Simple Rules for Open Markets
May 6, 1996
Richard A. Epstein
Good afternoon, ladies and gentlemen. My name is David Theroux, I am the president of The Independent Institute, and I am delighted to welcome you to our Independent Policy Forum program today.
As many of you know, The Independent Institute regularly sponsors programs featuring outstanding experts to address major social and economic issues, especially as they may relate to important new books. And, today is certainly no exception.
For those of you new to the Institute, you will find background information on our program in the packet at your seat. The Independent Institute is a non-profit, non-politicized, scholarly public policy research organization which sponsors comprehensive studies of critical public issues. The Institutes program adheres to the highest standards of independent inquiry, and the resulting studies are widely distributed as books, our quarterly journal, The Independent Review, and other publications, and are publicly debated through numerous conference and media programs, such as in our forum today.
Our purpose is a Jeffersonian one of seeking the truth regarding the impact of government policies, and not necessarily to just tell people what they might want to hear. In so doing, we will not take the public pronouncements of government officials at face value, nor the conventional wisdom over serious public problems. Hence, we invite your involvement, but be prepared for new and challenging perspectives.
Neither seeking nor accepting government funding, the Institute draws its support from a diverse range of foundations, businesses and other organizations, and individuals, and we invite you to join us with your tax-deductible Institute Associate Membership. Also in your packet, you will find information on the benefits in becoming a Member including receipt of new Institute books, The Independent Review, discounts to future Institute events and much more.
Our program today is a very special one. And in making this Independent Policy Forum possible, I want to especially thank the members of our Host Committee for their kind assistance and support, a list of which you will find on the program found in your packet.
Frustration with Americas increasingly Byzantine legal system has led to numerous calls for peaceful reform, yet few experts have articulated a vision for reforming the legal system as a whole. While the White House and Congress tinker with the rate of growth of government spending and whether the welfare state is better administered at the federal or state level, the eminent legal scholar and author Richard Epstein has been challenging the very roots of the liability crisis and the legal nature and effects of the regulatory-welfare state.
In his widely acclaimed, new book, Simple Rules for a Complex World, Epstein presents a new legal framework to restore a Jeffersonian society based on individual rights, freedom to choose and the Rule of Law. In his book, he echoes the thoughts of the Founding Fathers and such scholars as the late Nobel Laureate economist F. A. Hayekhe vividly demonstrates why as a society becomes ever more complex, the rules that govern behavior should be made simpler not more complicated. This is not to say that simplicity alone is sufficient for a just, productive, and humane society, but that complex rules breed uncertainty which breeds litigation, which in turn diverts scarce resources from productive use.
At this Independent Policy Forum, Professor Epstein will employ these principles to evaluate many of the thousands of burdensome and counterproductive regulations, taxes and other government policies.
Since publication of his highly acclaimed 1985 book, Takings, Richard Epstein has become widely regarded as perhaps the preeminent legal contrarian of our time, challenging the philosophies of liberals and conservatives alike. His path-breaking scholarship and penetrating analyses have launched a quiet revolution to restore the central importance of property rights to the law and society in general, earning him the respect of even his staunchest critics. Indeed, the entire movement to recognize and employ the Takings Clause in the Bill of Rights is due to his seminal work. Now with the escalating anti-political sentiment of the public and the growing demand to de-bureaucratize and de-politicize American life, Epsteins powerful and learned call for devolution, tort reform, economic liberalization and privatization could not be more timely.
Richard Epstein is the James Parker Hall Distinguished Service Professor of Law at the University of Chicago. A member of the American Academy of Arts and Sciences and the California Bar, he is editor of the Journal of Law and Economics and a Research Fellow of The Independent Institute. In fact, his new study, Antidiscrimination Health Care, has just been published by the Institute. He is further renowned for his expertise in communications, criminal law, legal history, private property, jurisprudence, real estate development and finance, land use, taxation, torts, and workers compensation.
A graduate of Oxford and Columbia Universities, Professor Epstein received his LL.B. cum laude from Yale Law School, and his many influential books include the new Simple Rules for a Complex World plus Takings, Bargaining With the State, Forbidden Grounds, The Bill of Rights in the Modern State, Labor Law and the Employment Market, Modern Product Liability Law, and Torts.
He is the author of over 160 articles and review in such journals as Harvard Law Review, American Journal Legal History, Stanford Law Review, Texas Law Review, American Economic Review, California Law Review, Columbia Law Review, and New England Journal of Medicine, as well as in The Wall Street Journal, Chicago Tribune, The New Republic, The New York Times, The Washington Post, and The Legal Times.
It gives me great pleasure and I know that you will join with me now in welcoming Richard Epstein.
David described me as Americas leading legal contrarian. There is both an honor and a liability associated with that particular position. It means that youre able to start out and to tread where others fear to go. But on the other hand, to the extent that you remain a contrarian for the twenty-odd years that you push a particular line, you start to wonder when it is that youre going to acquire this exalted status of majoritarian, and have somebody treat you in the uncomfortable position of being the conventional wisdom. Just once in my life, I would like to be thought not only clever, urbane or witty, but just simply to have the much humbler designation of correct. That much doesnt seem to come very easily to someone in my position, Im sorry to say, and in fact, what I have to do is constantly remind myself of the academic credo, which is to follow the argument to where it leads, and if a crowd decides to follow you, so much the better; and if it doesnt, you take comfort in the fact that the kinds of positions youre pushing are necessary in order to lend some degree of balance to the public debate.
In political life, one of the things that really troubles me is that while there is an enormous amount of discontent with the way in which our public institutions are running, there is an enormous volatility to the way in which they can go. That is, I do not see here the signs of discontent of the status quo pointing very strongly in a direction of the liberalization of the sort that David described. I see in the hands of some people a very powerful form of populist impulses that sometimes spring forth the darkest spirits of our natures and create a rather illiberal sentiment. I dont mean by that the twentieth century variety of liberalism, I mean the nineteenth century variety of liberalism.
To give you an idea of just how crazy the situation can often be, when people describe the world in Left or Right terms, and treat everything as though it can be arranged along a single dimension, folks say, Oh, we understand that youre an extreme right winger. So that means Im out there with the Freemen in upper-state Montana, or that somehow Im with the Ku Klux Klan. Indeed, when I wrote my book Forbidden Grounds, which is the case for the abolition of employment discrimination laws in so far as they apply to private, competitive marketsno further than thatI was branded a defender of Jim Crow, on the grounds that everybody knows that free markets and Jim Crow mean the same thing, and that only a form of government benevolence can protect us from these forms of illness.
If, in fact, you have that degree of confusion, that kind of uncertainty about where youre going to gowhere populism can one moment favor the deregulation of public utilities and in the next moment in favor of their nationalizationit seems to me that you are faced with a political situation which should leave everyone with a profound disease. What makes it even worse, I think, is that the role of intellectuals dealing with this situation has shifted from bad to worse.
There is a new term that has gained currency in the last few yearsand Im sure it was around before thenthe so-called public intellectual: the individual who takes those things learned in the academy, and then tries to transport them into the world of public affairs. I guess to some extent the moment someone stands here and gives some kind of speech, perforce he becomes some form of a public intellectual. But its a very risky business to get involved in. And its one that leaves me profoundly uneasy, because the question is whether or not you will take a series of results that to some extent are unpalatable, or difficult to understand, or which go against the political grain, and just migrate a little bit the way in which an expert witness may do under oath, in order to make a position that will have some degree of political splash or appeal. Its a constant tension, in my own business, to make sure that when you translate your academic ideas to the public at large, you do so in exactly the way in which you think about them. You may not present all of the detailed research, but you want to try to keep some degree of the appropriate balance.
I think were living in very troublesome times. I think the sense that we have too many nostrums and not enough cures is one that is widely shared. Rather than start from the political side, Im going to try to approach the questions of politics indirectly.
By training and by originand even to some extent by temperamentIm a common lawyer. And what that means, in effect, is not that Im just an ordinary bloke who doesnt care much about anything, but rather that Im somebody who thinks that the way to understand how legal principles evolve is to work up from particular cases which seem to be far removed from the controversy at hand, and then, by a process of analogy and extension, explain how your understanding of these particular problems shape and organize the kind of discourse that youre involved with.
Here, what I propose to do is to give an overview of the way in which I understand the legal system, and then try to indicate the way in which this will apply to one problem which I dont discuss in great lengths (perhaps not at all) in Simple Rules for a Complex World, but which came to the fore during the Buchanan campaign, and which I think we can be confident will come back to the fore in future times. That is the question of free trade and protectionism, which is the kind of issue of absolute, vital importance to the entire nation, and of special importance to a place like California, positioned as it is on the coast, and with ready access not only to Mexico and Canada, but, of course, to the Pacific Rim.
So let us then begin with the abstract and obscure theory, go through a few cases having to do with African tribes and their trading relationships with the English ships, and then try to get to free trade. Its a rather tortuous journey, but I think that the more indirect you make the trip, the more persuasive the intellectual case.
Limited Resources, Unlimited Desires and the Legal System
When trying to organize the legal system, you have the following kind of omnipresent constraint. The constraint is that there are lots of people to go around and lots of goods, but if you want to divide the world in the way in which each individual thought to be just, you would have to allocate to each individual more goods than there are available. Each person in this world has a clear recognition that scarcity is a biding constraint; and I think people do understand that. But somehow, when they start to think about the modes of allocation, it turns out that the sets of wants is always greater than the sets of needs that are going to be able to satisfy them. And the question about a legal rule is, How do you decide which of those sets of desires is going to have to be disappointed in order to make sure that you can get the number of allocations down, so that individuals and goods will somehow come into equilibrium? You cannot assign the same goods to two or more individuals unless you wish to risk some sort of hopeless conflict between them. But by the same token, you dont want to leave things that are of value utterly without owners, so that there is some degree of waste that is associated with the operation of the system. The first task you have, therefore, is running this kind of matching sort of arrangement.
Rule 1: The Right to Self-Ownership as the Foundation of a Just Legal System
When you do that, what are the kinds of resources that you can start with? One of the resources that you can start to deal with is human beings (and human labor), which is, of course, of immense importance in any system, from the most primitive to the most modern. Most of us dont even think about the question of how we allocate the rights to human labor and human titlements and so forth, because were so committed to what lawyers and philosophers have called the Autonomy Principal, that we scarcely reflect about why it is such a powerful principle of social organization. But essentially the first principal of any just society, it seems to me, is one which talks about individual self-ownership: the ability of each person to determine exactly what would be done with his or her body, how it is those labors and talents will start to be deployed.
There are going to be various kinds of questions about the limits in the way in which the talents will be used. But at least the first question is not, What are the limits of the use? The first question turns out to be, Who are those individuals who are entitled to be the users, and who are those individuals who are going to be the bystanders? Here, in effect, the matching principle gets rid of the scarcity problem in a very neat way. It says that for each body, there is one owner: the person who happens to reside in it. There is no way in which you have to go through elaborate principles of acquisition and negotiation in order to decide whether or not you own your own body. It just simply turns out to be the starting point from which all other deliberations take place.
Problems with Alternatives to Self-Ownership
Now the question is, Why is it that you believe in such an odd principle, if in fact you do believe in it? Most of you would say, I really havent given it much thoughtwhich is another way of saying, It is so obvious, why do I have to listen to anybody explain to me its various virtues? But its an instructive inquiry, because the question that you really want to ask in a more systematic form is, If in fact youre going to reject this principle, what are you going to put in its place?
Here it turns out that there are several alternatives, none of which, I think, turn out to be terribly palatable. But at least one of which turns out to be enormously fashionable. One of the other rules that we could have says, Look, instead of having a theory of individual of self-ownership, were going to tolerate some degree of slavery, in which some people would not only own themselves but will own other individuals, and other people would just be out of luck and will not own themselves, and of course will not own anybody else. (We could also, I assume, imagine more complicated patterns of allocation, in which in turns out that somebody is the slave of A, and it turns out to be the owner of B, and figure out exactly what it means to control an individual, when you have no rights to control yourself. But well pass by these kinds of complicated transactions for the moment.)
The issues that arise with slavery are very profound. The simplest way in which to put it is, Just who is going to be in the preferred position, and why? Once you reject conquest as a source of entitlement with respect to other individuals, you have to think of life as being some kind of a complicated lottery in which if every person is either a slave or a slave owner, you get a fifty percent chance of assuming either position by some sort of glorious roll of the dice. If you were to do that and just ask yourself whether you would enter into that lottery as opposed to a system of self-ownership, I think I know that the answer to that question is going to be perfectly clear: Generally, youll take one hundred percent of a sure thing rather than fifty percent of a rather risky thing, because as we like to say in the gambling business, the down side of this bet is really very bad indeed.
Now why is this important if its obvious? Because it starts to tell you the following thing about the way in which people think about legal rules. They basically have the intuition that theyre all deontological in their origins. That is, there is some kind of Imminent Principle of Justice, which if you dont bother to reflect about it, somehow youre going to able to apply it correctly. Most people when theyre intuitive tend to be kind of natural lawyers in the Jeffersonian tradition. Thats the right place to end up politically, but analytically, it strikes me as being the wrong place.
Virtually every time we appeal to antecedents, we do so by a justification that starts to look to consequences. To some extent, the way in which you think about the shape and the organization of all legal institutions is the way in which, when the rules are generally applied, they will work for the set of individuals who are subject to their government. And we ought not to shrink from the idea that somehow this form of utilitarian calculus, this form of economic logic, if you will, is going to be part of our discourse, because it seems to me that for the simplest questions, it is exactly this kind of logic which explains and fortifies our strongest moral intuitions.
Now there is another way of thinking about the question of individual ownership which is much more fashionable and dates from what in the philosophical language is called the Rawlsian tradition. This says that no individual has the right of ownership over his or her natural talents, because its a natural lottery as to who got what set of skills. Everybody therefore has a part claim on the intelligence of other individuals. And instead of having a regime of individual self-ownership in the good old Lockean tradition, you have a regime of shared ownership in this more modern tradition. This leaves you with, at the very least, a system of very strong, redistributive taxes.
So the Autonomy Principal isnt so self-evident to a large number of individuals after all. I think in answer to that, the question you would have to ask is, Exactly how is it that youre going to work this elaborate system of joint and mutual ownership? One of things that you typically discover is, If I dont own myself, what is it that gives me the right to vote with respect to what I want, when I may not be the person who is entitled to decide what happens to me? Or, What gives me the right to enter into contracts to sell and to dispose of my labor, or to buy particular goods, or to occupy a vacant piece of land, or do anything? Will a committee of the whole prescribe the action of each individual, so that well have a set of revolving and interlocking directorates so sufficiently complicated that all of us will wish for the simpler world of individual self-determination?
Again, it seems to me it that the way in which one starts to deal with the question of joint and common ownership, is to project out its consequences, in the event of its full implementation. We then discover that in the end, if we require the consent of all before anybody can do anything, we would all starve before anyone would be able to eat. And we discover that is it is better to have a little bit of individual egoism in the system, rather than to try and rest on the assumption that to the extent that we have unanimous consent, were always going to be working for a set of rules allegedly better than those which allow a little bit of unilateral action. Its from this understanding, I think, that the proper empirical bases start to take place with respect to claims for individual liberty.
Rule 2: The Right to Acquire Unowned Resources
It turns out also that this is the root of understanding with respect to property. One of the most reviled rules of property acquisition of the common law was a rule which said that the way you take possession of things in a state of nature is to grab them. The initial position says that everything out there in the world at large is generally unowned, and the first occupant can then exclude the rest of the world. While this will have certain major difficulties with respect to water and air (for which the rule for common law very cleverly adjusted), with respect to land and chattels, it is still the most efficient rule whatsoever that you can imagine (not withstanding all the fantastic transformations that have take place in the way in which husbandry development has proceeded over the generations).
The explanation for it, I think, is perfectly clear. If you dont have that rule, youre going to have some other rule. And to the extent that you have a rule that requires you to deal with the question of multiple consent, it means that before anybody can eat, we have to have an elaborate system of governance in place, and were going to have to decide who is going to be a part of the polity and who will be excluded, what are going to be the principles of representation, and how are things going to proceed. It is too complicated to make the system go.
Rule 3: The Right to Engage in Voluntary Exchange
A rule which in effect allows things to be owned and to be taken from a state of nature and put under private ownership creates all sorts of incentives with respect to their development, and when you take into account voluntary exchange, the third of the simple rules that I talk about in my book, it also gives a way for those who are non-takers in the original auction to become winners in the second round, through the prospect of voluntary exchange. You then have very egoistical rules or so apparently egoistical rules with respect to the ownership of labor and the ownership of external things. Now it turns out that in a world without trade, the only value you can get through these things is through their actual use. But to the extent that there is an efficiency through the division of labor and through voluntary exchange, you must have a system of voluntary contract, which will allow these things to be moved from their original taker to somebody else.
Now it may well be a terrible thing for someone to sell himself into slavery, but each of us does it on the installment plan every time we take a job and decide that were going to subject ourselves to instructions or the wisdom of an employer, or of an independent contractor of somebody else. Unlike the logic of slavery, however, with logic of exchange in each case the reason why we like exchange is not because we have some abstract moral predilection in favor of keeping as opposed to breaking promises, but because we know enough about scarcity and individual self-interest, that were quite confident that the only time youll enter into an exchange, is when you expect to get more from it at the back end, than you have to surrender today. The fundamental agency of social exchange is mutual gain from trades. And it turns out that one of the reasons you have to be so insistent upon the rules regarding individual ownership of self and the individual ownership of things that are external to the self, is that unless you have those two rules in place, subsequent voluntary exchange will be impossible to realize. And if you cannot realize these exchanges, it means that you freeze yourself into whatever inefficient allocation of resources is decreed by some kind of an alternative rule. So again, the way in which we start to correct the mistake or injustice that exists by systems of arbitrary allocation, is through voluntary exchange. Between the two parties, these things tend to have positive payoffs.
They also have positive payoffs with respect to what are sometimes called externalities. This is a very long and very popular word among the economists and lawyers in the trade, and is one which has a tin sound to individuals who think about legal issues, but have not been schooled in either of these two disciplines. Anytime A engages in a certain activity, its going to have consequences which will effect other people who did not participate in the action in which hes undertaking. This in essence is what an externality is. But externalities are usually thought of as strictly negative. For example, I will engage in acts that pollute the environment; I will take the profit, other people will bear the loss. Therefore, externalities are regarded as negatives, and since theyre negatives, they have to be restrained rather than encouraged.
Fortunately, the world doesnt always work that way. When youre dealing with exchange, for the most part the externalities are positive. That is, other people will be better off by virtue of the fact that A and B are entitled to enter into a voluntary exchange with each other. And you ask yourself, Now, why or how can that be the case? Its relatively simple if you think about it. Since the two gained by a voluntary exchange, each of them has more wealth and more satisfaction than before, at least on average (and when you have lots of transactions, its the averages that matter, not the outlyers). To the extent that we have more, we could take the things we acquire in one set of exchanges and re-exchange them for something else we want. This process can keep on going, so long as the legal system facilitates and doesnt frustrate exchanges. Whenever judges start to explain why a contract ought not be enforced, they have to always ask themselves whether theyre part of the solution or part of the problem, whether or not the negative nature of the externalities is strong enough to override the voluntary arrangements, or whether they just fundamentally misunderstood the transaction and are interfering with situations that should be allowed to go forward (which is the typical norm with respect to the usual voluntary sale of goods, the lending of goods and money, and things of this sort).
Now if you have these three rules, one of the questions you have to figure out is, What is the down side of them? Nobody talking in a serious fashion about the creation of legal rules under the condition of scarcity can announce to you that it is pure benefit and no cost. Theres always a cost when you exclude people from property, or in effect, when you allow one person to enter into a voluntary trade. Somebody else might have wished to enter into a trade with a person who has traded with a third, and so on down the line.
You must have enough confidence that in the long run the net benefits are going to be large enough and will be widely distributed, so that youre willing to impose these correlative duties. The law of tort, the law of wrongs, explains exactly what those correlative duties are. The first of them is that if we really believe in the sanctity of the person, we have powerful protections against assault and battery that one person may impose on another. And if we really believe in the importance of property, we have powerful constraints against taking goods, destroying goods, converting property of one sort or another.
These are not the sort of issues that are going to appear in the courts very often. Not because they are not very important, but because theyre so important that the legal principles ought not to be subject to serious doubt except in the most extreme cases. One thing that I would urge you when thinking about the law is to never worry too much about what the appellate cases do. First, understand the way the system operates in the simplest of cases; then, if you understand why those cases are rightly or wrongly decided, you can deal with the luxury of handling the most hard and difficult cases.
Even into this very day (notwithstanding all the things that the government does and does badly), the protection of individual liberty and the protection of property are still first and second on the list. Third on the list turns out to be in many cases the protection of the exchange relationship. That is, this whole contract stuff. Protection comes in two forms. One is the enforcement of the agreement between the parties. Otherwise, I would never enter into a contract where I have to perform first, if I know that when the time for return performance comes, the other fellow will be nowhere to be found. Im in the business of making exchanges, not in the business of making gifts. But the protection of the exchange relationship also involves the protection against third parties. So if somebody tries to disrupt a prospective contract between me and somebody else, thats got to be treated as a tort on par with killing somebody or injuring somebody.
Free Trade, Protectionism and the Legal System
Now, what about the case of foreign trade? Well, it turns out that it is possible to enter into exchanges with individuals or groups from totally alien cultures even under circumstances where there is no mechanism of contractual enforcement between the parties. That is, one can easily postulate a set of circumstances in which the gains for maintaining a relationship were so large for both sides, that if you were just simply to just go to the beach and drop down a bunch of goods, they would pick those goods up and leave a set of skins or trinkets in exchange, because they want to make sure you come back tomorrow, and the particular goods on the beach, if stolen, are worth less to them than the continuation of the relationship, and therefore you can have what is known in the trade as a system of self-enforcing contracts. But no system of self-enforcing contracts will work if, at the time youre about to enter the beach, somebody takes out a well-positioned Howitzer, and starts firing bullets to make sure that you and your trading partners will flee.
The common law dating back to the fourteenth century in the case of the Schoolmen, and in the eighteenth century in the case of the African trade, said that the disappointed tradereven if he was not injured or scratched by any of the bullets that were firedcan nonetheless maintain an action for the loss of expectation, even if he kept the property. The property may be worth a thousand to him if he kept it, two thousand if he sold it or exchanged it. You can get that thousand dollars of profit, even if you kept your goodsso important was the exchange relationship.
Now from here to international free trade is a very short step. The genius of the common lawyer, I like to think, is our ability to make preposterous analogies sound perfectly sensible. What do I mean by that? Well, suppose it turns out that instead of worrying about African trade, we assume that Im an American manufacturer who wants to enter into a contract with a Japanese firm with whom were willing to create legal relationships. I will ship certain goods to that firm, and that firm will ship either cash or goods back to me.
The question is, Do we protect this contract under the simple rules against interference by third parties? For example, a rival firm may want to disrupt that arrangement so that all the trade will be kept domestic either in Japan or in the United States. What about the American governments anti-dumping rules, tariff rules, quantitative restrictions rules, and so forth? (I dont care about the choice or technique, here, I just care about the fact of intervention.) In each and everyone of these cases, we side with the guy who is shooting the Howitzers over the barrel at the other boat; we dont side with the guy who wants to enter into the voluntary exchange. That is, the only reason we dont have violence today is that the threat of public force, which can disrupt the exchange relationship, is so powerful that nobody chooses to resist.
The way in which you can understand the case for free trade is simply to analogize the government, when it disrupts a voluntary exchange between the citizen on the one had, and a foreigner on the other hand, as being no different from the other fellow in that little longboat, who decided to disrupt the trade between the English ship on the one hand, and the African tribes on the other. The question of why and how we would want to justify that relationship then becomes the key question. One thing you want to immediately dismiss is the idea that somehow we do this because were protecting individuals from various kinds of harm.
This is not a situation where the first guy was trying to muscle out the second guy. In fact, one of things about every trade relationship is that it is deservedly fragile in the sense that to the extent that you could no longer supply goods at a lower price or higher quantity than your competitor, you will lose out to them. The legal system protects the exchange relationship; it doesnt guarantee you a trading partner. It doesnt put anybody in the position where theyre compelled to deal with you against their will. So you could be perfectly secure in the way in which you conduct your affairs, or they conduct theirs. The equality of persons which we talk about with respect to autonomy in the original position has to carry over with respect to voluntary exchange. Unless two want to tango, their ought to be no dance. And to the extent that I can offer you a position on my dance card and you reject it, I ought to be required to bear the insult, the hurt and the shame as best as I possibly can.
Now the question then becomes, Can we think of any other sort of justification to allow these sort of interferences to take place? I can think of none. It is often said that this will protect American business against competition from aboard. And the protection language and the security language which is used is often extremely attractive, because it is designed to evoke the kinds of images we had of the basic common law rules that protect the integrity of the person, protect private property, and protect the exchange relationship.
But there is a fundamental difference in the way in which these two kinds of systems operate. In one case what happens is that the protection given will raise the level of utility, of happiness, of satisfaction of all participants to the system. But the moment you start dealing protected tariffs, there is nothing that you can do to universalize the rules in question. Its the guys who make widgets who are going to be protected, but the fellows who make gidgets are the fellows who are going to have to pay the price. This is not a system in which you have a rising tide that raises all boats. This is a system in which youre engaged in preferences.
How does it then work? Well, here it turns out that there is a real and genuine paradox. The major function of legal rules, as far as I can see, is to protect the security of the person, the security of property, the security of exchange. What typically happens under these circumstances is that the moment you have selected protection, you have done that for one individual. But what have you done for the others? Youve increased the risk with which they have to do business. Because its as though you had a firm which had common stock which said to one individual: I want you to know that were giving out some debt paper to somebody else against our assets. You will still have your common stock, so why do you get upset about the fact that weve given somebody a preferred position? The answer is that your position is much riskier, because it turns out that not only do you have to bear all the ordinary vicissitudes of the business, but you stand second in line for the profits.
So, typically, the moment you start to engage in various forms of protectionism, you impose a very heavy set of risks on the firms that are going bear these particular burdens. At the same time you are trying to give some palliative to those firms who get the protection. And you have no idea whether the right balance is going to take place between benefits and burdens, because theres never a voluntary exchange between the party that gets the benefited protection and the party that has to bear the losses. This is therefore very different from a standard insurance contract, where Im willing to assume risk from you precisely because you pay me a premium. Here in effect you switch the risk, but the premium is never going to be paid. It also turns out that when you try to engage in activities like this, its a hopeless endeavor (and this again is not news to anyone who has followed the literature on international trade, because it goes back to David Ricardo).
Protectionism as Self-Destructive
But let me tell you what the phenomenon is, and why its so utterly self-destructive to think that protectionism will give you some degree of comfort as a nation. Let us suppose that you decide to protect your goods. And you think the only thing youre going to regulate is the exchange relationship in the commodities that come into your country. Well, it turns out that legal and economic systems are not closed, no matter what it is the lawyer thinks is at stake. Everything to some extent is connected to everything else.
The moment you start putting restrictions on what could be imported and exported into a country, you would have predictable and adverse effects on the rate of exchange with respect to the currencies. For example, if you could now import fewer goods from Japan, because we have some kind of protective quota, it turns out that the demand for the Japanese currency is going to decline because youre going to be buying fewer Japanese goods. So instead of having to have an exchange rate of a hundred yen per dollar, it may be a hundred and ten. The moment that the exchange rates changes, of course, your ability to export is going to be hurt, because youre going into an adverse market when you try to sell. The change in exchange rates will result in a price disadvantage in the export markets, which will offset whatever gains you hope to get by way of protection. So when you put the whole piece together, you lose both ways: you lose coming on imports, and going with respect to exports. And its the kind of policy which creates social futility, and does so with enormous cost. If there is any lawyer in this room who has worked in anti-dumping proceedings, you will understand why theyre called Full Employment Acts for lawyers. In the effort to reconstruct the cost structure in another country in order to make out claims of unfair competition, it turns out you lose them all.
Beware of Unfair Competition
Let me end on this note, which takes off from the unfair-competition point. Generally speaking, fairness is an extremely powerful tool for understanding the basic relationships weve talked about on labor, on autonomy, and so forth. But like every good term, it can be pressed into bad service. The moment you start to hear somebody talking about unfair competition, you have to immediately perk-up your ears and ask what form of unfairness is at stake. If youre dealing with the kind of unfairness that results from deception or coercion, you ought to be very sympathetic to the claim. But if it turns out that unfairness simply means that weve won a race and you happen to lose, the claim should be greeted with profound suspicion. So much of the talk about unfair competition in the international arena is simply due to he fact that domestic competition cannot meet up with low cost foreign supplies. Thats not a good argument within the domestic context, and it ought not in the legal sense be a good argument in the foreign context.
Once you understand the way in which the rules of property tie in with the rules of legal exchange, it doesnt only tell you about simple two-party transactions or little common-law disputes; it gives you an enormous window to understand larger and more complicated social arrangements (and when you understand them, the things that David Theroux talked about start to resonate with greater power). Even if you dont understand the full details of the system, once you start stressing individual liberty, strong property rights, and voluntary exchange, youre not going to go too far wrong most of the time.
There are some qualifications, but theyre going to have wait for another day. For the most part, however, remember that if you understand 90 percent of the truth, youre going to do a lot better in figuring out how the qualifications work, than if you figure out the 10 percent of the exceptions and assume that the world is completely filled with very difficult and controversial cases. Im not going to say that weve given perfection here, but I hope that at least weve given a long step down the road. Thank so much for your patience.
Thank you Richard for a most insightful talk. We would like to open up the discussion to our audience now for your questions.
Cant a country use the threat of imposing tariffs pragmatically, to negotiate lower tariffs in countries it exports to?
Let me state the more general proposition, so that I dont have to wed myself to a particular history which I may not understand. The question is whether or not you think the justification for tariffs in a particular case is to offset tariffs that have been running in the opposite direction. That is, youre going to use them as a strategic weapon. A couple of points about this. One, as a theoretical matter this at least might have the justification that the long-term intentions are to create open markets in both directions. So at least what it does is to admit the provision of international trade, comparative advantage, voluntary exchange, and the whole thing. To that extent, I think, it is reasonably well intentioned.
But over the years, Ive become persuaded that its utterly perverse in terms of the way in which it operates in practice. First of all, it turns out that it is an enormous battle to decide whether or not the other fellow has a tariff or a restriction thats in place, and if so whether its unfair. To give you but one illustration: Is an inspection law at the broader to be treated as though its a disguised tariff on the one hand, or a safety statute on the other? In order to answer that question, you have decide whether or not it discriminates between local and foreign producers. But in order to determine whether or not there is discrimination, you have to decide whether or not other forms of inspection at the plant are equal in the two countries. So by the time you go through all of this, you never know whether youre retaliating on the one hand, or initiating on the other.
Of course when it comes to the second round, they will say, Our rules were legitimate inspection rules, yours is a wretched tariff; therefore, were retaliating against you, youre not retaliating against us. And everybody has a different characterization of the events, so it becomes much harder to unravel the series of disputes.
The second point that makes tariffs crazy is that even if there was some sort of an offense against you, you would want the remedy proportionate to the offense in question. And, of course, you could never do that. Even if you decided that there was an infraction, you have to decide what the seriousness of the offense is before you could figure out what the sanctions are going to be. Suppose it turns out, to take a typical illustration, that we have Japanese tariffs on American automobiles being sent over there, but that were such great marketing wizards, we only send automobiles with left-side drive, when in fact they drive on the right side of the road! Well, the question is, Why didnt they buy our cars? You now have to estimate which percentage of lost sales is attributable to the fact that were marketing morons, and which percentage is attributable to the fact that they are basically devils with respect to the import business. Once you start having arguments over that, youre back to the same soup again.
Secondly, whom are you going to retaliate against? Its not as though you can retaliate against countries. Remember, there are individual firms and individual individuals within both of these countries. What typically happens is that the retaliation is not against the industry that did the wrong, but against some other industry which is relatively innocent of all the machination.
Therefore, what happens is that you now bring into the play a political battle in which youve got two sets of bad guys on the other side. The one who is a scoundrel to begin with, and the other fellow whos been gored by your rather ill-aimed arrow. Once you realize that, you understand that once you go down this particular road and put it into the hands of my learned profession and the economic witnesses that we could hire, you could make anything done by any government into an occasion for a war cause celebre. So the appropriate response given the fact that we could never make good on this ostensible program of Were going to retaliate in order to eliminate is unilateral disarmament. Or as Milton Friedman said when this issue came up years ago when I heard him speak about ithe gave a much shorter answer, which is why hes such a better speakerhe said, Look, theres a hole in the bottom of the boat. The cure is not to blow another one in, the ship will just sink faster. That was Miltons answer, and I guess it makes more sense than mine. So while my book may be simple, the mind that created it is convoluted.
If there are advantages to free trade, then how do we get from here to there? The second question is, If we dont have free trade in the United States, is there another place thats likely get it? The third question is, If we dont get to Utopia, how is a typical person best off?
One of the problems is that if you dont have free trade, youll be out of the loop. You import in order to export, right? Yet they impose various tariffs on the imports that youre then going to ship off into an export market. And by crippling your imports, youre crippling your exports! The way in which the learned folks say it is, What well do is well give you a refund at the exit door for the stuff that came through the entry door. But then of course it turns out that youve mixed your inventory and you dont know if its the same piece that needs to go out, or a piece of the same type that has to go out. So now you have to keep segregated supply lines in order to meet the quotas.
So the answer is: if you screw up your export markets because you have screwed up your import markets, people will find a way to just avoid you entirely. Instead of going through Japan, to the United States, to Singapore, theyll go by way of Taiwan or Australia. So we could be out of the cycle very quickly; and thats something which we dont want to do. And some of the real costs to protection are the transactions that we dont get because they simply migrate to somewhere else.
The second question is, What can ordinary citizens do? I think what they have to do is to give the raspberry every time they start to hear the protectionist line coming forward with respect to the particular benefits that are promised to a particular community. My rule about this is: unless youre prepared to state a proposition on free trade or its restrictions to the entire universe of people in the United States, you should never be allowed to play to that select audience which thinks its got a short-term benefit. This is a classic problem in which the concentration of benefits from a trade restriction may be palpable, but that the diffuse set of benefits may be difficult to manage. The reason why youre so worried about the economic theory here is that it allows you to have strong instincts about the size of diffuse benefits which will lead you to the conclusion that they are larger than the concentrated benefits that you get from protection. That is, the diffuse benefits of free trade swamp the rest of the system. So I think what people need to do is to change their mind sets about this. Its very hard to do. What ought judges do? They ought to become hard hearted. They have to understand that when victims come before them pleading for restraint, what they have to do is be a very disciplined parent and say, No, I have other children whom I have to look afterwards as well.
It cannot be that when you decide individual cases, you simply look at the gains and the loses of the individual litigants in complete ignorance of the circumstances and the broader consequences of the decision at hand. And it seems to me that the single hardest thing about judging is (although Ive never been a judge; and with my views, I dare say, I never will be a judge) is the ability to make the transformation. The ability to understand that when youre looking at an ex post dispute, you have to figure out what the ex ante effects are. That is, when you look at a dispute after the race has been run, you have to figure out how its going to influence the next race thats going to take place. And the only thing that we can do as academics is to constantly remind people that the set of relevant consequences are often broader than those that either of the two litigants that come before the court are going to be prepared to present.
So, I think that there are things that you can do. Im in the talking business; as somebody said, Im a member of the chattering classes. And its just a hope that if you get these ideas out, it will essentially favor those who believe that the way in which you do success by the world is to do success by yourself in selling goods, rather than in shutting them down foreign trade. And if you have that open and more expansionist attitude, I think in the long term it can make a very different and powerful impact upon the way a system works. But it is absolutely crazy to think that a coherent set of legal rules in the judiciary, or in the legislature, will be able to sustain itself in the face or in the teeth of a popular culture that repudiates the positions that youre talking about. It was said a long time ago that every judge is influenced by the election returns. We know thats true about legislatures, but its even true of judges and academics. So thats why operations like this become so important; because the way in which you influence public opinion, through speech and discourse and argumentation, will in the long run shape in indefinable ways the paths that one sees taking place in legislative forums.
Would you make exceptions to free trade, for example, to prevent sick livestock from entering the country?
Remember what I said about the quarantine laws? What I said in effect is that they are terrible when theyre abused. That is, when it turns out you claim hoof and mouth disease for animals that are as pure as your own. The right answer to that is to never pooh-pooh the consideration and to regard it as irrelevant. This is a real externality. This is a tort, as we say. And to the extent that in a domestic market you can kill animals that are likely to spread those diseases to others or to order them quarantined, exactly that policy ought to take place with respect to the international markets.
So if youre worried about the price of good beef undercutting yours, you dont have my sympathy. But if youre worried about the contamination of your cropsor even the destruction of a market which says, We wont buy any beef, because some of it has been contaminatedthen Im very much with you. What that requires (and its something which Im sorry to say I think this country has lost sight of) is, even in a relatively small trade environment, a non-political, technically astute professional service, in order to man the inspection operations. If you dont have that, then youre going to be lost, because the moment the service itself becomes unqualified, incompetent or not focused on its mission, youre going to have both sorts of complaints simultaneously. One, that it is letting in a bunch of cattle that ought to be kept out; and two, that its keeping out a bunch of cattle that it ought to let in.
And in my professional life, which I guess now runs about twenty eight years, I think the single largest feature of public life that bothers me most, is that I no longer have any confidence in the independence and the integrity of too many administrative agencies that are charged with these tasks. It used to be that technical expertise drove politics. Now I think its much more likely that politics drives technical expertise. With respect to the question that youre talking about (youre talking about real torts), you dont have to be delicate in the way in which you express the problem. But we have to figure out a way to provide the injunctive relief which is neither too narrow on one hand, nor too broad on the other. That requires an Immigration and Naturalization Service and a Customs Service that are rather better than the one we now have.
Would you extend your argument for free trade to immigration?
This becomes an infinitely more complicated problem. Let me explain why. In the simplest way in which you put it, when you import goods into your country from another country, they dont vote. When you import immigrants into your country from another country they do vote, they do receive welfare benefits, and so forth.
How do I therefore think about this? This is an issue on which, if youre not conflicted, my view is you do not understand the nature of the problem. The first thing I would want to mention is that Im not an immigrant myself, but I am a second generation American. As I always like to point out and mention in the Simple Rules book, I would have been born in Warsaw two days before the Warsaw ghetto went up in flames and I dont think I would have had much of a chance as a two-day old against that kind of a holocaust. So when you start talking about immigration, I basically owe the survival of my family to the policies of immigration which allowed them to come here around the turn of the century. This is not a small consideration.
What is clear to me is that the rise of the welfare state and the decline or the closing of the immigration borders are not unrelated. That is, if you believe as I do in the good libertarian society, which tends to have relatively little state re-distribution, then every time you admit a citizen to this country youre telling them that theyre going to have to contribute their fair share to the common expenses and that they will be better off in virtue of their own labor. And we will be better off in virtue of their labor, because they will basically expand the free trade zone inside the United States. So that immigration in a world where you have sound political Jeffersonian institutions seems to me something we ought to welcome and we ought to place no barriers against it. And indeed in the period between, say, 1850 and 1920, when we were pretty much a small government operation and we had free immigration, exactly that model seemed to work.
But the moment you introduce a system where in effect the nature of the goods that are going to be distributed by government will switch depending on who the electorate isthat is, whos going to get the windfall and whos going to bear the burden in the world of redistributivist politicsthen everybody starts to say, The folks whom you admit are not only going to be workers, but are going to be voters. And by voting they can take from you everything that you have. So that if you find yourself in a position where you think that you can no longer maintain as a political minority the prerogatives that you have as a political majority, youre going to be necessarily opposed to it.
This is to me one of the terrible costs of the modern welfare state. What it does in effect, by guaranteeing a certain kind of political redistribution within the polity, is to make it impossible for independent advancement by hard labor for individuals who are outside the country. Not 100 percent obviously, because we have some quotas. So, given the current requirement, the hard question is whether you think the productive impulse or the redistributivist impulse in both wealth and political power tends to dominate in a world in which you have smaller government and less redistribution, in which you would be, I think, very much more in favor of open immigration policy. How open? It goes back to the things that she mentioned, and the whole question about quarantine.
Anyone of you, if youve never done it, you should go to Ellis Island sometime and you will understand that the quarantine issue was as important with respect to people as it was with respect to animals. They inspected your eyes, they gave you various kinds of tests, and they wouldnt let you in if you carried a contagious disease. But they didnt slaughter you. In fact, on Ellis Island they maintained long-term detention centers, which gave you a month, two months, three months, six months in some cases, so you would be rid of your disease and then be able to enter the country. The odd thing is that for whatever reason, in a world without any judicial review, without any Fourteenth Amendment protections, or whatever it was, you had more confidence in the accuracy of those administrations determinations than you would have with respect of administration determinations today. And there it seems to me is something of a tragedy.
Your idea of mutual voluntary exchange seems to be founded on the concept of subjective value theory. Do you think that subjective value theory trivializes this whole argument people have about trade imbalances?
Well, thats a different sort of argument. Subjective value, it seems to me, in individual cases basically says, So long as you have consent and so long as you can negate external coercion, you dont have to worry about the value of the trade to the individual parties; they will protect themselves to extent that they see fit. When you start to worry about aggregate phenomena like trade imbalances and so forth, youre not necessarily trying to focus on individual exchanges and you have to ask the question as to whether or not there is some kind of a regulatory restraint on the way in which capital flows back and forth across borders that should lead to trouble.
If it turns out that you have basically an unregulated market, to the extent that you had a trade imbalance, you can simply describe that as the fact that those individuals who have the least favorable balance of trade have simply received an investment in capital from overseas, and that ought to be nothing to worry about whatsoever. Because you can certainly have firms that borrow and firms that lend, and both of them can be solvent. So in a world without the huge machinations that we now have at the border, I think the answer is: Dont worry about that stuff, because it will all come out in the correct sorts of processes. But in the current situation, once you have all sorts of currency restraints and other restrictions, when you start to look at a trade imbalance, it may signal that there is something wrong with the regulatory system, even though there is nothing wrong with the logic of contracts. Remember the difficulties: when you get a bad set of regulations, its going to induce a crummy set of contracts. Its not that you want to punish the contracts; you want to change the regulation that induces their rather distorted nature.
Thank you again, Richard. And thanks to all of you to have taken the time to join with us in making our program a great success. Richard has kindly offered to autograph copies of his books, which are available for purchase in the front. I want to thank each of you for joining with us today, and we look forward to seeing you again soon at another Independent Institute program.