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The Receding Case for Government Intervention
by Daniel B. Klein and Fred E. Foldvary
The justifications for many public policies are dissolving as technology advances. New detection and metering technologies being developed for highways, parking, marine farming, and auto emissions make property-rights solutions viable. Information becomes more accessible and user-friendly, suggesting that quality and safety are better handled by the private sector, undercutting consumer-protection rationales. As for public utilities, new means of producing and delivering electricity, water, postal, and telephone services dissolve the old natural-monopoly rationales for control and governmental provision.
Most market-failure arguments boil down to claims about market mechanisms being blocked by transaction costs. But technology has trimmed transaction costs and made the old rationales for government intervention increasingly obsolete. Obstacles to exchange or competition depend on the state of technology. For example, electronic technology has made it simple to charge motorists for highway use.
Besides trimming transaction costs, technological advancement accelerates economic change and multiplies the connections between activities. It brings fundamental upsets to even our best understandings of current arrangements and their shortcomings. Thus, by making the economic system ever more complex, technological advancement makes the notion that regulators can meaningfully know and beneficially manipulate the system ever less credible.
Technology makes it easier to charge users, define and enforce property rights, exit and utilize substitutes, gather information, gain assurance of quality and safety, and enter and compete in markets. We argue that technological advancement tends to enhance the case for free enterprise policy. It reduces the strength of market failure arguments and therefore reduces the case for intervention.
Our conclusion is bolstered by a second line of argument. Technology heightens the complexity of the economic system. The more complex a system, the less knowable it is. If government cannot know what it is dealing with, it probably cannot intervene beneficially.
Technology and Market Imperfections
The invisible hand, the nexus of voluntary social mechanisms, may fail if transaction costs are too high, obstructing gainful exchange. But better technology can reduce those costs. Applications of market failure theory may be found to have a technological “half-life,” after which their validity dissolves.
Some claim that the advantages of reduction in transaction costs may not be limited to entrepreneurs, arguing that, just as technology enhances the knowledge and capabilities of private entrepreneurs, so it enhances the knowledge and capabilities of public-spirited regulators and officials. No doubt there is much to the claim that government becomes more effective because of technology. Government agencies can, like private entrepreneurs, run highways as toll roads. On the other hand, government regulation introduces noncompliance problems and requires costly enforcement. The case for government regulation gains strength insofar as technology facilitates government monitoring and enforcement.
However, if both free enterprise and the government are technically capable of, for example, producing tomatoes, we assert that the sheer incentive argument recommends free enterprise. Good government itself is a public goods problem;1 government often fails to do the good that it is technically capable of doing. The free enterprise system, on the other hand, generally creates for its participants incentives to pursue what is good for society. The incentive advantage recommends free enterprise, given technical and institutional feasibility.
Technology and Property Rights
New technology is making it increasingly possible to define and enforce property rights and to charge for the use of property. The following are examples of this expanding capability.
Highways and parking
Until recently, charging for highway use or parking space entailed significant transaction costs, such as delays and inconvenience for motorists, the handling and securing of bulky cash, and costly or unsightly toll booths or parking meters. In recent years, these difficulties have been lessened considerably. On highways with electronic tolling, the charge is automatically recorded as the car rolls by, with no need to line up and stop. Highway users can now pay highway tolls as easily as they pay a monthly phone bill, weakening the case for operating highways as “freeways” and strengthening the case for privatization.
Street parking is another service that entrepreneurs can charge for. Modern parking meters no longer require coins for fixed periods of time, but can electronically vary the charge and dispense with time restrictions. New in-vehicle meters with LCD displays operate like pre-paid phone cards; anyone with curb space to rent could do so without even erecting parking meters. One could imagine turning on-street parking space over to private entrepreneurs or adjoining land owners, to rent by the minute using high-tech meters.
The foundation for the invisible hand is private property rights. New technologies are enhancing the ability to define, secure, trade, and enforce private property in marine resources. Just as ranchers and cattlemen in the American West secured and built up their property with such innovations as branding and barbed wire, today entrepreneurs can do likewise in oceans with the technologies of livestock herding, “fingerprinting,” tagging, sonar searching, satellite tracking, habitat creation, fencing, gating, and guarding. Technology has strengthened the intellectual case for aquatic farming and ranching.
Common law has traditionally treated air pollution as a nuisance. That approach accords with a policy made feasible by the technology of charging for pollution. For emissions from cars, the sensor technology developed by Donald Stedman measures pollution levels in the exhaust. When coupled with automatic license plate readers, the technology enables officials to send gross-polluting motorists a pollution bill. A direct approach in which the polluter pays is much more efficient than command-and-control methods such as smog-check programs, alternative-fuel requirements, electric vehicles, and mandates on automakers. Although remote sensing is a program for regional governments to undertake, it is nonetheless a property-rights approach to the problem: It protects the public air resources from violation and leaves non-violators undisturbed in the use of their own property. It is analogous to protecting public buildings from graffiti by setting up video surveillance of the buildings, rather than by placing restrictions on who can buy spray-paint and permanent markers at the local hardware stores.
Technology and Quality and Safety Assurance
Many “consumer protection” interventions suppose that quality and safety assurance cannot be adequately provided by voluntary practices and the tort system. Consumers suffer from imperfect or asymmetric information, which makes for transaction costs in marketplace decisions. Because the cost of overcoming consumer ignorance is high or even insurmountable, consumers are vulnerable in a free market to false representations of quality and safety. Services that are hired only infrequently or are especially hard for non-specialists to understand need to be restricted according to government approvals and permissions. This line of thinking justifies the Consumer Product Safety Commission, the Food and Drug Administration, the Securities and Exchange Commission, the National Highway Traffic Safety Administration, the Occupational Safety and Health Administration, and local and state occupational licensing, business licensing, and housing codes.
As consumers demand assurance, however, voluntary market processes also are capable of finding ways of supplying it. Service providers assure quality and safety by building and conveying a good reputation. They obtain certifications and seals of approval, seek affiliations with trusted sources, and develop a brand name. Consumers, for their part, also look to rating or recommending agents to ascertain reputations. All these methods and media depend on the generating, collecting, interpreting, formatting, storing, retrieving, and transmitting of information about service providers. Consider the following two examples.
Medical Services and Products
One area where consumers have a particularly strong need for quality assurance is in medical care. Here, too, information technologies are enhancing quality assurance. Computer technology, coupled with practice review and monitoring, have given hospitals, clinics, health organizations, and insurers new means of evaluating practitioner performance. These institutions function as certifiers. Furthermore, because of the Internet and other media, consumers themselves are more able to gain pointed expertise by learning of available therapies, tapping knowledge of fellow patients, and checking the credentials and affiliations of practitioners. The Internet provides consumers with both technical knowledge and assurances. Also, rating organizations can develop a good reputation for conveying accurate assessments of sellers and manufacturers. Using the Internet, consumers may look merely for the “thumbs up” (or seal of approval), read detailed reviews, or click to another vendor who provides better assurance.
Money and Banking
Electronic commerce can be extended to the private issuing of money, revitalizing the case to get rid of banking regulations. Critics of free-market banking suggest that the system would be marred by bank runs and panics, hyperinflation, embezzling, and counterfeiting. These would be significant lapses of quality. Yet banks today can meaningfully assure quality. Managing solvency and providing assurances of solvency are especially viable today. Up-to-the-moment financial statements and assessments can be generated and made widely available. Contractual arrangements giving banks options to delay redemption or withdrawal can be more easily posted, managed, and conveyed to worried depositors. Inflation and counterfeiting can be discouraged by rapid feedback mechanisms, such as adverse clearing. In an information age, reputation counts for more and therefore stays more current. Consumers can more readily be assured of safety.
Regulators claim that individuals suffer from an insurmountable ignorance about their own needs and the true quality of available options. We stress, however, that restrictions imposed in the name of quality and safety hamstring many important areas of business and everyday life. In every instance new technology is making claims of information asymmetries and consumer vulnerability less and less credible and proving that consumers’ demand for assurance elicits the development of methods of assurance.
Technology Dissolves Natural Monopoly Arguments
The so-called public utilities––water, sanitation, electricity, natural gas, telephone, and cable television––have long featured an interconnected network or grid, by which water, gas, or electrons are distributed from central sources to users throughout the community. The construction and operation of the distribution system involve large, irreversible up-front costs. Adding users to the system entails low marginal cost, and distributing product entails low current cost.
In this standard portrayal, a single distribution system continues to enjoy economies of scale as it adds volume over time. In a free market, the cost structure will, therefore, give rise to a single provider––a natural monopoly. The single provider may then charge high prices, produce low quantity and quality, and make excessive profits. Would-be competitors do not enter and bid down prices because, once they would have sunk investments into a competing system, the incumbent firm would lower its price and possibly bring losses to both firms. Hence, no one would be foolhardy enough to challenge the monopolist. Using this reasoning, regulators and interventionists have argued that government ought to supervise such utilities and control their prices.
Whatever the historical validity of the natural monopoly argument, it is clear that in many service areas new technologies have brought alternatives that belie the traditional assumptions about costs and integration requirements. Furthermore, rapid change itself complicates the problem of regulators and planners.
The recent electricity crisis in California was not the result of “deregulation” but, on the contrary, the restructuring of the industry that left in place restrictions on production, control, and pricing. Modern technology favors true deregulation of electricity. Increasingly viable is small-scale generation, powered by diesel, natural gas, or other fuels. On-site generators provide users––office buildings, factories, housing developments, or even single homes––with the option of creating their own self-contained loop. The costs of creating competing loops have also fallen by virtue of computer-controlled drilling and line laying, allowing workers to snake under streets and buildings without above-ground disturbance. Such developments dissolve the assumptions of high fixed and sunk costs. Entry and competition in the market would, in a free market, be very viable. Furthermore, technology has greatly advanced the possibility of combining electricity generation with steam power, heat, and air conditioning, and of combining electricity distribution with telecommunications, vastly complicating the job of any regulator attempting to improve upon the invisible hand.
Water and Sanitation
Technology has also made more viable the on-site recycling of water. Homes, developments, and businesses could, if permitted, choose not to hook up to the centralized utility pipes. The substitute for transporting massive amounts of water via the grid, both to and from users (the latter to deal with waste water), is to develop on-site systems. Such systems would inventory raw water, treat water according to a quality hierarchy for local uses, and then recover raw water from the waste for inventory and reuse. On-site water and waste treatment involves refinement, disposal, and replenishment. So-called gray water could be treated and used for landscaping, cooling, fire fighting, and sanitation. The small amount of water for sensitive human uses, such as bathing, cooking, and drinking, would be distilled to a purity and a safety that the current one-quality-fits-all water systems could not hope to match. The “black water” from toilets and kitchen-disposal units would be treated and disposed of via sewage, vacuum truck, or other method. Depending on recovery rates, the system would need replenishment from rainwater catchments, trucked water, or other sources. Combining on-site utilities may yield economies of scope (the heat from an electricity generator could warm and distill water, for example).
Postal service has long been a government monopoly in the U.S. and most countries, and one could well argue that there was never a good economic reason for this. Modern technology makes a free-market position stronger than ever, since postal communication now competes with alternatives such as faxes, e-mail, and the Internet. Such alternatives make price-gouging fears especially far-fetched. Express mail is already provided by private competitors, and the Internet provides for electronic bill paying and the transmission of documents with electronic signatures. The removal of monopoly protection for the U.S. Postal Service would enable a consolidated contracting of the distribution of goods to rural areas, enabling a company to deliver newspapers, packages, and mail in one delivery.
The Complexity/Unknowability Argument
While admitting some symmetry in the effects of technology, we believe that there is an important asymmetry that goes against the argument for government intervention. Any form of government intervention or enterprise depends for its justification on an understanding of what the private enterprise economy would otherwise be lacking or failing to achieve. For example, justification for occupational licensing depends on consumers being unable, in a regime without licensing, to obtain quality and safety assurance. Utility regulation depends on theories of natural monopoly. Government activism is predicated on a belief that regulators or planners can know the economy well enough to restrict, manipulate or supplement it beneficially.
Yet, after Adam Smith and Friedrich Hayek, the classic argument against government intervention is, aside from incentive problems, that the economy is too complex to be known, and therefore too complex to direct or manipulate in a beneficial manner. Like the spontaneous patterns of roller skating in a roller rink, the more complex the system, the more mischievous is the notion of centralized control. In a complex system such as that of 200 skaters in a roller rink, we ought to rely on decentralized decision making. After all, even if the rink is without bound, the increased complexity does not pose a comparable problem for the individual skater. He does not interpret the whole; he utilizes pointed knowledge in pursuing opportunities of his particular time and place.
Technology enhances government’s ability to gather, collate, and convey information, to monitor actions, to identify transgressions, and to enforce compliance. Technologies expand the informational capability of government. But technology accelerates economic change and multiplies the connections between activities. It integrates dimensions, connects multitudinous variables, and, moment-by-moment, alters constraints and opportunities. To know market arrangements—either those current or those that would exist under alternative policy—such fundamentals would have to remain unchanged for the time being. Yet technology makes the whole economy— that which is to be known—far more complex. It brings fundamental upsets, now and again, to even our best understandings of current arrangements and their shortcomings. After all, society includes the thoughts and potentialities of private individuals and organizations, each of whom has likewise enjoyed vastly expanded informational capabilities.
In his recent book, The Lexus and the Olive Tree, Thomas Friedman relates comments from a friend that illustrate the contest between informational capability and complexity. He quotes Leon Cooperman, former director of research for Goldman, Sachs:
"When I joined Goldman Sachs in 1967 . . . I was the head of research and I hired analysts. In those days, a typical analyst covered seventy-five companies . . . I was recently talking to one of the analysts I had hired back then and he told me he was terribly overworked now because he had to cover twelve companies. I just laughed. Only twelve companies? But you have to look into those twelve companies so much more deeply now in order to get some edge that it takes up all of his time."2
One might imagine that, because of today’s high speed data access, computation, and so on, the analyst would have enhanced informational capabilities, enabling him to cover more, rather than fewer, companies. But his informational capabilities do not keep up with the complexity of the world to be analyzed.
In 1879, Cliffe Leslie, an Irish economist and keen expositor of Adam Smith, wrote: "[T]he movement of the economic world has been one from simplicity to complexity, from uniformity to diversity, from unbroken custom to change, and, therefore, from the known to the unknown."3 In later years Friedrich Hayek took the point further: the economic world has moved not merely to the unknown, but to the unknowable. The effect of technology is asymmetric in the epistemic situations in which it leaves, respectively, private actors versus social planners (such as those at the FDA or the Anti-Trust Division). Technology’s heightening of society’s complexity outstrips its heightening of the social planner’s informational capabilities. Hayek, like Smith, drew a lesson for policy: Except in the most clear-cut cases of systemic harm like air pollution, the supposition that government officials can figure out how to improve upon the results of decentralized (i.e., voluntary) decision making becomes more and more outlandish. In his Nobel lecture, Hayek called that supposition the pretense of knowledge.4 As intellectuals who ponder the complex workings of the social world, we really know little aside from one hardy fact: If those who participate in an activity do so voluntarily, each is probably bettering his or her own condition. The more complex the system, the more skeptical we ought to be about claims to knowledge that go beyond and against that hardy fact.
There are, then, two ways in which technological advancement enhances the case for free enterprise: (1) It reduces the costs that had obstructed (actually or supposedly) invisible hand mechanisms, and (2) it makes the economic system ever more complex, and makes the notion that interventionists can meaningfully know and beneficially manipulate the system ever less credible.
Possible Challenges to Free Enterprise
Technological advancement may not always appear to enhance the case for free enterprise over intervention. For example, new technologies might make it especially difficult to secure and appropriate the value of one’s intellectual products, including basic scientific research, patents, software, music, and writings, because current technologies facilitate the replication of "knock-offs" and sharing without authorization. The situation might call for stepped-up government enforcement of patents and copyrights (whether one considers that government intervention or property rights enforcement), or more interventionist measures such as subsidization of knowledge and cultural products—akin to European television subsidies financed by taxes on television ownership.5 On the other hand, unauthorized replication might itself have a short technological half-life as new technologies develop methods to foil unauthorized replication.
It may also be argued that technology favors expanded government control of pollution because it enhances the effectiveness of detection, measurement, impact assessment, and enforcement. However, common law traditionally treated air pollution as a nuisance, and direct "polluter-pays" policies keep to that spirit. If government uses new technologies to define and enforce property rights in water, air, or animal resources, those might be seen as defensive "Nightwatchman" functions compatible with the principles of free enterprise.
National security is another area where technology might suggest a larger role for government. Capabilities to create advance quickly, but, alas, not as quickly as capabilities to destroy. New destructive capabilities in arms, biotechnology, and, eventually, nanotechnology might recommend vigorous national security measures. Again, depending on the measures, we might not deem them "government intervention" but rather "Nightwatchman" functions.
Finally, it might be argued that technology will make government more transparent and hence more accountable. We may put more trust in government because any abuse or outrage will be more readily exposed and investigated.6 This optimistic factor surely has some validity; there has been a profusion of Web sites supplying information about candidates, their positions, the voting records, their contributors, and so on. One may argue that technology will facilitate public discourse, public understanding, and participation in direct democracy. Perhaps government can be made more accountable and reliable through "electronic town meetings," in which each citizen may delegate their voting rights to proxies (as in shareholders’ meetings). If government were thereby improved, the case for activism would be strengthened.
Our conclusion, therefore, makes no claim to entirety or universality. We do not say that technology favors the case for free enterprise in all areas of policy. We submit a nuanced hypothesis that says "tends to," "mostly," "usually," and "in general."
The appropriateness of alternate policies depends on the state of technology. As technology advances, the intellectual case for specific policies changes. Thus, technology imposes on policies and their justifications what may be called an expected intellectual half-life. The faster technology advances, the shorter will be the half-life policy rationales.
This paper suggests, more specifically, that technological advancement usually favors the effectiveness of free enterprise over government intervention. If that is the case, interventionists especially need to concern themselves with the intellectual half-life of their positions, lest they promote policies appropriate yesterday but no longer appropriate today or tomorrow.
Just as policy depends on the state of technology, so technology depends on policy. The technological advancements help solve social problems. In doing so, they bring affected parties some kind of profit. Technological advancement is itself a member of the invisible hand—the invisible hand’s tending of its current shortcomings. Free enterprise and technological advancement form a virtuous cycle.
1 Gordon Tullock, "Public Decisions as Public Goods," Journal of Political Economy, 79, no. 4 (1971): 913-918.
2 Leon Cooperman, quoted in Thomas L. Friedman, The Lexus and the Olive Tree (New York: Farrar, Straus and Giroux), 101-102.
3 T.E. Cliffe Leslie, "The Known and the Unknown in the Economic World" (originally published in Fortnightly Review, June 1, 1879). Reprinted in Essays in Political Economy. (London: Longmans, Green, & Co., 1888), 224. Leslie also notes (p. 223): "And just in proportion . . . as industry and commerce are developed, does the social economy become complex, diversified, changeful, uncertain, unpredictable, and hard to know, even in its existing phase."
4 Friedrich A. Hayek, "The Pretence of Knowledge" (Nobel lecture, 1974), in New Studies in Philosophy, Politics, Economics and the History of Ideas, ed. Friedrich A. Hayek (Chicago: University of Chicago Press, 1978).
5 This is a policy that DeLong and Froomkin sometimes seem to favor. J. Bradford DeLong and A. Michael Froomkin, "Speculative Microeconomics for Tomorrow’s Economy." On DeLong’s Web page: http://econ161.berkeley.edu/ 2000.
6 David Brin,. The Transparent Society: Will Technology Force Us to Choose Between Privacy and Freedom? (Reading, MA: Addison-Wesley, 1998)