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.
Acknowledgments
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.
Notes
Introduction
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.
Chapter One: Are You Getting Ripped Off?
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.
12 Ben Stein, “Don’t Beat Up Big Oil. It’s Just Doing Its Job,” New York Times, November 20, 2005.
13 The actual statement by Menken was “There is always an easy solution to every human problem—neat, plausible, and wrong.” H. L. Menken, “The Divine Afflatus,” New York Evening Mail, November 15, 1917
14 Some of the discussion in this section is based upon 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: 14-23
15 David Asman, “Why We See Less and Less Life-Saving Breakthrough Drugs,” Foxnews.com, January 5, 2007 (http://www.foxnews.com/story/0,2933, 242098,00.html), and John R. Lott, Jr. and James Glassman, “The Drug World’s Easy Riders,” Wall Street Journal Europe, Wednesday, July 23, 2003.
16 Meghan Daum, “$4k Cat Is Nothing to Sneeze At,” Los Angeles Times, October 7, 2006, and “Hypoallergenic Cats for Sale,” ABC News, October 6, 2006 (http://abcnews.go.com/Nightline/story?id=2537618).
17 Http://www.amazon.com/Seagrams-Seltzer-Pack-oz-Cans/dp/B0005YW4HS/sr=85/qid=1162946960/ref=sr_1_5/102-2738756-5711361?ie=UTF8&s=gourmet-food and http://www.amazon.com/Canada-Dry-Seltzer-Water-Cans/dp/B00061EXQK/sr=81/qid=1162946860/ref=pd_bbs_sr_1/102-2738756-5711361?ie=UTF8&s=gourmet-food.
18 Http://www.amazon.com/Coca-Cola-Diet-Coke-Pack-Cans/ d p/B0005ZXEB2/sr=8-4/qid=1162946960/ref=sr_1_4/102-2738756-5711361?ie=UTF8&s= gourmet-food. These purchases were made on November 7, 2006 in Springfield, Pennsylvania.
19 I checked the prices at the supermarket near my home, Genuardi’s, which is owned by Safeway. The situation there was similar: cola costs less than carbonated water across the board. For two-liter bottles, the cheapest seltzer was a Safeway brand costing $1.49, while Coca-Cola Classic sold for ten cents less. Safeway’s own cola brand, Go2 Cola, normally sold for $1.49—the same price as their Seltzer—but was temporarily discounted for Genuardi’s members to just eighty-eight cents. Another brand of seltzer, Vintage, also normally went for $1.49, but was on sale for $1.09.
20 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, 14.
21 After all, New York City had 24,600 restaurants as of September 2006. (David B. Caruso, “NYC weighs ban on artificial trans fats,” Chicago Tribune , September 27, 2006).
22 John R. Lott, Jr. and Russell D. Roberts, “A Guide to the Pitfalls of Identifying Price Discrimination,” Economic Inquiry, vol. 29, no. 1, January 1991,18-19. I would also like to thank my cousin Jim Lyden, who has managed two different Outback Steakhouses, for helpful discussions on these topics.
23 Ibid.
24 Http://www.southwest.com.
25 Another puzzle is the requirement that consumers have to spend a Saturday night at their destination in order to receive the discount. This is typically explained as an example of price discrimination against business travelers, but it may only be a form of peak load pricing if those who stay over Saturday night travel on Sunday, the quietest day of the week. The puzzle remains as to why there is not an explicit discount for returning on Sunday, but this is also a problem for the price discrimination explanation.
26 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.
27 Rhode Island Gas Prices (http://riroads.com/everyday/gas.htm).
28 National Petroleum News Factbook, Des Plaines, Illinois: Hunter Publishing Co., (1987). An Associated Press story in July 1986 showed a similar pattern: “Regular unleaded gasoline at self-service stations costs about 80.13 cents a gallon, compared with 1.0994 at full-service stations, and premium unleaded costs about 95.01 cents a gallon, compared with $1.1965 at full-service stations.” Associated Press, “Gasoline Prices at 7-Year Low,” New York Times, July 28, 1986.
29 People would undoubtedly claim monopoly power if the price spread between full-and self-serve regular and premium unleaded were reversed. The explanation provided here would ask one to look at the number of gallons sold on average per customer.
30 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: 14-23.
31 This section is based upon Robert G. Hansen and John R. Lott, Jr., “Profiting from Induced Changes in Competitors’ Market Values: The Case of Entry and Entry Deterrence,” Journal of Industrial Economics, vol. 43, no. 3, September 1995, 261-276.
32 Brooke Group Ltd. v. Brown & Williamson Tobacco Corp., 113 S. Ct. 2578 (1993).For a discussion of the American Airlines case and the Federal jury’s decision to acquit, see Neuborne, Ellen, “Lawsuit could curb price wars,” USA Today, August 25, 1993. Continental and Northwest Airlines sought more than $3 billion in damages from American Airlines. They alleged that a price war that American instigated in 1992, where they reduced coach fares by an average of 38 percent and eliminated most discounts, was an attempt to drive them out of business.
Not everyone was satisfied with this decision. Alfred Kahn has argued that “The way big airlines respond to competition from start-ups could objectively be described as predation.” Richard Tomkins, “When Fares Aren’t Fair,” Financial Times (London), February 10, 1998.
Two papers that provide empirical evidence of predation are Malcolm R. Burns’s paper about American Tobacco (“Predatory Pricing and the Acquisition Cost of Competitors,” Journal of Political Economy, 1986) and Granitz and Klein on Standard Oil (“Monopolization by ‘Raising Rivals’ cost’: the Standard Oil Case,” Journal of Law and Economics, 1996. 1-47). See also my book, Are Predatory Commitments Credible, (Chicago: University of Chicago Press, 1999).
33 It should be noted that predation is not a factor i
n the phenomenon of large chains like Wal-Mart, Target, or Home Depot driving small mom-and-pop stores out of business. The success of these companies in eliminating smaller competitors stems from their huge selection and especially their low costs, which enable them to charge lower prices than small, independent stores. These low prices are permanent; the chains do not lower prices to drive out competitors, and then subsequently raise them once they no longer face competition. Therefore, these are not examples of predation.
34 Ibid., Chapter 1. See also Robert H. Bork, The Anti-trust Paradox: A Policy at War with Itself, (New York: The Free Press, 1978) 39-40.
35 Matthew Josephson, The Robber Barons (New York: Harcourt, Brace, 1934), 205. For a longer discussion of this and other examples, see my book, Are Predatory Commitments Credible?: Who Should the Courts Believe?, (Chicago: University of Chicago Press) 1999.
36 The predator must be a publicly trade firm for this tactic to be successful. Additionally, the maneuver is most successful when the predator is a non-diversified company.
37 Levitt and Dubner, Freakonomics (2005 ed.), 67.
38 The Lemons argument has actually been around for decades, though the person who first brought up the concern realized that there could be strong forces to solve the problem. See George Ackerlof, “The Market of Lemons,” Quarterly Journal of Economics, August, 1970, 488-500. There are other papers that have found evidence that the market solves this lemons problem (Eric W. Bond, “A Direct Test of the ‘Lemons’ Model: The Market for Used Pickup Trucks,” AER, 72(4), September 1982, 836-840, and Wimmer and Chezum, “An Empirical Examination of Quality Certification in a ‘Lemons Market,’” Economic Inquiry, 41(2), April 2003, 279-91).
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