump and Sanders See Losers Everywhere – Article by Steven Horwitz

The New Renaissance HatSteven Horwitz

Competition and the Zero-Sum Fallacy

Donald Trump, Bernie Sanders, many political actors, too many intellectuals, and much of the general public share a false and destructive belief about the nature of exchange: that economic activity is something akin to a battle or a full-fledged war in which the goal is for one group to “defeat” another. We see this mentality across the political spectrum.

Zero-Sum Losers

Think of the ways Trump and others on the political right talk about international trade. The basic framework is to see other countries as enemies in competition with us. The goal of trade policy is somehow to “beat” them, because if they are “winning” by selling us a lot of stuff, we must be losing. The result is mistaken policies such as Trump’s proposed 45 percent tariff on Chinese imports.

We see the same us-and-them thinking on the left, where progressives perceive a persistent battle between capital and labor, each trying to defeat the other. For leftists, capital is always the winner and labor is always the loser — unless the government intervenes. The appropriate policy response, from this perspective, is either to limit capital’s gains or, if you’re a bit more radical, to help labor vanquish capital once and for all. One of the related beliefs on the left is that the wealth of capital comes at the expense of labor. That is, capital’s gains come from labor’s losses.

Both arguments share the underlying belief that the winners’ gains must come at the losers’ expense. Economic activity, and specifically wealth creation, is at best seen as what economists would call a “zero-sum game.”

In zero-sum games, the winners’ gains do, in fact, come at the losers’ expense. Think of a poker game where each person buys $100 worth of chips. If there are five players, there is $500 to be apportioned out. If the game ends with me having $250, then the remaining $250 will be split among the other four players. My gain of $150 comes from others’ losses. Playing the game creates winners and losers because it simply reallocates fixed wealth around the group.

Positive-Sum Winners

Market economies, however, are not zero-sum games. Consider the profits of entrepreneurs like Steve Jobs or Bill Gates or Mark Zuckerberg or any of thousands of lesser-known inventors who have become fabulously wealthy by providing us with products and services that we value. Their gains are not our losses. To the contrary: markets are what we call positive-sum games. Entrepreneurs make huge profits, but they can only do so by providing us with products and services we value more than what we give up to obtain them.

Every time you get something yummy from a food truck, for example, you demonstrate the mutual benefit of trade: the truck owner gets your money and you get something delicious to eat. You both gave up something you valued less than the thing you acquired. Trade is made of win.

So when people complain that the United States is “losing to China,” presumably because we have a trade deficit with them, they are falling for the zero-sum fallacy. A trade deficit simply means that we are buying more of their goods and services than they are of ours. This doesn’t mean “they” are winning. First, there’s no “they.” The winners are individual Chinese sellers and the people they employ on one side, and individual US consumers on the other. Portraying trade as a contest between countries is deceptive: trade is always among specific individuals and groups.

Second, both sides are winning. Chinese sellers get US dollars and US consumers get products they like at low prices, which frees up income to buy other goods and services, creating jobs in other sectors of the US economy. Those US dollars, it is worth noting, make their way back to the US as Chinese firms invest in US assets, funding everything from private-sector construction to a small part of our government debt. The dollars we spend on Chinese goods do not just disappear; they come back as investments in US capital goods.

It would be more accurate to see what’s happening here as Chinese sellers arriving at the US border with boatloads of cheap goods for us to buy. Under what logic are we made worse off by the “gift” of lower priced goods?

Misunderstanding “Competition”

I suspect that much of the zero-sum thinking we see with trade is based on a misplaced application of the idea of “competition.” Competition in the market does share a number of features with the sorts of competition that people are more familiar with: sports, games, and war.

All are what F.A. Hayek called “discovery procedures.” We play games as a way to discover which individual or team is best. There’s no way to know who the best hockey team is without the discovery process of the Stanley Cup playoffs. We can’t know the answer just by looking at statistics, as every major upset in sports history demonstrates. In markets, we discover who is producing the best product at the best price by letting sellers and buyers compete. One might say the same about war.

Despite these similarities, however, there’s a critical difference: athletic competition and war are zero-sum and negative-sum games, respectively. In sports, one team wins and the other loses, or there’s a tie. Both of those outcomes are zero-sum. War destroys human and physical capital, and even when one country “wins,” everyone is worse off, making it negative-sum.

Market competition, by contrast, is positive-sum. When sellers compete with other sellers to keep prices low, it’s true that some sellers will win and others will lose, but in that process, all of the buyers win, too, not to mention the other people who will receive more income because the buyers who are paying less for the original product can now buy their products. Wealth is not redistributed, as in a poker game, and there is not an offsetting loser for each winner, as in sports. Instead, additional wealth is created. That makes it a positive-sum game.

Seeing the Bigger Picture

CEOs are used to seeing this process from the narrow perspective of their firms, which often do lose in competition with other firms, leading them to believe the same principles apply between countries, or for the economy as a whole. This may explain why Donald Trump thinks he can “defeat” China in the same way he might outcompete another firm. It also explains why Sanders can believe that we are in a competition to preserve jobs. By focusing on the growth in manufacturing jobs in China, Sanders sees trade as “stealing” US jobs rather than being part of the larger competitive process responsible for the overall growth in US jobs and wealth.

Yes, markets share much with other forms of competition, but the key difference is the one that matters. Markets are positive-sum games, and they are not about one country, one group, or one class defeating another. Competition and trade are the way we produce cooperation and mutual benefit. Failing to understand this important difference easily opens the door to demagogues on both the right and the left.

Steven Horwitz is the Charles A. Dana Professor of Economics at St. Lawrence University and the author of Hayek’s Modern Family: Classical Liberalism and the Evolution of Social Institutions. He is a member of the FEE Faculty Network.

This article was published by The Foundation for Economic Education and may be freely distributed, subject to a Creative Commons Attribution 4.0 International License, which requires that credit be given to the author.

Is the FDA Too Conservative or Too Aggressive? – Article by Alex Tabarrok

Is the FDA Too Conservative or Too Aggressive? – Article by Alex Tabarrok

The New Renaissance HatAlex Tabarrok
September 21, 2015

I have long argued that the FDA has an incentive to delay the introduction of new drugs because approving a bad drug (Type I error) has more severe consequences for the FDA than does failing to approve a good drug (Type II error). In the former case at least some victims are identifiable and the New York Times writes stories about them and how they died because the FDA failed. In the latter case, when the FDA fails to approve a good drug, people die but the bodies are buried in an invisible graveyard.

In an excellent new paper (SSRN also here) Vahid Montazerhodjat and Andrew Lo use a Bayesian analysis to model the optimal tradeoff in clinical trials between sample size, Type I and Type II error. Failing to approve a good drug is more costly, for example, the more severe the disease. Thus, for a very serious disease, we might be willing to accept a greater Type I error in return for a lower Type II error. The number of people with the disease also matters. Holding severity constant, for example, the more people with the disease the more you want to increase sample size to reduce Type I error. All of these variables interact.

In an innovation the authors use the U.S. Burden of Disease Study to find the number of deaths and the disability severity caused by each major disease. Using this data they estimate the costs of failing to approve a good drug. Similarly, using data on the costs of adverse medical treatment they estimate the cost of approving a bad drug.

Putting all this together the authors find that the FDA is often dramatically too conservative:

…we show that the current standards of drug-approval are weighted more on avoiding a Type I error (approving ineffective therapies) rather than a Type II error (rejecting effective therapies). For example, the standard Type I error of 2.5% is too conservative for clinical trials of therapies for pancreatic cancer—a disease with a 5-year survival rate of 1% for stage IV patients (American Cancer Society estimate, last updated 3 February 2013). The BDA-optimal size for these clinical trials is 27.9%, reflecting the fact that, for these desperate patients, the cost of trying an ineffective drug is considerably less than the cost of not trying an effective one.

(The authors also find that the FDA is occasionally a little too aggressive but these errors are much smaller, for example, the authors find that for prostate cancer therapies the optimal significance level is 1.2% compared to a standard rule of 2.5%.)

The result is important especially because in a number of respects, Montazerhodjat and Lo underestimate the costs of FDA conservatism. Most importantly, the authors are optimizing at the clinical trial stage assuming that the supply of drugs available to be tested is fixed. Larger trials, however, are more expensive and the greater the expense of FDA trials the fewer new drugs will be developed. Thus, a conservative FDA reduces the flow of new drugs to be tested. In a sense, failing to approve a good drug has two costs, the opportunity cost of lives that could have been saved and the cost of reducing the incentive to invest in R&D. In contrast, approving a bad drug while still an error at least has the advantage of helping to incentivize R&D (similarly, a subsidy to R&D incentivizes R&D in a sense mostly by covering the costs of failed ventures).

The Montazerhodjat and Lo framework is also static, there is one test and then the story ends. In reality, drug approval has an interesting asymmetric dynamic. When a drug is approved for sale, testing doesn’t stop but moves into another stage, a combination of observational testing and sometimes more RCTs–this, after all, is how adverse events are discovered. Thus, Type I errors are corrected. On the other hand, for a drug that isn’t approved the story does end. With rare exceptions, Type II errors are never corrected. The Montazerhodjat and Lo framework could be interpreted as the reduced form of this dynamic process but it’s better to think about the dynamism explicitly because it suggests that approval can come in a range–for example, approval with a black label warning, approval with evidence grading and so forth. As these procedures tend to reduce the costs of Type I error they tend to increase the costs of FDA conservatism.

Montazerhodjat and Lo also don’t examine the implications of heterogeneity of preferences or of disease morbidity and mortality. Some people, for example, are severely disabled by diseases that on average aren’t very severe–the optimal tradeoff for these patients will be different than for the average patient. One size doesn’t fit all. In the standard framework it’s tough luck for these patients. But if the non-FDA reviewing apparatus (patients/physicians/hospitals/HMOs/USP/Consumer Reports and so forth) works relatively well, and this is debatable but my work on off-label prescribing suggests that it does, this weighs heavily in favor of relatively large samples but low thresholds for approval. What the FDA is really providing is information and we don’t need product bans to convey information. Thus, heterogeneity plus a reasonable effective post-testing choice process, mediates in favor of a Consumer Reports model for the FDA.

The bottom line, however, is that even without taking into account these further points, Montazerhodjat and Lo find that the FDA is far too conservative especially for severe diseases. FDA regulations may appear to be creating safe and effective drugs but they are also creating a deadly caution.

Hat tip: David Balan.

This post first appeared at Marginal Revolution.

Alex Tabarrok is a professor of economics at George Mason University. He blogs at Marginal Revolution with Tyler Cowen. 
Does America Ban Immigration? – The Land of the Free Isn’t, For Most People – Article by David Bier

Does America Ban Immigration? – The Land of the Free Isn’t, For Most People – Article by David Bier

The New Renaissance Hat
David Bier
August 3, 2015

The United States has a de facto ban on immigration. We can debate about whether this prohibition is necessary, but its existence is undeniable. Other than a few exceptions for family members, refugees, and the highly-educated, it is virtually impossible to come to the United States to live and work legally.

Historically, America held its doors open to all. But in the 1920s, a coalition of unions, progressives, and eugenicists combined to slam them shut. Within a year of passing Alcohol Prohibition, America also banned almost all forms of immigration, cutting immigration by nearly 80 percent.

Alcohol regained its legal status, but immigration never quite recovered.

Today, the government lets in almost a million immigrants each year, but this impressive-sounding number misses the entire legal, historical, and global context of our immigration system. We must compare it to the number who would come if only they could do so legally — and the reality is that most types of immigration are entirely prohibited. To deny the ban on immigration because it has exceptions is like denying Alcohol Prohibition because it allowed communion wine.

The half million people apprehended at the border each year and the 11 million unauthorized immigrants in the country are the clear evidence of this prohibition. The massive immigration underground points to an obvious yet largely ignored fact: If there was a legal way for them to come, they would have taken it. But, trouble is, one doesn’t exist.

The drastic shortage of visas is evident in the unbelievably long wait times for permanent residency. For certain categories, the wait is decades. For employment-based visas, certain Indian and Chinese workers will wait more than a decade. For Mexico, three different family-based categories have wait times over 18 years. There’s northward of 4.3 million people in these lines alone.

Yet these impossible lines hide a deeper problem: most would-be immigrants have no line to stand in at all.

The reality is this: 92 percent of legal immigrants are either 1) immediate family members of US citizens or permanent residents, 2) refugees or asylees, or 3) college graduates — and over 80 percent those needed an advanced degree or at least $500,000 to invest in projects in the United States.

This leaves less than 65,000 visas for everyone else. More two-thirds of these come through a lottery system for which 11 million people applied last year. People in most of the largest countries in the world, including India, China, and Mexico, aren’t even eligible to apply.

This legal flow amounts to barely 7 percent of the average number of immigrants apprehended at the border each year since 2004 (and, of course, that doesn’t count those who crossed successfully, or those who entered and overstayed their visas, or those who would come if there was a legal opportunity). For people without a college degree or a close American relative, the Statue of Liberty’s “Golden Door” is almost completely shut.

Meanwhile, PhDs, scientists, movie stars, pro-athletes, and other elites have a number of different work visas available to them. These allow them to live and work year-round in the United States.

By contrast, there is no work visa that allows lesser-skilled laborers to live and work year-round in this country. Unsurprisingly, this lesser-skilled demographic is disproportionately represented in the illegal population, 85 percent of whom lack a college degree.

Another reason we know that illegal immigration is being driven by the lack of a legal alternative is because of what happened when the government allowed foreign workers to come and go legally.

Thanks to a fluke of history, America had a brief period when it experimented with freer migration between the United States and Mexico. In the 1950s and ‘60s, the Bracero guest worker program let in about 5 million Mexican farmworkers. From 1956 to 1965, when the program was at its height, the number of unauthorized immigrants at the border averaged just 41,000, compared to over 436,000 a year in the prior decade.

After it was terminated in 1966 by another union-led coalition, illegal immigration never again fell to such low levels — not even for a single year, let alone an entire decade. By the 1980s, a million or more immigrants were routinely being caught by Border Patrol every year.

Supporters of the ban on immigration will say that America is at its breaking point, that we’re overwhelmed, that we can’t “handle” any more immigrants. But this fear is groundless: As a share of its population, America admitted four times as many immigrants each year in the early 1900s as it did in 2014. For a century from 1830-1929, immigration was twice as high as a share of the population as it was in the last two decades.

In absolute terms, America admits more immigrants than any other country, but relative to its size, US immigration levels are far lower than many Western countries. Controlling for population, CanadaAustralia, and New Zealand all have higher levels of immigration than America today — even as high as the United States in the early 20th century — and they have not collapsed into chaos or poverty.

Immigration prohibition is real. Millions of people cross the border illegally (and thousands of businesses hire them illegally) for the same reason bootleggers had to brew booze in bathtubs. And, for the same reasons we repealed Alcohol Prohibition, we should also finally end America’s ban on immigration.

David Bier is an immigration policy analyst at the Niskanen Center. He is an expert on visa reform, border security, and interior enforcement. From 2013 to 2015, he drafted immigration legislation as senior policy advisor for Congressman Raúl Labrador, a member of the House Judiciary Committee’s Subcommittee on Immigration and Border Security. Previously, Mr. Bier was an immigration policy analyst at the Competitive Enterprise Institute.  

This article was published by The Foundation for Economic Education and may be freely distributed, subject to a Creative Commons Attribution 4.0 International License, which requires that credit be given to the author.

Ayn Rand and Friedrich A. Hayek: A Side-by-Side Comparison – Article by Edward W. Younkins

Ayn Rand and Friedrich A. Hayek: A Side-by-Side Comparison – Article by Edward W. Younkins

The New Renaissance HatEdward W. Younkins
August 1, 2015

Ayn Rand and Friedrich A. Hayek did more than any other writers in the Twentieth Century to turn intellectual opinion away from statism and toward a free society. Although they are opposed on many philosophical and social issues, they generally agree on the superiority of a free market. Rand’s defense of capitalism differs dramatically from Hayek’s explanation of the extended order. In addition, Hayek approves of state activity that violates Rand’s ideas of rights and freedom. The purpose of this brief essay is to describe, explain, and compare the ideas of these two influential thinkers. To do this, I present and explain an exhibit that provides a side-by-side summary of the differences between Rand and Hayek on a number of issues.

In their early years of writing, both Hayek and Rand were dismissed by intellectuals, but they were heralded by businessmen. Hayek began to gain some respect from intellectuals when he published The Road to Serfdom in 1944. He wrote a number of scholarly books, attained formal academic positions, and earned the Nobel Prize for economics in 1974. Rand never did write scholarly works or hold a formal academic position. Her philosophy must be extracted from her essays and her fiction.

Hayek was read in college classes sooner, and to a much greater extent, than was Rand. He was viewed by intellectuals as a responsible and respected scholar, and Rand was not. His vision of anti-statism was more acceptable to intellectuals because he called for some exceptions to laissez-faire capitalism. In his writings he permitted concessions for some state interventions. In his immense and varied body of work, he touched upon a great many fields, including anthropology, evolutionary biology, cognitive science, philosophy, economics, linguistics, political science, and intellectual history. During the last 25 years or so, Rand’s works have been increasingly studied by scholars. There is now an Ayn Rand Society affiliated with the American Philosophical Association and a scholarly publication devoted to the study of her ideas—The Journal of Ayn Rand Studies. In addition, her writings are now being covered in college classes.

A Summary Comparison

Exhibit I provides a summary comparison of Rand and Hayek based on a variety of factors and dimensions. With respect to metaphysics and epistemology, Rand holds that “A is A” and that reality is knowable. Contrariwise, Hayek argues that reality is unknowable and that what men see are distorted representations or reproductions of objects existing in the world. The skeptic Hayek goes so far as to state that the notion of things in themselves (i.e., the noumenal world) can be dismissed. Whereas Rand’s foundation is reality, the best that Hayek can offer as a foundation is words and language.

Hayek supports the view that the human mind must have a priori categories that are prior to, and responsible for the ability to perceive and interpret the external world. He adds to this Kantian view by making the case that each individual mind’s categories are restructured according to the distinct experiences of each particular person.   Each person’s neural connections can therefore be seen as semi-permanent and affected by his or her environment and experiences. The mind’s categories evolve as each specific person experiences the world. According to Hayek, there is pre-sensory knowledge embedded in the structure of the mind and the nervous system’s synaptic connections which can be further created and modified over time. For the neo-Kantian Hayek, knowledge always has a subjective quality.

Reason for Rand is active, volitional, and efficacious. It follows that she sees rationality as man’s primary virtue. She sees progress through science and technology as the result of the human ability to think conceptually and to analyze logically through induction and deduction. Rand also contends that people can develop objective concepts that correspond with reality.

In his philosophy, Hayek relegates reason to a minor role. He argues for a modest perspective of people’s reasoning capabilities. He contends that reason is passive and that it is a social product. Hayek’s message of intellectual humility is primarily aimed at constructivist rationalism rather than critical rationalism. As an “anti-rationalist,” he explained that the world is too complex for any government planner to intentionally design and construct society’s institutions. However, he is a proponent of the limited potential of critical rationalism through which individuals use local and tacit knowledge in their everyday decisions. Hayek views progress as a product of an ongoing dynamic evolutionary process. He said that we cannot know reality but we can analyze evolving words and language. Linguistic analysis and some limited empirical verification provide Hayek with somewhat of an analytical foundation. His coherence theory of concepts is based on agreement among minds. For Hayek, concepts happen to the mind. Of course, his overall theory of knowledge is that individuals know much more than can be expressed in words.

Rand makes a positive case for freedom based on the nature of man and the world. She explains that man’s distinctive nature is exhibited in his rational thinking and free will. Each person has the ability to think his own thoughts and control his own energies in his efforts to act according to those thoughts. People are rational beings with free wills who have the ability to fulfill their own life purposes, aims, and intentions. Rand holds that each individual person has moral significance. He or she exists, perceives, experiences, thinks and acts in and through his or her own body and therefore from unique points in time and space. It follows that the distinct individual person is the subject of value and the unit of social analysis. Each individual is responsible for thinking for himself, for acting on his own thoughts, and for achieving his own happiness.

Hayek denies the existence of free will. However, he explains that people act as if they have free will because they are never able to know how they are determined to act by various biological, cultural, and environmental factors. His negative case for freedom is based on the idea that no one person or government agency is able to master the complex multiplicity of elements needed to do so. Such relevant knowledge is never totally possessed by any one individual. There are too many circumstances and variables affecting a situation to take them all into account. His solution to this major problem is to permit people the “freedom” to pursue and employ the information they judge to be the most relevant to their chosen goals. For Hayek, freedom is good because it best promotes the growth of knowledge in society. Hayek explains that in ordering society we should depend as much as possible on spontaneous forces such as market prices and as little as possible on force. Acknowledging man’s socially-constructed nature, he does not view individuals as independent agents but rather as creatures of society.

According to Rand, the principle of man’s rights can be logically derived from man’s nature and needs. Rights are a moral concept. For Rand, the one fundamental right is a person’s right to his own life. She explains that rights are objective conceptual identifications of the factual requirements of a person’s life in a social context. A right is a moral principle that defines and sanctions one’s freedom of action in a social context. Discussion of individual rights are largely absent from Hayek’s writings. At most he says that rights are created by society through the mechanism of law.

Whereas Rand speaks of Objective Law, Hayek speaks of the Rule of Law. Objective laws must be clearly expressed in terms of essential principles. They must be objectively justifiable, impartial, consistent, and intelligible. Rand explains that objective law is derived from the rational principle of individual rights. Objective Law deals with the specific requirements of a man’s life. Individuals must know in advance what the law forbids them from doing, what constitutes a violation, and what penalty would be incurred if they break the law. Hayek says that the Rule of Law is the opposite of arbitrary government. The Rule of Law holds that government coercion must be limited by known, general, and abstract rules. According to Hayek certain abstract rules of conduct came into being because groups who adopted them became better able to survive and prosper. These rules are universally applicable to everyone and maintain a sphere of responsibility.

Rand espouses a rational objective morality based on reason and egoism. In her biocentric ethics, moral behavior is judged in relation to achieving specific ends with the final end being an individual’s life, flourishing, and happiness. For Hayek, ethics is based on evolution and emotions. Ethics for Hayek are functions of biology and socialization. They are formed through habits and imitation.

Rand advocates a social system of laissez-faire capitalism in which the sole function of the state is the protection of individual rights. Hayek, or the other hand, allows for certain exceptions and interventions to make things work. He holds that it is acceptable for the government to supply public goods and a safety net.

For Rand, the consciousness of the individual human person is the highest level of mental functioning. For Hayek, it is a supra-conscious framework of neural connections through which conscious mental activity gains meaning. He states that this meta-conscious mechanism is taken for granted by human beings. The set of a person’s physiological impulses forms what Hayek calls the sensory order. Perception and pattern recognition follow one’s sensory order which is altered by a person’s own perception and history of experiences

Aristotle is Rand’s only acknowledged philosophical influence. They both contend that to make life fully human (i.e., to flourish), an individual must acquire virtues and make use of his reason as fully as he is capable. Hayek was influenced by Kant and Popper in epistemology, Ferguson and Smith in evolutionary theory, Hume in ethics, and Wittgenstein in linguistics.

Although Rand and Hayek are opposed on many philosophical questions, they generally agree on the desirability of a free market and are among the most well-known defenders of capitalism in the twentieth century. The works of both of these intellectual giants are highly recommended for any student of liberty.

 Exhibit I

A Summary Comparison





Foundation Reality Words and Language
Knowledge Reality is knowable. Skepticism – The idea of things in themselves can be dismissed.
Reason Reason is active, volitional, and efficacious. Reason is passive and a social product.
Progress Based on power of human reason and conscious thought Evolution and social selection
Analytic Method Logical analysis, including induction and deduction Linguistic analysis and empiricism
Theory of Concepts Objective concepts that correspond with reality Coherence or agreement among minds
Freedom Positive case for freedom Negative case for “freedom”
Free Will Man has free will. Man is determined but acts as if he has free will.
Subject of value and unit of social analysis Individual happiness Perpetuation of society (i.e., the group)
The Individual Independent Dependent—man is socially constituted
Rights Based on the nature of the human person Created by society through law
Law Objective Law Rule of Law
Ethics and Morality Rational objective morality based on reason and egoism Evolutionary and emotive ethics based on altruism which is noble but cannot be implemented because of ignorance. Established through habits and imitation
Desired Social System Laissez-faire capitalism Minimal welfare state that supplies public goods and safety net
Highest level of understanding and mental functioning Consciousness of the Individual Meta-conscious framework—neural connections
Philosophical influences Aristotle Ferguson, Smith, Kant, Hume, Popper, Wittgenstein
Frédéric Bastiat’s “Economic Sophisms” Is Now More Important Than Ever – Article by Julian Adorney and Matt Palumbo

Frédéric Bastiat’s “Economic Sophisms” Is Now More Important Than Ever – Article by Julian Adorney and Matt Palumbo

The New Renaissance HatJulian Adorney and Matt Palumbo
June 29, 2015

The great economist Frédéric Bastiat would have turned 214 today. His contributions to liberty have been many, but while so many advocates of free markets focus on The Law, there is another book that represents his legacy even better: Economic Sophisms. This short work of essays epitomizes perhaps his most important contribution: using taut logic and compelling prose to bring the dry field of economics to hundreds of thousands of laymen. Bastiat did not, generally, clear new ground in the field of economics. He read Adam Smith and Jean-Baptiste Say and found little to add to these giants of economic thought. But Bastiat possessed a keen wit and a clear, pithy writing style. His writings have become immensely popular. One-hundred-and-fifty years after his death, essays like “A Petition” are still circulated as an effective counter to progressive economics. Bastiat makes three central contributions in Economic Sophisms. First, he reminds us that we should care about the consumer, not just the producer. Second, he dismantles the argument that there are no economic laws. Third, and more generally, he is one of the few politicians and writers who thought with his head, not with his heart. Bastiat used logic to clearly lay out the consequences of political actions instead of hiding behind good intentions.

Surplus, Not Scarcity

Economic Sophisms expresses a common theme over and over again: we should craft policies that focus on consumers, not on producers.When Bastiat uses these phrases, it can be easy to misinterpret him. Keynes, writing 100 years after Bastiat, hijacked the terms. But Bastiat wasn’t a Keynesian. When he discusses how consumption is the end goal of the economy, what he means is: having goods (which benefits consumers) is more important than making goods (which benefits producers). Put another way, producers prefer scarcity, because it drives up prices. Consumers prefer surplus for the opposite reason. Producers advocate all sorts of methods for reducing the total quantity of goods (theirs excepted, of course). Producers seek to tax goods from other countries that compete with their own. They outlaw machines that would replace them. Producers even favor policies like burning food to drive up food prices, a policy that caused much starvation when it was enacted in the United States during the Great Depression. Consumers, by contrast, prefer abundance. They are happiest when they have a plethora of goods to choose from at a low price. Bastiat points out that we are all consumers, including the producers. The man who produces railroads also uses his wages to buy goods. One can imagine a world with no producers, a paradise in which man’s every need is fulfilled by nature or a benevolent God. But one cannot imagine a world with no consumption. In such a world, man would not eat or drink, have clothing or buy luxuries. Consumption, and quality of life, is the essential yardstick to measure a society’s economic prosperity.

When we enact producer-backed measures like tariffs, Bastiat argues, we favor producers’ interests over consumers’. We show that we’d rather have scarcity than surplus. Taken to its logical extreme, such a policy is absurd. Would anyone truly argue that total scarcity is preferable to having plenty?

The Principle of No Principles

In Bastiat’s day, it was fashionable to claim that no real principles exist. X may cause Y, but a smaller X needn’t cause a smaller Y; it could cause Z instead, or A. Today, we see the same logic: people who claim, for instance, that a minimum wage hike to $100 would kill jobs but that a hike to $10.10 would somehow create them. In essay after essay, Bastiat destroys this myth. Economics is not a foggy morass where up is sometimes down, left can be right, and there are no absolute truths. Economics is not like nutrition, where a glass of wine can heal while two gallons can kill.In economics, a cause will produce a correlational effect, regardless of how large the cause is. If small X causes small Y, large X causes large Y. A minimum wage hike to $100 will kill many jobs; a minimum wage hike to $10.10 will still kill some. The effect does not vary, only the size of it. Indeed, one of Bastiat’s most common argumentative tools is reductio ad absurdum, or carrying a concept to its logical conclusion. Opponents of mechanization want to force railroads to stop at one city and unload goods, thereby generating work for the porters? Very well, says Bastiat. Why not have them stop at three cities instead? Surely that would generate even more work for the porters. Why not stop at twenty cities? Why not have a railroad composed of nothing but stops that will make work for the porters?

By carrying concepts to their logical conclusion, Bastiat provides a firm antidote to the fuzzy thinking of protectionist advocates.

Think with Your Head

In Bastiat’s time, just as today, it was popular to think with one’s heart. “We must do something!” went the rallying cry; never mind the consequences. Good intentions were enough. Make-work, for instance, has always been a favorite policy of those who think with their hearts. They see men and women unemployed and demand government take action. Often, this action takes the form of impeding human progress: using porters instead of railroads, for instance. The initial consequence, for the porters, is positive: more end up employed. But Bastiat recognizes that such policies, while they may protect the porters, harm the economy as a whole. They raise prices and create scarcity. Bastiat looked at more than just the direct consequence of an action. He examined all the outcomes, using taut chains of logic to demonstrate how each policy would impact those whom he was most focused on — the consumer.

Bastiat’s Legacy

Bastiat did not invent any new economic tools or schools of thought. But the clear logic with which he thought through economic ideas, and the clear and witty prose with which he lambasted those who did not do so, have made him one of the most popular economic figures of all time. Bastiat’s ideas in this text have been borrowed, rehashed, and republished for over 150 years. His insights have been appropriated by dozens of prominent thinkers. Most famously, Henry Hazlitt based Economics in One Lesson largely on the essays in Economic Sophisms. As we make note of his 214th birthday, perhaps we should raise a toast to the man whose ideas — in all their adopted formats — have done so much for the cause of liberty.

Julian Adorney is an economic historian, entrepreneur, and fiction writer.

Matt Palumbo is the author of The Conscience of a Young Conservative and In Defense of Classical Liberalism.

This article was published on and may be freely distributed, subject to a Creative Commons Attribution United States License, which requires that credit be given to the author.


Socialism Is War and War Is Socialism – Both Forms of Central Planning Are Reactionary, Not Progressive – Article by Steven Horwitz

Socialism Is War and War Is Socialism – Both Forms of Central Planning Are Reactionary, Not Progressive – Article by Steven Horwitz

The New Renaissance Hat
Steven Horwitz
June 10, 2015

“[Economic] planning does not accidentally deteriorate into the militarization of the economy; it is the militarization of the economy.… When the story of the Left is seen in this light, the idea of economic planning begins to appear not only accidentally but inherently reactionary. The theory of planning was, from its inception, modeled after feudal and militaristic organizations. Elements of the Left tried to transform it into a radical program, to fit into a progressive revolutionary vision. But it doesn’t fit. Attempts to implement this theory invariably reveal its true nature. The practice of planning is nothing but the militarization of the economy.”

—Don Lavoie, National Economic Planning: What Is Left?

Libertarians have long confounded our liberal and conservative friends by being both strongly in favor of free markets and strongly opposed to militarism and foreign intervention. In the conventional world of “right” and “left,” this combination makes no sense. Libertarians are often quick to point out the ways in which free trade, both within and across national borders, creates cooperative interdependencies among those who trade, thereby reducing the likelihood of war. The long classical liberal tradition is full of those who saw the connection between free trade and peace.

But there’s another side to the story, which is that socialism and economic planning have a long and close connection with war and militarization.

As Don Lavoie argues at length in his wonderful and underappreciated 1985 book National Economic Planning: What Is Left?, any attempt to substitute economic planning (whether comprehensive and central or piecemeal and decentralized) for markets inevitably ends up militarizing and regimenting the society. Lavoie points out that this outcome was not an accident. Much of the literature defending economic planning worked from a militaristic model. The “success” of economic planning associated with World War I provided early 20th century planners with a specific historical model from which to operate.

This connection should not surprise those who understand the idea of the market as a spontaneous order. As good economists from Adam Smith to F.A. Hayek and beyond have appreciated, markets are the products of human action but not human design. No one can consciously direct an economy. In fact, Hayek in particular argued that this is true not just of the economy, but of society in general: advanced commercial societies are spontaneous orders along many dimensions.

Market economies have no purpose of their own, or as Hayek put it, they are “ends-independent.” Markets are simply means by which people come together to pursue the various ends that each person or group has. You and I don’t have to agree on which goals are more or less important in order to participate in the market.

The same is true of other spontaneous orders. Consider language. We can both use English to construct sentences even if we wish to communicate different, or contradictory, things with the language.

One implication of seeing the economy as a spontaneous order is that it lacks a “collective purpose.” There is no single scale of values that guides us as a whole, and there is no process by which resources, including human resources, can be marshaled toward those collective purposes.

The absence of such a collective purpose or common scale of values is one factor that explains the connection between war and socialism. They share a desire to remake the spontaneous order of society into an organization with a single scale of values, or a specific purpose. In a war, the overarching goal of defeating the enemy obliterates the ends-independence of the market and requires that hierarchical control be exercised in order to direct resources toward the collective purpose of winning the war.

In socialism, the same holds true. To substitute economic planning for the market is to reorganize the economy to have a single set of ends that guides the planners as they allocate resources. Rather than being connected with each other by a shared set of means, as in private property, contracts, and market exchange, planning connects people by a shared set of ends. Inevitably, this will lead to hierarchy and militarization, because those ends require trying to force people to behave in ways that contribute to the ends’ realization. And as Hayek noted in The Road to Serfdom, it will also lead to government using propaganda to convince the public to share a set of values associated with some ends. We see this tactic in both war and socialism.

As Hayek also pointed out, this is an atavistic desire. It is a way for us to try to recapture the world of our evolutionary past, where we existed in small, homogeneous groups in which hierarchical organization with a common purpose was possible. Deep in our moral instincts is a desire to have the solidarity of a common purpose and to organize resources in a way that enables us to achieve it.

Socialism and war appeal to so many because they tap into an evolved desire to be part of a social order that looks like an extended family: the clan or tribe. Soldiers are not called “bands of brothers” and socialists don’t speak of “a brotherhood of man” by accident. Both groups use the same metaphor because it works. We are susceptible to it because most of our history as human beings was in bands of kin that were largely organized in this way.

Our desire for solidarity is also why calls for central planning on a smaller scale have often tried to claim their cause as the moral equivalent of war. This is true on both the left and right. We have had the War on Poverty, the War on Drugs, and the War on Terror, among others. And we are “fighting,” “combating,” and otherwise at war with our supposedly changing climate — not to mention those thought to be responsible for that change. The war metaphor is the siren song of those who would substitute hierarchy and militarism for decentralized power and peaceful interaction.

Both socialism and war are reactionary, not progressive. They are longings for an evolutionary past long gone, and one in which humans lived lives that were far worse than those we live today. Truly progressive thinking recognizes the limits of humanity’s ability to consciously construct and control the social world. It is humble in seeing how social norms, rules, and institutions that we did not consciously construct enable us to coordinate the actions of billions of anonymous actors in ways that enable them to create incredible complexity, prosperity, and peace.

The right and left do not realize that they are both making the same error. Libertarians understand that the shared processes of spontaneous orders like language and the market can enable all of us to achieve many of our individual desires without any of us dictating those values for others. By contrast, the right and left share a desire to impose their own sets of values on all of us and thereby fashion the world in their own images.

No wonder they don’t understand us.

Steven Horwitz is the Charles A. Dana Professor of Economics at St. Lawrence University and the author of Microfoundations and Macroeconomics: An Austrian Perspective, now in paperback.

This article was published by The Foundation for Economic Education and may be freely distributed, subject to a Creative Commons Attribution 4.0 International License, which requires that credit be given to the author.

The Other Half of the Inflation Story: Credit Expansion Adds Noise to Price Signals – Article by Sanford Ikeda

The Other Half of the Inflation Story: Credit Expansion Adds Noise to Price Signals – Article by Sanford Ikeda

The New Renaissance Hat
Sanford Ikeda
May 7, 2015

More money means higher prices. It’s too bad not everyone understands that connection. Even some economists don’t get it. Readers of the Freeman do, I’m sure. And they also understand why that’s a bad thing.

Increasing the supply of money and credit, other things equal, will cause a general rise in wages and prices across an economy. When the Federal Reserve, the central bank of the United States, excessively “prints money,” the result is “inflation” as it’s now commonly called. For those who get the new money after everyone else has spent theirs, inflation means incomes will now buy fewer goods, and every dollar lent before prices rose will be worth less when it’s returned.

If inflation continues, people will eventually learn to demand more for what they sell and lend in order to compensate for the purchasing power that inflation keeps eating away. That, in turn, will cause prices to rise faster, which makes planning for households and businesses even more difficult. In the past, that difficulty has led to hyperinflation and a breakdown of the entire economic system.

But as awful as all this may be, it’s really only half the story, and perhaps not even the worse half. What follows is a highly simplified story of what happens.

The structure of production

If you’d like to build a sturdy house, you’ll need to have some kind of blueprint or plan that will tell you two things:

  1. how the frame, floor, walls, roof, plumbing, and electrical system will all fit together; and
  2. the order in which to put these components together.

Even if the house was made entirely of identical stones, you would need to know how to fit them together to form the floor, walls, chimney, and other structural components. No two stones would serve exactly the same function in the overall plan.

The economy is like a house in the sense that each of its parts, which we might call “capital,” needs to mesh in a certain way if the eventual result will be order and not chaos. But there are two big differences between a house and an economy. The first is that the economy is not only much bigger, but it consists of a multitude of “houses” or private enterprises that have to fit together or coordinate, and so it’s an unimaginably more complex phenomenon than even the most elaborate house.

The second major difference is that a house is consciously constructed for a purpose, typically for someone to live in it. But an economic system is neither consciously designed by anyone nor intended to fulfill any particular purpose, other than perhaps to enable countless people with plans to do the best they can to achieve success. It’s a spontaneous order.

The way all the pieces of capital, from all the diverse people in the economy who own them, fit together is called the capital structure of production.

Credit expansion distorts the structure of production

When people decide to spend a certain portion of their incomes on consumption today, they are at the same time deciding to save some portion for consumption for the future. The amount that they save then gets lent out to borrowers and investors in the market for loanable funds. The rate of interest is the price of making those transactions across time. That is, when you decide to increase your saving, other things equal, the rate of interest (what some economists call the “natural rate of interest”) will fall. The falling interest rate makes borrowing more attractive to producers who invest today to produce more goods in the future.

That’s great, because when the market for loanable funds is operating freely without distortions, that means when people who saved today try to consume more in the future, there actually is more in the future for them to consume . Businesses today invested more at the lower rates precisely in order to have more to sell in the future when consumers want to buy more.

Now, if the Federal Reserve prints more money and that money goes into the loanable funds market, that will also increase the supply of loans and lower the interest rate and induce more borrowing and investment for future output. The difference here is that the supply of loans increases not because people are saving more now in order to consume more in the future, but only because of the credit expansion. That means that in the future, when businesses have more goods to sell, consumers won’t be able to buy them (because they didn’t save enough to do so) at prices that will cover all of the businesses’ costs. Prices will have to drop in order for markets to clear. Sellers suffer losses and workers lose their jobs.

And, oh yes, all that credit expansion also causes inflation.

While this process sounds rather involved, it’s still a highly simplified version of what has come to be known as the Austrian business cycle theory. (For a more advanced version, see here.) Of course, each instance in reality is significantly different from any other, but the narrative is essentially the same: credit expansion distorts the structure of production, and resources eventually become unemployed.

The explanation is more involved than the typical inflation-is-bad story that we’re more familiar with. Indeed, that probably explains why it’s the less-well-known half of the story. Even Milton Friedman and the monetarists pay little attention to the capital structure, choosing instead to focus on the problems of inflationary expectations.

Again, for Austrians, the problem arises when credit expansion artificially lowers interest rates and sets off an unsustainable “boom”; the solution is when the structure of production comes back into alignment with people’s actual preferences for consumption and saving, which is the “bust.” Most modern macroeconomists see it exactly the opposite way: the bust is the problem, and the boom is the solution.

An intricate, dynamic jigsaw puzzle

To close, I’d like to use an analogy I learned from Steve Horwitz (whom I heartily welcome back as a fellow columnist here at the Freeman).

The market economy is like a giant jigsaw puzzle in which each piece represents a unique unit of capital. When the system is allowed to operate without government intervention, the profit-and-loss motive tends to bring the pieces together in a complementary way to form a harmonious mosaic (although in a dynamic world, it couldn’t achieve perfection).

Credit expansion, then, is like someone coming along and making too many of some pieces and too few of others — and then, during the boom, trying to force them together, severely distorting the overall picture. During the bust, people realize they have to get rid of some pieces and try to discover where the others actually fit. That requires challenging adjustments and may take some time to accomplish. But if the government tries to “help” by stimulating the creation of more superfluous pieces, it will only confuse matters and make the process of adjustment take that much longer.

Inflation is bad enough. Unfortunately, it’s only half the story.

Sanford Ikeda is a professor of economics at Purchase College, SUNY, and the author of The Dynamics of the Mixed Economy: Toward a Theory of Interventionism.

This article was originally published by The Foundation for Economic Education.