Chapter Four: Ridicule for Regulations

Your tax dollars at work:

The [National Fluid Milk Processor Promotion] Board shall have the following powers:

(a) To receive and evaluate, or on its own initiative develop, and budget for plans or projects to educate consumers and promote the use of fluid milk products and to make recommendations to the Secretary regarding such proposals;

(b) To administer the provisions of this subpart in accordance with its terms and provisions;

(c) To make rules and regulations to effectuate the terms and provisions of this subpart;

(d) To receive, investigate, and report to the Secretary complaints of violations of the provisions of this subpart;

(e) To employ such persons as the Board deems necessary and determine the duties and compensation of such persons;

(f) To contract with eligible organizations or other persons to conduct activities authorized pursuant to this subpart;

(g) To select committees and subcommittees, to adopt bylaws, and to adopt such rules for the conduct of its business as it may deem advisable; the Board may establish working committees of persons other than Board members;

(h) To recommend to the Secretary amendments to this subpart; and

(i) With the approval of the Secretary, to invest, pending disbursement pursuant to a plan or project, funds collected through assessments authorized under §1160.211 in, and only in, obligations of the United States or any agency thereof, in general obligations of any State or any political subdivision thereof, in any interest-bearing account or certificate of deposit of a bank that is a member of the Federal Reserve System, or in obligations fully guaranteed as to principal and interest by the United States.

[58 FR 62503, Nov. 29, 1993, as amended at 63 FR 46639, Sept. 2, 1998]

§ 1160.209   Duties of the Board.

The Board shall have the following duties:

(a) To meet not less than annually, and to organize and select from among its members a chairperson, who may serve for a term of a fiscal period pursuant to §1160.113, and not more than two consecutive terms, and to select such other officers as may be necessary;

(b) To prepare and submit to the Secretary for approval a budget for each fiscal period of the anticipated expenses and disbursements in the administration of this subpart, including a description of and the probable costs of consumer education, promotion and research projects;

(c) To develop and submit to the Secretary for approval promotion and consumer education, and research plans or projects;

(d) To the extent practicable, carry out consumer education and promotion programs under §1160.301 in such a manner as to ensure that advertising coverage in each of the regions defined in §1160.200 is proportionate to funds collected from each such region;

(e) To disseminate information to fluid milk processors or eligible organizations;

(f) To maintain minutes, books and records that accurately reflect all of the acts and transactions of the Board, which shall be available to the Secretary for inspection and audit, and prepare and promptly report minutes of each Board meeting to the Secretary and submit such reports from time to time to the Secretary as the Secretary may prescribe, and to account with respect to the receipt and disbursement of all funds entrusted to it;

(g) To enter into contracts or agreements, with the approval of the Secretary, with such persons and organizations as the Board may approve for the development and conduct of activities authorized under this subpart and for the payment of the cost thereof with funds collected through assessments pursuant to §1160.211 and income from such assessments. Any such contract or agreement shall provide that:

(1) The contractors shall develop and submit to the Board a plan or project together with a budget(s) showing the estimated cost of such plan or project;

(2) Any such plan or project shall be adopted upon approval of the Secretary; and

(3) The contracting party shall keep accurate records of all of its transactions and make periodic reports to the Board of all activities conducted pursuant to the contract or agreement, and provide accounts of all funds received and expended, and such other reports as the Secretary or the Board may require. The Secretary or employees of the Board periodically may audit the records of the contracting parties;

(h) For the initial fiscal period, the Board shall contract, to the extent practicable and subject to the approval of the Secretary, with an eligible organization to carry out the provisions of this subpart;

(i) To prepare and make public, at least annually, a report of its activities and an accounting for funds received and expended;

(j) To have an audit of its financial statements conducted by a certified public accountant in accordance with generally accepted auditing standards, at the end of the first 15 months of the initial fiscal period, at the end of the initial fiscal period, and at least once each fiscal period thereafter as well as at such other times as the Secretary may request, and to submit a copy of each such audit report to the Secretary;

(k) To give the Secretary the same notice of meetings of the Board and committees of the Board, including actions conducted under §1160.206(b), as is given to such Board or committee members in order that the Secretary, or a representative of the Secretary, may attend such meetings;

(l) To submit to the Secretary such information pursuant to this subpart as may be requested;

(m) The Board shall take reasonable steps to coordinate the collection of assessments, and promotion, education, and research activities of the Board, with the National Dairy Promotion and Research Board established under section 113(b) of the Dairy Production Stabilization Act of 1983 (7 U.S.C. 4504(b)); and

(n) The Board shall conduct advertising using third parties only through contracts which shall prohibit the third party from selling, offering for sale, or otherwise making available advertising time or space to private industry members conducting brand-name advertising which immediately precedes, follows, appears in juxtaposition, or appears in the midst of Board-sponsored advertising.

[58 FR 62503, Nov. 29, 1993, as amended at 61 FR 27003, May 30, 1996; 62 FR 3983, Jan. 28, 1997] [1]

That is but a very small part of the regulation – brought to you as another disastrous offering of the New Deal - that establishes a 20-member panel empowered to use federal resources in order to undertake “public relations, advertising or other means devoted to educating consumers about the desirable characteristics of fluid milk products and directed toward increasing the general demand for fluid milk products”.  In other words, it uses your tax dollars to tell people that milk – except, apparently, for that nasty powdered kind – is “good for you.”  Maybe if the price of milk were not subsidized to the tune of $4 billion in taxpayer dollars per year such a program might not be necessary.

The second “pillar” of the modern democratic state, we are told, is regulation and the forces of the “anti-government campaign” are supposedly conspiring at this very moment to ensure that evil businessmen can slash your wages, poison your water, contaminate your food and sell you shoddy medicines.  Without the ever-vigilant, ever-benevolent government, no doubt everyone’s front yard would be a toxic landfill and no one would live to adulthood.  In the face of that belief, one is faced with the inevitable question: can anyone really be that stupid?

Those who defend the ever-expanding encroachment of governmental regulation into our daily lives operate from a specific set of conclusions.  First, it is government action, and government action alone, that prevents businesses from taking advantage of workers, customers and the general public.  Second, governmental concerns are more benevolent than are those of businesses and are, therefore, more capable of protecting the safety and security of the public.  And third, the “anti-government” forces want to eliminate essentially every protection that has ever been put in place.

Let’s deal with the last absurdity, first.  Obviously, no one is seeking to eliminate all law.  Even modern anarchist thought does not envision this outcome, instead seeking to replace the government legal system with a private alternative.  It is disingenuous at best to suggest that the effort to limit the expansive regulatory actions of government is essentially an effort to undermine or destroy all societal order.  Such a societal order is predicated upon the protection of the individual from infringement upon his rights and property by the actions of others.  It is neither necessary nor advisable to codify into law every possible circumstance that could result in harm.  Quoth the Roman sage, “A corrupt society has many laws.” [2]

The problem, as much as anything else, is a large group of lawmakers that have way too much time on their hands.  Since the dawn of civilization we have progressed from ”Thou shalt not kill” to “Thou shalt not, except as otherwise provided in this article, willfully mar, mutilate, deface, disfigure, or injure beyond normal use any rocks, trees, shrubbery, wild flowers, or other features of the natural environment in recreation areas of the state of Colorado” and “Though shalt not wear roller skates in a public lavatory in Portland, Oregon”.  And, of course, there’s the Internal Revenue Code of the United States, the longest and most complicated statute ever devised by the mind of Man, containing more than 3.4 million words and, if printed out in its entirety, more than capable of removing from the gene pool anyone foolish enough to be under the table it is placed upon.

Between these two extremes of straightforward laws against willfully injuring others and examples of outright legislative stupidity, rests that body of regulation that some view either as a model of success or worse, if anything, insufficient (minimum wage laws, banking regulation, the SEC, the EPA, the Consumer Product Safety Commission, OSHA), but, in reality are not the benevolent protections that some would have you believe.

Quite often, the state creates laws that penalize perceived harm that is not really an infringement of any kind.  Worse still, very often laws and regulations are written that, rather than acting in a protective capacity, attempt to impose a positive duty upon some party.  One example of this is the minimum wage.  The notion that this particular regulation is effective as an anti-poverty measure has already been disposed of and that the consequences of such laws is the destruction of jobs has been well established.  But just as the argument for public charity is based on the premise that doom awaits the poor without state intervention, so, too, it is argued that unscrupulous businessmen will “stick it” to the working man without such intervention.  This premise is no less silly than the last.

Businesses are created by human beings.  They, like everyone else, invariably act in what they perceive to be their own best interests.  If their perceptions are correct, they will reap the benefits of their decisions; if their perceptions are wrong, they will suffer the consequences.  Thus, it is fair to say that the one characteristic that distinguishes successful businessmen from the rest of society is not that they are greedier or more ruthless but simply that their perceptions have proven correct more frequently than those who have not been, on balance, successful.

Businesses are created for the express purpose of making the investors in those business activities better off.  They are not beneficent societies designed to help the working man but, in fact, that is exactly what they achieve.  Every employment opportunity ever created in the marketplace came into being as an opportunity for the investors in any given business activity to generate a greater return.  This is the “invisible hand” of Adam Smith at work.  The direct intended consequence is the betterment of the investor.  The inevitable unintended consequence is the creation of opportunity for the worker to engage in a productive activity and better his own circumstances.

It has been posited that the businessman will pay as little as possible for that newly created job.  This much is true.  It has also been posited that such a situation results in the worker being paid “starvation wages”, or perhaps even less, unless some legal minimum is established.  This is absurd on its face.  There are two fallacies behind such a belief.  First, because the employer has the final say with regard to any one employment opportunity, it is assumed that the employer has “all the power”.  This is nonsensical.  In reality, in a competitive labor market such as we have in the United States, the employer that fails to compensate employees at market rates will lose them to his competitors forcing him to incur higher turnover and greater costs.  Thus, the employer that sets out deliberately to harm his employees is acting against his own interests.  Any theory that requires people to act in such a manner must be instantly discarded as unworkable.

To this logical argument can be added a whole host of empirical evidence.  If the “unscrupulous businessman” theory carried any weight, then, by definition, entry-level wages would never exceed the legal minimum; wages on the whole, particularly for low-skill positions, would likewise remain at or near the legal minimum and would stagnate, rising only slightly over time.  All of the empirical evidence indicates exactly the opposite.  The current national minimum wage is $6.55/hr.  But entry-level positions throughout the US routinely offer more than that level.  It is nearly impossible to pass a fast food franchise in the northeast corridor offering less than $8 or $9/hr.  The median expected salary for a typical fast food cook is $17,492, [3] which equates to about $8.75/hr

But that’s just one example, and not the only one that has been touched on already.  At least some of the detrimental implications of the Environmental Protection Agency (EPA) appear in the introduction to this thesis.  There are more than can be addressed in a single volume.  There are, however, two points to be made.  First is that so many of the regulations that have been touted as “successes” have, in fact, been no such thing.  And second is that the unhindered preying upon the public that is presumed to take place in the absence of the crushing state regulatory apparatus is entirely fanciful.

Successful Regulation?  Don’t Bank On It

Another example concerns banking regulations, significant contributors to the Great Depression, to the savings and loan crisis of the 1980s and of the mortgage and liquidity crisis of 2008.  Events that are all too often characterized as failures of the market or of capitalism turn out to be failures of government policies and regulation.  These three particular financial crises are particularly of note because, beyond monetary policy failures, persistent (and, as it happens, sequential) failures of regulation played a material role in their development.

The commonly repeated story is that the Great Depression was a failure of capitalism and that so many banks failed because they were invested in the stock market when it crashed and depositors swarmed the banks to get money that was no longer there. [4]  The reality is quite different.  During the 1930s, some 9,000 banks failed but 90 percent of these were in small towns and nearly all of them were located in states with unit banking laws. [5]

Unit banking laws restrict the ability of banks to open multiple branches particularly in disparate states.  Thus constrained, banks in the 1930s were faced with a serious dilemma.  Prohibited by law from diversifying geographically and, to a large extent, financially, the small state banks constrained by these laws found themselves trapped in locations particularly hard hit by the Depression.  If any area were faced with economic hardship, depositors began demanding their money at the very time that their loan portfolios – concentrated in the same troubled location – were proving to be impaired.  While most unit banking laws were put in place at the state level, federally chartered banks were made equally vulnerable by … you guessed it … additional regulation.  The McFadden Act of 1927 permitted the individual states to place the same type of branching restrictions on Federal Reserve member banks.  Meanwhile, the larger, more diversified banks not only didn’t experience the runs and failures that restricted banks did, but were vocally resistant to the institution of federal deposit insurance because their banking organizations remained financially sound.

Had legislators been paying attention, they might have foreseen the crisis coming and placed the blame at the feet of the Federal Reserve System, where it belonged.  Ludwig von Mises famously said in 1929, “A great crash is coming, and I don’t want my name in any way connected with it”, when turning down a position at the Kreditanstalt Bank. [6]  And Friedrich A. Hayek wrote in early that year “the boom will collapse within the next few months.” [7]  But legislators are simply not known for their ability to pay attention.

In its infinite wisdom, the government solution to the banking crisis of the Great Depression was to pass the Federal Home Loan Bank Act of 1932 and the Banking Act of 1933, otherwise known as the Glass-Steagall Act.  These Acts accomplished four things: it gave the Federal Reserve system materially more power particularly with regard to the regulation of rates for depository instruments; it reaffirmed the McFadden Act restrictions upon interstate banking; it created new distinctions between commercial, investment and mortgage banking; and it created federal deposit insurance through the Federal Deposit Insurance Corporation (FDIC).  This pinnacle of reactive legislation is a perfect example of just how bad regulation can be.

The first two consequences of the act are particularly noteworthy.  Under the pretext of protecting the general public from further bank failures, it gave more power to the very government body that was the chief cause of the Depression as a whole and then reasserted the very rule that was the primary cause of so many bank failures.  As a result, banks were still unable to diversify geographically, certainly ensuring that still more banks would fail and they now had additional interference from federal regulators in an area – deposit pricing – that had absolutely nothing to do with either the Depression or the failure of banks.  Not exactly an auspicious beginning.

Contrary to popular belief, the other two provisions of the act were even more disastrous.  The artificial barriers placed between various banking functions were instituted based upon the belief that the cause of the financial crisis was investment banking exposure when the stock markets tumbled.  But the belief has proved to be entirely false.  No evidence exists that any of the thousands of small banks that failed across the country collapsed due to investment exposure and it was the large banks that engaged in investment banking activities that proved most resilient to the crisis and survived.  So, the most benign way to look at this particular regulatory action is that it did nothing to address any real problem.  The implications of this legislation, while immediate in their effect, would take decades to really do obvious damage.

The savings and loan (S&L) crisis of the 1980s is, inevitably, described as a failure of government to properly regulate the industry.  This view is pure mythology.  In reality, the problem was backward regulation and then poorly developed partial deregulation that combined to create and, ultimately, exacerbate the problem.  Let’s look at what really happened.

Prior to the Depression years, mortgage lending was primarily a function of insurance companies – who had large sums to invest for the long term – and larger commercial banks.  In the wake of the Federal Home Loan Bank Act of 1932, however, savings and loan associations sprang up all over the country, in no small part because of the low cost funds made available to them by the federal government from the Federal Home Loan Bank.  These institutions took in savings deposits, often from small depositors, and created long-term mortgage loans for homebuyers.  The basic problem with that arrangement was made abundantly clear – at least to those paying attention – in the movie, It’s a Wonderful Life, when the frightened depositors of Bedford Falls came looking for their money.  Our hero, George Bailey (Jimmy Stewart) tells a Building and Loan customer, “The money's not here. Your money's in Joe's house... And in the Kennedy house, and Mrs. Macklin's house, and a hundred others. Why, you're lending them the money to build, and then, they're going to pay it back to you as best they can….  We've got to have faith in each other.”

When there is such a tremendous mismatch between the ability of the depositor to withdraw his money and the ability of the lending institution to retrieve those funds from where they are invested, the only thing holding the institution up is “faith”.  In a further effort to distinguish these institutions from commercial banks, the savings and loans were, on the one hand, permitted to offer higher interest rates for deposits but, on the other, were prohibited from offering checking accounts.  Maintaining these entirely artificial distinctions between businesses in the financial services industry set the stage for ultimate failure.

So long as interest rates remained relatively low, the house of cards seemed to be holding up fairly well.  All that changed in the late 1960s.  By the end of 1965, a one-month CD could get you 4.8 percent, [8] making this very-liquid investment extremely attractive to those who had sizable deposits in the savings and loans.  Three years later, this rate had climbed to 6.2 percent.  By the mid-1970, it peaked at 8.0 percent and the savings and loans were in serious trouble, but, much to their relief, rates fell rapidly over the next eight months and disaster was averted.  Something might have been done then to prevent the crisis from recurring, but the opportunity was lost.

By mid-1973, rates were once more approaching eight percent and the S&Ls were once again in trouble.  Deposits were fleeing to find more lucrative investments while assets continued to be tied up in long-term mortgages.  Rates would climb to 12.2 percent (in 1974) before reform was considered and would not be enacted until 1980.  By the time rates hit 16.8 percent in March of 1980, the savings and loan industry was already dead; it just wasn’t well known yet.

No amount of short-term liquidity provided through the Federal Home Loan Bank could possibly reconcile the difference between short and long term interest rates that were responsible for the demise of these institutions.  This, of course, did not prevent an interventionist government from trying.  In 1980, Congress passed the Depository Institutions Deregulation and Monetary Control Act (DIDMCA). [9]  This Act did nothing to forestall the problems and, in many ways, made them worse.  The Act forced all banks and S&Ls to abide by Federal Reserve rules, often while still other rules remained in effect, complicating still further the management of these lenders.  It permitted savings and loans to offer checking accounts.  This made S&Ls more attractive as a single banking source on the one-hand but any deposits were attracted as a result were even more subject to rapid withdrawal.  It raised the deposit insurance level for US banks from $40,000 to $100,000, which might elicit a sarcastic comment about how successful this was at saving S&Ls but I’ll come back to deposit insurance shortly.  And it allowed banks to merge, which, at least, permitted more financially sound financial institutions to acquire the assets of certain S&Ls before the taxpayers had to foot the bill.

The Act had one other significant consequence: it deregulated interest rates, removing the power to cap interest rates from the Federal Reserve Board.  In ordinary circumstances, this likely would have been a boon to the industry.  But circumstances were far from ordinary.  In an attempt to save businesses that were often already doomed, many S&Ls began offering progressively higher rates in order to attract deposits while investing in ever more risky mortgages in order to cover the higher deposit costs.  The death spiral had begun.

In 1982, the Garn-St. Germain Depository Institutions Act [10] was passed.  It allowed thrift institutions to invest in commercial loans, initially up to 5 percent of total assets and eventually 10 percent and increased the level of assets that could be invested in consumer and commercial real estate loans.  Again, these measures might well have helped the industry better compete in an ordinary environment (they truly might have been a “jackpot” [11] in a typical rate environment), but the damage had already been done.  The chief cause of the problem was low net worth in the S&Ls, seriously impaired by the interest rate environment before the decade had begun and “[p]ressures felt by the management of many associations to restore net worth ratios.  Anxious to improve earnings, they departed from their traditional lending practices into credits and markets involving higher risks, but with which they had little experience.” [12]  These problems, not fraud, were the cause of 80 percent of the failures in the industry and they stemmed not from deregulation (which came later) but the initial regulations that created these entities in the first place.

The inevitable result: over the decade ending in 1995, the number of federally insured savings and loans in this country declined by half.  Apparently not satisfied that it had done enough damage in the financial sector up to this point, the federal government chose to intervene still further.  In 1989, the Financial Institutions Reform, Recovery and Enforcement Act (FIRREA) [13] was passed.  As a result, the Federal Home Loan Bank Board and the Federal Savings and Loan Insurance Corporation were abolished, effectively – if you’ll forgive the mixed metaphor - closing the barn door long after the barn had burned down.  These were replaced by the Office of Thrift Supervision (OTS), the Federal Housing Finance Board (FHFB) and the Savings Association Insurance Fund (SAIC) which, again, did nothing to address the underlying problems in the business.  And the Resolution Trust Corporation (RTC), a political football if ever there was one, was created to help dispose of the assets taken over by regulators with the taxpayer footing the bill.

This Act also had one other significant consequence: it gave both Fannie Mae and Freddie Mac considerably more responsibility to “support” mortgages for ever more low and moderate-income families.  Unlike the initial Depression-era legislation, this did not take four decades to wreck serious havoc on the financial markets.  It took less than two, as the events of 2008 bear out with alarming clarity.  No wonder Adam Smith once opined: “To be merely useless is perhaps the highest eulogy which can ever justly be bestowed upon a regulated company.” [14]

The artificial distinction between commercial banks and investment banks was no less destructive.  This aspect of the Glass-Steagall legislation was created based upon the widely-held assumption that bank participation in the securities markets at the time of the 1929 crash was a major factor in the demise of American banks.  The presumption, however, was completely without basis.  The major causes of bank failures during the Depression have already been discussed and securities problems were not among them.  In fact, in only one case, the failure of the Bank of the United States in 1930, was the securities operation of a bank cited as the proximate cause of the failure and, in that case, the failure was “due less to the operations of the bank’s securities affiliate per se than to inept management and outright fraud”. [15]  The evidence is pretty clear that securities affiliates were not a major cause of bank failures in the thirties.  This did not prevent Senator Glass, co-sponsor of the legislation from declaring, “These affiliates, I repeat, were the most unscrupulous contributors, next to the debauch of the New York Stock Exchange, to the financial catastrophe which visited this country and was mainly responsible for the depression under which we have been suffering since.” [16]

That no other country in the world created such distinctions, despite the global impact of the Depression, should be revealing in and of itself.  As a consequence, US banks suffered a very real competitive disadvantage in relation to other international financial institutions which was not terribly damaging in the thirties but became ever more so as the economy evolved to a more global footing.  By the 1980s, as individuals could use the internet to seek financial services and investment opportunities essentially anywhere in the world, the maintenance of such artificial distinctions became obviously archaic.

Inevitably, these distinctions were effectively eliminated through a process known as “regulatory arbitrage” by which, in order to remain competitive in the global marketplace, banks, insurance companies and investment houses, through holding companies and other avenues created legal, but often costly, methods of working around obsolete regulations in order to meet customer needs.  The costs associated with this practice over several decades are incalculable, but the economic costs to the country are likely far higher as a result of capital flows seeking better returns overseas.  Fortunately, much of this artificial distinction was eliminated under the Financial Services Modernization Act of 1999 – otherwise known as the Gramm-Leach-Bliley Act. [17]  Unfortunately, the effect of this Act, coupled with a tendency of government to socialize the losses in the financial services industry, would result in still more problems. [18]

But you simply can’t find fault with the institution of federal deposit insurance that protects depositors and prevents runs on banks, can you?  Actually, the benefits of deposit insurance are largely illusory, but the benefit of deposit insurance is not the only myth related to this particular type of intervention.

Perhaps the greatest misconceptions about deposit insurance relate to its inception.  It is widely believed the FDIC was created to protect depositors because so many of them lost their savings as banks failed; that banks were eager for the measure and that it ended runs on the banks ending a disastrous trend and restoring faith in the financial system.  Every one of those beliefs is false.

In reality, deposit insurance was created to protect banks, not depositors.  More importantly, while runs on the banks were perhaps the most visible symptom of the banking crisis, they were not the primary cause for those failures.  In the years before the Great Depression, unit banking laws made it difficult, if not impossible, to engage in branch banking with multiple diversified locations to meet customer needs.  This not only made individual banks vulnerable to any downturn in the local economy, it also created conditions in which the only way many local needs could be met was with the creation of new banks where otherwise a new branch for an existing bank might have filled the need.  This, combined with low reserve requirements in a fractional reserve banking system made it both advantageous to local communities to find someone willing to open a new bank and relatively easy to do with a minimum of invested capital.  As a result, the number of banks in the United States exploded.

The number of banks had grown to about 2,500 by the early 1870s; by 1887, that figure had nearly doubled; by the turn of the century, it exceeded 12,000; and by the time it peaked before the Depression, there were more than 30,000 individual banks in operation, the vast majority of which were small, local, undercapitalized operations.  “Many of the new banks were viewed by commentators as being ill-prepared for the business of banking. In other words, too many banks were formed without adequate financial or managerial resources. The banking market was overbanked.” [19]  And all of this stemmed from a need to meet consumer demand that regulations prevented from being addressed in an economically sound manner.  Research indicates that the majority of the banks that failed were weak and likely to fail regardless of runs. [20]

Might some of the failures of those banks been avoided if there had been deposit insurance?  Not a chance.  Quite the contrary, one of the factors contributing to rapid rise in the number of new banks was precisely that.  “The formation of state deposit insurance systems in a number of states may also have contributed to a perception of safety and allowed the rapid growth of new small banks.” [19]

Three other flaws with the theory that deposit insurance was needed because of depositor losses stemming from bank runs exist.  The first is that depositors really did not experience the huge losses that many now believe were endemic to the period.  In fact, “from 1875 through 1933, losses from failures averaged only 0.2 percent of total deposits in the banking system annually. Losses to depositors at failed banks averaged only a fraction of the annual losses suffered by bondholders of failed nonbanking firms.” [21]

The second is that runs are rarely the proximate cause of bank failure. “The danger of bank runs has been frequently overstated. For one thing, a bank run is unlikely to cause insolvency. Suppose that depositors, worried about their bank’s solvency, start a run and switch their deposits to other banks. If their concerns about the bank’s solvency are unjustified, other banks in the same market area will generally gain from recycling funds they receive back to the bank experiencing the run. They would do this by making loans to the bank or by purchasing the bank’s assets at non-fire-sale prices. Thus, a run is highly unlikely to make a solvent bank insolvent….  A survey of all failures of national banks from 1865 through 1936 by J. F. T. O’Connor, comptroller of the currency from 1933 through 1938, concluded that runs were a contributing cause in less than 15 percent of the three thousand failures. The fact that the number of runs on individual banks was far greater than this means that most runs did not lead to failures.” [21]

And the third is that the bank runs were not so much the result of bank weakness as they were of still another regulatory failure.  “The panic of 1933 is a special case, and was caused by the unprecedented resort of state banking officials to the declaration of bank holidays and the resulting uncertainty for depositors, who rushed to withdraw funds before their own banks were closed. Bank failures, although still at a high level, had declined and there was reason to hope for a return to stability when the Governor of Michigan declared a bank holiday on February 14 to protect the Guardian Group (Ford family) of Banks. This led to holidays in other states as Michigan (then Indiana and Ohio, then Illinois and Pennsylvania, etc.) depositors sought cash elsewhere until by the time Franklin Roosevelt was inaugurated on March 4 banks in all forty-eight states had either been closed or restrictions had been placed on their deposits. Although national in scope, the panic of 1933 was due less to depositors' fears of bank insolvency than to the actions of public officials.” [22]

It has, of course, been argued that the implementation of deposit insurance brought the bank runs and related closures to an end, but there are major problems with that assertion.  First, as we have seen, the vast majority of bank failures were the result of problems completely unaddressed by deposit insurance.  Second, by the time the FDIC was created, nearly a third of the country’s banks, obviously including those most financially vulnerable, had already disappeared.  That trend could not continue forever.  And third, in 1934 – the damage of the new administration’s economic policies and the “Roosevelt recession” of 1937-1938 still far in the future – the economy took a turn for the better.  Economic output in 1934 rose sharply after four years of decline, relieving much of the pressure on surviving banks

There was one reason why the institution of federal deposit insurance did perhaps help halt the trend of bank failures, though it is debatable whether this particular benefit outweighed the negative consequences.  In modern parlance, it is called ‘corporate welfare”.  By socializing any losses on accounts of less than $2,500 (and now the bar has been raised far higher) it both eliminated any business risk for banks to engage in risky behavior with those deposits and undermined the natural incentive for people to pay attention to the condition of their bank and, if prudent, move their money elsewhere before there is a problem.  This activity, long before anything resembling a “run” took place, had been a key warning sign to regulators if the bank were to be facing serious difficulties.  This canary-in-the-mine-shaft was now gone.  Worse still, the program assessed premiums for this insurance not based upon risk, but, instead, based solely on deposit levels.  This served to reward risky and irresponsible behavior among riskier banks while penalizing those banks that had engaged in more responsible practices.

“FDIC insurance provided a significant profit-boosting subsidy to the riskiest banks. With the government backing their deposits, in 1934 all banks could suddenly gather deposits at the risk-free interest rate. Those banks that might have failed in the near future—the riskiest banks—benefited most.  Unless depositors were completely oblivious to their bank’s health, in the absence of deposit insurance, such banks would have had to pay depositors high interest rates. Had the FDIC charged risk-adjusted deposit insurance [premiums], the riskiest banks would have enjoyed no benefit. But [premiums] were calculated as a simple percentage of deposits.  Therefore, troubled banks enjoyed a sudden boost in their profits due to the introduction of FDIC insurance. Failures would naturally be minimized, not because contagion was halted, but instead because FDIC insurance provided a subsidy to those banks most likely to fail.” [19]

This is not just some minor phenomenon that resolved itself in a short time span.  A revealing anecdote concerns a mid-Atlantic bank with which I am personally very familiar.  This bank is heavily involved in home equity lending but adhered to very strict underwriting criteria.  As a result, this bank, while experiencing some losses in its investment portfolio, did not have any sub-prime loans on its books and, as of this writing, was experiencing loan losses that were still lower than the industry average before the onset of the mortgage lending crisis.  How was this greater discipline rewarded?  The Fed has indicated that deposit insurance premiums for this institution will increase roughly eight-fold in 2009. [23]

This is called a “moral hazard”, a condition in which a party is likely to behave differently, perhaps rashly, if he is insulated from risk, typically by means of insurance or implicit guarantee – as was the case with regard to Fannie Mae and Freddie Mac in 2008 – such that the party does not bear the full consequences of his actions.  In the marketplace, the risk of moral hazard associated with ordinary insurance – one might be a less careful driver because of automobile coverage – is typically mitigated by risk-based pricing.  In the case of deposit insurance, there are actually two distinct types of moral hazard at work simultaneously.  First, because the risk of loss to banks is not risk-priced, there is no disincentive for the bank to engage in risky behavior in order to achieve a greater return.  Second, because the depositor incurs none of the cost directly (though the cost of premiums reduces the deposit rates offered to consumers), there is no incentive to monitor the performance of the institution holding their money so long as the balances do not exceed the insured threshold.

Studies show that, in the unhindered marketplace, there is a “strong link between bank fundamentals and the supply of deposits, consistent with the hypothesis that market discipline is at work [and] that an increase in bank risk leads to higher interest rates and lower deposits. The results also suggest that most of the market discipline comes from large depositors. Nevertheless, “small” depositors, with at least $5,000 to $10,000 in their account, are also found to respond to bank risk….  More importantly, we find that the introduction of explicit deposit insurance caused a significant reduction in market discipline….  Moreover, by exploiting the variation in the coverage rate across banks, we find that the effect of deposit insurance on market discipline depends on the coverage rate. The higher the coverage rate, the larger the decrease in market discipline after the introduction of deposit insurance.” [24]

More specific to the point at hand, a 2002 study by Linda Hicks and Kenneth Robinson analyzed Texas bank data from 1919 to 1926, when the state offered deposit insurance, and found that, far from adding stability to the marketplace, deposit insurance increased the likelihood of a bank’s failure. The study found that insured institutions, after experiencing declines in their capital positions, engaged in more risky activities than did uninsured banks.  Thus, the moral hazard of deposit insurance made failure even more likely. [25]

In the final analysis, it cannot be argued with any degree of certainty that this last aspect of the Depression-era banking regulations – deposit insurance – was successful in decreasing risk to either depositors or the banking system as a whole.  It can, however, be stated with certainty that the moral hazard that results, coupled with the socialization of losses under the “too big to fail” doctrine has cost taxpayers dearly.  What’s important to note is that, contrary to the insistence of those who are convinced that chaos is the only alternative to intrusive government regulation, banking regulation demonstrates just how much better the unhindered marketplace is at policing itself and just how far worse government involvement can make things.  This is, in fact, the rule – not the exception.

Fabricaphobia and Alphabet Soup [26]

While an examination of banking in the United States shows such a clear, uninterrupted string of one regulatory failure after another, it is, of course, by no means the only such example.  There is a whole list of acronyms that amount to a dictionary or regulatory disasters and excesses back over the years – everything from the Tennessee Valley Authority (TVA) created as a government monopoly to electrify the Tennessee Valley, even though the private sector was already doing exactly that, and still operating more than half a century after that goal was accomplished and its raison d’etre long since ceased to be, to the Federal Aviation Administration (FAA) rule that required every child to be belted in, which, by raising the cost of air travel, drove people onto the less-safe highways resulting in five to nine more deaths for every child saved, to the now infamous failure of the Federal Emergency Management Agency (FEMA) to respond adequately to Hurricane Katrina. [27]

Banks are certainly not the only businesses to be regulated endlessly by government.  Virtually every aspect of enterprise is weighed, measured, scrutinized, restricted and, of course, taxed.  If this were not the case, we are told, big business would victimize the general public at every turn.  This is why it is necessary to create such agencies as the Securities and Exchange Commission (SEC), without which, companies like Enron, Worldcom, Tyco and Global Crossing could perpetrate fraud….

We have already examined the businessmen-will-starve-the-worker canard in dispensing with the regulatory justification for the minimum wage.  Similarly, the notion that any regulation can prevent premeditated fraud is nonsensical.  And it may seem counterintuitive to find that I’ve referenced not one, but four, organizations guilty of fraud in making the case against further regulation, but, in reality, a better example of why government regulation is not the answer is hard to come by.

Consider: There are more than 25 million businesses in the United States today (that’s how many paid taxes in 2000) and as many as 20,000 businesses with 500 employees or more.  Nearly all of them operate seamlessly without ever running afoul of the law or harming the public.  Consider that these figures are for a single point in time. Every year, thousands upon thousands of new business ventures are begun. And every year thousands of businesses are sold, retired or simply fail. So when considering what percentage of businesses is found to engage in unsavory practices over a period of time, it should be remembered that even the 25 million figure is an understatement.

Now examine, in that light, perhaps the largest single business scandal (in terms of economic impact) in history: the 2002-2003 accounting debacle. In all, fewer than forty US companies were implicated in the scandal (there were foreign entities as well – i.e. Parmalat and Ahold, but to include them would mean including all the other foreign business entities in the comparison sample) including the accounting firms that failed to detect the improprieties, companies that were implicated but were never demonstrated to have engaged in any wrongdoing. That’s forty … out of millions.  How do you suppose that compares to the number of scandals related to the 435 members of Congress at any given time? Is it reasonable to view this group as more trustworthy? I think not. [28]

Examples of material fraud perpetrated by these companies, as opposed to against them, are, in fact, so rare that, when they do happen, they become part of the national consciousness.  The reasons are simple.  It is in the best interests of companies to avoid even the appearance of wrongdoing lest they suffer adverse customer reaction in the marketplace and either perform less well or fail altogether.  And frauds such as those perpetrated by the companies mentioned cannot remain undetected indefinitely.  Sooner or later – more often sooner – such losses cannot be hidden from investors, competitors, creditors and customers, all of whom have a vested interest in paying attention to how the company is performing.  Again, the evidence is clear that the marketplace is at least as well equipped as any regulatory body at policing these entities.

In the final analysis, the demise of Enron and Worldcom had, by far, the greatest impact on the American public and on the economy as a whole. Jobs were lost; pensions disappeared; shareholders were stuck with worthless paper while executives unloaded their holdings. While other companies also went into bankruptcy, these two were the largest (and by a wide margin) to be brought down.  According to the Brookings Institution, the total economic impact of the Enron and Worldcom scandals was estimated to be in the $37 billion to $42 billion range in the first year assuming that the market did not rebound from levels at the time. [29]  At the time of their report, the Dow rested just below 8,200. A year later the Dow had risen to just under 9,100 (having averaged 8,459 over the period).  Government estimates and shareholder lawsuits put the total cost at about $65 billion. [30]

The first thing that the government did in response was to prosecute those who were guilty of wrongdoing.  This is an entirely appropriate response.  After all, fraud was already illegal.  Had the response stopped there the damage might have been minimized.  But then, the powers that be insisted that Congress do something! What they did was, of course, Sarbanes-Oxley.  And it demonstrated everything that is wrong about irresponsible regulation in the United States.

First of all, it was ostensibly designed to prevent the recurrence of actions such as those that took place at Enron and Worldcom, but not only were those actions already illegal, but nothing in the new legislation could in any way prevent deliberate fraud on the part of company management.  Second, in an amazing display of legislative incompetence, the new regulations were to be put into effect immediately, but several months went by before any guidance was provided regarding the nature and methodology of compliance.  But, worst of all, its cost to the economy was, and still is, several orders of magnitude greater than the cost of the problems it was supposedly designed to prevent.

A year after the legislation was passed, PricewaterhouseCoopers Management Barometer indicated that 58 percent of smaller companies, the key drivers of job creation, found that compliance with Sarbanes-Oxley was “costly”. More than two-thirds of those surveyed indicated that they expected those compliance costs to remain the same or increase over the coming years. Further, executives indicated that some 10.4 percent of their management control budgets were devoted to Sarbanes-Oxley compliance. [31]  In fact, according study by Foley & Lardner, LLP, in the wake of Sarbanes-Oxley, average audit fees for small companies soared 96 percent to $1 million in 2004. In the aggregate, that comes to tens of billions of dollars in a single year just for “small companies”. Overall, Foley & Lardner concluded that the cost of being a public company jumped 33 percent in that one year.  And a university of Rochester economist examined the overall impact of the Sarbanes-Oxley Act and concluded that. “[t]he loss in market value around the most significant rulemaking events [of Sarbanes-Oxley] amounts to $1.4 trillion”! [32]

So, the failure of business to prevent fraud costs the economy as much as $65 billion and the governmental response costs the economy as much as $1.4 trillion.  Tell me again how much better the government is at regulating business than the free market.  I must have missed something.

It’s all part of a pattern, really.  The insistence that business needs to be heavily regulated typically stems from a condition I call “fabricaphobia” –  from the Latin “fabrica” meaning “trade/manufacture/craft” and “phobia” meaning “irrational fear” - fear of business, occasionally even expressed simply: “Business scares me.”  Don’t get me wrong.  I am not suggesting that you trust anyone on faith.  I don’t trust any businessman seeking an audience with Caesar on the Potomac any farther than I could throw them with two unset broken arms.  What makes the fear irrational is the concurrent belief that government can accomplish anything besides making matters worse. And, part and parcel of this mindset, is the certainty that only government can hold business abuses in check.  The evidence is entirely contrary to that view.

Consider the alphabet soup of agency designed to protect is from business.  We have already examined the damage that the Environmental Protection Agency caused with regard to DDT.  But was the EPA necessary to protect us all from a rapidly deteriorating environment?  The evidence indicates otherwise.  In fact, the correlation between the adoption of economic liberty and the cleanliness of the environment is hugely positive.  This is why the environment in the United States, with relatively fewer controls has so few problems – the controversial subject of carbon dioxide emissions notwithstanding – while Eastern Europe has only emerged from a layer of soot in the years since the Iron Curtain fell.  Siberia remains the world’s largest landfill.

These results are not in the least surprising.  A clean environment is what is called a normal good.  This means that as economic well-being increases – a direct result of economic liberty – the demand for it increases.  But, it is asked, what about supply?  Where private property is enforced, this is not a problem.  The property owner has a huge vested interest in keeping his own property clean and/or monitoring his property to prevent the infringement upon his rights by others.  What problems there are arise in cases where private ownership of resources does not exist.  “As Garrett Hardin pointed out in his classic 1968 article ‘The Tragedy of the Commons,’ when no one owns a resource, it will be overused, because no one has an incentive not to overuse it.  One obvious solution is to transform, to the extent possible, the commons into private property.  This has been done with rivers, lakes and land … turning rivers, for example, into private property, as is done in Scotland.  Scotland, not coincidentally, has pristine rivers.” [33]

Then, there’s the Occupational Safety and Health Administration (OSHA).  It was created because, of course, without stringent oversight, businesses cannot be trusted to provide a safe working environment.  But is that assertion true?  “In fact, employers have many incentives to make workplaces safe. Since the time of Adam Smith, economists have observed that workers demand ‘compensating differentials’ (i.e., wage premiums) for the risks they face. The extra pay for job hazards, in effect, establishes the price employers must pay for an unsafe workplace. Wage premiums paid to U.S. workers for risking injury are huge; they amount to about $245 billion annually (in 2004 dollars), more than 2 percent of the gross domestic product and 5 percent of total wages paid [and that figure does not include the cost of workers’ compensation]. These wage premiums give firms an incentive to invest in job safety because an employer who makes the workplace safer can reduce the wages he pays.

“Employers have a second incentive because they must pay higher premiums for workers’ compensation if accident rates are high. And the threat of lawsuits over products used in the workplace gives sellers of these products another reason to reduce risks….  How well does the safety market work? For it to work well, workers must have some knowledge of the risks they face. And they do. One study of how 496 workers perceived job hazards found that the greater the risk of injury in an industry, the higher the proportion of workers in that industry who saw their job as dangerous.

“Workers on moderately risky blue-collar jobs, whose annual risk of getting killed is 1 in 25,000, earn a premium of $280 per year. The imputed compensation per ‘statistical death’ (25,000 times $280) is therefore $7 million. Even workers such as coal miners and firemen, who are not strongly averse to risk and who have knowingly chosen extremely risky jobs, receive compensation on the order of $1 million per statistical death….  These wage premiums are the amount workers insist on being paid for taking risks—that is, the amount workers would willingly forgo to avoid the risk….”

“Other evidence that the safety market works comes from the decrease in the riskiness of jobs throughout the century. One would predict that, as workers become wealthier, they will be less desperate to earn money and will therefore demand more safety. The historical data show that this is what employees have done and that employers have responded by providing more safety. As per capita disposable income per year rose from $1,085 (in 1970 prices) in 1933 to $3,376 in 1970, death rates on the job dropped from 37 per 100,000 workers to 18 per 100,000….

“Beginning with the passage of the Occupational Safety and Health Act of 1970, the federal government has attempted to augment these safety incentives, primarily by specifying technological standards for workplace design. These government attempts to influence safety decisions formerly made by companies generated substantial controversy and, in some cases, imposed huge costs. A particularly extreme example is the 1987 OSHA formaldehyde standard, which imposed costs of $78 billion for each life that the regulation is expected to save. Because the U.S. Supreme Court has ruled that OSHA regulations cannot be subject to a formal cost-benefit test, there is no legal prohibition against regulatory excesses….  Increases in safety from OSHA’s activities have fallen short of expectations. According to some economists’ estimates, OSHA regulations have reduced workplace injuries by, at most, 2–4 percent.” [34]

Some years back, I worked for the domestic arm of a major foreign property/casualty insurance company.  As one might expect, insurance companies have some experience addressing workplace safety, so, when OSHA inspectors arrived for a normal inspection, there was little concern that any problems would be found.  At the conclusion of the inspection, those expectations were vindicated, or so everyone thought.  The company was cited and substantially fined for the improper handing of hazardous materials.  That’s a serious infraction.  Mishandling of toxic substances ranging from powerful acids to zinc stearate dusts that can be inhaled can place workers at serious, even lethal, risk.  The problem: unattended on some office worker’s desk was an open bottle of White-Out correction fluid.  This is not to say that every regulatory action results in such overreactions, but the possibility is created by the regulations themselves.

The Consumer Product Safety Commission (CPSC) was created in 1972 and regulates no fewer than 15,000 products because, again, without someone looking over their shoulder, businesses would apparently kill off their customers with impunity.  The CPSC covers essentially any consumer product not otherwise regulated by some other federal agency such as the National Highway Traffic Safety Administration (NHTSA), the Bureau of Alcohol, Tobacco, Firearms, and Explosives (ATF) and the Food and Drug Administration (FDA).  The circumstances surrounding the need/effectiveness of each of these agencies are essentially the same, which is why the activities of the NHTSA are mentioned in this analysis.  The high-profile of the FDA warrants additional comment and is addressed below.  Certainly, in the absence of such an agency, the consumer would be at serious and continuous risk, right?  Don’t be ridiculous. 

The CPSC has only been in existence for 36 years.  How is it that consumers did not die off in the dark ages before this agency came into being?  As in the case of workplace safety, the market already provides huge incentives to companies to provide safe and effective products.  Those companies that fail to meet consumer needs – including for safe and effective products – will soon find themselves out of business.  There’s no question that unsafe products do occasionally make it to the marketplace but they are by far the exception rather than the rule.

But what should be done to address even the rare case of those products that make it to market because problems were not foreseen by the manufacturer or because there was an undetected problem with the production of certain items or even in the extremely rare instance of unscrupulous individuals not interested in protecting their reputation who try to dump hazardous or useless products on an unsuspecting public?  The private sector can’t be relied upon to address this hazard, can it?

Underwriters Laboratories Inc. was founded in 1894 as a private sector means of testing the reliability and safety of consumer products.  The A. M. best Co. was founded in 1899 to evaluate for consumers the viability of insurance providers.  Consumers Research was begun in 1929.  None of these organizations were involved in public policy matters.  Their roll was to fill the market demand for information about products and services made available to consumers.

How did that change?  A look at the automotive industry gives some insight:

In 1899, when the US population was about 76 million, there were 26 traffic fatalities in this country. [35]  Vehicles were assembled by hand – the use of assembly lines in auto manufacture wasn’t introduced until the next year by Ransom Olds (and perfected by some guy named Ford by 1906).  No government regulation existed regarding the safety of automobile manufacture.  Clearly we were in serious danger.

Fifteen years later, the number of automotive fatalities had risen to 4,468.  While that appears to be a huge jump, it is still far smaller than the increase in the number of automobiles on the road.  That was the year that Henry Ford introduced the previously unheard of $5/day wage (typical wages at the time were half that) to combat excessive turnover.  He somehow managed to offer this in absence of a federal minimum wage.  Federal safety guidelines for automobiles were still a quarter century away.

It wasn’t until 1921 that statistics were captured not just on the total number of traffic fatalities but on the total number of vehicle miles traveled (VMT).  In that year, there were 13,253 traffic deaths and 55 billion vehicle miles (a fatality rate of 24.09 per 100 million miles traveled – the NHTSA standard).  Driving is clearly a tremendously dangerous endeavor.  Still no safety regulation had been put in place.

The United States began its love affair with auto safety regulation in 1940 with a law mandating the use of sealed-beam headlights, effectively freezing innovation in headlight technology for four decades.  That year, the number of traffic fatalities had risen to 32,914, but the vehicle miles traveled had skyrocketed to 302 billion.  In the absence of governmental interference, the fatality rate went from 24.09 to 10.89.

Over the next couple of decades, more and more regulations were implemented in order to “save the American public” from unsafe automobiles.  In each case, the new regulation represented not some innovation on the part of government, but the mandatory adoption of some safety feature already developed by the private sector in order to make their products more attractive to customers.  The market forces that result in better and safer products were demonstrably working despite the increased level of regulatory interference.

Fast forward to 1965.  In the quarter-century since safety regulations had been implemented, the fatality rate was slashed in half, arguably due to factors that had nothing to do with those regulations.  While fatalities rose to 47,089, vehicle miles jumped to 888 billion, yielding a fatality rate of 5.30.  That, however, just wasn’t good enough.  That year, Ralph Nader published Unsafe at Any Speed, a book that made a number of suspect claims about alleged safety weaknesses in American automobiles, particularly in the Corvair.

Chief among the claims was that the Corvair used a swing-axle rear suspension design was inherently dangerous – hence the title.  The claim was completely without basis.  In reality, several other car manufacturers used the same design including Volkswagen, Mercedes-Benz and Porsche.  And General Motors had, in fact, begun using an improved suspension design beginning with its 1964 models – a fact that was readily available to the public before Nader’s book was submitted for publication.  Moreover, both NHTSA data and independent tests found that the 1960-1963 Corvair compared favorably to other contemporary cars including the Ford Falcon, Plymouth Valiant, Volkswagen Beetle and Renault Dauphine.  That the charges were without basis, as was the case with Rachel Carson’s Silent Spring, did not dissuade regulators from using it as an excuse to further expand their interventions.

Charges of over-reaching have plagued the CPSC since its creation.  At the outset, the agency issued regulations for bicycles including, for example, a requirement that a white reflector be mounted above the handlebar stem - the ordinary location for a bicycle headlight – that could only be seen by if a motorist’s headlights hit it while the rider was on the wrong side of the road.  Detractors of these regulations pointed out that they had, in fact, reduced cycling safety because it interfered with existing safety features (the headlight) and created an additional hazard by encouraging riders to cycle against traffic.  More recently, the CPSC has acted against chemical suppliers that might be used to make fireworks.  In June of 2003, it sent camouflaged officers armed with M16s to the home of Bob Lazar and Joy White, who owned a scientific supply company that catered to the needs of amateur scientists, students, teachers, and law enforcement professionals.  Authorities were not looking for the next Osama bin Laden or Timothy McVeigh; they were concerned “that Lazar and White were selling what amounted to kits for making M-80s, cherry bombs, and other prohibited items; such kits are banned by the CPSC under the Federal Hazardous Substances Act.” [36]

Of course, sometimes inferior or defective products do make it to market.  In March of 2007, for example, Menu Foods, Inc. recalled dog and cat food produced in the preceding three months upon learning that a protein additive supplied by a Chinese company was contaminated.

Recalls are a fact of modern life. Even though millions of Americans will go their entire lives without having had a product they’ve purchased recalled, everyone has certainly heard about them. There are so many different products available to consumers, many of them exhibiting ever increasing levels of complexity, that the chances that all of them will be perfectly and flawlessly designed and produced are simply non-existent. Thus, recalls are a demonstration of the general responsibility and responsiveness of American business as, in the majority of cases, they are undertaken voluntarily by businesses concerned about their customers and their reputation – not, as is all too frequently believed, at the behest of regulatory bodies.

The menu Foods story is a case in point.  Pet food companies uniformly test their products on a regular basis. This is why pet food recalls are rare. As one might expect, their testing procedures concentrate on those risks that are most significant and most likely to occur. In this instance, certain wheat and rice protein concentrates were contaminated with melamine. Used in plastics manufacture, this substance has no place in a food product and was never subject to testing. It is simply not possible to test for every hazardous substance in existence.  We now know that, while melamine has not been demonstrated to be particularly toxic to humans or dogs, it can cause lethal kidney problems in cats.  Pet food companies acted swiftly to get the unsafe products of the shelves often recalling perfectly good product to eliminate even the perception that they would allow pets to remain at risk.

In the fall of 1982, seven people in the Chicago area died mysteriously after taking capsules of Extra Strength Tylenol. It was later determined that someone had taken samples of the product from various stores in the Chicago area, inserted solid cyanide into the capsules and returned the products to the shelves. Long before anyone suspected tampering, however – just a week after the first victim died - Johnson & Johnson, parent company of the pain-reliever manufacturer, issued warnings to hospitals and distributors, halted Tylenol production and advertising and recalled an estimated 31 million bottles of the product – at a retail value of more than $100 million (twice that in today’s dollars).

When it was determined that only capsules were affected, the company volunteered to exchange solid tablet medication for any capsules that were still held by the public. Johnson & Johnson soon leaped to the vanguard of pharmaceutical companies offering products in tamper-resistant packaging.  This was not something that was undertaken at the behest of regulators.  The company was simply acting in its own interests.

In the wake of the deaths, Tylenol’s share of the pain reliever market collapsed from 35% to a mere eight percent. But because of the company’s swift action, within a year its market share rebounded. In November, just thirteen months after the scare, the company re-issued Tylenol capsules (now in tamper-resistant packaging) and quickly recaptured the distinction of being the most popular over-the-counter pain reliever in the US. Johnson & Johnson reaped the benefits of acting in the public’s interest and, by extension, their own.

No examination of recalls, though, can be undertaken without considering the one most frequently referred to by liberals out to expose the “greed” and indifference of the evil businessman: the Ford Pinto.

The story goes that the powers that be at Ford condemned hundreds to their deaths by failing to recall the Ford Pinto because they had determined that it was cheaper to defend the lawsuits than to recall the cars. They found that it would cost $121 million to perform the repairs and only $50 million to settle the lawsuits according to a memo revealed by Mother Jones. The incident was used as a basis for the film Class Action in 1991. It is also complete nonsense.

The document which Mother Jones grossly misrepresented was not about the Pinto, was not related to the vulnerability of the gas tank, was not an internal document, and had nothing to do with an assessment of tort liability. In fact, it was part of a response to the NHTSA regarding the potential cost of a new standard (on vehicle rollovers) to the automotive industry as a whole. The calculation of the value of human life at $200,000 was not some morbid assertion by Ford or an assessment of tort liability but was a figure from an NHTSA study in 1972 to determine the “social cost” of accidents. The document was ruled inadmissible in litigation against Ford because it was irrelevant to the issues at trial.

In reality, the Ford Pinto was no more likely to burst into flame than other cars, just as, again, the Corvair was no less safe than comparable vehicles in 1965. It was but one of several cars with behind-the-axle fuel tanks. And over 2 million Pinto’s were produced with the characteristics subject to recall, but only 27 people ever died in Pinto fires (Mother Jones argued, “conservative estimates Pinto crashes have caused 500 burn deaths”), indicating it was no more fire-prone than other vehicles of the time. Moreover, accident fatality rates were actually higher in a number of comparably sized automobiles.

Again and again, the story is the same.  The perceived need for intervention is based on misperceptions, failed premises, popular mythology and outright distortions while examples of regulatory failure are legion.

One more example of the alphabet soup remains for this analysis: the Food and Drug Administration (FDA).  Wouldn’t we all be subject to the quackery of snake oil salesmen if not for this benevolent agency that ensures the food we eat and the drugs we take are safe?  Hasn’t it saved millions of American lives?  As must be abundantly clear at this point, the answer is a resounding “no”.

Interestingly, the example of “snake oil” is the perfect metaphor for the perceptions of FDA effectiveness.  Snake oil has come to mean any medicine or treatment that is either quackish, ineffective or an outright fraud.  The irony is that, the original “snake oil” was none of these things and was ridiculed by purveyors of patent medicines at the time many of which were … quackish, ineffective or an outright fraud.  Snake oil, still available in China and in traditional Chinese medicine shops in the US today, was sold as a very specific treatment for pain and inflammation.  Oils and fatty tissues in snakes contain relatively high concentrations of the omega-3 fatty acid EPA (eicosapentaenoic acid.  According to the National Institutes of Health, “[r]esearch has shown that omega-3 fatty acids help reduce inflammation [and] their anti-inflammatory effects may help protect against heart disease…. Evidence from several studies has suggested that amounts of DHA and EPA … lowers triglycerides, slows the buildup of atherosclerotic plaques (‘hardening of the arteries’), lowers blood pressure slightly, as well as reduces the risk of death, heart attack, dangerous abnormal heart rhythms, and strokes in people with known heart disease.” [37]  The FDA has been sold as an unqualified benefit to society.  In that context, its performance does not even match that of snake oil.

The FDA was created in June 1906 in the wake of public reaction to Upton Sinclair’s The Jungle.  Sinclair, an avowed socialist and muckracking journalist living on a stipend from the socialist newspaper An Appeal to Reason intended the novel as an indictment of poverty, working conditions and the lack of a social safety net.  Instead, the imagery of workers falling into rendering tanks and being ground into “Durham's Pure Leaf Lard" created a panic about food safety.  As Sinclair would later admit, the scene was entirely fictional and he did no real research into working conditions in the meat-packing industry.  Efforts of people in the industry to disseminate the truth, however, were either treated with suspicion or ignored outright.  Still, people today unknowingly cite The Jungle as a portrait of real conditions before the FDA came into being.  The tradition of relying on poor science or outright fiction as a basis for regulation had now begun.

Accutane, Avonex, Baycol, Celebrex, Crestor, Exanta, Iressa, Ketek, Merisia, Serevent, Seroxat, Strattera, TGN 1412, Tysbari, Vioxx.  The list of drugs that have passed FDA scrutiny only to have been subsequently found to present serious problems to users is unbelievably long, but that really is not a useful indictment of the agency.  Some of these drugs are still on the market.  Some have returned as effective treatments while controls are in place to prevent the types of problems that occurred in the past.  And some were removed from the market for risks so negligible as to be hardly considered problematic.  Vioxx, for example, was voluntarily removed from shelves in 2004 – yet another example of a company acting without regulatory mandate to protect its reputation – when it was reported that it might increase the risk of heart attacks among users.  But the correlation was so low (0.4 percent of users affected) that medical boards in both Canada and the United States have recommended its return because the benefit to patients often outweighs the risk.  Of eight liability actions initiated against Merck, the drugs manufacturer, two were won by the manufacturer, one was dismissed, one was postponed after it was discovered that the plaintiff had falsified evidence, one ended in a hung jury (8-1 in favor of Merck), one had a split verdict, and two were lost, including the case of a 71 year old smoker who had a fatal heart attack after taking a one week sample pack (even though medical studies indicated that the adverse reactions did not appear until after a full month’s usage).  The losses are, understandably, under appeal.

The point is not that the FDA has been a failure because these and countless other drugs have slipped through the cracks of regulatory scrutiny.  The problems of each of these drugs were also missed by the research protocols of the manufacturers and independent testing labs routinely used by the pharmaceutical industry to ensure the safety of their products.  The point is that there is no evidence whatsoever that the federal government is any more capable than private researchers at ensuring the safety of the food and medicine supply.  The costs of regulatory failure on this front come in entirely different area.

Perhaps John Stossel put it best in 2005 when he wrote, “Getting a new drug approved now takes 12 to 15 years. It takes that long because the FDA wants to be extra sure every drug is safe and effective. That seems reasonable. But this vigilant pursuit of safety also kills people.

“Some years ago, the FDA held a news conference and proudly announced, "This new heart drug we're approving will save 14,000 American lives a year!" No one stood up at the press conference to ask, "Doesn't this mean you killed 14,000 people last year -- and the year before -- by keeping it off the market?" Reporters don't think that way, but the FDA's announcement did mean that. Thousands will die this year while other therapies wait for approval.” [38]

A Professor Scammington – a possible alias – puts it in “The Simpleton’s Guide”: “The agency determines which medicines we can buy ourselves, which require a prescription from a doctor and which cannot be sold to anyone.  Before the FDA makes a decision on whether to allow a new drug to be sold, the agency requires a long series of tests….  Unfortunately these tests tend to be very lengthy and expensive.  A new drug can take several years to go through the entire process.  Some of these tests would have been carried out by drug companies even without FDA oversight.  Others, however, would not.

“When those tests are completed, FDA begins to review them.  It’s here the FDA can make two types of mistakes.  If the FDA approves a drug that later turns out to have unexpected risks, people will suffer.  On the other hand, if FDA delays a badly needed drug, people will also suffer.  From a medical standpoint, the two mistakes are similar.  But from a political standpoint, there’s a huge difference.  If FDA mistakenly approves a drug, the victim’s stories will often be front page news and the agency itself will be in huge trouble.  On the other hand, if FDA mistakenly delays a badly needed drug, hardly anyone will ever know about the suffering caused by the delay.  For this reason, FDA tends to be overcautious in approving new therapies.

“Now, caution may sound like a good thing, but if you’re drowning and some bureaucrat demands to see the paperwork for the life-rope that I’m about to throw you, you’ll probably be dead by the time I get his okay.  In short, for many people FDA’s caution really amounts to deadly over-caution….

“[T]he basic question we should ask whenever we hear that FDA has approved a new lifesaving drug: If the drug will start saving lives tomorrow, how many people dies yesterday waiting for the FDA to act.  The answer, quite simply, is too many.” [39]

So far we have only scratched the surface.  There are countless other examples of misguided regulatory intervention that has caused more harm than good – rent control, licensure requirements, etc., some of which will be enlarged upon as we continue to examine the “government is good” position.  Still, the point has been made that, like the social safety net covered in the last chapter, the regulatory “pillar” of the modern democratic state is fundamentally flawed.  And the anti-government arguments against these pillars are thoroughly justified.

[1] Electronic Code of Federal Regulations (e-CFR), Title 7: Agriculture, Part 1160: Fluid Milk Promotion Program, as of November 14, 2008; retrieved November 18, 2008: http://ecfr.gpoaccess.gov/cgi/t/text/text-idx?c=ecfr;rgn=div5;view=text;node=7%3A9.1.1.1.22;idno=7;sid=f48f430c7dd5f7c1c1aa866b43534ff7;cc=ecfr.

[2]  “Why So Many Laws?”, Legal Ethics and Reform, accessed November 18, 2008: http://www.legalethicsandreform.com/hm_pg22.html.

[3] Salary.com salary wizard, part of CNNMoney.com, accessed November 18, 2008: http://swz.salary.com/salarywizard/layouthtmls/swzl_compresult_national_HS08000274.html.

[4] An examination of the fractional reserve banking system is worthwhile but beyond the scope of this analysis.  Those interested in more on that topic should consider Murray Rothbard’s What Has Government Done to Our Money?, 1980: http://mises.org/money.asp and The Mystery of Banking, 1983: http://mises.org/Books/mysteryofbanking.pdf; Ludwig von Mises’ The Theory of Money and Credit, 1912: http://mises.org/books/Theory_Money_Credit/Contents.aspx; and Hans Herman Hoppe’s “The Devolution of Money and Credit”: http://mises.org/journals/rae/pdf/RAE7_2_3.pdf.

[5] Jim Powell, FDR’s Folly: How Roosevelt’s New Deal Prolonged the Great Depression (Three Rivers Press, New York, New York, 2003), p. 31.

[6] Margit von Mises, My Years with Ludwig von Mises. Arlington House, (1976) p.31.

[7] Austrian Institute of Economic Research Report. February 1929.

[8] All CD rates referenced are from: EconoMagic.com Economic Time Series Page: Series Title: 1-month CDs (secondary market): http://www.economagic.com/em-cgi/data.exe/fedbog/cd1m.

[9] Federal Reserve Bank of Boston: Depository Institutions Deregulation and Monetary Control Act of 1980: http://www.bos.frb.org/about/pubs/deposito.pdf.

[10] Federal Deposit Insurance Corporation: FDIC, Law, Regulations, Related Acts: Garn-St. Germain Depository Institutions Act of 1982: http://www.fdic.gov/regulations/laws/rules/8000-4100.html.

[11] Ronald Reagan, “Remarks on Signing the Garn-St Germain Depository Institutions Act of 1982” October 15, 1982: http://www.reagan.utexas.edu/archives/speeches/1982/101582b.htm.

[15] Susan E. Kennedy, The Banking Crisis of 1933. University of Kentucky Press, 1973. p. 1-5.

[16] Edward J. Kelly, III. Deregulating Wall Street: Commercial Bank Penetration of the Corporate Securities Market, p. 53.

[17] Gramm-Leach-Bliley Act: http://frwebgate.access.gpo.gov/cgi-bin/getdoc.cgi?dbname=106_cong_public_laws&docid=f:publ102.106.

[18] Economists Robert B. Ekelund and Mark Thornton have argued persuasively that the Act amounted to “corporate welfare for financial institutions and a moral hazard that will make taxpayers pay dearly”, but I disagree – not with their analysis of the effect (though with the Fed infusion of liquidity, I think it likely that the markets would have found ways to create financial instruments whether the vestiges of Glass-Steagall remained or not) but rather with their placement of blame.  As they concede, the Act would have made “perfect sense in a world regulated by a gold standard, 100% reserve banking, and no FDIC deposit insurance [which is the next topic in the analysis]”.  I would argue that the appropriate response is to suggest that the underlying cause be addressed - as the authors have done repeatedly – and place the blame there, and on the repeated governmental socialization of losses in the financial services industry, rather than placing it on the repeal of another governmental interference measure that was not designed to address the problems of fiat money, fractional reserve banking, deposit insurance, but provided protection against moral hazard on an essentially incidental basis.  Their take can be found here: “More Awful Truths About Republicans”, The Ludwig von Mises Institute: http://mises.org/story/3098.  While I disagree with their take on that one particular point, their analysis on the whole is insightful, on point and alarmingly accurate.  From either viewpoint, it remains an example of regulatory failure.

[19] John R.Walter “Depression-Era Bank Failures: The Great Contagion or the Great Shakeout?”, Federal Reserve Bank of Richmond Economic Quarterly, Volume 91/1, Winter 2005: http://www.unc.edu/~salemi/Econ423/Depression_Era_Bank_Failures.pdf.

[20] John R.Walter “Depression-Era Bank Failures: The Great Contagion or the Great Shakeout?”, Federal Reserve Bank of Richmond Economic Quarterly, Volume 91/1, Winter 2005: http://www.unc.edu/~salemi/Econ423/Depression_Era_Bank_Failures.pdf.  The paper cites further research: Calomiris, CharlesW., and Joseph R. Mason. 1997. “Contagion and Bank Failures During the Great Depression: The June 1932 Chicago Banking Panic.” American Economic Review 87 (December): 863–83 and Benston, George J., and George G. Kaufman. 1995. “Is the Banking and Payments System Fragile?” Journal of Financial Services Research

9: 209–40.

[21] George R. Kaufman, “Bank Runs”, The Concise Encyclopedia of Economics: http://www.econlib.org/library/Enc/BankRuns.html.

[22] John H. Wood, "Review of Elmus Wicker, The Banking Panics of the Great Depression." EH.Net Economic History Services, May 28 1997. URL: http://eh.net/bookreviews/library/0028.

[23] I make it a point not to reveal the identity of the institution for which I work as the opinions and research work I perform is entirely my own.  Were I not convinced that this level of increase in premiums is not isolated to this one institution but is impacting the rest of the industry in a like manner, I would have been hesitant to reveal even this much.  As this is, therefore, an un-sourced anecdote, it is provided for illustrative purposes only and is not used as the basis for any analytical conclusions.

[24] Vasso P. Ioannidou and Jan de Dreu. Tilburg University Discussion Paper No. 2006–05, “The Impact of Explicit Deposit Insurance on Market Discipline”, January 2006: http://arno.uvt.nl/show.cgi?fid=53872.  This article appeared in slightly different forms in “Proceedings”, Federal Reserve Bank of Chicago, issue May, pages 124-139 (2005) and DNB Working Papers 089, Netherlands Central Bank, Research Department (2006).

[25] Linda M. Hooks and Kenneth J. Robinson. ”Deposit Insurance and Moral Hazard: Evidence from Texas Banking in the 1920s”. Journal of Economic History 62, no. 3:833–53. (2002).

[26] Much of this section, and to a lesser extent the section above,  appeared in substantially different form in a series of columns I wrote some time ago: http://fletchforfreedom.blogtownhall.com/2007/05/14/do_you_recall.thtml, http://fletchforfreedom.blogtownhall.com/2007/05/16/enrons_and_tycos_and_worldcoms_-_oh_my!.thtml, http://fletchforfreedom.blogtownhall.com/2007/05/18/the_consumer_advocacy_fraud.thtml.  The first article in the series was the last one written before a number of columns were purged and wil be republished after this chapter is completed.

[27] The response to Hurricane Katrina, like the history of bank regulation provides a good example of another problem that arises in any discussion of regulatory failures: partisanship.  All too often, it is believed that if only the “other” party were in charge that the failure would not have occurred.  Given actual history, this amounts to nothing more than self-delusion.  Regulatory agencies fare no better under the auspices of any given party.  As we have seen, regulations have failed spectacularly under the administrations of both the major parties.  The pretense that is a Democrat or Republican problem is entirely without basis.

[28] Wikipedia, “Political scandals of the United States”, retrieved November 29, 2008: http://en.wikipedia.org/wiki/Political_scandals_of_the_United_States.

[29] Carol Graham, Robert E. Litan and Sandip Sukhtankar, “The Bigger They Are, The Harder They Fall: An Estimate of the Costs of the Crisis in Corporate Governance” The Brookings Institution, July 22, 2002: http://www.brookings.edu/papers/2002/0722corporategovernance_graham.aspx.

[30] “Group seeks Sarbanes-Oxley changes”, WFAA, November 30, 2006: http://www.wfaa.com/sharedcontent/dws/bus/stories/120106dnbussarbox.c23bb3.html.

[31] SmatPros Editorial Staff, “Execs Don't Agree on the Cost of Sarbanes-Oxley Compliance”, SmartPros, July 3, 2003: http://www.pro2net.com/x39489.xml.

[32] Ivy Xiying Zhang, “Economic Consequences of the Sarbanes-Oxley Act of 2002”, University of Rochester, February 2005: http://w4.stern.nyu.edu/accounting/docs/speaker_papers/spring2005/Zhang_Ivy_Economic_Consequences_of_S_O.pdf.

[33] David R. Henderon, “Are We Ailing From Too Much Deregulation?”, Cato Policy Report, Vol. XXX, No. 6, November/December 2008.

[34] W. Kip Viscusi, Job Safety, The Concise Encyclopedia of Economics, retrieved November 30, 2008: http://www.econlib.org/library/Enc/JobSafety.html.

[35] All traffic fatality data comes from the “Motor Vehicle Traffic Fatalities & Fatality Rate: 1899-2003”: http://www.saferoads.org/federal/2004/TrafficFatalities1899-2003.pdf.

[36] Steve Silberman, “Don’t Try This at Home”, Wired Issue 14.06, June 2006: http://www.wired.com/wired/archive/14.06/chemistry.html?pg=1&topic=chemistry&topic_set=.

[37] NIH Medline Plus. "MedlinePlus Herbs and Supplements: Omega-3 fatty acids, fish oil, alpha-linolenic acid". Retrieved on November 30, 2006: http://www.nlm.nih.gov/medlineplus/druginfo/natural/patient-fishoil.html.

[38] John Stossel, “Protecting us from the good things?’ Creators’ Syndicate, June 1, 2005, retrieved from Townhall.com: http://townhall.com/columnists/JohnStossel/2005/06/01/protecting_us_from_the_good_things.

[39]  Professor Scammington, “The Simpleton’s Guide”, Youtube.com, retrieved November 30, 2008: http://www.youtube.com/watch?v=ICqAK9tRmok.  I do not present the good professor as a reputable primary source, Youtube, not exactly meeting the criteria of a respected research journal.  That said, the points made are logically sound, consistent with the factual evidence and presented in an entertaining fashion.

Reclaiming Adam Smith – Part Three

Perhaps the most outrageous claim made by those who would co-opt Adam Smith to their cause is that he would embrace government intervention into international trade. This assertion is simply absurd. More than anything else, Smith’s seminal work, The Wealth of Nations, was a repudiation of mercantilism.

Mercantilism held, as do the populists of today, that economic prosperity resulted from its supply of capital in the form of physical assets – most notably among the early mercantilists, bullion held by the state – and was enhanced by protectionist tariffs designed to maintain a positive balance of trade. It was arguably the dominant school of economic thought (though it would not have been referred to as such) for much of the sixteenth, seventeenth and eighteenth centuries and was characterized by the greatest intervention, to that time, by governments into economic activity.

Then, as now, the underlying fallacy that behind the mercantilist and populist positions is that prosperity is a zero-sum game; that one can only achieve greater wealth at the expense of another. Interestingly, while many populists have taken these positions from the perspective of “protecting the worker”, most mercantilists argued that laborers should only live at the “margins of existence” in order to maximize production – ignoring the role of consumption in the economy.

Adam Smith rejected not only the concept of mercantilism; he rejected the interventionist role of the state that would make such a system possible. Smith was quite clear about what role the state should have and it left no room for economic tinkering:

“[T]he sovereign has only three duties to attend to ... first, the duty of protecting the society from the violence and invasion of other independent societies; secondly, the duty of protecting, so far as possible, every member of the society from the injustice or oppression of every other member of it, or the duty of establishing an exact administration of justice, and thirdly, the duty of erecting and maintaining certain public works and certain public institutions, which it can never be for the interest of any individual, or small number of individuals, to erect and maintain...”

Smith also understood (as apparently Paul Krugman and Lou Dobbs do not) that international trade is carried out not between nation states but between individuals acting in their own self-interests. Individuals, he believed should be permitted to manage their own economic affairs and, by extension, trade with whomever they pleased:

“It is the highest impertinence and presumption, therefore, in kings and ministers, to pretend to watch over the economy of private people, and to restrain their expense... They are themselves always, and without any exception, the greatest spendthrifts in the society. Let them look well after their own expense, and they may safely trust private people with theirs. If their own extravagance does not ruin the state, that of their subjects never will.”

He viewed governmental intervention with nothing less than suspicion:

“The statesman who should attempt to direct private people in what manner they ought to employ their capitals, would not only load himself with a most unnecessary attention, but assume an authority which could safely be trusted, not only to no single person, but to no council or senate whatever, and which would nowhere be so dangerous as in the hands of a many who had folly and presumption enough to fancy himself fit to exercise it.”

Faced with these responses, the populist falls once again back on the old stand-by, arguing that because Adam Smith was a “moral philosopher” that he would never have condoned trade with countries that employed “child or slave labor”. The issue of child labor has already been largely addressed. But what about slave labor?

Certainly, as a champion of liberty, the author of The Wealth of Nations was no fan of the practice. And he rejected out of hand the notion that the enslavement of “inferior” peoples was acceptable arguing that, “[t]he difference of natural talents in different men is, in reality, much less than we are aware of; and the very different genius which appears to distinguish men of different professions, when grown up to maturity, is not upon many occasions so much the cause, as the effect of the division of labour. The difference between the most dissimilar characters, between a philosopher and a common street porter, for example, seems to arise not so much from nature, as from habit, custom, and education.” But his objection to slavery as evidenced in his magnum opus was an eminently practical one:

“From the experience of all ages and nations, I believe, that the work done by free men comes cheaper in the end than the work performed by slaves. Whatever work he does, beyond what is sufficient to purchase his own maintenance, can be squeezed out of him by violence only, and not by any interest of his own.”

Even this was a remarkable position at the time. It must be remembered that, in England, slavery, while officially outlawed for centuries, existed as a result of a sort of legal neglect until 1772 when the Court of the King’s Bench ruled that servitude could not be enforced even upon servants brought into the country. For that matter, the last of the coal mining serfs in Smith’s native Scotland were not emancipated until 1799.

Smith never advocated curtailing the trade with America, for that matter, where the slave trade was still very much alive. In the end, he concluded that this was not sufficient cause to interfere with the trade that was taking place:

“It is the maxim of every prudent master of a family, never to attempt to make at home what it will cost him more to make than to buy... What is prudence in the conduct of every private family, can scarce be folly in that of a great kingdom. If a foreign country can supply us with a commodity cheaper than we ourselves can make it, better buy it of them with some part of the produce of our own industry, employed in a way in which we have some advantage.”

…and…

“Whether the advantages which one country has over another be natural or acquired is in this respect of no consequence. As long as the one country has those advantages, and the other wants them, it will always be more advantageous for the latter rather to buy of the former than to make.”

In the end, I would argue that the moral stance is to embrace free trade among free individuals, not merely in spite of, but, particularly in cases of those countries that have poorer wage systems, fewer worker protections and decidedly less free economies. This is because, if anything, history has demonstrated that this is the surest way to bring such oppressive systems to an end (a point I will elaborate on in my next column) and increase the general prosperity of all concerned.

I will not presume to say that Adam Smith would believe exactly as I do, but I think it’s fair to say that his writings are more indicative of such an agreement than they are of the positions otherwise attributed to him by the Left.

Reclaiming Adam Smith – Part Two

Unlike in the case of child labor, Adam Smith spoke extensively about the issue of governmental involvement in the economy. It was, in fact, his primary concern. Modern liberals, however, have attempted to distort what he actually had to say about the issue in order to claim that he would share their advocacy of worker protection laws, anti-trust laws, interference with the free trade of free individuals in the international marketplace, etc., as if Adam Smith were a kindred spirit. Again, nothing could be farther from the truth. The passage from The Wealth of Nations most frequently cited as endorsement of the modern liberal position is this one:

“People of the same trade seldom meet together, even for merriment and diversion, but the conversation ends in a conspiracy against the public, or in some contrivance to raise prices.”

It seems a simple enough declarative statement condemning the actions of businessmen who will typically conspire against workers and the general public unless something is done to prevent it, right? Wrong.

Smith was describing the behavior of tradesmen under the guild system that existed in late eighteenth century England and Scotland - a system he vehemently opposed. It was a state-enforced, self-perpetuating trade oligopoly that fostered such behavior. And while the system had characteristics that were in some ways similar to both modern corporate structures and organized labor, it was materially different from either. It was specifically this state-facilitated collusion that Smith was attacking, not the actions of free individuals in an open marketplace.

One need look no further than the remainder of the same paragraph in which those fateful words can be found in order to understand the context in which they were actually written and to see the gross distortion that is necessary in order to co-opt Smith’s message. If the man from Kirkcaldy were advocating a governmental solution, rather than the removal of governmental involvement, then would he follow with, “It is impossible indeed to prevent such meetings by any law which either could be executed, or would be consistent with liberty and justice (emphasis added)”? Obviously, not. It would be completely inconsistent with his entire body of work in defense of individual liberty to suddenly advocate state intervention to prevent free individuals from coming together.

It is in the next sentence that Smith identifies the real culprit in this scenario, as embodied by the guild system: “But though the law cannot hinder people of the same trade from sometimes assembling together, it ought to do nothing to facilitate such assemblies, much less render them necessary (emphasis added).”

The guild system as it existed in Smith’s time involved the incorporation of business interests [Note: the terms “incorporation” and “corporations” as described in The Wealth of Nations refer not to corporations in the modern sense, to which, as alluded to previously, they bear little resemblance, but, rather, to the guild system as legitimized by state sanction.] into protected trade organizations that could stifle competition, control wages and prices and act as an oligopoly. This, the ham-handed intervention by the state that undermines the free market process, was the target of the moral philosopher’s ire.

Smith even goes on to say: “A regulation which obliges all those of the same trade in a particular town to enter their names and places of abode in a public register, facilitates such assemblies…. A regulation which enables those of the same trade to tax themselves in order to provide for their poor, their sick, their widows and orphans, by giving them a common interest to manage, renders such assemblies necessary…. An incorporation [see the caveat mentioned above] not only renders them necessary, but makes the act of the majority binding upon the whole. In a free trade an effectual combination cannot be established but by the unanimous consent of every single trader, and it cannot last longer than every single trader continues of the same mind. The majority of a [guild] can enact a bye-law with proper penalties, which will limit the competition more effectually and more durably than any voluntary combination whatever (emphasis added).”

“The pretence that [guilds] are necessary for the better government of the trade, is without any foundation. The real and effectual discipline which is exercised over a workman, is not that of his [guild], but that of his customers. It is the fear of losing their employment which restrains his frauds and corrects his negligence.”

Smith explicitly argues that the absence of government involvement – as exhibited by, in this case, the creation of the guild - is sufficient protection for the workman and the public. This, alas, is not the only passage from Smith’s magnum opus that is grossly distorted to make it appear that he favored protections for workers against the depredations of unscrupulous businessmen. There is, of course, this passage:

“It is not, however, difficult to foresee which of the two parties [masters or laborers] must . . . have the advantage in the dispute, and force the other into a compliance with their terms. The masters, being fewer in number, can combine much more easily; and the law, besides, authorises, or at least does not prohibit their combinations, while it prohibits those of the workmen.”

And this one:

“The masters upon these occasions are just as clamorous upon the other side, and never cease to call aloud for the assistance of the civil magistrate, and the rigorous execution of those laws which have been enacted with so much severity against the combinations of servants, labourers, and journeymen (emphasis added).”

In each case, the thrust of Smith’s argument is not that workers require protection from “masters”, but rather that the involvement of the state (“those laws”) is the problem to be addressed, in the absence of which workers would not need further protection.

Again, if this were not so, then why, in the same passage, would Smith argue that there is frequently created “a contrary defensive combination of the workmen, who sometimes too, without any provocation of this kind, combine of their own accord to raise the price of their labour. Their usual pretences are, sometimes the high price of provisions; sometimes the great profit which their masters made of their work…. [the same pretenses used today to advocate unionization, minimum wage laws, etc.] In order to bring the point to a speedy decision, they always have recourse to the loudest clamour, and sometimes to the most shocking violence and outrage. They are desperate, and act with the folly and extravagance of desperate men, who either starve, or frighten their masters into an immediate compliance with their demands (emphasis added).”

The point was never that one side should be “given” more power or protection from the other. That simply makes matters worse. Smith, a vocal proponent of individual liberty for both the workman and the “master”, saw the intervention of the state as the problem and the chief threat to liberty, justice and an orderly, peaceful society.

There is simply no way to reconcile Smith’s writings with the modern liberal or populist positions when examined in context.

Adam Smith wasn’t perfect. And he wasn’t right on every single point. Smith, like everyone else, was a man of his times, limited by the available knowledge and by the culture and mores of the time in which he lived. He is, nevertheless, one of my heroes.

Smith, born in a small coastal Scottish village in 1723, grew up to become a moral philosopher, political economist and, when he published An Inquiry Into the Nature and Causes of theWealth of Nations 231 years ago this month, he became the father of modern economic thought. Not everything he wrote in his treatise has stood the test of time (most notably with regard to interest rates) - we have, after all, learned a thing or two in the past two centuries or so - but the great majority of it remains untouched (particularly by another treatise published in 1848). It isn’t simply that he was correct that makes him a hero to me. He saw the world in what was then an unconventional manner and was able to convey that vision to others in such a way that his ideas and even his phraseology (“the invisible hand”) have become pervasive in our society despite a conscious and concerted effort to attack the points he was making.

Sadly, two centuries later, the assault upon his ideas continues by those who either have a decidedly different agenda or who ignore the evidence that Smith so eloquently brought to light. Worse still, some have begun to twist his words and misidentify his positions in order to bolster their own fallacious arguments, sometimes claiming that Smith supported public charity (a welfare state), that he advocated the protection of laborers by the state, that he opposed what has come to be known as “wage slavery” and even, unbelievably, that he favored state-imposed barriers, of any kind, to free trade. It is my intention to dispel these obvious myths over the next few columns so that one might be better prepared for such assaults when they appear.

Like me, Adam Smith was interested in bettering the human condition. And, like me, he found that the greatest threat to these things was the interference of the state. It was his desire to advance human liberty and prosperity by demonstrating how conditions, as they existed at the time, undermined these things and made things particularly difficult for the poor. Thus, his Inquiry was an all out assault on those things that were interfering with the increased prosperity of the laborer, most notably mercantilism (which most resembles modern populism), the guild system (wherein the state enforced a collusive relationship among employers), and the “poor laws” (precursor to the welfare state which required each parish to support its poor … with devastating results). Before taking each of these items in turn, however, I’d like to begin with something about which he wrote nothing at all: child labor.

Frequently, those who would misconstrue Smith’s writings will concentrate, to the exclusion of all else, on the fact that he was a “moral philosopher”. This is a common tactic of the Left – perhaps the most common – wherein the position taken is deemed to be “on the side of the angels” and all others are deemed to be morally inferior and, therefore, unworthy of further consideration. In reality, this is a false debating tactic designed to obscure the fact that, typically, both sides of the debate agree that the societal issue to be addressed (poverty, tyranny, slavery, etc.) should be reduced and the real debate involves the suggested methodologies to bring this about. Thus, those cloaking themselves in the blanket of moral superiority conclude that because Smith was a “moral philosopher” that he must have objected to child labor. Nothing could be farther from the truth.

I have no doubt that Smith would have been delighted that child labor has largely come to an end in the Western world, but that is not the same thing. It must be remembered that the abolition of child labor is a conceit of modern prosperity in an industrialized world. In Smith’s time, child labor was the norm, considered by all concerned to be completely ordinary because the economies of the world in the late eighteenth century were overwhelmingly agricultural. Suggesting to a farmer then (and in many parts of the world today) that the family farm should not be worked by all members of the family would be met with simple incredulity.

As the very things that Smith observed began to take hold over time – primarily the greater reliance upon the division of labor and industrialization – the related increase in overall prosperity ultimately made it possible to consider freeing the society’s children to engage in other pursuits. It did not, however, happen overnight. As much as twelve years after Smith penned The Wealth of Nations, the new water-powered textile factories in England and his native Scotland were overwhelmingly staffed with children. It wasn’t until Lord Shaftesbury campaigned to bring an end to child labor in England that the trend was even reversed - and he wasn’t even born until more than a decade after Smith was in his grave.

In this country and elsewhere, the move to bring child labor to an end was less the result of concern for the little kiddies than an attempt by the newly growing organized labor movement (in the early nineteenth century) to restrict employment opportunities for others so that their own wages and employment levels would be increased. It was the trade unions that began agitating for restrictions upon child labor in the early 1830s and it wasn’t until the 1830s and 1840s that child labor laws were passed for the first time both here in the United States and in England. In fact, it would be another century (1938) before minimum ages of employment were established by federal law in this country.

It may be hard to grasp just how new the concept of abolishing child labor is in a world where the United Nations, in their Convention on the Rights of the Child states, “Parties recognize the right of the child to be protected from economic exploitation and from performing any work that is likely to be hazardous or to interfere with the child's education, or to be harmful to the child's health or physical, mental, spiritual, moral or social development”, but the history is indisputable.

This is not an advocacy of child labor or a desire to alter societal mores so as to encourage such practices, but the attempt by the “morally superior” to bolster their own positions by arguing that a renowned figure from the past (in this case, Adam Smith) believed as they do is not simply an example of dishonesty by the one making such a claim, but demeans the accomplishments of the personage cited which took place regardless of (and, frequently, in spite of) the conditions that existed at the time.

Smith deserves better than such mistreatment.

Chapter Two: The Ideological Divide

Modern socialists – that is, those not advocating a Marxian fantasy world in which the state abolishes itself upon the destruction of all classes and the implementation of “true” communism – often would have you believe that the attack upon ever greater government intrusion into the lives of the citizenry is some new phenomenon, born of the Reagan Revolution, reared by Newt Gingrich and kept alive by a radical fringe element – led by Grover Norquist - that wishes to tumble us all back to the dark ages. As this fairytale goes, the Founding Fathers were unapologetic advocates of governmental action [1] in essentially every part of our lives in order to achieve a “more just” society and anti-governmental sentiment did not really amount to much before Franklin Delano Roosevelt “saved” capitalism and selfish rich people refused to pay their fair share.

As is so frequently the case, actual history has a tendency to deviate substantially from socialist mythology. Distrust of government dates back probably as long as states have existed, certainly as far back as the ancient Greeks when Antigone, openly refusing to heed a rulers' decree, replied “ekhous apiston tênd anarkhian polei" (Nor am I ashamed to act in defiant opposition to the rulers of the city) [2] Put simply, the evolution of anti-government sentiments tracks very closely each practical application of greater governmental power.

Then, as now, this war of ideas was waged not in secret cabals and hidden chambers, but in the full light of day. A whole library of work from Karl Marx to David Friedman, from John Maynard Keynes to Murray Rothbard, and, historically, from Niccolo Machiavelli’s The Prince to Grover Norquist’s Leave Us Alone - Getting the Government's Hands Off Our Money, Our Guns, Our Lives. And the real world implications of these visions have been examined, again openly, from the likes of Adam Smith to John Kenneth Galbraith to James M. Buchanan.

Charges of “conspiracy” on either hand serve only to undermine the credibility of those making such charges. At the very moment that a group of individuals meets each Wednesday at the offices of Americans for Tax Reform to discuss ways “to cut government in half in twenty-five years … to get it down to the size where we can drown it in the bathtub", [3] still others are meeting at the National Committee for an Effective Congress and at those of Moveon.org. In fact, according to USA Today, “at the urging of House Democratic leader Richard Gephardt, a group of labor leaders, environmentalists, abortion-rights activists and others ... began a weekly session [every Wednesday] chaired by Rep. Rosa DeLauro, D-Conn…. to provide ‘an open exchange of information about a shared agenda.’” [4] This is not to say that anything is wrong with the meetings of any of these organizations, but it does demonstrate, particularly when Norquist’s statement is so secret that it is perhaps his most repeated missive, [5] that referring to such meetings as conspiratorial is foolish at best and blatantly dishonest at worst.

Correcting History: From Mercantilism to Adam Smith

In their ideological zeal to discredit any opinion not fully embracing the pro-government stance, some would have you believe that the push for a smaller or more-controlled government is some new creation that sprang magically into being when Ronald Reagan famously announced “Government isn’t the solution; it’s the problem” [6] and subsequently expanded upon it by saying “The ten most dangerous words in the English language are 'Hi, I'm from the government, and I'm here to help’” [7] In reality, the realization that government is more often the creator of problems rather than their solution has been learned, forgotten and relearned over and over again throughout history. When David Boaz suggested that the “real problem in the United States is the same one being recognized all over the world: too much government” he was discussing merely this latest relearning process and it had clearly been underway since at least the 1950s. He further argued not that this realization would result in any sort of conspiratorial backlash but simply that “in a fast-changing world where every individual has unprecedented access to information, centralized bureaucracies and coercive regulations just can't keep up with the real economy.” [8]

For most of human history, the economic concerns of the state fell into only two categories, taxation and slavery. In the first instance, the power of the state was used both to finance the crown and to enforce its authority. The concept of state intervention into the economy to achieve national goals did not arise until very recently from an historical standpoint, as is detailed below. Slavery is now, and has always been, a state enforced and protected institution. From ancient times we know that slavery was a governmental response to the care of prisoners of war, the penalty for commission of a crime, and a penalty for failure to pay debts. Moreover, while slavery can be characterized as an economic intervention, intertwined as it is with the concepts of property ownership, labor and industry, economic arguments were never put forth to bring it into existence and were only used in relatively recent history – untenable as such arguments are – as a reason for the institution’s retention. Slavery has always been a state creation, not a capitalistic one.

Economic intervention as a deliberate government policy did not really come into existence until the 16^th Century.  Machiavelli’s The Prince, written in 1513, was not published until 1532. It was probably the first tract regarding the proper exercise of state power of modern times. In 1589, a response was penned by Giovanni Botero entitled The Reason of State.  In it, Botero argued that Machiavelli’s view was amoral, but the most enduring aspect of Botero’s work was that he presented economics as an aspect of politics and the national interest.

It was this concept that evolved over the following decades as an embrace of mercantilism – the economic theory that links national economic prosperity to its supply of capital as determined by a positive trade balance. It is essentially this theory that is behind every claim that we face economic ruin (or are losing jobs) as a result of an out-of-control trade deficit. This theory’s greatest proponent was perhaps the English merchant Thomas Mun who believed “gold was a stable measure of wealth, and trade should be centrally regulated by the government to produce an excess of exports over imports in order to gain more gold for the country.” [9] Mun laid out much of his thesis in A Discourse of Trade, from England unto the East Indies (1621) and expanded upon it in England’s Treasure by Forraign Trade (1664) published after his death.

The embrace of mercantilism by European governments was the dominant economic trend until the late 18^th century. It was, after all, being implemented by human beings acting in what they believed to be their own best interests. As Lord Bolingbroke observed in a letter to Sir William Windham in 1717, “I am afraid that we came to Court in the same dispositions as all parties have done; that the principal spring of our actions was to have the government of the state in our hands; that our principal views were the conservation of this power, great employments to ourselves, and great opportunities of rewarding those who had helped to raise us, and of hurting those who stood in opposition to us.” [10] While the nature of government action has changed in the intervening three centuries, the nature of the individuals acting as its agents has clearly not changed in the slightest. Perhaps that is why Edmund Burke famously advocated the abolition of government in A Vindication of Natural Society (1756).

By 1773, the very same year that a revolt against taxation broke out in Boston Harbor, a student of moral philosophy and political economy from Kirkcaldy, Scotland, had begun a series of lectures that he would eventually expand into one of the most influential works of all time. Notes on these lectures, recorded by a student, were published more than a century later in Lectures on Justice, Police, Revenue and Arms (1896) by E. Cannan. The man was Adam Smith, oft described as the father of modern economics, and within three years he would publish An Inquiry into the Nature and Causes of the Wealth of Nations.

The Wealth of Nations is likely the earliest well-known critical evaluation and rejection of governmental interference in the economy. [11] It destroys the arguments of the mercantilists (though, sadly, such ideas survive today), attacks the government-supported guild system (monopoly created, as is nearly always the case, by the state) and undermines the economic argument in favor of slavery. It was perhaps the first fully articulated defense of the free market and, with a few exceptions (most notably his failure to foresee the subsequent embrace of the concept of marginal utility as a determinant of value and his attempt to artificially distinguish rent from other capital sources), it has stood the test of time. The important thing to note in this discussion is that it completely repudiated the the two major governmental forays into the economy underway at the time.

Some have argued that this moral philosopher, frequently referenced by modern capitalists, believed that the embrace of the free market would inevitably retain the institution of slavery. That position is preposterous. [12] Smith was a believer in the concept of “perfect liberty” and his assessment of slavery is quite clear:

“It appears, accordingly, from the experience of all ages and nations, I believe, that the work done by freemen comes cheaper in the end than that performed by slaves. It is found to do so even at Boston, New York, and Philadelphia, where the wages of common labour are so very high.” [13]

“But if great improvements are seldom to be expected from great proprietors, they are least of all to be expected when they employ slaves for their workmen. The experience of all ages and nations, I believe, demonstrates that the work done by slaves, though it appears to cost only their maintenance, is in the end the dearest of any. A person who can acquire no property, can have no other interest but to eat as much, and to labour as little as possible. Whatever work he does beyond what is sufficient to purchase his own maintenance can be squeezed out of him by violence only, and not by any interest of his own.” [14]

The bulk of this seminal volume was not directed at slavery but rather at the major tenets of mercantilism: the notion that the accumulation of gold bullion or other precious metals – primarily by ensuring a positive international trade balance – was the key to national economic success and that protectionist tariffs (a monopolization of home markets) yielded economic benefits. I will not present Smith’s entire argument here. There are, however, a couple of excerpts from The Wealth of Nations that sum up the position rather nicely:

“To give the monopoly of the home-market to the produce of domestic industry, in any particular art or manufacture, is in some measure to direct private people in what manner they ought to employ their capitals, and must, in almost all cases, be either a useless or a hurtful regulation.” [15]

“To expect, indeed, that the freedom of trade should ever be entirely restored in Great Britain is as absurd as to expect that an Oceana or Utopia should ever be established in it. Not only the prejudices of the public, but what is much more unconquerable, the private interests of many individuals, irresistibly oppose it…. The Member of Parliament who supports every proposal for strengthening this monopoly is sure to acquire not only the reputation of understanding trade, but great popularity and influence with an order of men whose numbers and wealth render them of great importance. If he opposes them, on the contrary, and still more if he has authority enough to be able to thwart them, neither the most acknowledged probity, nor the highest rank, nor the greatest public services can protect him from the most infamous abuse and detraction, from personal insults, nor sometimes from real danger, arising from the insolent outrage of furious and disappointed monopolists.” [16]

As the preceding passages indicate, the man from Kirkcaldy held particular contempt for monopoly. Perhaps his second most quoted passage (after his reference to the “invisible hand”) concerns this very issue:

“People of the same trade seldom meet together, even for merriment and diversion, but the conversation ends in a conspiracy against the public, or in some contrivance to raise prices.” [17]

Sadly, this statement is often misconstrued as an attack upon the unregulated free market. It is, in fact, an attack upon the state-imposed guild system that existed in England at the time. [18] Adam Smith was consistently critical of governmental intervention into the economy not on the basis of mere personal animus, but upon his observations on human action and the empirical evidence of the relative success or failure of such interventions. [19]

"That government which governs best, governs least."

This quote is often attributed to Thomas Jefferson, but such is not the case. Instead, the earliest attribution of the specific quote is Henry David Thoreau’s Civil Disobedience (1849), though it also appeared in another form ("The best government is that which governs least.”) from the pen of editor John L. O’Sullivan in The United States Magazine and Democratic Review (1837). [20] But often those most eager to point out the Jefferson misattribution leap to the false conclusion that he would not have said it.

Far from indicating that such a statement was inconsistent with Jefferson’s outlook, the statement

"We are now vibrating between too much and too little government, and the pendulum will rest finally in the middle" from Jefferson’s letter to Samuel Smith (1788) [21] does nothing more than demonstrate his concern that “too much government” was problematic and was expressed at a time when government was several orders of magnitude smaller than it is today. The argument is not that Jefferson favored of the abolition of government, but that he had legitimate concerns that it could grow too powerful. In fact, Jefferson spoke favorably of a society without government on more than one occasion, such as:

“The basis of our governments being the opinion of the people, the very first object should be to keep that right; and were it left to me to decide whether we should have a government without newspapers or newspapers without a government, I should not hesitate a moment to prefer the latter. But I should mean that every man should receive those papers and be capable of reading them. I am convinced that those societies (as the Indians) which live without government enjoy in their general mass an infinitely greater degree of happiness than those who live under the European governments. Among the former, public opinion is in the place of law and restrains morals as powerfully as laws ever did anywhere. Among the latter, under pretense of governing, they have divided their nations into two classes, wolves and sheep. I do not exaggerate. This is a true picture of Europe." [22]

This quotation strikes to the very center of the issue. The Jeffersonian view was not antithetical to government, per se, but was particularly concerned with its restraint to ensure the liberties of the populace. It was the very reasoning behind the construction of a Constitutional form of government with very specific enumerated powers. Consider the words of James Madison, father of the Constitution:

“If Congress can do whatever in their discretion can be done by money, and will promote the General Welfare, the Government is no longer a limited one, possessing enumerated powers, but an indefinite one, subject to particular exceptions.” [23]

“Since the general civilization of mankind, I believe there are more instances of the abridgment of the freedom of the people by gradual and silent encroachments of those in power than by violent and sudden usurpations.” [23]

“With respect to the words general welfare, I have always regarded them as qualified by the detail of powers connected with them. To take them in a literal and unlimited sense would be a metamorphosis of the Constitution into a character which there is a host of proofs was not contemplated by its creators.” [24]

These are not the words of men in favor of or merely indifferent to the expansion of government into essentially any area of human endeavor, particularly on economic grounds. Far from being unable to forsee the “needs” of scoiety that might otherwise warrant the rise of the welfare state, Madison expressly rejects the entry of government into the realm of public “benevolence”.

Such views may be contrasted with those of Alexander Hamilton who was far more enamored of governmental power. [25] It was Hamilton, for example, that in 1791, as Secretary of the Treasury, convinced Congress to tax distilled spirits, ostensibly to pay down the national debt incurred during the Revolutionary War, but "more as a measure of social discipline than as a source of revenue." [26] and because he "wanted the tax imposed to advance and secure the power of the new federal government." [27] It should be remembered that it was this action that precipitated the Whiskey Rebellion of 1794.

At the risk of over-reliance on quotations, consider this one from Samuel Adams:

"If ye love wealth better than liberty, the tranquillity of servitude than the animating contest of freedom--go from us in peace. We ask not your counsels or arms. Crouch down and lick the hands which feed you. May your chains sit lightly upon you, and may posterity forget that ye were our countrymen!" [28]

What could compel such men as Adam Smith, David Hume, Thomas Jefferson and James Madison to so reject the policy of governmental intervention that is so vehemently defended by pro-government thinkers, not merely those in the extreme Marxian mold, but those who believe passionately that capitalism is fine in “some” cases but must be supplanted with the welfare state in others else, in their view, all of society will collapse? It comes down to observation vs. mythology. These men applied analytical techniques to the world around them to ascertain the complexities of human behavior and societal function.

They did not assume, for example, that air pollution is best solved by government – there is no evidence to support such a claim – or that lack of health insurance coverage is more damaging than the rationing of care that takes place under so-called universal health care systems – it isn’t – or that it is rational to accept on face value the assertion that child poverty is highest in the US among “advanced Western nations” – when poverty is calculated on radically different bases and the US has the wealthiest “poor” on the planet – or that government is even capable of assessing, let alone addressing the perceived “threats” of economic globalization, nuclear proliferation or climate change. Instead of simply accepting prevailing wisdom of their times, consisting then, as now, mostly of popular rhetoric rather than fact, these thinkers took the time to examine the claims of governmental competency … and found them wanting.

In the mid-1800s, a new ideological concept began to take hold: socialism. Initially, the movement began as merely a response to the supposed injustices of the Industrial Revolution. Unlike later socialists, not all of these were enamored with a governmental role in solving society’s problems. Pierre-Joseph Proudhon, for example, was the first to describe himself as an anarchist in the modern ideological sense. [29]

The appeal of socialism is easily understood. Like all utopian systems it seems to provide solutions to a wide variety of problems with few, if any, drawbacks. (This description applies even to partial adoptions of socialism to the extent that it is applied to a specific societal problem.) It has the additional appeal that the solution appears to be the application of human will and planning where chaos otherwise reigns. Surely, planning must deliver better results than a lack of planning. Thus, the concept of socialism flourished, albeit not without difficulty.

“[T]he basic conception of Socialism had been quite clearly worked out in the course of the second quarter of the nineteenth century by those writers designated by Marxism as ‘Utopian Socialists.’ Schemes for a socialist order of society were extensively discussed at that time, but the discussion did not go in their favour. The Utopians had not succeeded in planning social structures that would withstand the criticisms of economists and sociologists….

“It was at this moment that Marx appeared…. [H]e was not slow in finding a way out of the dilemma in which socialists found themselves. Since Science and Logic had argued against Socialism, it was imperative to devise a system which could be relied on to defend it against such unpalatable criticism. This was the task which Marxism undertook to perform. It had three lines of procedure. First, it denied that Logic is universally valid for all mankind and for all ages. Thought, it stated, was determined by the class of the thinkers; was in fact an ‘ideological superstructure’ of their class interests. The type of reasoning which had refuted the socialist idea was ‘revealed’ as ‘bourgeois’ reasoning, an apology for Capitalism. Secondly, it laid it down that the dialectical development led of necessity to Socialism; that the aim and end of all history was the socialization of the means of production by the expropriation of the expropriators—the negation of negation. Finally, it was ruled that no one should be allowed to put forward, as the Utopians had done, any definite proposals for the construction of the Socialist Promised Land. Since the coming of Socialism was inevitable, Science would best renounce all attempt to determine its nature….

“[I]f we include under the term ‘Marxist’ all who have accepted the basic Marxian principles—that class conditions thought, that Socialism is inevitable, and that research into the being and working of the socialist community is unscientific—we shall find very few non-Marxists in Europe east of the Rhine, and even in Western Europe and the United States many more supporters than opponents of Marxism. Professed Christians attack the materialism of Marxists, monarchists their republicanism, nationalists their internationalism; yet they themselves, each in turn, wish to be known as Christian Socialists, State Socialists, National Socialists [Note: this fundamental observation was made in January, 1932]. They assert that their particular brand of Socialism is the only true one—that which ‘shall’ come, bringing with it happiness and contentment. The Socialism of others, they say, has not the genuine class origin of their own. At the same time they scrupulously respect Marx's prohibition of any inquiry into the institutions of the socialist economy of the future... Of course, not Marxists alone, but most of those who emphatically declare themselves anti-Marxists, think entirely on Marxist lines and have adopted Marx's arbitrary, unconfirmed and easily refutable dogmas. If and when they come into power, they govern and work entirely in the socialist spirit.

“The incomparable success of Marxism is due to the prospect it offers of fulfilling those dream-aspirations and dreams of vengeance which have been so deeply embedded in the human soul from time immemorial. It promises a Paradise on earth, a Land of Heart's Desire full of happiness and enjoyment, and—sweeter still to the losers in life's game—humiliation of all who are stronger and better than the multitude.” [30]

In the wake of World War I, a young economics student put it thus: “We felt that the civilization in which we had grown up had collapsed. We were determined to build a better world, and it was this desire to reconstruct society that led many of us to the study of economics. Socialism promised to fulfill our hopes for a more rational, more just world.” [31]

In 1922, however, a book was published that would materially alter that young man’s perceptions and those of the economic world with regard to the viability of government-run enterprises. Socialism, and Economic and Sociological Analysis, by Ludwig von Mises, subjected the tenets of socialism to logical scrutiny and critical analysis … and found it unworkable. The flaw in the socialist argument was, in at least one respect, very simple: centralized planning was not, in fact, imposing human will and order upon chaos. Instead, central planners were attempting to impose their own will and plans in preference to those of the free individuals interacting in the marketplace. Worst of all, it is readily apparent that no individual or group of individuals is equipped with either the flexibility or the knowledge base necessary to make decisions regarding the allocation of resources in any manner that could possibly be as efficient as that already taking place in the marketplace. This was primarily because extra-market activity such as must exist under a socialist system (or response to a specific problem) short-circuits the pricing mechanism that signals where the rational allocation of resources is most efficient. This dilemma, known as the “socialist calculation problem” had initially been put forth in a 1920 article entitled “Economic Calculation in the Socialist Commonwealth”. [32]

Still, as is abundantly evident, socialist movements remain all too powerful. The observation, three quarters of a century ago, that those embracing a socialist viewpoint are quite eager to avoid the label – and assert that their own variant is the only true and viable one – is, if anything, more apparent today than it was before the Great Depression. It was not, by any means, the only observation made by Mises that was eerily prescient. His assessment of social security programs, for example, writen in 1949, could easily have been written yesterday:

“In the process of government interference with saving and investment, Paul in the year 1940 saves by paying one hundred dollars to the national social security institution. He receives in exchange a claim which is virtually an unconditional government IOU. If the government spends the hundred dollars for current expenditure, no additional capital comes into existence, and no increase in the productivity of labor results. The government's IOU is a check drawn upon the future taxpayers. In 1970 a certain Peter may have to fulfill the government's promise although he himself does not derive any benefit from the fact that Paul in 1940 saved one hundred dollars.

“Thus it becomes obvious that there is no need to look at Soviet Russia in order to comprehend the role that public finance plays in our day. The trumpery argument that the public debt is no burden because "we owe it to ourselves" is delusive. The Pauls of 1940 do not owe it to themselves. It is the Peters of 1970 who owe it to the Pauls of 1940. The whole system is the acme of the short-run principle. The statesmen of 1940 solve their problems by shifting them to the statesmen of 1970. On that date the statesmen of 1940 will be either dead or elder statesmen glorying in their wonderful achievement, social security.”

Mises also notes that “It makes no difference whether Paul himself pays these hundred dollars or whether the law obliges his employer to pay it.” [33]

The next chapter explores the viability of such programs and their ultimate impact on society.

[1] Historian Garry Wills makes this unpersuasive argument (because it is a-historical as will be explored to some extent in this chapter) in A Necessary Evil: A History of American Distrust of Government, 1999, but then Wills concedes at the outset he “began this book in 1994, when the fear of government manifested itself in the off-year election of a Republican majority to Congress” and bemoans a view that he says “asks us to love our country by hating our government … turns our founding fathers into unfounders, that glamorizes frontier settlers in order to demean what they settled, that obliges us to despise the very people we vote for." The book, while full of historical references that do not fully support his thesis is, in the words of John J. Miller of Amazon.com Review “is plainly motivated by contemporary politics.” (http://www.amazon.com/Necessary-Evil-American-Distrust-Government/dp/0684844893).

[2] “history of anarchism”, Anarchopedia: http://eng.anarchopedia.org/history_of_anarchism

[3] Robert Dreyfuss, "Grover Norquist: 'Field Marshal' of the Bush Plan", The Nation, April 26, 2001: http://www.thenation.com/doc/20010514/dreyfuss

[4] Susan Page, “Norquist's power high, profile low”, USA Today, June 1, 2001: http://www.usatoday.com/news/washington/2001-06-01-grover.htm

[5] Beyond The Nation reference, there is Sourcewatch (http://www.sourcewatch.org/index.php?title=Grover_Norquist) which absurdly blames the return to deficits on tax cuts and military spending, dKosopedia (http://www.dkosopedia.com/wiki/Grover_Norquist), People for the American Way’s Right Wing Watch (http://www.rightwingwatch.org/category/individuals/grover-norquist), among countless others.

[6] Ronald Reagan’s First Inaugural Address, found at http://www.reaganlibrary.com/reagan/speeches/first.asp

[7] Ronald Reagan’s Remarks to Representatives of the Future Farmers of America, July 28, 1988: http://www.reagan.utexas.edu/archives/speeches/1988/072888c.htm

[8] David Boaz, Libertarianism: A Primer, 1997, selected excerpts can be found here: http://www.libertarianism.org/

[9] Editors. "Thomas Mun". The Literary Encyclopedia. 5 October 2004.
http://www.litencyc.com/php/speople.php?rec=true&UID=5846, accessed 1 November 2008

[10] The Project Gutenberg EBook of Letters to Sir William Windham and Mr. Pope by Lord Bolingbroke, February, 2004 [EBook #5132], Les Bowler, St. Ives, Dorset: http://www.gutenberg.org/dirs/etext04/ltww10h.htm

[11] To be fair, the French physiocrats had completely rejected mercantilism long before The Wealth of Nations was published. Economist Joseph Schumpeter, in his History of Economic Analysis argued, “The fact is that The Wealth of Nations does not contain a single analytic idea, principle, or method that was entirely new in 1776." He goes on to say that “His very limitation made for success. Had he been more brilliant, he would not have been taken so seriously. Had he dug more deeply, had he unearthed more recondite truth, had he used more difficult and ingenious methods, he would not have been understood. But he had no such ambitions; in fact he disliked whatever went beyond plain common sense. He never moved above the heads of even the dullest readers. He led them on gently, encouraging them by trivialities and homely observations, making them feel comfortable all along.” (Schumpeter 1954a, 185)” see: “Schumpeter’s Assessment of Adam Smith and The Wealth of Nations: Why He Got It Wrong” by Andreas Ortmannand David Baranowski, May 2001: http://home.cerge-ei.cz/ortmann/Papers/09SchumpeterWrongYK.pdf. I do not agree with Schumpeter’s assessment. In particular, given that my own talents, if I may be so bold, are in the area of making economic principles accessible to the layman, I find the second assessment unduly harsh.

[12] Professor Gavin Kennedy, “A Sad Attack on Adam Smith's Reputation” Edinburgh, Scotland (UK), Adam Smith’s Lost Legacy, http://adamsmithslostlegacy.com/2005/07/sad-attack-on-adam-smiths-reputation.html, [Professor Kennedy is the author of a book of the ame name: Adam Smith’s Lost Legacy (http://www.amazon.com/Adam-Smiths-Legacy-Gavin-Kennedy/dp/1403947899/ref=sr_1_1?ie=UTF8&s=books&qid=1225723698&sr=1-1)

[13] Adam Smith, An Inquiry into the Nature and Causes of the Wealth of Nations, Book I, Chapter 8, paragraph 40: http://www.econlib.org/library/Smith/smWN3.html#B.I,%20Ch.8,%20Of%20the%20Wages%20of%20Labour

[14] Adam Smith, An Inquiry into the Nature and Causes of the Wealth of Nations, Book III, Chapter 2, paragraph 9: http://www.econlib.org/library/Smith/smWN10.html#B.III,%20Ch.2,%20Of%20the%20Discouragement%20of%20Agriculture%20in%20the%20Ancient%20State%20of%20Europe%20after%20the%20Fall%20of%20the%20Roman%20Empire

[15] Adam Smith, An Inquiry into the Nature and Causes of the Wealth of Nations, Book IV, Chapter 2, paragraph 11: http://www.econlib.org/library/Smith/smWN13.html#B.IV,%20Ch.2,%20Of%20Restraints%20upon%20the%20Importation%20from%20Foreign%20Countries

[16] Adam Smith, An Inquiry into the Nature and Causes of the Wealth of Nations, Book IV, Chapter 2, paragraph 43: http://www.econlib.org/library/Smith/smWN13.html#B.IV,%20Ch.2,%20Of%20Restraints%20upon%20the%20Importation%20from%20Foreign%20Countries

[17] Adam Smith, An Inquiry into the Nature and Causes of the Wealth of Nations, Book I, Chapter 10, paragraph 82: http://www.econlib.org/library/Smith/smWN4.html#B.I,%20Ch.10,%20Of%20Wages%20and%20Profit%20in%20the%20Different%20Employments%20of%20Labour%20and%20Stock

[21] Thomas Jefferson letter to William Stephens Smith, February 2, 1788, Online Library of Liberty: http://oll.libertyfund.org/index.php?option=com_staticxt&staticfile=show.php%3Ftitle=802&chapter=86690&layout=html

[22] The Founders’ Constitution, Amendment I (Speech and Press) Thomas Jefferson to Edward Carrington, January 16, 1787, Papers 11:48—49: http://press-pubs.uchicago.edu/founders/print_documents/amendI_speechs8.html

[23] Quotes can be found here: http://www.quotationcollection.com/author/James_Madison/quotes; respectively, they are from (1) 1792, Letters and Other Writings of James Madison, Fendall, ed., vol. 1 (546) (2) a speech in the Virginia Convention, Richmond, Virginia, June 6, 1788.—The Papers of James Madison, ed. Robert A. Rutland and Charles F. Hobson, vol. 11, p. 79 (1977)

[24] Letter to James Robertson, April 20, 1831 (Madison, 1865, IV, page 174): http://en.wikiquote.org/wiki/James_Madison

[28] “Samuel Adams Advocates American Independence”, speech at the Philadelphia State House, August 1, 1776: http://www.nationalcenter.org/SamuelAdams1776.html

[29] Proudhon’s initial claim to fame was his declaration that “Property is theft!” (Pierre-Joseph Proudhon, What is Property? Or, an Inquiry into the Principle of Right and of Government, 1840 (http://www.marxists.org/reference/subject/economics/proudhon/property/index.htm) but recanted these views later in life arguing in Theory of Property, published after his death, "property is the only power that can act as a counterweight to the State." This lead Karl Marx, who had been influenced by Proudhon’s earlier work, to dismiss him as a member of the “socialistic bourgeois “(Karl Marx and Frederick Engels, Manifesto of the Communist Party, part 3, section 2, 1847: http://www.marxists.org/archive/marx/works/1848/communist-manifesto/ch03.htm)

[30] Ludwig von Mises, Socialism, and Economic and Sociological Analysis, 1922, Preface to the Second German Edition, January, 1932: http://mises.org/books/socialism/preface_second_german_edition.aspx

[31] F. A. Hayek, Foreword to to Ludwig von Mises’ Socialism, and Economic and Sociological Analysis (1922), August, 1978. Partial text is available online here: http://www.pbs.org/wgbh/commandingheights/shared/minitextlo/prof_friedrichvonhayek.html

[32] Ludwig von Mises, “Economic Calculation in the Socialist Commonwealth”, 1920, http://mises.org/pdf/econcalc.pdf; a reasonably good description of the problem can be found here: http://en.wikipedia.org/wiki/Economic_calculation_problem#cite_note-Mises-0

[33] Ludwig von Mises, Human Action: A Treatise on Economics, Part 6, Chapter XXXV, paragraphs 53, 54:

http://www.econlib.org/library/Mises/HmA/msHmA35.html

Chapter One: Do We Need to Stand Up For Government?

The question is asked “When was the last time you heard someone offering a positive vision of government – government as a good thing?” [1]  Certainly, few today are bold enough to vigorously defend government as an institution in its entirety, though, to be fair, many are willing to advocate any number of individual government programs, typically overlooking their flaws (i.e. Social Security), vastly overstating their purported benefits or, more frequently, operating under the illusion that progress does not take place in the absence of governmental intervention (i.e., environmental protections).  Tragically, politicians of both parties have continued to feed the beast.  While Ronald Reagan made progress on a few very specific fronts (primarily taxation and some regulation), government still grew at a blistering pace under his administration.  And while Bill Clinton told us “The era of big government is over,” [2] he continued by perpetuating the illusion that there was once some horrible time “when our citizens were just left to fend for themselves”.  Sadly, his eulogy for big government was inconsistent with the massive tax increase that Clinton passed and his subsequent statement regarding his never-anticipated surplus that “We could give it all back to you and hope you spend it right.” [3]

The problem is that, despite the wishes of the majority of Americans [4], politicians rarely walk the walk even if they talk the talk.  Gone are the days of the early half of the 20^th Century when many people accepted at face value the claims that government programs had “saved” the poor, curbed unemployment and ended the Depression.  While these myths persist among a certain ideologically motivated class of individuals, the reality is so starkly at odds with such a view that these myths have ceased to retain the traction they once had.  Where once government was perceived to be the best way to solve societal problems, the historical evidence that government is more frequently the cause of such problems is so overwhelming that confidence in the ability of government to solve much anything has steadily declined over the last four decades or so.

This evolution is entirely healthy.  As Milton Friedman noted in 1982, “Only a crisis - actual or perceived - produces real change.” [5]  While his meaning has been deliberately and egregiously distorted, most notably by Naomi Klein, all he was saying was that societal evolution occurs when chosen societal models fail.  In general terms, he was discussing the economic crises that the socialist economies of Eastern Europe were rapidly approaching.  As a contemporary example in American life, he referenced the societal backlash against the draft. [6]  In each case, he was proven correct.  As contemporary history demonstrates most profoundly, the most powerful force for change is the observable failure of existing policies.  Unfortunately, as the New Deal demonstrated, all too frequently, the wrong lesson is learned, or, as Friedman continued, “When that crisis occurs, the actions that are taken depend on the ideas that are lying around.” [5]  That is why it is so essential that we use every analytical tool at our disposal to properly diagnose what precipitated a given crisis so that we can better respond to it rather than simply making matters worse.

Government is Good?

“What exactly does it mean to say that government is good? It means that, on balance, government programs have a very positive impact on the lives of all Americans – that government has been a powerful force for good in our society.” [1]

That’s a pretty powerful statement.  But is it true?  The onus of supporting such a statement must devolve upon the author making the claim.  It is insufficient to baldly state that much of the improvement in our lives over the last 100 years (or 200 or 1,000) has been the result of the actions of federal, state and local governments.  Such statements must be butressed with verifiable facts.  Further, it must be demonstrated that “on balance” any benefits directly attributable to governmental action outweigh any detrimental consequences that resulted from those actions.  Moreover, it must be demonstrated that any such benefits are the result of government action and could not otherwise have evolved as efficiently, or even more so, in the private sector.

To provide a relevant example: consider the United States Postal Service.  Despite all the grief that the post office gets for delivering the ocassional piece of mail to the wrong address or losing an item now and again, the postal service still has a fairly good record when it comes to providing a delivery service at an affordable price, right?  Not so fast.

The simple fact is that the USPS cannot compete with private carriers in the overnight package and delivery markets.  Such companies as DHL and Federal Express do a better job of delivering these items on time and across great distances while making a profit despite the fact that, by law, they are prohibited from delivering anything for less than $3.00 per item or twice the US postal rate (whichever is greater).  In addition, these companies are prohibited from using home mailboxes, privately purchased by homeowners and affixed to their private property, and must either deliver each item directly to an individual, leave it out in the open or provide their own separate delivery box.

The postal service cannot compete with private carriers for regular mail service either.  In the 1840’s Lysander Spooner created the American Letter Mail Company and offered mail service at rates considerably lower than those offered by the postal service. [7] The business was commercially successful but the government shut him down because it’s illegal to compete with the post office. In fact, no one is permitted to compete with the post office on first or third class mail - period. Also, the monopolistic USPS has imposed regulations on commercial mailbox services requiring them to collect - and provide to the government - customer information (including photo identification) even though the USPS is legally prohibited from collecting that information from ordinary postal customers. The cost to business of this rule is estimated at more than $1 billion per year.

Ironically, the post office is a perfect example of something the author of "Government is Good" has expressly denounced: a monopoly.  Monopolies are not typically created by the normal function of capitalism. [9]  As in this case, monopolies are overwhelmingly formed by government intervention and are buttressed against competition.  What happens when governmentally created monopolies suddenly face competition?  The post office, again, provides a great example.  After decades of calling overnight delivery impossible, the United States Postal Service, faced with the entry into this niche of such companies as Federal Express, began offering ... overnight delivery.

The point is not that government is “bad” but that it, in the areas into which it has expanded particularly in the last century, has proven to be a poor substitute for the private sector, seldom providing tangible benefits and, more often than not, making matters worse.  It isn’t merely that government “isn’t perfect” or that some public officials are incompetent or corrupt, but rather that the state is ill equipped to the expansive tasks that it has so recently accrued to itself. [10]

Is Government Constantly Growing?

A frequent case made against government is that it is constantly growing, perpetually accruing ever more power to itself and wasting ever more of the taxpayers’ money.  But is this true?  Can a valid argument be made that this is not the case?  Are there trends overlooked by those who argue that government is not, on balance, “good”, that indicate that governmental bureaucracy is not, in fact, growing?

In a word: no.

But that doesn’t prevent some from making a valiant effort.  One such effort points to federal civilian employment levels.  It notes that. in 1970, there were approximately 2,977,000 federal civilian employees but that by 2003 that figure had fallen to approximately 2,743,000, [11] a 7.9% reduction.  But what does that tell us about the federal bureaucracy?  Very little.

Set aside for the moment the fact that federal civilian employment spikes by an average of more than 100,000 people due to the “temporary jump in executive branch employment for the decennial census” [12] every 10 years (1970, 1980, 1990, 2000).  The spikes are readily apparent on the same table that shows the apparent reduction.  Instead, consider the materially changing nature of federal civilian employment over the last few decades.

One of the most widely reported trends – we’ve all seen the complaints about “unfunded mandates” - has been the ongoing efforts to shift more and more responsibilities from the federal government to state and local authorities. [13]  Thus, it should comeas no shock that during the same period total governmental civilian employment (including state and local personnel) has exploded.  It grew by 5.5 million people, a whopping 34.7%, between 1982 and the selected end year of 2003 (from 15.84 million to 21.34 million) and climbed another 389,000 in the next two years. [14]  But even that does not tell the whole story.

On What Is Government Spending Our Money?

And what is the government doing with that money?  Well, that brings us to the wonderful topic of government waste.  Polls indicate that Americans believe roughly half of our tax money is wasted by government. [20]  Everybody knows about the $232 million “Bridge to Nowhere” in Alaska.  And, of course there’s the $2 million for a waterless urinal, the $797,000 for a Pennsylvania outhouse and the infamous $436 hammer and $640 toilet seat. [21]  But the basic problem of a discussion of government waste is that somebody actually believes that these expenditures are worthwhile.

In order to proceed, it is necessary to define waste in a way that can be defended even to those who are enamored of every cause that government has chosen to spend money on.  Government waste can properly be classified in four basic categories:

·         Resources spent on those things people don’t believe should be funded.  Everyone knows at least one example of such waste, but few would agree on every one.  This category is entirely subjective.  As such, it is fair to say that such waste clearly exists, and may even be substantial, but is ultimately indefinable.

·         Resources lost due to operational inefficiencies.  This is the type of waste that has received the most attention from government.  It is what Al Gore’s famous National Performance Review and “Reinventing Government” was aimed at addressing.  When someone asserts that somewhere in the neighborhood of 2 cents of every tax dollar is wasted, this is the type of waste that is being referenced.  It is, by several orders of magnitude, the least costly form of government waste.

·         Resources lost outright.  These resources are not necessarily spent inefficiently.  No one really knows.  These resources are gone.  No one can find them.  No one can account for them.

·         Resources expended that are wasted economically.  This category is only controversial to the extent that some would prefer to classify such waste as nothing more than part of the first category – and, thus, entirely subjective.  That is demonstrably not the case.  For each such expenditure, it can be demonstrated that the economic return, not just to the taxpayer but also to the society as a whole, is less than the amount of resources allocated to it by government.  That is, the society as a whole would be economically better off in the absence of these programs.

Don’t want to fund the War in Iraq?  Don’t believe that the federal government should spend $50 million on an indoor rain forest in Iowa?  Maybe you don’t think that your tax dollars should be spent to combat Goth culture in Blue Springs, Missouri.  Congratulations!  You have identified waste of the first type.  It is, again, impossible to reconcile the conflicting views regarding which of these items is truly wasteful.  That does not mean that these expenditures are unworthy of further comment.

In recent years, the subject of “earmarks” has come under particular scrutiny.  The Office of Management and Budget (OMB) defines earmarks as “specified funds for projects, activities, or institutions not requested by the executive, or add-ons to requested funds which Congress directs for specific activities”, but this is, unfortunately, not a uniform standard.  In an effort to identify the magnitude of the earmark issue, the Congressional Research Service issued a report in early 2006 attempting to quantify the level of earmarks included in the budgets of the 13 major federal departments from fiscal 1994 to fiscal 2005.  During that period, identifiable earmarks grew from $25.8 billion to $52.1 billion, doubling in just a decade. [22]

Much ballyhoo accompanied Al Gore’s famous National Performance Review.  It’s purpose was to “change … the way government works … to make government work better and cost less” and to provide the American people with “a new guarantee of effective, efficient, and responsive government”.  The result?  For the five-year period from 1995 – 1999, the initiatives undertaken as a result of this ambitions project were projected to save $108 billion or an average of $21.6 billion per year – an amount smaller even than the earmarks identified by the Congressional Research Service.  Moreover, the vice-president admitted outright that “[m]ost of the personnel reductions will be concentrated in the structures of over-control and micromanagement that now bind the federal government: supervisors, headquarters staffs, personnel specialists, budget analysts, procurement specialists, accountants, and auditors.” [23]  In other words, the chief means of achieving these vaunted cost savings were the elimination of those personnel whose chief function is to manage the resources spent by the federal government.  No wonder so much money is missing!

There can’t be that much, can there?  Back in 2001, Secretary of Defense Donald Rumsfeld conceded, “According to some estimates, we cannot track $2.3 trillion in transactions. We cannot share information from floor to floor in this building because it's stored on dozens of technological systems that are inaccessible or incompatible… [and we] maintain 20 to 25 percent more base infrastructure than we need to support our forces, at an annual waste to taxpayers of some $3 billion to $4 billion.” [24]  This revelation was followed by an admission that for a single year (FY 2000), the Defense Department “processed $1.1 trillion in unsupported accounting entries to DoD Component financial data used to prepare departmental reports and DoD financial statements”. [25]  For reference purposes, the entire Defense Department budget in that year was less than $300 billion.  Just imagine what would happen to a private company whose auditing standards were so poor.

And that’s just the accounting losses.  Consider the Defense Department’s track record for using equipment (which seriously undermines the assertion that only 2 percent of federal funds are wasted due to inefficiencies).  Greg Kuntz of the Government Accounting Office gives just one example: “Out of $2.5 billion dollars worth, the Pentagon used only 12 percent. Another 10 percent was transferred to other government agencies. A full quarter of it was thrown away, brand new stuff into the landfills. And the rest was sold to the public, $1.3 billion dollars worth of new gear sold for what the report terms pennies on the dollar, at the same time the military was paying top dollar purchasing the same or similar items new.” [26]

Not long before these revelations were made, the Department of Housing and Urban Development (HUD) revealed that they had discovered “a total of 42 adjustments totaling about $17.6 billion had been processed … to adjust fiscal year 1998 ending balances.  An additional 242 adjustments totaling about $59.6 billion were made to adjust fiscal year 1999 activity.” [27]  For reference purposes, HUD’s entire 1999 budget was approximately $25 billion.

The frightening thing is that this may be nothing more than the tip of the iceberg.  As the size and complexity of government increases, the challenges of monitoring and controlling the vast sums of money flowing through the federal treasury can only increase.  Also, keep in mind, what we are discussing here is money that disappeared without a trace.  To this point we haven’t even touched on things like the socialization of losses from Fannie Mae and Freddie Mac which, likewise, represent funds vanished into the ether never to be seen again but that have left a discernable trail of misery in their wake.

Last but not least (by any means) are those expenditures by government that are economically disastrous.  Some are particularly silly, such as the Department of Agriculture’s payments to farmers not to grow certain crops.  Some are tragic.  One of the clearest examples of government stupidity was the Agricultural Adjustment Act of 1933 - a centerpiece of Franklin Delano Roosevelt’s “New Deal”.  At a time when people were going hungry and unemployment had reached a point where one in four American workers were out if a job, the Act created a new government agency, the Agricultural Adjustment Administration (AAA), for the express purpose or restricting agricultural production.  In other words, the “New Deal” solution to hunger was to reduce the supply of food.  But the creation of the agency was not swift enough to achieve that objective before crops were actually planted so the AAA “oversaw a large-scale destruction of existing cotton crops and livestock in an attempt to reduce surpluses….  [S]ix million piglets and 220,000 pregnant cows were slaughtered in the AAA's effort to raise prices. Many cotton farmers plowed under a quarter of their crop in accordance with the AAA's plans.” [28]

This, of course, did not acheive the desired result.  From an economic perspective all subsidies and tariffs are economically detrimental.  At best, a subsidy is a charge to consumers (in the form of higher prices) paid for by taxpayers that undermines market efficiencies that ultimately are the only source of job growth.  At worst, the economic distortions of such interventions can be widespread and debilitating.  As has been noted by many in the past, the road to hell is paved with good intentions.  As an example, the steel tariffs passed by President Bush in 2002 in order to “save” jobs in the steel industry ultimately cost still more jobs in those industries that worked with finished steel. [29]  Similarly, supports for the American sugar industry have all but driven candy makers out of the US.  And efforts to encourage bio-fuels via ethanol subsidies have simply driven up the cost of corn in the marketplace. [30]

Those are just a few of the tasks that government regularly undertakes to our continued detriment.  Now, let’s consider a somewhat larger and more quantifiable figure: $243.9 billion.  That is the interest on the federal debt incurred in 2008 [19] - the direct cost of the government operating beyond its means.  For this outlay, society gains no benefit.  This amounts to approximately 8.3 cents of every dollar spent by the federal government in fiscal 2008 and every bit of it is wasted.  He’s an even more depressing figure: $10.5 trillion. [31]  That figure, the national debt, is the indirect cost of the government living beyond its means.  Make no mistake: this is not a debt that will fall on some future generation: the damage has already been done to the citizenry in the form of inflation.  The money in your pocket, your savings and your investments – not to mention your income stream – has been steadily and inexorably devalued by this governmental spending spree.   If you want to know why the goods and services that you buy are priced, on average, more than five times higher than they were in 1970, you need look no further than the spending habits of your public servants.

And then there are transfer payments.  Transfer payments are those expenditures of government not for goods or services (including the labor of government employees) but are merely redistributive in nature. [32]  And they never generate an societal benefit greater than their societal cost.  There are countless studies validating the economic dynamic that makes this inevitable, but a December 1998 report to the Joint Economic Committee by Professors Richard K. Vedder and Lowell E. Gallaway put it simply enough:

“It is a fact that no society throughout history has ever obtained a high level of economic affluence without a government. Where governments did not exist, anarchy reigned and little wealth was accumulated by productive economic activity. After governments took hold, the rule of law and the establishment of private property rights often contributed importantly to the economic development of Western civilization, and it has similarly impacted on other societies as well. Government is a necessary, though by no means sufficient, condition for prosperity.

“It is also a fact, however, that where governments have monopolized the allocation of resources and other economic decisions, societies have not been successful in attaining relatively high levels of economic affluence. Economic progress is limited when government is zero percent of the economy, but also when it is at or near 100 percent.  The experience of the old Soviet Union is revealing, as was the comparison of East and West Germany during the Cold War era, or of North and South Korea today. Too much government stifles the spirit of enterprise and lowers the rate of economic growth.”

“The findings here support the view that the growth of government in newly emerging nations and economies tends to increase output. Presumably this reflects the reduction in transactions’ costs and the improved environment for investment associated with a rule of law and enforceable property rights. At the same time, in modern times relative American federal government spending has expanded rapidly, reflecting sharp increases in transfer payments. The evidence suggests that large transfer payments in particular have negative consequences for growth. The results for the federal government are confirmed for state and local governments and several other countries. The findings suggest that a federal budget strategy of constraining spending growth below output growth, with particular attention paid to constraining transfer payments, would have positive effects on economic growth.” [33]

Transfer payments, including Social Security and the combined basket of Welfare payments, now amount to nearly 60 percent of the federal budget.  A full discussion of the failure of these programs appears in a later chapter, but for now the issue is economic efficiency, so I leave you with one question:  Can anti-poverty programs that have spent more than $11 trillion since the “War on Poverty” began [34] and have demonstrably resulted in increased dependency and greater levels of poverty really be considered “efficient”?

The general public is wrong.  It is quite clear that, objectively, much more than half of your tax dollars are wasted.

Why We Need to Set the Record Straight about Government

Those zealously in favor of ever more government intervention into our lives, conveniently turn a blind eye to the consequences of the programs they endorse.  They will invariably concentrate on the noble intent of a given program or the benefits to a select group of individuals without taking into consideration the harm done to the society as a whole.  They will blithely ignore continued intrusions upon our economic liberties (or worse, adopt the socialist model and pretend that such liberties do not exist when, in fact, they are among the most basic liberties we have) on the pretext that liberties are denied to the “have-nots” in our society, confusing lack of means with lack of freedom.  They will cherry pick examples of the misery caused by reductions in public services – typically selecting cut backs in the traditional role of government in protecting public safety – when, in reality, these reductions invariably indicate that governmental bodies have chosen, instead, to first fund other things not related to public safety.

But if we examine how government actually works taking into account the historical and economic evidence that has accumulated over a long period of time, we quickly see that, overwhelmingly, government programs do the most harm to the very people they are ostensibly designed to help.  So-called “management” of the economy creates the boom-and-bust cycle that is ultimately harmful to everyone.  Minimum wage laws destroy jobs and increase unemployment.  Anti-poverty programs have increased poverty and created an entrenched underclass.  Regulatory bodies such as the FDA do more harm than good by monopolizing the evaluation process and preventing sometimes hugely beneficial drugs from reaching the public for an average of twelve years.  Anti-“price gouging” laws ensure shortages are created – and remain – in times of crisis, such as in the aftermath of Hurricane Katrina.  The list is almost endless.

For that matter, the fostering of dependency isn’t limited to monetary considerations.  Consider: by adopting the role of primary safety guarantor for the public as a whole, the government has both pre-empted the normal investigative process that individuals would otherwise take when considering any product and, at the same time, desensitized the public to the very warnings that government requires by attempting to address risk levels so small that they become ridiculous: paint cans that say “do not drink”; the T-shirt transfer that tells us “do not iron while wearing shirt”; the letter opener whose manufacturer warns “safety goggles recommended”.  When you hear that either the lack or repeal of some regulation results in some tragic circumstance, the question must be asked: did those who suffered (or their guardian in the case of children) exercise a reasonable level of care in the first place?  More often than not, the answer is no.

We must dispel the image of the benevolent, competent government not because we have some vested partisan interest in denigrating any individual or group of individuals or because we want to “starve” people or “protect the rich”.  Exactly the opposite is true.  The people most harmed by these programs are the poor who find themselves trapped in the cycle of poverty and the elderly on fixed incomes whose savings are devalued by inflation or the unskilled who cannot find an entry-level job because legal minimums have eliminated the opportunities that otherwise would have been available.  And it’s not about Democrats and Republicans.  Neither party has a record of restraint when it comes to spending.  Each election cycle comes down to a comparison of what each respective candidate plans to “give” to his supporters.  That no one even believes the rhetoric anymore hasn’t changed the nature of the process.

We must explode the canards that socialized medicine yields better results than even our hybrid, state-distorted system with a simple presentation of the facts.  Along those same lines, we must dispel the illusion that differences in life expectancy (mostly driven by behavioral and genetic factors) and infant mortality (also driven behavioral and genetic factors and comparisons are undermined by disparate measuring methodologies) in the US have anything to do with a failure of government to do enough.  We must destroy the truly absurd notion that Americans are more likely to be “poor” than in other more socialistic countries, when, in reality, the US has the wealthiest “poor” in the world with, among other things, greater average living space than the average member of the middle class throughout Europe.  We have to debunk the canard that less government means a poorer environment when the correlation between less government and a cleaner environment is enormous.

A Cautionary Note: Avoid Overstating the Case

One must be careful not to attempt to portray everything that government does as “bad”.  Such is not the case.  Certainly, individuals are helped by specific programs - having your mail delivered is a good thing, and so forth.  The argument is that governmental action is on balance worse than the alternative.  For every example of deregulation resulting in injury, such as the example of poisonings in the wake of relaxed EPA standards – an example that, as it happens, is a fabrication [35] – there is another example of regulations resulting in far greater harm, such as the millions of deaths, mostly of children and the elderly, in the wake of the EPA war on DDT.

In 1962, environmental writer Rachel Carson published the scientifically dubious [36] Silent Spring.  The volume painted DDT as a major environmental hazard, a threat to wildlife, particularly eagles, and a likely cause of cancer.  In retrospect, we now know that these threats were incredibly overblown: that controlled spraying causes minimal environmental risks, that eagle populations fell before DDT use and increased during the DDT period [37] (and the research on which the book was based did not support the conclusion that such a threat existed) and that DDT actually has rather low toxicity to humans. [38]  While clearly no pesticide is completely harmless and should be treated accordingly, it must be noted that in a 1956 University of Arizona study, “volunteers ate DDT every day for over two years with no ill effects then or since.” [39]

But the facts did not mute the book’s impact.  It is widely credited with energizing the growing environmental movement and with providing the impetus behind the move to ban DDT in the United States in 1972.  As a direct result of this development, US foreign policy began tying foreign aid programs to reduced use of DDT elsewhere in the world.  This was done despite the overwhelming evidence that DDT had proven a particularly valuable tool in the battle against malarial mosquitoes.  In Sri Lanka alone, the use of DDT reduced the total number of malaria cases from 2.8 million in 1948 (and 7,300 deaths) to 17 cases (and no deaths) in 1963. [40]

Again, one must be careful not to overstate one’s case.  Malaria eradication was never an achievable goal.  Not every species of mosquito is susceptible to DDT; some develop resistances to the substance – albeit mostly when indiscriminate over-spraying is undertaken rather than in cases of controlled application and the notion that this, rather than the banning of DDT, was the reason for malaria’s resurgence simply do not hold up [41] – and there are certainly subsequently developed pesticides that are effective alternatives, most notably malathion.  But by forcing the abandonment of what, in many cases, was the most viable anti-malarial tool available, literally millions, mostly children and the elderly were condemned to needless misery and death. [40,42]

[1] Professor Douglas J. Amy, “We Need to Stand Up for Government”, Government is Good: http://www.governmentisgood.com/articles.php?aid=6&p=1

[2] Bill Clinton radio address January 27, 1976, http://www.cnn.com/US/9601/budget/01-27/clinton_radio/

[3] Pete DuPont, “Dead-Horse Democrats”, Wall Street Journal, March 7, 2001: http://www.opinionjournal.com/columnists/pdupont/?id=85000675  [Note: this infamous quote has been widely sourced but links to original sources such as The Washington Post and The New York Times are simply no longer available.]

[4] “Poll: Majority believes government doing too much”, CNN.com, October 27, 2006: http://www.cnn.com/2006/POLITICS/10/27/poll.government/index.html

[5] Milton Friedman, Capitalism and Freedom, preface to the 1982 edition

[6] Perhaps the silliest attack upon Freidman was undertaken by Naomi Klein, who, in her book The Shock Doctrine: The Rise of Disaster Capitalism, attempted to portray this ardent defender of freedom as a conspirator in favor of deliberately visiting crises upon an unsuspecting public: “Do the free-market policies packaged as emergency cures actually fix the crises at hand? For the ideologues involved, that has mattered little. What matters is that, as a political tactic, disaster capitalism works. It was the late free-market economist Milton Friedman, writing in the preface to the 1982 reissue of his manifesto, ‘Capitalism and Freedom,’ who articulated the strategy most succinctly.”

But, the entire Friedman quote (not conveniently truncated by Klein) taken in context paints precisely the opposite picture:

“What then is the role of books such as this?  Twofold, in my opinion.  First, to provide subject matter for bull sessions.  As we wrote in the Preface to Free to Choose: ‘The only person who can truly persuade you is yourself.  You must turn the issues over in your mind at leisure, consider the many arguments, let them simmer, and after a long time turn your preferences into convictions.’  Second, and more basic, to keep options open until circumstances make change necessary.  There is enormous inertia--a tyranny of the status quo--in private and especially governmental arrangements.

“Only a crisis - actual or perceived - produces real change.  When that crisis occurs, the actions that are taken depend on the ideas that are lying around.  That, I believe, is our basic function: to develop alternatives to existing policies, to keep them alive and available until the politically impossible becomes politically inevitable.

“A personal story will perhaps make my point.  Sometime in the late 1960s I engaged in a debate at the University of Wisconsin with Leon Keyserling, an unreconstructed collectivist.  His clinching blow, as he thought, was to make fun of my views as utterly reactionary, and he chose to do so by reading, from the end of chapter 2 of this book, the list of items that, I said, ‘cannot, so far as I can see, validly be justified in terms of the principles outlined above.’  He was doing very well with the audience of students as he went through my castigation of price supports, tariffs, and so on, until he came to point 11, ‘Conscription to man the military services in peacetime.’  That expression of my opposition to the draft brought ardent applause and lost him the audience and the debate.”

http://opinion.latimes.com/opinionla/2008/02/its-a-tough-exi.html

[7] John Bach McMaster. 1910. A History of the People of the United States. D. Appleton and Company. p. 116 and Lucille J. Goodyear, “Spooner vs. U.S. Postal System”, American Legion Magazine, January, 1981: http://www.lysanderspooner.org/STAMP3.htm

[8] Rick Geddes, “Opportunities for Anti-Competitive Behavior in Postal Services”, American Enterprise Institute for Public Policy Research, May 28, 2003: http://www.aei.org/publications/pubID.17488/pub_detail.asp

[9] See, in general: Antitrust by economist Fred McChesney: http://www.econlib.org/library/Enc/Antitrust.html#lfHendersonCEE2-001_div_012; via licensing: Mary J. Ruwart, Healing Our World: The Other Piece of the Puzzle, http://www.ruwart.com/Healing/chap7.html among others; historically (from the Penny Cyclopedia, 1839, vol. 15, p. 741): “It seems then that the word monopoly was never used in English law, except when there was a royal grant authorizing some one or more persons only to deal in or sell a certain commodity or article. If a number of individuals were to unite for the purpose of producing any particular article or commodity, and if they should succeed in selling such article very extensively, and almost solely, such individuals in popular language would be said to have a monopoly. Now, as these individuals have no advantage given them by the law over other persons, it is clear they can only sell more of their commodity than other persons by producing the commodity cheaper and better.”  While this view did not recognize the very real occurrence of “natural monopoly”, it is a reasonable indication of just how uncommon such naturally occurring monopolies are.

[10] It has been argued that the history of government until very recently in human history – the Magna Carta is not yet 800 years old - has been authoritarian and essentially unlimited.  This is true as far as it goes.  It does not, however, change the fact that in practice government has not engaged in the practice of directly managing the economy until even more recently.  The practice of mercantilism was not terribly old in 1776 when Adam Smith condemned it in An Inquiry into the Nature and Causes of the Wealth of Nations and the modern welfare state did not begin to evolve until the late 19^th century.  Thus, the argument that a discussion of recently adopted government powers is somehow incompatible with the unlimited authority of monarchies dating back to antiquity is simply without merit.

[11] U.S. Government, Statistical Abstract of the United States (Washington D.C.: U.S. Government Printing Office, 2006) p. 330, Table 481: http://www.census.gov/compendia/statab/2006/tables/06s0481.xls

[12] Changes in Federal Civilian Employment: An Update, May 2001: http://www.cbo.gov/doc.cfm?index=2864&type=0

[13] See for example The Urban Institute’s The Other Side of Devolution: http://www.urban.org/publications/307015.html

[14] U.S. Government, Statistical Abstract of the United States (Washington D.C.: U.S. Government Printing Office, 2008), Table 447: http://www.census.gov/compendia/statab/tables/08s0447.xls#Notes!A1

[15] The Federal Workforce: Characteristics and Trends, September 30, 2008: http://opencrs.com/document/RL34685

[16] Mercatus Reports, Mercatus Center, George Mason University, September 2006: http://www.cato.org/pubs/regulation/regv29n2/v29n2-mercreport.pdf

[17] United States Federal Register, Vol. 70, No. 250, Friday, December 30, 2005, p. 77752 retrieved at http://frwebgate.access.gpo.gov/cgi-bin/getpage.cgi

[18] This data is available from a number of sources.  I chose a specific government source to forestall claims of illegitimacy: National Science Foundation,  Science and Engineering Indicators – 2000, p. A-53, Appendix table 2-22: Trends in R&D and Federal Outlays: FYs 1970, 1980, 1990, and proposed 2000: http://www.nsf.gov/statistics/seind00/append/c2/at02-22.pdf

[19] The Budget of the United States Government: Fiscal Year 2009: http://www.gpoaccess.gov/usbudget/fy09/pdf/budget/tables.pdf

[20] “It’s Tax Day and We’re Not Happy About It”, ABC News, April 17, 2006: http://abcnews.go.com/Business/PollVault/story?id=1843313

[21] Citizens Against Government Waste http://www.cagw.org/site/PageServer?pagename=getinv_gotwaste

[22] Earmarks in Appropriation Acts: FY1994, FY1996, FY1998,

FY2000, FY2002, FY2004, FY2005, Congressional Research Service, January 26, 2006 http://www.fas.org/sgp/crs/misc/m012606.pdf

[23] Al Gore, National Performance Review, Letter to the President, September 7, 1993: http://www.ibiblio.org/npr/npintro.html#letter

[24] U.S. Department of Defense, Office of the Assistant Secretary of Defense (Public Affairs): http://www.defenselink.mil/speeches/speech.aspx?speechid=430

[25] Department of Defense Agency-Wide Financial Statements, Memorandum for Under Secretary of Defense (Comptroller), February 26, 2002:  http://www.dodig.osd.mil/Audit/reports/fy02/02-055.pdf

[26] “Major Government Waste Uncovered”, KGO-TV report, June 9, 2005 found at http://www.lookingglassnews.org/viewstory.php?storyid=798

[27] Statement of Susan Gaffney, Inspector General, Department of Housing and Urban Development, before the House of Representatives Committee on Government Reform Subcommittee on Government Management, Information and Technology, March 22, 2000: http://www.hud.gov/offices/oig/data/reform.pdf

[28] Text from Wikipedia http://en.wikipedia.org/wiki/Agricultural_Adjustment_Act; additional detail and source material can be found in FDR’s Folly, Jim Powell, 2003, "Chapter Ten: Why Did the New Dealers Destroy All That Food When People Were Hungry?"; Clifton Luttrell, “Government Crop Programs: High Cost and Few Gains", Cato Institute Policy Analysis, July 9, 1985: http://cato.org/pubs/pas/pa056es.html; and Brinkley, Alan (1999). American History: A Survey, 10th Ed., McGraw-Hill College, p.879

[29] See, for example, Sara Fitzgerald and Aaron Schavey, “Rusty Thinking on Steel Tariffs”, The Heritage Foundation, September 29, 2003: http://www.heritage.org/Press/Commentary/ed093003b.cfm; “Advisors to Bush Seek Steel Tariff Rollback” The Boston Globe, August 26, 2003: http://www.boston.com/business/globe/articles/2003/08/26/advisers_to_bush_seek_steel_tariff_rollback/; W. James Antle III, “Steel tariffs were bad economics and bad politics”, Enter Stage Right, September 22, 2003: http://www.enterstageright.com/archive/articles/0903/0903steeltar.htm

[30] “Subsidies and High Crop Prices”, US News & World Report, January 24, 2008, http://www.usnews.com/articles/business/economy/2008/01/24/subsidies-and-high-crop-prices.html

[31] The Debt to the Penny and Who Holds It: http://www.treasurydirect.gov/NP/BPDLogin?application=np

[32] Federal pensions and veterans’ benefits are sometimes included in the definition of transfer payments, but this is a misapplication of the term.  While it may appear that no service is provided for these payments, in reality these are really delayed payments agreed upon for services rendered at some prior date.

[33] “Government Size and Economic Growth”, Prof. Richard K. Vedder and Prof. Lowell E. Gallaway, Ohio University, December 1998: http://www.house.gov/jec/growth/govtsize/govtsize.pdf

[34] “The World’s Wealthiest Poor”, By Bill Steigerwald, Front Page Magazine, September 12, 2007: http://www.frontpagemag.com/Articles/Read.aspx?GUID=36BD9AB4-3667-48FC-A5FE-A89757979301; also “Importing Poverty: Immigration and Poverty in the United States: A Book of Charts”, Robert E, Rector, The Heritage Foundation, October 25, 2006: http://www.heritage.org/Research/Immigration/SR9.cfm; and “Mike’s Misstep”, Heather MacDonald, New York Post, July 15, 2008: http://www.nypost.com/seven/07152008/postopinion/opedcolumnists/mikes_misstep_119902.htm?page=0

[35] References have appeared online to a story in the Minneapolis Star Tribune indicating that, in the wake of a relaxation of EPA guidelines on rat poisons, accidental poisonings of children by these substances tripled from 2001, when the regulations were in place to 50,000 per year in 2004, when they were not.  The only problem is that the figure has no basis in reality whatsoever.  According to the American Association of Poison Control Centers which compiles the national statistics on poisoning (and is a primary source used by the Center for Disease Control), the total number of children under six unintentionally poisoned by all pestcides was 46,929 in 2001 (http://www.aapcc.org/archive/Annual%20Reports/01report/2001%20TESS%20Full%20Report.pdf) and this figure grew by 11% to 52, 174 in 2004 (http://www.aapcc.org/archive/Annual%20Reports/04report/AJEM%20-%20AAPCC%20Annual%20Report%202004.pdf).  For rodenticides (rat poisons), the total number of individuals exposed in 2004 up to age 19 amounted to 17,172 – a bit below the 50,000 figure – and a reduction from the 2001 total of 17,271.

[36] “Silent Spring at 40”, Ronald Bailey, Reason Magazine, June 12, 2007: http://www.reason.com/news/show/34823.html; “The Nine Most Dangerous Myths About Pesticides and High-Yield Farming”, Center for Global Food Issues, Dennis Avery, December 1, 2004: http://www.cgfi.org/tag/pesticides-myths/; “DDT: A Double Edged Sword” excerpted from The Fly in the Ointment, Dr. Joe Schwarz, 2004: http://members.shaw.ca/mrmoore/10%20App%20Sci/DDT%20-%20the%20Double-Edged%20Sword.pdf

[37] Marvin, PH. 1964 Birds on the rise. Bull Entomol Soc Amer 10(3):184-186; Wurster, CF. 1969 Congressional Record S4599, May 5, 1969; Anon. 1942. The 42nd Annual Christmas Bird Census. Audubon Magazine 44:1-75 (Jan/Feb 1942; Cruickshank, AD (Editor). 1961. The 61st Annual Christmas Bird Census. Audubon Field Notes 15(2):84-300; White-Stevens, R.. 1972. Statistical analyses of Audubon Christmas Bird censuses. Letter to New York Times, August 15, 1972

[38] Mader, Sylvia S. 1996. Biology - 5th Ed. WCB and Cox, G.W. 1997. Conservation Biology - 2nd ed. WCB

[39] “The Deathly ‘Silent Spring’ Movement”, Ken Lockitch, The Daily Californian, September 11, 2007: http://www.dailycal.org/article/25923/the_deathly_silent_spring_movement

[40] “Balancing risks on the backs of the poor”, Dr. Amir Attaran, Dr. Donald R. Roberts, Dr. Chris F. Curtis & Dr. Wenceslaus L. Kilama, Nature Medicine 729-731 (2000): http://www.nature.com/cgi-taf/DynaPage.taf?file=/nm/journal/v6/n7/full/nm0700_729.html

[41] "There is persuasive evidence that antimalarial operations did not produce mosquito resistance to DDT. That crime, and in a very real sense it was a crime, can be laid to the intemperate and inappropriate use of DDT by farmers, especially cotton growers. They used the insecticide at levels that would accelerate, if not actually induce, the selection of a resistant population of mosquitoes." – Robert S. Desowitz, The Malaria Capers, 1992

[42] “Malaria”, Michael Finkel, National Geographic, July 2000: http://ngm.nationalgeographic.com/2007/07/malaria/finkel-text; “Bring Back DDT, and Science With It!”, Marjorie Mazel Hecht, 21^st Century Science & Technology Magazine, Summer 2002: http://www.21stcenturysciencetech.com/articles/summ02/DDT.html; “DDT Ban and Malaria”, Norman Swan, The Health Report, April 19, 1999: http://www.abc.net.au/rn/talks/8.30/helthrpt/stories/s22432.htm

Is Government “Good”? [1]

A Systematic Refutation of Many of the Myths Believed by Socialists … and One in Particular

On a decidedly gloomy Monday in October of 2008, while researching information on the realtive costs of governmental regulations and economic inefficiencies, I was surprised to see a search engine result shouting “Government is Good”. Certainly, that could mean all sorts of things. It could be nothing more than a treatise on the historical applications of government in the areas of national defense (when the military is limited to that role) or public safety, with which I might not disagree, but, for some strange reason, I did not believe that to be at all likely.

The characterization of government as “good” was particularly interesting. Thinkers at least as far back as Tomas Paine believed that, "Government, even in its best state, is but a necessary evil; in its worst state, an intolerable one.” [2] Andrew Jackson’s belated reply argued that, “There are no necessary evils in government. Its evils exist only in its abuses.” [3] Of course, Jackson expressed this opinion while vetoing the charter renewal of the Second National Bank on the grounds that it was “unauthorized by the Constitution, subversive of the rights of the States, and dangerous to the liberties of the people” [3] so he was hardly arguing that government was “good” or not prone to the abuses of which he warned.

Still, intrigued, I decided to see what was to be found there. I was not surprised. The first thing that caught my eye was a blurb from the author’s introduction stating “It is not an exaggeration to say that the right-wing in this county has declared war on government.” [4] Comments such as that do not, as a rule, foster the belief that what follows will be an objective dissertation unencumbered by ideological bias. So before proceding further, I thought it of value to do a little research into the author of the piece to get an understanding of where he is coming from.

The author, or project creator if you will, is Douglas J. Amy, [5] Professor of Politics at Mount Holyoke College in South Hadley, Massachusetts. He is the author of Behind the Ballot Box: A Citizen's Guide to Voting Systems, an examination of the political advantages/disadvantages of voting systems used in Western democracies, Real Choices, New Voices: How Proportional Representation Elections Could Revitalize American Democracy, an advocacy of the proportional representation systems used in other Western Democracies (and a view with which I might agree) and The Politics of Environmental Mediation. The most recent contribution by professor Amy took the form of a guest column that appeared in the Seattle Post Intelligencer in April 2008. [6]  The points made in that column are indicative of what I was to find.

In a column discussing the implications of the mortgage loan crisis, the author begins by suggesting that we need to remember “just how dependent we are on government to minimize the considerable risks and dangers of a free market economy”. This is necessary, in his view, because we need “government to rein in the many problems that naturally afflict this kind of economic system. Without government coming to the rescue over and over again, life in a free market system would be unpalatable to most people”. The problem with this analysis is, of course, that nothing about the economic crisis under discussion had anything to do with any “natural” problems of a free market economy, [7] but rather was a direct result of the monetary policies of the central bank which create the “boom-bust” cycle so commonly misconstrued as a an aspect of capitalism. [8]

Professor Amy continues with a gross mischaracterization of the history of the early 20^th Century, blaming “grinding poverty, lack of adequate health care, absence of old-age pensions, unchecked and abusive monopolies, environmental squalor and rampant diseases in the cities, dangerous and often lethal working conditions, and the inevitable and hugely destructive economic depressions” on an “unregulated market system” and the “unaddressed problems of capitalism”. Of course, we know now that the problems he describes were either the direct result of governmental action or were societal problems actually solved by the embrace of capitalism. It is disturbing that a modern professor of politics is so historically misinformed. It seems as if the good professor has swallowed whole the myths of Friedrich Engels’ The Condition of the Working Class in England in 1844, which blamed disease, “misery and oppression of the proletariat” on the evils of capitalism. [9]  Unfortunately, those conclusions did not survive even Engels’ later scrutiny who observed in a subsequent edition, “Though not expressly stated in our recognised treatises, it is still a law of modern Political Economy that the larger the scale on which capitalistic production is carried on, the less can it support the petty devices of swindling and pilfering which characterise its early stages...” [10]  Oddly, Engels failed to realize that by crediting the greater advance of capitalism with the solutions to the problems he saw completely undermines his original thesis.

Perhaps the best refutation of Engels’ theory (and, to a certain extent, Professor Amy’s position as well), was penned by William Harold Hutt in 1925. In his “The Factory System of the Early Nineteenth Century”, he concluded, “there has been a general tendency to exaggerate the ‘evils’ which characterized the factory system before the abandonment of laissez faire and, second, that factory legislation was not essential to the ultimate disappearance of those ‘evils’. Conditions which modern standards would condemn were then common to the community as a whole, and legislation not only brought with it other disadvantages, not readily apparent in the complex changes of the time, but also served to obscure and hamper more natural and desirable remedies (emphasis in original).” [11] Or, as the eminent economist Ludwig von Mises put it, “It is not labor legislation and labor-union pressure that have shortened hours of work and withdrawn married women and children from the factories; it is capitalism, which has made the wage earner so prosperous that he is able to buy more leisure time for himself and his dependents. The nineteenth century’s labor legislation by and large achieved nothing more than to provide a legal ratification for changes which the interplay of market factors had brought about previously.” [12]  This is an issue I shall explore later.

The greatest period of economic upheaval in the early 20^th Century was the Great Depression, which was, again, a failure, not of capitalism, but of government policy. The pivotal work on the subject, from an historical perspective, is, of course, A Monetary History of the United States 1867-1960, by Milton Friedman and Anna Schwartz. In it, the two economists explained how Fed mismanagement greatly prolonged what might otherwise have been a short-term phenomenon. As Friedman pointed out some time later, “The Fed was largely responsible for converting what might have been a garden-variety recession, although perhaps a fairly severe one, into a major catastrophe. Instead of using its powers to offset the depression, it presided over a decline in the quantity of money by one-third from 1929 to 1933 ... Far from the depression being a failure of the free-enterprise system, it was a tragic failure of government.” [13]

Even Federal Reserve Chairman Ben Bernanke now concedes this no longer controversial view. On the ocassion of Milton Friedman’s ninetieth birthday, Bernanke put it bluntly: “Let me end my talk by abusing slightly my status as an official representative of the Federal Reserve System. I would like to say to Milton and Anna: Regarding the Great Depression. You're right, we did it. We're very sorry. But thanks to you, we won't do it again." [14].

Subsequent work, most notably by Murray Rothbard, placed the blame even for the initial recession squarely where it belonged: “What was the trouble? Economic theory demonstrates that only governmental inflation can generate a boom-and-bust cycle, and that the depression will be prolonged and aggravated by inflationist and other interventionary measures. In contrast to the myth of laissez-faire, we have shown in this book how government intervention generated the unsound boom of the 1920s, and how Hoover's new departure aggravated the Great Depression by massive measures of interference. The guilt for the Great Depression must, at long last, be lifted from the shoulders of the free-market economy, and placed where it properly belongs: at the doors of politicians, bureaucrats, and the mass of ‘enlightened’ economists. And in any other depression, past or future, the story will be the same. (emphasis added)” [15] And additional insight into how the Great Depression was precipitated and how it was prolonged for years by governmental mismanagement has been provided by Jim Powell in his insightful and well-researched FDR’s Folly: How Roosevelt and His New Deal Prolonged the Great Depression.

Proceeding from the observably false premise that all the evils visited upon mankind are the result of unfettered capitalism, it is small wonder that the good professor looks upon the interventions with reverence and awe: “Today, fortunately, myriad liberal government programs have greatly reduced the problems and risks of a market economy. We have unemployment insurance, Medicare and Medicaid, food and drug regulation, the 40-hour work week, Social Security, banking deposit guarantees, the minimum wage, environmental regulations and workplace safety rules. And government monetary and fiscal policies have ensured that we haven't had a major depression since the 1930s.” The economic and historical fallacies contained in those three simple sentences are legion. The last I have already addressed: not merely “major” depressions but the entire boom-and-bust cycle is caused, not prevented, by monetary and fiscal policies. Some of the others cry out for immediate comment – unemployment insurance and minimum wage laws invariably increase unemployment, for example – but each shall be addressed in detail as part of the analysis of the “Government is Good” thesis.

[1] While a discussion of the pros and cons of ideological anarchism, anarcho-capitalism and/or libertarianism/minarchism is certainly a valid one, it is beyond my scope here, those interested in examining these discussions might consider Anarchism/Minarchism: Is a Government Part of a Free Country, Roderick T. Long and Tibor R. Machan, 2008

The problem is not only that fiscal responsibility has been absent for so long, but that people have forgotten what it means. It has been mischaracterized as nothing more than not spending more than the state takes in, which justifies every conceivable tax increase, rather than not spending much at all. The idea that it is fiscally responsible to spend whatever you please so long as you ramp up the tax burden enough to cover it – assuming that’s possible – is pure absurdity.

Let’s put it bluntly: government spending destroys jobs; reductions in government spending create jobs – always, without exception. Recently, I have been challenged to “prove” the latter portion of this assertion by providing nothing more than a single example of reductions in government spending creating jobs. And I must admit: I can’t.

I don’t need to.

The problem with the challenge is that it is based on a false premise: that the point requires an example to be proven. Examples are hard to come by for two reasons. First, examples of the state reducing outlays by a significant amount are extremely rare. Second, while it is easy to identify job losses related to a specific action because a position that already exists is eliminated and the consequences are quite real to the individual no longer employed, greater job creation is indistinguishable from otherwise ordinary job creation because both are created by marginal economic efficiencies and no one can identify with certainty where that next given position will appear.

The demand for an example is nothing less than a disingenuous attempt to win the argument by setting unrealistic criteria as a minimum level of proof. It is on par with demanding that someone point out Neptune in the night sky or one has failed to “prove” its existence. In actual fact, Neptune’s existence became apparent logically due to variations in the orbit of Uranus some three years before its actual discovery in 1846.

So how does one logically prove that reduced government spending creates jobs?

One might begin with the first part of the assertion: government spending destroys jobs. Examples of this truism abound – everything from the Hoover and Roosevelt response to the Great Depression, to Welfare State spending that has increased poverty, to unemployment compensation, to steel tariffs that destroyed jobs in industries using finished steel. The list is almost endless. Each of these examples has been thoroughly examined in detail and show, conclusively, that increased government spending eliminates jobs.

Logically, then, if that spending had not been undertaken, more jobs, by definition, would have been created. That, in and of itself, constitutes sufficient proof of the stated premise, but there is an even more compelling argument.

Economic growth, and, by extension, job growth, is created by marginal economic efficiencies. Channeling resources to their most efficient use frees still more resources to be invested elsewhere. Those investments in other productive means create opportunities for the application of labor – jobs. Therefore, logically, anything that increases economic efficiencies creates jobs and anything that decreases economic efficiencies destroys them. The examples of job loss related to governmental spending and intervention already mentioned above are the real world results of this dynamic in action.

Why then is government spending invariably a destroyer of jobs – even when the spending is for so-called “job creation” or the supposedly noble task of “spreading the wealth around”? And, why is any reduction in governmental expenditure, by definition, a creator of jobs? The answer lies in the creation or destruction of those economic efficiencies.

Efficiency in the economic sense is more than merely efficiency in the traditional business sense. In a business environment, efforts to increase efficiency are typically limited to the elimination of waste. If a process can be altered so that less energy or labor is used to generate the same output, then efficiency has been increased. It is in this context that Al Gore’s National Performance Review came to the conclusion that waste consisted of less than two cents of every tax dollar. Setting aside for the moment the obvious point that the evaluation of prison security by the inmates is subject to question, this still does not address efficiency in the economic sense because economic efficiencies take into consideration factors that businesses have already dealt with that givernment cannot.

Put another way, it’s like bragging that you “only” waste two cents of every dollar for every car that you manufacture only to be reminded that (a) no one is terribly interested in buying the Edsels being produced and (b) it’s a truck assembly plant. Economic efficiencies do not merely reflect the ability to produce something using the fewest resources, but also the ability to identify what the best use of those resources are in the first place.

Ludwig von Mises used the example of wine and oil to illustrate this problem back in 1920:

“It will be evident, even in the socialist society, that 1,000 hectolitres of wine are better than 800, and it is not difficult to decide whether it desires 1,000 hectolitres of wine rather than 500 of oil. There is no need for any system of calculation to establish this fact: the deciding element is the will of the economic subjects involved. But once this decision has been taken, the real task of rational economic direction only commences, i.e. economically, to place the means at the service of the end. That can only be done with some kind of economic calculation. The human mind cannot orientate itself properly among the bewildering mass of intermediate products and potentialities of production without such aid. It would simply stand perplexed before the problems of management and location.”

The market mechanism, when permitted to function normally, easily determines how many resources should be allocated to each activity (in this case, the production of wine or oil) at any given time. In the case of oil, in particular, the needs can vary widely in a short time as demonstrated by the significant swings in prices over the last several months. No bureaucrat or group of bureaucrats could possibly anticipate these changes and respond accordingly in anything even approaching the manner that the free market does automatically every single day. It is objectively impossible for government to operate with the economic efficiency of the free market.

A few years back an insightful book by Philip K. Howard was published entitled The Death of Common Sense. Nothing illustrates this point more alarmingly (to an economist, anyway) than the decision, announced Monday, of the Nobel Committee to award the prize for economics to none other than Paul Krugman.

The discovery of this little tidbit was, to me, surreal. I learned it – before posting my scheduled column – as I turned on my computer Monday morning and read the blurb from the American Foreign Press (appropriately enough, alongside the advertisement for Disney On Ice’s presentation of Worlds of Fantasy). It was almost more than I could stomach and it was some time before I could bring myself to revisit the news.

As I write these words, I am less angry about the selection and more committed to my reasons for opposing what Paul Krugman has become. In the interests of full disclosure – and because it bears directly on the issue at hand – the reason that I am so disgusted with Mr. Krugman’s activities on the New York Times editorial page is that there was a time when he actual was a distinguished economist whose work, while in the now-diminished Keynesian school, was an effort to push the science forward and increase the knowledge of markets and human behavior. It is possible to respect those who have a sincere desire to expand human knowledge even when one disagrees with the outlook or conclusions of such individuals.

When Krugman took up the pen as a columnist, however, understanding and knowledge became secondary and it quickly became apparent (as I have discussed in earlier entries) that he had not merely set aside the science of economics but abandoned it entirely whenever basic economic principles were at odds with his ideological attacks on those who would dare to belong to another political party than he did. The prediction that the Reagan tax cuts would result in a tidal wave of inflation (which, of course, never appeared) was not even consistent with the economic school to which he ostensibly belongs. The same can be said of his view of the tax increases under Clinton, which magically enabled us to balance the budget (even though they did no such thing and even Clinton’s submitted budgets projected deficits as far as they eye could see) and thus created a “good” economy even though a surplus did not appear until the very end of his term. Nothing in that assessment is supported by the theoretical underpinnings of any economic school. His recent endorsements of economic stimulus packages, the financial industry “bailout” and the partial nationalization of the financial services industry are nothing more than the most recent examples of ideology trumping science.

As economist William Anderson pointed out long ago, Krugman “does not argue in economic terms; he simply appeals to envy and calls it economic thinking.” [Subsequent to my writing this much, Anderson described the Nobel Committee’s decision as “an intellectual event matched only by the sacking of Constantinople in 1453” – a tad farther than I am willing to go for reasons outlined below.]

At the very least, however, the Nobel committee did not reward the Times columnist for any of these activities though it did choose, ultimately to mention them. The award was instead given for “analysis of trade patterns and location of economic activity." Specifically, Krugman re-introduced into the comparative advantage model the concept of “tipping points” and, more specifically, by taking into consideration the positive impact of the free flow of capital and labor internationally that increases returns in each of the affected countries, he revitalized interest in the field of economic geography. While Krugman’s contribution was more one of calling attention to an under-appreciated economic field and flawed inasmuch as it suffers from the underlying Keynesian notion that trade takes place between different countries rather than individuals within different countries, the results of Krugman’s analysis (initially performed in 1979 and expanded upon in 1991) was a ringing endorsement for international free trade.

The incredible irony is that Krugman the columnist has demonstrated repeatedly that he vehemently disagrees with Krugman the economist, as he has been a staunch defender of government intervention and open critic of free trade policies (and in favor of “fair trade” which is entirely different). Or, as Peter J. Boetke recently put it, “unlike both Friedman and Galbraith, Krugman's work devolved from science to ideology and finally to political partisanship. Friedman and Galbraith had always kept (though from differing perspectives) on the scientific to ideological spectrum, but neither became overtly partisan in their writings. This cannot be said for Krugman and the way he has used his platform as an economist and as a columnist for the New York Times for his Democratic partisanship purposes…. This would be innocent enough if Krugman were just another political pundit, but now the prize has given him an enhanced platform from which to pronounce his partisan positions as if they are grounded in economic science.”

Thus, as in the case of so many of my economic peers (in the general sense – I like to think that my gifts, while not so much advancing the science, run more toward making concepts understandable to those who haven’t devoted the time to economic research), I have considerably less of a problem with the Nobel being given to Krugman for the reasons stated by the committee than I do with the undeserved air of legitimacy given to the economic posturing that he now engages in with such frequency.

This is not a new phenomenon. Joseph Stiglitz, for example, was awarded the Nobel Prize as part of the team led by George Akerlof and Michael Spence for their contributions in the area of “asymmetrical information” in the marketplace. This is a field popular among economists of the Left because it seems to legitimize the concept of “market failure”. Of course, this is nothing but a straw man as no economist describes the functioning market as “perfect” but rather as the most efficient allocator of resources. The pricing mechanism examined by Stiglitz, et al, does not even achieve equilibrium in the real world (true equilibrium is a theoretical concept) but instead is always approaching equilibrium because market conditions are always in flux. This is not an example of “failure” but simply the normal function of the market.

Stiglitz, who has been advocating a “third way” model of socialism for decades while attacking capitalism and so-called market socialism with equal fervor, used the Nobel recognition as an endorsement of his decidedly out-of-the-mainstream views. These views pervaded his work as a member of the Intergovernmental Panel on Climate Change.

Similarly, Edmund Phelps, who won the prize for works that ultimately helped demonstrate the uselessness of the Keynesian Phillips curve, has used his Nobel notoriety to push for governmental subsidies to firms employing low-wage workers, having completely missed the obvious problem that such a policy yields given that the government cannot possibly allocate these resources in a manner superior to that of the marketplace from which the resources needed for such subsidies must come.

The housing crisis is in full swing; fifteen banks have failed; the top five investment houses have either closed their doors, found themselves under new management, or completely altered the nature of their operations; and the economy as a whole is almost certainly in recession. Much discussion has taken place as to how this crisis began; the question remains how best to return the economy to stable growth and how to prevent this kind of thing from happening again.

Those seeking a sudden resurgence are bound for disappointment. As Ben Bernanke has told us, “a broader economic recovery will not happen right away." The problem is that the past cannot be undone. Irrational markets making certain loans and financial instruments appear viable when, under normal conditions, they obviously were not, cannot be rebuilt, nor should they be. Losses on these investments will be absorbed by the economy regardless of whether they are borne by financial institutions or by taxpayers. That said, what can be done?

Actually, the appropriate course is not all that hard to identify. The precepts have been with us for millennia in the field of medicine and its about time that the powers that be heeded these principles with regard to the economy. Sadly, those powers have been notably unwilling to pay any attention.

The first principle is perhaps the best known in medicine: primum non nocere – “first do no harm”. This obvious directive was the first tossed out the door. The major players have not even been able to adhere to a basic precept of the Hippocratic Oath which states “I will neither give a deadly drug to anybody who asked for it, nor will I make a suggestion to this effect”.

Arguably these concepts were discarded as far back as 2001 when the Fed began administering the deadly drug of excess liquidity into the marketplace, but nothing can be done about that now. Instead, it is essential that the narcotics currently being administered be curtailed so that the economy can heal. Continued cutting of the Fed funds rate may seem like “the hair of the dog” but can only result in a prolonged period of withdrawal. Socializing still more economic losses can only increase the likelihood of inflation and remove still more resources from productive endeavors in the economy. And a governmental equity stake in our financial institutions may be the worst kind of economic arsenic. (Arsenic kills cumulatively and often gives the illusion of making the victim appear to improve before reaching its foregone conclusion.)

Calls for still more damaging “treatments” continue. Democratic members of Congress are vocally calling for another “economic stimulus (sic) package” despite the overwhelming evidence that such measures do not work and, instead, cause further harm. Similarly some have pushed for relief for those who cannot afford their current mortgages. Again, this merely shifts inevitable losses from those who made ill-advised decisions to taxpayers.

Efforts to “jumpstart the economy” are also ill advised. New taxes on “windfall profits” have never been anything but a drag on the economy. It must also be remembered that government spending has never created so much as a single net job – not one. It’s impossible. Even if the government were 99% as efficient as the private sector, the best that it could accomplish would be to create 99 new jobs at the cost of only 100, or the economic equivalent, as the resources used by government to create jobs must, by definition, be taken from the more efficient private sector. Of course, governments are far less efficient than that.

A popular misconception is that the problem is simply “government waste”. In defense of governmental intervention, it is frequently argued that less than two cents of every tax dollar are spent on bureaucratic waste (so sayeth Al Gore’s National Performance Review). The problem with that assessment, even if it is true, is that it has no relevance to the question of economic efficiency – the function of the marketplace to allocate resources to where they can be employed to the greatest benefit.

So what can government do to facilitate recovery? Simple: let the market work. This is not merely a case of doing no harm, but rather undoing the harm that has already been done. Certain obvious measures come immediately to mind:

Repeal Sarbanes-Oxley. Co-authored by perhaps the least competent Banking committee chairman in history (including Christopher Dodd), this legislation has cost the economy several times the amount of the economic losses associated with the events (Enron, Worldcom, etc.) that it was ostensibly designed to prevent. One study (Zhang 2005) indicated that the impact is as high as $1.4 trillion. Another, conducted annually by Finance Executives International (FEI) put the figure for 2007 alone at 0.036% of corporate revenues which seems like very little until one realizes that the vast majority of personal consumption flows through corporate revenues and that amounts to more than $9.7 trillion (2007 GDP component). If just half of that flowed through corporate revenues, the cost of Sabanes-Oxley in a single year was greater than $175 billion.

End subsidies/price floors. Whether they are to protect American sugar interests (at the cost of American candy makers) or steel jobs (at the cost of jobs in industries using finished steel) or to promote bio-fuels, no subsidy or price floor has ever done more good to the US economy than harm. Whole most such measures are not as harmful (or stupid) as those that actually pay farmers not to grow certain crops, they all harm American consumers and, ultimately, workers, because they reduce economic efficiencies and thus destroy jobs. The popular defense of such measures is that they protect “vital” interests or “promote” alternatives that create jobs. But the arguments are nonsensical. No one industry is more vital to the country than the prowess of the economy as a whole and any “alternative” that would create jobs would, by definition, have already attracted private investment in the absence of governmental interference.

Open up ANWR and the continental shelves to oil drilling. While the price of a barrel of oil has plummeted due to changes in aggregate demand, the underlying market principles behind developing domestic resources remain unchanged. The largely unwarranted environmental concerns about these measures are easily addressed while the development of these resources both attracts capital in the near term and benefits consumers in the long term. That oil is a finite resource and will eventually be supplanted by some alternative as the chief source of energy does not in any way undermine the reasoning behind developing the resources that exist. And, again, no governmental intervention will accelerate that change without harming the American consumer and worker.

Despite all of the gnashing of teeth and pointing of fingers that engenders every crisis, it must be remembered that presidents are not really magical Wizard-Kings that can wave their magic wand and instantly transform something as complex as the entire economy overnight. Typically, it takes as much as six years for presidential economic policy to be fully realized though some actions – almost universally bad ones – can have a more immediate impact. Thus, despite the misconceptions of those who cannot grasp this simple concept, it should come a no surprise that the economically irresponsible policies of the administration would eventually result in yet another recession…

Having addressed the initial cause of the current financial crisis – irresponsible monetary policy by the Fed – and before moving on to the culpability of government sponsored (that is, “run”) entities, let’s take a moment to examine the sheer mendacity of the New York Times editorial board who, a bit less than two weeks ago opined, “Don’t Blame the New Deal”.

The editorial, published September 27 begins with the assertion that “[t]his year’s serial bailouts are proof of a colossal regulatory failure … [as] antiregulation disciples of the Reagan Revolution have eliminated vital laws, blocked the enactment of much-needed new regulations, or simply refused to exercise their legal authority “  There’s only one problem with that position: it is absurd on its face.  There is, in fact, not a single example of deregulatory action that can be demonstrated to have contributed to the current crisis in any way.  That does not, however, dissuade the Times from making a valiant, if misguided, attempt to show otherwise.

The first club out of the Times’ bag is “predatory lending”, a staple of liberal demagoguery and economic illiteracy.  The editorial complains that Greenspan, and subsequently Bernanke – who, as already examined, have more than sufficient responsibility for current conditions – failed to heed a congressional mandate to curb this practice.  There’s only one problem: it doesn’t exist.  It cannot possibly exist.

The concept of predatory lending is based on the premise that unscrupulous lenders will trick unwary borrowers into taking loans that they cannot possibly afford in order to rake in big bucks at borrower expense.  The problem, of course, is that defaulted loans are vastly more expensive than any revenue stream than could possibly be earned before failure occurs.  In order for the “predatory lending” scenario to be possible, an entire industry must be staffed with people who knowingly and willfully chose to act against their own interests.  Utter nonsense.  While some unscrupulous mortgage generation shops may have been willing to say anything to get people in the door, such actions cannot convince ultimate lenders to underwrite the risks.  That requires a market distortion of gargantuan proportions … and in that regard, the Fed was happy to oblige.

The next canard out of the bag was the suggestion that limits on shareholder lawsuits passed in 1995 in some way opened the floodgates to misstatement of financial condition.  Nothing could be further from the truth.  The Private Securities Litigation Reform Act of 1995 required nothing more than that the plaintiff in such a suit demonstrate that he suffered economic harm due to a deliberate “material misrepresentation or ommission”.  That protects no one from the kind of activity the Times alleges took place under a “sense of immunity”.  Moreover, the editorial absurdly blames the Enron fiasco on this change even though the company’s actions were unequivocally fraudulent – thus, obviously not impacted by the law change – and began before the legislation was passed (shadow companies were set up beginning in the early 1990s).

The Times, however, wasn’t finished.  It had to hold forth on the greatest indignity of them all – the dismantling of something created under the sainted Roosevelt Administration (which created Fannie Mae in the first place, but that’s a topic for another day).  In 1999, Congress dismantled much of what remained of the Glass-Steagall Act, described by the Times as “a pillar of the New Deal, which separated commercial and investment banking”.  Conspicuously ommitted from the Times’ analysis is the fact that the US is the only country in the world to make such distinctions – and financial institutions in those countries have not suffered ill effect as a result.  It was, in reality, the artificial distinctions under Glass-Steagall that placed the Savings & Loan industry in jeopardy in the 1970s; specifically, as interest rates spiralled out of control – also the result of irresponsible govermental actions – savings and loans faced a rapid outflow of low interest deposits into higher paying securities while their assets were tied up in long-range mortgage securities.  Under Glass-Steagall, S&Ls were unable to diversify as wihdrawals rapidly drove them toward bankruptcy.  By the time Congress acted to fix this problem, which could only have resulted in the collapse of the industry even in the absence of deregulation, the cure was frequently too late and, in cases, S&Ls were in the position of needing to offer products with which they had no experience and little understanding.  The rest is history.

If anything, both the S&L crisis and the current financial meltdown can be blamed in large part, not on the repeal of Glass-Steagall, but on the artificial distinctions that were created under Glass-Steagall in the first place.

Finally, the editorial takes two more completely baseless swipes at the deregulatory (or lack of regulatory) activity over the last eight years, first bemoaning the exclusion of derivatives from the Commodity Exchange Act of 1936 and then blaming the current administration for failing to reform Fannie Mae and Freddie Mac in 2005 because “President Bush wanted to fully privatize them and feared that if they were adequately reformed, privatization would lose steam”.  The first of these assertions I’ll come back to; the second is flatly absurd.  Absent from the selective memory of the writers is the fact that the president doesn’t get to sign legislation until it passes both houses of Congress and the measure was killed in the Senate Committee on Banking, Housing, and Urban Affairs under the Chairmanship of none other than Christopher Dodd (D-CT), who, by some strange coincidence, has received more political contributions from Fannie Mae than any other human being.

As a side note, the obtuseness of the Times editorial board is particularly evident in its clear disdain for the notion that Fannie Mae and Freddie Mac might be privatized even though that would likely have prevented these entities from making the problem worse as the private sector would not have permitted the continued accumulation of unwarranted risk and would almost certainly have detected the chicanery of Franklin Raines much sooner.

That leaves the claim that it was the proliferation of derivatives outside of commodity exchange oversight that caused the problem.  Here, again, the disease is ignored in favor of a symptom.  The unregulated free market is perfectly capable of correctly pricing the risks of essentially any financial instrument.  It is only when pricing signals are radically distorted either by rampant manipulation of the liquidity markets by government in the guise of the Fed or the explicit socialization of losses for certain investment vehicles by the government in the guise of government sponsored entities or both as happened in this particular case that the market cannot perform this function properly and chaos ensues.

On Friday, Federal Reserve Chairman Ben Bernanke “applauded” the passage of a $700 billion financial bailout because it was “a critical step toward stabilizing our financial markets and ensuring an uninterrupted flow of credit to households and businesses”. In addition, he promised that the Fed "will continue to work closely with the Treasury as it undertakes these new initiatives … [and] continue to use all of the powers at our disposal to mitigate credit market disruptions and to foster a strong, vibrant economy." What he didn’t say was that the bailout will do nothing to address the underlying causes of the financial crisis and, instead, will likely make things worse because it grants ever more power to the one institution most responsible for the crisis in the first place – the very entity Bernanke runs.

That’s right campers, despite all the rhetoric to the contrary, the sudden contraction of credit, the real estate fiasco and the ripple effect that these items have had on both Wall Street and Main Street were not the result of corporate greed or excess deregulation or even, at least at the outset, the nature of mortgage lending. The initial cause of the crisis was none other than the irresponsible actions of the Federal Reserve Board. And despite the comments of our come-to-the-rescue Fed Chairman, there is absolutely no doubt that he knows it.

In looking for a cause of the monetary meltdown, much attention has been focused on the policies of the current administration, the disinterest of Barney Frank and Chris Dodd, the endless appetites of mortgage lenders, the irresponsibility of borrowers, etc., but, while there is plenty of blame to go around, ultimately all of these things are merely symptoms, rather than causes. The desire of lenders to initiate mortgages and borrowers to purchase homes is not new. The corruption or inattention or incompetence of public officials is not new. And none of the deregulatory actions undertaken in the last thirty years had anything whatsoever to do with the failure of so many mortgage-backed instruments. What, then, caused these pre-existing conditions to become a suddenly severe economic malady?

What, indeed. While political sound-bytes eagerly compare current conditions to the Great Depression, it is interesting to examine what similarities there are between the two events. Certainly, there is no comparing the severity of the two events. Of the more than 25,000 banks in business in 1929, fewer than 15,000 survived to 1933; unemployment rose to 25% in 1933 (and, after improving, spiked again to 19% in the wake of FDR’s policies); the economy shrank by more than a quarter in just four years – an economic disaster such as the world had never seen. A contraction of that magnitude is, by no means, contemplated now. Fewer banks are expected to fail than during the S&L crisis a couple decades back – also the result of government failure – and unemployment at 6.1% is still below historical norms. What is truly comparable about the current crisis and the Great Depression is the set of actions that triggered them.

As eminent economist Milton Friedman and co-author Anna Schwartz pointed out in their groundbreaking “A Monetary History of the United States 1867-1960”, the Great Depression was caused by a loose monetary policy in the years preceding the Depression - fueling the “roaring 20s” – followed by a sudden contraction of credit that caused a liquidity crisis. Matters were made abundantly worse by banking laws that made it nearly impossible for financial institutions to diversify and a further Fed contraction of credit at a time when banks were going under from lack of funds. Additional insight into these events can be found in James Powell’s “FDR’s Folly” and Murray Rothbard’s “America’s Great Depression”.

Fast forward to 2001. After more than a decade of steadily bringing down interest rates to the approximate historical cost of liquidity, the Fed went on a further spree. Between May and November of 2001, the central bank slashed the Fed funds rate from 4.0% to 2.0%. Not satisfied with that massive infusion of liquidity into the economy, the Fed slashed rates below 2.0% in December and didn’t raise them above that level for three full years.   Liquidity flooded the market faster than the Katrina surge flooded New Orleans.

This influx of cash had an effect on the marketplace that was nothing less than predictable. Low rates create incentives for lenders to lend and borrowers to borrow. That the rates were held artificially low by government fiat does not change the impact that such low rates have on the marketplace. The problem was made worse – by several orders of magnitude – by the actions of Fannie Mae and Freddie Mac, giving a false sense of security to all the actors in the marketplace by essentially endorsing riskier mortgage-backed securities that would not otherwise have been available in the first place. This imprimatur influenced not only borrowers and lenders, but rating agencies and industry analysts. The whole series of malinvestments and market distortions began with the over-abundance of liquidity induced by Fed mismanagement. But that’s only half the story.

Beginning in July 2004, the Fed reversed course and began raising rates. This long-overdue adjustment began to stem the tide of excess cash in the economy. The rate rose to 2.0% by the end of the year; six months passed and it was at 3.0%; another six months passed and it was at 4.0%. Still locked into the interventionist mindset that caused the problem in the first place, however, the Fed kept right on going. Within another six months, the rate had risen to 5.0% and eventually topped out at 5.25%. Where once the rate had been well below the market rate for liquidity, it had now swung too far in the other direction. This is what we call a “credit crisis”. Liquidity disappears, asset values tumble. The economy does not merely correct itself – which, again, was inevitable, it over-corrects.

And the cycle that once created the Great Depression, in this case exacerbated by mismanagement at Fannie Mae and Freddie Mac rather than the disastrous policies of the New deal, repeats itself. The liquidity boom and bust created by the Fed - all-too-frequently mischaracterized as a fundamental aspect of capitalism when nothing could be further from the truth – and so thoroughly described in that seminal work by Drs. Friedman and Schwartz, had once again thrown the economy into chaos.

Back in November of 2002, on the ninetieth birthday of Milton Friedman, Ben Bernanke stated, “Let me end my talk by abusing slightly my status as an official representative of the Federal Reserve System. I would like to say to Milton and Anna: Regarding the Great Depression. You're right, we did it. We're very sorry. But thanks to you, we won't do it again."

Promises, promises.

It’s not merely the political Left that wants to intervene into the marketplace. Even some otherwise clearheaded individuals have fallen for the argument that “energy independence” is necessary on “national security” grounds, or because we are “transferring wealth” to Middle Eastern terrorists. The same arguments against intervention by liberals, however, are no less valid here. They’re actually even more persuasive because it is a matter of national security.

T. Boone Pickens, in his efforts to validate (and obtain government money - “ensure [his voice] will be heard by the next administration” - for) his huge natural gas holdings and recent $2 billion investment in wind turbines technology, argues that we are “transferring wealth” out of the country and it’s “crushing our economy”. Nothing could be further from the truth. When you go to the store to buy a loaf of bread, you aren’t “transferring wealth” to the grocer. He already owns the bread. You exchange money for product because you value the bread more than you do keeping the money. This is true for any purchase even if the seller happens to live overseas or is otherwise engaged in unsavory activities. Oil producers already own the oil, a valuable commodity for which there is worldwide demand. That oil is purchased for consumption in this country means that some American is willing to pay more (marginally) for that next unit of oil than a comparable consumer in Europe or China. From the perspective of the consumer, the source of the commodity makes no difference.

The reason so much oil is imported to the United States is that demand has outstripped domestic production because of the relative strength of the US economy. Consider that the only countries coming close to meeting their Kyoto targets are those of the former Soviet Union whose demand for oil dropped precipitously when their economies collapsed (conveniently after the base year set in the Protocol, but that’s another issue).  We import oil because other countries have a comparative advantage producing oil. We can therefore buy it from them at a lower price than at which we can currently produce it ourselves. The resources we would otherwise have expended on greater oil production are invested in more productive endeavors.

If the market operated normally, that would be the end of it (excepting the national security concerns addressed below). Unfortunately, the government has chosen to interfere by placing constraints upon production, primarily in ANWR and the continental shelves. It is abundantly clear that there is ample interest in developing these resources, which would both increase production (reducing prices to a level below what they would otherwise be) and inject the return for such investments into the American economy. Make no mistake: cost effective development of available resources yields a huge benefit to the US economy and would increase, perhaps substantially, the percentage of US energy consumption that is produced domestically … but that’s not the same thing as energy independence.

Understand: a societal goal of “energy independence” requires nothing less than government intervention to prevent the use of foreign oil (or even some other energy resource) even when it is economically beneficial to do so. In order to justify such an action, one must demonstrate that the benefits of independence are at least marginally greater than the costs. They are not.

The alleged benefits of an energy independence policy are usually expressed two-fold. First is the benefit of favoring the American producer and second is eliminating the national security risk associated with reliance upon foreign producers for a product considered vital to the economy. The first “benefit” simply doesn’t exist. Again, in the absence of government interference, American producers will deliver the optimal amount of oil (as determined by the interaction of supply and demand). Government intervention to either increase domestic production or inhibit domestic consumption yields economic inefficiencies and incents malinestment in otherwise too-costly endeavors that harm the economy rather than helping it.

That leaves the national security argument: What if a hostile nation (or nations) upon which we depend for oil chose to cut us off? How much damage would that do? How would our military function without oil for tanks and planes? Shouldn’t we eliminate that risk? In a word: no. The risk is largely imaginary. Neither the nature of US imports nor the functioning of the marketplace would allow such a crisis to manifest itself.

To understand the scope of the potential crisis, one must examine how much (or how little) of our oil consumption is subject to disruption by any single entity or group. According to the Department of Energy (source for each of the figures referenced), in 2007, the US consumed 7.55 billion barrels of crude oil and petroleum products. Almost exactly 35% of that amount was produced domestically, meaning that 65% (4.91 billion barrels) of our consumption was supplied by imports (alarmist rhetoric always rounds in such a way as to make things sound as dire as possible which is why we hear that we rely on imports for “nearly 70%” of our consumption).

The largest exporters of oil to the US are not from the Middle East. Canada, which sends us more than the entire Persian Gulf combined, and Mexico together exported 1.45 billion barrels to the US last year (19.1% of consumption). Another 1.28 billion barrels (16.9%) were provided by other non-OPEC sources. All told, this accounts for 71% of US oil consumption, which, of course, leaves OPEC.

Is that production is at risk? Not really. OPEC is a cartel created to restrict supply in order to increase revenues for member countries (and even that hasn’t worked). To exclude a potential customer from the market – particularly the largest customer – would work directly against that goal. Moreover, and this is the most important point, unless the country or countries wishing to stop supplying the US ceases production entirely, all that happens is that oil that would otherwise have come to the US is purchased by consumers in other countries and US consumers purchase the oil those other buyers would otherwise have gotten elsewhere. Excluding a relatively short term market adjustment period, the ultimate net impact would be negligible.

If either Saudi Arabia or Venezuela, the next two largest suppliers after Mexico, each supplying about 7% of US consumption, cut us off, we would simply purchase more from Russia or Norway or some mix of the other 95-odd countries from which we purchased oil in just the last year alone. In the interim, we’d tap the Strategic Petroleum Reserve, which holds about 16% of annual production (more, by far, than is necessary). By restricting consumption of foreign oil by governmental fiat (or tax or subsidy, which amounts to the same thing) we incur all the harm of such a cut-off while abandoning the option of seeking another supply source. If we don’t want others to do this to us, why should we do it to ourselves?