Thursday, July 23, 2015

The free-rider problem is an argument against democracy

Reply to: Friedrich Hayek Supported a Guaranteed Minimum Income

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Friedrich Hayek supported welfare like he opposed democracy. Welfare on its own is entirely wonderful. Same thing with democracy. But when you combine the two…

The best (most widely cited) justification for government is based on the fact that everybody wants a free lunch. The liberal Nobel Prize economist Paul Samuelson argued that taxation has to be compulsory because we can’t trust people to tell us how much they value public goods.

The free-rider problem is a real problem. Everybody wants the most bang for their buck. Which is great when it comes to private goods… we all shop around for the best deals. But when it comes to public goods… we all hope to enjoy the benefits and pass the costs onto others.

In order to be logically consistent, anybody who agrees that the free-rider problem is a real problem must also agree that democracy should be limited to issues that are not susceptible to this problem. If democracy isn’t limited accordingly, then it’s a given that resources are going to be diverted away from far more productive uses… which means less opportunities… which means a greater need for welfare. It’s a vicious cycle.

Did Hayek support a minimum welfare? Yup, you got that right. But the “minor” detail you either accidentally or conveniently forgot to mention was that Hayek also supported a definite limit to democracy. He clearly understood the problem with the majority directly or indirectly determining the amount of welfare that they receive.

The limit on democracy is just one, of many, conditional clauses which Hayek based his support of a minimum welfare on. If all these conditions are not met, then it’s very likely that the harm of government welfare will greatly exceed the benefit.

Uh, do you need me to go through and list all the conditions? Eh… it would be a lot of work. Plus, it’s really doubtful that anybody is going to successfully argue against the condition regarding democracy. Or even attempt to do so.

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James Kwak left this note…
You have the conceptual order backwards.. His argument for a guaranteed minimum isn’t conditioned on anything. He then observes that democracy can lead to problems.
Does concept/condition/concern/clause order matter? Even if it does, chapter 19, which contains the minimum welfare bits you referred to, begins with this quote…
The doctrine of the safety net, to catch those who fall, has been made meaningless by the doctrine of fair shares for those of us who are quite able to stand. — The Economist
Clearly Hayek was concerned with the ever-present and very popular topic of “fairness”. The problem isn’t with a bare minimum… it’s with people who think it’s unfair that others have so much more than they do. Of course, these people usually fail to recognize that they have so much more than many people in places like Africa. Everybody always wants more. Like I argued, everybody wants a free lunch. When it comes to public goods, the free-rider problem is a real problem.  

Along these same lines, Hayek wrote…
It is probably inevitable that this relief should not long be confined to those who themselves have not been able to provide against such needs (the “deserving poor,” as they used to be called) and that the amount of relief now given in a comparatively wealthy society should be more than is absolutely necessary to keep alive and in health.
Again, the concern is that people will want more than the minimum welfare. Who’s satisfied with a minimum amount of anything good? In a shopping mall… the powerful desire to maximize benefit is a powerful force for good. In a voting booth, however, this same exact desire becomes a powerful force for bad. This is true regardless of where or when Hayek points this out. 

Next he brings up the part you mentioned about compelling people to insure themselves against the “common hazards of life”. Hayek justifies this by arguing that, if people weren’t compelled to do so, then everybody would have to suffer larger harms. Of course, this recommendation, like all his welfare recommendations, has to be considered in terms of all the relevant and applicable conditions. 

In the second section, Hayek shares what I consider to be a very important condition/clause…
It is probably true that, at any given moment, a unified organization designed by the best experts that authority can select will be the most efficient that can be created. But it is not likely to remain so for long if it is made the only starting point for all future developments and if those initially put in charge also become the sole judges of what changes are necessary. It is an error to believe that the best or cheapest way of doing anything can, in the long run, be secured by advance design rather than by the constant re-evaluation of available resources. The principle that all sheltered monopolies become inefficient in the course of time applies here as much as elsewhere.
True, if we want at any time to make sure that we achieve as quickly as we can all that is definitely known to be possible, the deliberate organization of all the resources to be devoted to that end is the best way. In the field of social security, to rely on the gradual evolution of suitable institutions would undoubtedly mean that some individual needs which a centralized organization would at once care for might for some time get inadequate attention. To the impatient reformer, who will be satisfied with nothing short of the immediate abolition of all avoidable evils, the creation of a single apparatus with full powers to do what can be done now appears therefore as the only appropriate method. In the long run, however, the price we have to pay for this, even in terms of the achievement in a particular field, may be very high. If we commit ourselves to a single comprehensive organization because its immediate coverage is greater, we may well prevent the evolution of other organizations whose eventual contribution to welfare might have been greater. 
Decentralization is far more effective than centralization at finding where there’s room for improvement. If well-planned steps were frequently taken in the best directions…then socialism (= command economies = our public sector) would work. And there’d be absolutely nothing wrong with putting all our eggs in one basket. Hedging bets would be a waste. There’d be no point in allowing consumers to choose for themselves. There’d be no point in allowing entrepreneurs to freely enter and exit from endeavors of their choosing. In the real world, however, no amount of top down expertise can ensure that the best course of action is taken. Hence the value of decentralization. 

Hayek agrees that a minimum welfare should be provided. But how should it be provided? Liberals think it should be provided centrally. Hayek thought otherwise. This is a general condition. Are there some exceptions to this condition? For Hayek…probably defense, maybe justice… but certainly not welfare. And I’m using the term “welfare” broadly. 

Hayek again returns to the concern with “fairness”… 
Though a redistribution of incomes was never the avowed initial purpose of the apparatus of social security, it has now become the actual and admitted aim everywhere. No system of monopolistic compulsory insurance has resisted this transformation into something quite different, an instrument for the compulsory redistribution of income. The ethics of such a system, in which it is not a majority of givers who determine what should be given to the unfortunate few, but a majority of takers who decide what they will take from a wealthier minority, will occupy us in the next chapter. At the moment we are concerned only with the process by which an apparatus originally meant to relieve poverty is generally being turned into a tool of egalitarian redistribution. It is as a means of socializing income, of creating a sort of household state which allocates benefits in money or in kind to those who are thought to be most deserving, that the welfare state has for many become the substitute for old-fashioned socialism. Seen as an alternative to the now discredited method of directly steering production, the technique of the welfare state, which attempts to bring about a “just distribution” by handing out income in such proportions as it sees fit, is indeed merely a new method of pursuing the old aims of socialism. The reason why it has come to be so much more widely accepted than the older socialism is that it was at first regularly presented as though it were no more than an efficient method of providing for the specially needy. But the acceptance of this seemingly reasonable proposal for a welfare organization was then interpreted as a commitment to something very different. It was mainly through decisions that seemed to most people to concern minor technical issues, where the essential distinctions were often deliberately obscured by an assiduous and skillful propaganda, that the transformation was effected. It is essential that we become clearly aware of the line that separates a state of affairs in which the community accepts the duty of preventing destitution and of providing a minimum level of welfare from that in which it assumes the power to determine the “just” position of everybody and allocates to each what it thinks he deserves. Freedom is critically threatened when the government is given exclusive powers to provide certain services — powers which, in order to achieve its purpose, it must use for the discretionary coercion of individuals. 
Minimum welfare? Sure… if, and only if… we can keep fairness, redistribution, egalitarianism and socialism out of the process. This is a fundamentally important condition. Hayek is fundamentally concerned with this condition. To leave this condition out is to fundamentally misrepresent Hayek’s position on the matter. 

The third section contains the condition that there has to be a way for experts to provide an objective valuation of the welfare institutions. When this condition is not met, the barber is in charge of deciding whether we need a haircut. 

The fourth section reemphasizes the condition of decentralization…
Are we really so confident that we have achieved the end of all wisdom that, in order to reach more quickly certain now visible goals, we can afford to dispense with the assistance which we received in the past from unplanned development and from our gradual adaptation of old arrangements to new purposes? Significantly enough, in the two main fields which the state threatens to monopolize — the provision of old age and for medical care — we are witnessing the most rapid spontaneous growth of new methods wherever the state has not yet taken complete control, a variety of experiments which are almost certain to produce new answers to current needs, answers which no advance planning can contemplate. Is it really likely, then, that in the long run we shall be better off under state monopoly? To make the best available knowledge at any given moment the compulsory standard for all future endeavor may well be the most certain way to prevent new knowledge from emerging. 
Confidence in planning = fatal conceit. It’s a fatal conceit to fail to understand the universality of fallibilism. Embracing the fact of fallibilism means appreciating the value of heterogeneous activity (variety of experiments). Maximizing heterogeneous activity maximizes beneficial discoveries which maximizes progress and prosperity. Because people are all different… maximizing heterogeneous activity can be accomplished simply by protecting people’s freedom to allocate their resources as they best see fit. However, given that the free-rider problem is a real problem… when it comes to public goods… it’s not unreasonable to coerce people to contribute… but this really does not mean that we have to take away their choice regarding which public goods they contribute to. 

The fifth section contains the condition of fiscal equivalence. Fiscal equivalence is when there’s a clear and direction connection/bridge between taxes paid and services received. If this bridge is largely absent… then the result is fiscal illusion… people are clueless about the costs. The government becomes the Santa Claus for adults. Public goods are made by elves in the North Poll. Reindeer fly and there is such a thing as a free lunch. The logical consequence of fiscal illusion is that, even if people wanted to make rational democratic decisions, it’s impossible for them to do so. 
This development can be prevented only if, from the outset, the distinction is clearly made between the benefits for which the recipient has fully paid, to which he has therefore a moral as well as a legal right, and those based on need and therefore dependent on proof of need. 
The first part is the benefit principle. The second part contains the proof-of-need condition.

Further in… Hayek combines the limited democracy condition and the fiscal equivalence condition…
Though in a formal sense the existing social security systems have been created by democratic decisions, one may well doubt whether the majority of the beneficiaries would really approve of them if they were fully aware of what they involved. 
In the sixth section we also encounter the democracy condition…
It is easy to see how such a complete abandonment of the insurance character of the arrangement, with the recognition of the right of all over a certain age (and all the dependents or incapacitated) to an “adequate” income that is currently determined by the majority (of which the beneficiaries form a substantial part), must turn the whole system into a tool of politics, a play ball for vote-catching demagogues. 
Politicians milk the free-rider problem for their own personal gain. Also…
An inevitable result of this situation, which has become a normal feature in other countries besides the United States, is that at the beginning of every election year there is speculation as to how much social security benefits will again be raised. That there is no limit to the demands that will be pressed for is most clearly shown by a recent pronouncement of the British Labour Party to the effect that a really adequate pension “means the right to go on living in the same neighbourhood, to enjoy the same hobbies and to be able to mix with the same circle of friends.”
“No limit to the demands”. Again, Hayek was clearly concerned with the free-rider problem in terms of democracy. In no way, shape or form was he handing a blank check to government welfare. 

In the seventh section we find the condition of individual valuation…
Moreover, it is also not true that, in our individual valuation, all that might yet be done to secure health and life has an absolute priority over other needs. As in all other decisions in which we have to deal not with certainties but with probabilities and chances, we constantly take risks and decide on the basis of economic considerations whether a particular precaution is worthwhile, i.e., by balancing the risk against other needs. Even the richest man will normally not do all that medical knowledge makes possible to preserve his health, perhaps because other concerns compete for his time and energy. Somebody must always decide whether an additional effort and additional outlay of resources are called for. The real issue is whether the individual concerned is to have a say and be able, by an additional sacrifice, to get more attention or whether this decision is to be made for him by somebody else. 
Just because something is generally beneficial… doesn’t mean that it will be the most beneficial choice in every circumstance. Brushing our teeth is beneficial… but we don’t spend every second of every day brushing our teeth. Given the impossible-to-fathom diversity of preferences and circumstances… we maximize benefit by minimizing top down control. We should allow people to decide for themselves whether something is trash or treasure. 

In the eighth section we find the main sentence that you shared…
We shall again take for granted the availability of a system of public relief which provides a uniform minimum in all instances of proved need, so that no member of the community be in want or shelter. 
Here again we see the proof condition. 

In the following paragraph we find the limited union condition and the no minimum wage condition…
There is also the important instance in which unemployment is the direct effect of wages being too high in a particular trade, either because they have been pushed too high by union action of because of a decline in the industry concerned. In both cases the cure of unemployment demands flexibility of wages and mobility of workers themselves; however, these are both reduced by a system which assures to all unemployed a certain percentage of the wages they used to earn.
More about the limited union condition…
Such a system, which relieves the unions of the responsibility for the unemployment that their policies create and which places on the state the burden not merely of maintaining but of keeping content those who are kept of jobs by them, can in the long run only make the employment problem more acute.
In the final section Hayek again brings up the limited democracy condition…
The difficulties which social insurance systems are facing everywhere and which have become the cause of recurrent discussion of the “crisis of social security” are the consequence of the fact that an apparatus designed for relief of poverty has been turned into an instrument for the redistribution of income, a redistribution supposedly based on some non-existing principle of social justice but in fact determined by ad hoc decisions. It is true, of course, that even the provision of a uniform minimum for all those who cannot provide for themselves involves some redistribution of income. But there is a great deal of difference between the provision of such a minimum for all those who cannot maintain themselves on their earnings in a normally functioning market and a redistribution aiming at a “just” remuneration in all the more important occupations — between a redistribution wherein the great majority earning their living agree to give to those unable to do so, and a redistribution wherein a majority takes from a minority because the latter has more. The former preserves the impersonal method of adjustment under which people can choose their own occupation; the latter brings us nearer and nearer to a system under which people will have to be told by authority what to do. 
Also, more about the proof condition…
The assurance of an equal minimum for all in distress presupposes that this minimum is provided only on proof of need and that nothing which is not paid for by personal contribution is given without such proof.
And again with the decentralized condition…
The hope is now sometimes expressed by liberals that “the whole Welfare State apparatus must be regarded as a passing phenomenon,” a kind of transitional phase of evolution which the general growth of wealth will soon make unnecessary. It must seem doubtful, however, whether there exists such a distinct phase of evolution in which the net effects of those monopolistic institutions are likely to be beneficial, and still more whether, once they have been created, it will ever by politically possible again to get rid of them. In poor countries the burden of the ever growing machinery is likely to slow down considerably the growth of wealth (not to mention its tendency to aggravate the problem of overpopulation) and thus to postpone indefinitely the time when it will be thought unnecessary, while in the richer countries it will prevent the evolution of alternative institutions that could take over some of its functions. 
….also…
The introduction of such a system therefore puts a strait jacket on evolution and places on society a steadily growing burden from which it will in all probability again and again attempt to extricate itself by inflation. Neither this outlet, however, nor a deliberate default on obligation already incurred can provide the basis for a decent society. Before we can hope to solve these problems sensibly, democracy will have to learn that it must pay for its own follies and that it cannot draw unlimited checks on the future to solve its present problems. 
These are most of the conditions that Hayek places on minimum welfare… in Chapter 19. There are other necessary conditions in other chapters and in other books. 

Let’s review the conditions in Chapter 19…
  1. Limited democracy condition. Because the free-rider problem is a real problem… we can’t trust votes on issues where people can put their hands in other people’s pockets. Demand is unlimited… which is why democracy must be limited. 
  2. Decentralized condition. Institutions improve when they compete for consumers. Take away consumer choice and you minimize the incentive for institutions to discover better ways to serve consumers.
  3.  Unbiased condition. Any welfare experts we rely on shouldn’t stand to gain by an expansion of welfare. 
  4. Fiscal equivalence condition. Benefits have to be directly tied to (opportunity) costs. Every allocation has an opportunity cost. There’s no such thing as a free lunch. If people can’t clearly see and feel what they are sacrificing… then it’s a given that, more often than not, they will suffer net losses. “Free” shoes aren’t worth the cost of shooting yourself in the foot.
  5. Individual valuation condition. People don’t all have the same values, priorities, preferences, circumstances, goals, concerns, hopes, dreams and desires. Nobody can truly fathom the complexity of human variety. But this doesn’t mean that it doesn’t exist. Progress depends on difference…. so overriding human variety is a fatal conceit that will certainly harm humanity as a whole.
  6. Proof condition. Anybody who wants a minimum welfare must prove that they lack a minimum welfare. Again, any and every allocation has an opportunity cost. More resources for the less needy means less resources for the more needy. 
  7. Limited unions condition. The efficient allocation of labor depends on wages accurately communicating where labor is most needed. When unions, via coercion, prevent wages from doing their job, the logical result is that labor will be inefficiently allocated. The point of wages isn’t to compensate… it’s to communicate. When coercion is used to change the information that’s communicated, it results in a garbage in, garbage out (GIGO) situation. Labor is misallocated and the harm to everybody greatly exceeds the benefit to the few.  
  8. No minimum wage condition. Same reasoning as with unions. 
I suppose we could argue back and forth whether these were strict conditions. Maybe they weren’t all deal breakers. Maybe none of them were deal breakers. Maybe they weren’t strings attached. Maybe they weren’t conditions or clauses. Maybe they were just concerns. Maybe they were just mild concerns. Maybe they were just frivolous concerns. Maybe they are truly minor details. 

But this debate would really miss the point. The point is that Hayek’s support for a minimum welfare really didn’t exist in a vacuum. It was a part of a really powerful picture. Unfortunately, I don’t have the skills to really do the picture justice. Hence the quotes. Needless to say, Hayek’s picture of government is fundamentally different than the current picture of government. 

Hayek’s picture is so powerful because it shows us a world in which the need for a minimum welfare is truly minimized. Minimizing the need for welfare can be accomplished by maximizing opportunities. The greater the quantity and variety of opportunities that people have… the lesser the role for welfare. 

Perhaps it’s easy to think of welfare as a way to increase the opportunities available to people. But, there’s a fundamentally important distinction between opportunities that have been sponsored by consumer choice… and those that haven’t been. I’ll borrow Bastiat’s classic example. The government could sponsor the opportunity for people to get paid to dig unnecessary ditches. But what consumer in their right mind would choose to sponsor this opportunity? If you’re going to pay somebody to do something… then why not pay them to do something that you benefit from? Why pay for an unnecessary ditch when you can pay for a necessary ditch? Why pay for an unnecessary bridge when you can pay for a necessary bridge? Why pay for an unnecessary war when you can pay for a necessary war? 

Because consumer choice is missing from the government, diverting resources from the market to the government means hurting consumers. But, since we live in a democracy, it’s actually the consumers that hurt themselves. 

Consumers distribute resources. Voters redistribute resources. Voters override the spending decisions that they made as consumers. They buy a loaf of bread for $4 dollars and then reach into the register to take $1 dollar out and put it back into their pocket. Is it an after-purchase discount? Is it a democratic rebate? Is it buyer’s remorse? Is it theft? The morality isn’t the issue… as usual the real issue is abundance. When consumers use votes to change their original answers… the production shifts accordingly. There’s less bread and less opportunity for workers to help make bread… which is a problem if consumers truly wanted more bread. 

Who should we trust… Dr. Jekyll or Mr. Hyde? Do we trust consumers or voters? Do we trust people’s spending decisions… or should we trust their voting decisions? Should we trust their actions… or should we trust their words? According to the free-rider problem… we really shouldn’t trust their voting decisions. The free-rider problem is the best argument for compulsory taxation and limited democracy. 

The desire to maximize benefit has two sides… a good side and a bad side. The goal is creating an environment which maximizes the Dr. Jekyll and minimizes the Mr. Hyde… 
If man is not to do more harm than good in his efforts to improve the social order, he will have to learn that in this, as in all other fields where essential complexity of an organized kind prevails, he cannot acquire the full knowledge which would make mastery of the events possible. He will therefore have to use what knowledge he can achieve, not to shape the results as the craftsman shapes his handiwork, but rather to cultivate a growth by providing the appropriate environment, in the manner in which the gardener does this for his plants. There is danger in the exuberant feeling of ever growing power which the advance of the physical sciences has engendered and which tempts man to try, “dizzy with success”, to use a characteristic phrase of early communism, to subject not only our natural but also our human environment to the control of a human will. The recognition of the insuperable limits to his knowledge ought indeed to teach the student of society a lesson of humility which should guard him against becoming an accomplice in men’s fatal striving to control society — a striving which makes him not only a tyrant over his fellows, but which may well make him the destroyer of a civilization which no brain has designed but which has grown from the free efforts of millions of individuals. — Friedrich Hayek, The Pretense of Knowledge 
Democracy as it currently is, isn’t just tyranny over others, it’s tyranny over ourselves. We spend hours and hours shopping every week making the effort to research and find the best deals and reward the most beneficial producers and sponsor the most valuable opportunities… but then every couple years we spend a couple hours overriding all the consumption decisions that we made. We can’t see the difference in realities that our votes effect… but the difference is there. It’s reflected in the amount of welfare that’s truly needed.

Once we learn how untrustworthy Mr. Hyde is, then our reality will improve immeasurably, there will be an abundance of beneficial opportunities and the genuine need for welfare will become vanishingly small. 

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