Dr. John Lott has just released Freedomnomics: Why the Free Market Works and Other Half-Baked Theories Don’t which is a response to the 2005 bestseller, Freakonomics. He certainly is the perfect man for the job as he earned a PhD in Economics from UCLA, and has held positions at numerous educational institutions like the University of Chicago, Stanford, UCLA, Yale, Wharton, and Rice. Between 1988 and 1989 he was also the chief economist for the United States Sentencing Commission. Dr. Lott’s previous books, More Guns, Less Crime: Understanding Crime and Gun-Control Laws and The Bias Against Guns: Why Almost Everything You've Heard About Gun Control Is Wrong, established his reputation and are still in print.
BC: First off, allow me to say that I love your title. Obviously, with Freedomnomics being a play on Freakonomics what are the most important criticisms you have of that work? Do you believe that it seriously misled the public about the nature of economics?
Dr. John Lott: Thank you very much. I appreciate you reading the book.
I think that there is a general feeling that everyone from real estate agents to doctors are cheating their customers and that customers are being forced to do things that are not in their interest. Almost all firms are thought to commit some type of fraud. There is a predominate view that free markets are filled with what is known as “market failure.”
Take a simple case. The value of cars is claimed to fall by around 25 percent as soon as you take a car off a new car lot because potential car buyers fear that a lot of almost brand new cars people are trying to sell are “lemons.” Since customers can not be sure that the car they are being sold isn’t a lemon, even cars that are actually still worth what they were paid for when new have to be sold at a big discount.
To me, all these problems represent profit opportunities. It isn’t that these problems can’t theoretically exist it is that there is a lot of money to be made in solving them. Take the so-called “lemons” problem. In fact, there is no big drop in the value of new cars. Cars with just a few thousand miles on them and just a few months old suffered just a trivial drop in value. The private resale price is just a few percent below the actual new car transaction price. Why? Because there is everything from transferable warranties to services that can certify the condition of the car.
The same profit making opportunities exist to ensure that customers will not be defrauded. I think that what these fears miss out on is the way in which the market severely punishes those that defraud others. Whether it is an individual’s reputation or a firm’s, customers stay away from those who cheat and there are real profits to be made from protecting customers from being cheated.
BC: What’s the professional reaction been like to your book? How have economists responded?
Dr. John Lott: All the economists who have told me that they read the book said they liked it a lot. There are a number of economists who have mentioned the book on their blogs such as Craig Newmark, Art DeVany,
Lawrence White, and King Banian.
BC: Given all that we know about socialism and its repeated failures over the course of the last century, why does the electorate continue to support politicians who wish to inflate the size of the government?
Dr. John Lott: That is an important question.
I agree that it seems pretty obvious that when you look across countries that the wealthiest ones and the ones that are growing the fastest are also the ones with the freest economies. You would think that would be pretty obvious, and I think that people understand that (just look at the elections even in France). But there are a few reasons for this state of affairs. As I just mentioned, many people see the free market as being filled with fraud. Unfortunately, even in popular economics books one can see claims that virtually all companies are committing fraud.
Another problem is that many see the chaos of the market and desire some central authority to bring order to it. What is frequently missed here is that people who bear the costs and benefits of any decision are much more likely to make the right one. Some bureaucrat in Washington doesn’t face the incentives and is unlikely to see what all the options are. The bureaucrat's salary doesn’t vary with whether he makes the right decision. People who have their own money at stake will come up with innovations that no one else would have thought possible.
Here is a simple example of how the free market found a solution to a problem that would never have been thought of by the government. After radio was developed the problems of making it a viable operation seemed almost insurmountable. No one could figure out how to make listeners pay, radio hosts and entertainers usually had to work for free. For over twenty years, broadcasting primarily involved hobbyists and a few public service transmissions by government stations.
Many doubted there was any way to make listeners pay. In 1922, Herbert Hoover, then Secretary of Commerce, declared: “Nor do I believe there is any practical method of payment from the listeners.” Others assumed that radio transmissions would eventually be funded by paying subscribers, but no one could devise a method for limiting broadcasts to subscribers’ receivers. Consequently, some believed the government would have to provide the service. In 1922, Popular Radio magazine claimed that radio was “essentially a public utility” and discussed using city telephone wires to sell broadcasts to subscribers—in other words, providing radio service over the phone.
So what happened? Did private businessmen throw up their hands and invite the government to run the industry? Was society denied the benefit of radio because no one could solve the free-riding problem? Of course not. The problem was eventually resolved in 1922 when AT&T discovered it could make money by selling radio advertising airtime. In hindsight, it’s hard to believe that radio almost died in its infancy because people couldn’t figure out how it could make money. And it’s a good thing that the government decided not to turn radio into a subsidized enterprise, since it is highly unlikely that the state would have distributed payments as efficiently as advertisers do.
Finally, and possibly more important, many people see the government as a way of getting resources for themselves. Using the government can often be a much easier way of earning a living than going out and giving others something that they are willing to pay for.
BC: With what we know about the inefficiency of the public sector, what enables politicians like Hillary Clinton to continually confuse increasing taxes—stealing the earnings of the people—with advancing the public good? Does the polity support these persons due to ignorance or idealism?
Dr. John Lott: It is very hard to figure out what is going on in people’s minds so I won’t even try. But I assume that the damages done by taxes are fairly clear. Economists estimate that people who pay taxes lose at least two dollars for each dollar the government collects. The loss from taxes is not confined to what the government gets; it also reduces the incentives of people to produce. On the other side, government frequently gives those it is helping money which creates its own problems. Welfare frequently leads to the break up of families.
One interesting example of government inefficiency is provided by Jon Karpoff who studied the thirty-five government-sponsored and fifty-seven privately funded expeditions to explore the Arctic, the Northwest Passage, and the North Pole from 1818 to 1909. Arctic exploration, like space missions, is an excellent example of a public benefit that many would assume could not be achieved privately. Much of the exploration is similar to pure scientific research that offers no immediate commercial benefit. Compared to their private counterparts, government expeditions to the Arctic enjoyed much better funding, bigger ships, and crews that were over four times larger (averaging seventy members versus seventeen for private voyages). Nevertheless, public expeditions were more likely to end in tragedy—an average of nearly six crewmen died on government voyages, compared to less than one on private trips. Furthermore, government expeditions lasting over a year suffered scurvy rates that were four times higher, while the chance of losing a ship was over double that of private expeditions. Despite their smaller crews and lower funding levels, the private teams accomplished five of the six major Arctic discoveries.
Karpoff elaborated some of the reasons behind these results. Government expeditions had to operate by committee, while political factors played a role in dictating their crews’ composition. Private expeditions, in contrast, were more efficient and much faster at learning from past experience. Perhaps most importantly, private voyages were more responsive to incentives for success—their decision makers directly bore the costs and reaped the benefits of their own actions.
BC: Isn’t capitalism the ultimate form of social justice? How do you respond to the left’s misinterpretation of that term? I like to counter-define social justice as being “the act of letting people keep what they earn.” What would you say?
Dr. John Lott: I think that you are right about “justice.” Capitalism depends on voluntary trade. I buy something from you because I value it more than the money that I am giving you and you sell it to me because you value the money I give you more than the product. We only make the free exchange when we both gain from it.
BC: You mention in your book that women’s suffrage led to a massive increase in the size of government, why is this the case?
Dr. John Lott: When I originally started working on this my wife begged me not to do the research.
Two reasons. I think that women are generally more risk averse then men are and they see government as one way of providing insurance against life’s vagaries. I also think that divorced women with kids particularly turn towards government for protection. Simply giving women the right to vote explained at least a third of the growth in government for about 45 years.
The effect on state governments was pretty dramatic, and I think that it not only explains a lot of the government’s growth in the US but also the rest of the world over the last century. When states gave women the right to vote, government spending and tax revenue, even after adjusting for inflation and population, went from not growing at all to more than doubling in ten years. As women gradually made up a greater and greater share of the electorate, the size of government kept on increasing. This continued for 45 years as a lot of older women who hadn’t been used to voting when suffrage first passed were gradually replaced by younger women.
After you get to the 1960s, the continued growth in government is driven by higher divorce rates. Divorce causes women with children to turn much more to government programs. Of course, changes in the divorce laws from “at fault” to “no fault” helped cause some of this change. As I discuss in the book, the liberalization of abortion also led to more single parent families.
BC: The law of unintended consequence is not very difficult to grasp, but politicians and the media seem to be allergic to considering its effects. Do you have any ideas as to how conservatives can more effectively exploit this politically? Is it possible that being a leftist means that as long as your heart is in the right place you never have to consider the negative consequences of your actions?
Dr. John Lott: Let me give you one example regarding price controls. Economists may dispute just about everything else amongst ourselves, but we all agree that when demand rises or supply decreases, prices will rise, and that maximum price limits result in shortages. This, of course, was the outcome of the gasoline price controls instituted in the 1970s; Americans waited in lines for hours to fill up their tank due to sudden chronic shortages, which instantly disappeared as soon as the price controls were removed. So why did the debate over price controls never end?
One problem is time lags. People see the short-term effects of controls in keeping prices low, but it is only later that the pernicious effects of shortages set in. People naturally find it easier to make connections between events that occur closely in time. Imagine if a day elapsed between the striking of a match and the resulting fire. Some people would fail to associate the two incidents; many other events would have occurred during the intervening twenty-four hours that would seem to explain the fire.
Suppose that tomorrow the government set a maximum gasoline price based on what it costs today. Surprisingly, the controls would temporarily increase the amount of gas for sale. As I previously mentioned, gas companies hold inventories because of the possibility that prices will rise in the future. The greater the chance of future higher prices, the more gas that companies will store. But when price controls are imposed, firms no longer have any expectation that prices will rise. In turn, they no longer have any reason to hold these inventories and thus begin selling them off.
When controls are imposed on gas prices, consumers quickly see that prices are kept low and supply increases. It’s only once existing inventories are used up—and this could take months or even a year—that shortages set in. Companies do not instantly dump all their gasoline on the market when controls are instituted because prices would then fall even below the controlled price.
With all this it isn't too surprising that people don't see the connection between price controls and shortages.
BC: Thank you, Dr. Lott.