Category Archives: The Market Process

Review of Michael Munger, The Sharing Economy: Its Pitfalls and Promises (Institute of Economic Affairs, 2021)

Posted on November 17, 2021 | Comments Off on Review of Michael Munger, The Sharing Economy: Its Pitfalls and Promises (Institute of Economic Affairs, 2021)

Transaction costs are one of the most overlooked ideas in economics. They are also one of the most important. The lowering of transaction costs is an engine of modernity itself and key to understanding where future progress might take us. That is Duke University economist Michael Munger’s argument in his new book, The Sharing Economy: Its Pitfalls and Promises (free download from the Institute of Economic Affairs). It follows up his 2018 book, Tomorrow 3.0.

What are transaction costs? As the name implies, they are things that get in the way of making transactions. Think of them as economic friction. Things like waiting in line, searching for a product, comparing prices, driving to and from a store, or resetting another forgotten website password. Transaction costs often cannot be measured in money, but they are still part of the price of everything we buy. A good economist knows, money is not everything.

Countless beneficial transactions never happen because the time and hassle required outweigh the benefits. Successful entrepreneurs can make these lost transactions come to life just by lowering their attendant transaction costs. In a way, they succeed by making the invisible visible. Along the way, they can create new industries, revolutionize existing industries, and topple old ones. Transaction costs are the hidden engine of Joseph Schumpeter’s creative destruction.

Munger’s dissertation advisor was the Nobel laureate Douglass North, one of the pioneers of transaction cost economics, along with other laureates such as Ronald Coase and Oliver Williamson. Munger likes to tell a story about North explaining that, while there are endless questions to ask in economics, many of them have the same answer: transaction costs. Over the years, North’s advice has proved useful to countless graduate students in search of thesis topics. As The Sharing Economy shows, there remains plenty of uncharted territory. Today’s graduate students should take note—as should experienced scholars.

How do transaction costs apply to the new sharing economy? Broken down to fundamentals, Uber doesn’t sell taxi rides or food delivery. It sells access to a platform that drastically lowers transaction costs for some services. The product is the platform. Yes, people use it to buy and sell taxi rides and food delivery, but they could use that type of platform for almost anything.

This is why a lot of sharing economy startups describe themselves as the Uber or the Airbnb for this or that service. They’re selling transaction cost savings, not whatever product or service appears in their marketing materials.

Every transaction requires what Munger calls the three Ts: triangulation, transfer, and trust. Sharing platforms can solve the three Ts quickly and cheaply:

  • Triangulation means coordinating everyone involved in the transaction. In a food delivery transaction, those are the customer, the restaurant, and the delivery driver. Until recently, solving this coordination problem was so difficult that most restaurants did not offer delivery at all. And the ones that did had to hire their own drivers to work exclusively for them. Unless business was both brisk and consistent, this was a risky proposition. Today, sharing platforms can solve triangulation problems in seconds. As a result, restaurants that might not be able to afford full-time delivery staff can now share drivers with other businesses and earn additional sales, while customers gain additional choices.
  • Transfer means making sure everyone gets paid. Uber, for example, has all parties’ payment info stored in the app. It automatically charges customers the right amount, pays restaurants and drivers, and handles tips. That is far easier than in the old days of cash, checks, or reading out your credit card number over the phone.
  • Trust is all parties having confidence that everything will go as it should. This is what ratings systems contribute. Riders can avoid drivers with low ratings and drivers can avoid problem customers. They can do this in seconds just by glancing at their ratings. On the other side of the coin, high ratings can be lucrative for vendors, giving them a greater incentive to keep customers happy than a traditional cab driver. And keeping that five-star rating can encourage more civil behavior from customers. It doesn’t pay to be a Karen.

Sharing economy platforms solve the three Ts so quickly and easily that millions of transactions that would never have happened a decade ago are now routine. This, for Munger, is a reason for optimism. Similar platforms could emerge for all kinds of goods. In fact, they probably are doing so right now in a dorm room or a garage somewhere.

Tools that spend nearly all of their time in storage could be rented out, for example. Other possibilities include office equipment, professional-grade audio and video equipment, and designer clothing. Some of these ideas might be successful. Others might be duds. People will likely find out soon enough.

Munger believes the low-transaction cost sharing economy could transform manufacturing as we know it. Factories would make far fewer goods, and what they do make would tend to be professional grade and more durable. A drill that spends 30 years in someone’s garage might get a couple hours of use over its entire lifespan, but if it’s shared, it will get far more use on a wider variety of tasks. It will need to be more solidly built and easily repaired.

That is one reason why the sharing economy has costs, as well as benefits. Both words in the phrase “creative destruction” are important. Just because the benefits outweigh the costs doesn’t mean costs do not exist. Manufacturing jobs have already declined by about a third since their 1979 peak, from about 18 million workers to about 12 million. If sharing platforms become popular for a lot of goods, that decline will be deeper and steeper. At the same time, the higher-grade goods still being made might require more skills or more automation to make, displacing less skilled workers.

Other jobs would open up in warehousing and delivery, and likely in other sectors. Munger doesn’t know what these might be, and neither does anyone else. Some of these jobs might not be appealing, might not pay as well, or may not work with some workers’ family responsibilities or other personal situations.

On the other hand, the size of the labor force has stayed remarkably consistent relative to population  throughout America’s transition from agriculture to industry, and from industry to services. While the inability to predict the future is scary, that’s no reason to keep things as they are. As Munger says on page 89, “Platforms are disruptive, but outlawing disruption has never worked.”

Transaction Costs and a Policy Revolution

As transaction cost reductions transform the economy, they also transform public policy. The problem is that public policy usually takes long to catch up. Regulations classify many workers as either employees or contractors, and treat them differently. Employee status comes with certain rules for minimum wages, benefits, and working conditions, while the rules for contractors are generally looser. It is also a false dichotomy that poorly fits workers’ needs.

If an accountant uses a platform like Taskrabbit to work for several clients, is she an employee of any of them? Does she count as Taskrabbit’s employee because it handles her payments or is she a customer who pays to access its platform? Does it matter if she commutes to an office or works from home? What if she’d rather choose her own health insurance or retirement plan? My colleague Iain Murray explored this question in his 2016 CEI paper “Punching the Clock on a Smartphone App.”

Current regulations don’t have good answers to these questions. And laws like California’s AB5 gig worker law and the proposed PRO Act at the federal level would entrench the legacy labor law model even further. All this is because some entrepreneurs thought of a way to use smartphone apps to reduce transaction costs.

In the age of COVID, sharing platforms have made it easier for workers to avoid public transportation and crowded offices. When COVID subsides, many workers will still prefer to avoid commutes and offices in favor of more pleasant surroundings like home offices, coffee shops, or smaller shared offices—which some sharing platforms offer. Regulators should think carefully before they take those options away.

Antitrust policy is in the middle of its own revolution, thanks in part to transaction costs. Sharing platforms are just another version of the old make-or-buy decision. If a company needs legal help, does it use in-house counsel or hire an outside attorney? Should a firm employ its own custodian or hire a cleaning service? The answer depends on transaction costs. If it’s cheaper to do something yourself, do that. If transacting with someone else costs less, do that. The answer is different for every company—and can change over time within a company. Sharing platforms and their lower transaction costs provide new possible answers to this age-old problem.

As of this writing, the leading food delivery platforms are DoorDash, UberEats, and GrubHub. They could buy out smaller competitors or merge with each other in the coming years, which might result in antitrust action. It shouldn’t, and transaction costs explain why.

A restaurant that wants to offer delivery has a make-or-buy decision to make. Does it hire its own driver or outsource to a sharing platform? It will go with whichever has lower transaction costs. This provides a built-in competitive check on sharing platforms that will never go away—even if one sharing platform monopolizes the entire market. If its fees cost more than the restaurant hiring its own drivers, then restaurants will opt for the latter. Several restaurants in the same city could even band together and jointly hire a driver—if regulations allow them.

The reason people use sharing platforms in the first place is because their transaction costs are lower than the alternatives. And the alternative of doing something in-house will never go away. Sharing platforms do not have market power, and never will.

Sharing platforms also do not restrain trade, which is another threshold for antitrust enforcement. They enable new trades that would never have happened otherwise, because they lower transaction costs. Before sharing apps, food delivery options in most places were limited to pizza and Chinese. Now, everyone from McDonald’s to mom-and-pop diners offer delivery. Some restaurants, such as Panda Express, are even attempting to undercut sharing platforms by creating their own app-based ordering services to avoid platforms’ fees.

Transaction Costs and the Moral Economy

Contrary to popular belief, morals are an integral part of economics. One of the discipline’s founding works, after all, is Adam Smith’s Theory of Moral Sentiments. Man is an animal that trades, to paraphrase from Smith’s other great work, The Wealth of Nations. People want to exchange, cooperate, and compete. It is our nature. But transaction costs get in the way of our nature, because they get in the way of trade.

Economists Virgil Storr and Ginni Choi, of the Mercatus Center at George Mason University, argue in their book Do Markets Corrupt Our Morals? that markets are moral playgrounds. When people enter those playgrounds, they learn how to trust and earn trust. They learn to keep their word and be polite—the late, great Steve Horwitz delighted in the “double thank you” that accompanies most transactions. People on the playground learn that the best way to get something you value is to give others things they value even more.

These are skills that take practice and repetition to develop. Transaction costs raise the cost of this moral practice. And when something costs more, people consume less of it.

If the goal is an open, civil society, then transaction cost reduction should be an important priority. Sharing economy platforms have the potential to do exactly that on a massive scale. At the same time, they are just another chapter in a long story, and hardly the final one.

Munger, by taking Douglass North’s advice, has used an old and overlooked tool to better understand new technologies and emerging economic changes. Sharing platforms have already changed the way people take cab rides, order food, and go on vacation. In the coming years, they could reshape the manufacturing sector, office culture, and even urban design, if traditional offices and downtowns continue to fall out of favor.

Transaction costs can also lead to fresh insights about labor regulations, antitrust, and other areas of public policy, as well as the overlooked symbiosis of markets and morality. Though The Sharing Economy is geared to a British audience, American readers will still get far more value from this freely downloadable book than they spend in transaction costs. While this admittedly sets a low bar, I intend it as high praise. I could not recommend this book more highly.

Download The Sharing Economy for free from IEA’s website here.

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Posted in Antitrust, Books, Competition, Economics, Technology, The Market Process

I, Pencil Meets Today’s Political Realignment

Posted on October 22, 2021 | Comments Off on I, Pencil Meets Today’s Political Realignment

Conservatives are different than they were just a few years ago, and it isn’t just because of Trump, who is more a symptom than a root cause. There is a larger political realignment underway, as happens every couple of generations. Previously, conservatives saw communism as the enemy, and favored free markets as a bulwark against it. But the Cold War ended a generation ago. Today, the debate isn’t over communism vs. capitalism, it’s over open vs. closed.

The latest data point in the current political realignment comes from The American Conservative’s Declan Leary, in a piece taking on Leonard Read’s classic free-market pamphlet I, Pencil (see also CEI’s video adaptation). Leary’s article is titled “We Are Not Pencils,” though the article’s URL contains the phrase “pencils are from the devil.”

This is quite a change from the days when President Ronald Reagan was photographed reading The Freeman, the magazine published by I, Pencil author Leonard Read’s Foundation for Economic Education.

At the same time, the old and new conservatives aren’t as different as they seem, despite their differences on trade, free markets, antitrust, industrial policy, and Eastern European dictators. Their different views come from the same inborn human tendency to see the world in terms of in-groups and out-groups.

Those groups can be defined by almost anything, whether serious or silly—language, race, religion, nationality, political party, sports fandom, views on whether pineapple belongs on pizza, and more. People can simultaneously belong to several of these groups, and flit between them seamlessly as social situations dictate. A Democrat and a Republican can be friends at a baseball game where they cheer for the same team, for example, then go back to bickering after the game.

I, Pencil celebrates openness, giving that 1958 pamphlet a clear position in today’s realignment. Read’s point is that cooperation is so fundamental to the human condition that no one, by themselves, can make something as simple as an ordinary pencil. Interconnectedness makes modernity possible.

Making a pencil requires millions of people working in concert. These include loggers, miners, tool makers, paint producers, truck drivers, box makers, machinery designers, farmers and restaurant workers to feed them all, retail clerks, and more. Not only that, but nobody is in charge. Nobody is following any plan. This complicated order emerges spontaneously, guided by little more than the price system and social norms.

But where Read sees a source of wonder, Leary sees a source of fragility. “The Invisible Hand wrenched away not just American jobs but America’s very capacity to produce things,” he writes. What if a link in the supply chain breaks? What if China decides to cut off America’s supply of rare earth elements? What if some politically woke truck drivers go on strike?

It would be better, Leary argues, to turn inwards a little bit. Going full Juche, as North Korea calls its philosophy of self-reliance, is obviously harmful. But on the spectrum from open to closed, Leary argues that we have gone a bit too far toward the open side, and become too vulnerable because of that. Out-groups aren’t as trustworthy as the in-group, in that view.

But has the invisible hand really “wrenched away American jobs?” Look at the data for the size of the U.S. labor force, going back to 1948:

Labor force size is tied most closely to population size, not how open the American economy is to foreign trade. In 2000, the labor force was 143 million people. As of September 2021, it was 161 million. That’s a net gain of 18 million jobs, even accounting for the 3 million jobs lost during the pandemic that have not yet come back.

Leary is asking the wrong question. What is important is not how many jobs, but what types of jobs there are, and how much value those workers create. A subsistence farming economy has full employment, but low living standards. A globalized, high-tech economy also often has full employment, but its similarly sized labor force has much higher living standards and longer life expectancies.

So Leary’s argument about jobs doesn’t hold. What about “America’s very capacity to produce things?” Let’s look at the St. Louis Fed’s total index for industrial production from 1920 to the present. Notice that it is near an all-time record high right now, despite a COVID-related dip:

So Leary’s argument doesn’t hold there, either. To be fair, this record was set by fewer manufacturing workers. There were 12.8 million manufacturing workers when COVID hit, compared to a peak of 19.5 million workers in May 1979. That is concerning. But why is manufacturing output still higher? Because today’s workers are more productive than they were a generation ago.

This productivity surge—driven by technology, openness, and specialization—has freed up millions of people’s time and talent for other pursuits. Not only do Americans manufacture more stuff than ever before, we are also creating more service-related value, with less effort. It’s not manufacturing or services when productivity increases; it’s manufacturing and services. The pie gets bigger.

The key to mass prosperity is doing more with less. Politically directed industrial policy attempts to treat a healthy patient, while harming the rest of the economy by taking away its resources.

Moreover, the service jobs to which workers are migrating tend to pay better and have better working conditions. There is something to be said about working in an air-conditioned office or from home, rather than a noisy factory floor with potentially dangerous machinery.

Average hourly pay, as of September 2021, is $24.18 in manufacturing, versus $30.85 for the economy at large. Since wages are tied to productivity in the long run, a major reason for workers’ migration away from manufacturing is that the new types of jobs tend to create more value than the old ones.

Using government policy to migrate workers back to manufacturing jobs would mean paying many of them less. It would also mean that their hard work would create less value for people. That would be a double blow to worker’s egos, which is almost certainly not Leary’s intention. But as the economist Thomas Sowell likes to say, intentions are not results.

What about the theoretical case for more economic self-sufficiency? The first response is a simple one: Don’t put all your eggs in one basket.

Leary argues that elaborate supply chains are vulnerable. If one link breaks, the whole chain becomes useless. Fortunately, supply chains are nothing like chains. A link in a chain is connected only to the link directly ahead of it, and the one directly behind it. Real-world supply chains are more like webs or networks, where each piece is connected to nearly every other piece. That is a source of strength.

Breakages happen all the time in the real world. It’s important to have as many ways as possible to adapt and reroute. As the economist Israel Kirzner pointed out, entrepreneurship is all about alertness. Markets and supply networks are never perfect, and are always changing. Every flaw, and every vulnerability, is an opportunity for improvement. The economy is an ongoing process of experiment, trial, error, and adaptation.

But people will have fewer ways to make improvements and shore up against vulnerabilities if policies limit who they can cooperate with or confine their talents to certain industries. Industrial policy and self-sufficiency make people more vulnerable against threats because they lock people into old patterns, distort prices that convey important information, and make it more difficult to adapt. This is true whether the threat is a global pandemic, a foreign adversary, or a local labor dispute.

The economic case for why openness is more resilient than self-reliance is not new. It is not even controversial, at least among economists. But in politics, issues are often not about the merits. If Leary really is arguing against the economics, he has not succeeded. But if he’s staking out a cultural or political identity and attacking out-groups, then mission accomplished.

Leary also deserves credit for using the word “liberal” closer to its original and correct meaning—valuing freedom and openness—than do most commentators.

The insight that national conservatives and populists often care more about cultural identity than policy is key to understanding today’s political realignment. That is not to pick on conservatives; many progressives are no different. For them, too, signaling is often more important than real-world policy effects.

Affirming the in-group and vilifying the out-group is harmless at a ballgame, or in an argument about whether Star Wars or Star Trek is better. But in public policy, the stakes are higher. An old impulse that had survival benefits in hunter-gatherer times can have the opposite effect in the modern world—especially when COVID-19 is still a going concern.

It isn’t often that a pamphlet about basic economics offers insights about a political realignment that happens 60 years after its publication. But that is the case with I, Pencil. Leary would not have bothered writing about Leonard Read’s defense of openness if it didn’t strike a nerve. Fortunately for the economy and for our ability to respond to the COVID crisis, Leary’s criticisms do not hold up against real-world data or economic theory. If he instead wants to engage in culture war identity signaling, perhaps he should find ways to channel that impulse in ways that would not make America more vulnerable to threats both domestic and foreign.

For more on “I, Pencil,” see CEI’s video adaptation. See also my review of CEI Julian Simon Award winner Johan Norberg’s book Open.

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Posted in Economics, Philosophy, Political Animals, The Market Process

CEI Book Forum with Johan Norberg and Patrick Moore

Posted on March 25, 2021 | Comments Off on CEI Book Forum with Johan Norberg and Patrick Moore

Earlier today, CEI hosted a double book forum featuring Johan Norberg, author of Open: The Story of Human Progress, and Greenpeace co-founder Patrick Moore.

Video of the event is on YouTube here.

I also received a pleasant surprise around the 31:00 mark when Norberg, whose work I’ve long admired, quoted favorably from my recent review of Open.

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Posted in Books, Development Economics, Economics, Everybody Panic, History, Psychology, The Market Process

Upcoming CEI Event: Bart Wilson on The Property Species

Posted on February 8, 2021 | Comments Off on Upcoming CEI Event: Bart Wilson on The Property Species

At noon ET on Thursday, February 11, CEI is hosting an event with the experimental economist Bart Wilson, author of The Property Species: Mine, Yours, and the Human Mind. He is also a frequent collaborator with former CEI Julian Simon Award winner Vernon Smith.

Near the end of The Property Species, on p. 194, Wilson shows how the custom of property is essential for natural conservation efforts (footnotes omitted):

When some people are allowed to say, “This elephant is mine,” they defend attacks against the elephant like they defend against attacks against their own person. In contrast, when government agents are tasked with defending elephants against attacks, they are not as effective—the evidence strongly suggests—in protecting elephants about which they cannot say, “These are mine.” Think about it natural-historically: Isn’t it astonishing that people who can say, “This elephant is mine” will protect and defend the life of a distantly related fellow mammal against members of their own species who wish that distant relative harm? Isn’t it furthermore prudent for such people to do so? And isn’t it then morally incumbent upon us to consider the possibility that property can save elephants from extinction? Consider, for the moment, the beautiful and humane thoughts made possible by mine.

CEI has a long history of supporting private conservation, and here Wilson makes a powerful point in its favor.

Wilson also discusses other concepts in the book, such as his view that property is not a right; it is a custom. This view avoids some of the problems of rights theory while emphasizing property’s inherently social and cooperative nature.

Property, Wilson argues, is not just the ability to say “this is mine.” Any dog with a bone thinks that. Property is the ability to also say “that is yours.” Dogs do not have that ability. Only humans have made this cognitive leap. Property is unique to us. It is also universal among us. Every society on Earth, without exception, has social customs that involve notions of both “this is mine” and “that is yours.” This human universal is what makes non-violent trade possible. Property is what lets people act on Adam Smith’s natural propensity to truck, barter, and exchange.

As Wilson argues on p. 179, “we have to be open to the possibility that commerce may be an integral part of that socializing and ethicizing process.” Property is a fundamental concept in designing sound public policy, and in enabling virtuous and prosperous societies to emerge. There is much more to property than armchair philosophizing.

There is also more to property than commerce. The custom of property gives a convincing answer to the question that all social scientists seek to answer: how people find ways to get along with each other. Many people view property as an exclusionary, anti-social concept. This is a mistake. It requires multiple people for the concept of property to even exist. And those people must cooperate with each other for it to work. It does no good to say “this is mine” if other people do not agree to respect that, and expect to have their own claims respected.

Property is an ongoing dialogue between people. it requires listening, not just speaking. There is a reason why economics and related disciplines–nearly all of which Wilson draws from in the book–are called social sciences.

Wilson, of course, has much more to say on the matter. Click here to register for the February 11 event. The book is here. I highly recommend both.

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Posted in Books, Economics, Philosophy, The Market Process

Book Review: Erik Brynjolfsson and Andrew McAfee – The Second Machine Age: Work, Progress, and Prosperity in a Time of Brilliant Technologies

Posted on January 15, 2021 | Comments Off on Book Review: Erik Brynjolfsson and Andrew McAfee – The Second Machine Age: Work, Progress, and Prosperity in a Time of Brilliant Technologies

Erik Brynjolfsson and Andrew McAfee – The Second Machine Age: Work, Progress, and Prosperity in a Time of Brilliant Technologies (New York: W.W. Norton, 2014)

This book from two MIT professors is part big-picture history, and art techno-optimism. McAfee is also the author of the excellent 2020 book More from Less, which is better-argued from a public policy perspective.

The opening chapter sets the historical stage. Living standards were poor and stagnant for nearly all of human history, from our birth as a species until about 1750 or so. If you put human well-being on a graph, it runs almost perfectly flat for thousands and thousands of years. Then it spikes sharply upwards starting around 1750-1800, like a hockey stick on its side. This giant wealth explosion is still happening today, and the authors believe it will continue for some time to come. This is one of the biggest changes in human history.

What caused it? Brynjolfsson and McAfee think it was technology. More specifically, it was the steam engine. Even more specifically, it was James Watt’s iteration of the steam engine. Steam power existed as early as ancient Rome, but it was mostly used for amusement purposes, and not industry. That changed in Watt’s lifetime. This was the start of Bynjolfsson and McAfee’s First Machine Age.

The Second Machine Age is the computer revolution. The First Machine Age revolutionized physical power. The Second Machine Age is revolutionizing mental power. Just as Watt’s steam engine took time to influence manufacturing, technological development, government, and culture, so too is the Second Machine Age. It is far enough along where they argue its fundamental difference from the First Machine Age is clear. But it is also early enough where its impact is only beginning to be felt. The future has almost limitless potential—and some tradeoffs.

The larger arc they draw is the right shape, though I don’t know that their need for two separate Machine Ages is much more than a useful gimmick for talking about technology. I would also submit that the true cause of both revolutions goes a level deeper than just technology. Yes, steam engines and computers are necessary for the two machine ages. Necessary, but not sufficient.

They need another ingredient in the mix: culture. Larger cultural values are difficult to quantify, which is why economists and many other social scientists do not use them. They are still significant, even if they are immune to regression analysis and other quantification. Statistically significant? No. Real-world significant? Very.

Culture shifted in the centuries leading up to Watt’s generation. People were gradually becoming a little more open to change, progress, and improvement. It showed in literature, trade patterns, philosophy, and a new prestige for science and its discoverers. That is why a technology that was already around now began to be used more differently—people allowed it, approved of it, and were willing to countenance large fortunes being made from it.

After setting up their two-machine-ages framework, Brynjolfsson and McAfee go on a tour of new and emerging technologies to see where the Second Machine Age might take us. They take a ride in one of Google’s self-driving cars, among other highlights, and draw encouraging pictures of some of the things new technologies could do for people over the next few decades.

One area where they fall short is their discussion of inequality. They are so focused on the mathematical ratio of the differences between rich and poor peoples’ incomes, that they forget to ask how people at the bottom are actually doing. They also focus almost solely on wage income, which is a significant mistake. This leaves out non-wage income such as employer-sponsored insurance, tuition assistance, free meals, company cars, and other perks that do not show up in income data.

More to the point for a book about technology, Brynjolfsson and McAfee should have asked a question similar to one Don Boudreaux likes to ask: would you rather have 1970-quality medical care at 1970 prices, or today’s health care at today’s prices?

Very few people would rather have 1970’s health care, even at its lower price. That means people view themselves as better off with today’s options. Most people would similarly answer related questions about televisions, computers, cars, appliances, and many other products that both rich and poor people consume.

In fact, society today has substantial consumption equality. Most low-income households have cars that drive at the same speeds on the same roads as wealthy people. They watch the same television shows and have similar Internet connections. More tellingly, rich people are not substantially taller or longer-lived than poor people. In the olden days, one could tell nobles and peasants apart at a glance by their height. Children of nobility got enough to eat, while peasant children were often so malnourished that their growth stunted. There were also substantial differences in infant mortality and life expectancy.

While the very wealthy have orders of magnitude more wealth than ordinary people do, they don’t consume very much of it. Nor do they keep it in a Scrooge McDuck-like vault. They invest it, in an unexpected type of income redistribution. When it’s invested, borrowers use that money to buy homes, go to college, and start businesses. The wealth doesn’t just sit there, people make use of it. It is a subjective question how much of this type of wealth is the “right” amount. But this positive use of wealth is something inequality scholars need to account for, and rarely do. In fact, invested wealth is where most of the capital that funds the amazing technologies Brynjolfsson and McAfee discuss in this book comes from.

They make another lapse in quoting a professional trade association for civil engineers in calling for more infrastructure spending. Of course civil engineers want more infrastructure spending, they have a vested interest in it! This is basic public choice theory. While they briefly acknowledge this conflict of interest, they also do not acknowledge the seriousness of the point, or look at data from less self-interested sources.

Their promotion of a Universal Basic Income (UBI) is similarly idealistic. This model, essentially a straight cash grant, is an objectively better system of poverty relief than the current welfare state. A UBI is easier to administer and more flexible for the recipients. A UBI also makes it more difficult for nanny statists to tell the poor what they shall eat, what things they may and may not buy, what types of health care they may receive, or where they shall educate their kids.

The trouble is politics. Again, a little public choice theory would go a long way in this discussion. Replacing the current welfare state with a UBI would be a fantastic tradeoff, both for the poor and for taxpayers. But the way politics works in practice, this would not happen. A UBI would be negotiated in a Congress led by people like Nancy Pelosi and Mitch McConnell, or whoever succeeds them in a few years. Real-world politicians are unlikely to enact a well-functioning UBI, nor will their constituents let them. Public sector unions whose members administer the current system will block any reform they possibly can.

Tis means any politically-possible UBI would be added on top of the current system, preserving the current system’s flaws and minimizing a UBI’s advantages. Unless this problem is addressed, a UBI risks causing more harm than benefit.

Brynjolfsson and McAfee are consistently a little too idealistic. Some of the technologies they explore in this 2014 book turned out to be flops, and others are still materializing. Similarly, they assume that their political reforms will actually work as they intend them to.

They are certainly right about the larger arc of progress and prosperity. And though I take their technological hyper-optimism with a grain of salt, it is also inspiring. Books like this one and by other thinkers such as Kevin Kelly give me confidence that my daughter’s life will be richer, longer, healthier, and frankly, cooler than mine. This is a source of happiness for me, and gives me inspiration to continue my work on improving economic policy and defending liberalism against populists who would tear it down for no good reason.

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Posted in Books, Economics, History, modernity, Technology, The Market Process

Best Books of 2020: Virgil Henry Storr and Ginny Seung Choi – Do Markets Corrupt Our Morals? (Palgrave MacMillan, 2019)

Posted on December 24, 2020 | Comments Off on Best Books of 2020: Virgil Henry Storr and Ginny Seung Choi – Do Markets Corrupt Our Morals? (Palgrave MacMillan, 2019)

Most people see markets as dens of greed and moral corruption. In their new book, Do Markets Corrupt Our Morals?, Virgil Henry Storr and Ginny Seung Choi, of the Mercatus Center at George Mason University, argue the opposite. In fact, they go one step further: Markets make people more moral. Make that two steps further: Because markets have moral benefits, restrictions on markets have moral costs. They back up their argument with a healthy mix of theory and evidence. Along the way, they make a case for rethinking how people approach markets. Their arguments, rather than traditional “markets are efficient” arguments, are the liberal movement’s best hope for the future.

Storr and Choi describe their main thesis on p. 225:

But the evidence suggests that the consensus is wrong. Markets do not corrupt our morals. Not only are people wealthier, healthier, happier, and better connected in market societies, market activity makes us better people. Markets are spaces where we discover who is virtuous and can expect many of our vices to be revealed. Additionally, markets reward virtue and punish vice. As such, markets are moral training grounds.

In short: Less of Alfred Marshall’s supply and demand graphs, and more Adam Smith’s Theory of Moral Sentiments. Less Homo economicus, more Homo sapiens.

Their phrase “moral training grounds” is important. One of the most common mistakes in economics is the Nirvana fallacy. This says that because markets are not perfect, government can make things better. Storr and Choi know that perfection does not exist. Markets fail, but they also have a built-in improvement mechanism. Markets are an ongoing discovery process. People have to learn from experience what works and what doesn’t. They make mistakes, learn from them, and make changes. But because conditions are always changing, the adaptation process never ends.

People use markets to learn how to trust and to be trustworthy. This takes practice. It takes trial and error. The feedback people get from profit and loss help. So does learning what it takes to earn someone’s trust or their repeat business. Evidence from experimental economics shows that people who participate in markets learn these things more quickly than in other systems.

In one-shot games in lab experiments, people can cheat and get away with it, like doing a dine-and-dash at a restaurant in a town you’ll never visit again. Despite this, people in these studies who come from market-oriented societies cheat far less than one would expect from a traditional blackboard-economics model. They also cheat less than people from non-market societies who play the same games.  

Repeat-play games give the opportunity for cheaters to learn from their moral decision. Other players can punish cheaters in future rounds. They will often do so even when punishment also comes at a cost to the punishers. Upholding honesty is important enough that most people are willing to pay for it. In the long run, this reduces cheating. In fact, it happens almost automatically.

Without coaching, players often spontaneously settle on a tit-for-tat strategy. You start by assuming the other players are trustworthy, but if they cheat, return the favor. Depending on a game’s rules, this may mean punishing cheaters, or simply refusing to do business with them again. Regardless of whether the players come from countries with free markets or not, they tend to behave better in repeat-play games than in one-shot games. And again, players from market societies cheat less often than players from non-market societies.

Storr and Choi also take a tour of the different ways in which markets affect morals. The obvious one is that because people in market societies are richer, they can afford to be more moral. They can afford to give to charities. They can also afford a fuller life. Education, literature, the arts, and world travel all cost money. Dollars are nice, but they aren’t really wealth. Wealth is being able to treat others well, to have leisure to spend time with family, and to pursue friendships, hobbies, and to try new things. Market societies can afford far more of these life enrichments than non-market societies—and these experiences positively shape people’s characters.

Moreover, people in market societies have longer life expectancies, lower infant mortality, are more respectful of women’s rights, minority rights, and LGBT rights, are more religiously tolerant, go to war far less often, and have lower crime rates. All of these are moral outcomes. All of them are backed by abundant data. All of them are made possible by embracing markets. The moral conclusion is obvious.

Storr and Choi represent the future of the liberty movement. The Cold War is a generation in the past now. People still throw around the word “socialist,” but usually just to mean they don’t like something.

But markets are still very much under attack in the current political realignment. The in-groups and out-groups people are using are different now; capitalism-vs.-communism is out, and populist nationalism-vs.-liberal cosmopolitanism are in. Yet, most libertarians are still using the same materialist arguments.

Yes, markets are efficient and create more wealth than other systems. That’s important, but that also isn’t the main point. Markets have other positive effects that are ultimately more meaningful—and more persuasive in today’s society. Not only is Storr and Choi’s moral defense more versatile in today’s intellectual climate, it is more in tune with most people’s values. As CEI founder Fred Smith argues regarding values-based communication, it is important to speak to people in their language.

Most people don’t care about adding an extra decimal point to this quarter’s GDP growth, even though that is important in the long run. They do care about their kids growing up to be decent people. They don’t care that subsidies and taxes cause market distortions. They do care about having a well-rounded life.

Many market liberals only speak a niche language of efficiency. This is one reason why they remain a curiosity. Their disconnect is a major reason why so many people continue to oppose markets despite their moral benefits—hardly anyone makes the moral case.

Storr and Choi are not the only thinkers trying to correct this oversight. CEI Julian Simon Award winners Deirdre McCloskey, Johan Norberg, and Steve Horwitz are among them. But Storr and Choi just might be the ones to do it best. They deserve far more company.

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Posted in Argumentation, Books, Economics, Philosophy, The Market Process

Jean-Baptiste Say on Manufacturing Nostalgia and Industrial Policy

Posted on October 7, 2020 | Comments Off on Jean-Baptiste Say on Manufacturing Nostalgia and Industrial Policy

There is a reason the classics never go out of style. For example, on page 62 of Charles Robert Prinsep’s translation of Jean-Baptiste Say’s 1803 A Treatise on Political Economy, Say writes:

Production is the creation, not of matter, but of utility.

That one sentence captures one of today’s major debates: the decline of manufacturing. Which matters more: output for its own sake, or the value people get from that output? Most economists agree with Say that utility matters more. It doesn’t matter how much steel a factory can crank out if people don’t get value from it. On the opposite side are economic populists such as Oren Cass on the right and Sen. Sherrod Brown on the left.

Many politicians are convinced that manufacturing is in decline, and are advocating far-reaching industrial policies from Washington to save it. Unlike Say, they seem to believe that there is something intrinsically better about creating physical goods, rather than services, ideas, or technologies. To them, matter is what matters most. This is not a reductio ad absurdum. Cass, in his book The Once and Future Worker, advocates subsidizing industries and even entire towns engaged in manufacturing, even if their products create so little value that few people want to buy them. Rather than doing more with less, Cass argues for the opposite.

This view is mistaken in two ways. First, according to the data, U.S. manufacturing is in good health. Second, the size of this or that sector doesn’t matter anyway. What does matter is that people are able to create as much value for each other as they can. Sometimes that involves manufacturing, and sometimes it doesn’t. Policy makers in Washington will never be in a place to correctly decide that ever-changing mix.

Pre-COVID manufacturing output in the U.S. was at near-record levels, though dented a bit by President Trump’s trade policies. It is still too early to tell what COVID’s impact will be, but it almost certainly will not be good. Fortunately, economic fundamentals remain strong. While recovery will likely take a few years, manufacturing will likely resume its long-term steady climb.

Even when populists do acknowledge the data, they worry that manufacturing output growth is slower than in other sectors of the economy. This is why manufacturing’s share of GDP is smaller than it used to be. This is just a more nuanced version of the same mistake. The percentage of GDP taken up by this or that industry does not matter. What matters is that consumers are free to spend on what gives them value.

The ongoing shift from manufacturing to services is hardly at the same level as the earlier shift from farming to manufacturing. But the impulse to oppose the change is the same. Even Adam Smith, who was no Luddite, distinguished between “productive” labor, which was agricultural, and “unproductive” labor, which was most non-agricultural. Today, Cass and other industrial policy advocates draw a similar distinction between productive manufacturing and less productive non-manufacturing jobs.

The data have a problem with this argument, too. Even back in the 1940s and 1950s, the service sector had roughly triple manufacturing’s GDP share. The populists’ fixation on ratios, rather than how much wealth people are creating, is a similar mistake to the one in the inequality debate Iain Murray and I pointed to in our paper “People, not Ratios.”

Say’s Treatise was published in 1803, about a generation after Adam Smith and right at the point in history when industrialization was becoming noticeable in Say’s native France. This was the beginning of the Great Enrichment that has raised incomes in the richer countries by 30-fold or so, and is still operating today.

This brings up the second flaw in today’s economic populism. Not only do populists often get the data wrong, they make a fundamental error about what people value.

Say’s insight is that if people value something, it doesn’t matter if it was made this way or that way, or on a farm or a factory, or even whether it is a physical product that a person can hold, or sit on, or drive. This is true regardless of an industry’s NAICS code, which is an artificial distinction anyway.

The whole point of labor is to create value for people, not to create it only in ways that Peter Navarro or Elizabeth Warren approve of. As Say says, what matters isn’t matter; it’s utility.

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Posted in Books, Economics, History, The Market Process

Time for a Federal Price Gouging Law?

Posted on May 15, 2020 | Comments Off on Time for a Federal Price Gouging Law?

Amazon’s vice president of public policy, Brian Huseman, calls for a federal price gouging law in a recent post over at Amazon’s in-house blog. This is a bad idea for several reasons.

One is that there are already effective ways to reduce price gouging without regulation. At Amazon, Huseman writes, “We deploy dynamic automated technology to proactively seek out and pull down unreasonably priced offers, and we have a dedicated team focused on identifying and investigating unfairly priced products that are now in high demand, such as protective masks and hand sanitizer.”

This should be a competitive selling point for Amazon, not a call for more regulation. Regulations, remember, are made by the government we have, not the government we want. Amazon’s technology and in-house policies are almost certainly more effective than what Donald Trump, Nancy Pelosi, or Mitch McConnell would enact during an election year and a pandemic. Company-level policies are also more adaptable than federal-level policies as technology and circumstances change.​

In fact, if Amazon isn’t already doing so, it could license or sell its anti-price gouging technology to competitors for a profit. Price gouging is unpopular, and companies that fight against it look good to customers. Amazon does not need federal regulations to force this business opportunity into being.

Looking at price gouging legislation from Amazon’s perspective, but without the public relations filter, they stand to gain three things from a federal price gouging law:

  1. Regulatory certainty. One federal standard is easier to follow than dozens of state standards.
  2. Liability protection. Amazon will face fewer price gouging lawsuits if the company is cooperative with legislators, or even has a hand in crafting the rules.
  3. Rent-seeking, which is economists’ term for using government for unfair advantage. Price gouging legislation is a way for Amazon to raise rivals’ costs without having to improve its own offerings. Amazon has already invested in artificial intelligence algorithms (AI) and in enforcing guidelines for its third-party sellers. Many of Amazon’s competitors have not, especially the smaller ones.

There is something to be said for the first two items, though there are also arguments against them. But the third item, rent-seeking, is anti-competitive behavior at its worst. One of the primary reasons CEI opposes antitrust regulation, for example, is that antitrust regulations themselves are a major rent-seeking opportunity. Big companies routinely game the rules to thwart competition. Price gouging legislation is another example of the same rent-seeking process. These initiatives happen when companies compete in Washington, rather than the marketplace.

Other Factors

Amazon’s call for a price gouging bill might be part of a larger effort to get itself out of antitrust crosshairs. Ironically, such a bill would make retail less competitive. Not only would Amazon raise rivals’ costs, legislation would prevent companies from competing with each other to offer price gouging policies their customers most prefer.

The timing is as bad as the idea itself. Retail sales declined by 16.4 percent in the month of April, the worst ever recorded—for the second month in a row. Retailers have enough to deal with without having to spend resources complying with new rules their competitor helped to write.

There is a federalism angle, as well. A federal rule would impose standards on more than a dozen states that intentionally refuse them.

Prices Are More than Money

As any good economist will tell you, money isn’t everything. Prices are a lot more than money. Every good has a mix of both money and non-money prices. Price gouging legislation is ultimately ineffective because it only reduces ­money prices during a crisis. Tamping down on those means more severe non-money price increases. These cannot be legislated away.

A high money price causes people who don’t urgently need toilet paper or hand sanitizer to hold off until later, when the price goes back down. That leaves more left over for people who need it now. This matters a great deal during an emergency. On the other side of the equation, that same money price increase also induces producers and distributors to go the extra mile, often literally.

What about non-money prices? One example of a non-money price is when a good becomes harder to find. You might have to drive to a store further away or do some deep digging online for some potentially shady sources. Queuing and waiting lists emerge or shipping times might take longer. These things don’t cost money, but they still have a price. They are not measured in dollars, but in wasted time, extra hassle and stress, and lost opportunities. These non-money price increases leave people with less time left over for other things such as job searches, home schooling, or even taking some time for self-care.

Shortages will happen during a crisis. That is unavoidable. The question is how to deal with them. Just as pushing on a balloon doesn’t change how much air is in it, squeezing down on money prices with a price gouging regulation doesn’t actually do anything to stop price increases. It mostly just redirects them to non-money areas.

What is the correct mix of money- and non-money prices? That is a subjective value judgment. There is no truly right or wrong answer, which is another reason why federal price gouging legislation is bad policy.

Public opinion is pretty well set against price gouging. Importantly, though, most anti-price gouging activists have likely not considered the tradeoffs they would pay in steeper non-money prices. Some of them would likely change their mind if they did. Pollsters should find out. Corporate PR departments would likely change their tune quite a bit based on the results.

Federal price gouging legislation would not stop price increases or alleviate shortages. It would sharply increase non-money prices during emergencies and drive some economic activity into black markets. Companies can set their own price gouging policies without regulation, as Amazon has proven with a mix of AI and sanctions against violating sellers. The rent-seeking aspect of potential price gouging legislation is worth considering for people concerned about business ethics and about large companies gaining an unfair advantage over smaller rivals.

In short, a price gouging bill is #NeverNeeded. Congress has already passed enough harmful flash policy. There’s no need for still more.

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Posted in #NeverNeeded, Antitrust, Competition, Economics, Price and Wage Controls, The Market Process

Alvin E. Roth – Who Gets What ― and Why: The New Economics of Matchmaking and Market Design

Posted on December 13, 2019 | Comments Off on Alvin E. Roth – Who Gets What ― and Why: The New Economics of Matchmaking and Market Design

Alvin E. Roth – Who Gets What ― and Why: The New Economics of Matchmaking and Market Design

Roth co-won the 2012 economics Nobel. His work focuses on solving coordination problems in markets. His most famous work is on matching donors and recipients for kidney transplants. But his insights also apply to other areas from matching college dorm roommates to football bowl game opponents, to marriage matchmaking, to residency and internship assignments for medical school graduates.

He has also greatly improved K-12 school placement systems in cities that allow a limited amount of school choice, such as New York City. In ranked-choice systems, many parents found it in their interest to rank their choices not in their actual order of preference. This level of gamesmanship gummed up the works for both parents and schools, and prevented honest signals from being sent. Borrowing from auction theory, Roth devised a lottery system that worked best when parents honestly ranked their order of preference when applying for schools. This made life simpler for parents, students, and schools, lowered the transaction costs of engaging in the lottery system, and made for better matches all around. Roth advises that similar lessons apply to students applying to college. Apply to the best schools you can, but don’t do early admission unless you have enough information to know that’s your best match. At the same time, apply to some “safe schools” since the better schools tend to be more competitive.

Crucial to Roth’s work is his distinction between thick and thin markets. Thick markets have numerous buyers and sellers with all manner of different preferences. Thin markets are much more difficult to find matches in. Some of the biggest challenges Roth has faced involved thin markets that lack a price system. For example, not only do kidney donations have to match the recipient’s blood type, it is illegal to compensate the donor in every country except, of all places, Iran.

This is where Roth falls short. The obvious solution is to allow price systems to emerge. As numerous economists have pointed out, banning compensated organ donations quite literally kills people. It is one of the most immoral policies a government can enforce. Roth’s work has consisted of second-best workarounds of these bad policies. He has saved hundreds, if not thousands of lives—his Nobel is well-earned. The trouble is that Roth is aware that his matchmaking work treats symptoms rather than problems, and seems content to leave it at that. He does not oppose paid organ donations. But he is also in no hurry to work to change social norms and government policy in a more humane direction.

The astute reader will notice that even in lower-stakes markets where Roth has worked on solving coordination problems, they tend to be either non-profit markets or markets that do not use money. He has devised brilliant systems to work around a lack of a price system, and some good rules of thumb that any non-price market designer can use. But, as with organs, in many cases the better solution is simply to introduce a price system where possible.

At one point, looking back on one of his more successful designs, Roth was proud to view himself as an engineer, rather than a mere student, seeking understanding. This is hubris on his part. Adam Smith famously warned that people are not chess pieces that can be moved around the board as a planner sees fit. The pieces have their own wants and desires. They move on their own in ways nobody can foresee. Roth’s second-best solutions are often improvements. But they are just that—second-best. Even the wisest, most compassionate designer cannot meet peoples’ needs as well as an honest price system can allow people to adapt and create for themselves, on their terms.

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Posted in Books, Economics, The Market Process, Uncategorized

Vlad Tarko – Elinor Ostrom: An Intellectual Biography

Posted on December 6, 2019 | Comments Off on Vlad Tarko – Elinor Ostrom: An Intellectual Biography

Vlad Tarko – Elinor Ostrom: An Intellectual Biography 

Tarko is quickly establishing himself as a top-notch economist. In this, his first book, he offers the best available introduction to Nobel Laureate Elinor Ostrom’s work and the concept of polycentrism. Ostrom was the first, and so far the only, woman to win the economics Nobel [Update: I wrote this review before Esther Duflo co-won the 2019 prize in October]. She and her husband Vincent, also an accomplished economist and political scientist, ran a famous Workshop at Indiana University where they paid less attention to disciplinary boundaries than they did to solid theoretical and empirical research.

Elinor Ostrom also popularized the concept of polycentrism. It’s essentially a more finely graded version of federalism. The United States’ federal system has three main levels of government—federal, state, and local, plus a few in-between grades, most commonly counties. But not all services, Ostrom argues, fit cleanly into one of those categories. Services such as parks, police, and schools, have nothing to do with each other. They may also have different optimum characteristics. So why are they often provided at the same fixed level of government? What if a school district’s optimum size extends beyond a city’s boundaries? What if a park district would be better run as multiple, hyperlocal districts? Moreover, these optimum sizes will vary from place to place. A further complication is that these optimum sizes and structures are constantly changing and evolving as culture, technology, and demographics change. Nothing else stays the same, so why should the sizes of government “firms?”

From this polycentric framework, Ostrom teases out some ground rules for institutional design. One is that smaller is usually better. Most federal issues can be more effectively handled at the state level. Many state-level issues can be handled at smaller gradients, whether regional water or irrigation authorities, transportation authorities, or neighborhood-based policing, a term which now means nearly the opposite of what it did when Ostrom began using the term. Two, because times change, institutions need to be designed with flexibility in mind. They need to be able to grow, shrink, merge, separate, and evolve as circumstances dictate. The goal is the service, not this or that corporate structure, so make change easy.

Ostrom was much more than a theorist. She placed a far greater emphasis on field research than most scholars. This empirical backing greatly improved not just her own work, but that of her many students and collaborators. Tarko shares pictures, stories, and the research she conducted across the country and abroad over her long career. For an introduction to her thought and her broader approach, Tarko is an excellent place to start.

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Posted in Books, Economics, Great Thinkers, Public Choice, The Market Process, Uncategorized