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July 20, 2004 The discipline of the free market Tyler Cowen--one of the more interesting bloggers I read--links to this statement by Robert F Kennedy Jr.... "The best thing that could happen to the environment is free-market capitalism. In a true free-market economy, you can't make yourself rich without making your neighbors rich and without enriching your community. In a true free-market economy, you get efficiencies and efficiency means the elimination of waste. Waste is pollution. So in true free-market capitalism, you eliminate pollution and you properly value our natural resources so you won't cut them down. What polluters do is escape the discipline of the free market. You show me a polluter, I'll show you a subsidy — a fat cat who's using political clout to escape the discipline of the free market."This is a pretty fundamental assumption of many libertarians and proponents of the free-market. It follows from the a priori assumption that, in a free market where all transactions are voluntary, no actor will engage in a transaction that is not to his benefit. Therefore, every exchange will increase the overall wealth and well-being of a society. Now, that's a reasonable assumption, except for two things: These two factors can result in exchanges that reduce the wealth/well-being of a society, even though it was no part of the original intent of the transaction.
Those are the limitations of the free market. So, what's the solution? Well, it occurs to me that, with respect to pollutants, we could solve the externalities problem by assigning a tax to effluents. The problem would lie in assigning a value to each unit of pollutant produced that approximates the true cost to society, but if that could be done, then a tax on effluents could very nearly solve the externalities problem of pollution. What about "information"? Well, that's a bit harder. We've never had perfect information, though we're getting better and better at it. It occurs to me that, if we can roll the cost of externalities into the cost of production, then government would serve the people best by ensuring they had as much information as possible. If such were done, rational decision-making--the lifeblood of growth--would be enhanced immeasurably. |
Yup, its a nice quote since it shows what liberal economists were like in the past, but it ignores business concepts like revenue and cost centers. Pollutants are cost centers, they don't make you anything so if you can get away with it you win.
Posted by: Jeff the Baptist at July 20, 2004 07:30 AM
Doh! Missed the Junior at the end...
Posted by: Jeff the Baptist at July 20, 2004 07:33 AM
This would be a good entry for Carnival of the Capitalists; the question of how pure it can or should be. This is the second such post I've seen lately, though they had varying focuses.
Posted by: Jay Solo at July 20, 2004 03:51 PM
You said:
"Imperfect information can result in transactions that don't benefit one or both sides of the transaction. (ex: I give you $5000 for a used car, thinking it's worth it to me....but, as it turns out, the car is a lemon. With better information about the state of the car, I could have made a better choice)"
This is a poor exapmle. Why didn't you check the car before you offered the money? The information is out there. With a free market the onus is on the consumer to find it. As for externalities, taxation is NOT the solution. All taxation does is raise the cost to the consumer. You might say that taxation forces companies to take action in order to prevent pollution. However, it is equally likely that they will just pay the fines because in the long run, it is less expensive to pay taxes than it is to take actions to prevent pollution. This is not to say that pollution is an unavoidable by-product, but rather that state imposed environmental regulations can be made too restrictive that production actually drops, meaning revenues drop and prices increase. Businesses will opt to continue production at their current level and pay the taxes or fines with a minimal increase in end cost. Businesses operating without governmental interference are more likely to self regulate due to market forces. Stop reading so much Keynes and start reading some of the Austrians (Mises, Rothbard, etc.)
Posted by: Francis at July 20, 2004 06:25 PM
Francis - the cause of that imperfect information is irrelevant. It's the effect of that imperfect information that creates non-mutually beneficial outcomes.
Of course, you're correct to say that it's the responsibility of the consumer to check out the car. It's also the responsibility of the seller to not mislead on the condition of the car....or any other given product for sale.
Regardless of who failed, though, the lack of information led to a bad outcome.
All taxation does is raise the cost to the consumer.
- - -Not necessarily. The cost may already be borne by the consumer...and quite a few other people. In the case of pollutants, the cost is borne by people completely external to the transaction.
Now, a tax may not be a perfect means of assigning the cost, but--assuming the tax is directly related to the external costs of production/consumption--it is a far more direct way of making an externality into a cost of production.
As such, it may well raise costs to the consumer, but that cost is directly related to the consumption, and is a cost that should be borne by those involved in that transaction.
Posted by: Jon Henke at July 21, 2004 07:42 AM
Therefore, every exchange will increase the overall wealth and well-being of a society
I think that's a strawman argument. Not even the most strident free-market advocate would hold that every transaction always leaves both parties, and by extension the rest of society, better off. Especially, when everybody can personally recall at least one free-market transaction which they felt left them worse off than before.
Voluntary transactions are just far more likely to produce a good outcome for everybody than transactions that result from coercion. Regrettable free-market transactions occur because at one point in time both parties thought they would be better off. By contrast, transactions conducted under government coercion are often blatantly disadvantageous to one or both parties.( If they weren't the need for violent coercion wouldn't be necessary in the first place). This means that free-market transaction as an aggregate must be closer to the ideal of "everybody better off" than the aggregate government coerced transactions.
Externalities are also not failures of the free-market, rather, they arise from the failure to extend the the free-market into every part of the economy. Air and water pollution occur because air and water exists external to property system that forms the basis of the free-market. It simply the tragedy of the commons. The easiest solution is extend the property system to air and water in the form of emissions rights. This will internalize the cost of pollution into the cost of the product and the free-market will respond by seeking to eliminate pollution.
They free market isn't "perfect" it's simply "usually the best" solution to most problems. We should always try a true free-market solution before resorting to coercion.
Posted by: Shannon Love at July 26, 2004 02:03 PM
In the first example of imperfect information the reason that the buyer accepts the car is either that he trusts the seller not to knowingly sell him a lemon or he hasn't thought of it. If the car turns out to be a lemon the buyer will a) learn not to trust him again (better information), and b) tell others (more information) to beware and don't trust (buy from )him. That gives the seller an incentive, unless this is his last or only sale, to sell a quality product.
Posted by: jIM at July 27, 2004 11:09 AM
Shannon: I didn't say they were "failures" of the free market. Just that they are limitations. It does not detract at all from the belief that the free market is still the best method of coordination going.
Jim: You are correct to say that the unfortunate purchase would perhaps result in better information for the future. That doesn't idealize the initial purchase, though. The lack of information is a unavoidable problem in any market operated by humans. It is not necessarily a problem to be dealt with by fiat, but it is a limitation nonetheless.
Posted by: Jon Henke at July 27, 2004 11:28 AM
Joh Henke,
Sorry, I wrote "failure" when you wrote "limitations", my bad.
But my main point remains, externalities arise when the free-market system does not extend across the entire cost of production. It is equally valid to say externalities are an inherent result of government action against the market. The best solution is not to expand government involvement in the form of taxes but to expand the free market by enlarging the property system.
Posted by: Shannon Love at July 27, 2004 12:24 PM
If we could devise a method to account for, price and divide the externalities solely among parties to the transaction, then that would certainly be best.
In some cases, we could do so. In others, perhaps not. As you write, though, we should try the market solution first, before turning to taxation.
However, politics being what they are, I think a effluents tax would be the most pragmatic way to internalize what are currently externalities. I'm not arguing that it is perfect....just that it could be the most pragmatic solution at this point.
Posted by: Jon Henke at July 27, 2004 12:30 PM
Jon -
I would find some merit with your suggestion to tax pollutants if, and only if, those tax receipts found their way directly to those absorbing the ambient costs of said pollution. Absent that, and this is nothing more than incremental friction added to the system by alien government forces.
There is a better way to handle this that is currently enjoying wide acceptance. That is the Chicago Climate Exchange, where participants openly buy and sell emissions credits. The idea is the exchange creates a forum for price discovery for polluting in a host of geographical areas throughout North America and Brazil.
A far better idea than levying additional taxes.
Posted by: Speculator at July 28, 2004 08:23 AM
That's certainly a very interesting idea.
I should clarify the point of a tax on effluents, though. It is not simply to provide a cost to polluters, and a revenue stream to the government. That, in itself, would be bad. The only value would come if the taxes were determined by the cost of cleaning the pollutants and/or minimizing damage to external parties.
Of course, the difficulty would be in finding a precise way to do this.
Posted by: Jon Henke at July 28, 2004 08:42 AM
Well, it occurs to me that, with respect to pollutants, we could solve the externalities problem by assigning a tax to effluents. The problem would lie in assigning a value to each unit of pollutant produced that approximates the true cost to society, but if that could be done, then a tax on effluents could very nearly solve the externalities problem of pollution.
This is a fabulous idea, but I'm afraid that a fellow named Pigou had it first.
Posted by: Patri Friedman at July 29, 2004 12:26 AM
Heh....I've never heard of it, but yep...that's exactly what I had in mind. Rest assured, it's highly improbable that anything I write has not been thought of before. :)
Thanks for the heads-up.
Posted by: Jon Henke at July 29, 2004 06:41 AM