Bryan Caplan July, 1993 * Outline of a Critique of Tyler Cowen's "Law as a Public Good" * 1. Summary of Cowen's Argument Many critics of free-market anarchism have argued that collusion rather than competition would prevail, making anarchism no more attractive than government. However, up to now very little attempt has been made to justify this claim. On its face, the idea that defense services are a natural monopoly is highly implausible, as David Friedman points out in his _Machinery of Freedom_. It is for this reason that Tyler Cowen's recent critique of anarchism is a major contribution to the debate. For in his "Law as a Public Good: the Economics of Anarchy," Cowen puts forward a powerful reason to buttress the view that collusion would prevail. There are certain industries, which we may call network industries, that have a peculiar feature: competing firms must also cooperate (to some extent) with their supposed competitors in order to be in business in the first place. Normally, competitors have no reason to trade with each other -- why should one supermarket have any dealings with another? But this is not always the case: in industries like credit cards, banking, and franchises, competing firms must also cooperate. The member banks of VISA, for example, all require the services of the VISA central computer, and all depend upon the acceptability of VISA cards in general. In banking, one vital aspect of the business is check-clearing done through clearinghouses: each bank must be willing to honor its competitors' checks and be willing to balance accounts via a clearinghouse. The case is similar with franchises: while individual restaurants don't need to contract with each other, all of them need to contract with the central McDonald's corporation, which in turn sets common standards. Well, so what? Why does it matter that in certain industries, competitors must also cooperate to a limited extent? The answer is that this industry structure can make collusion work. The usual checks on collusion are cheating and new entry. But a network can punish cheating by expelling non-colluders from the network, thereby putting cheaters out of business. Similarly, the network could refuse to admit new entrants, thereby preventing new entrants from getting into the business. The network short-circuits the market checks on collusion. The network could also solve other checks on collusion such as the hold-out problem: recalcitrant members could be punished by expelling them from the network. (A fourth problem -- which we may call the "division of spoils problem" -- is that it is difficult for colluders to decide who gets what cut of the monopoly profits. Large firms often favor the status quo, small firms want to grow, etc. It does not seem that network industries would have any special ability to solve this problem.) What does all this have to do with the viability of free-market anarchism? Cowen's answer is that the defense industry is a network industry. Just like the industries discussed earlier, defense firms must cooperate with their competitors (to a limited extent) in order to do their job. In the event of a dispute, competitors must agree to arbitrate with their rivals in order to preserve peace. (Moreover, all of the advocartes of anarchism have forcefully argued that any sensible businessman would do precisely that.) But the very possibility of peaceful cooperation between competitors indicates that we have a network industry on our hands; and such a network, immune to the usual checks against collusion, is likely to suppress competition in the mutual interests of the members. In particular, since the defense industry, taken as a whole, has a near-monopoly on force, the entire society would be in danger should the various firms in the industry succeed in colluding. The united defense industry could do whatever it wanted. Anarchy would be transformed in a state of the worst sort. So much for describing Cowen's theory. It has, I believe, a number of gaps in it; moreover, these gaps, while not individually decisive, add up to a fairly strong critique. As a caveat, these points are somewhat speculative, and I would not commit to them without further research on network industries in general. Let us explore each of these points in turn. 2. Competing Networks First of all, Cowen neglects the possibility of competing networks. Granted, that collusion within a network can work; but is it the case that every industry with network properties automatically gets just one network? One obvious counter-example is the credit card industry. VISA, Mastercard, Discover, American Express, and other competing issuers exist. Some of these, like VISA and Mastercard, are actually just networks for member banks who do the real work of issuing the credit cards; clearly, the credit card industry has strong network features. But nevertheless, competition exists. Now it is quite possible that the intra-network competition that exists is due to the influence of the antitrust laws; if VISA tried to set common interest rates and annual fees for all VISA card issuers, it might find itself in court. But inter-network competition seems to be standard, uncoerced competition. You might reply that the competing networks of credit card issuers don't need to deal with each other, whereas competing networks of defense firms do. I'm not sure if the premise is correct; I suspect that VISA and Mastercard accept payments from one another and have other dealings with each other. But in any case, once we are down to a fairly small number of firms, it is possible to cooperate without a mega-network. With a small number of firms, bilateral contracts or even simple repeat can more than suffice to yield cooperation. Yet this form of cooperation doesn't seem to lend itself to the attendant collusion that Cowen discusses, since there would be no monolithic network to punish non-colluders; there would only be six, eight, ten, or twenty roughly equal bargainers trying to reach a limited understanding. To punish non-colluders would be to provide an uncompensated public good to the industry as a whole. 3. Two (Inconsistent) Systems of Belief About Private Supply of Public Goods; Self-Interested vs. Altruistic Boycotts Cowen rightly points out the contradiction between two widely- held libertarian beliefs: first, that collusion is impossible; second, that voluntary efforts can solve the public goods problem. Clearly, since the former is just a species of the latter (collusion is a public good for all members of an industry) the beliefs are incoherent. Right? Well, not necessarily. Let us distinguish between two kinds of boycotts: self-interested and altruistic. A self-interested boycott might be a boycott against cheaters or thieves. Once you learn that a person is a cheat or a thief, you don't need to be coerced to get you to respect the boycott: it is in your interest. We may contrast this with a boycott again, say, uncharitable people. Just because someone is uncharitable doesn't make them worse customers. A boycott like this would indeed need coercion (or at least strong ideological motivation) to work. This distinction shows a problem with one of Cowen's arguments. As he puts it, "If the network can implement successful sanctions against outlaws, however, the network can also implement successful sanctions against potential competitors. If punishing potential competitors is too costly, punishing outlaws is too costly." (p.259) However, punishing outlaws is surely a self-interested boycott: dealing with them is likely to get you or your employees killed. But punishing collusion is an altruistic boycott: it benefits the whole industry, not the individual firm doing it (which actually loses out by refraining from a profitable trade). Since collusion is rarely the kind of thing motivated by ideology, coercion would be necessary to make it work. The theory that boycott can squelch open violence and outlawry without facillitating collusion is therefore consistent. As an aside, it seems to me that what Cowen refers to as a "suspension of quality competition" (p.259) is actually an aspect of quality, since it brings about the peaceful and orderly settlement procedure that customers want. And it should probably not be thought of as collusion, since by conforming to common standards the firms benefit themselves by benefiting their customers, not by hurting them. It is also not collusive in another sense, since the firms that cheat would actually hurt their interests. A self-interested boycott is all that is needed to enforce adherence to common rules of law and procedures. 4. Networks by Degrees A closely related problem is that Cowen seems to think that being a network industry is an all-or-nothing thing. But in reality, industries have network properties to varying degrees; there are strong networks and weak networks. In general, the stronger a network, the easier it will be for it to make not only self-interested but also altruistic boycotts stick; and the weaker a network, the more it will have to rely on self-interested boycotts and despair of the use of altruistic ones. Let us take a few examples. Credit cards seems to be a great case of a really strong network industry. It would be impossible for a single bank to enter the market on its own and try to set up a new credit card. It would have to negotiate with millions of establishments to accept its card, build up a customer base, get a central computer to process claims swiftly, and so on. For this reason, banks must issue their cards via a network that takes care of these problems for it. And if a network became displeased with a bank, it could expel it from the industry by simply expelling it from the network. In sum: the network could apply a stinging sanction to members who didn't take part in an altruistic boycott (e.g., to enforce collusion), so it could probably make such a boycott work. From personal conversation, I learned that Cowen thinks that banks are another strong network industry. I am open to the possibility, but it doesn't seem too likely. Clearing checks is only one of the many things that banks do; a bank could continue most of its activities no matter what the network (in this case, the clearinghouse) threatened. Moreover, this seems like another industry in which competing networks are quite feasible: there might be twenty regional clearinghouses that settle their accounts with each other via bilateral contracts, or just by repeated relationships rather, rather than with a meta-network. In fact, unless the history books lied to me, the free market prior to 1913 obstinately refused to produce a national clearinghouse, so the Federal Reserve Act had to create one by law. How did clearinghouses handle inter-regional clearing before the Fed? I don't know, but I guess that they handled it by bilateral contracts. Now maybe at that time, clearinghouses were local natural monopolies; but in modern times, especially with new communications and computer technology, it seems that banks could easily contract with any willing clearinghouse to represent its interests, regardless of its location. So the likelihood that banks could organize an altruistic boycott (e.g., to enforce collusion) seems low. To take a third instance, consider professsional associations. It is hard to be an economist without joining the AEA. Yet the AEA hardly seems to have effectively enforced collusion in, say, hiring -- even though it would probably have fewer antitrust problems than a for- profit firm. Why is this? I would suggest that professional associations are a weak kind of network: if they tried to impose costs on its members, the consequences of withdrawal would not be very severe for the withdrawers. Members with tenure, for example, might just laugh. Most of the benefits that the AEA provides -- a place to meet and discuss -- could be carried on with some inconvenience outside of the network. It seems highly unlike that anything more than self- interested boycotts could work in such a network. In sum, then, networks vary in strength from strong to weak; and while all networks can easily apply self-interested boycotts, it takes a fairly strong network to enforce altruistic boycotts. 5. Factors Tending to Make a Network Strong or Weak Now let us consider the crucial question: would the defense industry be a strong or weak network? This is somewhat related to the question of competing networks, but it is sufficiently different to be worth discussing on its own. What factors contribute to the strength or weakness of an industry's network structure? This another area where I would like to do more empirical research, but I have some preliminary ideas to throw out. It will be noticed that typically, the same factors that make a network weak also make it more likely that there will be no network at all, but instead a lot of bilateral contracts. a. Let us call the first factor "the degree of interrelatedness" for want of a better term. The intuitive idea this that in some networks, every firm has dealings with every other firm in virtually every time period. In banking, for example, every bank has checks going to or from a huge number of other banks. In a professional society, in contrast, members might only deal with a small fraction of the membership. It seems likely that the higher the degree of interrelatedness, the stronger the network. b. Closely related is the "lumpiness" of inter-firm relations. If firms deal with each other rarely but their deals are large, bilateral contracts and the like may work better than a network. In contrast, a large number of small deals make a network more efficient. We can think of the same fact in another way. If deals are lumpy, then a network would involve wasteful transactions costs, since every firm would be paying to make it possible to deal with every other firm, even though such deals rarely materialize. In contrast, if deals are less lumpy, firms waste transactions costs by negotiating a new deal with each trading partner. c. Networks that provide services vs. networks that just coordinate cooperation. The VISA corporation has a giant supercomputer that processes the hundreds of millions of monthly VISA transactions at a very low per unit cost. No individual member could afford/find it profitable to buy such a computer. VISA also invests in a brand name, common advertising, etc. In short, there is something more this network than just the members: there are common resources that the network as such owns, and which it is uniquely able to supply. In contrast, other networks have few or no common resources; instead, they just coordinate the cooperation of the members. A professional association is probably a good example: it doesn't supply its members with anything significant; it just solves the coordination problem by announcing a single time and place for gathering, letting people spread information, and so on. Networks that provide services are probably much more able to enforce altruistic boycotts than networks that just coordinate cooperation. d. The extent to which inter-firm cooperation is based on consciously-designed terms vs. evolved traditions. The VISA corporation is an enormously complex, designed institution. It was consciously worked out to solve certain problems, and appears to require fairly frequent modifications, modernizations, and so on. In contrast, some kinds of cooperation are based more on tacit, evolved understandings -- e.g., don't use violence first, be polite, reciprocate favors. Networks based on explicit design are probably stronger, since they are the only cheap remedy for high transactions costs. But if cooperation is based largely on evolved tradition, then the network is likely to be weaker; tradition in a sense substitutes for formal (and costly) negotiation. e. The extent to which firms have other activities for which the network is unnecessary. Credit card issuers simply can't do business unless they are in a network; but members of professional societies, banks, and other network industries do a lot of non-network things too. Banks, for example, could still take savings and make loans even if they broke with their clearinghouse; professionals could still get jobs even if they didn't attend conventions, and so on. The more non- network substitute lines of business the firms have, the weaker their network will be. f. The final point is not so much a point about the power of a network, but rather a point about how likely a network is to use whatever power it has. Some kinds of collusion are easier to enforce than others: if the product is homogeneous, monitoring is cheap, and so on. With heterogeneous products and expensive monitoring, collusion may not work even if the power to enforce it exists. (See section 3 for why this factor preventing collusion wouldn't similarly prevent all order.) For example, malls forms a kind of network: no store can trade in a mall unless they have the permission of the mall owners. Now since the cross-elasiticities of demand for the goods sold in different stores are probably significant, it is clear that in theory all of the stores could make money money if they colluded (a little bit -- otherwise people would go to a different mall); and since they are in a common network, this would be feasible. But to my knowledge, no mall does this. Presumably, goods are too heterogeneous (clothes substitute for each other, but there is a huge variety of types of clothes) and monitoring costs are too high (prices need to go up and down, it would take a lot of watchdogs, etc.). Perhaps there are other factors, but I can't think of any right now. 6. The Defense Industry: Strong or Weak Network? Given this rough outline of factors tending to increase and decrease the power of a network, where does the defense industry wind up? I think that it winds up on the low end in almost every case. a. Degree of interrelatedness. Most crime is local; and most international crime consists in the drug trade and other activities that would presumably be legal in an anarchist society. So it is likely that each defense firm will have almost all of its dealings with other local firms. L.A. might have, say, 20 firms, each of which would have to arbitrate many conflicts with each other; but they would probably have very few conflicts to work out with Boston firms, since very few criminals travel from Boston-L.A. to commit crimes (or vice versa). Cowen himself concedes this point without admitting its full significance: "international criminal and legal relations are a very small part of the activities of, say, the American and Canadian governments. The benefits of forming a world government to more efficiently deal with Americans who murder Canadians are relatively small." (p.263) International crime is a minor problem because inter-local crime in general is a minor problem. If most crime is local, then networks (if they exist) will probably be local too, so at least a national monopoly wouldn't arise. Moreover, free entry would be harder to deter if whatever collusion existed were local, since the possibility of massive retaliation would not be present. It would not be the System vs. a lone rebel firm, but a conflict between roughly equal networks who would prefer live-and-let-live to fighting. b. Lumpiness. Again, this seems to hold. Once you consider only crimes with victims, you will be surprised to find out how few crimes there actually are in each locality. Moreover (and this is perhaps an aspect of lumpiness), each alleged crime is likely to be different from every other: particular circumstances of time, place, evidence, witnesses, and so on must be considered to reach the outcome. It is unclear why a network's transactions costs would be lower than if two firms just worked it out for themselves. In contrast, the transactions costs of highly standardized credit card deals can be reduced a lot by a network, since they can all be treated alike. The VISA central computer handles millions of transactions, each of them nearly identical; it average transactions costs are much lower than if each firm did it. But it is difficult to see how a central trial system would resolve cases at lower costs. (Maybe if Landes&Posner were right that providing efficient rules of law is a pure public good would this be the case. See my thesis "The Economics of Non-State Legal Systems," sections 3.1-3.8 for my doubts.) c. Would defense networks provide services or just coordinate cooperation? Since the main thing that the network is supposed to do is create orderly channels to resolve disputes between clients of different firms, it seems like the defense network's chief business is the second. Cowen points out that criminal files, extradition rights, and the like might be provided by the network. Quite possibly, but it still seems like the defense network mainly tries to reduce the transactions costs that firms would incur if they all made bilateral contracts with each other. d. Would industry standards be designed or evolved? To a large extent, the latter. We have a huge body of customary and common law, business practice, and so on; we also have widespread adherence to some simple norms of conduct. So I think that the standards for inter- firm relations would be basically set by our traditional practices: not starting conflicts, compensating the injured, fair trials, and so on. This is just a big parts of our cultural background and no one (in their private role, anyway) really wants to re-negotitate it. So the network's contribution to reducing transactions costs wouldn't be that big. There might be some designed aspects that would require formal (and high t.c.) negotiations, but we may reasonably doubt thir extent. It seems likely that designed innovations would be largely intra-firm. e. Extent of other activities. Defense firms would do a lot besides work out trials of accused criminals. They would patrol areas, guard buildings, walk people home, check out false alarms, and supply a long list of other defensive services that people would want. This bodes well for anarchy for two reasons. First, the power of the network is less when firms have easy substitutes lines of business. Second and more importantly, even if Cowen were entirely right about the collusive tendencies of the arbitration side of business, that would be just a tiny sub-market in the broader defense industry. The weapons would not be monopolized, because only one part of the defense industry would tend to monopoly/cartelization. And if that sub-market started to act like a state, people would still have many defensive alternatives. f. Heterogeneity and monitoring costs. To begin with, is clearly easier to enforce rules against violence and stonewalling than it is to enforce collusion; the former would be a self-interested boycott, the latter an altruistic one. Violence is more obvious than non- collusion. And given differences in location, quality, market niche, and so on, heterogeneity could be a big carrier to collusion even if the general Cowen picture is correct. 7. Ideology: Deus ex Machina? Cowen argues that to use libertarian ideology to prevent his scenario is just a deux ex machina. Perhaps. But suppose that it were argued that ideology is also necessary sustain government. Many social theorists have said as much (Hume, la Boetie, Hayek, Mises, and lots more). In this case positing libertarian ideology as one check on abuse of power becomes more reasonable. As I suggested in conversation with Cowen, people seem to behave "altruistically" ("ideologically" might be a more neutral word) in one sphere of life but not the rest. In their role as private individuals, people give huge amounts of money to charity. But very few businessmen run their businesses like charities, even if they are charitable people. (Even there, though, most people wouldn't murder for a living, even if the pay were good.) Perhaps this is a way to solve Cowen's paradox, that if private supply of public goods works, then collusion works, and if collusion doesn't work, then private supply of public goods doesn't work either. If people are (somewhat) ideological qua private individuals, but profit-maximizing qua businesspeople, then both good results (non-collusion and private supply of public goods) can spring from the same group of people. Another related observation: While in their business roles people are probably less charitable than in their private roles, most businesspeople still feel somewhat constrained by morality. Most wouldn't murder or steal to increase profits. In a way, the business role tends to relax some, but not all, of the moral constraints that they feel as individuals. (Not that this is a bad thing -- I agree with Milton Friedman that managers should be charitable with their own money, not their stockholders'.) Compare this to the governmental role: this seems to relax almost all of the moral constraints that people feel. It is a truism that the gentlest people will kill for their governments; but how many would kill for their employers? So perhaps this is another reason (and not just a deus ex machina) to think that ideological constraints on abuse of power would work better in an anarchist society. 8. My Picture of Anarchy Let me outline my picture of the defense industry in an anarchist society, to contrast it with Cowen's. There would probably be a middling number (10? 20? 30?) of weak networks; the networks would be bound to each other by bilateral contracts. Basic standards like adherence to peaceful and orderly procedures, willingness to negotiate, fair trials, and so on would be enforced by self-interested boycotts. Collusive standards, in contrast, would probably be too hard to enforce for all of the reasons suggested. It also seems likely that local firms might have more precise and detailed contracts with each other, since most crime is local in nature. The incentive to form networks above the local level would come from the desire for extradition and the like. This is a pretty minor benefit, but probably worth pursuing. (After all, ostracizing dangerous criminals is another sort of self-interested boycott.) Peter Kurrild-Klitgaard suggested to me that there would be many overlapping jurisdictions, and I am inclined to agree with him. The worst that could happen is that the criminal arbitration side of business would become a collusive network; but this would still leave open competition and protection from well-armed firms in other lines of business that have no need to network with each other (as I suggested: armed guards, patrols, etc.). But that is not too likely; not only are internally collusive but externally competing networks possible; but for the reasons stated above, the networks are likely to be too weak to enforce internal collusion either. Admittedly, this is a speculative picture; but so is Cowen's. Precise predictions of market structure are not forthcoming, but some predictions make more sense than others. Despite my view that Cowen's critique of free-market anarchism is the best yet, I must say that his prediction is much too pessimistic.