Government Functions | Basic Economics by Thomas Sowell | Ch. 18

Markets don’t exist by themselves, but are located within ecosystems. One of these ecosystems is often government institutions. In this chapter of Thomas Sowell’s Basic Economics, we will be taking a look at various government functions and how they affect a national economy.

If you want to see my summaries of previous chapters, please click here. Otherwise, let’s get going!

Chapter Summary

Every market works within a framework of rules, and those rules are enforced by entities, often what we call the government. Governments define limits, and sets the norm of measurements, taxes, and other related things, which are expected. However, governments, also sometimes do unexpected things or expand their role within an economy. Thus, across the present and in history, the role which governments play in an economy is often a controversial and varied one. Let’s take a look at these expected and unexpected facets of government.

Law and Order

A government which restricts its own role in an economy is actually a rare thing, and it often takes many hundreds of years to get there. Since human governments are often the people with the power to assert their authority, even when a country has an abundance of natural resources, corruption of the people in those governments can keep a country poor.

Corruption is often the culprit behind inefficiency in an economy. The vast amounts of red tape, idling bureaucracy, and bribery add to the costs consumers must bear, in addition to lowering standards of living. It sometimes gets so bad, that investors and aid agencies need to take corruption into account in calculating their investment and lending into certain countries, and nations known for high levels of corruption often have a hard time hiring out their workers. From delays in economic activity to nepotistic practices, corruption in countries only hurts those countries’ own economies.

Laws within countries must also be consistently applied for them to be economically effective. If or when laws change on the whim of political officials, the risk of investment tends to rise, and thus decrease. Historically, consistency in rule of law was what allowed Britain to become the first industrialized nation. It’s what allowed its citizens as well as foreigner to confidently invest in the nation. When the European powers began to colonize Southeast Asia, the consistency of western laws rather than the power of local rulers and tribes caused an influx of immigration from China and India to these regions.

Even when there is discrimination, as long as such laws are consistent, they may actually produce positive economic developments. For example, the Chinese and Indian immigrants to European colonies didn’t have the same rights as Europeans, but they still were able to create a profitable businesses in spite of this. Similarly, Christians and Jews in the Ottoman Empire (during its centuries of prosperity) didn’t have the same rights as Muslims, but were able to rely on dependable laws which enabled them to prosper commercially, industrially, and in banking than even the Muslims living there. This isn’t to say such discrimination is right, but rather a simple commentary on the positive effects of consistently applied laws.

Property rights are also an important aspect of the relationship between government and economics. What property rights do is incentivize individuals to ensure that the transmission of their property is secure and as free from loss as possible. In other words, property rights create a self-monitoring system that is more effective and cheaper than third-party monitoring. Unowned land is often unkept versus owned land, animals that are owned by someone aren’t ever threatened with extinction, and lumber companies will reseed the land they own and use so as to keep their business alive.

Thus, the ability to own property actually benefits society as a whole, even for people who don’t own much, but live in a society which allows others to do so. For example, entrepreneurs or other investors and venture capitalists can buy the massive estates of the rich and divide them into apartment complexes or smaller homes, and thus benefit for those who are not as rich. While individuals within these communities may have less money than a wealthy person, in aggregate, they actually have more buying power in a free market than a single wealthy individual.

Problems arise when the wealthy (read: politically connected) restrict others’ property rights through law. In California or Virginia, there are locales that require any lots that are sold to be one acre more per house. This restricts the price above the average person’s ability to pay. Furthermore, oftentimes there are commissions to preserve historical sites or provide zoning laws that will begin to limit the ownership ability of individuals within a community, justified often as “owned collectively”. These practices keep people with average incomes out of certain areas, while at the same time increasing the value of an increasingly scarce resource.

Sowell argues that “property rights need to be assessed economically in terms of the incentives created by their existence, their modifications, or their elimination”. In other words, the cure for the wealthy using their own property to restrict others isn’t the elimination of property rights, but an understanding of their economic incentives.

Order in society isn’t just about government and laws, but also about the very people within a nation. The ability to conduct honest and dependable business depends on the people within the country, especially since a lot of it is done between people who don’t know each other at all. Those who often can rely on each other in often have a competitive edge on those who can’t, regardless of whether the legal system is dependable. This is true whether you’re a Hasidic Jew in New York, Marwaris in India, or a Chinese immigrant in other Southeast Asian country. In this way, honesty becomes an economic factor, not just a moral idea.

Let’s look at landlords. Oftentimes, rent control laws are enacted because of complaints against dishonest landlords charging high prices. But, because maintaining good utility services have high costs, the landlords who are honest will have higher bills for their renters, or their property becomes worthless. On the other hand, landlords who accept bribes will allow their utilities to stay at a lower rate, so their charge to renters may be lower. In such a situation, rent control will have an adverse effect on the honest landowners, rather than actually hurting dishonest ones. In fact, some dishonest landlords have gone so far as to burn their own properties down in an effort to bid away their property for money a while after rent control laws are enacted. As Sowell points out:

When laws and policies make honesty increasingly costly, then government is, in effect, promoting dishonesty.

External Costs and Benefits

A lot of the decisions made in market transactions depend on whether prices reflect the real costs and benefits of products and services. Yet, there are costs that are counted as “external”, and not part of the actual transaction, and thus unaccounted for by the market. These external costs are more efficient for government to deal with than markets.

Here are a few examples. When an electric company purchases coal to power their generators, the pure cost of buying that coal does not take into account the pollutant that would result in health costs to residents around it. Another example is if people buy mud flaps for their cars, which prevents mud and water from being thrown on the windshield of a car behind them. In this case, the person behind is benefiting from the purchase, even though they didn’t pay the cost. These costs and benefits are external, in which case it is easier for the government can simply mandate all cars to have mud flaps than for a market to judge.

The same goes for a military defense. While individuals within a nation may or may not agree with spending money on it, a military defense would beneficially defend both supporters and non-supporters. And since a very small number of people would understand the cost and benefits of having such a thing, letting government be responsible for it would be more efficient for most circumstances.

The question isn’t a “government” vs. “private”, as if those are always mutually exclusive. Instead, it’s deciding between the benefits of decisions being made by collectives versus individuals. Many collective decisions don’t actually need to be made by official national or even local governments, but could be made by people simply coming together to form a group they agree or cohere with. In other words, external costs and benefits must be weighed when deciding whether to pursue an end goal with the incentives of the market or politics.

Incentives and Constraints

It is important to keep in mind the difference between what government can do, and what it is likely to do. Since government is made up of people, each of whom have separate interests, it is much more likely that those people will pursue those interests than the public interest, or even policy agendas. It is thus unwise to think of government as a monolithic structure, even when it is as centralized as a totalitarian regime. For example, in the Soviet Union, different government ministries would often go out of their way to avoid relying on each other, causing an extraordinary wasting of resources. Such differences are even more pronounced in democratic societies.

We must always remember that the main political incentive is popular action, even if the result of that action is worse than no action. For example, the results of good or bad education often requires years before results can be achieved. However, it is normal for politicians to promise and spend lots of money on it, even if there isn’t much to show that their policies have beneficial effects. What this amounts to, then, is more money being poured into ineffectual laws.

Furthermore, governmental policies are often applied categorically. Earlier, we talked about how things such as having clean water and air are more easily dealt with by the government. However, since there isn’t a limit to how clean the air or water could be (e.g. you can always want ‘purer’ water), government policy is incentivized to continue to increase the standard of that purity, and thus escalating costs and taxes. This doesn’t even touch how to determine whether something counts as an impurity or health risk. In these situations, the aggregate cost of policies can become extraordinarily heavy on the public of a nation at large.

The problem is that there are no incentives or constraints that would force government to hold account to these costs. In fact, oftentimes, governments will use whatever agreement exists for their power to increase it, or at the very least extend it. For example, in 1933, US President Franklin D. Roosevelt used presidential powers created during the First World War to take the US off the gold standard. However, this power was originally created only to prevent trading with enemy nations, and today, this power is continually used for other purposes, despite the fact that there hasn’t been a world war since.

The conclusion is this: before believing that a government apparatus is necessary to solve a problem, and thus expanding the role of that government, it is necessary to carry out the costs, incentive structures, and predict results before doing so. Otherwise, the government will just get bigger and bigger, and it is unlikely that the government will give up that power.

My Thoughts

This is a pretty big chapter, not only in length, but also in terms of content and understanding the role of government. There isn’t much to add to what Sowell has said, but here are a couple thoughts that I’ve had as I wrote the above summary.

Government Accountability: Can it Exist?

One of the big issues outlined by Sowell, and many others, is the fact that there isn’t much that can constrain and keep governments in check. Unlike the market, in which competition between people and businesses incentivizes higher quality as well as decreasing cost, there is no government apparatus that can keep it in check to make sure that any enacted policies are actually effective.

Well, that’s technically not true. Just like businesses that don’t improve quality or decrease costs will eventually become bankrupt (thus keeping markets in check), it is significant that governments and nations across time have done the same. Empires and kingdoms have fallen across the ages as corruption and oppression increased, and from Rome to the Soviet Union, the cycle of fallen nations continues even today.

But such things exist in the bloodiest of times. And so, the real question is whether a governing body can exist that will keep itself in check so as to not collapse and cause the destruction of many human lives.

The political system of the United States was founded with this ambition, with its three bodies of government (Legislative, Executive, and Judicial) created to “check and balance” itself. But, after nearly 300 years, it’s become pretty clear that the federal government of the United States has expanded beyond constraint.

When the US was first founded, its first two parties were not Democrat and Republican, but rather the Federalists and Anti-Federalists. The Federalists eventually won out to create the United States Constitution, and united the 13 colonies under a single nation. But, interestingly, the Anti-Federalists made a few predictions about the US that have turned out to be pretty true. According to wikipedia, these were their primary concerns:

The Bill of Rights was the only thing the Federalists agreed with and stuck onto the US Constitution. However, the other four points, having not been addressed, have become the insane reality of the US government.

Indeed, the US Presidency has expanded so much, that while it isn’t an official monarchy in terms of election, it certainly is in terms of power and authority. Additionally, the courts, especially the US Supreme Court, has become the battleground on which all policies are decided. In all this, the federal government has taken away much of the power of state governments, while being the least responsive to the needs of local populations.

And so, I believe we can see that, despite their best efforts, across the course of a few centuries, the current federal government of the United States is indeed in trouble.

While it is unlikely that government policy-makers and officials will vote to reduce their power, we can, perhaps, surmise a path that can work. In fact, it’s not too difficult to imagine a better system if we place government under the same lens as corporations and businesses. If corporations and businesses are kept in check through competition, then governments can be as well.

The easiest way to think about this is to realize that local governments are already in competition with one another. The municipals of cities and towns compete for residences and businesses. If a certain city or town has adverse laws, people can migrate away from them. This forces cities and towns to compete against each other, to create laws and policies that are actually beneficial for its citizens.

Of course, states and nations also compete with each other, but as Sowell points out, it often takes time to see the economic deficiencies of policies, and by the time such things happen, the politicians and wealthy elites who have benefitted from such terrible policies can up and move without suffering the same consequences as the people under them.

And so, the problem becomes, how do we deal with the role of governments greater than local cities or towns? How should we think of and define their roles?

I think a key lies in the founding of the US Declaration of Independence. Let’s take a look:

We hold these truths to be self-evident, that all men are created equal, that they are endowed by their Creator with certain unalienable Rights, that among these are Life, Liberty and the pursuit of Happiness. That to secure these rights, Governments are instituted among Men, deriving their just powers from the consent of the governed.

Notice the sentiment here: government is created to secure rights.

Historically, we’ve often viewed government from the top down. Like a pyramid, those with the highest authority preside over those with less, and the higher you move up the chain of command, the smaller the population. In a democracy or a republic, we’ve contextualized this to be a group of political elites rather than a single person, but this scheme still exists.

However, the genius behind the founding of the US is this idea: that government exists under the consent of the governed. In other words, rather than having the highest authority at the top, the highest authority should actually exist at the bottom, the foundation without which the top wouldn’t exist.

It is important, then, to recognize that, in this understanding, the local municipalities of cities and towns should have more authority than the state or federal. As government graduates from city to county to state to country, the authority of those presiding over more population should decrease in authority. This would keep the structure of competition, and would thus incentivize governments to create policies that actually benefit the public.

Practically, how would this work? Well, it’s actually quite easy. For example, if a federal government attempts to tax its citizens, each state should be able to refuse for its citizens the need to pay those taxes. If the state doesn’t exempt its citizens, then the cities and towns within it can do so. Such a thing can go from the simple realm of taxes to any kind of law the federal government enacts. If a city disagrees with a federal law, it can create an exemption for its own citizens from obeying it.

Thus, a city or state or federal government (in the event of a UN or other alliance type situation) has two roles: it can create laws for those under it to follow, and it can exempt the citizens under its jurisdiction from following the higher laws of the land.

For many, this may seem quite strange. After all, what if the federal government creates a beneficial law, and the city you live in doesn’t like it? Well, there’s no reason any individual citizen can’t obey it. After all, if you want to pay those taxes, then by your will, you certainly can. If for some reason a city actively tries to keep you from following federal law, you can simply move to a new city.

By incentivizing cities this way, the best laws will become more of a norm, since cities and states are incentivized to keep their populations happy through competition rather than popularity. And through the exemption process, a larger state or federal government can’t really create a law which will have adverse effects on its population. I mean, it can, but pretty soon, cities which experience the negative effects will be exempting its citizens from following such laws.

There would, of course, be certain laws that all cities and states in a country must follow. Such things would include the Constitution and the Bill of Rights (if such a scenario were to be in the US). This would of course, incentivize politicians to try writing laws as Amendments. There are many ways to deal with this, one of which could be a law that automatically increases the voting requirement the more Amendments are put into law.

In such a world, we will then have truly decentralized.

There’s actually a lot to unpack here, but rather than writing more in an already long-winded review, I’ll simply leave it here to ponder about.