Free Our Markets

by Howard Baetjer Jr

  Of course the unions never say their intention is to increase their own incomes at the expense of the lower-skilled. In fact, they say the opposite: They claim that they are working for the well-being, even the rights, of their laboring brethren. They express outrage at the injustice of working people being paid so little. Nevertheless, the consequence of their policy is that some people who would otherwise be working receive no pay at all.

  On the ethical issue here, no one has been more eloquent than Adam Smith, writing over two and quarter centuries ago:

  The property which every man has in his own labour, as it is the original foundation of all other property, so it is the most sacred and inviolable. The patrimony of a poor man lies in the strength and dexterity of his hands; and to hinder him from employing this strength and dexterity in what manner he thinks proper without injury to his neighbor, is a plain violation of this most sacred property. It is a manifest encroachment upon the just liberty both of the workman, and of those who might be disposed to employ him. As it hinders the one from working at what he thinks proper, so it hinders the others from employing whom they think proper.

  Whether or not one supports minimum wage laws, everyone must concede that minimum wage laws infringe on property and restrict freedom of exchange. In preventing people from offering their labor services for wages below the legal minimum, they prevent people from disposing of this “most sacred property” as they see fit. At the same time, minimum wage laws abridge freedom of exchange by making illegal any contracts specifying wages below the legal minimum. They deny the unskilled the freedom to compete with the higher-skilled in the only way available to them—on price. Those who have learned to evaluate public policy by the approach recommended in this book will immediately be wary of such laws, not just on account of their interference with the price system discussed in Chapter 1, but also on account of their abridgment of property rights and freedom of exchange. Whenever these occur, the analyst should look for incentive problems and efforts by special interest groups to turn the government power to personal, selfish advantage.

  Union influence over minimum wage policy is another instance of regulation being captured by special interest groups and used not in the general interest, but in their private interest, at the expense of their (would-be) competitors and of the general public.

  Pollution Controls and the Coal Interests

  The 1977 Amendments to the Clean Air Act are the starting point of another clear, and painful, illustration of how special interest groups can capture regulation and use it to their private advantage while harming the general public. This example is particularly interesting because the economic relationships are so complex that the benefit to the special interest group seems entirely unrelated to the regulation they pushed through the legislature.

  The Amendments required all newly constructed electricity generating plants in the eastern half of the U.S. that burn coal to clean the smoke coming from their stacks with a particular technology—a gigantic piece of equipment called a scrubber, which removes sulfur dioxide from the smoke. Much coal contains sulfur, which turns into sulfur dioxide when the coal is burned. Sulfur dioxide is a nasty pollutant, so we want to keep it out of the atmosphere. But is using a scrubber the best way to reduce sulfur dioxide emissions?

  As we discussed in Chapter 2, human beings can never know for certain ahead of time the best ways of achieving any purpose. We need freedom for entrepreneurs continually to try out new approaches, and we need profit and loss to select the innovations that perform best at low cost. That goes for reducing sulfur dioxide emissions. Environmental regulation by government, if any, should never specify what technology to use; rather it should specify the standard to be met and leave it up to plants’ owners to achieve that emission level as cheaply as possible. But the 1977 Amendments specified scrubbers. As long as a plant used a scrubber, it was in compliance regardless of the emissions it produced. Hence plants’ owners had no incentive to experiment with other ways of reducing those emissions.

  Why did the 1977 Amendments to the Clean Air Act specify the use of scrubbers rather than a particular target for sulfur dioxide emissions? The answer lies in capture of the regulatory process by a special interest group. In this case, the capture came early, in the very process of drafting the regulatory legislation.

  I’ll lay out the most relevant information below. My challenge to the reader is to deduce from this information the special interest group behind the scrubber requirement for plants that burn coal. Who had a financial incentive to push it through? How does that requirement benefit the special interest group?

  Not all coal has sulfur in it; there is low-sulfur coal that burns very clean of sulfur dioxide, and there is high-sulfur coal that burns filthy with sulfur dioxide. Coal mined in the eastern states, in the Appalachians, generally contains a lot of sulfur, whereas coal mined in the western states is generally quite low in sulfur. Indeed—and this is crucial—the untreated smoke from some clean western coal contains less sulfur dioxide than remains in the smoke from some eastern coal after it has gone through a scrubber.

  Western coal is more expensive than eastern, however. Whereas eastern coal lies close to the surface where it can be extracted at relatively low cost, western coal lies deep underground and can be extracted only at greater expense.

  Now consider what the incentives of coal-burning power-plant operators would be if the Clean Air Act were simply to require that the plants reduce their emissions of sulfur dioxide to some particular levels by any means they choose. They would try to do that at the lowest possible cost. (Remember, low cost in a free economy would mean that a power plant is able to abate pollution while using fewer valuable resources, so those resources may be used to produce other goods and services that consumers want.) That cost includes both the cost of the coal they burn and the cost of the scrubber, if they install one. For some plants, especially large ones close to the eastern coal mines, eastern coal is so much cheaper on account of both its extraction and its transportation costs that the least expensive means of achieving target levels of sulfur dioxide would be to install a scrubber and continue burning dirty but cheap eastern coal.

  For others, however, perhaps smaller plants in the West, it would be cheaper in the long run to avoid the huge up-front costs of a scrubber altogether, and meet emissions targets by burning more expensive but cleaner western coal.

  As the 1977 Amendments to the Clean Air Act were being drafted, what were the respective incentives of the eastern and western coal producers? Who would have benefited from a Clean Air Act that left technologies to the discretion of individual plants? Who would have benefited from a law that required every plant to install a scrubber, regardless of what sort of coal they burn?

  One more piece of information will be helpful in completing this picture of special interest group action: the eastern coal interests were unionized and the western were not. Of course the eastern interests, including the United Mine Workers, would have lost a lot of business to the western coal companies if the law had allowed power plants to keep emissions down simply by burning cleaner coal. For many companies, the least expensive approach to pollution abatement would have been to switch from cheaper eastern coal to more expensive western coal, because by burning western coal they could avoid the huge expense of a scrubber. That would have meant less business for eastern coal interests and the United Mine Workers.

  Offsetting that harm to eastern coal interests would have been the benefit to western coal interests, and, crucially, the benefit to society in general of having sulfur dioxide emissions abated at the lowest possible cost, as determined by the various plant owners, each in a position to judge the least costly course in his particular situation.

  But the eastern coal interests had the political muscle to force the scrubber requirement into law. Being unionized, they had the political organization necessary to put pressure on those drafting the legislation, and when the 1977 Amendments to the Clean Air Act bec
ame law, they required scrubbers on all newly constructed coal-fired electricity generating plants in the eastern half of the U.S. Plant owners, in compliance with the law once they installed a scrubber, had every incentive to burn the cheapest coal they could find, even if the resulting sulfur dioxide emissions were greater than they would have been if the plants had burned western coal with no scrubber.

  Summary

  Any government intervention in any area of human relationships carries a serious risk of capture by special interest groups because it introduces force into those relationships. Thereby intervention makes it possible for special interest groups to get what they want from others without the others’ consent. The sheer availability of legal force creates a nearly irresistible incentive for people to use that force to personal advantage. They organize, they lobby, they manipulate the governmental force for personal gain, disregarding harm to others.

  The intentions of those who support and implement the interventions don’t matter. The incentives of affected interest groups trump good intentions. Whenever governments intervene in the mutually consensual activities of people using their own property, even when the intervention is well-intended, they introduce power—force and compulsion, policemen, jails—into human relationships. People don’t handle such power well. We get tempted to use it to our advantage, even at the expense of others, especially when we can hide in a large group and thereby evade individual responsibility. The power to license hairdressing in order to exclude incompetents is also the power to raise established hairdressers’ incomes by excluding the competent. The power to regulate wages in order to protect low-wage workers is also the power to raise union wages by eliminating low-wage workers’ jobs. The power to require power plants to clean up their pollution in particular ways is also the power to increase the profits of eastern coal interests.

  It does not matter that in each of these cases—and in thousands of others like them—it might be possible, in theory, to make the intervention cause net social benefit. It does not matter that if we could find legislators immune from political pressure (angels, perhaps?) to draft the legislation, and if we could find truly public-interested bureaucrats (more angels?) to administer the programs, and if we could somehow insulate the legislative and regulatory process from the constant pressure of the interest groups affected, that then the interventions might have the good effects we intend. None of these ifs apply to real human affairs. Legislators and bureaucrats are self-interested human beings, inevitably influenced by the special interest groups that pressure them. The governmental force is wielded not only or mostly in the public interest, but also on behalf of private interests. The unavoidable danger with every government restriction of freedom of exchange is that on the whole, the private interests will prevail over the public interest, so that the intervention will result in net harm to society.

  This chapter addresses the incentive problems of restrictions on freedom of exchange, but we should note also that even if there were no incentive problems, regulators would still face problems of incomplete knowledge and lack of innovation addressed in Chapters 1 and 2. Government regulators presume to override the judgments of the distributed market process, but why should we suppose that regulators, however well-intentioned and well-educated, know enough to draft regulation that will cause net benefit? No one even knows how to make a pencil. Is it likely that legislators and regulators will know enough about the industries they restrict to make a good job of it? As for innovation, government regulation blocks it. Government regulations are static and free of competition from other, maybe better, regulations. Government agencies that cause harm and loss have no competing agencies offering competing rules for market participants to turn to. There is no profit-and-loss discovery process sorting out good rules from bad. There are no forces assuring that the regulations evolve as technologies and industries change. For these reasons, too, we should doubt that centrally planned restrictions benefit society when all their costs and limitations are accounted for.

  Jefferson was right that government should leave men “free to regulate their own pursuits of industry and improvement,” and the framers of the Constitution were right to give Congress no power to restrict the freedom of economic enterprise.

  I recommend to the reader, for cautionary inoculation against naïve trust in government restrictions, the skepticism in this passage from the great Chicago economist George Stigler, originator of the capture theory:

  Suppose you want to figure out why a particular regulation passes and the way that it’s written. Imagine the Legislature putting that regulation up for auction. Suppose people could bid on the terms of the regulation and the outcome went to the highest bidder.

  Under those rules it would be clear whose interest is served by a government restriction on freedom of exchange.

  I doubt that actual government regulation comes about, in most cases, by such a corrupt process. But Stigler’s thought experiment is close enough to reality that we should altogether shun government restrictions on freedom of exchange. Instead, we should rely on market forces for the regulation of safety and quality we all desire.

  We next discuss the way regulation by market forces could work, indeed, the way it already it does work to a great extent in our partially free economy.

  Chapter Six

  Market Forces Regulate

  How does the decentralized market process regulate goods and services? What are the elements of such regulation? Through which market participants does it operate? How might this process work (how does it, in some cases) in the absence of any government regulation at all? We return to hairdressing to start looking for answers to these questions.

  Elements of Regulation by Market Forces

  Let’s approach this with a thought experiment: Suppose there were no hairdresser licensing. Suppose state legislatures repealed or “sunsetted” their hairdresser licensing laws, relying thereafter only on freedom of exchange and regulation by market forces—what would happen? In a true free market for hairdressing, with no state license on the wall to assure the customer of a hairdresser’s competence, what reasons, if any, would a person have to trust a hairdresser or barber? What institutions and incentives would we expect to arise to pressure hairdressers and salons toward safety and competence?

  Please think this question through for a few moments before reading on. What’s the best the market could do to make you safe when you go for a haircut?

  * * * * *

  One way to begin is to consider how people choose their hairdressers now, in the presence of licensing. How many base their choices on their hairdressers’ license? Probably not many. Most of us rely primarily on experience. We try a hairdresser or barber, and if we like the results, we go back. If not, we go elsewhere. Hairdressers’ need for repeat business, along with customers’ freedom to go elsewhere, is enough by itself to enforce pretty high standards of quality.

  The most important regulator in the market is thus competition itself, which subjects every business to the continuous judgment of the consuming public, who are free at every moment to give their business to a competitor. One main reason we trust the stores we go to and the electricians and plumbers we hire is our understanding of competition. We know that because they need repeat business and because their customers are free to go elsewhere, they must do a decent job or go broke. Businesses that stay in business in relatively free markets are probably doing a decent job. It is not always or perfectly so, but competition is a good regulator.

  Note that the essential requirements for meaningful competition are freedom of sellers to enter into a business, if they can find a willing buyer, and freedom of buyers to take their business where they will. Consumers must have others to turn to and be free to turn to them in order for markets to punish businesses that offer shabby service or shoddy goods. Government licensing in hairdressing—and a host of other occupations—reduces competition by excluding many who would be able to find willing buyers, as it exclude
d Sharissa in our story of the last chapter. Market discipline grows stronger as freedom of exchange is expanded.

  Working together with customer experience are reputation and word of mouth, which give customers the benefit of experiences others have had with a particular hairdresser. I remember a conversation between my wife and cousin at a family party: “Kathy,” asked my wife, “who did your highlights for you?” On hearing Kathy’s enthusiastic reply, I knew the market was about to cost my wife’s hairdresser a customer. It did; my wife switched to Kathy’s hairdresser. Salons and salon franchises, such as the Hair Cuttery, work hard to establish and maintain a good reputation by giving good service.

  Suppose a customer is injured while getting a hairdo—perhaps the stylist burns the customer’s scalp or cuts her ear. Most salons would go to great lengths to make it up to the customer with free hairdos and the like to preserve their reputations, but perhaps not all would. What could the customer do then? In such cases—rare, we would hope and expect—the customer can sue for damages under the legal institution of tort liability. “Tort” means injury; holding people accountable for injury they do to another’s property or person is one of the foundational legal institutions—along with private property and freedom of exchange—on which a free market in a free society is based.

  While customers’ bad experiences with incompetent hairdressers would of course tend to drive such hairdressers from the market eventually, and while it is possible to sue a hairdresser who actually harms a customer, we would far prefer that customers not have such bad experiences to begin with. State licensing of hairdressers aims to restrict poor hairdressers from practicing in the first place. Are there incentives in an unhampered market that do the same?

  Certainly there are: Salons themselves have a strong financial incentive to establish and strengthen their reputations by hiring only hairdressers they expect to please their customers. Accordingly, they are likely to require some assurance of quality and competence before hiring. They might get that by observing apprentices’ work or giving their own tests to applicants. More commonly, many salons might require some third-party certification of the hairdressers they hire, such as a diploma from a reputable beauty school. Not only is such a diploma some assurance of quality to the salon, but also, hung on the wall, it is good marketing to customers.