Inequity Aversion and Public Policy

One of the more important psychological concepts for those interested in public and economic policy is that of inequity aversion.  Inequity aversion theorizes that human beings have a natural tendency to sway away from outcomes which they perceive as unfair or inequitable.

I find this to be fascinating because I believe that the root of trade and money can really be found in equity(note: by equity I mean the concept of fairness, not any of the other uses of the word).  Early trade and barter arose with individuals trading one good for another (or a good for a service).  Such calculations really had a rule of thumb approach to them which could be said to be rooted in the individual utility which was driving the actor’s decisions.  However, with the advent of standardized commodity units (like furs, bushels of wheat, cowry shells, etc.) a concept arose whereby people could visualize in their minds what was truly a “fair” deal or not in a way which went beyond a single transaction and could apply to all transactions as a gauge of real value.  Cultural norms could help indicate to someone just how many furs were equal to a bushel of wheat, which added a new dimension to trade beyond simple conceptions of utility. 

If one is to take a pure utility argument to an extreme, then the buyer could pay $1 million for a soda simply because it increases his own utility.  Of course nobody from a modern society would even consider such a deal, even if they really wanted to have a soda, because we know that $1 million is vastly too much to pay for such a good.  The idea of someone paying $1 million for a soda is absurd because any rational person could tell you that paying $1 million for a soda is an unfair deal.  But besides the fact that such a transaction simply doesn’t make economic sense, there is also a moral realm to such a transaction whereby one could say that actual inequity would be occurring.  If any individual were to convince a someone who is unfamiliar with the cultural and market norms of what the fair value of a soda is to pay $1 million for one, most people would say that such an action would constitute fraud, and that the act is not just bad business but bad behavior which amounts to an injustice which should be corrected.

 This moral sense of unfairness coincides with pure economic calculations of what a good deal is, and in many ways serves as an extra factor which helps guide economic actors to coordinate goods in an efficient way.  And this moral factor is not driven merely by being able to sense when an unfair or far deal is occurring, but also by our inner desire to prevent an unfair deal from occurring in the first place.  And it is through this aversion to inequity that we are able to develop standards of what is equitable and what isn’t, and these standards help guide market actors in their own economic decisions in a way that goes beyond mere utility.  The buyer is not trying to simply increase her utility or meet her needs when buying a good, she is also trying to do it in a way which she believes is equitable for her.  We can see this at work in real life, as in most cultures the greedy businessman who overcharges for goods and underpays workers is not seen just as being bad at business, but as a bad person who is a moral villain.  This adds a layer of complication to the argument that actors in a self-regulating free market would simply refuse to do business with unscrupulous individuals, because in addition to refusing to do business with them people also have a desire to actually enact retribution on them.  They do not simply want to harm them in the future by denying them business, they want to make them pay for past crimes as well, in which case simple market action of finding a different person to transact with may not be enough for people to feel that justice has occurred.

The best evidence for inequity aversion and how it works can be found in experiments done in game theory.   The dictator game for example, allows one individual to split apart a group of units he has (often a cake or a pile of money in an amount which is easy to divide), where he has to give a certain percent to another person and a certain percentage to himself.  In the dictator game, the “dictator” has the freedom to choose whatever ratio he wants, so that he could give himself a larger proportion or give the other person a larger portion, or split it 50/50.   Studies of this game found that the most common choice the dictator makes is to keep it all for himself, but the second most common result is to split it 50/50. 

This becomes even more interesting in another variation of the dictator game called the ultimatum game where the second individual can choose whether to reject the offer or not.  While the dictator still has the sole power to split the units apart, the recipient now has the power to veto the deal so that both he and the dictator end up with nothing.  Unsurprisingly, in the ultimatum game the dictator, having knowledge of this, is more likely to create fair deals from the start.  However even more interesting is that these studies have shown that the recipients regularly reject unfair deals, so as to sacrifice their own reception of money in order to cancel the dictator from receiving the higher share.  Offers of 70/30 and under tend to be regularly rejected.

These studies tell us a few interesting facts about human behavior.  First is that individuals in the dictator position do deal out unequal splits, sometimes even dramatically so (100/0) when they feel that they are in a position to get away with it.  And while the majority of individuals may give an unfair deal, there is a sizeable minority who do strive to give out more fair deals.  Secondly, these games show that the recipients will gladly forgo the benefit of the deal if it means canceling out what they perceive as an inequity.  Now there have been some criticisms of some that absolute value would alter the results, aka, if you actually could receive $30 in USD rather than $30 in monopoly money the recipient would be more likely to take the money and run.  However, amazingly enough, experiments done to see whether this is true have shown that the results are not greatly altered, the absolute value of what is being divided has not been shown to correlate with any decrease in the rate of rejection by the recipient, which indicates just how powerful this moral sense of inequity really is in determining human behavior.

And of course these findings should have very real relevance for looking at modern economic arrangements.  For example, we can see elements of this behavior with the labor movements of the late 19^th and early 20^th century. Workers addressing what they saw as inequity in economic arrangements would resort to strikes and demonstration which not only halted production, but also often cost them their very jobs.  These actions have puzzled many as it seems to be the workers shooting themselves in the foot, after all, they probably would have gained more income if they simply took the deal offered to them by their employers instead of protesting against it.  Those who demonize labor unions use these examples as evidence that labor unions are irrational and harmful to the economy.  However, when the concept of inequity aversion is applied to these events, they seem to make more sense, as they could simply be manifestations of the same behaviors observed in game theory which show just how deeply ingrained morality and a sense of justice is in our economic thought processes.

 Perhaps an even more interesting example could be in communism.  Outraged with what they saw as the unfairness of 19^th century predator capitalism, socialists and communists called for a total downfall of the system, and created numerous disruptions for society.  The revolutions which popped up over Europe inarguably created unrest and probably hurt the poor and middle class just as much as they did the rich.  The inefficiencies of socialism in those countries where communism did take hold probably prevented a growth of wealth to the degree that one could argue that economically the proletariat really had a zero sum gain, they probably could have made just as much if not more if they simply carried on with capitalism like those in Western Europe did (and indeed the wealth of Western European nations attests to this).   Of course, when inequity aversion is taken into consideration, one could postulate that these actions may have had more to do with principal rather than any attempt at replacing capitalism with a more efficient system.  In installing a communist regime they insured that the privilege and status of wealth was destroyed, the proleteriet in many ways impeded their own economic future so that they could ensure that the rich would not get away with this perceived injustice. 

And of course this should bring in mind some of the aspects of Nash Equilibrium in the ultimatum game as compared to the dictator game, where by the proposers (dictators) in the ultimatum game are more likely to give a fair proposal than in the dictator game as they understand that if they give an offer which is too one sided they risk losing everything if the receiver vetoes.  In terms of labor history in the West, the fear of losing it all prompted capitalist countries to develop policies such as workplace regulations and welfare states to help calm the proletariat and put them on a stronger footing.  And while some may argue that this had the effect of reducing the marginal utility of capital in favor of labor, it helped to reduce the social strife that characterized that age.  And if one were to consider to the losses which the capitalist would endure from large strikes and threats of revolution, one could argue that the economy actually achieved more wealth and growth after abandoning laissez faire for more social democratic policies as it reduced the incentives of laborers to sabotage the entire economic arrangement.  By realizing what was at stake due to the news coming from places like Russia, capitalist countries realized that perceptions of inequity could cause dramatic problems if they were not calmed.  

Of course, while there is ample evidence for inequity aversion in people, we still find that the dictator is still capable of cheating the other person if he can, a true free rider if you will.  But, the less confident he is that he will get away with it, the less likely he is to attempt such a feat.  Furthermore, variations of these games have found that the options available to the players can alter the level of altruistic behavior seen, with proposers who are overly generous under one variation of the game becoming shockingly licentious in another variation.  This suggests that people’s levels of altruism are directly related to their environment and the options presented to them can alter what they perceive is to be expected of them.  And what they perceive to be expected of them can cause seemingly good people to become much more abusive and unfair, which shouldn’t be surprising to those of us familiar with experiments like the Sanford prison study. 

Overall the findings from these games suggest a picture of humanity which is far more complicated than the one put out by people like Milton Friedman.  Humans are a species which is not only capable of acting in unfair and inequitable ways if they feel that they can get away with it or that it is expected of them, but also capable of amounting to extreme, self-defeating measures if they feel that an injustice has been committed against them.  These contradictions should be of no surprise to those who are familiar with human psychology and the complicated behaviors of our species.  However, to many these contradictions are simply over looked.  Clearly the actions of individuals in these games and real life indicate that there are elements of utility function which remain tantalizingly intangible, which should call into question any models of economic behavior which attempt to present utility function in quantifiable terms.  Because by all measurements, there really is no evidence that the vetoing by the receiver actually increases his utility at all, instead it indicates that an economic benefit can be costlier to an individual if it offends his inequity aversion, things like pride or desire to punish bad behavior are actually weighing in on utility function in a way which can be hard to predict and quantify.  Yet they have obviously shown to be a very important force in allowing an actor to come to an economic decision.

Also, it must be said that the results from the dictator and ultimatum games can be remarkably mixed, the only real constants we see are that proposers in the dictator game are more likely to give themselves a greater share and that receivers in the ultimatum game routinely reject divisions less than 30%.  However, there is still a great deal of individual specificity in just to what degree this occurs in a game and as stated earlier, slight alterations in the rules and options available to the players can yield different rates of unfair proposals and rejections.  We see that human behavior is not a monolith, and while there are trends, it remains incredibly difficult to create a model of a uniform actor in regards to these concepts.

In terms of social policy, we should be very keenly aware of the existence of inequity aversion and seek to avoid those instances where inequity exists.  And given the evidence that people can be willing to shoot themselves in the foot if it means exacting justice, it should be something that is to be feared.  People such as Milton Friedman seem to believe that free market capitalism has all the tools to deal with the complexities of human behavior, including that of inequity aversion.  However, the historical and real life data suggests otherwise.  The property and contract rights in free market capitalism can put people in a position very similar to the dictator in these games, and like the results of the dictator game, some of these individuals choose to act in a way which gives them a bigger piece of the pie.*  Workers, perceiving an unfair situation can resort to extreme measures to correct this injustice, in a way which goes beyond mere explanation of simple economic utility and reflects a level of seemingly irrational and emotive behavior within both the capitalist who knows his deal may anger workers and the workers who hurt their own economic utility in an attempt to exact justice.  

And of course this is exactly the problem which was occurring in the late 19^th and early 20^th century.  Thinkers like Friedman seem to suggest that courts and contract law could correct this, but this too is incorrect.  The property and contract laws of common law countries evolved from medieval and proto-capitalist economic situations, and were more focused on buyer seller relations and distribution.  While they worked well for the markets of the 18^th and early 19^th century, they really were not equipped to deal with the complexities of labor relations which emerged in the second industrial revolution.  Many workers were employed under at will employment contracts, which pretty much meant that employers could do whatever they wanted.  And the reactionary courts of the Lochner era were certainly not sympathetic to labor claims, and saw the capitalist as well within his rights to have the unequal bargaining power.  The courts of the late 19^th and early 20^th century were not friendly to labor, and indeed to this day contract and property law is more oriented towards distribution than towards worker rights.  There was also the element of the culture of the day, which held the capitalist in high regard.  Laissez faire economics puts the entrepreneur and the capitalist on a pedestal, and allows them much freedom in their decisions, as it is said that from their freedom to make decisions, economic coordination can occur which benefits all of society.  This notion is still very much present among laissez faire advocates today, who celebrate the capitalist and believe that his discretion should be respected at all time, as the decisions he makes fit within a bigger picture which in its aggregate makes life better for all of us.  Of course this should make us all think of what I discussed earlier in how the options presented to the dictator can alter his behavior, if the capitalist is told to believe that it is crucial that he pursue profits and must follow his self-enrichment to the fullest extent, he may not only feel entitled to give himself a greater share of the income from production, but that it is actually expected of him to do so.

And it would be hard to argue that these attitudes and behaviors were not the norm in the late 19^th and early 20^th century, and indeed many capitalists did try to deal out very unfair deals.  This of course created much strife, with an economic model and business culture conducive to allowing unequal distribution of profits from production and a legal system seemingly unable or unwilling to address these concerns, this was a breeding ground for inequity aversion to boil up and create unrest.  So how did society get out of this dilemma?

The answer of course lies with the new form of law which emerged in that period: the regulation.  Unlike the equity and contract law which simply seeks to correct a past harm, or penal codes which outright forbade certain behavior, the regulation dealt with behavior which was legal, and merely set in place guidelines as to how it should be conducted.  By putting in place regulations for the workplace, the capitalist was restricted in his options, making him less likely to and less able to deal out unfair distributions.  And with laws in place that guaranteed certain wages and benefits to workers, these unfair results were simply avoided in the first place.  The evolution and emergence of regulation as a form of law was meant to directly address the flaws in laissez faire capitalism, one of which was the social strife caused by inequity aversion.  The fundamental difference in outlook between regulations and the early common law, is that instead of waiting to correct a bad event, the regulation seeks to prevent it from occurring in the first place.  This notion is much more in line with the realities of human nature, rather than simply “letting things play out” as laissez faire advocates desire, regulations are made with the understanding that sometimes underlying irrationalities in human behavior can create outcomes which rather than correct injustice, only serve to make things worse.  Instead of falling for the Lockean fallacy that individuals will always try to be pro-social and avoid bad behaviors in a free market, regulations are made with the understanding that humanity is a complicated species which is very much capable of producing undesirable results if environmental conditions permit.  Many of the strikes and riots which occurred in that era did not correct any bad behaviors, nor did they yield greater efficiency, they simply represented sunk costs that only hurt society and markets, sunk costs which could have been avoided.

Those who complain about labor regulations and welfare states may not be fully cognizant of the alternative scenarios which could arise if a laissez faire scheme was reinstated.  The inconveniences of regulation and taxation (which as of yet have failed to destroy capitalist incentives and growth) may not just be wasteful spending, but rather important investments which fuel growth by allowing for greater social cohesion and lower incidences of strife.  The normal market mechanisms and cooperative exchange are not enough, there is an element of strong arming in both labor and capital which are unable to resolve these disputes in a cohesive way from market mechanisms and common law alone.  The attempt at creating policies which reduce labor tension and creates avenues for equity and reduction of social unrest are one of the main focuses of the highly successful social markets undertaken in the Nordic Model and Rhineland Capitalism. This also serves to add an objective element to arguments for helping the poor and protecting labor.  Some have mistaken earlier arguments I made regarding the welfare state as simply being moralistic ones on the grounds that we should avoid them simply because it is wrong to be “mean” to the poor.  But when concepts such as inequity aversion are taken into account, those who cannot be swayed on moral arguments alone should be swayed by purely utilitarian and materialistic ones in the fact that ignoring the concept of equity can create social harms which bring about real costs to society that can be quite devastating.

Finally, as one last point, it should be important to note that some studies of the ultimatum and dictator games have found that individuals from industrialized countries are more likely to deal out 50/50 splits than those who are not.  This ties in to the argument I made at the very beginning of this article about the role that perceptions of equity play in people’s ability to make economic calculations.  By having an industrialized economy with regulations, societies are also helping to create moral signaling which guides people as to what an actual equitable deal is.  This not only makes us more proficient economic actors, but increases instances of organic altruistic behavior.  Laws regulating behavior have an extra aspect to them, which while they are unable to govern morality, can signal to individuals just what sorts of behaviors are acceptable and which aren’t.  Just as the capitalist was taught and expected to be inequitable by the culture of laissez faire, the culture of social democracies with regulatory framework and welfare states teaches individuals to act in a way which does not give rise to inequity aversion.  This fits in with the social organism hypothesis I have outlined before, whereby successful societies through natural selection tend to choose actions which ensure their survival and wellbeing.  And if we have a system whereby equitable behavior arises more organically and spontaneously, we will have a better functioning economy and a more cohesive society.  And that is something which is better for all of us.

 

 

*At first glance this appears to be similar to Marx’s model of the capitalist firm, whereby the capitalist is ripping off the worker by stealing his labor value.  However, Marx seemed to see this as a trait inherent to capitalism that was almost structural and would inevitably occur.  In reality the results are a little more complex, some capitalists like Henry Ford or Costco CEO Craig Jelinek do go out of their way to give a fair deal to their workers, while others seem to go out of their way to take as much from their workers as they possibly can.  It is not a monolith, and of course this does fit in line with the findings of game theory which indicate that inequitable deals have an element of individuality to them that can vary from person to person.

The lies of Laissez Faire: Externalities

This article is first in a of series of articles I will publish over time where I try to point out the inconsistencies and intellectual dishonesty found within laissez faire philosophies.  As much of the anti-government rhetoric we hear today is phrased in terms of being economic science, it is important to scrutinize the supposed scientific facts on which it is based.  Today I will be focusing on the topic of negative externalities.

Externalities create a special problem for laissez faire economics, because if voluntary economic activity between two parties adversely affects an unrelated 3^rd party, it constitutes an encroachment or trespass on that 3^rd party.  And since encroachment on the person is a cardinal sin in libertarian ethics, the existence of such would justify some sort of action to correct it.

Free market economists often try to minimize the importance of externalities or create the impression that most externalities are only caused by the state.  Friedman and Hayek went as far as to label them “the neighborhood effect” as if to imply that they really aren’t a major deal.  Dismissing externalities as the neighborhood effect is convenient for Hayek and Friedman because it implies: 1) most externalities are local in scope and confined to a small area; 2) limited to a single activity or transaction at a time; and 3) can be dealt with by individual action, for example, the residents of a street can bring an action in equity against a local business that is creating loud noises in the middle of the night and preventing them from sleeping.  Thus, state action is not needed because citizens can take care of it themselves.

This conception of externalities is however horribly short sighted.  Certainly a nightclub or paint factory is going to be creating conditions which local citizens can address on their own using the court.  But what about externalities which affect more than just a few people?  What about externalities which affect entire populations or society in general?

Perhaps the greatest examples of these kinds of externalities can be seen in pollution and ecological problems.  There is no doubt that human activity can affect these, and that things like smog or water pollution can cause adverse effects on others with real economic costs.  For example, exhaust from cars causes much pollution in cities, and smog can affect people’s respiratory health.  Can an individual deal with these externalities in the ways that free market economists expect people to (i.e. courts of equity and individual action)? 

This would be a difficult thing to do, for one, while no one would argue that car exhaust in cities can cause real costs to individuals, chances are that on an individual basis, the costs may not be large.  I may only lose around $70 a year from car exhaust living in a city from costs incurred in buying allergy medicine and a few lost opportunity costs in dealing with or remedying respiratory irritation.  That is hardly enough to justify bringing an action in Court, where attorney’s fees, court costs and the costs involved in expert evidence and data (to prove my losses were caused by car exhaust) would greatly outweigh my costs in simply buying some Claritin and dealing with it.  This seems to negate the argument by thinkers like Mises and Coase that externalities can be corrected simply by having better defined property and individual rights.  Even if this were the case, many externalities are so miniscule on the individual that the opportunity costs of bringing court action simply isn’t worth it. In fact, many individuals may not even be aware of what is causing their problem and know who to sue to get relief.  And when the class of “victims” of such externalities are so large as to encompass an entire population, there is really no reasonable way for such an issue to be dealt with by individual actors alone.  Yet, this is still no small matter, for even if my costs are only $70 a year, in a city of millions people that amounts to hundreds of millions of dollars being imposed on the city in its aggregate.   Hundreds of millions of dollars of costs which are unable to be dealt with in the individual equity-like way that free market advocates hope for.

Now to get around this problem I could perhaps try to bring a class action suit representing all the citizens of the city, but then again, who will I sue?  Should I sue every car owner?  That would include the people I am representing, even myself, would we be suing ourselves?  That would go into the realm of legal impossibility.  Obviously if an externality can be traced to one source you know who the defendant will be, but when the externality is created by multiple players (such as a polluted river with dozens of factories on its shore) it becomes much trickier.  After all, if a river is polluted it doesn’t mean that all factories are guilty, some may actually be extra attentive and go out of their way not to pollute, while others don’t care.  Would it be fair to sue those factories who were not actually causing the harm?  And many drivers too may go out of their way to have vehicles which don’t emit harmful emissions.  Should I sue only those who don’t have clean cars?  It would be nearly impossible to identify and find all those people, and the notion of enforcing an action in equity on an entire city from court decree alone is rather insane, you would merely be replacing government regulatory activity with a court, but in a much more contrived and dangerous manner.

Perhaps I should sue the city council itself for not having adequate emissions standards.  And indeed in most common law countries this would be the most reasonable course of action.  But of course, by doing that I am assuming that the government entity I am suing would or should have the power to create and enforce regulations in the first place, and this is something free market enthusiasts don’t want.  If the government were to be set up so that it had no power to make such regulations over people, I could not sue it.  And given the practical impossibilities of suing all drivers I may not have anyone to sue at all.

Of course if I am creative I may sue the car manufacturer’s themselves for not making cleaner vehicles, this could perhaps work, but it would not give me any immediate relief.  I could perhaps get all new models to be made cleaner, but that doesn’t get the dirty cars off the road anytime soon.  The cars which are causing my respiratory distress are privately owned and beyond the control of car manufacturers.  Furthermore, the problem of car exhaust may only be an issue in cities themselves, by attacking the auto industry as a whole I could be putting unneeded costs on people in rural areas where car exhaust is not a major problem.

With all these options exhausted (pun intended), I would most likely be left to my fate and stuck with putting up with the encroachment on my person that is car exhaust.  And free market advocates would probably agree that I should just do nothing, after all its only $70 a year it’s costing me.  But if I live in a city of a million people that means that the total costs of the externality is actually $70, in which case we are talking about some pretty significant costs.  Environmental externalities are some of the most insidious ones because of this, their effects on any individual may be small, but as a whole they can be enormous, and given their nature, they are nearly impossible to correct by traditional legal means.  Climate Change is perhaps the mother of all externalities, slowly building up emissions which could cause catastrophe in the future.

Even $70 million may not seem like a whole lot to many advanced cities, but these kinds of costs from externalities exist all over the place, and can cause death by 1000 paper cuts if they grow too weighty.  Indeed, one of the major causes of the business cycle in my opinion is that in a monetized economy many people have the impression that all costs and benefits can be expressed in pure monetary terms, however, at the peripheries we find many costs which are not being reflected in monetary terms.  And although they are not being figured into monetary calculations, those costs are still present, and in the right set of circumstances the weight can be enough to have those costs come crashing in and bring the market’s monetary value back down to its real value.

In dealing with these smaller peripheral externalities like environmental pollution, state action is the most logical choice.  By enforcing regulations which force actors to conform their behavior, we are actually sending a signal which does reflect the real costs and value of this activity.  It is simple and easy for a city council to simply pass a law which requires emissions standards in vehicles, and in fact humanity has set up government for purposes such as these.  Government regulation is merely a natural process used to identify and correct certain costs from things like externalities which are not being expressed in monetary calculations.  By creating a regulation which imposes a duty on a private actor, the government is actually monetizing those costs so that the real costs are now being reflected in markets.  And the more our monetized economy reflects reality, the better it will function.

Now this concept I am conveying is essentially that of external costs (which one can read about more in depth on the Wikipedia link I provided at the top of the page).  As the argument goes, a free market is actually inefficient by allowing business entities to externalize the costs of certain economic activities onto the public which incur costs on society which are not reflected in prices and thus are not creating benefits to the same extent that they are creating harm.  Thus while free market advocates claim that their system is one which adequately balances costs and benefits, it in fact does the opposite and creates extra, unnecessary costs which not only hurt individuals but hurt markets as well. 

Pundits complain that regulations create costs for businesses, but that is exactly what they are supposed to do!  A good regulation is supposed to take these real costs and make so that they are expressed in monetary terms and taken seriously by firms, this reduces externalities and actually improves the sovereignty of the individual because now they do not have externalities imposed on them.  Libertarians should be embracing regulation if they truly care about the individual.  Markets like regulations because ultimately externalities are bad for markets by imposing costs on it, governments with regulatory powers and markets go hand in hand and always have.  The laissez faire characterization of collective action as emotion stirred mobocracy is pure nonsense, there is a real reason for its existence, it serves a vital role in helping to guide markets and reflect true costs.  The libertarian characterization of government action often described by the Austrian School or Public Choice Theory is nothing more than a conspiracy theory designed to cast it in a negative light rather than an actual objective view of collective action and what its role is in human society.

Now it is true that some regulations may be done in a poor fashion, and some may not be needed at all.  But then again, many business actions are done in poor fashion and are not needed.  Humanity is an imperfect species and individuals, firms and governments are imperfect actors.  As long as corrective measures as in place (for businesses the market can decide if an idea is bad and deserves to fail, for governments democracy, public opinion and successive administrations can correct bad policies), in the long run society should be fine, and the existence of regulatory institutions like governments are a good thing.

Thus externalities are downplayed and minimized by free market advocates for a good reason.  A thorough evaluation of them reveals a fundamental flaw in free market logic which should actually create a case for government action.  However since laissez faire economists have already made up their mind from the start that government is bad (as opposed to true scholarly open mindedness), they try to find a way to conveniently brush over this phenomenon and minimize it to the greatest extent possible.  But any logical and comprehensive review of externalities indicates that these are real costs which can have real effects on society, and can not only hurt the individual, but can actually hurt society as a whole and have negative effects on markets.  The most rational and reasonable way of dealing with many externalities is not simply to leave it up to courts and individual actions in equity, but to have a governing authority with the power to regulate and address these costs.  And of course, by addressing these costs, government is sending signals and inducing behavior which makes these real costs actually reflected in the monetized market, which makes markets healthier and more reflective of a reality, a win-win for collectivist and capitalist alike.  The attempts at downplaying this phenomenon are little more than intellectual dishonesty on the part of laissez faire advocates, who are more interested in enforcing a social ideology than they are on creating a prosperous and stable economic and social atmosphere.   

Is Roderick Long Really That Stupid?

Libertarian philosopher Roderick Long had a recent blog post entitled Against Maslow where he attacked Maslow’s hierarchy of needs.  He started off by saying “To say that food and safety are more basic needs than reason and morality is essentially to say:  “I am untrustworthy and will stab you in the back when the chips are down.””  He then went on to quote Aristotle, Seneca and Cicero basically saying that it is not natural for man to profit from his neighbor’s loss because then he would feel bad about himself.

Now I can understand not taking Maslow’s hierarchy of needs literally, obviously there are individual differences and one can certainly take issue with the order in which he takes them.  But I still believe that the overall message of Maslow’s needs rings true, which is that individual moral and altruistic behavior can be amplified or repressed depending on the person’s basic needs (food, shelter, friendship, etc.) being met.  If you deprive a person of some of their basic needs, we should expect to see more anti-social behavior, if you make sure that an individual is provided with those means, we should expect to see more pro-social behavior.

However Long seems to think that this isn’t the case, that morals and reason come first and foremost, that a starving man would not rob from his neighbor to fill his belly and would rather starve to death because stealing would be immoral and the pain of guilt would be worse than death.  That view is absurd and utterly ignorant of just about everything we know from behavioral sciences, history and our own personal life experiences. 

In battles individuals acting in their self preservation are capable of great cruelties, in situations of starvation like the siege of Leningrad people regularly stole, hoarded and even killed others to cannibalize on them.  In prisons individuals display distinctly more anti-social behavior than on the outside (and its not just because they are anti-social to begin with, even “normal” people can engage in it in such environments).  The famous Stanford prison study took student test subjects and put them in a prison environment, with some being guards and some being prisoners.  The study had to be cut short because within a few short days riots by the prisoners and abuse by the guards occurred- and keep in mind these were NORMAL people from the outside put into this experiment.

There are countless other studies which overwhelmingly indicate that human altruism and morality is profoundly influenced by the environment which we find ourselves in.  Starvation and desperation can bring out the worst in people.  Deprivation and depravation can cause people to wildly violate previously held moral beliefs.  Human morality is directly tied to our survival situation.

Now Roderick Long doesn’t look like he’s ever experienced true starvation (though he must be hungry a lot).  I doubt he’s ever experienced true desperation before.  Thankfully I, like most people in the developed world have never had to experience it either.  However unlike Roderick Long I am educated in the social sciences and am very familiar with what we know about human behavior.  And that is to say that a person’s conception of what is morally acceptable or not is directly tied to their current situation and what needs are being met and which ones aren’t.  What Roderick Long is saying however is that all people are inherently moral no matter what, and that if they do bad things they are simply bad people, but most people are good.  This is especially telling given that he advocates policies which would in all likelihood place certain individuals in desperate situations.  He seems to completely ignore the social/behavioral aspects of these things and how anti-social behavior in poor communities actually acts to increase the costs of living for those individuals.  Instead Long like many libertarians could be quick to dismiss those who are impoverished as morally defective, using higher rates of dysfunctional behavior as evidence of that.  In reality it is the other way around, by being subject to deprivation, the rates of anti-social and dysfunctional behavior rise, thereby creating a feedback loop that can be nearly impossible to escape from.  It is important that people understand the social sciences because they reveal the truths of human behavior to us.  Charlatans like Roderick Long are either completely ignorant of the social sciences or are in complete denial of them to the degree that it amounts to delusional thinking.  The scary part is that these people actually put themselves out to be legitimate academics whose policy recommendations are based on science.  Nothing could be further from the truth.

Yes Libertarians really do hate the Poor

Libertarians can get very sensitive about accusations that they don’t care about the poor and down-trodden.  Many of them go out of their way to say that even though they oppose the welfare state, they don’t think poor people should starve or be given undue hardship, and that charity and the forces of the free market will be able to make up for decrease in welfare payments.  But is that true?  Would getting rid of the welfare state and having a “free” market actually help the poor? Or will it only make things worse for them? Let’s analyze.

What does the Welfare state do?

The welfare state provides payments and benefits to qualified individuals.  Welfare states are found in countries all over the world.  The most common forms of welfare are: healthcare payments and subsidies, pensions for retirees, workers compensation, food stamps and payments for the subsistence to households of lower income.

Libertarians try to argue that these programs are not needed, and that the individuals receiving benefits could be able to obtain sustenance on their own in a free market and that in fact the welfare state makes them dependent upon the state.  But is that really true?

The average recipient of the so called “entitlements” are elderly and disabled individuals who are unable to be gainfully employed due to infirmity and old age.  Medicare and Social Security, by far the 2 largest federal benefits programs, is entirely catered to either people who are over age 65 or individuals who have met the designation of disabled.  These individuals are physically unable to work and even in a “super free” market their physical limitations would prevent them from obtaining income through employment.  The bulk of the welfare state is in fact geared towards such individuals, and the increase in welfare spending which we commonly see on charts and graphs put forth by the right wing is actually more correlated with the overall rise in median age of the western world, rather than an expansion of government into our lives.  The notion of the lazy poor “welfare queen” is largely a myth, the average recipient of public assistance is elderly or disabled.

The proportion of welfare state spending is correlated with median age.  It appears that with many people growing older, and the financial crisis wrecking pensions and 401ks, we have many elderly and disabled individuals who simply do not have the capacity to independently provide for their means.  Even with state level welfare programs, the majority of recipients remain elderly and disabled individuals who are unable to obtain employment in the private sector due to physical impossibility.

In other words, the bulk of the welfare state spending is not in fact “discretionary” gift giving done for fun, these are sunk costs reflecting conditions in the real economy.  If the welfare state vanished overnight, these individuals would still need to provide for their food, shelter and medical care.  The old adage “there’s no such thing as a free lunch” still holds true.  Saying that cutting welfare spending erases those costs is but a fiscal illusion, the real costs of having an aging society and a large number of people who cannot physically provide for themselves will still be present.  They instead will just be shifted elsewhere.

Can Charity and the Free Market really make up for it?

“Wait a second”, says the Libertarian, “even if the welfare state is mostly covering sunk costs, if those costs were shifted to the private sector it would be a good thing because charity and the free market are better equipped to provide for people.” This is the dominant rhetorical strategy that you hear about what could replace the welfare state.  They claim that the power of “voluntary” behavior, via the capitalist markets and charity would be able to come up with better, more creative and more efficient ways of dealing with these sunk costs.  This argument can be incredibly seductive to some.  But is it just a bunch of bullshit?

For the vast majority of the recipients themselves, obtaining wage labor to cover the costs of living is simply not an option because they are physically unable to engage in productive labor.  The idea of a regulation free economy being able to cure this is preposterous, their physical condition keep them from engaging in such activities.  Thus they will always be dependent on others to obtain the means of survival.

               Charity

One way that the non-working poor would be able to obtain the means of subsistence in the non-welfare state economy could be charity.  The laissez faire advocates say that charities are not only more efficient in that individual “social entrepreneurs” can better calculate and plan a competent strategy for helping the poor.  Because charities tend to be issue oriented (addressing singular problems like cancer research or running a soup kitchen) they can better target specific problems and eliminate them in a way which the top heavy government cannot.  Thus through the same “voluntary” framework of the capitalist profit sector, charity allows for more innovation and creativity in addressing these needs, according to the laissez faire advocate.  The libertarian also celebrates charity as it is “voluntary” while taxation is not, therefore the moral purpose behind it is more “legitimate” in their eyes.

This of course could not be further from the truth.  Empirical measurements of the efficiency of charities are not encouraging.  The levels of fraud and waste in charities are often higher than those seen in government finances.  While some charities are more efficient than others, the notion that they are somehow more efficient than government is a myth, many charities have a dollar inefficiency rate as high as 95%.  This is even more damning when you take into account that many charities falsify or misrepresent their data.  Unlike public expenditures, which are subject to review by the population via things like the freedom of information act, charities are privately run, and have the ability to distort all figures and hide them from objective evaluation.  But those studies which have looked at charity as a whole paint a bleak picture with rampant inefficiency, fraud and abuse.  Sending your dollars to charity is certainly no more efficient than having them work through the welfare state, and in fact the data suggests that charity is far less efficient than public welfare.

Of course this efficiency measure is only measuring a dollar effectiveness in terms of the money you give being used for the designated purpose of that charity.  And the designated purposes of many, if not most charities, have nothing to do with alleviating or targeting the sunk costs which the welfare state addresses. Many charities like the Make A Wish Foundation, are not only posting dismal efficiency numbers, but the actual purpose (giving children with cancer “one last wish”) really has nothing to do with helping the poor.  The same goes for those charities which fund cancer research or clean up the environment or help homeless pets.  Even those charities which do seem to target the poor (like soup kitchens for the homeless or vaccines for impoverished African villagers) are not addressing the whole problem, the non-working poor suffer because of a lack of consistent income, giving them soup or medical care does not help that.  Now one could try to argue that this is simply because the government is crowding out those charities which would provide income to the poor, but this too is an unqualified statement.  Before the welfare state existed there were no charities which could provide fixed payments to the poor and elderly in such a dependable way as something like social security did, and indeed if such charities had existed we would have never had a need to create a welfare state in the first place!  The focus of charities before the welfare state (and in countries which have much weaker welfare states) are no more altruistic than those in the countries which do have strong welfare states.  There is no indication that the welfare state is crowding out charitable giving, and it seems that in all likelihood the welfare state is in fact performing a task which charity is unable to perform.  Thus the welfare state is not crowding out charity, but complementing it.

Even if one were to ignore the significant statistical evidence which suggests that charity is less efficient than the welfare state, there is still great doubt that charities could replace the welfare state in the libertarian laissez faire economy due to lack of taxation subsidy.  Truth be told, most of the private “voluntary” charities are quite heavily subsidized, sometimes from direct contributions from the state, but even more so because of the favorable tax policies put in place.  Charities as non-profits, are not taxable in the United States.  This stands in contrast to for profit entities and individuals who do have to pay taxes.  In such an environment, those entities which are deemed un-taxable are in fact being subsidized by the state via the supply side.  Say we have 5 people, I could choose to give one of those people $10, and I would be in effect subsidizing them, however instead of directly giving them money, I could also take $10 from all the other 4 and not take any from the last person.  The real effects in either situation would result in my actions making that person $10 richer than he would’ve been had I not specifically targeted him for special treatment.  Tax cuts, when done in a disproportionate way
such as that, do in fact act as subsidies, whose real effects differ little from direct subsidies.  There is also the even bigger factor that taxable contributions by individuals and businesses are counted as tax deductions.  That is to say, if you give a portion of your income to a charity, you can deduct that from your overall income taxes.  This is a powerful tool that incentivizes charitable giving, and in fact many try to take advantage of this to lower their overall income, and perhaps if they’re lucky bump themselves into a more favorable tax bracket.  Thus, when charitable deductions are taken into account, the charities are even more heavily subsidized by government action than they are from being tax exempt.  Take my example of the 5 people and giving one $10, say that I make a rule which says that the other 4 people will only be taxed $5 if they give $3 to the tax exempt man, this lowers their overall tax burden and allows them to keep even more money.  Thus, not only is the tax exempt man making $10 from the taxation subsidy, but he is also making $12 from the contributions of others.  Now my rules alone have just enriched him by $22 (or perhaps $20 if one is to count $8 as the real loss rate of the others).  Charities are extraordinarily subsidized by our income tax rules.

However, the libertarians actually oppose income taxes, and most of them would like to see it disappear and replaced by sales or consumption taxes.  This would actually destroy most of the government subsidy to charity.  If sales taxes were to replace income taxes, the charities are paying them through purchasing commodities to achieve their purpose, rather than being subsidized through tax cuts they are now losing money by being at an equal level.  And furthermore, with the abolishment of income taxation, the incentive for charitable tax deduction is destroyed, thus they lose even more money.  Absent some kind of corrective system which allows government to reimburse charities for their expenses via a rebate of sorts, the charity is at a substantial disadvantage, and even if a reimbursement measure existed, the charity would still be at a substantial loss because of the charitable contributions would be lower.  Thus under the libertarian tax system, charities will have a substantial deficiency of capital inflows and in all likelihood would not be able to have the same broad applications which they can under our current tax system.  This when combined with the inefficiency, lack of targeting of the poor and fraud which naturally exists in charities makes for a substantial loss of aid to the poor.  The idea that charity could replace the welfare state or even being to approach its effectiveness in a libertarian economy is thoroughly preposterous.  However, these facts won’t stop the libertarian from arguing his next point, which is to play up the ability of the free market to help them.

               The free market

The libertarian will say next that charity would not be needed as much in the laissez faire economy because the de-regulation will increase productivity and opportunity which allow poor families to achieve even more income.  The poor disabled elderly person will be able to live off of the money which her family members gives her, and since the free market increases their job opportunities, the families of these people will be able to support them and they will be just fine. 

This argument, like the charity one, is bullshit.  First off, what if a disabled elderly person has no children?  Are they to starve and be ignored? Are they to beg assistance from stranger?  Are they to look for charity?  Well, we already know the answer to the charity question, because chances are their sources of charity are dried up due to an unfavorable tax code.   No, in all likelihood, the childless elderly would have no one to look after, and they would be forced into utter poverty and humiliation, begging for pennies on a street corner.  There is no doubt that the quality of their lives is substantially reduced in the libertarian economy.

However those who do have children are creating an even more insidious problem.  By having to support your parents, the children are forced to begin work at a young age.  The sunk costs of living (shelter, food, medical care) are not going to go away, and they require immediate attention.  This means that instead of going to school and investing in one’s self, the children of poor families must begin work at an early age, an often times this is in unskilled labor as they are the only jobs which untrained, unprofessional young people are qualified for.  This traps them in diminished opportunities, because rather than making long term investments in themselves, they are forced to cover the costs of their elderly or disabled family members.  Education requires large investments which do not yield a return until well into the future, but grandma’s medical bills can’t wait that long, they need to meet significant costs in the present.  Thus, going to college and then medical school to become a successful doctor is simply not an option for the many of these children, even if they are smart and capable of doing so, the time it takes to see a return from these self-investments is simply too great, and the immediate expenses of paying for their disabled family members takes precedence over any goals and dreams they have.  Instead of going to college they trim bushes or flip burgers to pay for the here and now costs of their disabled family members.   Furthermore, by having all of his income go to pay for the fixed costs of supporting a disabled family member, the children of poor families are prevented from making savings of their own.  Even after their disabled or elderly family members pass away, the child finds himself in the middle of life without an inadequate nest egg.  And because he has no opportunities to climb the ladder to higher income (because he never had the chance to get an education), the child is himself at risk.  Because he has saved less money, he must delay retirement to as late possible, this creates downward pressure on the job market, increasing unemployment among the youth and forcing them to bargain down their work hours, thus depressing wages and overall income to these families.  After a long hard life of working for miniscule wages, the child retires with very little savings to show for it, the lack of investment and savings means that when the child reaches old age or becomes disabled, he too must rely on the assistance of his children.  Thus a vicious cycle emerges which keeps families in poverty for generations.  The laissez faire economy creates a permanent underclass, and indeed the observations of the real world confirm that the laissez faire free market policies create this.

It is a bitter irony that vulgar libertarians like Hans Herman Hoppe claim that the poor are simply poor because they have “high time preference”, as if to infer some kind of moral defect.  Because the conditions which the poor are placed create this high time preference in the first place.  This cycle creates a Charles Dickens society, and indeed the Oliver Twist world had the economic policies which libertarians seek to enact.  However, this is also a substantial loss for all of humanity, as humans are being under-utilized. It is a profound waste of human capital, one which causes a potential Einstein or Marie Curie to waste away in a factory or fast food joint, in such a situation not only is the intelligent poor person losing out, but society is losing out as well by not having the positive influence of her human capital being used in the most efficient fashion.  Such an economic system is not only a crime against the poor, but a crime against all of humanity.

The libertarian may still try to argue that the lack of regulations give the poor more opportunity to be creative, someone like lil Wayne lifted his family from poverty by a capitalist system which allowed for free enterprise.  This argument falls woefully on its face however, the increase in opportunity by deregulation would be slim, US markets are already quite liberal, there are very few productive opportunities which would be opened up if they changed.  Furthermore, most start-ups require capital investment to get going, and capital for the poor is scarce in this environment, most of it is held by the rich and only used to invest in acitivities which enrich the financiers.  So someone like lil Wayne may be able to make money by performing some trick if it helps out a rich record owner, but the overall availability of capital to the poor is quite scarce.  And when coupled with the time preference increasing vicious cycle described earlier, there is no doubt that it actually decreases opportunities substantially for the poor.

Furthermore, the de-regulation includes curtailing of Civil Rights legislation which allows for people to work free of discrimination.  The point of things like the Civil Rights Act and Americans with Disabilities Act is to make sure that the most qualified person gets the job, thus employers cannot refuse to hire solely on the basis of things like race, age, disability.  If these laws were repealed there is no doubt that there would be an increase in these behaviors, making job opportunities even more scarce for these people.  A poor, African American family with a disabled elderly family member to support would be at an extreme disadvantage.  Thus, the idea that de-regulation and Charity can better provide than the welfare state is absurd.  There is a reason why populations all over the world have chosen to have welfare states, welfare states simply work better than the alternatives.

Conclusion

In conclusion we can see that the Welfare state is not merely payments done for fancy out of emotive and naïve concerns.  The Welfare state is mostly paying for sunk costs which would exist regardless, to say that cutting these programs saves money is but a fiscal illusion, the costs would merely be shifted onto the private sector.  And once shifted onto the private sector they disproportionately hurt the poor, disabled and minorities in a way that is thoroughly unconscionable.  There is a reason why rates of physical and mental illness are higher among the poor, and it is not because they are somehow morally defective, but because our economic system is morally defective.  Although our system could be doing even more, the existence of a welfare state has greatly mitigated these effects and improved the lives of millions of poor people, giving them both relief and the opportunity to make investments in themselves to lift themselves out of poverty.  It is the backbone which keeps the middle class alive, but unfortunately it is under attack.

There is one demographic which does share a heavier load of the burden for the welfare state, and that is the upper and upper middle class, affluent, mostly white members of society.  There is no doubt that if the laissez faire economy was put in place, these people would see more opportunity, because the potential Einsteins and Marie Curies of the lower class are wasting away their lives in menial labor to support their family members, this actually creates a surplus of opportunity for the affluent and privileged.  Simply put, because there are less poor people taking jobs in these higher paying careers which require substantial self-investment, there are more of these jobs available to the wealthy who can afford to make these investments.  Also, the lower tax burden for the affluent means they get to keep more of their money, which means they get to control more of the capital in society. As the laissez faire economy is entirely private (meaning that all capital must come from private individuals) this means that this demographic will have even more social control by controlling most of the capital and controlling all production. Thus if the poor wish to advance themselves, it can only be done through investment of capital coming from this class of wealthy white men, and as only, they are only going to make those investments which benefit them. All production is being done to enrich this class of people, everyone works for them. Not only do white affluent males gain more economic strength in this model, they also gain more social power by being the sole source of capital for all production. This becomes even more curious when you consider that the majority of the advocates of laissez faire and the intellectual thinkers behind it, are in fact affluent white males, the very demographic which would benefit the most from the system they advocate.  Perhaps they are simply well intentions but misguided thinkers, who legitimately think that their system helps the poor.  But a more likely explanation is that they simply have lop-sided priorities, they value the benefits this system gives them more than they do the burdens it saddles on the poor.  They know that there are substantial holes in their argument that laissez faire helps the poor and they simply choose to ignore them. 

Just as the advocates of slavery and segregation claimed that their system helped blacks by upholding “the natural order of things”, the advocates of laissez faire claim that their policies will help the poor by doing the same.  However, in reality, just like slavery and segregation, laissez faire is nothing more than a system which benefits affluent white males at the expense of everyone else.  These individuals seek to reverse the great progress we have made, they seek to misinform the populace and make false claims.  We must arm ourselves with the truth, for if we lose these laws and programs, it may be years before we ever get the chance to regain our progress.  America it seems, cannot afford to repeal the welfare state.