Arguments for
government and against private alternatives, both in general and in specific
areas, are frequently based on the existence of market failure. In the first
part of this essay I briefly sketch the idea of market failure and show that it
provides problems for, hence arguments against, both private markets and the
political alternatives. In the second part I discuss some of the imperfect ways
in which private markets deal with such problems in the small, providing public
goods or internalizing externalities within a framework of enforced property
rights. The third part describes how that framework itself might be privately
provided, examines difficulties that might arise due to forms of market failure
within a system of private law and law enforcement, and considers how those
problems might be dealt with. In the conclusion I argue that a society without
a government, market in the large, could be stable under some but not all
circumstances, and if stable could be expected to produce more attractive
outcomes than a society with a government for reasons closely related to the
reasons to expect the market in the small to work better than its political
alternatives.
It is sometime in the
12th century, somewhere in Europe, and I am one of a line of men
with spears, on foot, facing another bunch of men--on horseback with
spears‹moving rapidly in our direction.
I make a rapid cost benefit calculation. If we all stand, we might break their charge. If we run, we
die. I should stand.
The mistake I have
just made is the word ³we². I
only control me, and I am only one spearman out of several
thousand. If everybody else stands and I run, my running has little effect on
whether their charge is stopped--and I won¹t be one of the men who dies
stopping it. If everybody else runs and I stand, I die. So whether the rest of
the line is going to run or stand, I should run. Everybody else in the line makes the same calculation. We all run and most of us die.
Welcome to the dark
side of rationality.
This is an example of
market failure‹a situation where each individual correctly chooses the action
that best accomplishes his objectives, yet the result is worse, in terms of
those same objectives, than if everyone had done something else. More familiar examples include the
Prisoner¹s Dilemma, a situation where each of two criminals is better off
confessing even though both would be better off if neither confessed, and air
pollution in circumstances where it is in each person¹s interest to pollute but
we would all be better off if none of us did so.
Central to these
examples is the fact that my decision provides costs or benefits for other
people. In deciding what to do, I take account of the effect on me.[1]
I correctly conclude that I am better off running than standing, ignoring the
cost my running imposes on my comrades. They correctly conclude that they are
better off running, ignoring the cost imposed on me. I gain by my decision but
lose more by theirs, and similarly, mutatis mutandis, for them. We each decide correctly and are
all worse off as a result.
This is clearly a
failure of some sort‹but the examples I have given have nothing to do with
markets, so why is it called ³market failure?² A likely answer is that the
concept was developed in the context of neo-classical economics. Economists
generally assume that individuals are rational, that they take the actions
which best serve their objectives.[2]
That suggests that if we simply let each person do what he wants, the outcome
should be attractive for everyone, a suggestion that can be converted into a
formal proof, an efficiency theorem showing that, under some set of simplifying
assumptions, the outcome of individual choice in a market system cannot be
improved even by a wise and benevolent central planner.[3]
In economic theory,
market failure provides the exception to that conclusion‹an exception that may
arguably swallow the rule. Where one person¹s acts impose costs or benefits on
others that he has no reason to take account of, individual rationality cannot
be expected to lead to group rationality, so there are opportunities for a wise
and benevolent central planner‹perhaps also for a real world government‹to
intervene in ways that make everyone better off. So economists are used to
viewing the various forms of market failure they have analyzed‹the public good
problem, externalities, adverse selection‹as reasons why free markets,
laissez-faire, sometimes fails, hence arguments for government intervention.
They are half right.
Market failure is a reason why free markets sometimes fail. But it is also a
reason why the alternatives to free markets, the political mechanisms proposed
for correcting those failures, fail. In order for government intervention to
improve on the market outcome, it is not enough that there is something
government could do that would give a better outcome. There must also be a
reason to expect government to do it. Putting the point in the language of
economics, the incentives of the relevant political actors have to be such that
it is in their interest to act in ways that result in the improved outcome.
To see why this is
unlikely, consider the simplest argument for why democracy works‹what I like to
think of as the civics class model. In that model, politicians act in the
voters¹ interest because if they do not the voters will vote them out at the
next election.
The problem lies in
the incentives not of the politicians but of the voters. In order to punish politicians for
doing bad things, voters have to know that they are doing them. Politicians
rarely run as bad guys or introduce bills to Congress entitled ³A Program to
Make Farmers Richer and City Folk Poorer.² In order to figure out both what a
politician is doing and whether he should be doing it, the voter must spend
substantial amounts of time and effort studying the issues and the politician¹s
voting behavior. In doing so, he is producing a public good‹better laws‹for a
very large public; he himself collects only a tiny fraction of any benefit.
Seen from the other side, he is bearing a large cost for a trivial gain‹an
increase of perhaps one chance in a million in the probability that the right
politician will get elected. Spearmen facing that logic run, firms pollute, and
voters remain ignorant‹rationally ignorant. So far as achieving their
objectives is concerned, since they know their vote has almost no effect on the
outcome, it makes more sense to choose how they vote on other grounds‹which
candidate is more handsome, more articulate, more popular with their friends
and neighbors. That fits my observations of how voters behave. When I ask my
students if they know the name of their congressmen, about half of them say
they do. It is hard to keep track of what a politician is doing if you don¹t
know his name.
As a second example,
consider a less idealistic theory for why democratic government might work. A
congressman proposes a bill that will benefit some interest groups and harm
others. People on both sides of the issue offer campaign contributions, illegal
bribes, endorsements, and other goods and services of value to politicians in
exchange for voting their way. The amount they are willing to spend getting
their way depends on how important it is to them. If the gainers gain more than
the losers lose, the gainers are willing to spend more, lobby harder, with the
result that the bill passes‹and should.
This argument too runs
into the public good problem. How much an interest group is willing to spend to
get its way depends on how important the issue is to that group, but that is
not all it depends on. From the standpoint of the members of an interest group,
contributing to the group¹s political efforts is the production of a public
good‹where the public is not the whole population but the members of the
interest group. If the auto industry gets a tariff passed all the firms will
benefit, not just the ones that contributed to the campaign funds of the
politicians who passed it. If opponents block the tariff, all consumers of
autos will benefit, not just the ones who contributed to the campaign against
the tariff.
One of the things
public good theory tells us is that it is harder to produce a public good for a
very large public than for a very small public. A concentrated interest
group‹the auto interest group, say, which consists mostly of a handful of
firms, one large union, and a few Michigan politicians‹can raise a substantial
fraction of the value to its members of legislation they support in order to
support the legislation. But consider a dispersed interest group such as those
injured by auto tariffs, mostly consumers of autos and producers of export
goods. It is a large and very dispersed group‹lots of people, each of whom
loses only a little. Each individual member has little incentive to spend his
time and effort opposing the tariff, when the result will be a tiny reduction
in the probability that the tariff will pass‹a benefit received mostly by the
other members of the group.
Two conclusions
follow, both confirmed by real world experience. The first is that tariffs will
get passed, even though they do net damage‹hurt the losers by more than they
help the winners. The second is that the opposition to tariffs will come not
from those who bear most of the loss but from those who bear a concentrated
loss‹not auto consumers and export producers but foreign car dealers.[4]
Generalizing these
examples to the more general political market, we conclude that there is no
reason to expect individual rationality in that market to lead to group
rationality. In private markets, most of the time, an individual who makes a
decision bears most, although not all, of the resulting costs, and receives
most of the resulting benefits.[5]
In political markets that is rarely true. So we should expect that the market
failure that results from A taking an action most of whose costs or benefits
are born by B, C, and D should be the exception in the private market, the rule
in the political market. It follows that shifting control over human activities
from the private market to the political market is likely to increase the
problems associated with market failure, not decrease them.
A market failure is
also a profit opportunity. If the result of individuals acting rationally in
their own interest is to make them worse off than if they acted in some other
way, it follows that an entrepreneur who could somehow move them to the better
outcome would produce a net benefit‹some of which, with luck, he could pocket.
Hence in a market society there is an incentive for private parties to find
ways around the inefficiencies due to market failure.
Consider one example
of the public good problem‹radio and television broadcasts. By producing and
broadcasting an entertaining program, I provide a benefit to everyone who
listens to it. Since I cannot control who listens to it I cannot, as in the
case of ordinary production, collect my share of that benefit by charging for
it. The public in question is a large and disorganized one so it is clear, on
theoretical grounds, that programs cannot be privately produced.
Yet they are. Some
clever person thought up the idea of combining a public good with positive
production cost and positive value with a public good of negative cost and
negative value and giving away the package‹a program plus advertisements. As
long as the net value is greater than zero and the net cost less than zero,
people listen to the program and the broadcaster covers his costs.
There are a lot of
other ways in which such problems get solved‹imperfectly but adequately.
Consider any case in which two firms interact in such a way that decisions of
one have large costs and benefits for the other, of a sort not easily
controlled by contract. One way of internalizing the externalities is for the
firms to merge. Indeed, one way of looking at the theory of the firm is to
consider the size of the firm as a balance between the advantages of getting
mutually related activities within a single organization with a single bottom
line and the disadvantages of organizational diseconomies of scale‹too many
layers of administration between the president and the factory floor.
For a final example
out of many I might give, consider the problem of producing ideas and
information. One solution is intellectual property law, but that solution is
difficult to apply in areas such as basic research or business methods where
defining just what is owned and who is infringing can become a very difficult
problems. It is hard to imagine how a patent on the laws of physics or the idea
of the supermarket could be defined and enforced. In the context of software,
an additional problem is enforcement cost. When any individual customer can
copy a four hundred dollar program onto a one dollar CDR and pass it on to a
friend, it becomes hard for the producer of the program to enforce his
copyright.
Solutions to this
problem in the context of basic research are discussed at some length by
Kealey.[6]
Knowledge of current cutting edge research‹Kealey¹s field is biology‹is of
considerable value, and it is not the sort of knowledge easily summed up on a
one page memo. In practice, the knowledge is largely restricted to the people
doing the research, both because they are the ones who can understand each
other¹s work and because they are the ones that the other researchers want to
talk to. That makes such researchers valuable employees and consultants for
firms and universities. While the researchers are unlikely to internalize the
entire value of the information they produce, they may internalize enough so
that the resulting income, along with nonpecuniary rewards of their work, make
their research worth doing for them, and subsidizing for firms and
universities. Kealey¹s conclusion, looking at several different fields where
government subsidies went from near zero to very substantial, was that there
was no observable effect on the rate of progress in the field. One might
interpret that as evidence that the cost of misallocation of resources through
the political mechanism‹diverting smart people into whatever field looked good
in the popular imagination at the moment‹at least balanced the benefit of the
additional money.
A similar pattern of
incentives can be observed in the case of Open Source software and has been
discussed at some length by Eric Raymond.[7]
Programmers claim no rights over others use of the code they contribute‹the one
restriction is that any program derived from an open source program must itself
be open source.[8] Why then is
it in the interest of programmers to spend their time and effort contributing
to an open source project?
Part of the answer is
nonpecuniary returns‹status from doing work that others use and know is yours,
satisfaction from helping to produce something worth producing. Part of it, as
in the case of scientific research, is the real benefit to the programmer of
being part of the relevant community. A contributor to an open source project
who encounters a problem with the software that he cannot deal with or finds it
lacking some feature that he cannot easily add has immediate access to the
other contributors, some one of whom may be well positioned to solve the
problem‹and happy to do favors for someone who is contributing to the project
and may next week do a similar favor for them.
That explains how
programmers get useful services from their work, but not how they pay their
bills. Part of the answer to that is that most programming is not done to be
sold but to be used‹customized software for a particular firm. By basing its
software on open source code, a firm not only saves a lot of programming time,
it also provides itself with access to a
pool of experienced programmers familiar with the code. That makes
familiarity with an open source project and access to the associated
community‹advantages that programmers contributing to the project already
possess‹valuable assets for a programmer who wishes to be an employee or
consultant of such a firm.
These examples are
suggestive, not exhaustive. They do not imply that the problem of market
failure does not exist. But they do suggest that the problem can easily be
overestimated, due to the failure to consider the many ways in which ingenious
individuals can work around the inefficiencies due to market failure‹and find
it in their interest to do so.
The point applies to
the political market as well as private ones. There too, inefficiencies due to
market failure provide opportunities for enterprising individuals to rearrange
the outcome and gain by doing so. Arguably that is why government does not work
even worse than it does. One relevant mechanism was hinted at by the title of a
news story in the Harvard Crimson that I remember from when I was an
undergraduate, reporting on a talk by a prominent political scientist: ³Banfield
Favors Corruption.² When the incentives generated by the political marketplace
are sufficiently perverse, illegal market transactions may be the best way of
dealing with the problem.
The argument for
favoring private over political markets is not that market failure is always
insoluble in one but not in the other. It is that the conditions leading to
market failure are the rule in political markets, the exception in private
markets.
It is tempting to
think that we could get the best of both worlds by permitting the political
market to intervene only where the private market fails badly. But someone has
to decide what situations fit that criterion‹and it is in the political market
that the boundaries of political control are set. The range of possible
arguments for the existence of market failure is broad enough so that
intervention can be justified almost anywhere‹if there is enough to be gained
by justifying it.
My examples so far
have been within the familiar structure of legal rules created and enforced by
a government. In this section I give a brief sketch of how private markets
might replace government in its most fundamental activities, including the
creation and enforcement of legal rules, and then discuss problems such a
system might raise and how they might be dealt with.
Imagine a society
without a government to provide law and law enforcement. Individuals wish to
protect their rights and settle their disputes, so private firms arise to
produce those services. Each individual is the customer of a rights enforcement
agency that provides him the service of enforcing his legal rights against
others. Each pair of such agencies contracts with an arbitration firm, a
private court that settles disputes between their customers, and agrees to
abide by its decisions.[9]
There is no government
over the agencies to force them to abide by their contracts. Instead there is
the discipline of repeat dealings. A firm that reneges on its arbitration
agreement when the decision goes against it will find other firms unwilling to
contract with it for arbitration. Violent conflict is more expensive and risky
than arbitration, so a firm that can only enforce its clients¹ rights by violence
is at a severe market disadvantage compared to firms that abide by mutual
arbitration agreements. So we can expect an equilibrium in which such
agreements are made and followed.[10]
The legal rules and
the structure of rights they embody in this society are created not on the
political but on the private market. Part of the product that an arbitration
firm sells to the enforcement agencies that are its customers is the set of
legal rules it applies in deciding cases. [11]
As in ordinary private
markets, the result is a tendency towards an efficient product‹in this case, a
set of legal rules that maximizes the welfare of the people living under it. To
see why, consider first a case where some change in legal rules would, on
average, benefit the customers of both agencies. The better the service they
provide to their customers, the more willing customers will be to pay for the
service, so it is in the interest of both agencies to persuade the arbitration
firm to alter its rules accordingly‹or if it does not, to shift to one that
does. In the case where the change produces benefits for customers of one
agency and (smaller) costs for customers of the other, it is still in the
interest of both to agree on the change‹accompanied by an appropriate side
payment from the one agency to the other, or changes in other rules that favor
the second firm.[12]
This is one advantage
of the institutions I have described over those we are familiar with. For
reasons discussed above, the creation of legal rules in the political market has
only a very weak tendency to generate efficient rules, since the efforts that
go to supporting or opposing legal changes are proportioned not only to the
size of their effects on different interest groups but also to the degree to
which each interest group is able to solve its internal public good
problem‹loosely speaking, to how concentrated or dispersed each interest group
is.[13]
A second advantage of
private law is that it avoids the public good problem associated with
rationally ignorant voting. What determines the legal rules of the private
market for law is individual choice‹the same mechanism that determines the
characteristics of ordinary private goods. The individual consumer who decides
that agency A has, on the whole, chosen a better set of legal rules for its
customers than agency B is free to switch agencies, just as a consumer is free
to decide to buy a different brand of car. He pays the cost of his research‹and
gets the benefit. We expect rational individuals to be better informed about
their market choices than about their political choices‹and in this system, law
is chosen on the market.[14]
These are examples of
my earlier point about market failure on private and political markets. On the
political market each is jointly choosing for all. Externalities and public
goods are routine features of that market, private goods exceptions, hence
market failure is the norm. The market failures I have just discussed occur
naturally on the political market‹and are naturally absent in the alternative
private market.
Rather than going on
to a more extensive discussion of the logic and structure of the private market
for law and law enforcement, I next consider problems that might be expected to
arise with such a system and might outweigh its benefits.
In the system I have
described, enforcement agencies serve much the same function as police forces
in our system. This raises an obvious problem‹the risk that a group of such
agencies may have sufficient force to overcome the others and establish a
government, perhaps a worse government than we now have.
Such a project faces
several difficulties. One is that, if there are many agencies, customers
threatened by an agency that wishes to convert them to subjects can hire
another to defend them. To put the point differently, what I am describing is a
cartel and cartels are hard to maintain if there are many firms and easy entry
to the industry. Thus one important issue will be how many agencies there are;
the answer will depend upon economies of scale in the rights enforcement
industry.
A second difficulty,
also faced also by a tyrannical government of the present sort, is that
governments do not have all of the relevant resources. Individual citizens
control themselves and may have access to weapons, communication equipment,
reputational and information assets of various sorts, and so some ability to
use force in their own defense.
Finally, the
practicality of converting a society from market anarchy to tyranny depends on
a set of important but hard to define ideological factors. Consider the
corresponding change in our society. Our military and police forces control
most of the weaponry and are not particularly well paid. Why do they not seize
power and revise our political system in their favor? Presumably the answer has
to do with what sorts of actions they regard as appropriate and expect
potential allies and opponents in such a move to regard as appropriate. Similar
constraints would exist in the society I have described.
Earlier I mentioned the
issue of economies of scale in the enforcement industry. If a firm with a third of the market can produce a
better service at a lower cost than any smaller firm, we will end up with at
most three firms‹making a cartel agreement in favor of them and against us a
likely outcome. If a firm of optimal size serves only one percent of the
market, such an outcome is unlikely.
So far as the ordinary
business of rights enforcement is concerned, the evidence of existing police
forces suggests that economies of scale do not go very far‹big city forces do
not seem to provide better services at lower cost than smaller forces, although
that judgment is complicated by the fact that big cities and small towns differ
in lots of ways relevant to the cost of preventing crime. It is also
complicated by the fact that most of what we observe are geographical
monopolies. It is possible that a firm with 80% of the customers in a given
area can outcompete a firm with only 20%, even if police forces in large areas
cannot outcompete those in small.
A more interesting
complication comes from the fact that the agencies are producing two related
products. One is the enforcement of
legal rules. The other, via the arbitration firms, is the set of rules
being enforced. I have described how bargaining between agencies would change
legal rules in the direction of efficiency but I have left out one important
element of the problem. I have ignored the distributional outcome, the
background starting point from which the agencies bargain.[15]
If the customers of one firm prefer rule A to rule A¹ by a million dollars and
those of another prefer A¹ to A by two million, we expect them to end up with
A¹‹but does the bargaining involve the second group offering to pay the first
more than a million to get A¹, and having the offer accepted, or the first
group offering the second less than a million to get A and having the offer
refused? Where does the bargaining start?
The pessimistic answer
is that the distributional outcome arises form the underlying threat game‹the
options each party has if bargaining breaks down and conflicts must be settled
by violence. If so, we would expect firms to get better results for the
customers the better they were at interfirm violence. Economies of scale then
depend both on economies in the business of enforcing rights and on economies
in the business of threatening other firms with violence‹and evidence from
current institutions suggests that economies of scale in the latter activity
may exist to a considerably larger size than in the former. That brings us to
the nightmare scenario that some critics of private law imagine, with the big
fish eating the small and private order dissolving into civil war and eventual
tyranny.
The optimistic answer
is that once a stable system is established the recourse to violence is no
longer a credible threat, hence the ability to use violence is no longer an
important asset. If two firms get into a mini-war, both lose‹because both now
have higher costs for producing a lower quality service than all the other
firms that are peacefully settling their disagreements by arbitration. The
distributional outcome, the background state from which firms bargain, is
determined by history not threats‹the dead hand of the past providing the
Schelling points of the bargaining game which both parties fall back on if no
offer to change the rules can be agreed on.[16]
That view is supported by the extraordinary stability of national boundaries,
also, presumably, the outcome of a mutual threat game. They do not shift a mile
one way or another every time one of the two countries expands its army by a
division or launches a new battleship. If this view is correct, it will be
economies of scale in police services, not warfare, that determine the
equilibrium size and number of rights enforcement firms.
So far I have been
discussing the stability of the system against internal threats. Another
concern is stability against external threats‹the defense of an
anarcho-capitalist territory against aggression by adjacent states. Defense
against governments is a public good with a large public, hence difficult to provide privately.
Difficult but not
necessarily impossible. Providing an open source operating system is also a
public good with a large public‹yet Linux exists. Tipping cab drivers who do
their job well, and so providing incentives to good service, provides a public
good for a large public‹and happens. As these two very different examples
suggest, there are a variety of social mechanisms by which it may be possible to
provide, at some level, public goods even for quite large publics.
Consider the following
model for one way in which a large, modern, stateless society might defend
itself‹a model variously inspired by Open Source, a Kipling story,[17]
and the 18th century militia system underlying the Second Amendment
to the U.S. Constitution.
At the bottom level we
have the militia, made up of a large number of volunteer units of amateur
soldiers. For the volunteers, part of the reward is the same sort of fun they
used to get from paintball, video games or mass medieval combat in the Society
for Creative Anachronism‹a chance to play soldier. Another part is the
satisfaction of feeling that they are doing their part in defending their
homes, families, and the society they are a part of.
Military units require
more than volunteer manpower. In my imaginary future, many of them are financed
by firms. What the firms get out of it is good public relations‹when the
liberty parade goes by, on April 15th of each year, their banner is
there, carried by a trimly uniformed band of their employee/volunteers. Thus
the firm demonstrates‹as firms today try to demonstrate, sometimes at
substantial cost‹that they are a good corporate citizen, the sort of people that
one ought to buy from and work for.
What the model so far
lacks is organization‹ten thousand separate companies of a hundred men each do
not an army make. To provide that organization we have a small cadre of full
time professional soldiers, funded by charitable donations. In peacetime they
organize war games for the militias, define communication standards, recommend
weaponry, teach tactical doctrine, provide the professional superstructure for
an amateur army. In wartime, if there is a wartime, the cadre is the command
structure of the army.
Whether such a system
could successfully depend its territory depends on a number of factors. One
crucial one is the size of the threat relative to the resources of the
ungoverned society. If, as we might expect, a stateless society grows faster
and so becomes richer than competing states, it may not take a large fraction
of its resources to fund an adequate defense‹perhaps no more than can be
provided in the ways just described. The collapse of the Soviet Union considerably
increased the chances that a stateless America could defend itself, since what
I have just described, or something similar, should be more than adequate
against any likely threats from either Canada or Mexico.
Another factor is the
system of norms and values in the society. Some stateless societies, such as
the Apache, have been militarily formidable despite the lack of a government to
fund and coordinate their efforts. Others have not.
One advantage to this
particular model for defense, like the historical model on which it is based,
is that it provides a protection against the threat of internal tyranny. The
cadre, like the professional army of the original U.S. system, is too small to
seize power. The amateurs who control most of the military force are ordinary
citizens widely distributed through the population.
So far I have been
concerned with the stability of a society without government against internal
and external threats. Another set of issues arise if we ask how well such a
society, if stable, would work‹how nearly the laws it enforced would fit our
views of either justice or efficiency.
To a first approximation, the answer is
that such a system would generate efficient law, for reasons sketched earlier
and discussed in more detail in Friedman (1996,2), legal rules that maximized
to welfare of the people to whom they applied. But in this case as in other
private markets, efficiency is only the first approximation, and may be
prevented by market failure.
One problem arises
when the legal rule applying between A and
B has substantial effects on C. Intellectual property law provides one example.
By agreeing to respect your copyrights, I increase the incentive for you to
write books or create computer programs. One consequence is that there are more
books and programs available to be pirated without payment by people who, via
their enforcement firm and arbitration agency, have not agreed to respect
copyright. My incentive to agree to respect your intellectual property rights
understates the real benefit from my doing so. It follows that I will sometimes
fail to so agree even when doing so would produce net benefits. We can expect,
in a world of privately produced law, a less than optimal level of protection
for intellectual property. Similar arguments imply a less than optimal legal
protection against pollution. Another form of the same problem might be
associated with the deterrence of crime. By paying my protection firm to make
strenuous efforts to apprehend and punish those who violate my rights I make
crime less profitable‹and the reduction in the number of criminals may benefit
you as well.
In this case, however,
the result is ambiguous. It is in my interest to not merely pay for protection,
but make sure that potential aggressors know I have done so‹to identify myself
and my property as protected. We observe such efforts today‹³We prosecute
shoplifter² signs in department stores, ³These premises protected by Š² signs
on stores. In a world where all protection against crime is private we can
expect more such efforts, converting deterrence, in large part, into a private
good.[18]
So while the deterrence I have paid for may help you by deterring a criminal
who does not know which of us is protected, it may also deter criminals from
crimes against me, leaving them more time for crimes against you. Thus the sign
of the potential externality from my efforts at deterrence is uncertain‹we
might get either a suboptimal or superoptimal level.[19]
These examples bring
us back to a central point of this essay. Market failure is a real phenomenon
on private markets. Hence we cannot expect perfectly efficient outcomes from
private markets, whether in law or in other things. But we have more reason to
expect them from private markets than from public markets.
Intellectual property
law at present is in large part the product of concentrated producer
interests‹while the claim that whenever Mickey Mouse is about to go out of
copyright the term of protection is extended is no doubt an exaggeration, it is
an exaggeration of a real pattern. On theoretical grounds, it is hard to tell
what the optimal level of protection would be, given the advantages and
disadvantages of treating ideas as property.[20]
Whatever it is, there is no reason to expect our present institutions to
produce it. As some evidence that they do not, consider the extraordinary
stability of the term of U.S. patent protection, roughly speaking from fourteen
to twenty-one years, over the past two centuries--a period during which the
conditions likely to determine the optimal term, most notably the rate of
innovation, have changed drastically.
Similarly for
protection against crime. It is possible that a private market would produce a
sub or superoptimal level of criminal deterrence. But is hard to see any reason
to expect the political system to do better, or as well.
Similarly for defense
against foreign nations. The private market may well produce a suboptimal
level. But the public market has not always produced an optimal level of
defense either, and what it produces often seems to be produced at a
considerably superoptimal cost. And a government equipped with an army may face
political incentives to use it under circumstances that do not increase the
welfare of its subjects.
I have discussed the
law provided by the market so far in terms of economic efficiency‹to what
degree it maximizes the welfare, the ability to achieve their ends, of the
people it applies to. Some readers may reasonably ask, not whether the law will
be efficient but whether it will be just.
Unfortunately I have
no theory of justice adequate to answer that question. For those readers who
are libertarians, however, I can point out the existence of a variety of
arguments and evidence for the claim that liberty is efficient, that it permits
people to achieve their individual goals better than any alternative set of
social arrangements. If so, a society with efficient law should be, on the
whole, a free society.
What follows from
these arguments is an uncertain conclusion. There are circumstances in which a
stateless society would be unstable against internal or external threats,
making the creation of such a society an unattractive gamble. There are other
circumstances in which such a society should be able to maintain itself.
If a modern stateless
society did prove stable, would it be attractive? Here I think the conclusion
is clearer, although it is hard to imagine any rigorous proof. There are forms
of market failure that would make the outcome of such a society less than
perfectly attractive, inferior to what could be produced by a wise, all
powerful and benevolent despot. But Superman as philosopher king is not a real
world option. The political alternatives to the market for law can be expected
to suffer from more frequent and more serious problems of market failure.
The private market
will not produce perfectly efficient law, but it is hard to see why the public
market will come even close‹and there is little evidence that it does. The
economic arguments to show that a tariff injures the country that imposes it,
for most countries most of the time, were worked out by David Ricardo almost
two hundred years ago. Most countries still have tariffs‹and we know why.
References
Friedman, David, The Machinery of Freedom. Harper and Row (1973), Arlington House
(1978), Open Court (1989).
³Private Creation and Enforcement of Law ‹ A
Historical Case.² Journal of Legal Studies, (March 1979), pp. 399-415.
³Efficient Institutions for the Private
Enforcement of Law.² Journal of Legal Studies, June (1984).
Price Theory: An Intermediate Text. South-Western (1986, 1990).
³A Positive Account of Property Rights,² Social
Philosophy and Policy 11 No. 2
(Summer 1994) pp. 1-16.
³Making Sense of English Law Enforcement in the Eighteenth
Century,² The University of Chicago Law School Roundtable (Spring/Summer 1995): 475-505.
Hidden
Order: The Economics of Everyday Life.
Harper-Collins, 1996. German translation published 1999, Japanese translation
(date?).
³Anarchy and Efficient Law² in For and Against the State, edited by Jack Sanders and Jan Narveson, 1996 (2).
Law¹s Order: An
Economic Account, Princeton University Press, Spring 2000.
Kealey, Terence, The Economic
Laws of Scientific Research, New York: St. Martin¹s Press, 1996
Kipling, Rudyard, ³The Army of a Dream,² in Traffics
and Discoveries .
Webbed at:
http://whitewolf.newcastle.edu.au/words/authors/K/KiplingRudyard/prose/TrafficsDiscoveries/armydream_p2.html
Eric Raymond, The Cathedral & the Bazaar. O'Reilly 2001. Part
of the material is webbed at:
http://www.catb.org/~esr/writings/cathedral-bazaar/
[1] I may, of course, care about some other
people, although rarely as much as they care about themselves. Part of the
effect on them is then also an effect on me, and I take account of it to that
extent.
[2] A discussion and defense of this assumption
can be found in Chapter 1 of Friedman (1990) and Friedman (1996). The former is
webbed at
http://www.daviddfriedman.com/Academic/Price_Theory/PThy_Chapter_15/PThy_Chap_15.html.
[3] For the purposes of this essay I am not
discussing the precise meaning of economic efficiency or its various
definitions; interested readers may wish to look at Chapter 15 of either my Hidden
Order or my Price Theory. The latter is webbed at:
http://www.daviddfriedman.com/Academic/Price_Theory/PThy_Chapter_15/PThy_Chap_15.html.
[4] The analysis can be found in more detail in
chapter 19 of Friedman (1990) and Friedman (1996). The former is webbed at:
http://www.daviddfriedman.com/Academic/Price_Theory/PThy_Chapter_19/PThy_Chap_19.html
[5] This statement is true, but far from obvious.
It is not an assumption but a conclusion from price theory, which tells us that
in a competitive market price, whether of consumer goods or of inputs such as
labor, equals both marginal cost and marginal value.
[6] Kealey (1996).
[7] Eric Raymond, The Cathedral and the Bazaar. Webbed versions of his essays can be found at
Š .
[8] This means both that any such software must be
freely copyable without charge and that the source code, the information needed
to modify the software, must itself be freely available.
[9] In this essay I refer to enforcement agencies
and arbitration firms not because of some fundamental difference in the
organizations but merely as a way of making it easier to distinguish between
the two in my presentation.
[10] There is indirect evidence to support this conclusion in the way in which auto insurance firms in resolving conflicts between their clients. Just as the enforcement agencies face a choice between expensive violence and cheap arbitration, so the insurance companies face a choice between an expensive conflict in the courts and a less expensive informal resolution. Most such conflicts manage to stay out of the courts.
[11] A much more detailed description of such
institutions can be found in Part III of D. Friedman, The Machinery of
Freedom.
[12] The analysis of this market and the forces
that end to move it towards an efficient set of legal rules can be found in
Friedman (1996).
[13] We may think of a concentrated interest group as one that can raise a
relatively large fraction of the value of a public good for the members of the
group in order to pay for it, a dispersed group as one able to raise only a
small fraction.
[14] The discussion here somewhat oversimplifies
the situation, since the market for law is constrained by the fact that legal
rules apply to a pair of individuals. My rights against you are part of both my
legal rules and yours. Implications of that problem are discussed in Friedman
(1996,2).
[15] I am indebted to James Buchanan for pointing
out this problem in a perceptive review of my The Machinery of Freedom.
[16] The idea of Schelling points underlying the
equilibrium of the social mutual threat game is discussed in some detail in
Friedman (1994).
[17] ³The Army of a Dream,² in Traffics and
Discoveries.
[18] For a historical example of institutions to
make deterrence a private good in a society where criminal prosecution was
private, see Friedman (1995).
[19] This point was discussed at greater length in Friedman (1984), along with other issues having to do with the efficiency of private law enforcement.
[20] An issue discussed at some length in Chapters
10 and 11 of Friedman (2000).