VOLUME 60, NO 7 SEPTEMBER 2010fee.org/files/doclib/fee-sept-text.pdf · ment or full market...

Features6 The VAT: Not Just Another Tax by Roy Cordato

9 The Fourth Amendment and Faulty Originalism by Joseph R. Stromberg

17 In Defense of the Huddled Masses by Aeon J. Skoble

20 Alexander Hamilton and the Perils of State Capitalism

by Nicholas Curott and Tyler Watts

26 Financial Regulation Snake Oil by Chidem Kurdas

30 Why Do Futurists Get So Much Wrong? by Steven Horwitz

35 Regulatory Failure by the Numbers by Robert L. Bradley, Jr., and Richard W. Fulmer

Columns15 Thoughts on Freedom ~ Secure in Freedom by Donald J. Boudreaux

24 Our Economic Past ~ The Economic Way of Thinking Makes a Comeback

by Stephen Davies

33 Peripatetics ~ The Evil of Government Debt by Sheldon Richman

39 Give Me a Break! ~ Confiscating Your Property by John Stossel

47 The Pursuit of Happiness ~ The Decline in Civil Liberties by David R. Henderson

Departments2 Perspective ~ What Does the Oil Spill Prove? by Sheldon Richman

4 Opposing the Civil Rights Act Means Opposing Civil Rights? It Just Ain’t So!

by Charles Johnson

40 Capital Letters

Book Reviews

42 Animal Spirits: How Human Psychology Drives the Economy, and Why it Matters

for Global Capitalism

by George A. Akerlof and Robert J. Shiller Reviewed by Dwight R. Lee

43 Black Maverick:T. R. M. Howard’s Fight for Civil Rights and Economic Power

by David Beito and Linda Royster Beito Reviewed by George Leef

44 Mad About Trade:Why Main Street America Should Embrace Globalization

by Daniel Griswold Reviewed by William H. Peterson

45 The Great Decision: Jefferson, Adams, Marshall, and the Battle for the Supreme Court

by Cliff Sloan and David McKean Reviewed by Kevin Gutzman

Page 44

Page 30

Page 47

VOLUME 60, NO 7 SEPTEMBER 2010

You’ve got to hand it to the people who dislikefree markets.They see them everywhere, espe-cially wherever any serious problem arises.That

no free market exists within a thousand miles makes nodifference whatsoever.

Take the oil spill in the Gulf. Market opponents arehaving a field day.They say this finally demonstrates theneed for government to run things. Private firms can’tbe trusted.

But it looks more like government can’t be trusted.The central government is, in law and in fact, the ownerof the part in the Gulf where BP drilled for oil. (I didnot say it is the legitimate owner.) The owner leased itsproperty to a private company, BP, with a bad safetyrecord, issued permits for the drilling operation, andrequired the company to use the government’s ownflawed models in preparing for spills. It then failed tokeep a sharp eye on what BP and subcontractorsTransocean and Halliburton were doing to its property.That might have something to do with the fact thatgovernment regulators don’t have the sort of relation-ship to “their” property that normal private owners do,and they can always be counted on to get friendly withthose they regulate.The Minerals Management Servicein the Interior Department has a special conflict ofinterest: It makes money off the drilling it permits andregulates. Thus it could benefit from decisions that arebad for the public.

So what failed here, the market or the State? The callisn’t even close.The free market was nowhere near thescene. It has an airtight alibi: It didn’t exist.

Now you might get a die-hard anti-market person toconcede this. So we move to the next step.What shouldreplace the current hybrid (government-corporate) sys-tem? I see only two choices: full government manage-ment or full market management. Full governmentmanagement wouldn’t appear terribly promising, con-sidering that the current problems are traceable back togovernment management. How would things changesubstantially if, instead of contracting out the drilling toa nominally private company, the government instead

2T H E F R E E M A N : w w w. t h e f r e e m a n o n l i n e . o r g

What Does the OilSpill Prove?

Perspective

Published byThe Foundation for Economic Education

Irvington-on-Hudson, NY 10533Phone: (914) 591-7230; E-mail: [email protected]

www.fee.org

President Lawrence W. ReedEditor Sheldon Richman

Managing Editor Michael NolanBook Review Editor George C. Leef

ColumnistsCharles Baird David R. Henderson

Donald J. Boudreaux Robert HiggsStephen Davies John Stossel

Burton W. Folsom, Jr. Thomas SzaszWalter E.Williams

Contributing EditorsPeter J. Boettke Dwight R. Lee

James Bovard Wendy McElroyThomas J. DiLorenzo Tibor Machan

Joseph S. Fulda Andrew P. MorrissBettina Bien Greaves James L. Payne

Steven Horwitz William H. PetersonJohn Hospers Jane S. Shaw

Raymond J. Keating Richard H.TimberlakeDaniel B. Klein Lawrence H.White

Foundation for Economic Education

Board of Trustees, 2009–2010Wayne Olson, Chairman

Harry Langenberg Peter J. BoettkeWilliam Dunn Frayda Levy

Jeff Giesea Kris MaurenEthelmae Humphreys Roger Ream

Edward M. Kopko Donald Smith

The Foundation for Economic Education (FEE) is anonpolitical, nonprofit educational champion ofindividual liberty, private property, the free market,

and constitutionally limited government.The Freeman is published monthly, except for combined

January-February and July-August issues. Views expressed by the authors do not necessarily reflect those of FEE’s officers and trustees. To receive a sample copy, or to have The Freemancome regularly to your door, call 800-960-4333, or e-mail [email protected].

The Freeman is available electronically through products and serv-ices provided by ProQuest LLC, 789 East Eisenhower Parkway, POBox 1346, Ann Arbor, Michigan 48106-1346. More informationcan be found at www.proquest.com or by calling 1-800-521-0600.

Copyright © 2010 Foundation for Economic Education, exceptfor graphics material licensed under Creative Commons Agree-ment. Permission granted to reprint any article from this issue,with appropriate credit, except “Confiscating Your Property.”

Front cover: www.flickr.com/ideum; back cover courtesy USCoast Guard

3 S E P T E M B E R 2 0 1 0

P E R S P E C T I V E : W h a t D o e s t h e O i l S p i l l P r o v e ?

hired the personnel itself and paid them directly fromthe U.S. Treasury? Who cares if the rig says “BP,”“Transocean,” or “U.S. Government” on it? The samefallible people would be in the same position to makethe same fateful mistakes. Not much would change.

That’s because what matters is incentives, notwhether a worker is on the government payroll. Whyassume that civil service employees know or care morethan people paid by corporations?

But, it will be said, government workers will have amandate to protect the environment and the public.Okay, let’s go with that. Let’s say the decision-makersare environmental hawks who really don’t like oildrilling anywhere. They’ll be tough: no drilling unlessit’s 100 percent safe. Leaving aside the obvious problemwith this standard, that policy would have costs. Therisk of oil spills may drop to zero, but we might have toforgo certain important benefits in the process. Poorpeople, say, might have their prospects dimmed by moreexpensive energy.

Is the tradeoff worth it? How do we go aboutanswering that question? Government is no help here.It can certainly impose a plan, but constructing a planbeneficial to the public would be like playing darts inthe dark. Mises and Hayek covered this in their writingson State socialism and economic calculation.

Things are sure looking bleak. Government assur-ances are worthless whether it contracts out for drillingor does it itself.That leaves only the free market. Can itbe trusted?

First off, let’s remember that we live in the real world.There are no iron-clad guarantees.The best we can hopefor is relative security. When people conclude that gov-ernment management is the best alternative, knowinglyor not they have rigged the game.They are comparingthe messy real world in which free markets would oper-ate to an impossible government-managed utopia, whereregulators have complete knowledge and total dedicationto the public interest.This is the Nirvana Fallacy.

Only two options are on the table: an arrangementwhere incentives align economic activity with the pub-lic interest and one where they don’t. Now which setupseems more promising? One where personnel risk nocapital, face no prospects of bankruptcy, and procuretheir revenue by force (taxation) after flattering mem-bers of special-interest-serving congressmen? Or one

where capital has to be raised from wary investors in acompetitive environment, insurance is priced accordingto risk, products have to be sold to buyers who are freeto say no, and full and strict liability haunts every deci-sion, with bankruptcy always looming and no govern-ment bailout even implied?

When you come down to it, the choice is reallyrather easy.

* * *

The fiscal fiasco we’re mired in is driving “responsi-ble” heads to search for new sources of revenue, amongthem the value-added tax. It’s an idea whose timeshould never come, Roy Cordato writes.

The Fourth Amendment appears to enshrine theright to privacy against government intrusion. But ithasn’t quite worked out that way, according to researchby Joseph Stromberg.

How can a nation of immigrants be so down onimmigration? Aeon Skoble has some explanations.

We often assume the Founding Fathers would bespinning in their graves if they knew what’s going on inthe United States. But probably not Alexander Hamil-ton, Nicholas Curott and Tyler Watts suggest.

A new era of financial regulation is upon us. ChidemKurdas has the details of what’s been cooked up by someof the chefs who prepared the last collapsed soufflé.

Predicting the future is big business, but why do mostprognosticators get it so wrong? Steven Horwitz appliessome good economics and comes up with an answer.

The record of government regulation is consistentlybad. Robert L. Bradley, Jr., and Richard W. Fulmer giveus 15 reasons why this has to be the case.

From our columnists: Donald Boudreaux examinesthe language for bias. Stephen Davies detects a returnof the economic way of thinking. David Hendersonassesses the state of civil liberties. John Stossel lamentsthe destruction of property rights. And Charles John-son, confronting the assertion that opposing civil rightslegislation means opposing civil rights, responds, “It Just Ain’t So!”

Books on animal spirits, a black entrepreneur, freetrade, and Marbury v. Madison are evaluated by ourreviewers.

—Sheldon Richman, [email protected]

Just after winning his Republican primary in May,Rand Paul got himself into a political pickle overhis views on property rights and the 1964 Civil

Rights Act. Having reluctantly discussed concernsabout antidiscrimination laws with the LouisvilleCourier-Journal and NPR, Paul made his now-notoriousappearance on the Rachel Maddow Show, where Mad-dow grilled him for 15 minutes on whether heopposed government intervention to stop racial dis-crimination. After saying he favored overturning government-mandated discrimination, Paul finally admit-ted that he opposes Title II, whichforbids private owners from discrimi-nating in their own businesses.

As he told the Courier-Journal: “Idon’t like the idea of telling privatebusiness owners—I abhor racism; Ithink it’s a bad business decision toever exclude anybody from yourrestaurant; but at the same time, I dobelieve in private ownership. . . .”

Maddow responded: “I thinkwanting to allow private businessesto discriminate on the basis of race,because of property rights, is anextreme view.” Within a day Progressives were toutingthe interview as proof of a deep conflict between liber-tarian defenses of private property and struggles forracial equality. Meanwhile, compromising libertarianslike Brink Lindsey reacted by discovering exceptions tolibertarian principles—to make room, again, for federalantidiscrimination laws. The entire debate has playedout as an argument over libertarianism and “extrem-ism,” with Progressives and many nominal libertarians

both condemning Rand Paul’s simplistic “extremism”about private property and libertarian rights.

I have little interest in defending Paul but it’s strangeto treat him like some case study in the dangers of lib-ertarian extremism. Rand Paul is a conservative, not a libertarian—let alone an “extreme” one. He’s said asmuch, in so many words, in repeated interviews. Now,you could simply say, “He may be no libertarian, butnever mind Rand Paul—what about the issue?” Liber-tarianism opposes government control of private busi-ness decisions; taken to extremes, doesn’t that include

laws against racist business practices—the civil rights movement’s crowningachievement?

Well, I do have something to say onbehalf of “extremism.” Not on behalf ofsacrificing the civil rights movement’sachievements to “extreme” stands onantistatist principle. Rather, “extreme”stands on antistatist principle showwhat the civil rights movement didright, and what it really achieved, with-out the aid of federal laws.

To be sure, uncompromising liber-tarianism does mean uncompromised

property rights. That includes, if we’re to be “extrem-ists,” a conscientious defense of businesspeople’s right tobe awful, to discriminate against anyone for any reason,so long as they do it on their own property withoutviolence.That ain’t Jim Crow as practiced in the South:State laws and Klan terrorism there enforced segrega-

Opposing the Civil Rights Act Means Opposing Civil Rights?

It Just Ain’t So!


B Y C H A R L E S J O H N S O N

Charles Johnson ([email protected]), a third-generation Freemancontributor, is a research associate at the Molinari Institute and author ofthe Rad Geek People’s Daily weblog (www.radgeek.com).

Organized protests like these sit-ins usedeconomic and social pressure to end racistcompany policies.

5 S E P T E M B E R 2 0 1 0

tion on unwilling businesses. But Maddow’s correct—Jim Crow was also a social and economic system, andwhite businessmen colluded even without legal man-dates. Woolworth’s lunch counters were segregated bycompany policy not by law. Rand Paul “abhors” thatpersonally and wouldn’t eat there but thinks govern-ment shouldn’t intervene.

Maddow was baffled: “But isn’t being in favor ofcivil rights, but against the Civil Rights Act like sayingyou’re against high cholesterol but in favor of friedcheese?” She’s begging the question; you may as wellask how someone could be for patriotism but againstthe PATRIOT Act. But while mistaken, the questionisn’t cheap rhetoric. It’s revealing of Maddow’s premisesabout law and social progress.

As she insisted later,“Let’s say there’s a town right now.. . . [T]he owner of the bowling alleysays, ‘we’re not going to allow blackpatrons.’ . . .You may think that’s abhor-rent and you may think that’s bad business. But unless it’s illegal, there’s noth-ing to stop that—nothing under yourworldview to stop the country fromresegregating.”

Unless it’s illegal anything could happen; nobody canstop it; a just social order can only form through socialcontrol. Private segregation should stop and only gov-ernment can stop it; hence, Title II. Paul helpfully suggests you can loudly announce your personal abhor-rence of racism, even without laws. Maddow rightly dis-misses that as a response: Entrenched white supremacywas indifferent to personal outrage; it demanded con-certed, political resistance.

But if libertarianism has anything to teach aboutpolitics, it’s that politics goes beyond politicians; socialproblems demand social solutions. Discriminatory busi-nesses should be free from legal retaliation—not insu-lated from the social and economic consequences of theirbigotry. What consequences? Whatever consequences youwant, so long as they’re peaceful—agitation, confronta-tion, boycotts, strikes, nonviolent protests.

So when Maddow asks, “Should Woolworth’s lunchcounters have been allowed to stay segregated?” neithershe nor Paul seemed to realize that her attempted coupde grace—invoking the sit-in movement’s student mar-

tyrs, facing down beatings to desegregate lunch coun-ters—actually offers a perfect libertarian response toher own question.

Because, actually, Woolworth’s lunch counters weren’tdesegregated by Title II. The sit-in movement did that.From the Montgomery Bus Boycott onward, the Free-dom Movement had won victories, town by town,building movements, holding racist institutions sociallyand economically accountable. The sit-ins proved thereal-world power of the strategy: In Greensboro, N.C.,nonviolent sit-in protests drove Woolworth’s to aban-don its whites-only policy by July 1960.The NashvilleStudent Movement, through three months of sit-insand boycotts, convinced merchants to open all down-town lunch counters in May the same year. Creativeprotests and grassroots pressure campaigns across the

South changed local cultures and dis-mantled private segregation withoutlegal backing.

Should lunch counters have beenallowed to stay segregated? No—butthe question is how to disallow it. Big-oted businesses shouldn’t face threats of

legal force for their racism. They should face a forcemuch fiercer and more meaningful—the full force ofvoluntary social organization and a culture of equality.What’s to stop resegregation in a libertarian society? Weare. Using the same social power that was dismantlingJim Crow years before legal desegregation.

I oppose civil rights acts because I support civil rights movements—because the forms of social protestthey pioneered proved far more courageous, positive,and effective than the litigious quagmires and palebureaucratic substitutes governments offer.

Libertarians must change the terms of this riggeddebate. The problem isn’t that libertarian views get“extreme,” but that some don’t take free markets farenough, forgetting they mean freedom not just for busi-nesses and stereotypical forms of commerce but for everysort of consensual social experimentation, nonviolentsocial struggle, and people-powered solidarity free peoplecan practice. The question is not whether to make ourviews less “extreme,” but how to make our “extremism”more thoughtful. Perhaps libertarianism, the nation, andthe world are in dire need of creative extremists.

O p p o s i n g t h e C i v i l R i g h t s A c t M e a n s O p p o s i n g C i v i l R i g h t s ? I T J U S T A I N ’ T S O !

Politics goes beyondpoliticians; socialproblems demandsocial solutions.

Recently there has been a great deal of specula-tion about how the U.S. government will dealwith its massive budget deficits and increasing

levels of debt. For readers of The Freeman the answer israther simple: Since most of what the federal govern-ment does goes beyond its “legitimate” role, cut spend-ing. Drastically. Discussions about balancing spendingcuts with tax increases are misplaced given the currentsize and scope of government activity.

But, alas, Freeman readers are not the relevant deci-sion-makers.Tax increases are drivingmuch of the discussion, and nooption is discussed more than avalue-added tax, or VAT. Indeed thereis much speculation that PresidentObama’s Bipartisan Commission onFiscal Responsibility and Reformwill include a VAT as the majorsource of new revenues in any set ofrecommendations.

The VAT is a pernicious andinsidious tax that promises to fueldramatic growth in government. But this cannot beunderstood without first examining the mechanics ofthe tax.The devil is indeed in the details.

Theory

Theoretically a VAT is levied on the “value added”at every stage of production to goods and services

ultimately purchased by consumers. The consumer,however, pays the final tab.

The table on the next page shows four stages ofproduction leading to the final sale. (This example isfrom Michael Schuyler’s Consumption Taxes: Promises and

Problems, Fiscal Issue 4, Institute for Research on theEconomics of Taxation, 1984.) As each stage is com-pleted, a partially finished product has value addedbefore it is sold to the next stage. In this example, valueadded is taxed at 10 percent.To simplify, a starting pointis picked with “prior producers” having added the first$10 of value.At the point of sale a 10 percent tax, $1, iscollected.Thus the cost to the manufacturer is $11.

After adding further refinements the manufacturersells his partially finished product for $30 to the whole-

saler and charges a 10 percent VAT,receiving $33. To figure the tax, themanufacturer subtracts the tax fromthe previous stage to avoid doubletaxation. Before sending the tax to thegovernment, he deducts the $1 paid to the original producer. With valueadded at $20, he sends $2 to the government.

The wholesaler adds $50 in valueto the product and sells it to theretailer for $80 plus the 10 percent,

for a total of $88. But before he sends the $8 to thegovernment, he deducts the $3 in VAT paid to themanufacturer. The net tax collected is $5. Ultimatelythe retailer sells the finished product to the consumerfor $100 plus the 10 percent VAT, or $110. Again, theretailer deducts the $8 that he had previously paid andsends $2 to the government, or 10 percent of the $20in value added at this final stage. (If at any stage a pro-ducer sells his goods for less than the cost of his mate-

B Y R O Y C O R D AT O

The VAT: Not Just Another Tax


Roy Cordato ([email protected]) is vice president for research andresident scholar at the John Locke Foundation in Raleigh, N.C.

The VAT is apernicious andinsidious tax thatpromises to fueldramatic growth ingovernment.

rials, he would pay tax only on the actual sellingprice.)

In principle there is no difference, in terms of thetotal tax collected, between a VAT and a retail sales tax. But the compliance costs of a VAT would be much higher because the tax is collected at every stageof production.

Practice: The Invoice-Credit Method

Most governments have adopted the “invoice-credit method” for collecting a VAT. The

United States would likely do the same. This methodmakes tax collection automatic. In the example, which doesn’t use that method, companies deduct theamount of tax already paid at each stage of productionbefore sending in the tax on value they added. Butwith the invoice-credit method, the taxpayer at eachstage is responsible for the entire amount of the tax onhis sale and can only obtain a credit for taxes paid pre-viously if he provides an invoice from his suppliers. Forexample, the retailer that purchases the product fromthe wholesaler for $88,VAT included, must pay the full$10 tax on his sale to the final customer and then sub-mit an invoice provided to him by the wholesalershowing that he paid $8 in tax. Only then can he getcredit for it.

Michael Schuyler, economist at the Institute forResearch on the Economics of Taxation, points out thatthe invoice-credit method ensures that the tax is “self-policing.” Focusing on the transaction between themanufacturer and wholesaler in the example, Schuyler

writes, “Suppose . . . that the manufacturer wants tounderstate the sale price of its output . . . so that it canreduce its tax. . . . Would the wholesaler allow thephony amount to be listed on its purchase invoice? Thewholesaler would object because the [amount gainedby] the manufacturer would be lost to the wholesaler.”

Thus there is a strong incentive for businesses topolice the reporting of their suppliers.

A Central Planner’s Dream Tax

From the perspective of the State, this is a near-per-fect tax. It touches every stage in every production

process, from new homes to hair cuts, and allows thegovernment, because of the required invoices at everypoint, to keep track of every business’s buying and sell-ing. For a State bent on managing the details of busi-ness, possibly to implement CO2 controls or to makesure that politically favored firms (say, unionized ones)are patronized, the information can establish a usefuldatabase.

But beyond this, the VAT would be a revenue-gen-erating machine, unmatched by any other form of tax-ation. First, it guarantees that a percentage of the totalvalue of all goods and services sold in the economygoes to the State. Nothing escapes the tax. Also,because it is levied on such a broad base, very smallincreases in the rate would bring in large amounts ofrevenue.While this is also theoretically true of a retailsales tax, the multilayered enforcement mechanism ofa VAT makes it almost impossible to avoid. Note thatthe tax on the full value added up through any stage

7 S E P T E M B E R 2 0 1 0

T h e VAT: N o t J u s t A n o t h e r Ta x

Calculating Value Added and the Value-Added Tax by the Subtraction Method

Producer Selling Price Purchases Value Added 10% of Value Selling Pricewithout Tax from Other Added (Including

Producers 10% VAT)

Prior Producers $10 $0 $10 $1 $11

Manufacturers 30 10 20 2 33

Wholesaler 80 30 50 5 88

Retailer 100 80 20 2 110

of production is the responsibility of the companyoperating at that stage, until the company provides theneeded invoices from his suppliers that allow him toreceive the credit. As a product passes through differ-ent stages of production, the incentive is always to col-lect the tax from those you are selling to and to collectthe invoices from those you are buying from. Everybusiness becomes a revenue agent. With very littleenforcement effort, the government watches themoney roll in.

Adding insult to injury for the taxpayer and icing onthe cake for the State, the tax is usually hidden from thefinal consumer. Unlike a retail sales tax, the VAT is usu-ally included in the sticker price of the product. Con-

sumers are not directly confronted with the fact thatthey are paying it. This both makes the tax easy toincrease and masks the true cost of government. If weare ultimately going to reduce the size of the State,individuals need to feel the pain it inflicts. This startswith making people keenly aware of the taxes they pay.There is no tax more hidden from the people who payit than a VAT.

The VAT is not just another tax. It poses a funda-mental threat to liberty and a free society. And since atax with such massive revenue-generating capabilitieswould be nearly impossible to repeal, it is likely thatthere would be no turning back the advancement ofLeviathan.


R o y C o r d a t o

“All arrests are at the peril of the party making them.”—Alexander H. Stephens,August 27, 1863

These days the Fourth Amendment to the Con-stitution means next to nothing. Consider, forexample, the choice offered a few years ago:

surveillance under routine, easy “warrants” from thedrive-through FISA Court or warrantless surveillanceat the whim of George W. Bush and his allegedlyboundless reserve of unitary-executive authority. A January 2006 Justice Department memo (“LegalAuthorities Supporting the Activitiesof the National Security Agency . . .”)explained the executive’s claims inmind-numbing and unconvincingdetail. But the memo at least sug-gested how far below any practicalservice to Americans’ liberty theFourth Amendment has fallen, and did so by heaping up available (andrather bad) search-and-seizure prece-dents, many of which arose from theterminally futile war on drugs (pages37–38).The result is something like “your Constitutionon drugs”—with the searchers and seizers on steroids.

Turning to the Fourth Amendment itself, we read:“The right of the people to be secure in their persons,houses, papers, and effects, against unreasonable searchesand seizures, shall not be violated, and no Warrants shallissue, but upon probable cause, supported by Oath oraffirmation, and particularly describing the place to besearched, and the persons or things to be seized.”

This sounds pretty good, doesn’t it? And solid, like itmight actually mean something. Alas, no such utopian

state of affairs actually obtains. It is possible of coursethat my elementary school teachers just plain lied to uswhen they spun golden tales about American freedoms.

Yet surely there is more to it. But if so, what doombefell the Fourth Amendment? We might try looking atvarious eventful periods when governments—state andfederal—felt unusually strong needs to arrest, search,and seize, such as the Civil War, Reconstruction,WorldWar I, Prohibition (see Lacey, in works consultedbelow),World War II, the Cold War, and (naturally) thewar on drugs. It seems, however, that long-running

negligence, evasion, and misinterpre-tation have done more harm to theFourth Amendment than have vari-ous short-run authoritarian panics.Central to this slow but continuousprocess was the rise of modern polic-ing in the nineteenth century, creat-ing a new institution not foreseen inAmerican constitutions (state or fed-eral) and therefore largely incompati-ble with them and unaddressed bythem (see Roots).

Gradualism and crisis, always headed the same way,have yielded a constitutional trail of tears catalogued inAmerican state and federal case law.The U.S. SupremeCourt hardly noticed the Fourth Amendment until thetwentieth century. In the Prohibition-era case Carroll v.U.S. (1925), the Court sanctioned searches of privateautomobiles on the rather forced analogy of ships atsea. (The next time cops pull you over and search your

B Y J O S E P H R . S T R O M B E R G

The Fourth Amendment and Faulty Originalism

9 S E P T E M B E R 2 0 1 0

Joseph Stromberg ([email protected]) is a historian and freelancewriter.

Gradualism and crisis,always headed thesame way, haveyielded aconstitutional trail of tears.

car, you may blame Chief Justice William Howard Taft.)But the amendment’s core meaning survived awhilelonger in areas where it was thought to have alwaysapplied.

Meanwhile, emboldened by the Fourteenth Amend-ment, the Supreme Court undertook to supervise statepolice practices from the late 1940s on; it would decideif the states were following the Fourth and otheramendments. This new project annoyed the states butdid little enough for the public. Examining federalsearch practices in U.S. v. Rabinowitz (1950), the Courtdeclared the word “unreasonable” the key to the FourthAmendment. Henceforth the Court would philoso-phize on the “reasonableness” of searches (“in the cir-cumstances”) and periodically announce our ever-waxing-and-waning rights on the accordion model ofcivil liberties. Warrants pretty muchdisappeared.

We have been saddled with thisunsatisfactory outcome ever since.The subjectivity of judicial balancingacts, along with fluctuating judicialmoods, has made the Court’s under-standing of “reasonable” rather lessstable than that of the Oxford EnglishDictionary. The war on drugs has rendered the Court (particularly“conservative” justices) unsympathetic to complaintsabout searches. The upshot is that the Fourth Amend-ment is now mostly just another empty marker atwhich American politicians, bureaucrats, and ideo-logues can wave when praising the precious freedomsthat supposedly cause Americans to be hated.

Legal History vs. Politicized Originalism

In constructing the above account, I have relied heavily on the work of Thomas Y. Davies, professor

of law at the University of Tennessee. (The rhetoric is mine.) In essays running from 1999 to 2007 Davies painstakingly reconstructed the late eighteenth-century context of the Fourth Amendment, accountedfor its later reinterpretation, and thus described itseffective demise. At the same time, he assessed conser-vative constitutional “originalism,” which he findsharmful.

For Davies the key to Fourth Amendment mysteriesis the displacement of eighteenth-century common-law rules by later legal tinkering.As “judge-discovered”law, common law constituted a whole system (albeituncodified) able to address almost any issue that couldget into court, naturally or under a legal fiction. It cen-tered on private prosecutions between parties, whowere often large landholders, and its rules aimed at pro-tecting their rights and “quiet enjoyment” of theirproperty. (The radical historian Barrington Moore, Jr.,has noted the aristocratic origins of our civil liberties.)

Of course common law adopted, or was forced toadopt, a number of royalist and Parliamentary premisesperhaps not essential to its workings, in such matters ofState concern as sovereignty, treason, customs, and rev-enue. Given its environment, common law also incor-

porated social prejudices regardingwomen, employees (“servants”), andother disfavored classes, and remainedmired in semi-feudal verbiage. Com-mon lawyers worked new contentinto their “feudal” categories in a waythat eased the transition from “feudal-ism” (for lack of a better term) toEnglish agrarian capitalism and fromone form of State to another. In thehands of Whig justices like Sir

Edward Coke (1552–1634), locked in battle againstStuart royal prerogative, the common law became apotential weapon for individual and popular rightsagainst State abuses. Coke’s views were very influentialin revolutionary America.

In the nineteenth century, though, the common lawcame to be seen as a barrier both to industrial capital-ism and to further expansion of the modern state; forthese and other reasons it was interpreted into nothing-ness or quietly abandoned.

Common-Law Arrest, Search, and Seizure

With common-law rules in view, Davies sees thewhole point of the Fourth Amendment as con-

trol of warrants to be achieved by defining themstrictly. In the common-law environment of the lateeighteenth century, warrantless searches—or arrests—were rare and subject to strict conditions. Thus con-


J o s e p h R . S t r o m b e r g

The Supreme Court’sunderstanding of“reasonable” has beenrather less stable thanthat of the OED.

fined, these few warrantless actions hardly threatenedpublic liberty. Let us see why.

First of all, no one—constable or freeman—couldarrest or search someone merely for looking “suspi-cious.” Accusers (public or private) had to have a casebefore applying for any kind of warrant.To have a case,an actual crime had to have been committed already.An accusation also had to include sworn testimony ofone or more witnesses asserting direct, personal knowl-edge supporting the belief that a named defendant haddone the deed. Strung-out informants selling hearsay“evidence” about crimes that might occur in the futurewere not consulted, although hearsay could be admittedto establish background facts. Judicial action—indict-ment, issue of warrants—rested on the kinds of evidence described above. Arrest war-rants did not normally issue for mis-demeanors. The defendant remainedat large but would be wise to attendhis trial. A search warrant gave per-mission to look only for the specificthings named.

Further, a defendant never appearedas a witness, but could, with or withoutcounsel, impeach the evidence againsthim and cross-examine witnesses.Accordingly, the rule against self-accusation (self-incrimination) did notprotect a defendant’s trial rights, butmeant instead that his diary, calendar,papers, and effects—as extensions of himself—were notsubject to general ransacking and fishing expeditions.The other side had to make its case without such mod-ern conveniences. Only Parliament claimed to be ableto license fishing expeditions (such as the “general warrants” that so nettled colonial Americans) andmainly in the narrow areas of “treason,” customs, andrevenue. (The last two items came under admiralty lawwith its civil [Roman] law rules.) The Fourth Amend-ment sought to limit the ability of Congress to playsuch games.

There was a short list of warrantless arrests andsearches allowed under common law.An officer or free-man who saw a misdemeanor underway in his presence(affray or breach of the peace) could make an arrest.

Someone traveling at night could be detainedovernight to account for himself. In “hot pursuit” of afleeing felon who had committed an actual crime, anofficer or freeman could “break” (into) a house. Hereagain is the combination of actual crime and personalknowledge.There were a few other complications, butthey and the above-mentioned practices were rooted incommon sense and had definite boundaries.

Under common-law rules arrests were few and farbetween. In a system based on enforcement by pri-vate parties (freemen), or by constables with few addi-tional powers, defendants could sue for “personal tres-pass” anyone who brought a bad prosecution. Logi-cally enough, a right to resist false arrest also existed.(Nowadays the concept of false arrest is nearly dead

and resistance is not generally recom-mended.) Damages for bad prosecu-tions were a useful incentive forkeeping peace officers and privateprosecutors reasonably careful.Tightly drawn warrants, whererequired, actually protected officersfrom resistance or suit.

Since arrests were few and gener-ally followed indictment—and thaton real evidence—defendants notformally accused were seldomdetained. Hence modern dilemmasinvolving interrogation seldom arose.Asking questions was a judicial func-

tion carried out at trial. Constables, who were consid-ered judicial (not executive) officers, had littlediscretionary authority and few occasions for third-degree Q&A sessions in the back room. And of coursecommon law had no plea bargaining, that ubiquitous,contemporary solution of “overworked” courts thatPaul Craig Roberts and Lawrence M. Stratton refer toas a form of torture.

In the United States, federalism set further limits.Only a few matters fell under federal jurisdiction, fewerstill under exclusive federal jurisdiction. At the statelevel special language in revolutionary-era state consti-tutions about the “law of the land” or “due process oflaw”—“terms of art”—protected and perhaps “consti-tutionalized” common-law rules of arrest, search, and

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Under common-lawrules arrests were fewand far between,defendants could sueanyone who broughta bad prosecution,and there was a rightto resist false arrest.

seizure. (“Due course of law” referred to trial proce-dures.) At the federal level specific constitutional lan-guage in the Fourth and Fifth Amendments andelsewhere served a similar purpose. And in practiceAmerica avoided what Jeffersonians most feared: a fed-eral claim to enforce the whole common law, whichpotentially reached everything under the sun. Theobjects of federal action were limited in number, andthe claim of extreme federalists to general common-law jurisdiction failed. But the common-law rules (“dueprocess,” “law of the land”) seemed well entrenched atboth levels of government. Could courts and legislatureslegally (“constitutionally”) throw away these protec-tions? It is hard to say what informed legal opinionwould have said on this point in 1790. Later, of course,courts and legislatures contrived to do exactly that.

Rise and Fall of the Fourth Amendment

The framers’ quest to establish cer-tain common-law rights largely

failed. The disjunction between theclauses of the Fourth Amendmentencouraged the leap to a “reasonable-ness” standard. In fact, as Daviesshows, the words “unreasonablesearches and seizures” were Revolu-tionary-era rhetoric condemningBritish general warrants of the 1760sand 1770s as without reason (outside of reason) and there-fore illegal and unconstitutional; they were not meant tolicense future judicial speculation.The core ideas of theFourth Amendment were better expressed in the Mass-achusetts Constitution of 1780 and the Ohio Constitu-tion of 1802. Davies speculates that James Madison’sinnovative phrase, “probable cause,” was meant to allowa little leeway for customs and revenue enforcement,which already enjoyed partial exemption from com-mon-law rules. (A warehouse, for example, did notenjoy the same immunities from search and seizure as aprivate dwelling.) Still, even Madison’s slightly weak-ened version meant something, although “probablecause” (taken by itself) had a big future as a means ofreducing restrictions on power to a nullity.

In Davies’s view the Fourth Amendment unraveledfor several reasons. Judicial and legislative amnesia

undercut the common-law rules.With growing indus-trialization, capitalists feared workers, Protestants fearedIrish immigrants, and most people feared propertycrime more than they feared the State.To allay these fearsand address some genuine problems caused by over-crowding, urban elites created police forces in majorAmerican cities by the 1830s. In eighteenth-centuryterms these new bodies were “standing armies.” Theirpractices brought about pressure for revised rules ofarrest, search, and seizure, and new rules encouraged thenew police practices. Davies speculates that the rise of“relativistic and probabilistic notions of truth andproof,” diminished reliance on oaths, and fear of toofew convictions also eroded the old common-lawregime.

Finally, state and federal courts rather forciblydragged “due process” into property law—rathernotoriously in Dred Scott (1857), with its substantive

due process for slaveholders—with alittle left over for trial procedures.“Due process” of arrest, search, andseizure receded into the shadows. Insearch of improved ideas, Americanstate courts looked to Britain, wheresince 1780 judges had been adjustingthe rules in favor of industrialism andmodern State practices. (Right-wingcommentators who gripe about “for-

eign law” influences ought to investigate this connec-tion.) For once the federal government was fairlyinnocent. Precedents that undermined the old com-mon-law regime largely trickled up from the states,especially in the second half of the nineteenth cen-tury. The upward trickle was slow at first: Down to1935 federal marshals still had to have proper warrantsto make an arrest.

Here then is today’s Fourth Amendment as seen by alife-form afflicted with supreme-judicial eye syndrome:

“The right of the people to be secure in their per-sons, houses, papers, and effects, against unreasonablesearches and seizures, shall not be violated, and no War-rants shall issue, but upon probable cause, supported byOath or affirmation, and particularly describing theplace to be searched, and the persons or things to beseized.”


J o s e p h R . S t r o m b e r g

The framers’ quest toestablish certaincommon-law rightslargely failed.

(As this ocular condition worsens, all but a fewobjects dwindle into dim grayness.)

On Davies’s argument the view that the FourthAmendment came into its own from the mid-twentiethcentury forward, when reasonableness took centerstage, puts the cart well before the horse. And yet theFourth Amendment cannot really be recovered.This iswhere good legal history—concrete originalism—leavesus. Potentially beneficial constitutional provisions are oflittle use today, even when their meanings can bereconstructed in legal-historical context. We can’t goback, since “activist” judges and legislators have workedfor almost 200 years to institutionalize a legal regimewith only slight resemblance to anyoriginal plan.

Can Anything Be Done?

Oddly enough, nineteenth-centuryAnglo-American legal bragging

about freedom crested at roughly thetime when many common-law rulesworth saving were on the way out.Common law had reactionary social biases, to be sure,but an accelerated “trickle-down”—to everyone—ofimportant rights that common law protected mighthave been preferable to their elimination. Purging com-mon law of its English royalist and absolutist accretionswas precisely the goal of St. George Tucker’s annotatededition of Blackstone (1803). And there was no reasonto stop with Tucker’s “republicanized” Blackstone. Moreright than wrong on this, Murray Rothbard wrote thatthe common law minus some “statist accretions”fairly approximated a libertarian law code. Thinkers outside the mainstream periodically rediscover the radi-cal potential of English law: people like Gerrard Win-stanley, John Lilburne, John Adams, Thomas Jefferson,Lysander Spooner, and others closer to our own time.They may not agree with one another, but their exam-ple is interesting.

This is the path not taken. Most arrests and searchestoday are without warrant, and getting a formal warrant

is fairly easy. Concrete, sworn personal knowledge hasyielded to vague (“reasonable”) suspicion or whimsy asa “standard.” Once we enjoyed rules that provided forconcrete privacy. By the 1960s privacy seemed soimperiled that the Supreme Court with its usual job-bery was driven to invent an artificial “right of privacy”just to restore some balance. Later, “originalist” conser-vative justices wrathfully informed us that passage of alaw by Congress is nine-tenths of “due process” (youvoted, didn’t you?) and the rest is enforcement—sternlaw-and-order formalism indeed. Translated, conserva-tive “due process” seems to leave us subject to arrest,search, or seizure at the whim of any functionary capa-

ble of forming a whim.Americans have let themselves be

systematically excluded from land,from effective political participation,and from effective legal participa-tion. When collapse of the new-model system comes, as one day itmust, we may perhaps give ourselvesa new constitution. Where might

we begin? Chapter XXIX of Magna Carta looks rather promising.

Works ConsultedThomas Y. Davies, “Recovering the Original Fourth Amendment,”

Michigan Law Journal (1999), and “Correcting Search-and-SeizureHistory: Now-Forgotten Common-Law Arrest Standards” [&c],Mississippi Law Journal (2007). (These two are essential. See alsoDavies in Wake Forest Law Review (2002), 239ff, Tennessee LawReview (2003), 987ff, Brooklyn Law Review (2005), 105ff, andBrooklyn Law Review (2007), 557ff.)

Morton Horwitz, The Transformation of American Law (1992).Theodore B. Lacey,“The Supreme Court’s Fluctuating Reaction to

National Prohibition in Fourth Amendment Decisions from1920–1933” (Senior Thesis, Princeton University, 2005).

Roger Roots, “Are Cops Constitutional?” Seton Hall ConstitutionalLaw Journal (2001).

St. George Tucker, “Of the Unwritten, or Common Law of Eng-land,” in View of the Constitution of the United States (1999 [1803]),313–369.

(All the above except Horwitz may be found online.)

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Most arrests andsearches today arewithout warrant.

B Y D O N A L D J . B O U D R E A U X

Secure in Freedom

Thoughts on Freedom

Language is indispensable to civilization. Butbecause we rely on language so heavily—becauseit is our chief means of communicating with

each other as well as a tool for forming and storing ourthoughts—if used carelessly it can misshape ourthoughts.

Careless language (or, even worse, verbal legerde-main) often turns words or phrases with positive con-notations into Trojan horses that sneak mistaken,vague, or confusing notions into our thought processes.

A familiar example is the word “fair.” By definition,“fair” denotes something desirable. So by attaching theword to any noun or verb, a speaker anoints the thingas something good.The speaker is subtly instructing thelistener simply to accept without ques-tion that the thing described by theword is good. A careless listener, then,is at high risk of accepting a conclu-sion that, with careful thought orwithout having heard the word “fair,”he might not accept.

Consider the frequently heardphrase “fair wage.” If Sen. Jonesexplains his support for raising the legislated minimumwage, he’s sure to insist that his goal is for low-skilledworkers to receive a “fair wage.” Scholars seeking toexplain the consequences of minimum-wage legislationobjectively then have to overcome the emotional biasthat the word “fair” smuggles into the conversation.

Another example is the phrase “secure our borders.”Opponents of open immigration frequently allege thatillegal immigrants are proof that America’s bordersaren’t “secure” and that those of us who wish to abolishnumerical limits on immigration are insensitive to theneed for government to “secure our borders.”

Such allegations, however, sneak in so many implicitpresumptions that rational discussion becomes quitedifficult.

The very phrase “insecure borders” conjures animage of government failing at its most fundamentalresponsibility—namely, protecting citizens from invad-ing marauders. People see in their minds’ eyes an Amer-ica increasingly at risk of being conquered byforeigners, leaving Americans at the mercy of invadingrapists, plunderers, and murderers.

Immigrants, however, aren’t invaders, much less war-riors in a conquering army.

Reasonable people can disagree over what kinds ofnational-security protections should exist on America’sborders and what sorts of screening of would-be immi-grants should be done to reduce the risks of terroristattacks on American soil. But it is not reasonable to

imply that immigration is chiefly, oreven mostly, an issue of nationalsecurity. Unfortunately, such anunreasonable implication is preciselywhat people who frame immigrationas a matter of border security sneakinto the discussion.

For perspective, ask if America’sborders were insecure until 1921

when, with the Emergency Quota Act, Uncle Sam firstbegan seriously to restrict the number of immigrantsallowed into the United States. Were Americans, untiljust 90 years ago, living in peril of their lives and liveli-hoods because U.S. borders were “insecure”?

Or ask this question: Does the fact that Uncle Samimposes no numerical limits on foreign visitors to theUnited States mean that American borders are inse-cure? Short of the U.S. government’s imposing dra-conian restrictions (to be enforced with draconianmeasures) on visitors—say, admitting only 1,000 visitorsannually, each of whom must first get a high-security

15 S E P T E M B E R 2 0 1 0

Donald Boudreaux ([email protected]) is a professor of economics atGeorge Mason University, a former FEE president, and the author ofGlobalization.

Immigrants aren’tinvaders, much lesswarriors in aconquering army.

clearance from the State Department—it’s almostimpossible to see how numerical restrictions on foreignvisitors would make America’s borders more secure.Therefore, anyone who would now seriously suggestthat the lack of numerical restrictions on foreign visi-tors to America is evidence that U.S. borders are “inse-cure” or “broken” would justifiably be ridiculed.

Keep these points in mind when you encounterdebates over immigration policy.

My proposal is to return to thepolicies under which anyone whowanted to immigrate to Americacould do so as long as he or she had noserious communicable disease and wasnot a terrorist.

That policy was much like the onewe have today for foreign visitors tothe United States: Anyone may visitAmerica as long as he or she likelyposes no serious threat to Americans.So, too, before 1882 anyone couldimmigrate to America as long as he orshe posed no serious threat to Ameri-cans. (This policy actually continuedlargely unchanged until 1921, with thehorrid exception of would-be immigrants from China.Starting in 1882 Uncle Sam imposed severe restrictionson Chinese people’s ability to immigrate into America.)

In fact, the security of American borders—if by thisphrase we mean genuinely decreased risks to Ameri-cans’ persons and property—would almost certainly risewith open borders.

Points of immigrants’ entry, such as Ellis Island,would be reestablished. All peaceful persons immi-grating to America would flow in through thesepoints, be checked for communicable diseases and forties to terrorist organizations, and, if cleared on bothfronts, enter the United States. Uncle Sam would no longer spend hundreds of millions of dollars polic-ing the borders, catching “illegal” immigrants,

deporting them back to Mexico,and monitoring employers whomight have hired “illegal” immi-grants. Those resources could beused instead to seek out and toapprehend terrorists.

Because all legitimate steps tosecure the borders would aim only atreducing Americans’ risk of beingviolated in their persons and prop-erty, government’s policing effortswould—with the open-bordersregime I recommend—focus on thisgoal. Such worthy efforts would notget mixed in with, or be confusedwith, efforts to prevent peaceful peo-ple from coming to America and

finding gainful employment here.With government enforcement efforts concentrated

on securing us from criminal violence and theft, wewould be more secure than we are now with so manyresources and so much manpower instead concentratedon “protecting” us from people whose only crime is toseek out better economic opportunities.


D o n a l d J . B o u d r e a u x

My proposal is toreturn to the policiesunder which anyonewho wanted toimmigrate to Americacould do so as long as he or she had no seriouscommunicable disease.

In April Arizona attracted national attention when it enacted a strict anti-immigration law, SB1070,which authorizes police having “lawful contact”

with a person who arouses “reasonable suspicion” thathe is an illegal alien to make a “reasonable attempt . . .to determine the immigration status of the person.”The law is intended to make life more difficult for ille-gal immigrants. It has been widely criticized for unnec-essarily expanding police powers and invitingharassment of legal immigrants, especially Hispanics,and U.S. citizens of Hispanic descent.

The controversy surrounding immi-gration is not limited to Arizona, ofcourse; many states have wrestled withthe issue. But something about this isconfusing: Almost all Americans are thedescendents of immigrants, and theinscription on the base of the Statue ofLiberty seems to give an explicit wel-come message to immigrants. So whyshould anyone be concerned about the“problem” of immigration in the firstplace? What underlies the anxiety? I am not a psychia-trist, of course, but from reading both print and webdiscussions I think there are several reasons, each ofwhich I believe is unfounded, though I will make aconcession for one. In many cases, the anxiety and self-contradiction are due to conceptual confusion aboutrights and economics.

One of the concerns I see expressed frequently isthat immigrants will come here and go on welfare.Thisargument has traction even among people who wouldotherwise be sympathetic to a libertarian open-bordersposition: It’s bad enough we have to subsidize people

who don’t work, so why increase the number of peoplewe subsidize?

This argument grants the idea that open borderswould be fine as long as everyone were working. Peo-ple who make this argument recognize that immigrantsin the past came to the “land of opportunity” to make abetter life for themselves. Proponents of immigrationlike to point to the Ellis Island experience, in whichpeople came to America from the old world, foundjobs, and by the third generation were solidly upper

middle class. Here opponents of immi-gration will note that there was nowelfare state to speak of, so the immi-grants had to work to succeed.The fearnow is that immigrants can skip thatstep. They will come to make a betterlife, sure, but that just means they willsoak up our generous welfare benefits.

Is this argument to be taken seri-ously? On the one hand, there’s thecounterargument that no one has theright to stop anyone from moving any-

where or prevent anyone from employing anyone. Onthis view, borders must be open regardless of whethersome people come here for welfare. Proponents of thisposition are sometimes accused of taking libertarianpurity too far. I am not sure what it means to be “toopure”—either one has principles or one doesn’t. In anycase, if it turned out that immigration did put morepressure on the welfare system, that might help in theeffort to roll it back.

B Y A E O N J . S K O B L E

In Defense of the Huddled Masses

17 S E P T E M B E R 2 0 1 0

Aeon J. Skoble ([email protected]) is professor of philosophy andchairman of the philosophy department at Bridgewater State College inMassachusetts.

Our great-grandparents weren’t exactlywelcomed, either.

On the other hand, though, there is no evidencethat illegal immigrants are a net drain on the welfarerolls. First, illegal immigrants can’t just move here andfile for welfare checks. Second, while they may getsome benefits of the welfare state, they are a net gain forthe economy. The majority of them do come here toget better jobs than they would have been able to get athome—in some cases they take jobs that native-bornAmericans won’t take. Keep this in mind as we exam-ine the next bogeyman.

Taking Whose Jobs?

Another argument is that immigrants will take jobsaway from “real Americans.” The first thing we

notice about this argument is that it contradicts theprevious one. Make up your mind: Are they coming totake your job or to go on welfare? But more substan-tially, competition is supposed to begood not bad. When one companycompetes with another, they areobliged to improve service or lowerprices. It is the same thing with labor:If there are other people competingfor your job, you’ll have to get betterat it. (This would be true even if wehad hermetically sealed borders. Ifyou are that uncompetitive at your job, it will be out-sourced.) Individual workers, like companies, have noright to be free from competition. Anticompetitivepolicies impoverish everybody. Lastly, this argumentpresupposes a fixed number of jobs, such that if oneworker is replaced by another, he will never again beable to work at all. In a free market, where resources arescarce and demand is open-ended, there is always workto be done and thus no shortage of jobs. Protectionismis just as bad for workers as it is for companies.

Some fear that since many immigrants are comingfrom Mexico and the rest of Latin America, increasedimmigration will lead to increases in the drug trade.This argument is predicated on several mistakes. First,immigrants cannot move their climate with them. Idon’t think you can grow coca plants in Wisconsin. Ifit’s not a matter of moving the crops, then the concernmust be that there will be more places to send drugs.But that’s an argument for allowing immigration and

normalizing immigrants’ status as Americans with kidsin school and jobs in the community. How many ofyour neighbors and coworkers are drug dealers? Ofcourse, if there were no prohibition, this would be anon-issue. But again we see a contradictory set of fears.Those who think drugs should be illegal, and are wor-ried that increased immigration will increase the drugtrade, are undermining their own position. Assimilated,productive, middle-class immigrants won’t be nearly aslikely to be drug mules or abettors of illegal activity.

More broadly, some fear that increased immigrationwill produce more crime. (In one sense this is tautolog-ically true: Increased illegal immigration by definition isincreased “crime.”) There’s no way to predict whetherimmigrants from Guatemala are more or less likely thanimmigrants from Italy or Ireland to commit crimes, butburglary, robbery, and assault are already illegal. So we

have a system in place to respond tocrimes regardless of the ethnicity ofthe criminal. Some argue that thiscreates added burdens on the penalsystem, but that’s not a reason to cur-tail immigration. Of course, the penalsystem would be considerably relievedof its burden if it were rid of victim-less crimes, and in any event violent

immigrant offenders could be deported rather thansentenced to American prisons.

No Irish Need Apply

Iam afraid that one additional fear about increasedimmigration is a generic dislike of those of darker

complexion. (I hasten to add that I understand that notall anti-immigrant sentiment is so motivated, but it’smyopic to deny that any of it is.) This concern requiressome historical perspective.There was a time in the his-tory of American immigration when the Irish were, forall intents and purposes, nonwhite. They were openlydiscriminated against. Later, when the Irish had beenhere for a couple of generations, the Italians, Poles, andJews became the new aliens. Now we think nothing ofseeing a Jewish-American or Italian-American CEO orSupreme Court justice, or an Irish-American president.

Today, seeing waves of immigrants from LatinAmerica, South and East Asia, and the Middle East,


A e o n J . S k o b l e

Individual workers,like companies, haveno right to be freefrom competition.

perhaps some people are concerned about Americabecoming less white. I can’t say that I feel the need totake this concern too seriously. It seems hypocriticalto think that your ancestral homeland has made agreat contribution to the American melting pot, butthat no new homelands should be able to add to themix. Nevertheless, for those who areconcerned about their neighborsbeing culturally different, again thesolution is to have a completelyopen stance on immigration. Earliergenerations of “foreigners” whoemigrated freely were relativelyquick to assimilate to the prevailingcultural norms, even while simulta-neously changing those norms. Thebest way to keep new immigrantsubcultures alien, mysterious, andpossibly hostile is to marginalizethem and drive them underground.They can’t assimilate if they can’t getjobs and send their kids to school.Ultimately, “assimilation” is a two-way street: As newgroups settle in, elements of the new cultures becomepart of the ever-changing norm. If you asked afourth-grader to name four “regular Americanfoods,” you will surely hear “pizza,” and probably“tacos.”

The one point I will concede to the anti-immigra-tion contingent is the worry about voting. Will largenumbers of (presumably legal) immigrants vote to makechanges antithetical to the American ideal? Well, theymight vote for reductions in the welfare state. It turnsout that assimilated and upwardly mobile immigrant

groups don’t support expanded welfareprograms any more than indigenousgroups do. If they voted to roll welfareprograms back, that wouldn’t be a badthing. More worrying, will they votein such a way as to chill speech by, forinstance, pressing for bans on cartoonsdepicting Mohammed? I would beconcerned if trends like that started toemerge. Fundamental constitutionalprinciples are not supposed to be sub-ject to majoritarian whim, but I realizethey sometimes are. So rather thanthink of solutions to the problem, itmight be better to think of ways toavoid it in the first place.The best way

to do that is to help the immigrants to become Ameri-cans.That means allowing them to seek work and findways to contribute to the economy; it means allowingthem the freedom to assimilate into, even while subtlychanging, American culture—the very same freedomyour grandparents had.

19 S E P T E M B E R 2 0 1 0

I n D e f e n s e o f t h e H u d d l e d M a s s e s

The best way to keep new immigrantsubcultures alien,mysterious, andpossibly hostile is tomarginalize them and drive themunderground.

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Historians have long praised Alexander Hamil-ton’s activist government promotion of capi-talism. Hamilton’s “financial revolution”

brought secure government debt, fluid securities mar-kets, and a modern banking system to the UnitedStates. Most scholars believe these factors were respon-sible for the amazing growth of the U.S. economy in the subsequent 200 years. Thus while George Washington is commonlyknown as father of hiscountry, Hamilton is lauded as thefather of Ameri-can capitalism.

H a m i l t o nmay indeed beworthy of thistitle; but lestwe give himand his economicideas undue credit,we should pause toconsider exactly whatkind of “capitalism”Hamilton and his Fed-eralist allies bestowedon the U.S. economy.Capitalism can mean differ-ent things to different people. Economic prosperityrequires a legal system that protects individuals andsecures their property from expropriation, whether itbe private theft or political predation.Advocates of thissystem of rules often call it “capitalism.” We’ll call it“free-market capitalism.”And it’s a good thing for gov-

ernment to let this kind of capitalism develop by pro-tecting private property, sanctity of contract, and con-sensual exchange. This ensures individual freedom ofchoice—and not coincidentally, it is the only knownrecipe for economic prosperity.

Another line of argument claims that governmentsshould actively create and promote the products, organ-izations, and institutions of capitalism. Let’s call this

“state capitalism.” Advocates ofstate capitalism argue that

the institutions of capital-ism should be forcefullyimposed even if they areunwanted. The theory isthat this will make the

nation wealthier and so itshould be done regardless

of any objections.It is by no means certain

that the forceful imposition of the mere institutional trappings of an advanced

capitalist economy actu-ally promotes eco-nomic growth. Underthe legal framework offree-market capitalism,

individuals save, invest, trade,and set up markets as they see fit. Intricate patterns ofinteraction emerge, including some of today’s complex

B Y N I C H O L A S C U R O T T A N D T Y L E R W AT T S

Alexander Hamilton and the Perils of State Capitalism


Nicholas Curott ([email protected]) is a Mercatus Graduate Fellow in Economics at George Mason University.Tyler Watts([email protected]) holds a Ph.D. in economics from George Mason University.

institutional forms of finance, industry, and commerce.Focusing on creating these institutions instead of theframework that lets them grow puts the cart before the horse. It means constructing the byproducts ofprogress instead of the mainspring that makes suchprogress possible.

Thus the statist approach to capitalist development is backward and unlikely to create wealth, even if the constructed institutions are industrial or financial.Constructivism—the idea that government can designeconomies to ensure growth—doesn’t work becausecentral planning cannot substitute for the knowledgegenerated by the trial and error of the market process.Even the best-intentioned government officials cannotreplicate the competition of market participants guidedby profit and loss. Moreover, it defies human nature toassume that those who would implement state capital-ism would promote solely the general welfare, withoutany bias toward shaping these institutions to benefitthemselves or the special interests they represent.

The Early U.S. Economy

Proponents of state capitalism point to the historicaldevelopment of American financial institutions as

their strongest supporting evidence. In particular,Hamilton and his “financial revolution” embody theideas of government leadership in building up a nation’sfinancial infrastructure. Fans of the finance-led growthhypothesis like to trumpet Hamilton’s achievements,which include a well-funded government debt, activesecurities markets (a stock exchange), a large andvibrant banking sector, and an enlarged money supply.

Thus many historians argue that with this infrastruc-ture in place the financial means were created for cor-porate development and the growth of large-scaleindustry.They contend that Hamilton’s policies set thestage for the industrial revolution in America and thatthis experience should be replicated everywhere today.

But is government design really necessary for free-market capitalism to flourish? A closer investigation ofearly U.S. economic performance challenges thathypothesis.

At the close of the American Revolution, theUnited States was economically “underdeveloped.” In1790 about 90 percent of the nation’s four million peo-

ple were farmers. There were few large cities, and thepopulation was clustered on the coast and near largerrivers. Poor roads impeded communication and com-merce with the sparsely populated interior regions.

As for money, the United States was on a speciestandard, with foreign silver and gold coinage formingthe basis of the money supply. As of early 1791 therewere three banks in the country, one each in Boston,New York, and Philadelphia. All issued banknotes representing claims on specie money. Although thebank notes were reportedly safe and reliable, they didnot circulate widely, and there were constant com-plaints of a “scarcity of money.”While actual money—in both coin and note form—was present and fuelingtransactions in the commercial centers, in the remotefarming regions barter was still commonplace.

Like banks, securities markets were rare. In 1792only five domestic securities were quoted in New York.There were irregular and economically insignificanttransactions in domestic and foreign equities. However,a larger, more continuous securities market was arisingdue to speculation in state and Continental Congressbonds issued during the Revolutionary War.

Grand Financial Scheme

When Hamilton became the first secretary of theTreasury under the Constitution in 1789, he

surveyed a U.S. economy that was significantly lessfinancially developed than England’s. Yet he also sawan opportunity to use his new office to spur thedevelopment of financial institutions and thereby givemercantile interests a helping hand. In the politicalclimate of the early 1790s he was able to use the out-standing war debts as a tool to overhaul America’sfinancial system.

Hamilton laid out his grand financial scheme in fourreports to Congress from 1790 to 1791. According tohistorian Frank Bourgin, Hamilton’s reports “consti-tuted a unified and integrated program of planning onsuch a grand scale that even today it would appear as amagnificent conception of an economy directed andcontrolled toward socially chosen objectives.”

Hamilton used the public debt to implement aneconomic program that provided the impetus for thecountry’s first continuous securities market and also for

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its first brush with central banking. The first plank ofhis program was to secure the government’s credit byhonoring the pre-constitutional war debt. Congressobliged in 1790, authorizing over $60 million in newU.S. bond issues to take responsibility, at face value,for all revolution-era debts.

The second plank in Hamilton’s program called forthe creation of a national bank. Northern merchantslargely supported the proposal, pointing to the advan-tages it would procure for their economic interests andfor strengthening the position of the central govern-ment.Agrarian southerners were mostly opposed, argu-ing that such a bank would be unconstitutional andinterfere with states’ rights. President Washington waseventually convinced by Hamilton’s broad interpreta-tion of Congress’s constitutional powers and signed theBank Bill into law on April 25, 1791.

The BUS Bubble

The Bank of the United States(BUS) was not technically a cen-

tral bank in the modern sense; it wasnot granted a monopoly of note issue,nor did it regulate the commercialbanking system. It was, however,granted important legal privileges: Itwas the only bank exempt from anotherwise nationwide restriction onbranch banking, and its banknoteswere accepted in payment of customs duties. This priv-ilege provided the bank with a strong advantage over itscompetitors.The BUS charter called for an initial capi-talization of $10 million—an enormous sum at thetime.Three-quarters of it, however, was to consist of thenew government bonds.Thus Hamilton used the bankto boost the market for government debt, making thebank and the government codependent.The size, scope,and privileged position of the BUS ensured that itsactions would exert a titanic influence on the moneysupply and credit conditions in the United States.

Hamilton also introduced other measures to roundout the overhaul of the financial system.Thanks to hisprodding, a bimetallic currency was introduced toenlarge the money supply. The federal governmentbegan to recognize gold as legal tender in addition to

the Spanish-based silver dollar at a 15:1 silver-to-goldratio. And finally, Hamilton ushered in a policy ofactivist industrial promotion and protectionism in theform of tariffs, subsidies, and “public-private partner-ships” designed to foster large-scale industry.The entireHamiltonian program—the BUS in particular—was,in the words of David Cowen, designed to “stimulatethe economy [and] enhance the shaky credit of thegovernment.”

The Funding Act and Bank Bill brought about mas-sive speculation in government debt and BUS stock.Although only five securities—three U.S. bonds and twobank stocks—were publicly quoted in 1792, publicinterest in them was intense and widespread, rangingfrom millionaire financiers to day laborers and widows.When the BUS opened, it began pumping vast amountsof credit into the economy.A substantial portion of BUS

loans went to stock speculators in theform of “accommodation loans,” orunsecured debt, similar to modern-day margin accounts. A classic assetbubble ensued as the intense demandfor these issues led to higher andhigher prices. But this stock maniawas soon revealed to be unsustainable.An abrupt contraction of credit bythe BUS in February 1792 led to amassive selloff in securities markets—the first stock market bust in Ameri-

can history. Many of the speculators were heavilyleveraged, expecting to repay the accommodation loanswith the sale proceeds of ever-appreciating stocks andbonds. When the short-term loans came due and thebanks refused to extend further credit for fear of beingdrained of their specie reserves, leveraged investors hadno other choice but to settle their debts by liquidatingtheir securities portfolios.

The crash piled up unprecedented losses and leftseveral prominent speculators in debtors’ prison. Manyeconomic historians laud Hamilton for successfullymanaging this crisis by using government funds to sup-port bond prices and steady the nerves of the market.But government involvement in money and bankingcaused the panic in the first place. Furthermore, theevents of 1792 did not signal the resolution of the BUS


N i c h o l a s C u r o t t a n d Ty l e r Wa t t s

When the Bank ofthe United Statesopened, it beganpumping vastamounts of creditinto the economy.

credit expansion. Over and above the securities panic,the inflationary practices of the BUS set into motion anunsustainable investment boom and consequent bustthat would play out over the entire decade.

The BUS engaged in monetary overexpansionthrough the early 1790s, causing price inflation and dis-order in the intertemporal structure of productionalong the lines theorized by capital-based macroeco-nomics. This expansion also pushed down real interestrates by making banks far more eager—and able—tolend. The resulting distortion of marginal returns toinvestment and saving led entrepreneurs to make malinvestments in transportation improvements,manufacturing, and other capital-intensive projects. Furthermore, theexpectation of inflation induced indi-viduals to bet on continued priceincreases by borrowing money to pur-chase real estate.Thus the atmosphereof easy money created by the bankalso channeled resources into westernland speculation and fueled local realestate bubbles.

Eventually a correction to thecredit overexpansion occurred, but ittook time and required a painfulmonetary contraction. Initially, as thenewly injected bank credit worked itsway through the economy, it created adisparity in international prices. Steep inflation withinthe United States made American exports relativelymore costly abroad and foreign imports into the coun-try relatively cheaper for Americans, leading to a reduc-tion in net exports. By 1795 specie was flowing out ofthe country to pay for the increased imports, and thegrowth rate of bank-issued money tapered off. As aresult, the money supply and price level began to fall,causing the real interest rate to rise sharply. In the ensuing credit crunch businesses that counted onrolling over short-term debt for their financing wererendered unsustainable. At this point many investmentsthat had appeared reasonable when they were under-taken were revealed to be errors, and a wave of businessfailures ensued.

The long-run consequences of the Hamiltonianfinancial revolution were a crushingly large central gov-ernment and a burdensome government debt. Accord-ing to advocates of state capitalism, this last aspect wasactually a good thing—they portray government debtas a blessing because it allowed for a strong central gov-ernment. But contrary to their mercantilist interpreta-tion, a bloated central government is not a blessing. AsThomas DiLorenzo’s book Hamilton’s Curse demon-strates, the strong central government, built on Hamil-tonian policies, enabled unnecessary military spending,unjustified wealth transfers, and a slew of ever-expand-ing governmental programs and activities down to

the present day.

Despite Hamilton

Hamilton’s schemes impregnatedthe U.S. economy with the

institutions of a financially advanced,capitalist economy. But the acceler-ated development of securities mar-kets and the banking industry waspremature.The truly beneficial aspectsof these markets would have devel-oped in due time through the naturalcourse of economic growth. Hamil-ton’s reforms merely induced a pre-cursory period of unproductivetrading in government debt instru-

ments and credit-fueled speculation. More important,the centralized banking system created by Hamilton’snationalist party destabilized the American economy.The new banking system immediately created asequence of financial panic, deep-seated malinvestment,and a delayed recession.

Hamilton’s expansionary program did no better overthe long run. Primarily, it left the United States with aneconomy prone to central bank-induced business cyclesand a squandering of economic resources on redistrib-utive polices and wars, financed by the accumulation ofa burdensome debt. On net the Hamiltonian revolutionwas not a blessing for the U.S. economy. The UnitedStates became the world’s leading economy despite thelegacy of Alexander Hamilton, not because of it.

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The long-runconsequences of theHamiltonian financialrevolution were acrushingly largecentral governmentand a burdensomegovernment debt.

B Y S T E P H E N D AV I E S

The Economic Way of Thinking Makes a Comeback

Our Economic Past

As readers of this magazine know, its main goal,and that of FEE as a whole, is economic educa-tion—that is, to explain and spread essential

economic insights so more people become familiarwith the “economic way of thinking,” as Israel Kirznercalled it.This brings insight to politics, society, and his-tory. Above all, it gives a better understanding of thebasis of a free society and of the malign consequencesfor liberty, prosperity, and social peace of denying therealities of economic life—or trying to, rather.

Even a brief look at the contemporary media orpolitical debates—or conversations with acquain-tances—quickly reveals how much this understandingis needed. Put simply, the level ofignorance of basic economic insightsis staggering. Elementary fallacies suchas the “broken window” argumentpop up regularly and are apparentlywidely shared.

All of this has obvious and damag-ing effects on public debate and ulti-mately on public policy.To the extentthat policy and debate actually reflect widespread mis-understanding of economic principles, among both thegeneral public and the opinion-forming elite, they willbe misguided—at best futile, at worst damaging andcounterproductive. When results are disappointing, thereasons will not be understood and the frequentresponse will be to push even further down the wrongroute and to reinforce failure.

One view is that ’twas always thus. According tothis school of thought, the evidence we have fromsocial surveys and mass observation is that the eco-nomic way of thinking is counterintuitive and diffi-cult for the majority to grasp. Some argue that thisreflects how we are hardwired as a species to thinkabout the world in certain ways that in turn predis-pose us to look at economic matters in a particular

fashion. So we see only intended results and ignoreunintended ones, underestimate the benefits of tradeand are wary of strangers, see the costs of change morereadily than the benefits, and so forth. If these per-spectives are widely held, then a democratic systemthat reflects popular predilections will always tend inan economically harmful direction.

It Wasn’t Always Thus

However, the evidence of history suggests that thiscondition is not predetermined or inevitable.

Even if there is some kind of biological predisposition,it is not so strong that it cannot be overcome by educa-

tion and propaganda (in the original,good sense of the word). The recordalso suggests that this is true for intel-lectual and political elites as well asthe general public. The evidence forthis is the history of the early nine-teenth century in both Britain andFrance, as well as the United States,when economic ideas were widely

understood and were a major part of popular cultureand public discussion.

The works of Smith, Malthus, Ricardo, and NassauSenior were all widely read and discussed. In France,Say’s 1803 Treatise of Political Economy was one of thebest-selling books of its time.The works of their popu-larizers made their ideas accessible to the mass of thepublic.

An early example of this in England was Jane Marcet(1769–1858), who published a successful introductionto economics (particularly Say and Ricardo) in her1824 Conversations on Political Economy. Even moreprominently, the great classical-liberal feminist and pio-


Stephen Davies ([email protected]) is a program officer at the Institutefor Humane Studies.

Put simply, the levelof ignorance of basic economicinsights is staggering.

neer sociologist Harriet Martineau (1802–1876) pub-lished a series of short stories that illustrated andexplained economic principles, collected as Illustrationsof Political Economy (1831). Sold in a low-cost format,these were the best sellers of the time. Martineau fol-lowed up with further series on such topics as reformof the Poor Law, which was equally successful. Later inlife she wrote regular editorials for the Daily News, apopular paper, many of which were concerned witheconomic exposition and argument. John Stuart Millalso combined the roles of economic thinker and pop-ular expositor. His Political Economy was a popular aswell as intellectual success.

Educated Public, Educated Policy

All this had a significant effect on public opinion asreflected in popular culture and entertainment,

letters to the press, and voting pat-terns. On issues such as free trade,government regulation, the PoorLaw, and government finance, therewas a clear movement toward sup-port for economically sensible policy,limited government, and soundmoney. Thus demands for the repealof the income tax, for stringentreductions in government spending,and for complete free exchange(which meant general laissez faireand not just free trade) became a staple of British radi-cal working-class politics and liberal politics generally,as reflected in the policy of Gladstone as both chancel-lor and prime minister. Moreover, these attitudes andthe underlying understanding persisted. When a cam-paign began to restore protection in the early1900s, theresponse was a popular countermovement that culmi-nated in the landslide victory of the Liberals on a free-trade platform in 1906.

Of course there were also plenty of rejoinders andhostile responses to this successful spreading of eco-nomic ideas.The two most prominent exponents of thisreaction were Thomas Carlyle and John Ruskin. It wasCarlyle who coined the phrase “the dismal science” todescribe economics—on grounds that economic think-ing led to support for the abolition of West Indian

slavery, an institution he supported. He and Ruskin didnot put forward a form of economics of their own.Rather, they attacked economic reasoning as such. Inthis they were more clear-sighted and intellectuallyhonest than many contemporary authors.

How It Was Lost

So if we compare the situation for much of thetwentieth century and today with what went

before, we have to ask, “What happened?” There aremany explanations of why economic reasoning fell outof favor, such as the rise of mass media.Three seem par-ticularly pertinent, however. First, from about the 1890sonward economics became increasingly mathematicaland, as such, abstruse and inaccessible for many people.At the same time it was affected by the general move-ment of intellectual life into the academy, with its asso-

ciated specialization.A second factor was the movement

to make economics into a value-freesocial science. It lost its earlier connec-tion to political and social philosophyand its moral element, which had beenone of its main features. Argumentsabout efficiency are simply less mov-ing than ones that combine this with amoral perspective (as Martineau’swork did, for example). Finally, func-tioning as both cause and effect was a

general shift of public discourse to a position thatdenied constraints, one based on the passionate convic-tion that everyone could have his cake and eat it too—as a right. Since a central insight of economics is thenecessity of tradeoffs, economic argument found itself at odds with this sentiment and found fewerreceptive listeners.

Recently, though, there are the first faint signs thateconomics is once again becoming a part of wider cul-ture. There is the success of a new generation of pop-ularizers, including Russ Roberts, who has followedthe example of Martineau in using the fictional mode.This can only be a good thing, and we must try toensure that politics and public discourse, from all pointson the ideological compass, once again become eco-nomically aware.

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Arguments aboutefficiency are simplyless moving than ones that combinethis with a moralperspective.

Recent turmoil set off by the threat of Greekinsolvency shows how fast markets change.Fear about the inability of European govern-

ments to pay their debts caused the 2010 turbulence.By contrast, the 2008–2009 havoc was rooted in thecollapse of property values.The next crisis will be aboutsomething else, possibly another government’s debt.

Meanwhile, Congress put the finishing touches on amammoth regulatory bill called the Restoring Ameri-can Financial Stability Act of 2010.(Editor’s note: It was passed andsigned in mid-July.) As I write there isno way to know what final shape itwill take. But considering how it wasshaping up, what are the probableeffects?

The rationale for this vast expan-sion of government oversight is toprevent, or at least reduce, financialinstability, as the bill’s title declares.Therefore it is useful to remind our-selves of why and how marketsbecame so unstable in the first place.

There are two fundamental reasons why marketsgyrate. One is human emotion, in particular a penchantfor over-optimism about financial prospects, whichturns into panic once things go downhill—a patternknown colloquially as greed and fear. Business cycles areunavoidable to the extent they’re rooted in humanbehavior. On top of this, governments have caused nor-mal cycles to become extreme and destructive with amultiplicity of interventions and their own financialwoes—as with Greek sovereign debt.

Thus the boom in the American housing market

was set off by optimism that property prices wouldkeep rising and the bust initiated by the panic thatensued when prices faltered. But the cycle becamemonstrous because the Federal Reserve kept moneycreation too loose in 2001–2004. To make mattersworse, Congress pushed the two government-createdentities, mortgage buyers Fannie Mae and Freddie Mac,to go easy on less creditworthy loans.

As a result of these policies, taking out a mortgagebecame child’s play. People whomight have otherwise been moreprudent mortgaged up to the hilt, andenormous piles of mortgages becameavailable to be bunched together andturned into securities—a lucrativeactivity that drew the attention ofWall Street, but was done largely byFannie Mae and Freddie Mac.

When real estate turned, it tookdown banks that lent heavily todevelopers, homeowners who bor-rowed beyond their means, and finan-

cial companies that held or insured mortgage-backedsecurities. As for Fannie and Freddie, they continue tosuck down billions of dollars of taxpayer money everymonth, with no end in sight.

Human nature has not changed, and the govern-ment is becoming more interventionist, not less so. Sothe conditions that produced the dramatic bubble-and-bust remain in place. How, then, will the Financial Stability Act prevent crises?

B Y C H I D E M K U R D A S

Financial Regulation Snake Oil


Chidem Kurdas ([email protected]) is a financial journalist in NewYork. She writes investment analysis on www.HedgeFundSmarts.com andpolicy news spoofs on www.JenniferKerfuffle.com.

The conditions thatproduced thedramatic bubble-and-bust remain in place.How, then, will theFinancial Stability Actprevent crises?

Since it is not practical to analyze all the disparateelements that constitute a 2,300-page grab bag of a bill,I will focus on the centerpieces that were most likely tobecome law. These are from the version of the billintroduced April 15, sponsored by Sen. ChristopherDodd.

The first is the creation of a supra-bureaucracycalled the Financial Stability Oversight Council, withnine voting members who are to make decisions bymajority vote. Among them are the Treasury secretary,the Federal Reserve chairman, the Securities andExchange Commission chairman, the director of theFederal Housing Finance Agency, and an independentmember appointed by the president.

Almost all council members are heads of depart-ments and agencies that have been around for decadesand shown not the slightest ability toprevent risky behavior by financialfirms, the population at large, or forthat matter themselves and fellowgovernment entities. Somehow, theyare supposed to do together what theydon’t do on their own.

The act also adds a new bureau-cracy, the Office of FinancialResearch, with responsibility to col-lect and process data and conductstudies for the council. This newlycreated apparatus of the council and research office is towork as “an early warning system to detect and addressemerging threats to financial stability and the econ-omy,” according to a congressional committee report.

The research office would get the power to sub-poena information from any financial company. It is “todevelop and maintain metrics and reporting systems forrisks to the financial stability of the United States” and“monitor, investigate, and report on changes in system-wide risk levels and patterns.”

If you ask what the systemwide risks are, you won’tfind an answer in the act. The director of the office,appointed by the president for a six-year term, “shallhave sole discretion in the manner in which” he or sheexercises the authority provided by the bill. Indeed, thewide discretion the bill provides to future bureaucrats isremarkable.What they’re going to do to promote stabil-

ity is about as clear as how snake oil was supposed tocure cancer, bunions, and lovesickness.

The act says certain bank companies may be requiredto have a “risk committee” with “at least one risk man-agement expert having experience in identifying, assess-ing, and managing risk exposures of large, complexfirms.” That is like requiring water to flow downhill.Almost every financial business already has risk controlpeople. Even hedge funds have risk managers.

Risk management is a well-established disciplinewith an ever-increasing number of practitioners whospend their time trying to measure and reduce futurehazards. In finance the number of risk managementexperts has grown tremendously in past years—withoutany legal mandate. These specialists have been notablyunsuccessful in preventing occasional crises, as the past

several years demonstrated.Risk experts constructed the

mathematical models that gave mis-leadingly benign views of the dangersin mortgage-related complex instru-ments.The models will improve overtime, but will occasionally be mis-taken regardless of legal requirements.It is not the case that financial com-panies want to lose money.

The basic reason they sometimesdo lose money is that making money

requires some risk.This is no different from many otheractivities, such as drilling for oil. Yes, you can end upwith a nasty spill, but no risk, no oil. Similarly, no finan-cial risk, no financial gain.

The object is not to avoid risk but rather to keep itunder control, and that has always been a most delicatetask. The early twentieth-century economist FrankKnight made a distinction between risky situations,where the possible outcomes and their odds can beestimated, and uncertainty, where there is no meaning-ful way to know the probabilities. There are knownunknowns and then there are unknown unknowns.

Throwing dice exemplifies risk with known odds. Bycontrast, Fannie Mae (which, along with Freddie Mac, isunaddressed in the new law) is a source of uncertainty;the consequences of its creation were unexpected, andits future is an unknown unknown at this time. It stands

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Somehow,government regulatorsare supposed to do together what they don’t do on their own.

as a shadowy but colossal monument to man’s ability tocreate monsters in the name of doing good.

Dealing with risk is hard enough; we’re lost dealingwith uncertainty.This shows up especially with rare butbig events—known as the tail risk of a bell-shapedprobability distribution. More vividly, Nassim NicholasTaleb, a trenchant critic of financial industry practices,has dubbed them black swans.

As long as an event like the real estate slump has notyet happened, people make money by ignoring it.Therefore risk managers “play politics, cover themselvesby issuing vaguely phrased internal memoranda thatwarn against risk-taking activities yet stop short ofcompletely condemning [them],” to quote from an ear-lier book by Taleb, Fooled by Randomness, published adecade ago—when risk managers were already recog-nized players.

Same Goes for Government

This criticism applies no less togovernment agents. Nobody has

a reliable way to predict rare events,and human nature is all for ignoringthem. Regulators don’t do any bet-ter—from the chairman of the Fed-eral Reserve on down, officials issuevague warnings but don’t stop risk-taking.After all, theyare subject to the same behavioral biases and face similarincentives. Just as shareholders are displeased when abank does not make money, voters are displeased when a government imposes economic hardship.

Therefore, like banks, governments keep dancing aslong as the music lasts. It is hard to imagine that chang-ing. So preventing future crises is the least likely out-come of the Stability Act. But might it have some otherbenefit?

Emergency measures used by the U.S. Treasury andthe Federal Reserve to prop up companies in2008–2009 left in their wake the absurd problem oftoo-big-to-fail—taxpayers appear to be on the hook forany large financial concern whose failure might havefar-reaching impact. Given that taxpayers also ended upwith the vast pension liabilities of General Motors, theproblem of bailouts is not really confined to financialcompanies, though it is widely described as such.

Nobody wants a repeat of the widespread panic andlosses caused by the bankruptcy of Lehman Brothers inSeptember 2008. That failure resulted in market chaosin large part because the assets of Lehman clients gottied up in bankruptcy courts, not just in the UnitedStates but in the United Kingdom. With their capitalfrozen in years-long litigation, the clients sold securitiesto raise money, with the predictable catastrophic effecton prices.

So instituting a process by which large financialcompanies can be shut down without a lengthy bank-ruptcy case would both reduce the impact of failuresand get rid of the notion that investment banks need tobe bailed out. Expeditious, orderly, and internationallycoordinated winding down of failed companies is anobvious solution for the too-big-to-fail problem.

The act gives the Treasury, in con-junction with judges from the U.S.Bankruptcy Court for the District ofDelaware and other agencies, broadpowers to take control of a financialbusiness perceived as a threat to thesystem and turn it over to the FederalDeposit Insurance Corporation(FDIC) for liquidation. The FDIC,which unwinds failed commercial

banks, is to do the same for other financial businesses.“Once a failing financial company is placed under

this authority, liquidation is the only option; the failingfinancial company may not be kept open or rehabili-tated,” says a Senate committee report.

That may sound like a way to prevent bailouts, butthe government is given such open-ended discretionthat perverse outcomes are possible.To go this liquida-tion route a company does not need to be actually indefault as long as the Treasury determines that it is asufficiently serious threat. On first read, my primaryconcern was that companies that were not going to failmight be liquidated.

On second thought, it is just as possible that thosewhich are failing will be bailed out instead of being liq-uidated.This could happen if there are politically pow-erful interests behind a company. Think of the unionsthat came out on top in the government’s handling of GM. In effect, we’re asked to trust politicians and


C h i d e m K u r d a s

Nobody has a reliableway to predict rareevents, and humannature is all forignoring them.

bureaucrats. No doubt they will make politically advan-tageous decisions, with goodies for the politicallyfavored and sticks for the politically vulnerable.

A better alternative to the creation of this extensiveauthority would be to streamline bankruptcy to make itsimpler and faster.The act calls for studies of bankruptcyand international coordination, the latter of which isnecessary because large investment banks are globalentities—but the possibility of bankruptcy reform isremote.That could reduce legal fees, not something thata Democratic Congress will allow. Lawyers are a majorconstituency for the Democrats. They will be amongthe big winners of the regulatory onslaught, which isbound to increase the demand for legal services.

More Of The Same

It is ironic that the act expands the government’sdomain in the name of stability, since public policies

have increased instability, public functionaries havebeen clueless in foreseeing threats, and politicians havecreated uncertainty—with Fannie Mae, for instance.

One of the members of the Stability Council, theFederal Housing Finance Agency, was set up by a 2008law to be the successor to the Office of Federal Hous-ing Enterprise Oversight. The latter, the overseer ofFannie and Freddie, presided over debacle after debacle,year after year, from accounting shenanigans to endlesstaxpayer bailouts. Congress obviously wanted an agencywith a different name.

But the new bureaucracy is simply the old onemerged with another entity. So the same bureaucratsthat did so well ensuring the safety and soundness ofFannie and Freddie are supposed to ensure financialsoundness on a wider stage in the new setup! If thatdoes not inspire confidence, neither do other membersof the council.

The Securities and Exchange Commission letBernard Madoff continue his Ponzi scheme year afteryear despite repeated complaints from a whistleblowerand even news stories about the fraud. More recentlyanother astounding SEC failure came to light.

In 2009 Texas resident Robert Allen Stanford wasnabbed for an $8 billion fraud—Stanford InternationalBank had for years sold certificates of deposit promisingunachievable returns. An investigation found that the

SEC Fort Worth office had known since 1997 thatStanford was likely operating a scheme. Despite exami-nations indicating this, the enforcement division chosenot to take action.

The preferred excuse for numerous governmentdebacles is that the bureaucracies lacked authority,personnel, or information.Yet the SEC in fact repeat-edly examined Stanford and had the power to stop hisactivities.

Here is the punch line to the Stanford affair. In adramatic instance of the revolving door for former reg-ulators, the SEC lawyer who made enforcement deci-sions at Fort Worth left and represented Stanford—before he was told that this was improper.That’s howregulation works in reality.

Expanded Crony System

The vast new powers given to regulators will nodoubt enhance the fees and salaries that former

bureaucrats like this SEC lawyer command. They willhave greater opportunities to sell their protection andexpertise to the regulated and will also, of course, ben-efit from enlarged budgets while in public employ-ment. Politicians and political staffers, too, will be ableto extract more money from the regulated and getlucrative jobs in the financial industry.

This is already an established trend, with PresidentObama’s former White House counsel moving toGoldman Sachs and a former aide to Rep. BarneyFrank on the House Financial Services Committee tak-ing a job with a derivatives exchange. Such crossoverswill no doubt become even more common as firmslook to protect themselves while government agentsget a broad mandate to intervene and decide whichcompanies to liquidate and which to bail out—who’s asystemic risk and who’s not.

Even as they go “tsk-tsk” chiding business lobbies,the President and Congress are laying the groundworkfor an infinite growth in the crony system intermin-gling government with private interests.The rest of uswill pay for the resources that will be redistributed infavor of bureaucrats, politicians, lawyers, and the politi-cally favored.The impact of the act on financial stabil-ity is uncertain at best, but its corrupting influence onthe Republic is a sure thing.

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F i n a n c i a l R e g u l a t i o n S n a k e O i l

The Austrian economist Ludwig Lachmann oncewalked into the colloquium room at New YorkUniversity, where the blackboard displayed this

quotation:“When it comes to the future, one word saysit all:You never know. – Y. Berra.”

Having built much of his economics on theunknowability of the future, Lachmann noticed thequote. However, having lived in South Africa fordecades and being unfamiliar with the wit and wisdomof the former New York Yankees catcher, he ponderedthe chalk inscription for a bit, turned to those assem-bled, and in his heavy accent said,“I’m afraid I’m not familiar withthe works of Professor Berra.”

It is indeed difficult to predictthe future, but many folks make agood living trying. From self-pro-claimed “futurists” who hope tosell books and DVDs with theirpredictions about the decades tocome, to cartoon visions of the flying-car, meal-in-a-pill, three-hour-workday 21st century so common in the 1950s,to the authors of some of the finest science fiction ofthe last hundred years—trying to imagine and describewhat the future holds keeps a lot of people occupiedand makes some wealthy. But how good are the pre-dictions? What is it that makes predicting the future so difficult?

Obviously if we are trying to predict the specificactions of specific individuals, or the price of Applestock in 2015, the difficulties are clear. I am more inter-ested in bigger and broader predictions. Is there a pat-tern to the ways people tend to err in predicting how

technology will evolve and be used? If such a patternexists, what might explain it and how could “futurists”learn from that explanation? I think the answer to thefirst question is yes, and below I attempt to answer thesecond set of questions.

To do so, we must recognize one important insightabout technology, social evolution, and economicgrowth. It is common for people to attribute the west-ern world’s stunning economic growth over the last200 years to technology. True, technology does con-tribute to growth in important ways, although it’s also

true that economic growth helpscreate new technologies by gener-ating capital to fund research.Tech-nology, however, does not createwealth by itself, as decades of tech-nology transfers to the third worlddemonstrate. For technology tolead to wealth, the right institu-tions are required. I like to call thisthe Three I’s approach: Innovation= Invention + (good) Institutions.

More specifically, the market must be free enough thattechnology can be turned from simply an inventioninto an innovation. Rising wealth requires innovation,and innovation happens when inventions meet themarket.

In their excellent book, How the West Grew Rich,Nathan Rosenberg and L. E. Birdzell provide many his-torical examples to illustrate this point. Consider how

B Y S T E V E N H O R W I T Z

Why Do Futurists Get So Much Wrong?


Contributing editor Steven Horwitz ([email protected]) is theCharles A. Dana Professor of Economics at St. Lawrence University andthe author of Microfoundations and Macroeconomics:An AustrianPerspective, now in paperback. He is a columnist at TheFreemanOnline.org.

This kind of futurism ignores economic considerations.James Vaughan (flickr.com/x-ray_delta_one)

many ancient civilizations developed better technologythan the West did during the same period. For centuriesthe Chinese were on the cutting edge of invention andWestern Europe lagged behind. But why couldn’t theChinese translate that invention into increases in wealthand the sort of industrial revolution we later saw in the West? One answer is that the Chinese lacked theWest’s decentralized political institutions, which werecrucial for nations engaging in wealth-generating trade,which in turn required protection of property rightsand enforcement of contracts. The West grew richbecause it had the institutions to translate inventionsinto innovations.

This is the piece of the puzzle so often overlookedwhen people speculate about the future, particularly thefuture of technology. By ignoring how technologymust interact with markets to generate increasing livingstandards, futurists tend to get too caught up in the bigimportant technologies and imaginethey will be used primarily for themost noble of purposes. It turns outthat what seem to really enhance thestandard of living and the quality oflife for many human beings are thingsthat are far more mundane and com-mercial than those imagined by manywho make a living predicting thefuture.

Revolutionarily Mundane

Take two examples that were common in mid-twentieth-century visions of the 21st century: fly-

ing cars and the meal-in-a-pill. The flying car, ofcourse, was the height of the romantic vision of thetechnological future.The assumption was that our mas-tery of flight would link up with the obvious centralityof the car to the emerging suburb-oriented mass cul-ture to give us the ultimate in personal conveyance.What the futurists overlooked was that technologyalone won’t do the trick. Inventions have to be prof-itable to be real innovations. As it turns out, the flyingcar was, and still is, simply too expensive to produce tobe worthwhile for the vast majority of Americans. Inaddition, the cost of coming up with the equivalent ofhighways would likely be prohibitive as well.

Instead, the way technology has interacted with thecar has been much more mundane. Without question,cars today, despite their inability to fly, are far betterthan even the best one driven by futurists in mid-cen-tury. Blinded by “big technology” and deaf to theimportance of economic considerations and marginaladjustments, the futurists failed to imagine terrestrialvehicles with CD/mp3/DVD players, GPS, built-in cellphones, computer-monitored performance, sturdiertires, and enhanced safety devices, not to mention over-all quality. Getting 100,000 miles, which used to be onemeasure of a high-quality car, is now expected. Ourlives today have been notably enriched by the incre-mental improvements in the automobile.Would we beeven better off with a flying car? Perhaps, but if one isto predict the future, one has to take both costs andhuman preferences seriously. Neither has seemed tojustify the flying car.

The meal-in-a-pill works in some-what of the opposite direction. Thatvision of the future was concernedwith abstract notions of technologicalefficiency and scientific notions ofhealth: Why waste time worryingabout food and risking eating thewrong things when you can get all thenutrients you need by swallowing a

few pills every day? Of course this overlooked two keyfactors: Humans enjoy eating in itself—efficiency bedamned—and markets would make it possible for moreand more people to consume a larger variety of high-quality foods than even the most optimistic of futuristscould have imagined.

One need only think of the common food staples oftoday that were unknown even a generation ago. Hav-ing grown up in the middle-class suburbs in the 1970s,I don’t believe I ever saw an avocado in my house orate sushi until I was well into my adult years. My ownkids take foods like this for granted, even growing up ina rural town in New York State, over an hour from anymajor city. No longer is just “ground beef ” acceptableeven at the most common of restaurants.We must havehigh-quality Angus beef, washed down with a coffeedrink made with high-quality beans and prepared in amanner that was once consumed only by the upper

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W h y D o F u t u r i s t s G e t S o M u c h W r o n g ?

Futurists tend to get too caught up inthe big importanttechnologies.

crust of Americans. (How many Americans knew whata cappuccino was in the 1950s?)

Further consider that, contrary to the spirit of futur-ism, we can afford to consume food that is produced inless-efficient, more labor-intensive ways through organicfarming and the “slow food” movement.These are theindulgences of a rich society where we have put ourtechnology to use not to make the mundane act of eat-ing more efficient, but to open up that mundaneness tothe variety of human desires.The proliferation of cook-ing shows, books, and even whole TV networks, not tomention the fancy kitchens more people can afford, isevidence of how technology meeting the marketimproves our lives—not by large, dramatic changes butby the accretion of marginal ones that enable us toenjoy the mundane more completely.

Information Supertollbooth

The Internet is another exampleof this problem. A number of

writers foresaw the Internet, andmany imagined, romantically again,what a boon to human intelligence,science, and the arts it would be to“have the world’s libraries at yourfingertips.” And indeed we have pre-cisely that.What the futurists did not see was how theInternet’s greatest impact would be through commerce.Again, Innovation = Invention + Institutions. Puttingthe world’s libraries at our fingertips required prof-itability, and as it turns out, what made the Internetprofitable was e-commerce.

Yes, the world’s libraries are at our fingertips, butyou need a credit card to buy a book from Amazon.That’s not a bug. It’s a feature. Without the market,there wouldn’t be a way to accomplish the romanticvision of the futurists.

But even there it took years for the vast majority ofe-commerce to be profitable. For most of the firstdecade or so of the World Wide Web, the only profitablebusiness was that most mundane of human activities:sex. Adult websites provided perhaps the only consis-

tently profitable business in cyberspace; they also pio-neered many of the technology-meets-commerce inno-vations that are now part of our everyday webexperience. For example, adult sites were among thefirst to master streaming video and to figure how best touse credit cards securely.They launched a number of theconsumer-friendly data-tracking processes that are nowstandard at places like Amazon.com. Futurists saw thetechnology but overlooked that its biggest impact wouldcome through its combination with commerce, and thatthis combination would be driven by the demand forsexual content.

Good futurists wouldn’t have overlooked the sexualaspect because almost every other advance in commu-nications technology of the last hundred years has had

sexual content at its leading edge. Inour own times one need only point tothe early success of the VCR, a signif-icant demand for which came frompeople who wanted to watch adultfilms in the privacy of their ownhomes rather than in some dreadfultheatre on the wrong side of town.Nude photographs are as old as pho-tography itself, and the same is true ofpornographic films. Even as you read

this, there is a burgeoning market in 3-D adult filmsthat will surely drive the spread and improvement ofthat technology. For an invention to enhance wealthand happiness, it must meet up with the market.

If anything, futurists aren’t imaginative enough! Thefuture is always a lot weirder than we think it will beprecisely because the spontaneous order of the market-place will create outcomes that no one can design andthat are very hard to predict. Rather than focusing onthe big, dramatic technologies and what seem to betheir efficiency-enhancing elements, predictors of thefuture should be thinking more about the everydaythings that matter to human beings and trying to imag-ine how technological change might interact withcommerce and culture to produce the weird but stillrecognizable future.


S t e v e n H o r w i t z

For an invention to enhance wealthand happiness, it must meet up withthe market.

B Y S H E L D O N R I C H M A N

The Evil of Government Debt

Peripatetics

As we’ve seen in the last two issues, Destutt deTracy, writing in early nineteenth-centuryFrance, had solid insights about the market

process and government spending as a form of con-sumption not investment. In light of that, no one willbe surprised that Tracy opposed government borrow-ing. In this day of trillion-dollar-plus federal deficits, hiscritique is especially relevant.

Tracy begins by noting that government debt is “asubject on which the general good sense has greatlypreceded the science of the pretended adepts. Simplemen have always known, that they impoverished them-selves by spending more than their income, and that inno case is it good to be in debt. . . .”On the other hand, “men of geniusbelieved and even wrote, not longsince that the loans of governmentare a cause of prosperity, and that apublic debt is new wealth created inthe bosom of society.” (All emphasishas been added.)

In his sarcasm about “men ofgenius,” Tracy was clearly rejectingthe idea that government borrowing creates wealth.He had already disposed of the claim that governmentspending could stimulate productive economic activity.Rather than adding to “the general mass of circula-tion,” he said, government expenditures “only changeits course and in a manner most often disadvanta-geous.” Here is Bastiat’s “broken window” a fewdecades early.

Still, he takes up this question: “When expenses arevery considerable, ought we to felicitate ourselves onbeing able to meet them by loans, rather than taxes?”

Politicians and pundits say yes, believing that bor-rowing brings good economic times, provides moneyin emergencies, and “thus . . . is the true palladium ofsociety.”

“Yet,” Tracy responds, “I think I have good reasonsfor combating their opinion.”

Here Tracy pauses, cagily, to state he “will say noth-ing of the grievous effects of loans on the social organ-ization, of the enormous power they give to thegovernors[,] of the facility they afford them of doingwhatsoever they please, of drawing everything to them-selves, of enriching their creatures, of dispensing withthe assembling and consulting the citizens; which oper-ates rapidly the overthrow of every constitution.”

Economic Effectshe first thing said in favour of loans,” he wrote,“is, that the funds procured by these means are

not taken involuntarily, from any one.”Tracy didn’t buy the argument: “Ithink this an illusion. In effect it isvery true, that when government bor-rows it forces no one to lend; . . .When, therefore, the lenders carrytheir money to the public treasury it isfreely and voluntarily; but the opera-tion does not end there.These capital-

ists have lent, not given: and they certainly intend tolose neither principal nor interest. Consequently, theyforce the government to raise, one day or other, a sumequal to that which they furnish and to the interestwhich they demand for it. Thus, by their obligingness, theyburthen without their consent not only the citizens actuallyexisting, but also future generations. . . .”

Borrowing doesn’t dispense with taxes; it merelyshifts them to the future, except that they must beraised high enough to pay the interest as well as theprincipal. “Thus, sooner or later, it [borrowing] affectsindustry as much and in the same manner as if it hadbeen levied at first.”

T“

33 S E P T E M B E R 2 0 1 0

Sheldon Richman ([email protected]) is editor of The Freeman.

Borrowing doesn’tdispense with taxes;it merely shifts themto the future.

But this raises a question “which I am astonished tohave seen no where discussed”: Does government have“a right thus to burden men not yet in existence, and to compel them to pay in future times [its] presentexpenses?”

No, Tracy answered. “One generation does notreceive from another, as an inheritance, the right of liv-ing in society; and of living therein under such laws asit pleases.The first has no right to say to the second, ifyou wish to succeed me, it is thus you must live andthus you must conduct yourself. For from such a rightit would follow that a law once made could never bechanged.”

Here he offered a proposal:“[W]hatsoever is decreed by any

legislature whatsoever, their succes-sors can always modify, change,annul; and that it should be solemnlydeclared, that in future this salutaryprinciple shall be applied, as it oughtto be, to the engagements which agovernment may make with moneylenders. By this the evil would bedestroyed in its root: for capitalists,having no longer any guarantee,would no longer lend; many misfor-tunes would be prevented, and thiswould be a new proof that the evils of humanity pro-ceed always from some error, and that truth curesthem.”

Repudiation

He was calling for future generations to repudiatethe government debt of past generations and pre-

dicting, sensibly, that no one would lend money to thegovernment if that principle is in effect! Laissez-fareadvocates were true radicals in those days.

Tracy also debunked the claim that money lent tothe government has no opportunity cost:

“The second advantage which is found in loans, isthat the sums which they furnish are not taken fromproductive consumption: since it is not undertakers of

industry who place their funds in the hands of the state;but idle capitalists only living on their revenue, whochoose this kind of annuity rather than another. . . .[E]ven admitting that all were equally idle if the statehad not borrowed, it is certain that if they had not lentit their money they would have lent it to industriousmen. From that time these industrious men would havehad greater capitals to work on, and, by the effect of theconcurrence of lenders, they would have procuredthem at a lower interest.”

Well, then, how about this justification for borrow-ing: Loans “furnish in a moment enormous sums,which could only have been very slowly procured bymeans of taxes, even the most overwhelming.”

Tracy rejects this too. “Now I donot hesitate to declare that I regardthis pretended advantage as the great-est of all evils.”

Use Is Abuse

Some might contend this is an abuserather than a use of credit, but not

Tracy. “I answer, first, that the abuse isinseparable from the use, and experi-ence proves it.

“But I go farther. I maintain thatthe evil is not in the abuse; but in the

use itself of loans, that is to say that the abuse and theuse are one and the same thing; and that every time agovernment borrows it takes a step towards its ruin.The reason of this is simple: A loan may be a goodoperation for an industrious man, whose consumptionreproduces with profit. By means of the sums whichhe borrows, he augments this productive consump-tion; and with it his profits. But a government whichis a consumer of the class of those whose consumptionis sterile and destructive, dissipates what it borrows, itis so much lost for ever [sic]; and it remains burdenedwith a debt, which is so much taken from its futuremeans.This cannot be otherwise.”

I think you’ll agree that they’re not making manyeconomists like that anymore.


S h e l d o n R i c h m a n

Does governmenthave “a right toburden men yet notin existence, and tocompel them to pay[its] presentexpenses?”

Between the current financial mess and the debateover carbon dioxide emissions controls, there is alot of talk about regulation these days. We are

told, for example, that the recession would have beenprevented if proper regulations had been in place.Whileit is true that (by definition) the “right” regulationswould have prevented bad and ensured good, it is alsotrue that had an omniscient, omnipo-tent, omnibenevolent dictator been incharge, the recession would have beenavoided as well. The problem, ofcourse, is that God didn’t run for pres-ident during the last election.

Enacting the right regulations issomewhat simpler than electing anomni-everything being to run theworld—but not by much. As evi-dence, consider all the bad regulationsthat got us into this mess in the firstplace. Also consider the oft-heardargument that financial regulatorsneeded to “get out ahead of the inno-vators.” Clearly, a job for the omniscient.There is, afterall, a reason why the Wright Brothers’ flight at KittyHawk preceded the establishment of the Federal Avia-tion Administration.

Any time government regulators try to do muchmore than lay out the basic rules of the game, unin-tended consequences and moral hazards rear their uglyheads. The following list of pitfalls, adapted from ourbook Energy:The Master Resource, is offered as a cautionto regulatory enthusiasts.

1. Laws and regulations may institutionalize the tragedyof the commons.The rule of capture (which stated that oil

belonged to whoever pumped it out of the ground)and related regulations led petroleum companies todrill as many wells as possible in order to get the oilbefore their competitors could. By encouraging com-panies to drill otherwise unnecessary wells, the rule ledto wasted resources and sometimes to reservoir damage.

Groundwater in the United States is still a common-property resource. Because no oneowns it, no one has an incentive toconserve it. Farmers in California,enjoying subsidized water prices, havebeen growing water-intensive cropssuch as rice and cotton in desert areasdespite endemic water shortages.

2. Special interests lobby the govern-ment to get their products or services man-dated by regulation. The mandated useof ethanol in automotive fuel is anexample. In the United States mostethanol is made from corn. Farmerswho grow corn and companies thatmake ethanol from it have heavily

pressured Congress to require its use. As a further sub-sidy the government has banned imported ethanol eventhough it can be purchased from other countries forless than it costs to make it here. One unintended con-sequence has been an increase in food prices. As theprice of corn has risen, so has corn-based animal feedand with it the price of beef, milk, chicken, and eggs.

3. Regulations can create (or destroy) entire industriesovernight. The use of such power adds uncertainty and

B Y R O B E R T L . B R A D L E Y, J R . , A N D R I C H A R D W. F U L M E R

Regulatory Failure by the Numbers

35 S E P T E M B E R 2 0 1 0

Robert Bradley, Jr., ([email protected]) is the CEO and founder of the Institute for Energy Research of Washington, D.C., and Houston,Texas. RichardFulmer ([email protected]) is a senior fellow with the institute.

Any time governmentregulators try to domuch more than layout the basic rules ofthe game, unintendedconsequences andmoral hazards reartheir ugly heads.

risk to the market. If risk reaches unacceptable levels,investors put their money elsewhere.The concentrationof political power in Washington forces companies tolobby Congress and the White House for protectionagainst its arbitrary use. Corporate lobbying, in turn,increases people’s distrust of the system.

4. Regulations are often the result of compromise. Afterconcessions have been made to this powerful represen-tative or that influential senator, the resulting law orregulation may be very different from the original pro-posal and have far different consequences. Politics maybe “the art of the possible,” but what is politically pos-sible may be neither practical nor environmentallyfriendly.

Compromise can also result in laws so vaguelyworded that they can be interpreted in any number ofways. In the end it is left up to regula-tory agencies and the courts to decidewhat a bill actually means. Theirinterpretations may be very differentfrom the original intentions of thebill’s proponents.

The Clean Air Act Amendments of1977, for example, stated that onlynew factories and power plants wouldhave to meet the tighter emissionsstandards imposed by the act. Existingplants would continue to be regulatedunder the preexisting standards unlessthe old plants were “substantially modified.” Unfortu-nately, Congress did not precisely specify what “sub-stantially modified” meant.

In 1998 the Environmental Protection Agency(EPA) sued the owners of a number of old plants,charging that the upgrades done over the years to theseplants had cumulatively added up to “substantial modi-fications.” The owners responded, with some justifica-tion, that the EPA had originally approved theirchanges and that altering the rules after the factamounted to passage of a retroactive law, somethingexplicitly forbidden by the U.S. Constitution (Section9,Article 3).

5. Lobbyists may support regulations as a way of hurtingtheir competition. Utility companies with “old source”power plants, for example, welcomed the Clean Air Act’s

1977 amendments because they put potential competi-tors at a disadvantage by raising the cost of market entry.

Other amendments to the Clean Air Act requiredpower companies to reduce sulfur dioxide emissions byinstalling scrubbers.A less expensive way to lower emis-sions would have been to switch to low-sulfur coal, buteastern labor unions and coal mining companies(which produce high-sulfur coal) successfully lobbiedto get the requirement for scrubbers enacted into law.This resulted in a waste of resources since (otherwiseunnecessary) scrubbers had to be built, installed, andpowered.

In the United States during the twentieth century,government intervention in the energy market wascommonly industry-driven. Firms often organized lob-bying groups to obtain favorable regulation or special

subsidies. Free-market economistMilton Friedman complained, “Timeand again, I have castigated the oilcompanies for . . . seeking and gettinggovernmental privilege.”

6. Regulations can eliminate or alterfeedback. Feedback is an essentialcomponent of any activity. Imaginehow dangerous the world would befor a person who had lost the abilityto feel pain (as happens with certainforms of leprosy). Such a personcould do serious damage to himself

by continuing to walk on a badly sprained ankle orputting his hand on a hot stove without knowing it.

Government action can create a sort of institutionalleprosy by weakening or even destroying the feedbackloops that make it possible for companies to know whethertheir activities are of any value. For instance, by taxing productive companies in order to subsidize unproductiveones, governments perpetuate the waste of resources.

7. “Hard cases make bad law.” All too often, regula-tions are hastily written in response to the public’sdemands that the government “do something” in theface of a crisis. Petroleum price controls during the1970s are a case in point. Under the provisions of therules, refiners could charge more for higher-octanefuels, so they were encouraged to increase the lead con-tent to artificially boost octane ratings.


R o b e r t L . B r a d l e y, J r. , a n d R i c h a r d W. F u l m e r

Politics may be “theart of the possible,”but what is politicallypossible may beneither practical norenvironmentallyfriendly.

At the same time that crises lead to demands foraction, they tend to increase the cost of any action. Forinstance, in response to the power shortage of2000–2001, the state of California negotiated long-term contracts for the purchase of electricity.Within afew months market electricity prices dropped wellbelow what, in the midst of the crisis, had appeared tobe justified. California taxpayers bore the costs of thismultibillion dollar mistake.

8. Regulations often have unintended side effects. Newlaws or regulations may change the incentives peopleface and encourage them to act in ways that the law-makers had not foreseen.

Recall the 1977 Clean Air Act amendments thatplaced strict emissions regulations on new powerplants, while grandfathering existing facilities. Thoserules increased the costs of new plants relative to exist-ing ones, encouraging power compa-nies to keep older plants in servicelonger than they otherwise wouldhave. Old plants are less efficient thannew ones, and the result was morefuel used and more pollution created.

Fears of oil spills have led lawmak-ers to prohibit offshore drilling inmany of America’s coastal areas. As aresult, the nation must import moreoil than would otherwise be the case. However,imported oil is delivered via tanker. Notwithstandingthe recent tragedy in the Gulf of Mexico, tankers posea greater oil spill danger than does offshore oil produc-tion. Similarly, forbidding drilling in onshore and near-shore locations forces oil companies to drill in morehostile areas, making accidents more likely. Americancoastlines are, therefore, actually less safe thanks to suchlegislative “protection.”

The Community Reinvestment Act and the Amer-ican Dream Downpayment Act were supposed tomerely increase home ownership. As should have surprised no one, however, they also set off a housingprice bubble.

9. Regulators do not bear the costs of their regulations andhave little incentive to ensure that the benefits outweigh thosecosts. The U.S. Forest Service does not pay the cost ofbuilding timber roads in the nation’s forests; the money

is paid out of the Treasury. However, the Forest Serviceis allowed to keep some of the proceeds from timbersales. This practice provides an incentive to build log-ging roads into remote areas of the nation’s parks toallow timber companies access to trees that would oth-erwise be uneconomical to harvest.

The result, according to Tom Bethell (The NoblestTriumph: Property and Prosperity Through the Ages) is that“[b]y 1991, the service had constructed 360,000 milesof roads—eight times the length of the U.S. InterstateHighway System.” Because the cost of many of theseroads exceeded the value of the timber harvested,resources were wasted. Because the link between costsand rewards was eliminated, damage is being done tothousands of acres of parkland through deforestation,loss of habitat, and soil erosion for no net gain.

10. Public officials are self-interested, and their self-inter-est may not always be in the public inter-est, as James Buchanan and GordonTullock, the main developers of PublicChoice theory, pointed out.

For instance, managers with thefederal government are often paid inproportion to the number of peoplewho report to them. Their incentive,therefore, is to expand their depart-ments.All too often they act in accor-

dance with this incentive regardless of the cost totaxpayers.

More familiar are the politicians who purchase votesby using tax dollars to pay for projects of questionablevalue, or city officials who get kickbacks in return forconstruction contracts.

11. Once in place, regulations are difficult to eliminate—Friedman’s “tyranny of the status quo.” For example, eventhough the problems with ethanol have been knownfor years, the regulations requiring its use have yet to be repealed.

No matter how detrimental a regulation is, or howoutdated it has become, there is usually someone whobenefits by it.The beneficiaries of the regulation gener-ally have a stronger interest in keeping it in place thananyone else has in getting rid of it. As a result, they arewilling to spend time and money lobbying the govern-ment to support their position.While the benefits of a

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R e g u l a t o r y F a i l u r e b y t h e N u m b e r s

Public officials areself-interested, andtheir self-interest maynot always be in thepublic interest.

regulation may be enjoyed by a relative few, the costsare often spread out among many. If the per-person costof a regulation is only a dollar or two a year, no one hasa financial incentive to travel to Washington to lobbyagainst it. Economists call this the problem of concentratedbenefits and diffused costs.

Moreover, the benefits of any particular governmentaction are usually quite visible, but the costs are oftenhidden. For example, if the recycling industry receives asubsidy, the new facilities and jobs are open to publicview. Those gains may be more than offset by the loss of facilities and jobs in other industries because taxesraised to subsidize the recycling industry leave con-sumers fewer dollars with which to purchase othergoods and services.

Perhaps most important, people just do not like toadmit when they have made a mistake, and politiciansare no exception. If the “Smith Act”causes problems, Senator Smith isunlikely to apologize and proposethat his act be repealed. Instead, thesenator will probably argue that hislegislation was not properly fundedor enforced. In the end the law ismore likely to be expanded thanrepealed.

For example, the laws and regula-tions encouraging lenders to give home mortgages topeople who cannot afford to pay them back are still ineffect. Rather than admit their mistake, legislators create straw men (such as Wall Street “greed”), then passregulations to battle them.

12. Industries exert enormous influence over the govern-ment agencies created to regulate them. Reformers, believ-ing this problem is due to an imbalance of power, oftenseek to remedy the situation by increasing the author-ity of the regulatory agency. Such measures will likelyserve only to solidify the positions of those companiesthat already dominate the regulated business.

Industry sway over government agencies is a naturalresult of the incentives inherent in the regulatoryprocess.As already noted, no one has more incentive tolobby regulatory agencies than do the companies theyregulate.And regulators’ self-interest gives them a pow-erful incentive to listen.

There is also the “revolving door” phenomenonwhereby personnel leave industry for jobs with govern-ment agencies and vice versa. Some see this as proof ofcorruption, but there is a simpler, less sinister, explana-tion. When an agency is created to oversee a business,one of its first needs is employees with knowledge ofthat business. Where can it go for such people but tothe industry itself? Similarly, when governmentemployees retire and wish to begin second careers,where can they go other than to the business aboutwhich they have spent their professional lives learning?

13. Laws and regulations stifle innovation. Once a par-ticular solution is written into law, there is little incen-tive for companies to develop a better one. Laws arenotoriously difficult to change, particularly when lob-byists’ businesses depend on the mandated solution.Even if the mandated solution was cutting-edge tech-

nology when the law was signed,technology quickly becomes outdatedin a free market.

14. National regulations can createnationwide problems. In 1978 the Carteradministration, mistakenly convincedthat the country was running out of oiland natural gas, passed the Powerplantand Industrial Fuel Use Act. Under theact existing plants were prohibited

from increasing their use of natural gas, and new plantswere prohibited from using either natural gas or fuel oil.This restriction left coal as the only alternative despitethe fact that coal emits more pollution and CO2 thandoes natural gas. (While nuclear power was also an alter-native, the Three Mile Island incident, which occurredthe following year, made the option politically impossi-ble.) President Reagan lifted the restrictions on existingplants in 1981 and on new plants in 1987.

15. The existence of regulations and regulatory bodiesgives people a false sense of security. Bernie Madoff ’s vic-tims, for example, were reportedly as angry with theSEC for leading them to relax their guard as they wereat Madoff for taking advantage of them. Consumerswho believe that government watchdog and licensingagencies weed out incompetent and fraudulent serviceproviders may be less vigilant than they would other-wise be.


R o b e r t L . B r a d l e y, J r. , a n d R i c h a r d W. F u l m e r

No one has moreincentive to lobbyregulatory agenciesthan do the companiesthey regulate.

B Y J O H N S T O S S E L

Confiscating Your Property

Give Me a Break!

In America, we’re supposed to be innocent untilproven guilty. Life, liberty, and property can’t betaken from you unless you’re convicted of a crime.

Your life and liberty may still be safe, but have youever gone to a government surplus auction? Consumerreporters like me tell people, correctly, that they aregreat places to find bargains. People can buy bikes for$10, cars for $500.

But where did the government get that stuff? Someis abandoned property. But some I would just call loot.The cops grabbed it.

Zaher El-Ali has repaired and sold cars in Houstonfor 30 years. One day, he sold a truck to a man oncredit. Ali was holding the title to the car until he waspaid, but before he got his money the buyer wasarrested for drunk driving. The cops then seized Ali’struck and kept it, planning to sell it.

Ali can’t believe it “I own that truck.That truck done nothing.”The police say they can keep it under forfeiture law

because the person driving the car that day broke thelaw. It doesn’t matter that the driver wasn’t the owner.It’s as if the truck committed the crime.

Something has gone wrong when the police canseize the property of innocent people.

“Under this bizarre legal fiction called civil forfei-ture, the government can take your property, includingyour home, your car, your cash, regardless of whether ornot you are convicted of a crime. It’s led to horribleabuses,” says Scott Bullock of the Institute for Justice,the libertarian law firm.

Bullock suggests the authorities are not just disinter-ested enforcers of the law.

“One of the main reasons they do this and whythey love civil forfeiture is because in Texas and over40 states and at the federal level, police and prosecu-tors get to keep all or most of the property that theyseize for their own use,” he said.“So they can use it to

improve their offices, buy better equipment.”Obviously, that creates a big temptation to take stuff.This is serious, folks.The police can seize your prop-

erty if they think it was used in a crime. If you want itback, you must prove it was not used criminally. Theburden of proof is on you.This reverses a centuries-oldsafeguard in Anglo-American law against arbitrary gov-ernment power.

The feds do this, too. In 1986, the Justice Depart-ment made $94 million on forfeitures.Today, its forfei-ture fund has more than a billion in it.

Radley Balko of Reason magazine keeps an eye ongovernment property grabs: “There are lots of crazystories about what they do with this money. There’s adistrict attorney’s office in Texas that used forfeituremoney to buy an office margarita machine. Anotherdistrict attorney in Texas used forfeiture money to takea junket to Hawaii for a conference.”

When the DA was confronted about that, hisresponse was, “A judge signed off on it, so it’s OK.”But it turned out the judge had gone with him.

Balko has reported on a case in which police confis-cated cash from a man when they found it in his car.“The state’s argument was that maybe he didn’t get itfrom selling drugs, but he might use that money to buydrugs at some point in the future.Therefore, we’re stillallowed to take it from him,” Balko said.

“When you give people the wrong incentives, peo-ple respond accordingly.And so it shouldn’t be surpris-ing that they’re stretching the definition of lawenforcement,” Balko said.“But the fundamental point isthat you should not have people out there enforcingthe laws benefiting directly from them.”

Balko is exactly right.

39 S E P T E M B E R 2 0 1 0

John Stossel hosts Stossel on Fox Business Network and is the author ofMyths, Lies, and Downright Stupidity: Get Out the Shovel—WhyEverything You Know is Wrong. Copyright 2010 by JFS Productions,Inc. Distributed by Creators Syndicate, Inc.


Can We Really Do Without FDIC?Warren Gibson’s otherwise interesting article, “Fed-

eral Deposit Insurance: A Banking System Built onSand” (The Freeman, June 2010, http://tinyurl.com/2v5u9cf), contains at least three errors. One is that “the Fed, out of confusion, failed to inject new money”during the time of the Hoover administration. Not so.Federal Reserve notes increased by 25 percent, from $4billion to $5 billion between 1930 and 1933; see IrvingFisher’s 1935 book, 100% Money, pp. 5-6. It was the $8billion contraction in demand deposits that made thebig difference.

Second, Gibson faults modern fractional reservebanking because “We think of banks as custodians ofour money, keeping it safe for us and making it availablewhenever we need it. But present-day banks are notdeposit banks.” Wrong. We deposit our savings—non-consumed income. Money (cash) is only one of themedia through which we make deposits. As AdamSmith well puts it in the Wealth of Nations, “money isthe mere instrument of transfer.”The other instrumentsinclude electronic transfers and checks.Thus, so long asbanks pay us back our deposits when we want them,they commit no fraud.

Third, he says that “Any benefit this system [FDICinsurance] provides is incidental to its real objective: toserve the cartel.” The claim is seriously misleading. Arun on one bank may jeopardize the survival of allbanks, including those with financially sound invest-ments (assets), since no bank has enough cash toredeem its liabilities—pay all depositors. Thus, alldepositors will lose some of their savings if a run onbanks were to occur in the absence of deposit insur-ance.An economy’s growth also depends upon increas-ing savings to provide the capital (funds) businessesneed for their investment. In the absence of the secu-rity of deposits created by the FDIC, the rate of savingswith banks would be lower, hence the rate of invest-ment.Therefore, besides saving banks from the hazardsof bank runs and contagion, the public—depositors

and businesses—directly benefit from the depositinsurance.

—JAMES C.W.AHIAKPORProfessor of economics, California State University,East Bay

Warren Gibson replies:I thank Prof.Ahiakpor for his response to my article

on federal deposit insurance and would like to respondbriefly to his three objections.

On Fed monetary policy during the Great Depres-sion, I rely on Milton Friedman and Anna Schwarz’sdefinitive A Monetary History of the U.S. in which chart31 shows a decline in the money stock from about $45billion in 1929 to $30 billion in 1933. Friedman sum-marized this as the Fed’s “disastrous mistake between1929 and 1933, when it permitted the quantity ofmoney to decline by a third and thereby turned asevere recession into a disastrous depression” (MoneyMischief p. 208).

When I wrote, “We think of banks as custodians ofour money, keeping it safe for us and making it availablewhenever we need it,” I was attempting to describewhat I believe (perhaps mistakenly) to be the averageperson’s perception of what banks do.A dictionary def-inition of “deposit” is “that which is placed somewherefor safekeeping,” like depositing your jewels in a hotelsafe, so perhaps bank “deposits” should be given someother name. I agree with Lawrence White’s and GeorgeSelgin’s view that fractional reserve banking need notbe fraudulent; Murray Rothbard and others are wrongabout this. I am not charging fraud but merely suggest-ing that fractional reserve banking is misunderstood bythe general public and perhaps should be spelled outmore explicitly to depositors. I also suggest that reserveratios are too low compared to what would come outof a free-banking system, where market forces severelydiscipline both managers and depositors.

My statement that the benefits of FDIC insuranceare “incidental to its real objective: to serve the cartel”

Capital Letters

41 S E P T E M B E R 2 0 1 0

was admittedly a bit hyperbolic. But in assessing theFDIC or anything else we have to ask: compared towhat? Prof. Ahiakpor compares FDIC insurance to noinsurance whereas my article suggested that privateinsurers would enter the picture. Private insurers wouldhave incentives that would make a bank panic (a conta-gion of bank runs) extremely unlikely.They might, forexample, adopt option clauses which were successfullyused by free banks in Scotland in the 1800s.The FDIC,by contrast, does not eliminate risk but instead social-izes it, and in so doing it politicizes, subsidizes, and de-incentivizes the banking system. Lastly, regarding hiscomment on saving and investing: Of course prosperitydepends on saving and investment. But there can be toomuch saving. The right amount for each of us is the

amount at which the marginal benefit of an additionaldollar saved matches the marginal cost.Where there is afree market for investments, the overall saving rate isdetermined by the interplay of savers acting on theirmarginal cost/benefit estimates. Government interfer-ence such as subsidized deposit insurance can result intoo much saving.

We will print the most interesting and provocative letters wereceive regarding articles in The Freeman and the issues theyraise. Brevity is encouraged; longer letters may be editedbecause of space limitations. Address your letters to: The Free-man, FEE, 30 S. Broadway, Irvington-on-Hudson, NY 10533;e-mail: [email protected]; fax: 914-591-8910.

C a p i t a l L e t t e r s

Book Reviews

Animal Spirits: How Human Psychology Drives theEconomy, and Why it Matters for Global Capitalismby George A.Akerlof and Robert J. ShillerPrinceton University Press • 2010 • 256 pages • $16.95paperback

Reviewed by Dwight R. Lee

Neoclassical economic theory(in which I include Austrian

economics, ignoring the method-ological differences) doesn’t explaineverything in the world, not eveneverything that occurs in what isconsidered the economic realm. Inrecent years this has been thetheme of the growing subdiscipline

“behavioral economics,” which has, often usefully,focused attention on economic anomalies—outcomesinconsistent with the predictions based on fullyinformed and perfectly rational actors.

This isn’t surprising, given the usefulness of makingsimplifying assumptions in theoretical endeavors. Obvi-ously no one is fully informed or perfectly rational, butthe assumption that they are generates remarkablyaccurate predictions on issues that interest economists.

One of the most powerful implications of neo-classical economics is that the case for free markets doesn’t depend on people being fully informed andrational, as is mindlessly repeated in many principlestextbooks. Quite the contrary, the case for markets isthat they increase the rationality of economic deci-sions by providing information and motivationthrough prices, profits, and losses that cannot existwithout markets.

With that as background, I review Animal Spirits byGeorge Akerlof and Robert Shiller. Both Akerlof andShiller have done creative and interesting work, muchof it based on the anomalies highlighted in behavioraleconomics. They begin by considering how “animalspirits” affect economic decision making. That termoriginated with Keynes, who used it to describe emo-

tional factors that enter into, and often distort, invest-ment decisions that are necessarily made with incom-plete information.

Akerlof and Shiller take a more expansive view ofanimal spirits, which they break into five categories:confidence, fairness, corruption and antisocial behavior,money illusion, and stories.The five chapters in Part 1discuss those separately, showing how they can lead toirrational economic outcomes and how understandingthem can help us design appropriate policies for cor-recting them.The remaining chapters look at how ani-mal spirits may be responsible for the current economicdownturn.

Not having the space to deal with each of thesechapters individually, I’ll keep my discussion general.Although Akerlof and Shiller suggest that they appreci-ate the importance of markets, their emphasis is clearlyon “market failure.” A few examples illustrate their tendency to qualify any positive statement about capi-talism (emphasis in original):“Capitalist societies . . . canbe tremendously creative. . . . On the other hand, left to their own devices, capitalist economies will pursueexcess, as current times bear witness.” “But the bountyof capitalism has at least one downside. It does notautomatically produce what people really need; it givesthem what they think they think they need, and arewilling to pay for.”

This last statement isn’t blatantly false, although itputs the free market in the worst possible light by sug-gesting that many consumers want “snake oil.”

A more balanced approach would have also pointedout that government doesn’t automatically providewhat people need either; it gives everyone what themajority, or a politically influential few, think theyneed, whether or not they’re willing to pay for it. Sucha comment is nowhere to be found. Akerlof andSchiller ignore the problems with the perverse out-comes of government actions.

Sometimes the authors show their bias with thetone of their statements. For example, they state that“[t]he proponents of capitalism wax poetic over thegoods that it provides” (emphasis added).And they referto Milton Friedman’s “sleight of hand” when describ-ing his analysis of the fallacy behind the Phillipscurve—analysis that undermined, at least intellectually,


the fiscal excesses of government that brought us thestagflation of the 1970s.

Akerlof and Shiller use “animal spirits” to considersome important economic issues in different andpotentially productive ways. But for this concept torealize its potential it would have to be used to develophypotheses that are more discriminating and testablethan anything found in Animal Spirits.

The authors give the impression that they see “ani-mal spirits” as an all-purpose explanation to be trottedout to explain anything that cannot be readily explainedwith existing economic theory. Indeed, they seem tobelieve that the strength of their approach is that byexplaining almost everything, it cannot be refuted.

“Animal spirits” are ubiquitous and surely play a rolein much economic activity.When economic questionscannot be adequately answered with existing theory,however, the way to come up with better answersinvolves hard work in developing refutable hypotheses,then testing them. That isn’t what Akerlof and Shillerdo. They use animal spirits as the answer to the ques-tions they consider in much the same way oxygen canbe used as the answer to the question,“What caused thefire?” The answer cannot be refuted, but it’s not veryhelpful.

Dwight Lee ([email protected]) is professor of economics at SouthernMethodist University.

Black Maverick: T. R. M. Howard’s Fight for CivilRights and Economic Powerby David Beito and Linda Royster BeitoUniversity of Illinois Press • 2009 • 336 pages • $35.00

Reviewed by George Leef

Black Maverick is the only biog-raphy of Dr. Theodore Roo-

sevelt Mason Howard, whoseremarkable life (1908–1976) com-bined entrepreneurship, medicalpractice, civil-rights activism againstsegregation, philanthropy, and highliving. He was an irrepressible butflawed character, a man on the

make who grew up under Jim Crow and took advan-

tage of the few opportunities that system of repressionleft open. He then used his wealth and persuasive abili-ties to combat the system. Howard proved that freedomand capitalism were powerful weapons that could beused against bigotry.

For blacks living in Kentucky early in the twentiethcentury, life was mostly on the Hobbesian model—nasty, brutish, and short. Segregation limited the workavailable to blacks largely to exhausting physical labor.They lived under the constant threat of violence by theKu Klux Klan against those who “got out of theirplace.” While growing up, Howard heard stories aboutlynchings and Klan raids against black towns; he alsoheard that the intended victims had sometimes boughtguns and defended themselves.That was one of the les-sons young Howard learned well: Later in life, he wasusually armed.

One profession open to blacks was medicine,although they were expected to serve “their own kind”in the South. A well-known white doctor who knewHoward as a young man sensed his interest in medicineand decided to help him.The first step was to enroll the16-year-old Howard in a junior college in Alabama runby the Seventh-Day Adventist Church.After graduating,Howard enrolled in another Adventist school, UnionCollege in Lincoln, Nebraska, where he was the soleblack student. His grades were only fair, but he distin-guished himself in public speaking, winning a nationaloratory contest in 1930 before a mostly white audience.

The next step for Howard was the College of Med-ical Evangelists in Loma Linda, California, where hebegan medical studies in 1931. He also got involved inpolitics, civil-rights activism, and even journalism, writ-ing columns for the leading black newspaper in thestate. A frequent theme of his was the importance forblacks to enter business and teach their children thevirtues of thrift and self-reliance. Howard found greatinspiration in the philosophy of Booker T.Washington,and while he did not oppose FDR and his New Deal,he was skeptical that it would do anything to helpblacks. He advised blacks to follow the example of theJapanese in California and succeed on their own with-out looking to politics for assistance.

After receiving his medical degree Howard firstwent to a decaying public hospital in St. Louis, where

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he developed an excellent reputation as a surgeon. Hisbig break came in 1941, when he was invited tobecome chief surgeon at a black hospital being built in the all-black town of Mound Bayou, Mississippi,by a fraternal organization. Under Howard’s direction,the hospital grew and provided quality medical care to its members. Howard’s self-help philosophy dove-tailed with that of the fraternal order. Soon it was sell-ing insurance to members; for an annual premium ofonly $8.40, they were entitled to up to 31 days of hos-pital care.The response among poor blacks in the areawas overwhelming. They had excellent medical insur-ance long before such insurance became common, andwithout any government involvement.

Howard shrewdly invested much of his salary inarea businesses and soon was one of the wealthiestblack men in the South. In the years to come, he usedsome of that wealth to aid the fight against segre-gation. In the early 1950s, for example, he was instru-mental in a boycott of filling stations that refused to allow black customers to use the restrooms. Thatboycott caused the major national gasoline com-panies to change policies and insist that their fran-chisees no longer discriminate. They didn’t want thebad publicity and loss of customers. Howard under-stood that under capitalism, profits usually trumpprejudices.

After the infamous murder of a black teenager,Emmett Till, in 1955, Howard threw resources into anattempt to bring Till’s killers to justice. Unfortunately,he couldn’t overcome the segregationist-dominatedlegal system, and the defendants, guilty beyond doubt,went free.

The Beitos have written a timely and enlighteningbook. Howard was a fascinating man, and his belief thatfree enterprise offers poor people (of all races) the pathto success needs to be trumpeted as loudly as ever.America today is torn by counterproductive govern-mental “affirmative action” policies such as quotas for“minority-owned” contractors and racial preferences incollege admissions.The book’s subtext is that what gov-ernment needs to do to help poor people and minori-ties is to get out of their way.

George Leef ([email protected]) is book review editor of The Freeman.

Mad About Trade: Why Main Street AmericaShould Embrace Globalizationby Daniel GriswoldCato Institute • 2009 • 205 pages • $21.95

Reviewed by William H. Peterson

Free trade is the consumer’s bestfriend and a great contributor

to peace. Pressing those ideas homeis Cato Institute trade expert DanielGriswold’s challenge in this book.He is mad for trade, while too manyothers are mad against trade.

As an example of the latter, con-sider radio host and writer Lou

Dobbs, who dismissed concern for consumers in hisbook Exporting America, where he wrote, “I don’t thinkhelping consumers save a few cents on trinkets and T-shirts is worth the loss of American jobs.” Similarly,then-Senator Barack Obama told a stadium filled withcheering union members in 2007 that “people don’twant a cheaper T-shirt if they’re losing a job in theprocess.” The idea here is that desire of consumers tosave money should be trumped by the supposed needto “save jobs.”

Griswold points out that politicians generally favor“the noisy producer interests over the silent, sufferingconsumer” and reminds the reader that life itselfdepends on consumption.To that end, he quotes AdamSmith in The Wealth of Nations:

Consumption is the sole end and purpose of all pro-duction; and the interest of the producer ought tobe attended to, only so far as it may be necessary forpromotion of the consumer. The maxim is so per-fectly self-evident that it would be absurd to proveit. But in the mercantile system, the interest of theconsumer is almost constantly sacrificed to that ofthe producer; and it seems to consider productionand not consumption, as the ultimate end and objectof all industry and commerce.

The problem, of course, is that there is usually politicaladvantage in running a “mercantile system” that bene-fits some domestic producers at the expense of con-


Book Reviews

sumers—and other producers who need the “pro-tected” goods to make their own products.

Griswold’s tour de force explores and documents themany ways in which import competition benefitsAmerican consumers, enabling them to improve theirstandard of living with a greater range of choice, lowerreal prices, and better quality. Those are not insignifi-cant benefits. When the likes of Dobbs and Obamaridicule free trade as merely a matter of saving a smallamount on T-shirts and trinkets, they’re giving a delib-erately distorted picture of reality.

Big-box retailers, such as Walmart, Home Depot,and Best Buy, that purchase much of their inventoryfrom overseas producers and ship it to stores in theUnited States, managed to hold their sales fairly steadyor even increase them during the current recession. Butwhat was good for those chains and their customerswas sour news for organized labor. Unions oftendemand a “level playing field” and claim that foreignproducers enjoy various “unfair advantages” such as alower wage scale and export subsidies. When they callfor tariffs, they say they don’t want special favors butonly “fairness.”

Our author begs to differ. He explains to readersDavid Ricardo’s 1817 insight about comparative advan-tage—that each nation (or better still, each person orfirm) will tend to discover where it has comparativelylower costs and then concentrate on producing thosegoods.Whether a producer’s cost advantage is “fair” or“unfair,” the best policy, Griswold argues, is for the gov-ernment not to interfere with trade. Instead of furtherbuilding up trade barriers, as various special interestsadvocate, he urges that we drop the barriers that sepa-rate us from the peaceful global marketplace.

But what about American manufacturing? Won’tfree trade reduce us to a “service economy” consistingof mostly low-paying jobs? Politicians and pundits havebeen saying that for years, but Griswold replies that itisn’t true.The number of Americans working in manu-facturing has indeed fallen, but that is due more toincreases in productive efficiency than to “unfair com-petition.”While protectionists like North Dakota Sena-tor Byron Dorgan wring their hands over the demise ofsome household name products like Huffy bicycles andSwingline staplers, they neglect to mention that Amer-

ican manufacturing has significantly increased in realterms since 1970.

Furthermore, Griswold explains that the U.S. gov-ernment is responsible for a huge “swindle” of con-sumers—our Harmonized Tariff Schedule, filling nearly3,000 pages. Our sugar tariff, for example, compelsAmericans to pay two to three times the world pricefor sugar. In turn, that has caused American food pro-ducers to shift production to Mexico or Canada toescape the cost. Protectionist politicians never mentionthe flip side of their “save jobs!” coin.

The book’s closing paragraph states: “Free tradeunites us with other people in an ever-widening ‘com-munity of work’ that provides a powerful alternative toconflict and war.” I strongly recommend Mad AboutTrade.

William Peterson ([email protected]) is the 2005 winner of theSchlarbaum Award given by the Ludwig von Mises Institute for LifetimeAchievement in the Study of Liberty.

The Great Decision: Jefferson, Adams, Marshall,and the Battle for the Supreme Court by Cliff Sloan and David McKean Public Affairs • 2009/2010 • 269 pages • $26.95hardcover; $14.95 paperback

Reviewed by Kevin Gutzman

The Supreme Court’s decisionin Marbury v. Madison (1803) is

among the most famous in its his-tory. Shrouded in myth and featur-ing a cast of historical demigods,the story of the case is a staple ofbiographies of the second, third,and fourth presidents, as well asChief Justice John Marshall. Con-stitutional law courses commonly

begin with consideration of Marshall’s opinion in thecase, which supposedly established the federal courts’power of judicial review.

In The Great Decision, journalist-lawyer Cliff Sloanand biographer David McKean offer a popular accountof this seminal decision. They begin with an extensivediscussion of the litigation’s background. The tale willbe familiar to anyone with knowledge of American

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politics in the early Republic: John Adams’s administra-tion is in its closing days.The chief justice is resigning.Multiple candidates have turned down the appoint-ment, and Adams finally decides to appoint Marshall,his secretary of state. Thus did Republican chieftainThomas Jefferson’s Federalist cousin come to rule thejudiciary roost even as Jefferson’s party dealt the Feder-alists a fatal drubbing.

Marshall, finding himself both secretary of state andchief justice as the final Federalist administration drewto a close, committed the great gaffe of failing to deliverseveral judicial appointees’ commissions.When his suc-cessor, James Madison, found those commissions sittingon his desk, he decided (surely with Jefferson’s support)not to deliver them. That laid the ground for WilliamMarbury’s lawsuit for possession of his commission.

Counsel for Marbury insisted that presidential nom-ination plus Senate confirmation entitled him to theoffice of D.C. justice of the peace. The administrationmaintained that actual delivery of the commission wasnecessary.

Nowadays, Marshall likely would have to recusehimself from the Supreme Court case. After all, whatwas really at issue was the significance of his own failure to deliver the commissions. Marshall didn’trecuse himself.

Also nowadays, a federal court would be expected tostructure the explanation of its decision differently thanin Marbury. As courts of limited jurisdiction, federalcourts first ask whether they have jurisdiction over aparticular case; if not, the case is at an end.

Marshall structured his opinion the opposite way:First he asked whether Marbury had a right to hiscommission, then whether there was a remedy, andonly then whether the Supreme Court was constitu-tionally empowered to afford Marbury that remedy. Bythe time he got to the point in his opinion where heanswered no, he had already leveled a powerful politicalblast at Jefferson and Madison for supposedly havingdenied Marbury his rightful commission.

Marshall noted that although the Judiciary Act of1789 granted the Court power to hear suits for writs of

mandamus in the first instance, such suits did notappear among the types of cases over which the Courtwas granted original jurisdiction by Article III. Marshallclaimed that Congress did not have power to lodgeoriginal jurisdiction over other types of cases in theSupreme Court.Thus Congress had exceeded its con-stitutional powers in granting the Supreme Court orig-inal jurisdiction over cases like Marbury. Judicial reviewwas born.

The authors display a worshipful attitude as theyrecount the endorsement of Marbury offered to themby now-retired Justice John Paul Stevens and the incor-rect summary of the case’s meaning by ex-Justice San-dra Day O’Connor. Her synopsis—that Marbury makesthe Supreme Court “the final arbiter of the constitu-tionality of all acts of government”—is the current wis-dom, although it overlooks the people’s ability toamend the Constitution. For Sloan and McKean, wide-ranging judicial policymaking is a Good Thing, andwhatever laid the groundwork was a Good Develop-ment.That is the message underlying the book.

That is not a new message but par for the course.The book offers no new insights or data that will addto experts’ store of knowledge; actually, it’s pepperedwith factual errors.

The idea that the Supreme Court is the final arbiteris a severe betrayal of the idea of self-governmentunderlying the American Revolution. Presidents as dis-parate as Thomas Jefferson, Andrew Jackson, and Abra-ham Lincoln contradicted it directly. In our day, it hasbeen used to justify forced busing for racial integration,judicial imposition of tax increases, and myriad otherunconstitutional social experiments.

Far from this vision of a Grand Council with theFinal Say, the Revolution stood for popular sover-eignty—for the People as ultimately responsible andfinally empowered.While Supreme Court justices’ eyesmay glisten at the mention of their self-empoweringvision,America is about something far better.

Kevin Gutzman ([email protected]) is professor of history at WesternConnecticut State University.


Book Reviews

On a flight from Chicago to Washington, D.C.,in 1981, I sat beside a U.S. foreign serviceofficer who had just finished a stint in

Moscow. He told me that although he had enjoyed thejob, he needed to get his family back to Americabecause he wanted his children to grow up understand-ing what it was like to live in a free country. His chil-dren were only aged five and seven.“In what ways would your childrenhave even known they were not liv-ing in a free society?” I asked. Heanswered: “They noticed that whenwe traveled, we, and those aroundus, had to show an ID to a govern-ment official. You couldn’t travelfreely.”

Although he probably doesn’tremember that conversation, I won-der if he remembers the thoughtsthat caused him to return to theUnited States. The reason I wonderis that Americans are no longer freeto travel by commercial air withoutshowing a government official agovernment-issued ID. So the free-dom that he sought in the UnitedStates no longer exists. In an impor-tant way, the United States hasbecome Sovietized.

Now before you conclude,“Henderson is off his rocker; he can’t tell the differencebetween the USA and the USSR,” let me say that I dounderstand the difference. Governments in the UnitedStates don’t oppress us nearly as much as the Sovietgovernment oppressed its citizens. On a scale of oppres-sion where 1 is the least and 10 is the most, the USSRwas a 9 or 10 and the United States is, say, a 3. But in1981, when I took that flight, it was about a 2. Name

the civil liberty, and chances are it has declined overthat period.

Consider a basic freedom-of-speech issue, the rightto organize and petition the government. In parts of theUnited States that right is under assault. When two ormore people in Colorado, for example, join to speakout about a political issue and spend more than $200 to

do so, they must register with thestate and report all their contribu-tions, even if only in kind, andexpenditures.They must also disclosethe identities of anyone who con-tributed money. Better-organizedpolitical activists have used this lawas a club to go after their politicalopponents. In 2006, for example, thesupporters of annexing the town ofParker North to the town of Parkerfiled a campaign-finance complaintagainst the six most vocal opponentsand threatened to go after anyoneelse with a yard sign opposingannexation. Similar legal assaultshave occurred against opponents ofincreased gasoline taxes in Washing-ton state.

Or consider the drug laws. In the1970s, when police raided a home fordrugs, they often knocked on thedoor and waited for someone to

answer.Then they entered and looked for drugs.Today,it’s much more common for them to show up in heavilyarmed and armored SWAT teams, ready to shoot if any-

B Y D AV I D R . H E N D E R S O N

The Decline in Civil Liberties

The Pursuit of Happiness

47 S E P T E M B E R 2 0 1 0

David Henderson ([email protected]) is a research fellowwith the Hoover Institution and an economics professor at the GraduateSchool of Business and Public Policy at the Naval Postgraduate School inMonterey, California. He is the editor of The Concise Encyclopedia ofEconomics (Liberty Fund) and blogs at www.econlib.org.

You aren’t necessarily free to move about thecountry.flickr.com/mtsl

one in the house makes a false move. Reason writerRadley Balko has written often about the outrages of thedrug war. In a May 2010 Reason article, he writes: “I’vebeen writing about and researching these raids for aboutfive years, including raids that claimed the lives of inno-cent children, grandmothers, college students, andbystanders. Innocent families have been terrorized bycops who raided on bad information, or who raided thewrong home due to some careless mistake.”

Enforcement Victims

Fortunately, such incidents are still relatively rare, butthat they happen at all is intolerable. Enforcing the

drug laws requires such raids because the violators arepeople engaged in mutually beneficial exchange. Inmurder or burglary there is clearly a victim, or a vic-tim’s friend or relative, who objects to the crime andtherefore has an incentive to reportthe crime to the police. But whenillegal drugs are bought or sold, thereis no victim.Whatever the wisdom orfolly of exchanging illegal drugs,those who do so believe they benefit.Otherwise, they wouldn’t do it. Soone way to catch people who trade inillegal drugs is to surprise them byinvading their homes.

The drug laws have also led toother violations of people’s civil andeconomic freedom. When President Ronald Reaganstepped up the drug war, he started requiring peoplemaking purchases with $10,000 or more in cash to fillout a federal form.The government also seizes propertythat police suspect has been used or earned in the saleof drugs and has carved out an exemption to the Con-stitution’s prohibition on illegal search.

It’s not as if we get a big benefit from enforcementof the drug laws. Just as the prohibition of alcoholhelped create criminal gangs, so does the prohibition ofdrugs. The nice thing about freedom is that it allowspeople to either use or avoid using the drug(s) of theirchoice. And among the tragedies of the drug war arethe consequences it imposes on innocent people caughtin the crossfire.

As for government restrictions on our freedom totravel by airline, the simple fact is that commercial air-lines, even with the risk of terrorism, are by far the safestway to travel. According to Michael Sivak and MichaelFlannagan in an article in American Scientist, your chanceof being killed in one nonstop airline flight, even withthe increased threat from terrorist attacks, is about onein 13 million. To reach that same level of risk whendriving on rural interstate highways, which are Amer-ica’s safest roads, you need travel only 11.2 miles. Inother words, you are in about as much danger driving tothe airport as in flying from the airport.

Reduced Safety

Why is driving relevant? Because when the gov-ernment invades our privacy, as it systematically

does when we fly, it causes some, especially those whowould have traveled less than 500miles each way, to travel by carinstead. What is the unintended, buttotally predictable, consequence ofthis loss of freedom whose stated goalwas to make us safer? Less safety.Adding to the irony is the fact thatsince 9/11, passengers have beenquite good at restraining those terror-ists who try to blow up airlines.WhenRichard Reid, the shoe bomber, triedto blow up a flight, passengers

restrained him. Ditto with Umar Farouk Abdulmutal-lab, the underpants bomber on the Christmas 2009flight heading into Detroit.

Fortunately, there’s some good news, both here andin Great Britain. The Real ID Act, which Congresspassed in 2005, requires drivers’ licenses and other stategovernment-issued identification cards to conform totight federal standards. Many state governments, in a fitof federalism, have said no.That part of the Real ID Actlooks to be really dead.And in Britain in May the newlyformed coalition government announced that it wouldscrap a similar plan.

Let’s not stop there. Let’s be able to say, like theSouthwest Airlines ads, “You are now free to moveabout the country.”


D a v i d R . H e n d e r s o n

Government’sinvasions of privacywhen we fly causesome people to drive, decreasing their safety.

VOLUME 60, NO 7 SEPTEMBER 2010fee.org/files/doclib/fee-sept-text.pdf · ment or full market...

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Transcript of VOLUME 60, NO 7 SEPTEMBER 2010fee.org/files/doclib/fee-sept-text.pdf · ment or full market...