It has long been assumed, in most economic theories and civics textbooks, that public employees (public “servants”) act in the public interest rather than in their own personal interest. This is beginning to change. Public choice economics is beginning to persuade the economics profession that people who work in the public sector are as self-interested as people in the private sector. This assumption helps explains much of what goes on in government. By contrast, assuming that public servants aim to serve the public interest helps explains very little of their behavior. In order to understand people’s choices, in both public and private life, we should assume that all people are self-interested, that they are trying to achieve their own personal goals at the lowest possible cost to themselves.
Note how this view differs from that of many people who support large, controlling government. People who believe “the government” should provide this service, regulate that activity, and subsidize the other industry implicitly believe that “the government” will do all this in the public interest, not their own personal interest. Or at least, such public-minded service is believed to be possible, if only the right people or the right party get control of government and put “good people” in charge of government agencies and policy-making.
Long experience with governments around the world shows that people in government are as self-interested as people anywhere else. All people behave according to their personal self-interest as they see it, whether they are entrepreneurs or public servants. Of course there will always be people of great integrity in both private and public life who do their duty to others even to their own detriment. There are too few such people, however, to staff a large government, and no reliable way of identifying or electing them in the first place, or persuading them to serve if they could be identified. Of necessity, then, governments will be staffed by people like the majority of those we know, who put their personal self-interest first and the public interest second.
Of course pursuit of self-interest means more than a sterile pursuit of more money, regardless of what some economics textbooks imply. People earn money to accomplish various purposes. They want to feed their families, provide music lessons for their children, strengthen their places of worship, support the United Way, help cure heart disease, and so on. And wise people understand that they promote their own self-interest when they thoughtfully consider the well-being of others. Decent people seek to live honestly and generously as well as prosperously. We know that our true, enlightened self-interest is harmed when we seek material benefit at the expense of a customer, employer, employee, co-worker, supplier, or investor. Honorable people—most, I hope—interact with others only in ways that benefit both themselves and others. As Mises wrote, “If honour cannot be eaten, eating can at least be foregone for honour.”
In both private and public life, people’s aims may be lofty or low, admirable or ugly, considerate of others or contemptibly selfish. Most people probably have a combination of aims across some range of that spectrum, as most of us are a combination of good and bad. In our actions in pursuit of those goals, we can be kind or mean, magnanimous or petty, diligent or lazy. A lot depends on our upbringing, but surely much of our actual behavior depends on the incentives we face.
Incentives are crucial.
Given the inescapable self-interestedness of human beings, the key to a productive and cooperative social order is incentives that channel human beings’ pursuit of their own self-interest into actions that benefit others at the same time. To this end we need underlying institutions—basic rules of the game—that give everyone the incentive to cooperate with others and contribute to others’ well-being as a way to accomplish their own interests. Private property and freedom of exchange are the core institutions that provide this incentive.
When society adheres closely to the underlying institutions of private ownership and freedom of exchange, people tend to establish particular-purpose institutions—organizations, religions, enterprises, associations, clubs—that give people strong incentives to serve others, because in that free setting, people must serve others in order to achieve their own ends. By contrast, on the underlying institutions of government ownership and restriction of exchange are built particular-purpose institutions—government agencies, regulations and private-sector enterprises adapted to that governmental control—that give people weaker incentives to serve others. These institutions often give people perverse incentives to use governmental power for their own benefit, at others’ expense.
The General Superiority of Free-Market Incentives
The incentives we face depend on the institutions we live and work within, because the institutions shape the way we pursue our self-interest.
Ubiquitous self-interest has profound implications for the desirability of government intervention in general, because intervention establishes legal power to infringe on property rights and restrict freedom. That power is dangerous. It is dangerous because people are self-interested. Self-interested people in both the private and public sectors will be attracted to this governmental power and use it to their personal advantage, even at others’ expense. In words attributed to George Washington, “Government is not reason, it is not eloquence; it is force. Like fire, it is a dangerous servant, and a fearful master.”
People interacting by governmental authority thus face incentives very different from those interacting in voluntary association. Where property must be respected and people are free to exchange with one another or not as they wish, the incentive to serve one’s fellow man is much stronger than where government compulsion is in play. Accordingly, voluntary associations generally perform better in achieving human well-being. Though the same sorts of people work in both, particular-purpose institutions based on property rights and consent generally contribute far more to human well-being than those based on governmental power. Indeed, the latter often reduce human well-being.
At the core of the difference is that in the private sector—in both for-profit and non-profit voluntary associations—if you want something from someone else, you must persuade her to give it to you. Somehow you must offer her something she values more in return. (In this I exclude, of course, the closest human relationships of family and intimate friendships, which are too strong to be called just “associations.” We do things for our loved ones out of love alone.) General Electric and the local supermarket, your church and the United Way all want your money, and they do not know or care about you personally (well, we hope your church does). But to get your money, they must offer you something you want—light bulbs, vegetables, an uplifting religious experience or the satisfaction of helping troubled people—at a price you are willing to pay. They must persuade you to give them your money, and they don’t get a nickel without your consent. The interaction must offer mutual exchange to mutual advantage, or it does not happen. Hence in the private sector, based on underlying rules of private property and freedom of exchange, all of us have strong, systematic incentives to serve our fellows. Serving them is the only reliable way we have to induce them to give us what we want.
The consequence of these incentives is generally cooperative, productive outcomes. The underlying institutions of private ownership and freedom of exchange require people to cooperate if they are to interact at all—we are not permitted to force our wills on those who do not wish to cooperate. And because we may not take from others by force, we must produce goods and services they want, to exchange for those we want.
In the government sector, by contrast, people may interact by legal force. Where governments intervene in society, when you want something from somebody else, you can use that intervention to force him, legally, to give it to you. The government threatens him with punishment if he does not. Loggers in the Tongass, employees in government schools and in the US Postal Service, and bondholders of failing financial institutions all want your money also, and they don’t know or care about you personally either. To get your money, however, they don’t have to
offer you something you want at a price you are willing to pay. The logging companies, the government schools, and the failing financial institutions get your money indirectly but legally, through the taxes that pay for the logging roads in the Tongass, the salaries in government schools, and the bailouts of the financial institutions. You must surrender those taxes or go to jail. The law forces you to use the Post Office for first-class mail service because the private alternatives you would use if allowed to are forbidden. (For more on this intervention see the notes to Chapter 4.) Government-supported enterprises and agencies need not gain your consent to interact with you; therefore they may gain at your expense, against your will. Where governments intervene in society, where private property may be legally invaded and exchange may be forbidden or compelled, all of those in positions to gain from the intervention have strong, systematic, corrupting incentives to get what they want the easy way, regardless of the desires of their fellows.
The consequence of these incentives is generally contentious, less productive or unproductive outcomes. When property and contract may be legally infringed, where people may force their wills on unwilling others, (many) human beings succumb to temptation. Rather than produce and exchange, they take. Hence, the lobbying; the manipulation of regulation; the grasping for subsidies, corporate welfare, licensing, tariffs, and industry bailouts; and the growth of bureaucracy, taxation, and government spending.
Self-interested people, both inside and outside government, will be tempted to use government power to achieve their goals if government power is available to them. Government intervention in the economy, even when ostensibly or initially intended for good purposes, often gets used by people for their own, selfish purposes at the expense of everybody else. Both private interests and government employees, often acting in concert in crony capitalism, will be tempted.
The consequence of this insight for public policy is straightforward: No matter how good the intentions nor how important the goals of interference with private property or freedom of exchange, that interference is dangerous to the public well-being. It carries with it incentives for some people, usually in special interest groups, to use the intervention for their own selfish purposes at the expense of the general public. It is preferable—safer for society—to avoid such interventions altogether. Any net good some particular intervention might do on occasion is more than offset by the net harm most interventions do most of the time. The safest course is to free our markets, completely.
Does this mean markets should be totally unregulated? Not at all. Freedom of exchange, and the corresponding freedom to decline exchange, engenders very strong and effective regulation, as we shall see in Part II.
Part I
Conclusion
The three principles we have discussed in Part I help us understand spontaneous economic order. Let’s review them and give each a name for ease of reference.
We’ll call the principle from Chapter 1 the Price Coordination Principle:
Market prices coordinate the actions of billions of people pursuing their myriad goals, by communicating the changing, particular knowledge of everyone about the availability and potential uses of everything.
We’ll call the principle from Chapter 2 the Profit-and-Loss Guidance Principle:
In free markets, profit and loss guide entrepreneurs to discover the most value-creating uses of scarce resources by providing those entrepreneurs feedback about how well they are serving others: profit rewards value creation; loss punishes value destruction.
We’ll call the principle from Chapter 3 the Incentive Principle:
Private ownership and freedom of exchange, the foundational institutions of a free market, lead people to serve others in order to benefit themselves, whereas government interventions tempt people to benefit themselves at others’ expense.
The more free an economy, the better these principles will work to make it coordinated, innovative, and responsive to people’s desires. On the other hand, the more governments interfere with private ownership and with peaceful, voluntary exchange, the more the operation of these principles is inhibited and economic well-being is undermined.
This is not to say that free markets work perfectly! On the contrary, for reasons of inescapable human ignorance we have discussed, in free markets we all make lots of mistakes, some of them desperately costly (remember Iridium). But we don’t all make mistakes all the time. With prices to tell us what others know (or think they know), with profit and loss to guide us, and with market incentives to keep us focused on the good of others, we do pretty well for one another when we are free to interact, or not to interact, as each of us sees fit.
One implication of these principles is that free market forces can and do regulate the actions of market participants (not perfectly but) better than government regulators can. That is a hard idea for many people to accept, so we devote Part II to considering it.
Part II
Regulation by Market Forces Outperforms Government Regulation
Readers of Part I may be ready to agree that market prices, profit-and-loss feedback, and the private ownership and freedom of exchange on which they depend are important to human well-being—even very important.
Many of those readers may nevertheless hesitate to endorse fully free markets. Largely free markets make sense, they may think, but don’t we need government intervention here and there to make sure the free market works properly? People should have private ownership rights and freedom of exchange mostly, but suppose people misuse their property or try to take advantage of others? Don’t we need some government regulation—restriction of property use and limits on free exchange—to make sure that markets work well?
I used to have the same misgivings. I still have a few, but they have weakened over time, almost to the vanishing point. I’ve come to appreciate the power of property rights and freedom of exchange to discipline human action, and I’ve grown increasingly uneasy about government action as I have watched it turned to private advantage.
Even though free markets don’t work perfectly—nothing human is perfect—they work better than government. The basic institutions of free markets—private ownership and freedom of exchange—set in motion a dynamic regulation by market forces that benefits society better than government intervention can. Even when intended to further the public interest, interventions backfire. They distort prices, distort or block profit-and-loss feedback, and tempt special interest groups to use the intervention for their own sakes. In these ways government interventions damage the spontaneous economic order on which rising standards of living depend.
Part II will emphasize that government interventions tempt people to benefit themselves at others’ expense, the second part of the Incentive Principle discussed in the previous chapter. Good people who support governmental intervention in the economy want “the people” to discipline “business.” They want “business” controlled—lest business put its own interests ahead of the people’s. So far as it goes, this concern is wise. But based on this concern they support government control of the economy; and this step is deeply ironic and mistaken.
The irony is that governmental power intended to restrain business is power that gets used by business to restrain competition and secure bailouts and subsidies. The power, once created, gets out of control. Regulated capitalism becomes crony capitalism. It doesn’t work. We need free market capitalism.
The only way to make sure “the people” discipline business is to ban the use of force in the economy—to free our markets completely. Then, if “business” wants to further its own interest, it must offer “the people” what the people see as a beneficial exchange. “The people” do control “business” in a free economy.
I suggest that the reader put aside now forever the idea of “unregulated free markets.” The conception is fundamentally misleading. In free markets each participant’s actions are tightly regulated by the property rights of others and the freedom the parties have not to d
eal with each other.
Our choice is not between government regulation and no regulation; our choice is between regulation by centrally planned, static dictates of government and regulation by decentralized, dynamic market forces. It is between regulation handed down by a few authorities with power to coerce and regulation emerging bottom-up from the choices of market participants, none of whom may impose his will on others. It is between regulation by the edicts of monopoly agencies immune from profit and loss and regulation by the choices of consumers and businesspeople, all of whom are subject to profit and loss, as are the standards of behavior they follow.
The fundamental but limited role of government remains: there must be some organized force in society that protects property rights and enforces contracts. But doing that “is the sum of good government,” in Jefferson’s words. Nothing more is needed from organized force. All the other regulatory functions—assuring quality and safety, establishing industry standards and the like—are or would be handled better by market forces.
Let us see how.
Chapter Four
Ownership Matters
The incentives and rights of private ownership are potent regulators. Keeping in private hands the rights to use natural resources and to run enterprises of all sorts promotes good stewardship of resources and good organizational performance. Private owners have strong incentives to look after their property so that it can be a source of profits and other benefits to them year after year. Private owners also have strong incentives to perform well in their interactions with others because their income depends on the quality of that performance.
Under government ownership, things are different. Public administrators of government-owned property may care for or neglect the resources under their charge; but either way, they face no consequences of personal profit or loss from that care or neglect. Hence, their economic incentives to be good stewards of valuable resources are weaker than those of property owners. And, because government-owned enterprises are generally tax-funded, the income they receive does not depend on the quality of their performance; so their incentive for good performance is weaker than it would be if their income depended directly on satisfying customers.
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