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CHAPTER 21: Measures of Wealth and Assumptions of Right: An Inquiry * - Paul Heyne, “Are Economists Basically Immoral?” and Other Essays on Economics, Ethics, and Religion 
“Are Economists Basically Immoral?” and Other Essays on Economics, Ethics, and Religion, edited and with an Introduction by Geoffrey Brennan and A.M.C. Waterman (Indianapolis: Liberty Fund, 2008).
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Measures of Wealth and Assumptions of Right: An Inquiry*
There is no more important function of a first course in economics than to make the student see that the whole problem of social management is a value problem; that mechanical or technical efficiency is a meaningless combination of words.1
It is now almost sixty years since Frank Knight urged this perspective upon teachers of introductory economics, but his advice has not been heeded. To cite just one example: The glossary of a current Casebook edited by one of the profession’s most experienced and respected specialists in economic education includes the item “technical efficiency” and does not define it as “a meaningless combination of words.”2
The first section of this paper will attempt to demonstrate that Knight was correct, that “technical efficiency” cannot be defined except in a way that completely strips it of significance. Section two will argue that because, as Knight maintained, “the whole problem of social management is a value problem,” many other familiar concepts of economic theory cannot have the meaning commonly attributed to them. Section three will try to show that economists can coherently formulate and apply a wide range of concepts relating to efficiency and wealth only because they are implicitly using judgments about the rights people ought to have. The fourth and final section of the paper will consider and finally reject the conclusion that might seem to follow from the first three sections, the conclusion that economics is not and cannot be a science. Economics can be scientific, in a very defensible sense of that word, if economists simply recognize what they are doing and give up their claim to possess some wholly impartial perspective.
Efficiency refers to the ability to achieve a given objective with a minimum expenditure of resources or, alternatively, the ability to obtain from a given amount of resources a maximum amount of one’s objective. Efficiency is thus a ratio of output to input.
The crucial question, however, is how we measure output and input. Economists know that a ratio of mere physical quantities is not sufficient to determine the relative profitability of alternative processes. Decision makers who want to maximize net revenue must pay attention to the ratio between dollar values of outputs and inputs. Quite often, however, this concept of efficiency is called economic efficiency and is then contrasted with a purely physical efficiency, usually called technical efficiency. The significance of economic efficiency will often be argued for by showing the irrelevance of mere technical efficiency to any kind of goal-directed behavior.
The fatal slip occurs at this point, for efficiency has no meaning except with reference to goal-directed behavior. From a purely physical or technical point of view, the output of any process will always be equal to the inputs into that process. Technical efficiency is invariably one, at least if we can rely on the laws of the conservation of matter and energy. It follows that there is always a unique, invariant output from “given inputs,” so that the notion of “most output” simply makes no sense. It seems to make sense to economists who use the concept of technical efficiency because they have smuggled in an evaluation: Only selected outputs will be recognized as outputs; the rest will be called “waste.” The familiar term “engineering efficiency” acquires its meaning in precisely this way. A machine’s efficiency, supposedly measured by the work done or the energy developed relative to the energy supplied, is in fact measured by the useful work done or useful energy developed relative to the energy supplied. The work or energy is evaluated before it is admitted to the category of output.
The concept of technical efficiency is misleading because it distorts the problem that economists are trying to study. For example, a popular introductory text asserts:
In economics we generally make the assumption that technical efficiency is being maximized because there is not much else that economists can say about this topic. It is mainly in the hands of managers and engineers.3
The technocratic error looms close behind those sentences: the belief that “experts” are in command of costless procedures for achieving optimal arrangements. In reality, managers and engineers search for optimal input combinations until the expected benefits of further search no longer exceed the expected costs.
The same text, one page earlier, had defined “maximum technical efficiency” as a situation in which “resources are not being wasted,” and offered this illustration:
For example, a given amount of labor and capital might produce only 20 bushels of tomatoes if time were wasted or the machine used inappropriately. But if the inputs were fully utilized in the correct manner, 30 bushels might be produced.4
The author implicitly asserts in this passage that people producing tomatoes never want to use time on the job for conversation rather than single-minded tomato production, and that people who use tomato-picking machines in ways that don’t maximize the tomato output have no valued reason for doing so. This is obviously false. There is nothing inherently wasteful, inappropriate, or incorrect about any use of labor or capital.
The notion that there is an efficiency which exists independently of any valuations lends support to other misleading ideas. Consider the common belief that society (government officials? voters?) is faced with a tradeoff between efficiency and equity. If equity is valued, however, it will affect either the numerator or the denominator as people estimate the efficiency ratios of alternative processes. If the owner of a firm maintains certain wage differentials on the grounds of equity, despite his belief that net revenue could be increased by reducing those differentials, he is saying that the value imparted to the total outcome by equity exceeds, at the relevant margin, the value imparted by increased monetary income. From whose perspective is it “inefficient” for someone to prefer more equity to a larger money income?
The claim that “society” must choose between efficiency and equity obscures the actual situation, which is that people assign value to processes and their outcomes and that these valuations are often mutually incompatible.
The concept of technical efficiency will not be put to rest as long as the concept of objective costs continues to survive. The reformulation of economic theory that occurred in the last quarter of the nineteenth century produced the conclusion that all costs relevant to economizing decisions were the expected value of opportunities that would have to be forgone. Almost a century later, however, many economists continue to employ arguments that implicitly assume the existence of objective costs, costs that can be measured independently of anyone’s evaluations of alternatives.
A good example is the concept of “absolute advantage” which most textbooks use to explain comparative advantage. In the typical exposition, “absolute advantage” is rejected as an adequate reason for a nation to produce a good; a nation should import those goods in which it has a comparative disadvantage, even if its “real costs” of production are below those of any other country. This is usually taught with an air of presenting a paradox. There is no paradox, however, because there are no costs that are not the value of foregone opportunities and hence no advantages except comparative advantages. The “real costs” whose ultimate irrelevance to trade we triumphantly demonstrate to our students are not costs at all. They are merely physical units of inputs, usually “man-hours” in our examples, which we surreptitiously assume to be all of equal value. The existence of a comparative advantage, however, implies that the value of inputs varies as they are used to produce alternative outputs. To assume them equal in value is to assume away the possibility of comparative advantage.
Royall Brandis demonstrated the mythical character of absolute advantage in 1967,5 but his demonstration seems to have been largely ignored. Perhaps that’s just as well. The logic of the opportunity cost perspective, which demonstrates the chimerical character of absolute advantage, will do the same damage, if consistently applied, to much more fundamental concepts in the economist’s everyday kit of working tools. The casualties include a disturbing percentage of the supposedly empirical, objective concepts that we regularly use in discussing the performance of economic systems.
“Output restriction” provides a particularly instructive example. Suppose that widget producers establish a cartel and agree to reduce their rate of widget production in order to raise the market price above marginal cost. We commonly refer to this as “output-restriction,” and go on to show the “deadweight loss” that the cartel policy generates: the area above the marginal cost curve and below the demand curve between the “competitive” output and the cartel output.6
It is true that fewer widgets are produced as a result of the cartel’s operation. But is this an “output-restriction”? Outputs are ultimately valued opportunities, not things. The sum of the values produced under the “competitive” and under the cartel arrangement cannot be empirically compared, because the two arrangements produce different distributions of different goods among participants in the economic system. There is consequently no way to show empirically that the cartel arrangement results in less value than “competition” produces. The cartel arrangement produces fewer widgets, but that is because those who have the de facto right to determine widget output and prices believe that the lost widgets will be of less value than whatever it is they expect to gain by their decision.
There is one way in which we might succeed in demonstrating that the competitive situation generates a greater sum of values than the cartel arrangement. This might be done by showing that every interested person prefers the competitive situation. But if that were the case, the cartel would not exist. Faced with this fact, we may fall back on the argument that those who prefer the competitive situation could gain enough from its restoration to pay the cartel members a sum sufficient to persuade them to abandon the cartel. The continued existence of the cartel, however, is evidence that consent to its abandonment cannot actually be secured, which means that the prospective gain to any person or group from abandonment of the cartel is in reality less than the prospective cost to that person or group of securing its abandonment.
Some economists would reply: “The cartel situation nevertheless entails less total output because it is not Pareto-optimal.” And how do they know that? “Because an alternative arrangement exists under which no one would be worse off and some would be better off.” Then why isn’t the situation changed? “Because positive transaction costs prevent negotiation of the superior arrangement.”
That rejoinder amounts to the assertion that people would be better off under different circumstances that no one is able to create. We can all imagine a more satisfactory world, of course. We can imagine a low-cost procedure for creating energy by a fusion process and thereby imagine the OPEC cartel out of existence. But we have no more warrant for assuming away transaction costs than we have for assuming away the research costs of discovering an economical fusion process.7
Economic theory assumes that what people don’t do they don’t want to do, given their estimates of the prospective costs and benefits. These estimates presuppose a given state of knowledge. More knowledge of the right kind reduces costs, of course; that’s why people try to acquire additional knowledge. But until they have acquired it, production possibilities are limited by the knowledge people currently possess. Exchange is production, too, and the possibilities for increasing wealth through exchange are likewise limited by the knowledge people actually do possess. The knowledge they would have if they were, for example, completely familiar with everyone else’s true preferences has no significance for any empirical question.
Economic growth is another of the major concepts that economists talk about and even measure with little apparent recognition of their fundamentally subjective nature. The Nobel lecture of W. Arthur Lewis, for example, titled “The Slowing Down of the Engine of Growth,”8 speaks of various percentage growth rates in “more developed countries” and in “less developed countries” almost as if they were data quite as objective as average temperature reports.
Lewis betrays (without admitting) the dubious nature of what he’s doing right at the outset, in discussing reasons for the skepticism of many people in 1950 about “the capacity of LDCs to grow rapidly.”
The sun was thought to be too hot for hard work, or the people too spendthrift, the government too corrupt, the fertility rate too high, the religion too other worldly, and so on.9
This skepticism turned out to be mistaken, but that’s not the point. The point is that what the skeptics were really doubting was the willingness of people in the LDCs to change their preferences and values in ways that would yield a higher annual rate of increase in the monetary value of marketed goods.10 Empirical measures of economic growth are not, as is so often assumed, measures of increasing wealth.
The much-discussed “decline in productivity” in the United States economy in recent years is another “fact” that presupposes a variety of value judgments. A decline in the ratio of gross national product to compensated working hours is not necessarily a “problem.” It might mean, and apparently does in part, that many people are becoming less interested in purchasing money (and the goods that money can buy) with their labor and more interested in making work itself a satisfying experience. If that constitutes a decline in productivity, then productivity is being measured without reference to the human purposes that give to the concept of productivity whatever significance it has.
The concept of “voluntary exchange” plays a crucial role in the descriptions, predictions, and explanations of economists. We “know” that specialization and trade increases wealth because people would not voluntarily take actions unless they expected those actions to better their condition. The economist’s preferred way of speaking about efficiency, Pareto optimality, also relies upon the distinction between voluntary and coerced transactions. Despite all this, there seem to be no clear and agreed-upon criteria among economists for distinguishing a voluntary exchange from one that is involuntary. When we think carefully about what we mean in saying that a transaction was voluntary, rather than coerced, we discover how extensively economists’ descriptions, predictions, or explanations derive their content from assumptions about the rights that people ought to have.11
Suppose an armed robber confronts you with the choice, “Your money or your life.” We would say that you are not engaging in a voluntary exchange when you hand him the money in your wallet. We call that coercion, I suggest, because the robber induces you to do what he wants by threatening to reduce your options.
Contrast this situation with the one created by a cab driver who won’t give you a ride unless you give him your money. If you choose in this case to turn over the contents of your wallet, we would all agree that you are engaging in a voluntary transaction. The difference between the robber and the cab driver is that the cab driver induced you to do what he wanted by offering to extend your options.
It follows that we must know who has what options to begin with if we are to be able to distinguish a voluntary from an involuntary transaction. Is someone who induces you to do what he wants by threatening not to give you something you would like to have coercing you? He is not coercing you if what is in his power to bestow or withhold is in fact his and not yours. If the good is by right yours already, then he is coercing you.
We can illustrate by taking the case of an employer who tells an employee who wants to work the eight-to-five shift that he will have to work the graveyard shift instead. If the employee reluctantly agrees, has he been coerced or has he engaged in a voluntary exchange? Someone who maintains that the “job” is the property of the employer will deny that the employee was coerced. But someone who believes that the employee had earlier acquired a right in the job would quite properly deny that the transaction was a voluntary one. We cannot distinguish between voluntary and involuntary exchanges without a prior decision about the initial rights of the parties involved.12
Moreover, the rights in question are moral rights, not de facto rights. The armed robber has the de facto right to obtain your money by threatening to take your life. But he has no moral right to do so, and that’s what makes his behavior coercion. Or is it coercion because he has no legal right to obtain your cooperation by threatening to take your life? Many economists would be extremely unhappy to learn that voluntary exchange can’t be recognized except by those who are willing to decide what rights people ought to have (moral rights). They might be far more comfortable if the concept of voluntary exchange depended merely upon what rights prevailing law assigned to people (legal rights). In most cases a decision regarding legal rights will in fact be adequate to distinguish voluntary from involuntary transactions. But it will fail in precisely those cases where legal and moral rights diverge. In all such cases the person who wants to know whether an action was voluntary or coerced will be forced to decide whether people ought to have the rights that the law assigns them. The alternative is to adopt the position that people ought to have all those rights and only those rights that current law happens to assign them. However, this is itself a judgment about moral rights, and one that few people would be willing to uphold.
Very little of what currently passes as economic description, prediction, or explanation would survive in the absence of shared presuppositions regarding the rights that people ought to have. Economists are able to agree on whether particular actions increase or decrease efficiency, productivity, output, or wealth only insofar as they work within a particular moral consensus.
This conclusion should not be surprising. Efficiency, productivity, output, and wealth all refer to the values and interests of human beings. These values and interests do not form a completely harmonious whole. An action that increases the wealth of some will inevitably increase the wealth of certain others by less than an alternative action would have done, and in most cases it will actually reduce at least a few people’s wealth. Those who build better mousetraps diminish the wealth of competitors and increase by less than they might have the wealth of those who were hoping for an improved cockroach trap. It follows that economists must have some way to weigh values and interests before they can assess the relative contribution of alternative arrangements to overall efficiency, productivity, output, or wealth.
Does monetary or pecuniary wealth provide a common denominator that will enable us to weigh and thus to compare the otherwise incommensurable values and interests of different people? Wealth measured in monetary terms is the common denominator used, for example, in the extensive “economic analysis of law” literature associated with the work of Richard Posner and others.13 Unfortunately, most of those who advocate monetary wealth maximization as a norm for assessing alternative social arrangements omit the qualifying adjective and speak only of wealth maximization. George Stigler, in a provocative essay entitled “Wealth, and Possibly Liberty,” equates efficiency with wealth maximization and identifies changes in wealth with changes in utility. As the rest of the article makes clear, however, it is monetary wealth and not wealth in the utility sense that he is talking about. But monetary wealth maximization does not provide a policy norm that is superior, on all counts, to the advancement of liberty, as Stigler maintains. The cogency of Stigler’s essay depends largely upon the success with which he shifts back and forth between wealth and monetary wealth as his argument requires, in turn, a criterion relevant to human purposes or a common denominator in terms of which values can be compared by an observer.14
Marxists have long complained that conventional economic analysis takes for granted the existing system of property rights. The charge is fundamentally correct. Offers to supply goods and efforts to purchase goods always depend upon people’s expectations of what they can and may do under specific contemplated circumstances. What a person may do expresses, in the broadest sense, that person’s property rights. In order to predict, explain, or even talk intelligibly about those patterns and instances of social interaction that we call “the economy,” we must begin with people’s expectations, that is, their property rights.15
It is their de facto property rights, of course, or people’s actual expectations, that generate demand curves and supply curves. Legal rights that exist only as statutory or judicial declarations do not influence action. Similarly, the rights that people believe they ought to have will affect supply and demand schedules only insofar as these people also believe that others will in fact accept the obligations that their claims of right entail. In short, supply curves and demand curves plus the predictions and explanations that they produce can be obtained without any decision regarding the rights people ought to have. Economists only have to decide what rights people do have in the society being studied.
The contention in this section of the paper is that economists in their professional work have typically gone well beyond what mere agreement on de facto rights will allow. They have measured changes in productivity growth rates; they have assessed the relative efficiency of alternative government policies; they have contrasted positive-sum games with zero-sum and negative-sum games; they have articulated such concepts as “deadweight losses,” allocations “off the contract curve,” and output combinations “inside the production possibility frontier” and have attempted to illustrate such concepts in experience. It is these extensions of economic analysis that presuppose a moral consensus by assuming what property rights people ought to have. Economists who believe that economics should be value-free must therefore give such concepts up.16
What would be left? Would an economics deprived of all these concepts still be a science relevant to policy formation?
Anxiety about value judgments in economic science has produced two opposite responses. One is a quest for purity; it aims at eliminating all value judgments from economics in order to create a purely positive science. The other might be called a quest for impurity; it aims at exposing the value judgments that remain even after the purifiers have done their best, in the hope of demolishing the claim that economics can be or is a purely positive science.17 The anxiety may be a larger problem than the value judgments. A more constructive approach, I shall argue in this final section, is closer attention to what we can and cannot infer from observed behavior, and what we must postulate if we want to offer particular judgments about alternative social institutions.
The best way of making the argument is through examples. I’ve chosen the issue of rent controls.
The political popularity of legislated controls on residential rents has surged in the United States in recent years, largely as a consequence of actions and misconceptions related to an accelerated rate of decline in the general purchasing power of money. What can economists as economists say about rent controls?
One common contribution of economists is the prediction that rent controls will prevent residential space from moving to its most highly valued use. This prediction changes no one’s mind, because most advocates of rent control want to prevent residential space from always moving to its most highly valued use. They believe that elderly people on low, fixed incomes should not have to give up their apartments simply because someone else is willing to pay a higher rent. The advocates of rent control believe that the monetary bids of current tenants should, at least in certain cases, have more weight in social allocation processes than the identical money bids of prospective tenants. “Most highly valued use” as defined by the typical economist does not correspond to “most highly valued use” as defined by the typical advocate of rent controls.
What else might economists contribute to the discussion? They could predict the evolution of key fees; the harassment of tenants by owners who want to terminate tenancies; the disappearance of housing stock from the rental market as owners sell or shift it into other uses; and cases where wealth will be transferred from low-income to high-income people. None of these predictions is a conclusive argument against legislated rent controls, however. Proponents can (and do) respond with proposals to tighten the law and prevent such “abuses.”
Still the discussion does not have to end. Economists can ask exactly how the law could be tightened to prevent, for example, a withdrawal of housing stock from the rental market, and then offer predictions about the consequences of such additional legal provisions. None of these predictions will be a conclusive argument, either, because a determined advocate of rent controls will be able to point to additional possibilities or neglected considerations that may overcome the force of the economist’s predictions.
Is this not why economists make such extensive use of pseudo-empirical aggregative concepts? Predicting the various consequences of a proposed policy will not be sufficient, in many cases, to establish the consequences relevant to a decision. Economists have long admitted their inability to evaluate consequences; but they have insisted upon their ability as “scientists” to predict consequences. The difficulty in practice is that the set of predictable consequences potentially relevant to a decision is indefinitely large. As a result, economists frequently cannot even establish “what is” in an adequate way (quite apart from any inability to achieve consensus on their specific predictions, often a considerable difficulty in itself). The appeal of pseudo-empirical concepts like efficiency or economic growth lies in their supposed summation of the “net effects,” a summation that enables economists to “stick to their last” (description and prediction) and still contribute to the discussion and formation of public policy. Few economists seem to be aware of the value judgments that give these concepts their content and significance.18
Can economists get safely back inside the circle of a purely “positive economics” by abandoning pseudo-empirical aggregates and confining themselves to concrete, well-specified descriptions and predictions? As the opening paragraph of this section suggested, the best answer may be a rejection of the question.
Economists cannot describe all the features or predict all the consequences of any situation. They therefore focus on significant facts. Since most economists are opposed to legislated rent controls, the consequences they predict are usually the undesirable ones. Economists are not likely to predict that properly written rent controls will reduce tenant mobility, thereby enabling urban neighbors to become better acquainted and to create safer neighborhoods. Nor are they likely to point out that rent controls can reduce congestion in already densely populated cities by restricting in-migration, or that they may contribute to the preservation of older buildings with historic architectural significance. The typical economist will instead predict a decline in the rate of new apartment construction, and will often not even notice that this presumably undesirable effect is the corollary of effects that are desired, at least by some people.
Advocates of a value-free economics seem to suppose that “positive economics” can and should describe all the consequences of a given policy proposal plus all the consequences of alternative policies, and only then allow value judgments to enter into the decision process. This is an impossible agenda. It is not made any less absurd by invoking the phrase “in principle,” the phrase we use so often when we want to argue for the desirability of doing something no one currently knows how to do. Economists will not (this is a prediction) be able to spell out all the facts, current and predicted, relevant to a policy decision in any case where there is substantial public disagreement on the policy. Of course, they can always present more of the consequences, working in the dialectical manner illustrated earlier. How long they will continue depends upon the estimated marginal benefits and costs of continuing.
Is there any good reason for refusing to appeal, in this kind of dialogue, to considerations of justice or fairness? That is surely the implicit argument in many predictions, such as the prediction that rent controls will increase the wealth of some tenants at the expense of owners who are less wealthy than themselves. Why not make it explicit? The reluctance or outright refusal of so many economists to appeal explicitly to moral considerations frequently makes their arguments less clear. Does it also make them more purely “economic” or “scientific”?
The belief that it does seems to be rooted in two widespread misconceptions. One is the general failure of economists to recognize the extent to which their analyses already make use implicitly of presuppositions regarding justice or fairness. The property rights or expectations that generate supply curves and demand curves are usually assumed by economists to be rights in whose exercise people ought to be secure. This is a controversial (and perhaps mistaken) claim which will not be defended here. A defense would run, however, along two lines. One line of defense would point out that prediction and even description becomes impossible in the absence of reasonably stable property rights. The other line of argument would attempt to show how frequently economists use measures of change (in wealth, output, efficiency, etc.) on the assumption that certain people—and not others—have a moral right to control the allocation of particular resources.
The other misconception is the belief that moral argument cannot be rational argument. As Sidney Alexander once observed, “the economist’s calendar of philosophy lies open to the year 1936.”19 Economists usually do not question Milton Friedman’s assertion that, when a policy disagreement is rooted in ethical rather than factual disagreement, the only resolution possible is through fighting,20 as they did not generally question Lionel Robbins’ claim twenty years earlier that in all such cases it was a matter of “thy blood or mine.”21 On this issue Robbins, Friedman, and the economists who join them are demonstrably wrong. People do not always resort to force when they find the path to policy agreement blocked by disagreement regarding what is just or fair. Instead they frequently turn to moral argument.
“Do you think it’s fair to change the rules of the game suddenly, thereby confiscating the property of apartment owners?”
“Do you think it’s fair for landlords to raise their rents even though most of their costs aren’t going up at all?”
Answers can be given to these questions. They aren’t likely to be definitive answers; but as we saw earlier, definitive assertions are equally hard to produce when we confine ourselves to empirical description and prediction. Moreover, just as the significance of empirical claims often depends upon underlying assumptions about fairness or justice, so people’s disagreements regarding fairness or justice often rest upon conflicting empirical claims. An empirical analysis can sometimes resolve an apparent disagreement about justice. It is no less true that attention to moral arguments can sometimes clarify and thereby resolve what seem at first to be empirical disagreements. In fact, it does not even seem possible to separate in any wholly satisfactory way the moral and the empirical aspects of any dialogue concerning public policy.
Economists persist in trying and continue to suppose they can succeed (at least “in principle”) because they want to be scientists. Interestingly, many people who take stands on policy issues that economists tend to condemn—in favor of rent controls, increases in the minimum wage, usury laws, etc.—are delighted to find themselves the only ones making moral claims on behalf of the policies they support. They know that, in the political arena, the unanswered claim that a particular policy is unjust will almost always defeat a similarly unanswered argument that the alternative is inefficient.
Surely we would not want it to be otherwise. If the argument of this paper is correct, it cannot be otherwise. A defense of efficiency is, in any particular case, a defense of some particular distribution of rights. If we want to argue for efficiency, we have two choices. We can examine the justice of the particular distribution of property rights we are defending. Or we can defend without examination the rights we are presupposing. Either choice is legitimate. Unexamined presuppositions are finally unavoidable at some level, and the search for hidden value judgments can too easily, as Lionel Robbins once suggested, take on the features of a witch hunt.22
But there is surely no reason for the economics profession to excommunicate those colleagues who choose to ask about the ethical norms that inform their own analysis or to call explicit attention to the ethical implications of the situations they describe and the consequences they predict.
[* ] Unpublished typescript of discussion paper prepared for a Liberty Fund conference, “Science, Markets, and Liberty,” San Antonio, Texas, 5-8 March 1981. Reprinted by permission of Mrs. Juliana Heyne.
[1. ] Frank H. Knight, “The Ethics of Competition,” published originally in 1923 in the Quarterly Journal of Economics, reprinted in Knight, The Ethics of Competition and Other Essays (Chicago: University of Chicago Press, 1976 Midway Reprint), p. 43.
[2. ] Rendigs Fels, Stephen Buckles, and Walter L. Johnson, Casebook of Economic Problems and Policies: Practice in Thinking, 4th ed. (St. Paul: West Publishing Company, 1979), p. 161. The definition offered is: “production by a firm of the most output with given inputs of labor, capital, and natural resources; producing a given amount of output using the least inputs.”
[3. ] Willis L. Peterson, Principles of Economics: Micro, 4th ed. (Homewood, Ill.: Richard D. Irwin, 1980), p. 230.
[4. ] Ibid., p. 229 A similar argument is presented on p. 8.
[5. ] Royall Brandis, “The Myth of Absolute Advantage,” American Economic Review, March 1967, pp. 169-75.
[6. ] For proof that those who throw stones sometimes live in glass houses, see Paul Heyne, The Economic Way of Thinking, 2nd edition (Palo Alto: Science Research Associates, 1976), pp. 106-7, 142-44. The 3rd edition (1980) is more circumspect but still in error. The evidence may be found on pp. 144-47.
[7. ] The argument of this paragraph is a minor variation on the theme developed by Carl Dahlman in “The Problem of Externality,” Journal of Law and Economics, April 1979, pp. 141-62.
[8. ] A revised version of the lecture is printed as an article in the American Economic Review, September 1980, pp. 555-64.
[9. ] Ibid., p. 555.
[10. ] Ibid.
[11. ] The central idea in this section of the paper turned out to be much less “original” than I had initially supposed, when I began thinking about it in the course of reflecting on a manuscript by Terry L. Anderson and Peter J. Hill, published as The Birth of a Transfer Society (Stanford: Hoover Institution Press, 1980). The concept that informs the argument was clearly stated by John Egger in his comment on a paper by Harold Demsetz, both reprinted in Mario Rizzo, ed., Time, Uncertainty, and Disequilibrium (Lexington, Mass.: Lexington Books, 1979). See Demsetz, “Ethics and Efficiency in Property Rights Systems,” pp. 97-116, and Egger, “Comment: Efficiency Is Not a Substitute for Ethics,” pp. 117-25. A similar analysis is presented by Mario Rizzo,” Uncertainty, Subjectivity, and the Economic Analysis of Law,” ibid., pp. 71-89, and by Murray Rothbard in his “Comment: The Myth of Efficiency,” ibid., pp. 90-95. An entire issue of the Journal of Legal Studies, March 1980, titled “Change in the Common Law: Legal and Economic Perspectives,” revolves around the issues discussed here, and several of the authors make the point, from different perspectives, that I am arguing for here. I now suspect that the entire paper may be implicit in the writings of James Buchanan over the years. See especially his unjustly neglected article, “Positive Economics, Welfare Economics, and Political Economy,” Journal of Law and Economics, October 1959, pp. 124-38, and his presidential address to the Southern Economic Association, “What Should Economists Do?” Southern Economic Journal, January 1964, reprinted in the collection of his essays assembled by H. Geoffrey Brennan and Robert D. Tollison, What Should Economists Do? (Indianapolis: Liberty Fund, 1979). Many of us cannot recognize a conclusion until we work it through for ourselves.
[12. ] “Other people’s actions place limits on one’s available opportunities. Whether this makes one’s resulting action non-voluntary depends upon whether those others had the right to act as they did.” Robert Nozick, Anarchy, State, and Utopia (New York: Basic Books, 1974), p. 262. Consider the opening sentence of a paper by Benjamin Klein, “Transaction Cost Determinants of ‘Unfair’ Contractual Arrangements,” American EconomicReview, May 1980, p. 356: “Terms such as ‘unfair’ are foreign to the economic model of voluntary exchange which implies anticipated gains to all transactors.” The term “unfair” is implicit, I am arguing, in the concept of “voluntary exchange.” The contention of Harold Demsetz that “extortion” is not an economic concept seems to me to require that we simultaneously banish the concept of voluntary as against coerced transactions. See Demsetz, “When Does the Rule of Liability Matter?” Journal of Legal Studies, January 1972, especially p. 24, and, by the same author, “Wealth Distribution and the Ownership of Rights,” ibid., June 1972, especially pp. 231-32. The question of “extortion” has been usefully examined by, among others, Donald C. Shoup, “Theoretical Efficiency in Pollution Control: Comment,” Western Economic Journal, September 1971, pp. 310-13; Richard O. Zerbe, “Theoretical Efficiency in Pollution Control: Reply,” ibid., pp. 314-17; Harold Demsetz, “Theoretical Efficiency in Pollution Control: Comment on Comments,” ibid., December 1971, pp. 444-46; G. A. Mumey, “The Coase Theorem: A Reexamination,” Quarterly Journal of Economics, November 1971, pp. 718-23; Donald H. Regan, “The Problem of Social Cost Revisited,” Journal of Law and Economics, October 1972, pp. 427-37; George Daly and J. Fred Giertz, “Externalities, Extortion, and Efficiency,” American Economic Review, December 1975, pp. 997-1001; David Bromley, “Externalities, Extortion, and Efficiency: Comment,” ibid., September 1978, pp. 730-35; and Daly and Giertz, “Externalities, Extortion, and Efficiency: Reply,” ibid., pp. 736-38.
[13. ] Richard Posner, Economic Analysis of Law, 2nd edition (Boston: Little, Brown and Company, 1977). See also, by the same author, “Utilitarianism, Economics, and Legal Theory,” Journal of Legal Studies, January 1979, pp. 103-40, and “The Value of Wealth: A Comment on Dworkin and Kronman,” ibid., March 1980, pp. 243-52.
[14. ] George J. Stigler, “Wealth, and Possibly Liberty,” Journal of Legal Studies, June 1978, pp. 213-17.
[15. ] The Coase Theorem is frequently summarized as the assertion that the allocation of resources will not be affected by the assignment of property rights in a world of zero transaction costs. This is an odd way to state it. A rich literature dealing with property rights has grown up over the past twenty years on the soil Coase cultivated, because economists have recognized that transaction costs are important. Why do so many persist in stating the theorem in a way that suggests property rights don’t matter, when the obvious contribution of the theorem was in inducing economists to see all the ways in which property rights do matter?
[16. ] Here is as good a place as any to acknowledge a book that I discovered too late for it to influence this paper: A. Allan Schmid, Property, Power, and Public Choice: An Inquiry into Law and Economics (New York: Praeger Publishers, 1978). This is a careful, well-informed, and comprehensive examination of most of the issues raised in the present paper. Its “institutionalist” orientation may keep it from having as much impact on “mainstream” theorizing as I think it ought to have.
[17. ] For an excellent historical survey, see T. W. Hutchison, “Positive” Economics and Policy Objectives (Cambridge, Mass.: Harvard University Press, 1964).
[18. ] A. Allan Schmid, op. cit., especially pp. 24-34, 201-50. I would disagree only with Schmid’s conclusion that, when values conflict, we have no rational procedure for resolving the disagreements. See pp. 248-49.
[19. ] For a lucid and cogent refutation (by an economist) of the prejudice that we cannot rationally discuss and resolve normative disagreements, see Sidney S. Alexander, “Human Values and Economists’ Values,” in Sidney Hook, ed., Human Values and Economic Policy (New York: New York University Press, 1967), pp. 101-16. The quotation is from p. 102.
[20. ] Milton Friedman, “The Methodology of Positive Economics,” in Essays in Positive Economics (Chicago: University of Chicago Press, 1953), p. 5.
[21. ] Lionel Robbins, An Essay on the Nature and Significance of Economic Science, 2nd ed. (London: Macmillan, 1935), p. 50.
[22. ] Lionel Robbins, Politics and Economics (New York: St. Martin’s Press, 1963), p. 6.