Economic Arguments for Government
Econ textbooks have a standard list of economic arguments for
High transaction costs
The most recent addition: irrationality.
From a comparative institutions perspective, these are unconvincing. After all, all of these “market failures” can
and do afflict governments, too.
Some would argue that these problems are actually worse for government.
Monopoly: How about the two-party system?
Imperfect information: How about voter ignorance?
Public goods/externalities: How about sensible voting as a public good?
High transactions costs: Look how hard it is to “buy out” teachers’
unions, turnpike workers, and kleptocrats.
Irrationality: Isn’t voter irrationality vastly worse than consumer or
It is particularly hard to wean economists away from the public goods
rationale for government. (In fact, it
is a struggle to get economists to stop equating “government spending” with
“spending on public goods”!)
The source of its appeal: The intuition that, “Public goods problems
don't solve themselves."
The Paradox of Public Good Provision
Isn't monitoring the government to act in socially beneficial ways
itself a public good?
The Paradox: If citizens can voluntarily produce the public good of
monitoring government, why can't they solve other public goods problems without
government? If they can't voluntarily
solve this problem, what reason is there to expect government to improve matters?
Cowen and Kavka (2003) offer several solutions to this paradox:
The tying hypothesis. This is
very similar to the stationary bandit model: As long as leaders have a
reasonably long time horizon, socially beneficial policies are a private good for government leaders.
Altruism and noise hypothesis.
Governments can leverage a small initial altruistic donation. “The establishment of a government… may
require a smaller number of acts of altruistic support than non-monopolistic
mechanisms for producing public goods would require. Unlike a competitive firm,
once a monopolistic government obtains a certain amount of initial support, it
can use its monopoly power to induce continued support in the future.”
Bootstrap hypothesis: Support for government is really a coordination
game, not a Prisoners’ Dilemma, because if most people support a state that
provides public goods, it is selfishly optimal for you to do so as well.
From discussion with Tyler: Unless anarchy is better than government,
government must on net produce public
Are the Functions of the Night-Watchman
State Really Public Goods?
OK, so what about anarchy?
If you remain dissatisfied with democracy,
reject constitutional reform (even futarchy!) as a solution, and abhor
dictatorship, anarchy is all that’s left.
There is a surprisingly large economic
literature on the possibility of “free-market anarchism” or
“anarcho-capitalism,” beginning in 1849 with Gustave de Molinari’s article,
“The Production of Security” in the Journal des Economistes. See
Stringham’s Anarchy and the Law for a broad survey.
Lasalle was not imagining things when he attacked, “Those modern barbarians who
hate the state – not this or that state, not this or that state-form, but the
state altogether. And who, as they now
and again have clearly admitted, would most prefer to abolish the state, auction
off justice and police to the cheapest suppliers, and have war run by
joint-stock companies, so that there should nowhere in all of creation still be
an ethical point from which resistance could be offered to their capital-armed
mania for exploitation.”
Our analytical procedure: Start with the functions
of the night-watchman state (NWS) – dispute resolution, rule formation, and
enforcement – and work backwards.
Specifically: What aspects, if any, of these
functions are really public goods?
Dispute Resolution as a Private Good
Two people have a contract dispute. The night-watchman state takes it upon itself
to adjudicate. For disputes it labels
“criminal,” the NWS goes further by handling the prosecution.
Where is the public good? Why
couldn’t the parties (or their insurers) simply put an arbitration clause in
their contracts, which the night-watchman state enforces? And why does the NWS have to handle the
Hard case for arbitration: complete
strangers. Night-watchman state could
still minimize its role by compelling defendant to choose from an approved set
Hard case for private prosecution: indigent
Rule Formation as a Private Good
The NWS also takes it upon itself to pass civil
and criminal laws.
Where is the public good? Private
arbitration firms could (and to some extent already do) ex ante woo customers
by offering the most efficient set of rules.
Efficient rules give parties incentives to
maximize joint wealth of signatories, factoring in expected cost of disputes.
Landes and Posner argue that lack of intellectual
property rights in precedents leaves little incentive for rule formation.
In practice, though, public courts often defer
to expert judgments of arbitrators.
Intellectual property rights in rules could be strengthened, and
non-patent incentives are often effective.
Enforcement as a Private Good
The NWS also tries to monopolize enforcement.
Where is the public good? Once an
arbitrator makes a decision, why can’t it be enforced by ostracism, bonding, or
private security guards?
An unconventional solution to the problem of
indigence and crime: indentured servitude and private prisons.
NWS could again mechanically defer to
Moderate versus Radical Privatization
To a surprising extent, markets already share
the supposedly exclusive turf of the NWS.
Arbitrators’ codes of rules
It would be easy to drastically expand the role
of the market in these areas, while leaving the state as the final
authority. Let us call this moderate privatization.
But this is hardly an alternative to government,
because the state remains – and decides how far the alternatives are allowed to
What about radical
privatization - getting rid of the last remnants of the NWS state?
What would this even look like? Standard picture:
Individuals subscribe to services of a defense
Defense firms arbitrate their disputes in
Private courts issue monetary judgments.
Reliable people unable to pay their debts have
their earnings attached.
Others, especially criminals, become indentured
servants and work off their debt in private prisons that bid for inmates.
Main Objections to Radical Privatization
Obviously, free-market anarchism is not a
popular proposal. What are the main
"Externalities of defense services.”
Reply: These have more to do with current policy
than the nature of the product. If police only help paying customers, if
judges charge for adjudication, if victims who prosecute win restitution, where
is the externality?
Turnaround: Government defense has lots of
externalities. Bureaucrats who make the world safer get paid the same as
those who don't. Oftentimes "crusaders" become very popular by
causing the crime they claim to be fighting (e.g. Prohibition).
"It would lead to violent chaos."
Reply: Why? It is cheaper to negotiate than to
fight, especially since police companies repeatedly interact with each other.
Also, police company employees, unlike conscripts, have to be paid more for a
Turnaround: Existence of government leads to
wars, which are far more serious than police agency shoot-outs because
governments control the resources of the whole society.
One strong agency would take over and become the
new government." (Alternate version: Agencies would merge until they had a
Reply: This would only be possible if there were
a large MES relative to the demand for defense services. In the current U.S.,
there are already about 10,000 security guard companies, so there is little
reason to fear the dominance of one strong agency.
Turnaround: A much bigger risk from governments,
since their MES is much larger than for mere police agencies.
“Police agencies would build up demand by
defending their clients to the death."
Reply: This would create a severe "adverse
selection" problem, just like the one that insurance companies face. If you announce that you will protect your
clients to the death, you encourage high-risk, lawless people to hire you,
raising your costs enormously.
“People would have no incentive to prosecute
Reply: Monetary restitution provides the
incentive; the ability to impose indentured servitude ensures that almost all
convicted persons will be solvent.
Turnaround: This is true today: the only
incentive of victims to cooperate with prosecutors is desire for revenge. E.g.
rape victims are often better off staying quiet.
“Criminals would be over-punished."
Reply: In many ways, profit-making prisons would
be more humane: there is an incentive to protect the safety of workers, to
separate workers by size and strength, and to provide useful job training.
Legal codes could incorporate prisoner protection as well.
Turnaround: Numerous non-violent offenders are currently
sentenced to harsh prison conditions.
Cowen, Anarchism, and Collusion
Tyler Cowen has a novel objection to free-market
anarchism: Defense is a network industry. Collusion is relatively easy to orchestrate
in such industries due to the threat of expulsion.
There might seem to be a lot of firms, but for
practical purposes there will only be one.
In such industries, some forms of collusion
(relating to product standardization) are actually beneficial; but this opens
the door to the traditional forms of inefficient collusion (like price-fixing).
According to Cowen, this leaves basically two
Case 1: Transactions costs are low enough to
make collusion work. Then both the
efficient and inefficient forms of collusion thrive. The public faces a profit-driven monopoly defense
firm, a great example of Hobbes’ Leviathan.
Transactions costs are too high to make collusion work. Then neither the efficient or the inefficient
forms of collusion appear. The public
faces chaos, a great example of Hobbes’ “state of nature.”
Stringham and I reply to Cowen in the RAE.
Main argument: Cowen conflates coordination problems with prisoners’
Product standardization is a coordination
problem. Once firms expect certain
standards to prevail, it pays to conform.
Price-fixing, extortion, etc. are prisoners’
dilemmas. If other firms are changing
high prices and mistreating customers, it pays to stay honest and gain their
Historically, network industries do not seem to
have been especially able to achieve collusive outcomes, but they have solved a
lot of coordination problems:
After anti-trust: Credit cards
Before anti-trust: Clearinghouses
What about national defense? Isn’t that clearly a public good?
Answer: It depends. “National defense” is not a public good for
the world because if no country had
“national defense,” no country would need it!
Implication: Countries’ “national defense”
programs are often a public bad – and the losers typically include their own
Simplest reply to the national defense
objection: Our country’s national defense is a public bad, and both we and the
rest of the world would be safer without it.
This argument became far more convincing after
the fall of the Soviet Union.
Still, how would a free-market anarchist society
defend itself against invasion by an aggressive state? Surely that
would be a public good.
Voluntary charity. Members of the anarchist society could
volunteer both money and their labor to defend their society from attack.
A successful anarchist society would have many external sympathizers,
making it difficult to rationalize aggression.
Look at how little the capitalist world did to crush the Soviet Union in
If this seems naïve, consider a Tullockian
challenge: “Give me one good reason not to invade Brazil.”
The Transition Problem
The biggest challenge to anarcho-capitalism: The
transition problem. How do we get from
here to there?
Most radical movements consider violent
revolution. But even if this were
feasible, what are the odds that violent revolution would create a freer society, much less a free society?
David Friedman’s quip: “Revolution is the hell of it.”
From a libertarian point of view, most
revolutions are a complete disaster. Even
the American Revolution is greatly overrated by libertarians – government
didn’t really shrink, and the rights of slaves and Indians would have been
better protected by the British.
Question: Are revolutions a good example of the
Other options are viable for marginal change,
but offer little hope of radical change in the foreseeable future:
Infiltrating the political system to take
advantage of slack
Coordinated movement to change the median voter
(e.g. the Free State Project)
What about just creating a new society?
“Create your own country” projects end in
failure or conquest by neighboring old country.
Paul Romer’s solution: Charter cities
Patri Friedman’s solution: Seasteading
My case against fatalism: Radical change is very
difficult to achieve, but what sensible person ever thought otherwise? To quote Tollison, “We’re all part of the
equilibrium.” You can still make a
marginal difference – and do good while doing well.