Sunday, March 27, 2011

What Laissez Faire Looks Like

I am convinced that the most powerful expositor of laissez-faire is Harold Demsetz. His writings are just so damn good. No economist, to my knowledge, has ever attempted to challenge his arguments. How could you? Here are some quotes from one of my favorite papers of his:

"The allegation is that even perfectly competetive markets fail to achieve efficiency. But, this reasoning generally fails to take account of the fact that the provision of a market (for the side effect) is itself a valuable and costly service."

"In asking the implications of the nonexistence of some markets, we seem to have fogotten the cost of providing market services or their government equivalent."

This is such a clever argument. Any situation can be justified by invoking the theory of transaction costs. In other words, what appears undesirable is really efficient once sufficient account is taken of the costliness of any proposed alternative for remedying it. How can you get around this? Demsetz gives several examples to illustrate his thesis:

1.) Free parking. "But while we have reduced the resources committed to constructing parking spaces, we have increased resources devoted to market exchange. We may end up by allocating more resources to the provision and control of parking than had we allowed free parking because of the resources needed to conduct transactions. By insisting that the commodity be priced, we may become less efficient than had we allowed persons to ration spaces on a first come, first serve basis."

2.) Use of nectar by bees. "A valuable and costly good, nectar, is provided free of charge because it would be too costly to take account of the indirect benefits to beekeepers."

3.) Public goods. "If the cost of policing the benefits derived from the use of these goods is low, there is an excellent reason for excluding those who do not pay from using these goods."

The logic in these arguments is really great. First of all, the argument acknowledges the existence of market imperfection. Markets are imperfect and usually do not work. But every activity involves a cost, even government regulation. Therefore, the reason why we haven't seen the elimination of costly and imperfect market arrangements is because every possible alternative (government regulation, for example) is more costly.

Carl J. Dahlman summarized this position beautifully: "If you do not like the smell of the air, seek comfort in the knowledge that it would cost you more than it is worth to you to do away with the stench, for, otherwise, would you not do it?"

Forget about the Austrians. This is real laissez-faire economics. This theory is much more sophisticated than Austrian libertarianism. In fact, Austrian economics was never intended to serve as a defense for the market. Menger, Bohm-Bawerk, and others in Austria were concerned mainly with methodological questions. It was only with Mises' arrival in New York that Austrian economics became identified as libertarian. Had Mises remained in Switzerland, it is likely that the American libertarian movement would have never encountered Mises and the Austrian tradition. Mises' decision to leave for the United States was a disaster for Austrian economics; it brought an end to the Mengerian tradition, and transformed Austrian economics into libertarian anarcho-capitalism.

The economics of Ronald Coase, Harold Demsetz, and Armen Alchian (on information cost and unemployment theory) is the real theory of laissez-faire, and I think this is the body of work that economists hostile to free market capitalism should be attacking. This, however, is not going to be an easy task. Harold Demsetz has easily one of the sharpest minds in the profession. But this is the guy to beat. No doubt about it.


Armen Alchian "Information Costs, Pricing and Resource Unemployment" Economic Inquiry, 1969.

Carl J. Dahlman "The Problem of Externality" Journal of Law and Economics, 1979.

Harold Demsetz "The Exchange and Enforcement of Property Rights" Journal of Law and Economics, 1964.

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