A Curious Miscellany of Items Philosophical, Historical, and Literary

Manus haec inimica tyrannis.

Wednesday, November 24, 2010

The Freedom to Breed

In his much-cited 1968 paper “The Tragedy of the Commons”, ecologist Garrett Hardin presented the tragedy of the title as a story about how individual choices which seem rational have irrational consequences at a collective level. Unfortunately, the story has meant many things to many people, so I thought it would be good to take a look at the original context of Hardin’s thought experiment.

The so-called “tragedy of the commons” takes this form: Imagine a fairly primitive community of sheep herders. These herders graze their respective flocks on a piece of common pasture (thus, the term “community”). Let’s say that there are ten herders, each having a flock of ten sheep. Thus there are 100 sheep grazing on the common pasture, which number, let us further imagine, is exactly the carrying capacity of the commons. Any more sheep on the pasture would constitute overgrazing, leading to gradual degradation of the land and decreased well-being for both sheep and community.

Now, a herder might wonder to himself whether it would pay to increase his herd by another sheep. This would constitute overgrazing of course, but he might naturally look at it in the following way. “I would stand to gain $10 from the extra sheep. Unfortunately there will also be $10 loss due to overgrazing, but since that loss is spread amongst me and the nine other herders, my personal share of the loss would be $1. That makes a net profit of $9.”

On the basis of such reasoning, there would be a strong incentive for our enterprising herder to expand his operations, at least up to that point at which the marginal gain of another sheep equals his share of the marginal loss of doing so.

Although Hardin didn’t consider the possibility, we might like to give our herder the benefit of the doubt and credit him with some level of community spirit. Seeing that his actions would impose costs on the community, he might wish to refrain from expanding. But unfortunately, he is also rational and knows that his fellow herders will be doing the same calculations he is doing, and they might not be quite so altruistic. He may have confidence in enough of them doing the right thing, but if he has doubts about enough of them, the pressure not to let oneself become a sucker will begin to pick away at the stitches of his better intentions.

If the other herders are going through the same thought processes (and we have no reason to believe they aren’t), well, the results will be predictable. Choices that seem individually optimal, have disastrous collective outcomes, in the form of overgrazing, sick and malnourished herds, and a poorer community.

How could this poor outcome be avoided? Well, many who have read Hardin’s tale see in it a justification for private property. If that common land were divided into ten plots and distributed to each herder according to the size of his flock, our herder would no longer have an incentive to overgraze, because the loss resulting from his overgrazing would be paid solely by himself.

And if it happened that our herder was better at his occupation than his compatriots, he might have an incentive to pay the other herders for the use of their lands, enough perhaps for them to leave the business completely. And so on (the remainder of the story can be filled out by reading Smith or Ricardo).

Why the Concern with Property?

The fact that so many have seen in this tale a moral about the needfulness of private property is somewhat peculiar.

First of all, the “solution” they see to the dilemma is by no means the only or most obvious one. For instance, as Aristotle pointed out in his Politics, there is more than one way that common ownership can be instituted, not all of which would lead to the disastrous results envisioned in the tale. The herders might (i) hold both sheep and land in common, or (ii) they might — as in Hardin’s version — hold the sheep privately but the land in common, or (iii) they might hold both sheep and land privately, but make the profits common property, to be divided up equally. Although, as Aristotle pointed out, each of these scenarios comes with its own particular problems, there is no prima facie reason why (iii) couldn’t constitute a solution to Hardin’s specifically environmental dilemma. There would be a potential lack of productivity and work incentives, but it is less likely that there would be overgrazing.

Furthermore, there are at least two solutions that countless pastoral and agricultural communities have commonly used since the beginning of time. One is to have a system of common morality that includes injunctions against free-riding at others’ expense. The other is to have a public figure such as a village chief or elder (or council of elders if you prefer) who is responsible for organizing production and making decisions for the good of the community. Both of these methods are consistent with commonalty of property and work surprisingly well in small communities, although a strong system of morals is difficult to consciously institute where it doesn’t already exist.

Other non-private property solutions aside, what makes it peculiar that commentators should take from “The Tragedy of the Commons” lessons about the importance of private property is that Hardin himself intended it to illustrate something else, namely the problem of overpopulation. (To be fair, in other writings, he does specifically advocate for private ownership as a solution to many such “tragedies of the commons”, an example being overfishing).

To Breed or Not to Breed?

Where the seemingly property-obsessed see the enterprising herder as making a decision about production, Hardin is trying to get across the point that he is actually making a decision about reproduction.

The additional sheep represents “another mouth to feed”, the herd represents a family, and the commons is in reality our environment. I think it’s a nice way to look at reproduction, because too often it’s viewed as a basic human right, even where the decision (or impulse, as the case may be), imposes significant externalities in a world of limited resources.

Unfortunately, the logical conclusions of following such a conceptualization are not very comforting to those who, like me, value individual liberty. As we approach the carrying capacity of our environment, we may have to stop viewing procreation with so cavalier an attitude, as adding one more member to the herd may be an act of free-riding at the expense of others.

(I long ago stopped viewing procreation cavalierly, which is why I long ago stopped listening to anything that comes out of the mouth of “environmentalist” David Suzuki. He has five children, while my wife and I made a conscious decision not to have any children. As such, Dr. Suzuki has done far more damage to the environment and left a much bigger carbon footprint on the earth than we could ever hope to do. In truth, Dr. Suzuki free-rides on our restraint, which makes us better environmentalists. Go figure! The funny thing is, Garrett Hardin also ended up having five children, so I suppose I should take anything he had to say with a grain of salt too…)

The problem is, how do you stop people from reproducing without resorting to gross violations of individual liberty? You can’t just go around castrating people. (Or can you? Sometimes when I look around me I can’t help but think that a program of social eugenics might be just the thing… I’m joking of course.) The fact is, so long as we continue to view procreation as a basic human right, any infringement of freedom of procreation is ipso facto an infringement of a human right, of the liberty to reproduce.

Hardin is of the opinion that whatever population control program was implemented, to be effective, would quickly run into problems, especially if we wish to limit reproduction to a rate that still maintains us as a species (which itself begs a valid question). To keep our species in existence, some procreation would need to continue. We would wish to pick a population level, whether it be our present one or another below it, and somehow adjust reproduction to match the replacement birthrate, and maintain that population level.

But the replacement birthrate is 2.1 children per woman, and it is obvious that an individual woman cannot have precisely 2.1 children. Some will have 1 or 2, and others will have 3 or 4 (or more). These latter women — and their mates — would essentially be free-riding on those who have more restraint. And yet, if the population is to replace itself (at whatever level), there is no possibility of avoiding this free-riding. Decisions must be made as to who will be allowed to over-reproduce and who must under-reproduce. But then we find ourselves back in that unpalatable situation of having some authority making decisions about individuals’ procreation, with all the eugenic implications arising therefrom.

Hardin considered the option of “moral suasion”, of a mass propaganda campaign to convince people to limit their procreation. This would have the virtue of not being as intrusive on individual liberty as outright coercion of reproductive choices. But Hardin sees a long-term problem with this too.

Imagine that a program of moral suasion is in place. The population will divide roughly into three groups. There will be some, like me, who accept that new morality and wholeheartedly agree not to reproduce. Call this group 1. I imagine such people will be few, but let’s imagine that there are enough — or that they are respected enough — to influence a second group of people who, although they don’t accept the morality as such, yet still wish to maintain their reputation with their peers in group 1. Call these group 2. And then there will be group 3, who simply don’t care.

Group 3 will breed unabashedly. This will likely cause some instability in group 2 who are not as committed to the new morality and who will not relish the idea of being suckers, limiting what they would otherwise like to do while others get away with it and free-ride at their expense. Nevertheless, for argument’s sake, let us imagine that group 2 mostly holds the line and exercises procreative restraint. Nevertheless, says Hardin, the inexorable callousness of mathematics will thwart the best intentions of groups 1 and 2, at least in the long run.

You see, members of group 3 are less conscientious. Much like David Suzuki, they simply don’t care about the effects of their procreative decisions on others. And, by definition, they have a higher birthrate. In each generation, they will outbreed their more conscientious fellow citizens, grabbing an ever larger share of resources, while the conscientious proportion of the population continually shrinks. In other words, in each generation, the portion of the population lacking procreative restraint will grow larger. And thus, population will increase. Thus, says Hardin, moral suasion may, in the long run, be counterproductive. There is a sort of biological Gresham’s Law implicit in this vision, in which the “bad” breed out the “good”.

Of course, this argument only works if “conscientiousness” is somehow hereditary, right? Well, Hardin says we needn’t insist on heredity in the strict biological sense (which is not proven). All we need accept is that there is a fairly strong correlation between being conscientious and having conscientious offspring, whether this be due to genetics or upbringing. Although it is still a questionable premise, standing in need of empirical verification, it is much less implausible when stated in this form.

(And the fact is, David Suzuki notwithstanding, it does commonly seem to be the people we’d least like to see reproduce themselves that have the greatest number of children.)

And in case you think Hardin is way off base, there is a considerable and growing literature on psychopathy which suggests that it is a heritable condition. And, more chillingly, the birthrate of psychopaths tends to be higher than that of the general population. If true, why hasn’t our species been swamped with psychopaths? Well, for one thing, they make poor parents, which means that through much of our evolutionary history fewer of their children have tended to survive. And because they are greater risk-takers and have a proclivity to high-risk lifestyles, psychopaths tend to die at a younger than average age. They scatter their seed to the four winds and quickly die off, much like mayflies or dandelions. This is a different reproductive “strategy” from that of the tacitly accepted moral norm, which urges us to have fewer children but invest more resources in rearing them and ensuring they reach adulthood. Both strategies may be found in various species, and neither is necessarily unsuccessful from a strictly evolutionary point of view.

(The uncomfortable possibility has been suggested that our more materially comfortable and civilized — and anonymous — society may be a good breeding ground for psychopaths. They can more easily slip under the radar, and society will pick up the slack for their poor parenting. After all, it takes a village to raise a child, right? Only a little research on this issue has been done so far. I would be interested in seeing more.)

Spaceship or Lifeboat?

Besides arguing that effective population control will likely involve infringements of individual liberty that many find objectionable, the tragedy of the commons also brings us face-to-face with some hard questions regarding the movement of existing populations, not just those yet unborn. Most environmentalists, says Hardin, envision the “spaceship earth” model of ecology, in which the entire planet is a commons to be shared among all the earth’s peoples. This has the uncomfortable implication that rich countries must share their resources with the world’s poor, even where — as is commonly the case — those poor come from countries whose people have bred past what would be the optimal population level for either its economic or resource base. To distribute the earth’s “common” resources among all her people would likely require some kind of overarching world government. National governments are too self-interested, too parochial to accomplish this feat. But is it a feat we should wish to accomplish?

Instead of the spaceship, Hardin says that we should adopt a “lifeboat” model. The lifeboats are individual (rich) nations. In the water about them are the world’s poor. These people are spillovers from other lifeboats whose inhabitants increased at too high a rate and sank the boats. Imagine that your lifeboat only has enough space and provisions to take on 10 more people, but there are 100 desperate swimmers in the water surrounding it. To take on all 100 would be national suicide, as would taking on 50, or 20. Perhaps you could take on 10. But then, you also have a moral duty to leave enough and as good for the next generation that will be born on the boat. So it would likely be fewer than 10. And fewer still if you envision that these swimmers will procreate at a rate likely to swamp the ten places reserved for future generations. You cannot with a good conscience take on swimmers at the expense of future generations. The swimmers had their chance, but your children and grandchildren have not yet had theirs. If you wish to leave a spot on the boat for your offspring, you cannot give it away to newcomers.

In a later paper, Hardin gave another reason for preserving the lifeboat model rather than favouring some kind of cosmopolitan spaceship captained by a world government. The lifeboats can be viewed as laboratories, each conducting its own experiments in history. They can look over at one another, observe what they are doing (or failing to do) and see what might work and what doesn’t. Some lifeboats might sink, but the passengers in the other ones might learn and prosper. This is a much safer way of doing things than risking the possibility of all of us going down in the same leaky vessel.

Reasons for Optimism

It seems to me that Hardin’s anti-immigration argument is tinged with more than a little paranoia, and more than a little xenophobia too.

First of all, we must be careful about appeals to the rights of “future generations”, for the appeal is to the rights of beings that do not exist, and may never exist. If something were to happen to make it so that the future generation did not come to be, they could not suffer a loss by this fact, because the agent whose loss it is supposed to be simply does not exist to experience the loss. Grammar tends to bewitch us here; it forces us to refer to “they” and “the future generation”, as if these already had some kind of existence. They do not, any more than unicorns or the tooth fairy do. By this point in my life I suppose I could have scattered my seed to the four winds and sired countless offspring, at least as a matter of bare biological fact. By not doing so, have I committed an injustice on countless unborn? Am I history’s greatest monster? No, because those “unborn” (again, grammar forces us into a corner here) do not exist. And that which does not exist cannot be a bearer of rights. Indeed, it’s at least questionable whether anything can be a bearer of rights, the very concept itself is so utterly mysterious.

Second, refugees are not necessarily poor because of overbreeding in the home country. They may simply be fleeing natural disaster, political tyranny, or civil war (though granted the last is often an outcome of overpopulation). Furthermore, even if there has been overbreeding in the home country, the refugees themselves aren’t necessarily guilty of it. They may have no children, and may themselves be the children of parents who bred below the replacement level. Might we be punishing them for the “sins” of others?

Third, once settled, refugees will not necessarily continue to outbreed the native-born (if they ever did). They may end up adopting most of the customs (including the procreative habits) of the people into which they’ve largely assimilated. World population statistics show the trend: with increasing wealth comes a decreasing birthrate. Given other opportunities to lead meaningful lives, people will forego procreation to pursue them. The education and material security of women and their ability to make decisions pertaining to their own reproduction is crucial here. Given these conditions, there is much to hope for. Which is why it is important that, whatever customs and traditions certain immigrant communities bring to our shores, it is imperative that they be made to leave behind their patriarchy and misogyny (with which we already have enough of our own to contend).

Fourth, amidst all the environmental bad news in the world today, there has been one small bright light that is in my opinion under-reported: the rate of increase of the world’s population has begun to level off. Now, that means population will continue to increase for some time yet, and it’s still unclear if the world’s population will rest at a number that is sustainable. It also seems to be a natural trend for which we can take little credit. But still, it is cause for hope.

Some Strange Parting Thoughts

Despite his ignorance about immigration, Hardin does pose one question that in my opinion we have not adequately considered:

“In the welfare state, how shall we deal with the family, the religion, the race, or the class (or indeed any distinguishable and cohesive group) that adopts overbreeding as a policy to secure its own aggrandizement?”

Such groups exist. We all know they exist, although I won’t name any for fear of legal repercussions. Luckily, the policy of overbreeding has not been notably successful in this country. But that could change. And we need not live in a welfare state nor even be resource-scarce for the question to press on us. If we use Hardin’s “tragedy of the commons” as our conceptual compass, then how are we to deal with such groups?

In a multicultural society, if we take official “multiculturalism” seriously, perhaps we might think about viewing “cultural space” as a common good that must be shared amongst all? Groups that try to breed out others would then be like the herder who tries to move extra sheep into the commons at the expense of others. But then we would have to be willing to do some very unpalatable things to stop the practice, things which, luckily we have never had to seriously contemplate.

On the other hand, could not proselytizing be viewed as a similar wrongful appropriation of common cultural space? I think the idea is too fuzzy to work without gross violations of free expression, which is too bad, because then I could really stick it to those Mormon wackjobs on the Broadview bus.

Friday, November 12, 2010

Life in the "Great Society"

Friedrich Hayek is usually classified as a libertarian thinker. But in Chapter 14 of his masterwork Law, Legislation, and Liberty (3rd volume, Chicago: University of Chicago Press, 1979), Hayek has some very un-libertarian — and rather refreshing — things to say about the respective roles of the public and private sectors in the provision of goods and services.

He begins with the observation that it is an article of faith among libertarians to regard almost all functions currently performed by the state as capable of being more efficiently performed by markets. The ideal form of government for libertarians is, to use the language of Robert Nozick, the “minimal state”, or what in classical liberalism used to be quaintly called the “night watchman state”. This would be a state whose areas of legitimate activity were largely confined to the maintenance of national defense, and the enforcement of contracts, property rights, and the criminal laws. Perhaps it might also build a few roads for its soldiers to march on. However, Hayek dissents from this faith:

“Far from advocating such a ‘minimal state’, we find it unquestionable that in an advanced society government ought to use its power of raising funds by taxation to provide a number of services which for various reasons cannot be provided, or cannot be provided adequately, by the market.” (p. 41)

Indeed, he notes a number of areas where the state has an interest in providing services, even in the very name of preserving and enhancing the market order itself. An example would be the collection and dissemination of information in the form of statistics and education. Information helps to make markets operate more efficiently, and yet markets cannot in all cases adequately provide this vital service for themselves.

Indeed, the later Hayek, as he became increasingly conservative, added to this function the propagation of valuable cultural information (e.g. religion, art, and morality) from one generation to the next. What could be less libertarian than allowing government to play an active role in the inculcation of forms of worship, taste, and morals? And yet, my inner Tory applauds the move, at least with regard to the last two items.

Hayek on the “Taxation-as-Forced-Labour” Argument

In his Anarchy, State, and Utopia (1974), Robert Nozick (in)famously equated taxation with forced labour. It is a common mode of argument among libertarians to claim that some expenditure X amounts to theft or extortion from those citizens who don’t want X and who therefore would rather not pay for X. In a social order that respects people’s liberties, I should at least be able to opt out of paying for “my share” of X. By being taxed to support X against my will, some share of my labour is being taken from me to contribute to someone else’s ends. In other words I am compelled into forced labour. I am to that extent a slave. Or at least, that is how the argument is usually run.

Hayek has a very interesting alternative way of conceptualizing this situation. First of all, we live in what he calls a “Great Society”. By “Great” he doesn’t necessarily mean “powerful” or “hegemonic”. Rather, the term connotes extensiveness and complexity. For better or worse, our society has grown complex, and with this complexity comes certain trade-offs. A Great Society depends on many services that are unnecessary in more simple forms of social organization. For instance, only a numbskull would claim that we could live in sprawling modern cities without some form of mass transit, and for various reasons, such transit is a collective good that for various reasons is more efficiently provided by the agency of government.

“Collective” vs. “Public” Goods

Before proceeding, some clarification of terminology is in order here. I use the term “collective” good to refer to goods that everyone benefits from, whether directly or indirectly. Mass transit in a large city is a collective good because even those who do not use it benefit from it: If I drive my car, I benefit from less congested roads, from decreased costs of road maintenance, from decreased demand for the gasoline I need to fill my car, and so on. Since there is no way to stop me from benefitting from this good, if I do not contribute I am in essence a free rider (pardon the pun). Thus, a collective good is one from which there is no fair way of opting out, because even if you didn’t contribute to its provision, you would still benefit from it. This characteristic of collective goods has been used by some philosophers to justify requiring everyone to contribute. (I do not think it is a sound justification, but that is a subject for another day…)

I use the term “public” good to refer to those goods that are more adequately or efficiently provided by public rather than private agencies. This is obviously not the same thing as a collective good. We may all benefit from X (a collective good), while at the same time X can be provided by the market. On the other hand, Y might be most efficiently provided by a public agency, and therefore be a public good, while only benefitting a minority of the population.

Rather than looking at each item of government expenditure in isolation and judging its legitimacy according to whether or not one personally benefits from it, Hayek says we should view taxation in the aggregate, as everyone’s contributing to a common pool, out of which expenditures will be made for collective and public goods. Although I may not agree with or make direct use of some of the goods provided out of that pool, Hayek says that so long as I get at least as much benefit from what comes out of the pool as what I contribute to it, then taxation is a legitimate practice and not merely a form of forced labour or slavery.

Of course, none of this is to say that a government’s powers of taxation aren’t abused. No doubt, much of what comes out of the common pool could be spent more efficiently than it is, and could benefit more people than it does, rather than being spent on goods that are in truth neither collective nor public. Indeed, it could even be the case that a number of citizens do not receive as much benefit from taxation as they contribute to it. Hayek’s aim is merely to justify the principle that taxation by government is not ipso facto illegitimate or a violation of liberty.

How Collective?

I suppose the drift of Hayek’s argument so far is that in an ideal libertarian world, taxation is legitimate when it is expended on goods which are both collective and public, with some allowance for expenditures that do not meet this rather stringent requirement, so long as every taxpayer benefits at least as much from government expenditure as he or she contributes in taxes, taken in toto. Another way of putting this last point, in economists’ jargon, is that to be legitimate, taxation taken in the aggregate must be Pareto efficient; that is, it must make at least one person better off, without making anyone worse off.

(When we speak of taxation “not making anyone worse off”, opportunity costs must be taken into account. Let’s say that the benefits I receive from government expenditure exactly correspond to the amount of money I’ve contributed in taxes. But when I stop to think about all the things I could have benefited more from if I had been allowed to spend the money on my own rather than contribute it to the common pool, I might find that I’m actually much worse off. Pareto efficiency is more stringent than it sounds, and than Hayek would lead us to believe. In other words, for the bundle of goods X I receive through public expenditure, there is likely to be another possible bundle Y that, while containing some of the same goods, also contains other goods, and where in terms of benefits, Y > X.)

Using collectivity as a necessary condition for justified taxation can be tricky. For example, I’m sure that there are many goods we might wish to classify as collective that are not entirely so. There might always be some naysayer who would rather not spend his money on any given item, because he doesn’t personally stand to benefit enough from it.

Again, this worry is partly dealt with by Hayek’s requirement that we view taxation and expenditure in the aggregate rather than item by item. A certain item of expenditure might not be Pareto efficient, while a bundle of items that includes it might be.

Hayek’s strategy of assessing the collectivity of goods from the aggregate level is probably better than at least one obvious alternative method, which would involve adding a requirement to the effect that a good can be classed as collective if a certain threshold proportion of the population would benefit from it. We might call such a good imperfectly collective; it is “collective enough” to justify taxation. So long as it benefits enough people, the naysayer is legitimately required to “suck it up” and contribute for the good of the larger community.

This is a tricky move. First of all, what number should we set as the threshold proportion of the population we are justified in benefiting through the forced sacrifices of others? Second, we would also have to put limits on how much people can be required to sacrifice for the greater good. We could bankrupt the naysayer and spread his wealth among a lot of people who need it. We could create one have-not but also create several haves in the process. Should we be allowed to do this? I think not. Ideally, we would want to say that there is some “fair share” that we can commandeer from the naysayer. We cannot take everything.

And third, there is the problem of limiting the uses which can be made of what is commandeered, even if it is used on a good which is putatively collective. Imagine we could take all of the naysayer’s money from him, and make a reality television show that documents his subsequent skid row life, providing much satisfying entertainment for masses of people. I think the naysayer should not be required to contribute to this dubious sort of “collective good”. And this is not because it would bankrupt him. It is not the amount of the sacrifice that matters here. I don’t think he should be made to contribute a single dollar to minister to such depraved tastes. This is where morality has something to say to the calculations of economists.

How Public?

Besides some lack of clarity as to whether a good is really collective, there is also the difficulty of assessing whether a good is really public. For one thing, there are some goods that are currently viewed as public that might not be such at all. Hayek gives the example of postal delivery. In the US and Canada it happens to be publicly provided, even though it is relatively inefficient, and even in the face of a large amount of evidence that it could be better provided by the market. Indeed, most nations have now privatized their postal systems, almost all of them successfully. (I would like to say all of them, but I can’t be confident that there isn’t a counter example lurking somewhere that I’ve missed.)

Hayek says that we must be wary of considering something a public good merely because the government, as a matter of contingent historical fact, has happened to be the sole provider of that good. In the case of postal delivery, governments historically had their own raisons d’├ętat for instituting it, reasons having more to do with the aggrandizement of administrative power than with the good of the people. From this it does not follow that governments must continue to provide it.

He says we must also be careful of falling into the habit of too starkly delineating supposed classes of goods that are of necessity publicly provided. Such a view blinds us to the possibility of improvement. In many cases there may be good reasons for why a particular good can best be provided by government. However, in the future circumstances could change and those reasons may no longer be good ones. If that becomes the case, the government should cede that sphere of activity to market forces.

And lest you think I’m plumping too much for the libertarian side here, and driving at the claim that the natural development is unidirectional — i.e. a natural takeover by the private sphere of public functions — things could just as easily work the other way around. As a matter of fact, many of the things that are considered properly public goods were once exclusively private. Education would be an example. Health care (at least in Canada) is another. I know many libertarians would dispute classifying health care as properly public, but I see no evidence anywhere that the market can do a better job in that area (not to say that there is no possibility of some form of mixed system).

As a matter of fact, many historians and anthropologists have argued that in primitive societies the enforcement of rights was often done privately, through self-help, clan feuds, or other “private” security arrangements. In other words, in the beginning, all was private. At some point many of these societies came to see the obvious drawbacks of arranging the proto-legal order this way and ceded large areas of activity to some public body. This was the birth of the rule of law and maybe even of government itself. There is a delicious irony here, the tantalizing possibility that the public sphere itself was born of market failure! But much of this is speculation.

Social Security in the Great Society

There are many people in society who, through no fault of their own, are unable to participate in the market economy, perhaps because of old age or disability. Hayek says that such people must be provided with an income. (Actually, in his other writings he seems to indicate that perhaps everyone should be guaranteed some minimum income). He has more than one argument for this.

First, the things that make such people unable to participate in the market are such that they could in principle befall anyone. I could become gravely injured tomorrow. And sooner or later — if I live long enough — I will reach an age where I am no longer able to work. These are “common risks”, which makes the provision of an income to people disadvantaged by them a collective good. Of course, this argument only works if we add the assumption that we are all relatively risk averse. If we all have a rational fear of being disadvantaged by common risk factors, then we benefit by contributing some share of resources to a pool to insure against those risks.

In other writings Hayek buttresses this “common risk” argument with what we can call the “risk encouragement” argument. He says that in order to be successful, capitalism depends on a certain level of entrepreneurship, which by definition involves risk-taking. Another sort of risk-taking “entrepreneurship” also happens when I leave a job in the hope of securing a better-paying one. Such risk-taking makes for a flourishing economy, from which in theory we all stand to benefit. But people will be less willing to take such economic risks if the costs of failure are too high. This provides justification for things like lenient bankruptcy laws (which in effect subsidize debtors at the expense of creditors) and unemployment benefits. These provide a sort of “smooth landing” in case of failure.

Of course, more militant libertarians (e.g. Milton Friedman) would say that if there is a common risk, then everyone has an incentive to plan for it through, for example, an insurance scheme, and there is no reason why such a scheme shouldn’t be available through a market. In other words, even though social security might be a collective good, it is not a properly public good. And if you fail to insure yourself, maybe because you are not sufficiently risk averse, then you are responsible for the consequences. Perhaps a voluntary charity may help you, but the state should neither use its coercive powers to force you to insure yourself nor to force others into providing relief for your folly. This is the only consistent way to respect the autonomy of the individual. And after all, why should 95% of people be forced to pay for the other 5% of people who are improvident or reckless?

Hayek has an answer to this, at least in the “common risk” cases, although I am sure it wouldn’t satisfy the hardened libertarian. Every society has recognized a moral duty to help the aged and infirm, a duty not based solely on the personal virtues of the sufferer, but either on personal ties of affection or common humanity. Thus, traditionally this duty was most commonly fulfilled by family members or, where this was not possible, by those voluntary charities and religious foundations that libertarians seem so fond of. But, says Hayek, we no longer live in those simpler societies. We live in a Great Society, in which those ties of kinship and feelings of moral duty have weakened and can no longer be taken for granted. Although the duty to help the disadvantaged still stands (how so?), the old ways of fulfilling it seem to have vanished. The suffering individual no longer has a claim on others based on kinship or shared belief in a religious commandment. In its place, government must step in and help, as impersonal as that help must necessarily be.

I find this argument fascinating in its admission that capitalism has not been an unadulterated success. In order to live in the general prosperity that the Great Society provides, much that was meaningful has been traded away. Perhaps it was a good bargain, but it was a hard one, as those that suffer in our midst can attest.

It is a recognition that is very un-libertarian. But my inner Red Tory nods in agreement.

* * * *

To return to the above discussion about privatizing postal delivery, this past summer I was drawn into an argument about this very subject with two “progressive” friends (I didn’t start it). In the course of a conversation I made the barest suggestion that Canada Post could be privatized, and was immediately set upon. I was told in no uncertain terms that it would not work, that no country does it, and that where it has been tried it has failed.

I should mention that one of these two friends has the maddening habit of adamantly claiming an empirical statement to be true, and refusing to back this claim up with an authoritative source, leaving the disputant at a dead end as to how to refute him. If you don’t happen to have briefing notes on hand, you cannot dispute such a proffered “fact” conjured up out of thin air. On this occasion the “fact” he proffered was that Canada Post is a profitable enterprise.

The sheer emotionality and increasingly aggressive drift the argument was taking caused me to wisely drop the subject. However, I was not convinced by my opponents. I did some follow-up research. It turns out that (i) many countries have privatized their postal delivery, including most developed ones, (ii) that it has worked in these places, by any objective standard you care to use to assess it, and (iii) that there are few complaints about the market-delivered service.

Furthermore (iv), as for my friend’s vouchsafing Canada Post’s profitability, I looked up the latter’s annual reports, something which I was obviously unable to do during the heat of our discussion in the context of a backyard barbecue. In the fiscal year just passed, the corporation barely broke even. By its own admission, this accomplishment was due to certain unforeseen and one-time-only increases in revenue. Therefore, it would seem that Canada Post must have actually budgeted for a net loss and been pleasantly surprised when, despite its best attempts at fiscal incompetence, it actually ended up in the black (which, incidentally, it has consistently failed to do in previous years). Of course, this does not take account of the fact that much of their “revenue” in any given year consists of government transfers.

I hope my friend is reading this, because although I like to have the last word, I have no wish to return to that conversation and play the bear, to be baited by people who offer articles of faith in the place of reasoned argument.

Wednesday, November 3, 2010

From Arbitration to Arbitrage

Arbitrage happens when someone — an “arbitrageur” — profits from a price differential between markets for some good. He buys low in one market to sell high in another, and pockets the difference as risk-free profit. Etymologically, the word “arbitrage” is French, and refers to the decision of an arbitrator. The term was first used in English in its current sense early in the 18th century. At first sight it seems difficult to see how its meaning could drift so far from its original source. However, I can tell a little story that might shed some light on this.

According to Cicero (De Officiis, 1.33), Quintus Fabius Labeo (consul in 183 BC) was appointed by the Roman Senate to arbitrate a boundary dispute between the cities of Nola and Naples:

“[H]e took up the case and interviewed both parties separately, asking them not to proceed in a covetous or grasping spirit, but to make some concession rather than claim some accession. When each party had agreed to this, there was a considerable strip of territory left between them. And so he set the boundary of each city as each had severally agreed; and the tract in between he awarded to the Roman People. Now that is deceiving, not arbitrating [Decipere hoc quidem est, non iudicare].”

The same story is also related by Valerius Maximus (Facta et Dicta Memorabilia, 7.3.4), where he writes that “arriving at the scene, he [Labeo] advised both separately not to be greedy but to go backwards from the nodal point of the dispute [regredi a nodo controversiae] rather than forwards.”

Now, although it might not seem like it, this case bears a more than analogous relationship to arbitrage. Let us imagine that, instead of separate parties to a bargaining situation, we redescribe Nola and Naples as different markets for a single type of good. This case is somewhat unusual in that there happens to be only one token of that kind of good, namely, a specific tract of land lying between the two cities.

Let us further imagine that each market/city values that land at a certain price. In other words, each has a price in mind at which they are willing to part with the land. Unfortunately, when Labeo first appears on the scene, it seems that the land is — paradoxically — worth more to each party than the price at which the other is offering to purchase it. Nola thinks it is worth 1,000,000 denarii and would be willing to purchase it in exchange for some amount of money less than this, say 800,000 denarii. Same with Naples. In other words, each city would not pay more than 800,000 denarii for the land, but would not sell it for less than 1,000,000. Under these conditions, no bargain can be struck. There is a further and more obvious reason no bargain can be struck.

There is a theorem in economics called the Coase Theorem, which roughly states that, so long as property rights are well-defined and transaction costs are zero, parties will reach an efficient bargaining outcome. (Strictly speaking, this formulation of the theorem is grossly oversimplified, but it will do for our purposes.) Besides the fact that there is almost never such a thing as zero transaction costs, the obvious problem in this case is that there is an absence of defined property rights. A defined property right is precisely what they are bargaining for. And for this reason, neither party is sure whether it is playing the role of buyer or seller.

Here is where an arbitrator can come in and restore the conditions for efficient bargaining under the Coase Theorem. In effect, both parties give up their claims to some other party, namely the arbitrator. Under normal circumstances the latter, although he is now the “owner” of the land for purposes of bargaining, stands in a fiduciary relationship to the parties: rather than owning the land, he is more properly described as holding it in trust, and as such, he is not supposed to profit from it himself. The advantage to establishing this trust is that, for the purpose at hand, there is someone who can play the role of seller, while the two original parties become, in effect, bidders.

Once this new arbitrated bargaining structure was in place, Labeo, in the role of seller, accepted offers of purchase from the parties separately. It was exactly the circumstance that the parties were consulted separately that made them more akin to separate markets than to parties to a single transaction. In effect, it was a sealed auction. Cicero’s account says as much, and I think it must have been, because if either party caught wind that the other party was bidding so low (or rather, was willing to part with so much), they would have driven a harder bargain and asked for more. There must have been an information gap created by Labeo.

Obviously it differed from a normal sealed auction in that the auctioneer was privy to what was in the bid envelopes before they were opened. Indeed, Labeo was instrumental in helping the bidders to formulate their respective (inefficient) bids. Through what must have been his considerable powers of persuasion, he in effect convinced both parties to reduce their respective valuations of the land in question, leaving a differential which represented a profit to be pocketed by himself (on Rome’s behalf, of course).

Labeo effectively opened up a price differential between two markets for the same good, and made a risk-free profit as a result. If he had been bargaining in good faith in the role of trustee, he would have done his best to ensure an efficient outcome, which would have meant creating a price convergence between the two markets, so that there was no differential. In other words, he would have worked towards some optimal solution where each party was willing to purchase just so much of the land at just such a price as would ensure no surplus leftover for some third party to pocket. Labeo was an arbitrageur, not an arbitrator.

What makes arbitration and arbitrage similar is that both involve some agent who acts as go-between. In the former the go-between is a trustee who works to bring about market efficiency without profit to himself. In the latter the go-between takes advantage of market inefficiency rather than seeking to correct it. Thus, the difference between an arbiter and an arbitrageur is one of motivation.

The irony is that in economics, arbitrage can lead to long-run efficiency, because arbitrage activity acts as a signal to markets, alerting them to inefficient pricing, and leading to its correction. It would be as if after being burned by Labeo, Nola and Naples had a better understanding of what was at stake and what they lost. Armed with this new knowledge, if they were to do it over again, they would come to an agreement to split Labeo’s differential equally between, leaving no differential to be scooped up by a third party. Then they would both end up better off. Unfortunately, their’s was not a currency market; they won’t get another chance to do things right.

The trickery of Labeo aside, the profit margins in arbitrage are usually quite small and the opportunities presented tend to be rather fleeting. Once price information becomes available, markets adjust themselves quickly.

* * * *

The world is full of modern-day Labeos. They’re called real estate agents, and they work in pairs. One represents the seller of a home, and the other “represents” the prospective buyer. It’s supposedly a fiduciary relationship, at least in the sense that the two agents are supposed to be looking out for the interests of their respective principals. In reality, only the seller’s agent can be said to do so. Because they make their money from the percentage commission they receive from selling the house, both agents in reality represent the seller. They both have a vested interest in having the house sell for as high a price as possible, and thus in fleecing the buyer.

Unlike other kinds of arbitrageur, real estate agents don’t correct market valuations; they grossly inflate them. This is because they have an effective monopoly over whatever it is they do: if you wish to buy or sell a house, you must use their services, which means that although they distort prices, there is no real way the market can correct this unless buyers and sellers are allowed to interact directly with each other, thereby establishing non-collusive price signals to guide the market.

This monopoly may be breaking down, at least where I live. Real estate agents are now being forced to open up access to the Multiple Listing Service (MLS), meaning that they are about to lose their monopoly on access to the real estate market. In conjunction with this, I’ve noticed that a number of small firms have appeared on the scene whose aim is to make it easier for people to buy and sell homes without requiring the “services” of an agent. I predict that such developments, if allowed to continue apace, will lead to a moderation of prices and hopefully will someday make shelter more affordable in this city. I say “if allowed to continue apace” because there is a large lobby — guess who it’s funded by? — trying to put a stop to it.

Interestingly, the agent who “helped” us buy our home had the stones to tell us not to worry about what she was making in commission from our purchase, because we weren’t the ones paying it. She claimed that it was coming out of the seller’s pockets. She must truly have thought we were cretins, too stupid to figure out that the sellers would be paying the commission out of money that we had forked over to them in the first place. If the agents have done their jobs well, once the seller makes his end, he will be paying the commission out of the differential between selling price and the non-collusive market price.

Homework assignment: Can you find other examples of economic activity requiring a similar level of structural fraud and collusion? In a wry aside in The Selfish Gene, Richard Dawkins gives the example of divorce lawyers. The lawyers of both parties have a stake in not having the split settled quickly and amicably, as this would lead to a reduction of billable hours. This differs from the real estate case in that instead of both agents representing only one of the principals, they truly represent neither of them.

None of this is to say that there aren’t ethical lawyers and real estate agents out there who don’t operate in this unscrupulous way. However, I think it is useful to be aware of the underlying structure of such relationships, so that one doesn’t end up with an arbitrageur instead of an arbitrator.