Your browser has JavaScript turned off.
You will only be able to make use of major viewing features of this page of The Self-Sovereign Individual Project website if you turn JavaScript on.

Discourses on Social Order

Critique of The Machinery of Freedom,
Chapter 43: Answers: The Economic Analysis of Law

This is the third of three essays of comment on the chapters of The Machinery of Freedom: Guide to a Radical Capitalism, by David Friedman, (MoF) which I (Paul Antonik Wakfer) consider to be the most important for libertarian theory among those chapters of MoF which are online. Note that I have only commented on the first half of chapter 43 because the last half is based on principles which I have already shown are faulty in my critique to that point. By carrying on my critique, little more would be gained than a constant repetition of the same points of disagreement.

Chapter 43: Answers: The Economic Analysis of Law1

We wish to know what the laws of a society--statist or anarchist--ought to be. The obvious way to find out is to start with general principles of justice and see what laws are necessary to implement them. In an earlier chapter, I argued that that cannot be done; libertarian principles of justice cannot, at least as they now exist, answer the relevant questions. They provide no way of deciding what ought to be included in property rights, how they may legitimately be defended, or how violations ought to be punished.

1) Friedman begins right off with an implicit assumption - that any stable ordered society must have some rules of order which have the attributes of "laws". However, the essential character of "laws" are that they are imposed on every member of the society to which they apply whether voluntarily agreed to or not, whereas, if a certain rule of operation or behavior has been agreed to by everyone in a society it is not reasonable to call it a "law" at all. This can even be done without specifying some of the details of such rules of behavior which details are left up to the choice of the persons to whom they will apply at the time of application. Such a system is derived from Social Meta-Needs theory2 (SMN) and its rules are implemented in the Natural Social Contract3 (NSC). It is my contention that this system provides a complete and consistent basis for libertarian principles of justice which provides full and acceptable answers to all of Friedman's "relevant questions".

2) However, Friedman makes another major error in his assumption here and throughout Chapter 43 - that "violations ought to be punished" as opposed to restitution of harm being achieved. This is a kind of collectivist assumption since it ignores the justice requirements of the victim in favor of the apparent benefit of society which such punishment will promote. However, Friedman never justifies his assumption that punishment will benefit society more than full restitution of the victim.

When I say that libertarian principles cannot answer the questions, I do not merely mean that answering them is hard. That would be true wherever we started; these are hard questions. I mean that I cannot see how to even start answering these questions--what facts I need, what calculations I should do. It is as if I were faced with an engineering problem and had no way of finding out how to start setting up the relevant equations.

3) His science background makes it clear to Friedman that the current so called "libertarian principles" are not any kind of theory of reality for answering such practical questions. It is as if a savage were trying to build a dam without knowing any of the relevant properties of matter and physics involved. However, it is also unfortunate that this same science background (which I consider my own strength) did not allow Friedman to imagine that since humans exist in reality as natural objects their nature and actions also should be able to be studied and described by scientific theory. He even had the example of a science describing a portion of such human nature and actions in praxeology - the basis of free market economics. Perhaps it is because Friedman's science background extended no further than physics and not into biology or psychology that he was unable to make this connection.

Perhaps someone else does know how to do it--but someone else is not writing this book. My solution is to find a different starting point from which to solve the problem. That starting point is utilitarianism. As a moral philosopher I am a libertarian, insofar as I am anything. As an economist I am a utilitarian.

4) The reason why economics can be utilitarian is precisely because "money" provides the means of comparing and calculating individual and total utility. To the extent to which money is not a good measure of individual utility, even free market (Austrian school) economics will give wrong answers.

One could describe most of this book as a utilitarian approach to libertarianism, but only by using "utilitarian" in a very general sense. I have tried to show that libertarian institutions produce attractive results, but I have not defined "attractive" as anything so specific as "tending to maximize the sum total of human happiness." In this chapter, however, I am trying to answer much more specific questions--not merely "should we have property rights?" but "exactly what sort of property rights should we have?" To do so I require a more specific definition of the objective I am trying to achieve. When I am finished your conclusion, if you agree with everything I say, should not be "we should have property rights X, Y, and Z" but rather "If we wanted to maximize total utility we would want property rights X, Y, and Z."

5) However, any such reasoning must depend totally on the exact definition of "total utility", which brings one right back to the requirement of an ethical basis for any conclusions about what is "best". It is noteworthy that Friedman puts his proposition not in the form of a categorical imperative (moral precept) but as a hypothetical imperative with the premise "want to maximize total utility". (But he again errs by construing this desire to be that of a non-existent collective "we"4). This is close but fundamentally distinct from my own hypothetical imperative derived in SMN2 - If one wants to maximize one's lifetime happiness, one will want [certain social rules] to prevail. The rationally accomplished desire of each individual to maximize his lifetime happiness requires that the lifetime happiness of others be maximized at the same time. Thus, each individual working for his rational long term widest viewed interest will automatically maximize the total "utility". In SMN, I also argue that the premise "one wants to maximize one's lifetime happiness" is an axiom of the nature of humans in reality, which I call the Maximum Lifetime Happiness (MLH) purpose.

Even if I can demonstrate that, why should I bother? By adopting a philosophical position that I believe is false, merely because it makes it easier to answer a particular set of questions, am I not making the same error as the drunk who, having lost his wallet in the middle of the block, looked for it under the streetlamp at the corner because the light was better there?

I think not. Even if utilitarianism is not true it may still be useful. There seems to be a close correlation between rules that make people free and rules that make them happy; that is why it is the East Germans and not the West Germans who erect barbed wire fences and guard towers on their common border. Perhaps that correlation comes from some deep connection between freedom and happiness; perhaps it is merely an accident. In any case, it is there. I conclude that, by figuring out what legal rules would best make people happy, I may learn something about what legal rules are suitable for a free society.

6) Logically a statement which is false implies any statement at all. Therefore, it cannot be true that something which is not true "may still be useful". If utilitarianism is useful (and I agree that it is), there must be some interpretation of it under which it is valid. The reason that there is "a close correlation between rules that make people free and rules that make them happy" is, of course, because only by having all possible choices actually available for undistorted consideration and action is one able to maximize one's lifetime happiness (which is, to use Friedman's words: a "deep connection between freedom and happiness"). In the last sentence here, Friedman appears to be reversing cause and effect. A free society is only useful in order to maximize individual lifetime happiness. It has no other purpose. Thus, figuring out what legal rules make people happy would be entirely sufficient on its own. Any production of a free society which they make would merely be a byproduct. However, precisely because of the "deep connection between freedom and happiness" it is a necessary one. Rules which permit the achievement of individual maximum lifetime happiness will always produce a society of maximum freedom and vice versa.

A second reason utilitarian arguments may be useful is that even if they cannot tell us what the legal rules should be they may, under some circumstances, tell us what they will be. In Chapter 31 I tried to show that the institutions of anarcho-capitalism tend to produce economically efficient law. By figuring out what legal rules would be economically efficient we can learn something about what rules would be generated by such a society. Richard Posner, one of the leading writers on the economic analysis of law, has made the same claim for the existing body of common law. If he is right, then economic efficiency is useful for understanding what the law is as well as what it ought to be. Economic efficiency and total happiness are, as you will shortly see, closely related; the former is best understood as an approximate measure of the latter.

7) Here Friedman attempts to substitute an "is" for an "ought". What he apparently fails to understand, however, is that when the "is" ("what they will be") is a fundamental defining attribute of human nature, the "is" will necessarily become the "ought" of human behavior as I have shown in SMN2. Once again Friedman speaks of a term, "economic efficiency", without having clearly defined what is the basis for and the measure of that term; but he implies that he will soon do so and will contrast it with a closely related term: "total happiness".

A third reason was suggested at the end of the previous chapter. Most people, myself included, are at least partly utilitarians. While a demonstration that a particular legal rule tends to increase the total of human happiness does not prove that the rule is a good one, it is a strong argument for it. Since I have no very good way to settle disagreements about values, it makes sense to base my argument on values that most people share.

8) Friedman does not appear to have sufficiently examined the fundamental nature of his own thoughts. Every person is necessarily a utilitarian with respect to the utility of the promotion of his own life and happiness. The problem with utilitarian calculations about society, as opposed to that of each individual for himself, is that the amount which one can know about the values of other people is generally insignificant relative to what one knows about oneself. Therefore, before any method may be used to decide if "the total of human happiness" is increased, some way of deciding how such a total is computed and/or known to be increased or decreased with some certainty must be found. At the time Friedman wrote this book there was no existing set of libertarian principles which had produced a method of computing such a "total of human happiness".

9) Unfortunately Friedman continues to frame inconsistent statements such as his third sentence here, presumably because he cannot understand that there is no necessary conflict between theory and practice. Any operational method which is clearly beneficial to everyone must necessarily be a "good" rule. "[D]isagreements about values" can only be settled by clear general rules about whose jurisdiction each value lies within, and then allowing the person in whose jurisdiction the value lies to make his own decision unfettered by others (except for social preferencing which will always apply).

The final reason is that, whether or not people care about the sum total of human happiness, most of us care a good deal about our own happiness. If a particular legal rule increases the average level of happiness there is at least a presumption that it will, on average and in the long run, make me better off. That is a reason, although not necessarily a compelling reason, why I should favor it.

10) This is not a good "presumption" at all! In effect, it puts the "cart before the horse", since it is certain that if a rule increases everyone's individual happiness then it must necessarily increase average or total happiness. It is all too easy to compose definitions for "total human happiness" which, even when increased, will cause many (even most people) to be worse off than before, even by their own evaluation. Whereas, if human happiness is correctly defined, all reasonable people will understand why their own happiness can only be maximized if the happiness of others is maximized at the same time. This will have the enormously positive effect that strong rules of social order will then only be needed for those who are unreasonable or when misunderstandings occur.3

For all of these reasons, it makes sense to ask what legal rules tend to maximize human happiness. The rest of this chapter is devoted to trying to answer that question. My tool for doing so is the economic analysis of law. The first steps are to explain what economic efficiency means, how it can be used to choose legal rules, and why it may be a useful measure of total happiness.

Consider some change that affects only two people. For each, one may ask how much the change is worth to him--how many dollars he would if necessary pay in order to get it (positive value) or prevent it (negative value). One could then sum the answers to get a dollar value for the effect of the change. If one person was willing to pay four dollars to get the change and the other two dollars to prevent it, one might say that the change increased total value by two dollars. One could make the same calculation with any number of people, summing the positive values of those who favor the change and the negative values of those opposed to it. If the net is positive we describe the change as an economic improvement or an increase in efficiency, if negative as an economic worsening or decrease in efficiency.

11) One problem right off with such a method is that when humans decide values "on paper" the results are often very different than when they actually act to make the events related to those values occur. However, even if one observes people's actions to make such evaluations, such actions will be quite different for people who are more rational than those who are less rational. (Rational is defined as: thinking over the longest time span and the widest range of choices and consequences.) In fact, I would contend there is no question that people in the US today will evaluate very differently than those of 50 or 100 years ago, even for the exact same things. Finally, and worst of all, if most people think irrationally, such a method will not ensure their maximum long-range happiness, even though it may increase their immediate happiness. In fact, the major problem with the world today is that most people are sacrificing the future for the present. Their choices are generally going to be harmful to their own happiness in the long-run, precisely because they have not been shown the correct basis by which their lifetime happiness can be maximized.

Although we are measuring values in dollars, no money need actually be involved. The change might be the transfer of an apple from you to me. The apple is worth two dollars to you and four to me. You would pay up to two dollars to keep the apple (prevent the transfer), so the change has a value to you of minus two dollars. I would pay up to four to get the apple, so the change has a value to me of plus four dollars. The change produces an economic gain of two dollars.

How would we find out whether a particular change produced a net gain or a net loss? The best way would be to observe people's values as reflected in their actions. Suppose I offer you three dollars for the apple and you accept. The fact that I make the offer implies that the apple is worth more than three dollars to me; the fact that you accept implies it is worth less than three dollars to you. Assuming that we are the only people affected, the transfer must result in a net gain. Generalizing the argument, we conclude that any voluntary transaction that has no effect on third parties must result in an economic improvement.

12) However, one might well ask at this point what is most efficient about the price of three dollars? If the apple is actually worth only two dollars to the seller and as much as four dollars to the buyer, then why should the price not be three fifty or two fifty? Why not even four dollars or two dollars? My own answer would be that three dollars is the most efficient price because it generates both the economically efficient transfer (the gain to both people together of two dollars) and the maximum equal gain in utility for both (one dollar) individually. I will define such a price as the "just" price and the transaction at that price will be termed a "just" transaction. However, unless the valuation of each party is known beforehand by each (or a third party), a simple observation of the open transaction does not allow anyone to determine whether or not it was just.

Voluntary transactions are improvements, but improvements are not necessarily voluntary transactions. Suppose I am lost in the woods and starving. I stumble upon your locked cabin, break in, and use the telephone to summon help. Being both grateful and responsible, I leave you an envelope containing enough money to pay for the damage several times over. The exchange is not voluntary; you did not give me permission to break into your cabin. But, just as with a voluntary transaction, we have both ended up better off (assuming my calculation of how much to leave was correct), so there was a net improvement.

13) Here Friedman again makes the mistake of thinking that the person breaking into the cabin has any ability to determine the harm done to the person who he violated. Such a person cannot presume that any amount of money left is sufficient. One reason for this is because one can imagine various scenarios for which such an event is the initiating cause and which are far worse than merely the damage of a broken door. For that reason, the only correct course of action is to find the owner of the cabin, tell him what happened and offer to pay whatever restitution the owner requires after he has checked everything out and decided what it will take to fully return his own lifetime happiness to what it would have been if the violation had never occurred. Only in this manner will justice have been done to the innocent party (the one who did no violation). Thus, the flaw in Friedman's argument which invalidates his method of operation for this example is the phrase "assuming my calculation of how much to leave was correct". There may still be a net gain. In fact, because of the good will generated, the gain will likely be greater when the owner is first contacted and permitted to determine his own restitution. However, if the gain is determined as Friedman has outlined, there is no guarantee that the transaction is either economically efficient (net improvement) or just.

In both cases--selling the apple and breaking into the cabin--the cash payment provided evidence that there was a net gain, but the gain was produced by the transfer not by the payment. The same two dollar gain would have occurred if you had accidentally lost the apple and I had found it, although in that case it would have been the sum of a four dollar gain and a two dollar loss instead of the sum of two one dollar gains (lose an apple valued at two dollars, get three dollars for you; gain an apple valued at four dollars, lose three dollars for me).

14) Now Friedman is really treading on dangerous ground! For if there is a net gain in human happiness simply by a transfer of goods from those who value them less to those who value them more, why is it not correct for governments to redistribute all the wealth according to this utilitarian principle in a very similar manner to any socialist state? Surely it is the voluntary character of the apple transaction which "provided evidence that there was a net gain". Whereas, since the cabin break-in and the loss of the apple were not voluntary to both parties there is no such evidence of net gain. (For example, the apple could have been lost by someone who valued it at four dollars and found by someone who valued it at only two dollars.)

So far, we have been talking about changes, not about rules. The next step is to ask what legal rule will result in only efficient changes--changes that produce a net economic benefit. In the case of the apple, we want a rule that will result in the apple being transferred to me if and only if it is worth more to me than to you, since only then is the transfer an economic improvement. The obvious solution is to allow the transfer if and only if both of us agree to it. If the apple is worth more to me than to you I will make you an offer for it that you will accept; if it is not I will not. In this case, the solution is simply property rights, enforced by a punishment for anyone who steals an apple.

15) Since such an exchange is voluntary, one needs no rule at all. Moreover, if the exchange were not voluntary, the net gain of total human happiness is the same. From a utilitarian point of view, this example appears to show no need for any social rules at all. Thus, Friedman has certainly not shown why property rights of ownership in the apple and protection of it being stolen are needed in order to maximize total human happiness. In fact, punishment for anyone stealing an apple is even negative from a utilitarian point of view, as long as the person who steals it values the apple more then the one who originally had it. This is because any such punishment always lowers the total of human happiness regardless of what happens to the apple in the end.

If Friedman had argued that promulgation and protection of property rights are necessary so that voluntary actions of exchange could show just who values the apple more and who values it less, then he would have a logical argument. But that is not what he has done here. However, even if Friedman did argue this way, then if the very same people interact by having the one who values the apple more steal it from the one who values it less, any punishment still lowers the net gain. Furthermore, making him return the stolen apple and suffer punishment would be worst of all, since it would be a net reduction in the total of human happiness.

What about the case of the cabin? Property rights will not solve that problem, since the owner of the cabin is not available to rent out the use of his phone. This time the solution is a damage rule. If I break into the cabin (and turn myself in for doing so), I owe the owner a payment equal to the amount of damage I have done to his property. If the use of his phone is not worth that price, I will keep wandering; if it is, I will break in. That is, in each case, the economically efficient outcome.

16) There are at least two major problems to Friedman's solution. First, as I have stated before, without the owner being there to assess it and/or the passage of time to assess the ensuing effects before the damage is fixed, the person breaking into the cabin has no method by which to compute the full restitution cost that his action will bear. In making his decision, he must be prepared to risk the worst possible consequences of his action. Therefore, he must make a risk/benefit calculation. If he decides to go ahead, then, again as I have described, his risk of loss will be minimized not by leaving money behind (which might be stolen), but to contact the owner in order to effect full and complete restitution according to the evaluation of the owner. In order that such contacts can be easily effected is one reason why real estate should be publicly registered.

Second, where is the dividing line between acts of intentional or vicarious damage which should be punished, and acts of desperation which one thinks are necessary to save one's life? Is it alright for the wanderer to break in and use the phone just because he is tired of walking or he is late for an important appointment, even though he now knows his way back home and his life is not in any danger? At what level of necessity is punishment added on to the costs of restitution for the damage done? These are some of the many important questions omitted by Friedman which are addressed and solved by the philosophical approach of SMN2 as implemented in the NSC.3

I have now gotten far enough so that you can see how, in principle, economic analysis can be used to figure out what laws ought to be. Before I go on to discuss these two examples in more detail and to apply the analysis to some of the problems mentioned in Chapter 41, I should first fill in a missing step in the argument. I have talked about maximizing total happiness and about economic improvement, but have not shown that the two have anything to do with each other. I have not shown when or why the fact that some change is an economic improvement implies that it increases total utility. There are two important differences between the economist's criterion and the philosopher's. The first involves the measurement of utility for an individual, the second the comparison of the utility of different people.

In defining value, the economist accepts the individual's own evaluation of whether something does or does not make him better off. If I prefer gaining an apple and losing four dollars to doing neither, that shows that the apple is worth at least four dollars to me. That definition of value is what economists call "the principle of revealed preference." The possibility that I am wrong in judging my own interest, that I am willing to pay for apples even though they are bad for me, is assumed away.

17) There are two different major problems with Friedman's "principle of revealed preference" as applied to both of his examples. The first problem is that with respect to the apple example, the four dollar evaluation of the purchaser (or the two dollar evaluation of the seller) is not "revealed" by a voluntary transaction. Yes, the fact of economic efficiency is revealed by the transaction, but the amount of such economic efficiency and the justice of it is not. The second problem is that in his cabin break-in example, Friedman did not accept "the individual's own evaluation of whether something does or does not make him better off" in the case of the owner of the cabin. He only used the evaluation of the wanderer, which is not sufficient to "reveal" the preferences of both parties and to calculate the true economic efficiency. In addition, Friedman shows very sloppy thinking in his statement: "If I prefer gaining an apple and losing four dollars to doing neither, that shows that the apple is worth at least four dollars to me", since if he prefers the exchange then he must, in fact, value the apple more than the four dollars! Finally, it is imperative in any complete system which attempts to describe and analyze human behavior, to not "assume away" the "possibility that [a person may be] wrong in judging [his] own interest", since ultimately the long-range negative and positive effects of one's action will show themselves and moderate future actions of himself and others.

One implication of that assumption is that the value of heroin to a heroin addict is just as real as the value of insulin to a diabetic. If you are unwilling to accept such implications you will conclude that an economic improvement is not inevitably an increase in total human happiness; some of the values gained may represent mistakes by individuals about what is in their own interest. You may still agree that, for most people most of the time, revealed preference is the best available way of measuring value, and that economic efficiency is therefore a good, although not a perfect, measure of total happiness.

18) I certainly do not agree that "revealed preference is the best available way of measuring value" as Friedman has defined it. And economic efficiency, as here defined by Friedman, is only a very narrow and short-term approximation to measuring human happiness. How good a measure it is in the longer term depends to a great extent on how rational are the actors under consideration and how complete are the facts of reality available to them. In addition, Friedman's definition of economic efficiency takes no account of any principle of justice or efficiency such as that of Pareto5.

The second divergence between economic improvement and increased utility involves comparisons between people. In summing individual values in order to decide whether some change is an improvement or a worsening, we count a one dollar gain to one person as just cancelling a one dollar loss to another. We act as if a dollar (or what a dollar can buy) were worth the same amount of happiness to everyone.

19) I see no problem with such an assumption. In fact, I seen no other objective manner (other than using some other commodity which everyone values to some extent) to compare happiness between different people. However, I also do not see that using such a comparison is a "divergence" from what utilitarianism necessarily does.

If the rule that the economist uses for making interpersonal comparisons is wrong, why should we use it and how can it tell us anything about what legal rules maximize total happiness? The answer to the first question is that we use the rule because my value for an apple is much easier to observe than my utility for an apple. We can observe my value for an apple by how much I am willing to pay for one, and we can, as I have just demonstrated, set up legal rules (property rights) that give me the apple if and only if its value to me is greater than its value to anyone else.

20) Ah, but I can also set up a rule which is just as economically efficient (with respect to these two people) as are property rights and their protection. Here is my rule. A government agency asks persons who have apples what is the minimum dollar amount they will sell them for. Then the government agency asks those who do not have apples what is the maximum amount they would pay for an apple. Once these facts are known, the government agency takes all the apples from those with lower dollar figures and transfers them all to those with higher dollar figures, thereby maximizing the economic efficiency of the population having and wanting apples. Of course, the government agency will have to charge a small fee for this service, but then there was a cost for buyers and sellers finding each other and transacting also.

Now it is obvious that this will only happen once (at least with apples and those who had them), because the producers of apples will not grow any more if the apples are going to be appropriated from them. However, the point of my example is to show that Friedman's economic efficiency is not any logical foundation for property rights. Some other principles (of justice) other than economic efficiency are needed for any logical argument for them to succeed.

A system of rules that gave me the apple only if I got more utility from it than anyone else would be very much harder to construct. My actions show my utility for an apple relative to my utility for some other good that I am offering to exchange for it (dollars in this case), not relative to someone else's utility for the same apple. In order to give the apple to the person who got the highest utility for it, someone would have to judge how much happier an apple made each of us. Observing other people's utility may not be impossible, but it is much harder than observing our own. It follows that it is much easier to design institutions that maximize value--that produce changes if and only if they are economic improvements--than to design institutions that maximize total utility.

It is easier to figure out what increases value than what increases utility, but is the answer of any use? Am I not again searching where the light is best instead of where I dropped my wallet? I think not. In many situations, although not in all, the fact that a change is an economic improvement--increases total value--is strong evidence that it also increases total utility. Since changes in economic value are much easier to measure than changes in utility, we may use the former as a proxy for the latter.

21) A voluntary exchange which by definition increases total value also always increases the happiness of each person and thus the total happiness or it would not take place. However in general, Friedman's argument here depends on the comparability of people's evaluations of different kinds of values - ie. that for any individual so much happiness is comparable to so many dollars. The only cases where this is not so are in the extremes. Some particularly valuable things may be more valuable than any amount of dollars. In fact, one's life and liberty are probably in this category (of being effectively priceless) for most people. (Both of my eyes are priceless to me in the sense that no amount of money would induce me to sell either.) However, this pricelessness of certain categories of existents has profound affects which weaken the ability of economic efficiency arguments to solve many problems that can still be solved by Social Meta-Needs theory.2

Consider, for example, the abolition of a tariff. Suppose we could show (as in many cases we can) that it is an economic improvement--the benefit to those who are better off as a result of abolishing the tariff (workers and stockholders in export industries and consumers of imported goods), measured in dollars, is greater than the loss to those who are worse off (workers and stockholders in industries that compete with imports). Individual gainers and losers may have greatly varying values for a dollar; a change that benefits one of them by six dollars and hurts another by five is not necessarily an improvement in total utility. But both gainers and losers are large and diverse groups, and there is no obvious reason to expect the one group, on average, to value dollars more or less than the other. If the average is about the same for both groups, then a change that produces a gain in value probably produces a gain in utility as well. That was the argument used by Alfred Marshall, who invented the idea of economic improvement, to justify using it as an approximate way of identifying changes that increase total utility.

The approximation should be a good one as long as we are considering situations where there is no reason to expect gainers and losers to have, on average, different utilities for a dollar--different relations between value measured in dollars and utility measured in some absolute units of happiness. In many cases that is a reasonable assumption. Buyers and sellers of apples, lost hunters and owners of locked cabins in the woods, are likely to be similar people--even the same people at different times.

22) This is a very poor argument for eliminating a tariff in comparison with one showing that in the long run everyone benefits from the elimination of a tariff. The redistribution of wealth by socialist governments aims directly to increase utility by taking money from those who have a lot, and generally do not value a dollar as highly (in terms of the happiness it can give them) as those who have much less, and giving the money to those who have less. I think anyone would be hard pressed to make the case that each particular transfer of money does not indeed increase the total human utility, even though in the long run the total of human utility is greatly decreased in all socialist regimes. Indeed the same would be true if the government transferred material goods from those who have more to those who have less. Therefore, one must look for a deeper answer than mere economic efficiency or increase in utility, on which to base rules of social order which are maximally efficient not only for every short-term transaction, but in the longer term as well.

There is one obvious exception. We expect, as a general rule, that the more money you have the less an additional dollar is worth to you, and therefore that, on average, a dollar represents more happiness for someone with very little money than for someone with a lot of money. That is why we rarely give charity to millionaires. We therefore expect that, if gainers and losers have very different incomes, the net change in value will be a poor measure of the net change in happiness.

A change that makes a rich man ten dollars worse off and a poor man nine dollars better off is an economic worsening, but it may well increase the amount of happiness in the world. The same is true for a change that harms a large group of rich people by a total of ten million dollars and benefits a large group of poor people by a total of nine million. The obvious conclusion, and one that many utilitarians have drawn, is that income redistribution is a good thing. Taxing the rich and giving the money to the poor may be an economic worsening, due to collection costs and disincentives, and yet a utilitarian improvement.

23) In his last sentence here where Friedman talks about "taxing the rich", he introduces new requirements of his economic efficiency definition which were not made at the start. Nowhere before did he say anything about "collection costs and disincentives"; even voluntary exchanges have such "costs" associated with them. In addition, he makes no logical argument that collection costs result in an "economic worsening". Since no money is actually gained or lost by the total of the people under consideration, by Friedman's definition, there can also be no economic worsening for this situation. Furthermore, since collection costs also transfer money from the rich to those who are generally poorer (the taxing and collection agents), it would seem that even the costs of collecting the taxes also increase the general utility. Again Friedman has erred by trying to suggest that there is a difference between economic and utility methods in inherent in single transactions, when, in fact, the major differences lie in the long term effects due to the incentives and disincentives.

My reasons for disagreeing with that conclusion are two. The first is that since the poor are, as a rule, politically weak, they are at least as likely to be the victims of governmental income transfers as they are to be the beneficiaries. That is the point that I made in Chapter 4. The second is that the struggle among groups trying to make themselves beneficiaries rather than victims is likely to be an expensive one, making practically all of us, rich and poor, worse off in a society that permits such redistribution than in one that does not. That is the point that I made in Chapter 38. Those two chapters were a utilitarian attack on one of the chief doctrines that divides utilitarians from libertarians.

24) I reject Friedman's first argument above because in a democracy, those who have less money (and think they ought to have just as much as some richer person) are far more numerous than those who have more (and do not desire any of someone else's money), and therefore they are politically far stronger. His second argument is correct, but introduces ideas of "worse and better off" which are not related to his definition of economic efficiency. However, both arguments have no relevance to a determination of the optimal rules of a social order in which everyone can mutually maximize his lifetime happiness.

Some pages back, I abandoned the subject of specific rules in order to show the connection between economic improvement and increases in total happiness--to show why designing rules to maximize economic efficiency makes sense as a way of increasing human happiness. I have now done so. I have not shown that economic improvement and increases in total utility are the same; they are not. I have shown why the former is an approximate measure of the latter, and may, for practical purposes, be the best measure available. Readers who are not convinced may want to look at Marshall's original argument or at the much more detailed discussion of economic efficiency in another book of mine; both books are listed in Appendix 2. Readers who are economics students should be warned that those are almost the only places to look. Modern economics texts other than mine use a different, although for most purposes equivalent, definition of improvement.

25) Actually Friedman has prematurely abandoned the possibility that increases in total utility and economic improvement are identical, because if they are defined correctly, this can indeed to shown to be the case. A correct definition needs to always use the individual's evaluation of harm and benefit to himself and to use some principle of justice wherein innocent parties (ie those which are not the effective cause of any harm) always have their lifetime happiness not decreased after the completion of any interaction, to the extent that this is possible without harm to other innocent parties. For details see my essay on Social Meta-Needs theory2.

It is now time to go back to discussing specific rules. The question I shall be investigating is how one would design legal rules to maximize economic efficiency--to permit changes that are economic improvements and prevent changes that are economic worsenings.

Consider again the solution to the apple problem. If we do not enforce property rights in apples at least two kinds of inefficient change may occur. First, apples may be transferred from owners who value them more to thieves who value them less. Second, thieves may spend time and money stealing apples instead of buying them.

26) I have already shown another method for how economic efficiency can be optimally achieved without property rights. Therefore, as I have contended, there must be some other basis for arguing that economic efficiency requires property rights. Moreover, Friedman's last reason for property rights, that otherwise "thieves may spend time and money stealing apples instead of buying them", makes little sense at all. Property rights are necessary before the act of theft can even be defined. People must also spend money on finding and procuring apples which is likely no less than a thief would have to spend unless and until penalties against theft and other protective measures to secure property make the cost of theft much higher than the cost of buying apples. Finally, Friedman's first reason will generally be untrue for those who produce more of certain products than they want for themselves, since it is then almost certain that they value each less than others do.

Suppose the apple is worth two dollar to you and four dollars to me. Instead of buying it for three dollars I sneak into your orchard at night and steal it, at a cost of a dollar's worth of time and effort. You are worse off by two dollars (the value of the apple to you) and I am better off by three dollars (the value of the apple to me minus the cost to me of getting it), so there is a net gain of one dollar; my stealing the apple is an economic improvement over my not getting it at all. But not getting the apple is not the only alternative; I could have bought it instead. Stealing the apple is worse than buying the apple, since that would have produced a net gain of two dollars. An efficient legal system will include some way of making it in the interest of people who want apples to buy them instead of stealing them. That is why we punish thieves.

27) I hate to have to say it, but Friedman's logic here is really bad. Mainly this is because he does not look at the bigger picture of the events surrounding the two different acts. In effect, he is guilty of the fallacy of the "broken window". First, because Friedman does not also consider the cost to the buyer and seller of finding each other and consummating a transaction, he does not even look at the two kinds of transactions (voluntary versus theft) in an equal and unbiased manner. Second, Friedman does not examine the transactions with others which take place with respect to these costs of making transactions (either theft or voluntary exchange). There is no clear reason available, in terms of any economic efficiency analysis as Friedman has defined it, why theft should always be more expensive than voluntary exchange. This, in fact, will only become the case when penalties for theft are made high enough so that the risk/benefit calculation becomes clearly pushed in the direction of voluntary exchange. But this has no relevance to and is not a requirement derivable from Friedman's definition of economic efficiency.

How much should we punish them? If all thieves were caught, a fine equal to the value of what is stolen would be sufficient; since stealing things is more trouble than buying them, theft would be the less attractive of the two alternatives. If only a fraction of thieves are caught, say one in ten, the same argument suggests that the punishment should be scaled up accordingly. If the fine for stealing an apple is ten times the price of buying one, then stealing costs the thief, on average, as much money as buying and more trouble.

28) There are several problems with this paragraph and proposed solution:

  1. There is no "we" to punish anyone nor to determine the punishment. There are only individuals.
  2. The statement "stealing things is more trouble than buying them" is generally untrue unless there are risks to stealing. This fact makes the use of that statement not a logical basis for any argument that there should be strong fines or punishments (ie. high risks).
  3. Even if "all thieves were caught, a fine equal to the value of what is stolen would" not be sufficient. From the point of view of the victim, what is needed is not a fine, but complete restoration of his lifetime happiness back to the state that it would have been in, after such restoration, if the theft had never taken place. Thus, what needs to be paid by the thief is not only the value of what is stolen (as evaluated by the victim) or its actual return undamaged, but all harm from deprivation of the use of what was stolen and all costs of recovery.
  4. If there is a "fine", to whom does the money go? If there is a fine of 10 times, does the victim get 10 times the amount stolen? If so he may get a windfall and people will have no incentive to protect things from getting stolen, so long as the thieves are caught. Thus, his incentive will, in fact, be to make sure that his property gets stolen and that any thief who steals it gets caught. At the same time, the owner will try to make sure that thieves of other people's property do not get caught so that the ratio of fine to value of what is stolen remains as high as possible. This sounds like an incentive/disincentive recipe for disastrous interpersonal relationships.
  5. The whole idea of "costs the thief, on average" is illogical since thieves are not a collective being or organized society which works on averages and neither are victims.
  6. If the restitution is either more or less than the actual sum of the losses, then the entire decision making process of protection and harm-doing is distorted from the existing reality of the values.
  7. Since often one does not know whether harm is done accidentally, negligently or intentionally, one must separate the restitution portion of the harming action from the intent portion of it. From the victim's point of view what is required is full restitution back to the state of lifetime happiness that he would have been in if the harming event had not occurred.

We now have the same rule for apples and for cabins. The rule I suggested for someone who broke into a cabin was that he should pay a fine equal to the damage done--provided he turned himself in. I included that condition in order to make it a case where the probability of being caught was one.

29) Except for his use of the word "fine", Friedman has now stated this equivalence in a form with which I can agree, given that the damage done is determined by the owner of the cabin after the person who broke in (the violator) reports it to him and he has had time to check it out to his satisfaction. Of course, this will increase the full cost of harm to the owner that the violator will have to pay.

In order to eliminate inefficient transactions, the amount of the fine (or the probability times the amount, if only a fraction of thieves are caught) must be at least the value of what is taken. The case of the cabin in the woods is an argument against making the fine any higher than that. While we could have one legal rule for apples and a different one for cabins, it may be easier to have a single set of rules defining what property rights are and what happens if you violate them. Such a set of rules should take account of the possibility that some violations of property rights, such as the lost hunter breaking into the cabin, are desirable changes that for some reason cannot be arranged via a voluntary exchange. A punishment lower than the damage done permits some inefficient changes; a punishment higher than the damage done prevents some efficient ones. So the ideal punishment equals the damage done, appropriately adjusted for the probability of catching and convicting the criminal.

30) Once again I have a problem with even calling the restitution amount a "fine". The purpose of a fine is punishment whereas the purpose of restitution is justice - ie. restoration of the happiness state of the innocent party. This difference is of paramount importance and not keeping it solidly in the forefront of one's thinking leads Friedman and many others astray. Fines and other forms of punishment are inherently collectivist because of their lack of benefit for the individual and their emphasis on benefit for society. Restitution with its emphasis on benefit for the victim and lack of any regard for non-involved third parties is inherently individualistic.

31) Once "fine" is replaced in Friedman's text with "restitution" it becomes very clear that the idea of charging more restitution than the actual amount of harm done to the victim (including all ancillary costs of course) makes no sense at all from any justice point of view. Why should one victim get this kind of windfall just because his violator happens to be caught while other victims whose violators are not caught get nothing? In addition, where is the justice in making the violator who gets caught pay for all the ones who do not get caught?

32) At this point I will cease my comments on this chapter. I have only commented on the first half of this chapter 43 because the last half is based on principles with which I have already shown are faulty in my critique so far. By carrying on my critique little more would be gained than a constant repetition of the same points of disagreement. I have provided a method of solution to the problems with libertarian principles that Friedman has posed, which is far more fruitful and still ethically consistent with a libertarian approach than what he does using his economically "efficient law" approach.

Footnotes and References:

1. The Machinery of Freedom: Guide to a Radical Capitalism: Chapter 43.

2. Such a theory is explicated in the essay: "Social Meta-Needs: A New Basis for Optimal Interaction".

3. For complete definitions and details see: the "Natural Social Contract".

4. For more detail concerning why such undefined plural usages have negative effects on logical thought see: "Essential Collectivism in Language: its Effects on Rational Thinking".

5. In my own phrasing, Pareto's principle may be stated: an event is just if and only if afterwards everyone affected has at least as much lifetime happiness as before. If "value" is substituted for "lifetime happiness", then this same principle can be seen to describe a globally economic efficient transaction.

Previous Page
Next Page