Freedomnomics: Why the Free Market Works and Other Half-Baked Theories Don't (28 page)

Government spending on education is widely viewed as an indisputably positive endeavor. Rival political candidates regularly compete by trying to top each other’s promises to spend more on schools. But our discussion raises a few doubts about this precept, as public schooling has always been aimed, at least partially, at instilling government values. Thus it should not be too surprising to learn that totalitarian states on average spend twice as much on education per student as do free countries with the same total income.

This isn’t because totalitarian countries generally care more about their children. In fact, on average, totalitarian states have spent less money on health care than freer countries have,
¹¹⁵
and they have lower immunization rates of children against tuberculosis, DPT, polio, and tetanus. Thus, when Communism collapsed in Eastern Europe and the Soviet Union, education spending fell sharply in the newly free countries while health care spending soared.
¹¹⁶

Governments have always used public education as a form of indoctrination, and the more authoritarian a regime is, the more constraints we find against private education. It’s interesting to note that countries with socialized medical care usually allow much more competition between government hospitals or doctors than they allow between schools.
¹¹⁷
If patients can pay to travel a long distance to see a certain doctor, they’re typically allowed to do so. Students, however, can’t so easily choose which public school to attend. The reason for this is clear in light of the above discussion: while competition between hospitals or doctors produces better health care, competition between government schools reduces the effectiveness of government indoctrination efforts.

Altruism is a noble quality—but in a large economy, it only goes so far. Adam Smith had it right: individuals, by pursuing their own self-interest, enrich society. Smith understood the fundamental principle of economics: when you make something more costly, people will do less of it. In other words, incentives matter. Studying the incentives that underlie our everyday decisions shows us that economic, criminal, and political policies work best when they direct individuals’ natural motivations toward a common good. These are policies that allow people the freedom to profit from their own work, that create meaningful and fair disincentives to committing crimes, and that carefully consider what factors encourage people to participate in our democracy by voting.

In a free market, those who only see the incentives of professionals and corporations to rip off their consumers are only considering one type of incentive. They miss the complex and fascinating process of how markets tend to evolve to solve cheating problems without government intervention. They fail to see not only that reputations matter,
but that there are great incentives for the continual evolution of new mechanisms to guarantee the quality of products and services. As technology improves, these mechanisms become ever more efficient and creative.

It is easy to point to some area of economic dissatisfaction, claim that the market is failing, and demand that the government step in. Whether forcing insurers to give discounts for LoJacks, lobbying for government subsidies for honey producers, or mandating professional licenses to ensure the quality of professionals, advocates of government intervention fail to understand that consumers and producers tend to find solutions themselves when their own money is at stake. Solutions to free-riding problems that seem so simple and obvious today, such as advertising on radio, almost didn’t come along in time before the government stepped in. Because a modern economy is so complex, the wise men tasked with devising regulations frequently create more problems than they solve.
¹

There will always be some duplicity in the free market. But there is also an ever-present incentive ingrained in the system for individuals and companies to behave honestly. If someone can make a buck by treating his customers better than someone else, eventually someone will try it. Political markets also have their own mechanisms to limit cheating, resulting in the election of politicians who, by and large, accurately represent their constituents.

The free market isn’t perfect, but that isn’t the right standard by which to judge it. The government is hardly perfect either.

Markets not only increase our wealth, they also increase our freedom. And so long as people have the freedom to act on their own incentives, the U.S. economy will continue to embody the best, most creative, and—I would dare say—the most honest aspects of our society.

This book has more than the usual share of people to thank because it is based on my academic research, much of which I coauthored with other scholars. The coauthors whose work is touched on here include: Bruce Bender, Stephen Bronars, Michael Davis, Andrew Dick, Gertrud Fremling, Robert Hansen, Kevin Hassett, Gi-Ryong Jung, Jonathan Karpoff, Larry Kenny, William Landes, Richard Manning, Tim Opler, Robert Reed, Russell Roberts, Eric Wehrly, and John Whitley. Bronars, Hansen, Karpoff, Kenny, and Roberts have worked with me on up to five papers each, and I am especially indebted to them. I also must express my gratitude for the useful comments I received from numerous faculty members at hundreds of academic seminars, presentations, and conferences held around the world.

Jack Langer, my editor at Regnery, has been extremely helpful, dedicating a large amount of time to this project and offering consistently excellent advice. I would also like to thank Bob Hansen, Peter Hartley,
and Jon Karpoff for allowing me to bounce ideas off them, and Gertrud Fremling, Craig Newmark, and Maxim Lott for reading and commenting on the manuscript.

The list of hardworking research assistants who helped in the production of all my academic papers is too long to fully elaborate here, but from the last five years, I’d like to thank Brian Blasé, James Knowles, Maarten Burggraaf, Ilyse Fishman, Michael Roth, Jack Soltysik, Drew Johnson, Jill Yablonski, Jill Farias (formerly Jill Mitchell), Soojin Kim, Refael Lav, Benjamin Berthomieu, Gregory D’Angelo, Alykhan Velshi, and Lydia Regopoulos. My three oldest sons, Maxim, Ryan, and Roger, also provided me with many hours of valuable research assistance.

This book is largely a statement of my personal views on economics, but I could not have written it without the influence of others. The thinking and writing of my teachers have had a major impact on me, and I’d like to acknowledge in particular Armen Alchian, Gary Becker, Harold Demsetz, David Friedman, Ben Klein, Ed Leamer, Earl Thompson, Thomas Sowell, and Finis Welch. Among the many others who influenced my work are Bill Landes, Sam Peltzman, Richard Posner, George Stigler, and James Q. Wilson. Finally, I would like to thank the late M. Bruce Johnson. I became an economist only through a series of unlikely events that all began with my conversations with Bruce after he moved next door to me in Florida when I was sixteen years old.

1
Adam Smith,
The Wealth of Nations
, edited by Edwin Cannan, (Chicago: University of Chicago Press, 1976), 18.

2
From the official
Freakonomics
website:
http://www.freakonomics.com/the-book.php
.

3
Steven Levitt and Stephen Dubner,
Freakonomics
(New York: William Morrow, 2006), 63.

4
Regarding corporate crime in the early 2000s, Levitt and Dubner argue that the feeble justification given by corporate criminals that “everybody else was doing it,” in fact, “may be largely true.” See
Freakonomics
, 69. In addition to attacking corporate America in books like
Downsize This!
, Michael Moore introduced viewers to the character “Crackers,” a corporate crime-fighting chicken, in his series
TV Nation
.

5
Paul Resnick, Richard Zeckhauser, John Swanson, and Kate Lockwood, “The Value of Reputation on eBay: A Controlled Experiment,”
Experimental Economics,
June 2006, 79-101.

6
In a Gallup Poll, only 14 percent of respondents rated the honesty and ethical standards of congressmen as “high” or “very high.” Senators received
a 15 percent rating, while business executives registered at 18 percent. The Gallup Poll, “Honesty/Ethics in Professions,” December 8 to 11, 2006.
Http://www.galluppoll.com/content/?ci=1654&pg=1
.

7
One example involved a famous paper by Orley Ashenfelter and Robert Smith that was published in the
Journal of Political Economy
. The study drew attention to a puzzle: that minimum wage laws only punished violators for a fraction of the underpayment to the workers, but at the same time few people seemed to violate the law. Their paper generated many attempts by economists to explain this conundrum. It was only in talking to some people involved in enforcing minimum wage laws while I was at the Sentencing Commission that I learned the authors’ claim that the penalties were small, in fact, wasn’t true. Ashenfelter and Smith had simply misread the law, which provided for much bigger penalties than they assumed. All the succeeding economists who addressed the issue took it for granted that Ashenfelter and Smith’s figures were correct. See Orley Ashenfelter and Robert Smith, “Compliance with the Minimum Wage Law,”
Journal of Political Economy
, April 1979, 333-350. Among the many papers that attempted to explain this puzzle were Gilles Grenier, “on Compliance with the Minimum Wage Law,”
Journal of Political Economy
, February 1982, 184-187. See also John R. Lott, Jr. and Russell D. Roberts, “The Expected Penalty for Committing Crime: An Analysis of Minimum Wage Violation,”
Journal of Human Resources
, Spring 1995, 397-408 and John R. Lott, Jr. and Russell D. Roberts, “Why Comply: One-sided enforcement of Price Controls and Victimless Crime Laws,”
Journal of Legal Studies
, June 1989, 403-414.

8
Milton and Rose Friedman,
Free to Choose
, (New York: Harcourt Brace Jovanovich, 1979) 214.

9
Jac C. Heckelman, “Economic Freedom and Economic Growth: A Short-run Causal Investigation,”
Journal of Applied Economics
, May 2000, 71-91.

1
Jad Mouawad, “2 Senate Committees Interrogate Wary Oil Company Executives,”
New York Times
, November 10, 2005.

2
The concern among politicians is bipartisan. For example, after Katrina in August 2005, Republican governors such as Missouri’s Matt Blunt, Georgia’s Sonny Perdue, and Kentucky’s Ernie Fletcher, as well as Democratic governors like Illinois’ Rod Blagojevich, Pennsylvania’s Ed Rendell, and
Michigan’s Jennifer Granholm all advocated prosecuting gas companies who profited from the price increases. The Bush administration got into the act by ordering the Justice Department and the Federal Trade Commission to investigate allegations of price-gouging and expressing concern that retail and wholesale gasoline prices were “too high.” See “In Praise of ‘Gouging, ’ ” editorial,
Wall Street Journal
, September 7, 2005, and John R. Lott, Jr. and Sonya D. Jones, “A Look at the Positive Side of Price-Gouging and Greed,”
Houston Chronicle
, August 31, 2005.

3
Armen A. Alchian and William R. Allen,
Exchange and Production: Competition, Coordination, and Control
, Belmont: Wadsworth Publishing Co. (3rd edition), 1983. See also John R. Lott, Jr. and Gertrud Fremling, “Time Dependent Information Costs, Price Controls, and Successive Government Intervention,”
Journal of Law, Economics, and Organization
, vol. 5, no. 2, Fall 1989: 293-306, and John R. Lott, Jr. and Russell D. Roberts, “A Guide to the Pitfalls of Identifying Price Discrimination,”
Economic Inquiry
, vol. 29, no. 1, January 1991: 21.

4
The prices may not be exactly equal due to storage and interest costs, but the current price plus storage and interest rate costs should equal what the price is expected to go up to.

5
“As Prices Rise, Car-Pooling Begins to Win Out Over Privacy,”
New York Times
, September 8, 2005.

6
Jad Mouawad, “2 Senate Committees Interrogate Wary Oil Company Executives,”
New York Times
, November 10, 2005.

7
Alchian Allen,
Exchange and Production
. See also John R. Lott, Jr. and Gertrud Fremling, “Time Dependent Information Costs, Price Controls, and Successive Government Intervention,”
Journal of Law, Economics, and Organization
, vol. 5, no. 2, Fall 1989: 293-306.

8
Leonard Theberge, “Coverage of the Oil Crisis: How Well was the Public Served?,” vol. 1, Washington, D.C.: Media Institute, 1982, 24.

9
U.S. drug companies just can’t say that they won’t sell drugs to these companies. If they don’t, they risk losing their drug patent and foreign companies in those countries will be able to sell generic versions of the drugs. The American companies will not receive any compensation for this loss. In their view a small profit is better than no profit. James Glassman and John R. Lott, Jr., “Cheaper Drugs Are No Cure-All,”
The Globe and Mail
(Canada), Monday, November 17, 2003. See also John R. Lott, Jr. and James Glassman, “The Drug World’s Easy Riders,”
Wall Street Journal Europe
, Wednesday, July 23, 2003.

10
Ibid.

11
Price controls, even when intended as a short-term remedy, often prove difficult to abolish for political reasons. For example, the gasoline and oil price controls discussed here, first imposed on August 15, 1971, were not removed until almost ten years later, on January 28, 1981 See National Public Radio, “Fuel Prices Chronology,” NPR Online (
http://www.npr.org/news/specials/oil/gasprices.chronology.html
). An even longer example is found in New York City, where older apartments are still subject to price controls dating back to World War II. See Robert Bartley, “New York’s Self-Destruction,”
Wall Street Journal
, May 19, 2003.