Rent-Seeking, Public Choice,
and The Prisoner's Dilemma

Mankind soon learn to make interested uses of every right and power which they possess, or may assume. The public money and public liberty...will soon be discovered to be sources of wealth and dominion to those who hold them; distinguished, too, by this tempting circumstance, that they are the instrument, as well as the object of acquisition. With money we will get men, said Caesar, and with men we will get money. Nor should our assembly be deluded by the integrity of their own purposes, and conclude that these unlimited powers will never be abused, because themselves are not disposed to abuse them. They should look forward to a time, and that not a distant one, when a corruption in this, as in the country from which we derive our origin, will have seized the heads of government, and be spread by them through the body of the people; when they will purchase the voices of the people, and make them pay the price.

Thomas Jefferson, Notes on Virginia, 1784 [color added]

From 1999 through 2005, the USDA [Department of Argriculture] "paid $1.1 billion in farm payments in the names of 172,801 deceased individuals.... 40 percent went to those who had been dead for three or more years, and 19 percent of those dead for seven or more years." One dead farmer got more than $400,000 during those years.

John Stossel, "Dead Men Farming," quoting a General Accounting Office (GAO) report, The Freeman, November 2007, p.37.

The first lesson of economics is scarcity: there is never enough of anything to fully satisfy all those who want it. The first lesson of politics is to disregard the first lesson of economics.

Thomas Sowell

If something cannot go on forever, it will stop.

Herb Stein (1916-1999), "Herbert Stein's Law"

If you rob Peter to pay Paul, you've already got half the vote.

Enklinobarangus ()


Rent-Seeking

Adam Smith divided income into three types: profits, wages, and rents. The essential feature of profit is risk: capital is ventured in the hope of a return, and there may be a very great return, or little, or none. There is no guarantee of a profit in any enterprise, which is why businesses, both large and small, go bankrupt all the time -- unless, like Chrysler, they have enough political influence to get bailed out by the government. Profits ultimately represent the real growth of wealth in an economy, for the profits of one enterprise do not always come out of the profits for another. Say's Law is that supply creates demand, that a successful business adds to the productive capital of society, which increases the goods, and the profits, available for everyone. If the "profit motive" is rejected by governments because it is selfish or evil, and enterprises are conducted without concern for profitability, then what actually happens is that they will need to be subsidized, and the subsidies will have to come, if not out of profitable enterprises, then out of the stock of capital itself. This means that the economy will gradually consume itself, just as a starving person lives off their own tissues, until there is too little left to sustain life. That is what happened to the economies of the Soviet Union and Eastern Europe, and to countless, ill-advised Third World countries.

Wages, on the other hand, represent no risk, except that their source might (illegally) default or (legally) go bankrupt. Wages are a fee for a service, naturally discounted by the market mechanism for the absence of the kind of risk germane to profits. Market wages are otherwise proportional to productivity, and productivity is proportional to the capital investment in the person (education, honesty, diligence, etc.) and in the job (machinery, computers, etc.). Capital value in the person ("human capital") comes from natural endowments (talent, intelligence), upbringing (honesty, conscientiousness, reliability, etc.), and education (training and knowledge). Most of this belongs to people before they ever go to work, but employers may invest in workers further through on the job training or additional education. Labor intensive work means low skills, low productivity, low wages, and so a larger, less wealthy work force to produce a given amount of goods. Capital intensive work means higher skills, higher productivity, higher wages, and so a smaller, wealthier work force to produce a given amount of goods. People fear and hate being thrown out of work by mechanization and automation, but that is the only way that life gets better for most people. The labor that is not needed after productivity increases is then available to produce new kinds of products, further enriching life for everyone. The best example of this kind of shift is that for most of human history over 90% of the work force was necessary just to produce food (still 85% in Tanzania). By 1840, the United States for the first time had less than 90% of the population living in rural communities (of less than 2500 inhabitants). By 1880, the United States for the first time had less than 50% of the work force in agriculture. Now only about 1.6% of the work force is engaged in agriculture full time. No one thinks that the solution for unemployment is for people to go back into agriculture. The only real solution is for new products and new industries to arise. For this to happen, however, someone must risk some capital, with the hope of profit, in order to attempt to increase productivity or attempt to produce something new. Those attempts often fail, which is why profit involves risk. Also, some of them must fail, or many useless and uneconomic activities will continue to burden the economy (as in the Soviet Union, the U.S. Federal Government, etc.).

Rents are the easiest kind of income. A rent is money paid for the use of a capital asset, whether land, a building, an office, a car, a bicycle, or whatever someone might want but cannot or does not want to own. The owner who rents out his assets need only worry about (illegal) damage like vandalism, theft, etc. and about (inevitable) depreciation, where the capital value of the asset declines in time through ordinary use. Loaning money is a kind of renting, where the asset may depreciate through inflation and where there is considerable risk that the borrower may default or go bankrupt. The element of risk introduces an element of profit, but a careful lender can see to it that borrowers have the assents to cover any defaults: and the legal right to recover capital distinguishes renting from a straight investment for profit (where the whole capital can be lost without legal, moral, or any other recourse). Like banks in that respect, most renting enterprises mix rents with profits: they invest for profit by running a business where they collect rents.

Because rents are the easiest and most secure kind of income, it is natural for people to want income from rents rather than principally from profits or wages, and to want rents that involve the least risk and labor as enterprises. This motive is called "rent-seeking," and there is nothing wrong with it. Indeed, those who collect rents in an economy serve the valuable function of seeking to maintain and preserve capital assets [1]. It becomes wrong when rent-seeking means trying to collect rents off of capital that is not the rightful possession of the rent-seeker. This can be legally accomplished through the means that secure the rights of property in the first place: politics and the law. Through political influence people can be given ownership of things that are not their property, or should not be anyone's property. The theory of rent-seeking began with the economist Gordon Tullock.

A government that grants a monopoly in a certain enterprise cannot determine a market-clearing price and so is either going to victimize a company by not allowing a high enough price or is going to victimize the public by mandating or engineering prices that are too high: those prices then include "monopoly rents," the amount of money the company makes over the profits of a competitive market. The rent comes from the "ownership" of the monopoly market. Similarly, on the other side of the coin is labor law, which tends to vest workers with property rights in their own jobs. Since that is how feudalism worked ("livings," like property, were bestowed on people, and these consisted in collecting feudal rents), and it does contain the attraction of job security, there is a powerful historical and emotional pull to such rent-seeking, although it is contrary to the flexibility (albeit insecurity) for growth that the free market provides. The seduction is the thought that workers are better off with their monopoly rents and security, when in fact workers in general are far better off that the free market allowed the growth of wealth and erased the kind of peasant life (with security, apart from plagues, invasions, the droit de seigneur, etc.) that most people had under feudalism.

Public Choice Theory

Since sterile and inappropriate rent-seeking is possible through political means, this brings us to the issue of Public Choice theory, centered on the Virginia School of Public Choice and the Nobel Laureate economist James M. Buchanan (b. 1919). Buchanan and Gordon Tullock collaborated in creating the theory of both rent-seeking and Public Choice. Nevertheless, the basic insight of both rent-seeking and Public Choice theory is already evident in the Thomas Jefferson quote in the epigraph of this essay. Public Choice theory is about the different incentives and processes that operate when goods are sought through political means rather than through purely economic means. The essential point is about the distribution of costs and benefits. The political appropriation and distribution of goods is attractive because it concentrates its benefits and disperses its costs. Many people can be taxed only a small amount and then a small number of people can be given large sums. This means that the many hardly notice the wealth that they have lost, while the few become active partisans of their own benefits. Politicians hear nothing from the many and a lot from the few, who also have some money to contribute to the politicians, money that may actually be, or be freed up by, the benefits they receive -- like the money teachers' unions get from compulsory union dues, from the money paid by the government to teachers. Thus, constituencies and interest groups are created for each particular political benefit program, and it becomes nearly impossible to get rid of them. The rent-seeking aspect of this is that the beneficiaries receive rents on the basis of their participation in the interest group. They benefit because of who they are, not because of what they do or what they own in a more conventional sense.

Individually, these political rents are not damaging to the whole -- in the 2012 election we just heard about how little "Big Bird" costs individual taxpayers, who are forced to support the Public Broadcasting System, which is actually used as a front for the Democratic Party -- but each group of people which sees another obtain benefits then seeks to create some program for itself. Such things are hard for politicians to resist, since it holds the promise of a group of dedicated voters beholden for their own program. The process then continues, piling one interest group upon another, until the many small taxes for each program begin to amount to a very large cumulative total: the many then begin to notice that they are damaged by the overall burden. Considerable anger and discontent will be generated, but the object of the anger is diffuse, and the many will have trouble identifying the source of their discontent. It is then in the interest of politicians to scapegoat someone whom they can blame for the whole problem (like "the rich") but who actually is not a serious constituency, or who actually won't be harmed by whatever kind of pseudo-solution the politician proposes. The former case occurs with illegal aliens, who cannot vote and who thus are not a constituency at all (except through voter fraud).

The latter case occurs with respect to welfare, which for decades has been unpopular with most Americans. Welfare is actually a relatively minor expense and involves a relatively small number of people, compared to massive swindles like Social Security, Medicare, or Farm Subsidies; but Americans as a whole are particularly offended by it and are aware of the perverse incentives it creates that have resulted in the breakdown of inner city families and the spawning of several generations of sociopathic criminals and gangsters. The Clinton Administration "solution" for this in 1993, with tough rhetoric (the "end of welfare as we know it") was a classic case of misdirection: a job training program, which is the kind of thing that was seen to fail with its very first implementation in the Great Society, and then a Federal jobs program for those who don't get real jobs, which always creates meaningless, make-work button-sorting. The "solution" thus does nothing but provide for the same kind of unproductive dependency that angers people about welfare in the first place. In a classic Public Choice strategy, however, this may mollify the many, even while continuing to provide the political rents for its own constituency, a constituency that includes everyone who sympathizes with the "compassion" of welfare, even if they are not on it [2].

The economic distribution of benefits works in a fashion opposite from political rents. The benefits go to the many and the costs are concentrated on the few in the free market. The successful business provides goods or services that a large enough fraction of the public finds preferable that the business is able to turn a profit. The unsuccessful business, not providing anything relatively preferable to the other options available to the public, goes bankrupt and removes itself from the competition, also in the process freeing the capital and the labor that it had tied up in a relatively unproductive fashion. This is the very process that swept away subsistence agriculture, horses and buggies, whaling for lamp oil, slide rules, and countless other ancient, obsolete, and inefficient industries. The cost falls entirely on the owners and participants of those industries. They may be hurt and be mad as hell about their personal fate, but their loss is actually an unalloyed gain for everyone, including them.

It is ironic that businessmen are often morally condemned for their "greed" at seeking profit, even though, as I have noted, profit is necessary if the wealth of a society is to grow and life is to get better, and profit cannot be obtained unless, in a free market, something is offered that people actually want. It is correspondingly ironic that labor unions and businesses (e.g. Lee Iaccoca's Chrysler, or the Chrysler and GM of the 2008 financial collapse) that seek to protect themselves and preserve obsolete, uncompetitive, and unprofitable industries, in the name of the jobs that they provide, are rarely accused of "greed" themselves, even though what they want is a benefit for themselves that must be directly withheld from the public, which is obliged to pay the monopoly rents created by protectionism (or by the bailouts of 2008/2009 that were universally unpopular with the public, spawning both the Tea Party and "Occupy Wall Street" movements, but were supported by both Republican and Democrat politicians, pretty much without apology). Because a few people retain their jobs, the quality of life of the many is degraded in order to support the few in the manner to which they have become accustomed. If this trick could work for everyone, it might even be unobjectionable; but of course it cannot work. Not everyone can collect monopoly rents without ultimately destroying those profitable sectors that produce the wealth in the first place. Just as rapacious dictators (e.g. Ferdinand Marcos) destroy the wealth of their own countries by letting their cronies steal too much of it, a democracy can just as easily destroy itself when everyone gets the idea that they can acquire wealth and easy living through political means instead of through their own hard work and enterprise (as in 2012 we see most acutely in Greece and California).

The "Prisoner's Dilemma"

This all creates what in Game Theory has been called the "Prisoner's Dilemma." The basic idea is that if you are a prisoner planning to escape with some fellow prisoners, you have the choice of being faithful to them and benefiting from their plan, or you can betray them and earn what may be a very considerable reward from the authorities. You also must consider that this choice will have occurred to the others, which means that you stand in danger of special retribution if you are betrayed first. This kind of problem can be abstracted into a little game.

A,BB, Keep
Faith
B, Betray
A, Keep Faith3,30,5
A, Betray5,01,1
In the game all the players choose secretly whether to Keep Faith or Betray each other, and then points are scored when the choices are revealed. If two players (A & B) Keep Faith with each other, then moderate benefits are earned by both. If both players Betray each other, then there is a minimal benefit. But if one player can sucker the other into Keeping Faith while Betraying him, he earns the maximum benefit while the victim gets nothing.

Game Theory was developed by the great mathematician John von Neumann (1903-1957) [3]. To von Neumann, the Prisoner's Dilemma was a paradox that all but destroyed what he hoped Game Theory would accomplish: there did not seem to be a strategy that would benefit both parties to the extent that they would not want to betray each other. Instead, it seems that the best strategy for a player is to continually devise a way to sucker an opponent into Keeping Faith while being Betrayed. A familiar example of this is the famous recurring piece in the comic strip "Peanuts," where Lucy over and over fools Charlie Brown into trying to kick the football she holds, even though every single time she pulls the ball away and he falls painfully on his back. The benefit for both them of getting the football kicked is obviously less than the benefit Lucy enjoys at Charlie Brown's humiliation. Lucy has a very large score, while Charlie Brown still has zero [4].

Public Choice theory gives rise to a serious Prisoner's Dilemma. The largest benefits with the least effort come from political rent-seeking, and those who fail to participate in the political process will have their wealth drained way with no corresponding return. Even if it is obvious to all that not everyone can live off of the wealth of everyone else (1,1), and that the best mutually beneficial course is for everyone to give up political rent-seeking (3,3), it is obvious that the best course for each individual group is to get everyone else to give up rent-seeking while they alone covertly continue to collect their monopoly rents (5,0). The fear that others will pursue such a strategy is easily sufficient motivation not to give up rent-seeking. No one, of course, blatantly advertises their rent-seeking in terms of their own self-interest. Instead, there are always high sounding, moralistic slogans and rationalizations, arguments that special benefits are necessary because of poverty, compassion, discrimination, racism, the environment, greedy insurance companies, greedy businessmen, etc. Whatever the arguments, the significant question to ask is whether they can be translated, as P.J. O'Rourke says, into "Give me a dollar."

The solution to the dilemma is simple, but it does not sound like it will directly provide any obvious benefit: the Classic 19th century Liberal principles of (1) the Rule of Law, (2) the Sanctity of Private Property (including self-ownership), and (3) the Freedom of Contract. The Rule of Law, in its proper meaning, completely erases political rent-seeking by the limitation of the power of government; and the other principles are simply those that guarantee the growth of wealth through the economic distribution of goods in the free market. The Freedom of Contract is the most easily misunderstood, since it is the principle that any agreement which is not an agreement to commit a crime and results from mutual consent is valid. "Mutual consent" does not mean, however, that both parties have to particularly like their agreement. It is simply the one that, in the absence of other options, they would prefer over nothing. Not liking the options you may have is actually a powerful motive of political rent-seeking.

One may ask, "What if we prefer to pursue our self-interest through political rent-seeking, with its self-serving moralistic rhetoric, rather than renouncing that for a Liberal economic order that can only benefit us much less directly?" Then we will have to face the consequences of the sequel to the Prisoner's Dilemma; for it turns out that there really are TWO Prisoner's Dilemmas, one for the short term and one for the long run. This circumstance emerged in 1980 when Robert Axelrod, a professor of political science at the University of Michigan, invited computer program entries for a computer "tournament" of a Prisoner's Dilemma game like the numerical one above. The tournament goes on for many turns, and one particular entry won easily, both the first time and later when Axelrod had published the results and asked for new entries to challenge the first winner. The champion entry was called "TIT FOR TAT" and was one of the simplest possible. It only contained two rules: (1) start with Keep Faith, and (2) do the next turn what the opponent did on the last turn. Any entry willing to Keep Faith with TIT FOR TAT will consistently do well. Any entry trying to Betray TIT FOR TAT will not be able to betray it more than once in a row, and a particularly treacherous entry will consistently be Betrayed itself, accumulating little. A consistently Faithful entry will do fine with TIT FOR TAT, but it will of course get wiped out by the treacherous entries, so its overall score will be lower.

These results contain a stunning moral and political lesson. The two rules clearly can be translated into three traditional moral injunctions: (1) be honest (rule one), (2) an eye for an eye (rule two), and (3) forgive (rule two). We can say that the results demonstrate that the honest will prosper while thieves will not. Furthermore, we can say, with F.A. Hayek, that the Liberal capitalist economic order will surpass in prosperity and overwhelm any system based on theft or political rent-seeking. This can even explain why evolution by natural selection results in altruism and social cooperation, since the cooperative can ultimately do better than the uncooperative and be naturally selected. However, this still leaves the difference between the Prisoner's Dilemma as a matter one of turn and as a matter of many. Someone might think that the virtues that emerge over the long run are not relevant when making decisions about a unique case. Of course, when faced with betraying someone for the greatest gain, one does not know for sure that it is a unique case. Furthermore, someone who thinks that it is simply wrong to betray an agreement will not have to worry and plan about doing that, and will also be properly prepared for the long run. Part of the simplicity of TIT FOR TAT is that it relieves one of the necessity of constantly looking for the best way to betray the good faith of an associate. Instead, the problem is simplified, and a person can focus all their energy on the most productive forms of cooperation. Those who waste their time looking for a dishonest angle devote themselves to an enterprise that is essentially sterile. Without trust and cooperation no truly great enterprise can be undertaken, while the fruit of such enterprises is wealth beyond the dreams of narrow chiselers.

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Copyright (c) 1996, 1999, 2002, 2007, 2008, 2012 Kelley L. Ross, Ph.D. All Rights Reserved

Rent-Seeking, Public Choice, and The Prisoner's Dilemma, Note 1


What has been called the "tragedy of the commons" is that communually owned assets often deteriorate because no one in particular owns them and so it is in the interest of no one in particular to perserve and protect the assets. Individuals end up in competition to see how much they can get out of the assets in relation to others, whether the capital value of the assets is destroyed in the process or not.

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Rent-Seeking, Public Choice, and The Prisoner's Dilemma,
Note 2, Insurance and Mutual Aid Societies

A case that looks rather like the political distribution of benefits is insurance. The cost is distributed among a body of payers, the insured, and the benefits are concentrated on a small body of beneficiaries, those who have experienced a loss and have an insurance claim.

However, the insured enter into this relationship voluntarily, because they understand the principle by which this works. The insured are a group that are at risk of some kind of harm. They own a ship, which may sink. They drive a car, which may be in an accident. They own a house, which may burn, be burglarized, or be damaged in a storm or earthquake. Or, like all humans, they may be vulerable to disease or early death. By buying insurance, they have chosen to pay some money to pool their risk. Because not all the insured will actually suffer harm, the cost of the insurance will be much lower than the cost of the actual harm that will happen to a few of them. But should that harm happen, they will be protected.

This is a sensible and prudent business -- although economists have noticed the "moral hazard" that those with insurance may be less careful of their well being, since they feel protected against the consequences of possibly imprudent actions. The cost of insurance for particular threats can be determined mathematically, once the incidence of harm has been studied and actuarial tables can be compiled. Some of the earliest insurance was created at Lloyd's Coffee House in London, opened in 1688, where sailors and merchants met to chat and then began creating insurance policies for their ships. This institution still survives as Lloyd's of London, presumably without the coffee.

In the United States, a great deal of insurance in the 19th century began in mutual aid societies, which offered various benefits to their members, including medical and life insurance. Such societies could be religious, professional, "fraternal," or purely commercial in nature. The "fraternal" societies were "lodges" that were essentially social organizations, with ritual, costume, initiation, charitable projects, and morally edifying teachings -- but without the religious identities that, for instance, still distinguish the (Catholic) Knights of Columbus. Some of the fraternal societies famously survive, like the Masons, or are still engaged in conspicuous charitable works, as with the Shriners; but most, like the Fraternal Order of Eagles, may strike people as useless and ridiculous. Nevertheless, modern insurance companies often display evidence of their origin. It is not difficult to guess where companies like Fireman's Fund, Traveler's, or State Farm Insurance came from. Purely fraternal lodges, however, sometimes had names that sounded like professional associations, such as "Woodmen of the World."

The function of mutual aid societies has been all but destroyed by the belief of many people, and its political implementation, that the government should handle many of their essential purposes. This shift was accomplished largely thanks to the Great Depression, which damaged the economical viability of societies, many of whose members became unemployed and were unable to keep up their dues. These difficulties allowed those who had always believed in socialism, that government should provide "social" insurance for everyone, to make political inroads.

Indeed, it had long been the practice of government to provide the ultimate backstop to the private institutions that, in the 19th century, provided most of the charitable aid to the poor. Government run poor houses, work houses, and orphanages were, in turn, infamous as unpleasant and even cruel places. In part, this was deliberate. As Benjamin Franklin said, it was not proper to make anyone "easy in poverty." In a 1766 essay, "The Encouragement of Idleness," Franklin said:

I am for doing good to the poor, but I differ in opinion of the means. I think the best way of doing good to the poor, is not making them easy in poverty, but leading or driving them out of it. In my youth I travelled much, and I observed in different countries, that the more public provisions were made for the poor the less they provided for themselves, and of course became poorer. And, on the contrary, the less was done for them, the more they did for themselves, and became richer.

This was all based on a moral distinction between the "worthy poor," who were willing to work but were in difficulties through no fault of their own, and the "unworthy poor," who were actually seeking to avoid work and sought support through fraudulent or dishonest means. Private charity, which was largely religious in motivation, was very serious about this; and the able bodied were frequently required to do some nominal amount of work for the charity before being fed, for instance, in their soup kitchen. In public institutions of "relief," much of the debate was about whether there should be provision of "outdoor relief," i.e. welfare payments to people living on their own, or only "indoor relief," i.e. the poor houses and work houses. Outdoor relief would avoid the scandals of filth or cruelty that often embarrassed the latter institutions. Outdoor relief, however, then required supervision, i.e. "social workers," who would make sure that the recipients actually were in need and were not engaged in immoral (and so socially and prudentially "unworthy") activities. Foster care for orphans, of course, was the "outdoor" version of orphanages, even as it also required supervision by social workers -- generating its own corresponding stories of neglect, cruelty, and abuse.

The Depression overwhelmed most charitable institutions, including government ones, and opened the way even to Federal relief programs, such as Aid to Families with Dependent Children, despite there being no Constitutional provision for such things. An argument could be made that this was necessary in the emergency of the Depression; but of course, once established, Federal programs continued to exist, and only the rare, heartless crackpot ever tried to remind the Nation that the continuation of such things was unconstitutional. What does "constitutionality" matter when so much good can be done? But then, the moral and prudential principles, not just of relief, but also of insurance, began to be undermined by the very forces of the political provision of goods that I am considering.

Thus, in the United States "Social Security" was introduced in 1935 as part of New Deal legislation. It was presented as a pension plan, where workers paid into their own account, with their contributions matched by employers, from which they would draw in their old age. A pension system is a form of insurance, previously provided by many businesses and mutual aid societies, which is subject to actuarial realities. At its inception, however, Social Security had nothing to do with sound principles of insurance and was entirely a plan for the political provision of benefits. As long as the number of workers was vastly larger than the eligible number of retirees, the System could continue along; and no one would think of it as benefiting a limited political constituency, since anyone who paid in and lived long enough would be elligible. Who could object to that?

Unfortunately, two realities would undermine the solvency of the System. One was that it was expanded to cover disabled workers. But there has never been any separate tax or assessments for making Social Security viable as a System of disability payments. Such payments would be drained from general Social Security revenues, regardless of how early or how many workers became disabled. They might be supported the rest of their lives, having contributed only a nominal amount to the System. At the same time, the aging of the Baby Boom generation, and the drop in birth rates, meant that the ratio of workers to beneficiaries (retirees & the disabled) would drop, perhaps disastrously.

In preparation for future shortfall, Social Security taxes were raised in the 1980's in order to run up a surplus, a Trust Fund, that could be tapped in the future at need. This was a fraud, since the surplus has always simply been given to the Treasury, which issued United States Treasury Bonds to the Social Security Administration and then spends the money on current Federal expenses. The "Trust Fund" is therefore a room full of paper, whose value depends entirely on future Federal revenues, which can only be obtained by taxing, borrowing, or debasement. The surplus gained through present Social Security taxation thus must be resupplied all over again by future Federal taxing, borrowing, or debasement. Because of this, Democratic Senator Daniel Patrick Moynihan (19272003), who had his moments of marvelous clarity and honesty, said that the "Social Security Trust Fund" was simply a box that, when opened, would contain nothing but a piece of paper that said, "I O U Five Trillion Dollars."

Social Security is thus not insurance, but a Ponzi Scheme, in which present benefits are paid from present revenues, ultimately of the Treasury, regardless of future liabilities and promises. In 2012, the only national politician who had the courage, or foolishness, to actually say this, was Governor Rick Perry of Texas. It was probably foolishess, since Perry later demonstrated that he had difficulty remembering his own political talking points. Periodically, claims are made that Social Security is financially sound at least until the 2030's. However, this prediction is based on the judgment that the "Trust Fund" represents real assets. Since it doesn't, the day of reckoning for Social Security is when it ceases to run a surplus in its own revenues and begins cashing in its Bonds with the Treasury. At that point, the Treasury loses the revenues it has been drawing from Social Security and must begin returning the sums that it previously took, using its own taxing and borrowing powers. This day may have already arrived as I write [in 2012]. Thus today payments for Social Security, Medicare, Medicaid, and interest on the National Debt currently consume Federal revenues in their entirety. All the rest, including the whole Defense budget, must be borrowed. As I understand it, the Federal Reserve is presently buying 60% of United States Treasury Bonds, which means that the Federal Government is simply creating and printing much of the money it is spending. Sooner or later, this debasement will create a period of explosive inflation.

The mention of Medicare and Medicaid brings me to something that most people now think of as a matter of insurance:  Health care. In popular and political discourse, however, what is commonly called "health" or "medical insurance" is not actually insurance at all. This is because current forms of medical "insurance" are not primarily matters of pooling risk. If you know you are going to get a flu shot every year, and your "insurance" pays for the shot, there is no uncertainty and no risk involved. You are not at risk of getting a flu shot. You know you are going to get one. If you have paid for "insurance" that will cover the shot, and the insurance company pays for everyone's shot, then there is no pool of risk. Everyone has simply prepaid for the shot. This may involve some economy, since the insurance company gets its revenues up front and can discount what it has earned from holding your money; but the savings here for you are marginal. Ultimately, most of the cost of the flu shots must be born by the insured. The more things that are added to "insurance" that are not risks but certainties, such as routine doctor visits, birth control, and other predictable expenses, the more expensive the "insurance" will be, since the number of beneficiaries will approach the actual number of the insured. There is no genuine economy to such an arrangement, and no reason, except political deception and economic ignorance, to call it "insurance."

This reality seems to be lost in most of the public discussion of medical insurance. The sophistry involved seems to be the impression that "insurance" necessarily will cost less than the full cost of benefits. But if insurance is turned into a political program, in which benefits are concentrated but costs dispersed, but costs are not actually dispersed, the deception quickly erodes any benefit derived from actual insurance, let alone from a market distribution of goods. Meanwhile, the sort of people who promote medical "insurance" as a right of citizenship, or even of non-citizenship, are hostile to the operation of markets and wish for all goods to be politically distributed.

That the economies of both true insurance and of markets are abolished meanwhile means that the economic characteristics of socialism -- increasing costs and declining quality, with political favoritism -- begin to work their magic. Whereas the dynamic of markets is to decrease costs and increase quality by capital investment in innovation and productivity, the political approach to limiting costs is rationing (tempered, of course, by political favoritism). This is already evident in the theoretical background of the supporters of the socialized medicine in "Obamacare." They all advocate, and the legislation mandates, a Federal board (the Independent Payment Advisory Board, or IPAB) that will approve forms and levels of care, and the suitability of patients to receive the care. In 2009, when Sarah Palin labelled such a board a "death panel," this was protested as a distortion or even a lie; but limiting the care of the elderly, especially terminal care, had long been advocated. In 1984, Richard Lamm, the Democrat Governor of Colorado (19751987), had famously said, "We've got a duty to die and get out of the way with all of our machines and artificial hearts and everything else like that and let the other society, our kids, build a reasonable life."

The IPAB is supposed to achieve savings in Medicare spending "without affecting coverage or quality," but it simply will not be able to limit spending without limiting care through rationing. Meanwhile, while the denial of care by insurance companies has been the stuff of indignant protest, and of Michael Moore movies, Medicare already has a record of denying care more frequently than insurance companies. Socialists like Moore either do not realize, or disingenuously conceal, the circumstance that the Federal government (no more than Moore's beloved Cuba) is under no obligation to provide any care its bureaucrats do not judge expedient, while insurance companies are contractually obligated, with the threat of lawsuits close by (from ambulance chasing lawyers), to provide the care they are contractually bound to (although lawsuits are frequently about things that the actual policies do not cover, with no more than an argument that the patient needs them). This is similar to what happened to the original Federal assurances about Social Security. Eventually, the Supreme Court ruled that citizens had no rights to money they had contributed to Social Security, which could be used for any purpose that Congress thinks appropriate, and that any benefits from Social Security, or none, are entirely at the discretion of Congress. Meanwhile, the socialized medical system in Canada accomplishes rationing with waiting lists. Many patients simply do not survive until they are due for care. The ability of Canadians to go to the United States for treatment may now be cut off by Obamacare, increasing the stress on the Canadian system.

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Rent-Seeking, Public Choice, and The Prisoner's Dilemma,
Note 3, Positive, Negative and Zero Sum Games

Von Neumann substantially invented the digital computer. He built the prototype in the basement of the Institute for Advanced Study at Princeton, although it was later torn out, despite its historical value, because the Institute doesn't believe in machinery. Von Newmann is buried near the great mathematician Kurt Gödel in the Princeton Cemetery.

One of the most conspicuous and durable contributions of Game Theory is the distinction between positive, negative, and zero "sum" games. A "zero sum game" means the values found at the end of the game or transaction are equal to the values at the beginning, so that the difference (the "sum" of a substraction) is zero. Another way to look at it is that if one player ends up in possession of greater value at the end of the game than he did at the beginning, his gain must have come from the loss of the other player. Popular games, from chess to baseball, where one player wins and the other loses, are zero sum games because, where the only value is winning, one player wins and the other loses. People with Cargo Cult conceptions of economics, where wealth simply exists in fixed quantities, and everyone deserves their slice of the "pie," will think of economics as a zero sum game, so that the successful have acquired their wealth at the expense of others. A good example of that is in the original Wall Street movie [1987], where "corporate raider" Gordon Gekko (Michael Douglas) flatly asserts that business is a "zero sum game," where money simply moves from losers to winners. This reflects the Leftist, Cargo Cult ideology of director Oliver Stone and co-star Martin Sheen, who have consistently disgraced themselves with fawning adulation for communist dictator Fidel Castro.

However, free economic transactions are generally positive sum games. This was already understood with great clarity by Benjamin Franklin:

In transactions of trade, it is not to be suppos'd that like gaming, what one party gains the other must necessarily lose. The gain to each may be equal. If A had more corn than he can consume, but wants cattle, and B has more cattle but wants corn, an exchange is a gain to each; hereby the common stock of comforts in life is increas'd. [1783, The Compleated Autobiography by Benjamin Franklin, Compiled and edited by Mark Skousen, Regnery Publishing, 2006, p.300]

In such transactions, each party is better off at the end. The quantity of corn and cattle may be the same at the beginning and end of the exchange, but the surpluses of corn and cattle are useless in themselves to their producers. In the end, each has more of what he can use and the value of the whole has increased. In free economic exchanges, neither party may get exactly what they want, since a vendor would always like to sell for more, and a buyer would always like to buy for less, but the voluntary nature of the exchange means that each must compromise with the other.

On the other hand, robbery is a negative sum game. The exchange is involuntary. One party is left with nothing, while the other party, the robber, has acquired goods that are worth less to him than they had been to the original owner. Usually, the best that the robber can do is recover a fraction of the value of his loot by selling it to a fence. The fence will only buy at a deep discount. Very often the robber acquires things that were only of personal value to their owner and that the robber realizes will be worth nothing to him. So he throws them away. This is frequently the most painful aspect of burglary and robbery. Television sets or cash are usually fungible -- i.e. they can be replaced with items that are equally valuable -- but personal items are not. Sometimes robbers deliberately destroy homes and personal items in acts of vandalism, just to express their contempt and hostility for their victims. This is a particularly ugly manifestation of human nature, but not at all uncommon. The wicked not only have no sympathy for their victims; they despise them.

There is one kind of free market exchange that is a negative sum game. That is short trading. This is a negative sum game just because it occurs with falling prices. The value at the end of the business is thus necessarily going to be less that at the beginning. The only question is who gets stuck with the depreciated asset. The skill of short trading, and it is a skill that specialists exercise best, is to make sure that others get stuck with the loss. As prices fall, the short trader borrows stock or some other asset, sells it, and then buys it back, for less, after the price has gone down. This leaves the original owner of the stock, who might simply be a broker, back in possession of an asset that has lost its value, while the short trader has made a profit in the standard way -- of buying low and selling high, although the sequence is reversed.

Short traders often have a bad reputation. They are not liked because, as "Bears," they profit from a falling market, where mostly everyone else loses. Also, they may engage in spreading rumors or other manipulations that encourage or even cause falling values (George Soros, a short trading master, has been accused of this). It is also possible for them to engage in "naked trading," where they don't even bother to borrow an asset, but sell with a promise to deliver, and then wait to deliver the asset after they buy some with the money from the sale. This is of questionable, at least, legality.

Nevertheless, short traders often perform a very important service. When Jay Gould tried to corner the Gold market in 1869, his strategy was to buy gold and drive up prices. Others then borrowed gold (even from Gould) to sell, on the expectation that Gould would fail in his play and the prices would fall back down, enabling them to buy back and recover a profit. In "cornering the market," Gould thus was actually trying to bankrupt everyone betting against him by the short trading. Nobody, of course, wanted Gould to succeed; and when President Grant ordered the Treasury to sell gold, the price broke, the short traders won, and Gould's position was destroyed. However, seeing the crash coming, he had secretly been selling as well as buying and so was protected from significant loss. It did, however, destroy his reputation. Few shed a tear over this.

The episode set off a Congressional investigation, where Grant's enemies (i.e. Southern sympathizing Democrats) wanted to blame it all on him. Much the same thing happened when the Hunt Brothers (Nelson Bunker Hunt and Herbert Hunt) tried to corner the Silver market in 1980. The short traders, of course, don't always win. In 1863, a rival of Cornelius Vanderbilt, Daniel Drew, began shorting the stock of Vanderbilt's New York and Harlem Railroad (later to merge into the New York Central). This was in league with New York politicians who revoked construction permits to damage the value of the railroad. Vanderbilt, however, had bought up all the outstanding stock. Drew and his allies were legally liable to produce stock that Vanderbilt wouldn't let them purchase. In the end, Vanderbilt let them off with a $5 million loss. Drew summed up the mess with a jingle:  "He that sells what isn't his'n, must buy it back, or go to prison." Later, in 1868, Drew would do better, with the help of Jay Gould, in a fight with Vanderbilt over the Erie Railroad.

Populist thinkers, such as commentator Bill O'Reilly, have difficulty believing that rising prices are not being manipulated by a conspiracy of "speculators." O'Reilly has often challenged economists and financial reporters on his show by asking, "Who sets the prices?" This is a reasonable question; but, oddly enough, the experts often seem to have difficulty answering it. They should know better. The answer is that prices are set by the last persons whose bids to buy or whose bids to sell are accepted. Prices go up when your bid to buy is not accepted and you offer more. Prices go down when your bid to sell is not accepted and you ask for less. Every broker, of course, wants to buy low and sell high (or sell high and then buy low) -- which the ordinary consumer may not be aware of until they try buying or selling foreign currency. Since O'Reilly only sees conspiring speculators behind rising prices, he ignores the circumstance that there are perhaps an equal number of conspiring speculators, the short traders again, betting on falling prices. There are Bulls and Bears in the markets. When prices actually do rise or fall, this means there is something more going on than just the speculators.

Since short traders are usually disliked, as dark angels of falling prices, commentators and politicians can often get some mileage out of proposals to ban or restrict short trading. One wonders if such persons are put up to it or subsidized by the speculators looking for higher prices. Bill O'Reilly should investigate. Perhaps the short traders (George Soros?!) could subsidize him.

Political rent seeking tends to be a negative sum game. Economic exchanges may become involuntary in whole or in part. One party is forced into something they would not otherwise agree to at all, and the result easily is no benefit for that party and an absolute loss of value. A classic case, curiously enough, is rent control for residental housing. The rent seekers are actually the renters, who want terms and conditions that landlords would not or could not agree to. The renters, however, believe that they have a right to pay rent on their own terms, and, in places like New York, San Francisco, Santa Monica, etc., they are able to get their way through politics. Since the result is that landlords may be required to operate their properties at a loss, since they cannot charge market rents, a striking consequence over the years, particuarly in New York City, has been, not only the neglect of the properties, which are not worth the maintenance, but outright abandonment of residential apartment buildings. Abandoned buildings attract squatters, crime, and fires, so the buildings in time tend to get demolished, leaving vacant areas in the South Bronx or Harlem. It has thus been said that the only thing worse for a housing market than rent control is bombing. Areas of New York City have looked bombed out for years (see the review here of Koyaanisqatsi). Leftists like to imagine that the neglect and abandonment of buildings by landlords is part of some conspiracy to derive profits from the process -- explicitly voiced in the director's commentary of Alex Proyas on the movie The Crow [1994] -- but the landlords, generally small investors and/or recent immigrants, are only acting to cut their losses, not gain any positive return. In New York, they lose title to the properties which, by law, they are not allowed to abandon. Meanwhile, the city in which The Crow is supposed to be set, Detroit, now has entire abandoned neighborhoods, not just of rental apartments, but of single family homes. Nor is Detroit unique among cities in Michigan in de-urbanization. People moved to abandon their homes may be reminded of what Davy Crockett told Congress:  "you may all go to hell, and I will go to Texas."

The justification for government intervention in economic exchanges has long been the argument that one of the trading parties is at an unfair disadvantage. This sometimes happens. If you wander out of the desert dying of starvation and thirst, it actually would be a positive sum game if you are required to sell yourself into slavery in order to receive food and water. Otherwise you would be dead. Since no person of good conscience would wish to enforce such an exchange on someone so vulnerable, it is more than reasonable that the law should refuse to enforce the terms of that kind of exchange. Most people would agree that this is proper. The principle, however, can be improperly generalized. Marxism or other critiques of Capitalism hold that wage laborers in general are in the situation of the starving wanderer, and that no agreement between capital and labor can be trusted to be fair to the latter. This view is quite common even among intellectuals who do not otherwise seem to be leftist ideologues, like Jacques Barzan, who says:

[Simonde de Sismondi's] detailed criticism of the new society includes the observation that it splits labor from capital and makes them enemies, with the power all on one side. The idea of their "bargaining" over wages is absurd. Tyrant and victim describes the relation, yet without cruel intent of the one or knowledge by the other of who his oppressor is. [boldface added, see reference and discussion in note for Say's Law]

The claims here are mistaken at at least two crucial levels. If workers only had one employer to bargain with, they might indeed be in the situation of the starving wanderer, and their relationship would be "tyrant and victim." However, in a free market economy there are other employers, and the employers are engaged in competitive bidding for the workers. Supply and demand determine a market wage. The Marxist will counter (1) that employers will collude to hold down wages, and (2) as the economy consolidates into monopolies, the number of employers will also decline, perhaps down to just one anyway.

While such claims tend to be immune to contrary evidence, the evidence is nevertheless against it. Employers may indeed attempt to collude over wages (or prices), but the problem with such combinations has always been the temptation of some members to gain an advantage by violating the agreements. Paying higher wages will attract better (and happier) workers. Even before anti-trust law prohibited collusion between employers on wages and prices, modern law never enforced contracts "in restraint of trade." A cartel of employers (or vendors) thus could never enforce its agreements against its members, who were then free to undercut such agreements. The result historically was rising real wages in both Britain and America all through the 19th century, when the workers supposedly were at the greatest disadvantage. This is what happened, and theoretically it is not that difficult to understand why.

The further Marxist claim that an economy matures into monopolies begins with some superficial plausibility. The chaos of a young industry in time does lead to a shake down where smaller participants go out of business or are bought by larger ones. Since 1980 this has been the visible dynamic in the computer industry. However, even where an industry may only have one real participant, as Alcoa was once the only American aluminum company, its prices may not have the look of monopolistic price gouging. That is because they know that competition is always possible. A free market has "free entry," where a new business can always be created to compete with an old one. IBM was about to be prosecuted for anti-trust violations as a monopoly ("Big Blue") when prosecutors realized that it was in some danger of being bankrupted by new businesses in computers. The case was quietly dropped, as IBM tried to adjust to a new competitive environment.

Thus, collusion between employers or the monopolization of a market historically has not had the practical effect expected by Marxism. Most importantly, Barzan's statement that capitalism "splits labor from capital and makes them enemies" overlooks the most improtant feature of "free entry":  Wage laborers can and have simply started their own businesses. This erases the "split" between labor and capital and introduces further competition in both wages and prices.

An interesting complication there is that we see that small businesses tend to get started by certain ethnic groups -- Chinese, Indians (from India), Jews, Arabs, Koreans, Nigerian Ibos, etc. This happens because starting and running a small business requires particular kinds of knowledge which are best learned by doing, at the knee of one's parents, rather than by book learning. Where the relevant experience is part of a cultural tradition, as with Chinese or Jews, this is a stock of human capital that is not otherwise obtained as easily.

Not surprisingly, a great deal of anti-Capitalist critique focuses a special hostility on successful entrepreneurial minority groups. Marxism not only tends to anti-Semitism but begins with a great deal of anti-Semitism in Marx himself. The success of Jews or Koreans highlights the existence of free entry and the very avenues out of "wage slavery" that someone like Marx is at pains to deny. There is also the circumstance, I suspect, that because intellectuals like Marx and Jacques Barzan do not know how to start or run businesses, they have little understanding or awareness of how this can even be done.

When the law accepts something like the Marxist critique of Capitalism, which it does to a great extent even in the United States, one effect is to burden entry with costs and regulations that express a distrust and dislike of all business. The ironic effect of this is to make it more difficult for people to start businesses, enter a market, introduce new competition in wages and prices, or escape "wage slavery." The effect is thus to produce something like the very conditions that such costs and regulations are supposedly being created to prevent. Even worse, it is not unknown for businesses to perceive the anti-competitive and protective tendencies of such laws and to enthusiastically join in their promotion and enforcement. Policies to "protect" workers or consumers become instruments of rent seeking by business.

Involuntary exchange thus strongly tends to slip into a negative sum game, motivated by rent seekers, even when the rhetoric and the noble purpose may be to prevent exchanges at unfair advantage. Some people simply don't know or don't care what an unfair advantage is. In 1980 a cousin of mine built houses in San Bernardino County (California) by taking out $34 in permits. By 1992 the permits had risen to $14,000. In 1998, the City of Los Angeles might tax a new business, which hadn't even turned a profit yet, $11,000 -- while the City of Glendale only demanded $124. It is not hard to imagine how the rising costs of the San Bernardino permits, or the taxes in the City of Los Angeles, consitute barriers to entry that make it impossible for many and difficult for all to become their own employers. Oh yes, there is also the little trick that the self-employed immediately pay twice as much in Social Security taxes. One could be excused from wondering if, after all, some monopolistic conspiracy is not indeed behind such things.

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Rent-Seeking, Public Choice, and The Prisoner's Dilemma,
Note 4, John Nash

In the game above, the 1,1 result of mutual betrayal is actually the Nash Equilibrium, named after mathematician John Nash (b.1928), the subject of the 2001 movie A Beautiful Mind. In 1994 Nash, with two others, received a Noble Prize for their work, much of it in the early 1950's, in Game Theory. In the later 50's, Nash developed symptoms of schizophrenia, which for some years ruined his career. The movie is largely about that, though it places the development of the disease earlier than it actually was. Otherwise, much of what is said about Nash's work is simply false. Nash did not refute Adam Smith or "[fly] in the face of a hundred and fifty years of economic theory." These statements look like the wishful thinking of a leftist Hollywood scriptwriter hoping for any angle with which to belabor capitalism -- though then unwilling, or unable, to explain in any cogent way why it is so. In fact, Nash's results have often been thought of by "progressives" as unfair or irrational.

In the case of the game example above, a positive sum game, where only one "non-cooperative" move is involved, which means that the players have no knowledge of the other's move, the betrayal strategy is the best strategy for each individual because it will always produce a positive result. The 1,1 outcome is the "Nash Equilibrium" because, in the absence of knowledge of the other player's move, it is the rational strategy to "maximize utility" by avoiding the possibility of a 0 result. However, it is the characteristic of the Prisoner's Dilemma that this "best strategy" result does not maximize mutual or overall utility, and in retrospect it seems foolish (or, at best, unfortunate), even if the players cannot have known better:  The double "keep faith" result involves a 6 point benefit overall, the single betrayal 5, and the double betrayal only 2, which is worse than the individual benefit, 3, as the result of mutually keeping faith. Each player, indeed, can do better individually by consistently getting the other player to keep faith while being betrayed, like Lucy and Charlie Brown (this would involve communciation and thus ironically would be a "cooperative" game), but in real life with sensible persons this is unlikely and is not an issue in a non-cooperative game anyway. The Nash Equilibrium thus could be accused of suffering from the same evils as capitalism itself, allowing self-interest to overcome the common good and tempting each player into deceiving the other, like Lucy, and scoring the maximum benefit.

This failing can be seen as partially remedied in the "Nash Solution," which is about cooperative games and which includes the condition that both players cannot have simultaneously done better through different strategies. With those conditions, the 3,3 result would be the Nash Solution. Although I don't have the dates pinned down, this could well have been Nash's response to the first examples of the Prisoner's Dilemma-like games, about which he was informed, in 1950. Unfortunately, the Nash Solution is also subject to objections that it is unfair or inequitable. This is because in the real world the same objects have different utility for different persons. Thus, if a bequest is left to two persons, one rich and one poor, on the condition that they decide among themselves how to divide it up, otherwise they lose it, this puts the poor person at a negotiating disadvantage. The money means more to the poor man, has greater relative utility, than it does to the rich man, who doesn't really need it in the same way. The result is that the rich man, by the threat of sinking the deal, can obtain agreement for a larger share. This would strike most people as unfair, and indeed in such real bequests the condition usually would only be that the recepients "share and share alike." That condition would strike most people as just because it shouldn't matter what the relative utility of the money is and each person should be treated alike. The requirement of equal utility both explains the real world advantage of a wealthier person in a real situations that are like this and is thus likely to remind those inclined to believe such things of the evils of capitalism itself. Both the Nash Equilibrium and the Nash Solution are thus going to be cold comfort to the Left, whether in Hollywood or elsewhere.

Although the same amount of money may be of less relative utility to the rich person, there is also the circumstance, for those concerned about the common good, that the money in the hands of the rich man is of greater social utility. That is because the rich man will not need to spend the money on necessities and very likely will not even spend the money on luxuries. It will probably be added to investment capital (so as to increase income permanently rather than just blowing a windfall). This is of greater social utility because capital spending increases wealth, even for the poor man. This is the effect of Say's Law, which is what the Left disbelieves and hates about capitalism the most. If the rich person doesn't "need" the money, then it should go to the poor man, the reasoning would go, and all this talk about capital spending is just "trickle down economics" -- a lie designed to deceive the poor and gullible while all that the capitalists are doing is increasing their profits. Capital spending can, indeed, increase profits -- though after several years in operation a very successful business, Amazon.com, still has not turned a profit:  Profit, in that example and as seen above, is uncertain; so capital spending must initially mean something else. It means, indeed, increased production or increased productivity, both of which serve to drive down real prices across the economy, thereby benefiting the poor man who is spending his money on consumer goods. That is Say's Law, and the real benefit of capitalism. The Nash Solution therefore does not represent anything unjust or inequitable. It is about maximizing social utility overall, which benefits everyone, rich or poor. So Adam Smith doesn't quite get refuted yet.

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