Knowledge And Decisions

Among the many variables impinging on one’s happiness and well-being, some require relatively frequent adjustments while others do not, and some derive much of their value precisely from their constancy. Obviously, formal organizations would not exist if informal relationships met all human needs.

The apportionment of decision making as between informal and formal processes involves a trade-off of flexibility for security. A’s flexibility is B’s uncertainty as to what A will do. The cost to B of this uncertainty cannot be measured in terms of A’s most likely prospective action nor in terms of A’s retrospectively observed action. The cost of uncertainty to B is the cost of preparing for a range of possibilities of A’s behavior. Depending upon the cost of these precautions to B and the value of flexibility to A, it may be possible for both sides to become better off by signing a contract awarding money to A for agreeing in advance to follow a given course (or restricted range of courses) of conduct. In short, a more rigidified process may be made preferable to both sides. Total risk can be reduced in some cases by rigidity, just as it is reduced in other cases by flexibility.

In many cases a much broader kind of rigid agreement may be in order. Society itself may need to guarantee that certain relationships will remain rigid and inviolate in all but the most extraordinary circumstances. Much socially beneficial prospective action will not take place, or will not take place to the same extent, without rigid guarantees. The heavy investment of emotion, time, and resources necessary to raise a child would be less likely in a society where the child might at any moment, for any capricious reason, be taken away and never seen again. Such behavior is rejected not only for its retrospective injustice but also for its prospective effect on parental behavior. Not only will the state forebear from such behavior; it will use severe sanctions against private individuals who do such things (kidnappers). This rigid legal framework of parent-child relationships provides the protective setting within which the most flexible kinds of parent-child social relationships may develop. Formal and informal processes are not mutually exclusive but mutually supporting.

Similar considerations apply across a spectrum of other social arrangements, particularly those involving long and large individual investments of efforts for prospective personal and social benefits. Property rights introduce rigidities into the use of vast amounts of many resources — by excluding all but the legal owner(s) from a serious voice in most of the decisions made about the disposition of the resources — on the assumption that such losses as are occasioned by this rigidity are more than offset by the gains in prospective behavior by people acting under these guarantees.

Someone who is going to work for many years to have his own home wants some fairly rigid assurance that the house will in fact belong to him — that he cannot be dispossessed by someone who is physically stronger, better armed, or more ruthless, or who is deemed more “worthy” by political authorities. Rigid assurances are needed that changing fashions, mores, and power relationships will not suddenly deprive him of his property, his children, or his life. Informal relationships which flourish in a society do so within the protection of formal laws on property ownership, kidnapping, murder, and other basic matters on which people want rigidity rather than continuously negotiable or modifiable relationships.

Formalized and rigidified decision-making processes (or frameworks for processes) are not only social investments in certain behavior patterns; they are direct consumer goods as well. Peace of mind and a sense of independence and dignity are immediate psychic dividends from operating under known rules, applicable to all, rather than being personally assessed and controlled by other individuals. Informal decision-making processes flourish only where such assessment and control are in the hands of those biased in favor of the individual concerned — e.g., family, friends, and lovers. Similar informal processes in the hands of strangers might be intolerable. In short, the comparison is not solely between two different kinds of institutional processes — formal vs. informal — but between two different kinds of processes engaged in by two different kinds of people.

ECONOMIC INSTITUTIONS

Economic decisions may be made through informal processes or through structured organizations. If the lawn needs mowing, the homeowner may do it himself, tell his son to do it, pay his son to do it, pay another individual to do it, or contract with a lawn-care firm to do it. Similarly he may grow his own vegetables, buy them from a local farmer, or from a store, or buy them already prepared at a restaurant. The theoretical spectrum, ranging from the most informal to the most formal decision-making processes, is far greater than is likely to be encountered in the real world. Why this is so is worth analyzing in order to understand the peculiar advantages and disadvantages of more formal and less formal economic processes.

Theoretically, the various components which typically make up a product could all be bought separately and assembled either by the consumer or by other persons hired by him to perform that service on a one-time basis as needed — the way he hires a plumber or electrician when he needs their services. There is no inherent need for a firm to exist to sell him a finished product. By the same token, there is no need for workers to be employed by such a firm. Theoretically, they could sell their services directly to those who want them, as plumbers, doctors, and shoe shine boys ordinarily do.

For some products and to some extent, there is much consumer assembly of finished products. Stereo systems often contain amplifiers, speakers, turntables and tape decks, each made by a different manufacturer and assembled with knowledge purchased from the publisher of a do-it-yourself book. A whole pre-assembled stereo system may also be purchased at most department stores. A similar range exists among cameras. The view camera used by professional photographers is usually sold as a camera body with no lens or shutter, and with nothing to hold the film. All these essential components are typically available in a wide variety of types and brands, all of which are to be assembled by the photographer into a functioning camera. At the other end of the spectrum is the “Instamatic” camera with all these components preselected, preassembled, and preset for a specific focusing distance, lens opening and shutter speed selected by the manufacturer, who is in effect selling a “package” that includes not only physical items but also the application of elementary knowledge of picture taking settings.

From this it is clear that one reason for the existence of a business firm is to economize on the production or application of knowledge. Any user of an “Instamatic” camera could acquire as much knowledge as is used in presetting the lens and shutter by purchasing an elementary book on photography and investing a few hours in reading it. Since the consumer sees people all around him with adjustable cameras, he knows that it is neither impossible nor probably very difficult to acquire such knowledge. His is therefore an informed choice to purchase the knowledge from the camera manufacturer, rather than produce this knowledge himself from a book. This is a perfectly rational choice where the camera firm can produce the quantity of knowledge needed (for casual snapshots) at a lower cost than the consumer. From the point of view of society at large, fewer resources are used to produce a given product or to achieve a given end result.

One of the reasons the firm has lower costs than the consumer would have is that it engages in fewer transactions in proportion to its volume of output. A consumer who wished to hire a photographic expert to tell him at what distance to focus his lens would have to determine the likely sources of such experts and the means of determining their expertise, as well as not buying more expertise than he needed, and other such problems. The cost of hiring the expert, spread over one or two cameras would be much higher per camera (or per picture) than when a camera manufacturer hires experts to guide its decisions on thousands of cameras. Similar considerations apply to the hiring of many kinds of workers (including management) and to the hire or purchase of specialized equipment.

In the theoretical extreme, each worker could hire various fractions of his time to various employers, as some workers do in practice to some extent. But theoretically the worker would be ready to sell the tiniest fraction of his time to different employers or to change employers at any given instant of the working day when the fluctuations of the labor market might offer a marginally higher wage rate somewhere else. Such behavior would, of course, involve very high transactions costs to the worker — and to the employer, who would have to be constantly prepared to fill vacancies at a moment’s notice. Contractual and semicontractual arrangements, including “adequate notice” customs, reduce these transactions costs, at the cost of reduced institutional flexibility in the quantity and quality of labor employed, and in the quantity and quality of work obtainable from given workers in a situation where “instant firing” is often not a feasible option. That many firms voluntarily chose to accept such costs of institutional rigidity implied in having “regular employees” — even before union or legal pressures for job security — suggests that transactions costs would be substantial otherwise. That other firms had to wait for such outside pressures suggests that the relative weights of those costs and benefits vary from situation to situation.

As in the general question of the relative advantages of formal versus informal procedures, the point here is not to determine which is better categorically. On the contrary, the point is to suggest why there is a trade-off. The particular terms of that trade-off, and the way those terms vary incrementally, is likely to be far better known to those directly involved than to others operating on general principles.

Even after acquiring the formal institutional structures implied where firms sell to consumers, economic processes still retain substantial elements of incremental rather than categorical decision making. The consumer, by choosing among firms to patronize, implicitly weighs the effectiveness of different sets of workers and managers, rewarding some with fuller, more sustained employment, and forcing others to work less or not at all — despite any institutional guarantees — for lack of consumer demand can force the institution itself out of business. Even where the consumer chooses to buy prepackaged products, his range of choice among such products and retailers of products usually prevents his being forced into the kind of take-it-or-leave-it “package deal” choices common in such fields as politics, where he must vote for one candidate’s whole “package” of positions on foreign policy, civil liberties, ecology, race relations, monetary policy, etc. The almost continuous revision of most economic decisions adds a temporal flexibility not found in political systems with fixed terms of office, where recall and impeachment are costly options.

Because economic transactions often involve repeated satisfaction of the same desires, there is continual feedback from those most knowledgeable about the extent to which a given product or service is satisfactory — namely, the consumers. Moreover, this is not merely abstract knowledge but knowledge conveyed in a monetary form, conveying persuasion as well as information.

Economic transactions, whether through formal or informal processes, have as a serious disadvantage the possible disregard of affected interests not party to the transactions. A sale of coal to an electric generating plant may represent a mutually advantageous transaction from the point of view of the coal company and the electric company, and yet create millions of dollars worth of costs in dirt and lung disease which are not represented in the decisions as to the kind of coal to use, the location of the plant, or the presence or absence of devices to reduce harmful emissions. Theoretically, with a perfectly functioning and costless legal system, all these costs would be felt in the form of damage liabilities, which would be foreseen at the time of the economic transaction — leading to the same kinds of decisions as if the excluded third parties had in fact been included.¹¹ The external costs in some economic processes, and the high transactions costs of organizing thousands of scattered individuals, create special problems for affected third parties. Viewed as a social process, the problem with such economic processes is that the transacting parties are not coextensive with the affected parties.

Another problem with an economic system is that different people have varying amounts of money with which to convey their consumer preferences to producers. For many social critics, this invalidates any hope of an optimal use of resources via market processes. However, this may be a more formidable problem in theory than in practice. When groups of consumers compete for the same products, each of the competing groups usually includes a wide range of income levels, so that a rich-versus-poor competition need not be involved. Moreover, even where such a competition is involved, lower income consumers often bid goods and resources away from the affluent, through sheer numbers, even if not to the theoretically optimal extent. Much of the outcry against middlemen (“developers,” “commercial interests,” etc.) who would redirect resources from a “higher” to a “lower” use is implicitly a protest against large numbers of lower-income people whose collective wealth is bidding shoreline, forest, and lakeside property away from a use favored by higher-income people to uses more consonant with the tastes and individual resources of lower-income people: typically higher density use, substituting apartment buildings for individual houses, hotels for rustic cabins, automobile access roads for backpack trails, etc. The middlemen, as such, typically have no bias toward any particular use, but only toward making money — a charge bitterly made by critics, despite the inconsistency of that charge with blaming the middlemen for a particular end result.

POLITICAL INSTITUTIONS

Political and legal institutions provide the rigidities — “rights” — people want in some vital areas of their life, where they reject both the transactions costs and the indignity of having to submit to, or negotiate with, those who might challenge or threaten their possession of their home, their children, or their life. Constitutional systems attempt to sharply demarcate these areas of basic rights from other areas in which the discretion and flexibility of individual choice and interpersonal negotiation may achieve whatever arrangements are deemed mutually satisfactory by the individuals concerned. In short, Constitutional political and legal systems attempt to limit their own scope to areas in which they have a relative advantage as decision-making processes, leaving other areas to other decision-making processes, whose advantages may be either in the quality of the decisions or in the personal dignity implied by free choice.

Political systems provide some feedback via the electoral process, so that laws can be amended, repealed, or given varying amounts of financial support. This feedback is neither as fast nor as universal, nor as immediately coercive as in economic market processes. The growing area of administrative decision making is even more insulated from electoral feedback, and legal institutions at the higher, appellate court levels have been made virtually election-proof, except for the confirmation process. As compared to economic institutions, the virtues of political, administrative, and judicial institutions are not so much responsiveness as reliability. Their decisions are not separate and episodic but precedential: political, legislative, and administrative rulings are in effect until explicitly repealed or declared unconstitutional, and changes in court rulings are self-restricted by deliberate reluctance to needlessly upset precedents. The basic framework of political, administrative, and judicial rulings is categorical — legal or illegal, guilty or innocent — though much ingenuity may go into introducing elements of flexibility and incremental decision making into these institutional processes. Still, these flexible and incremental features are not as integral to such processes as to economic institutions.

Political systems allow affected third parties to influence economic transactions from which their interests are excluded. Political decision making can lower transactions costs by allowing a relatively few surrogates to make and implement decisions reflecting the will of millions who have insufficient individual stake (or resources) to incur the huge costs of devising and transacting some of the decisions they believe in.

Social transactions may generate not only costs external to the transacting parties but also benefits external to those parties. Economic institutions do not bring such benefits to bear on the decision makers. Theoretically, the beneficiaries might bring such considerations to bear through offers of reward to the transacting parties to shape their decisions so as to optimize third party benefits, but in practice the number and dispersion of the beneficiaries, and the corresponding cost of identifying and welding these diffuse interests into a coherent bargaining agent typically prevent this.¹²

A special case of external benefits is “social overhead capital” — investments whose benefits accrue to a wide variety of individuals and institutions which do not themselves incur the cost of making the investment. For example, a sewage system reduces the incidence of disease and debilitation, enabling workers to work more days and earn more pay, and enabling employers to have a more reliable workforce and correspondingly higher profits. Raising children to be honest is an investment made by parents, but among the beneficiaries are credit card companies, self-service stores, and the Internal Revenue Service. The fact that those who incur the costs of the investment are not the same as those who reap the dividends makes it more difficult for economic institutions to achieve the level of investment justified by the returns, and thereby creates a role for political surrogates.

The time horizon of the constituent may be his lifetime, and perhaps that of his children, or even the longer range interest of the whole society as an on-going enterprise. The inherent incentive structure facing a political surrogate emphasizes the time remaining between a given decision and the next election. The opportunity for policies with immediate benefits and longer run negative consequences are obvious, not only in theory but in practice. Similarly, differences in information and transactions costs per unit of benefit between the citizen and organized interest groups, as well as between the citizen and his political surrogate, create inherent incentives for policies with concentrated benefits and diffused costs — even though the costs may be several times the benefits, whether measured financially or otherwise.

Another problem inherent in political processes is that the degree of reliability or rigidity desired in a governmental framework, within which individual planning and action can take place, is jeopardized by political incentives to continually adjust this framework for the real or alleged benefit of particular groups of constituents. This is a special case of the concentration of benefits and the diffusion of costs. Everyone with an objective interest in a known and predictable set of laws and policies pays the cost of innovative political activities. This means virtually everyone in the society, including those who benefit from particular subsets of changes. It is not merely so-called “liberals” who innovate; so-called “conservatives” may be equally creative with “tax breaks” or monopolistic concessions for a variety of constituent groups as their political opponents are with expenditure programs and government controls for a variety of their constituents. The point is that political surrogates, for whatever constituent coalition they serve, have an incentive to continually adjust the legal framework — whatever it may be at a given moment and regardless of its merits or demerits — because of specific concentrated benefits and the diffused general costs of reduced predictability.

This is neither a moral comment on individuals nor an exhortation for more citizen knowledge of specific governmental policy. On the contrary, it is an attempt to explain the causes of these phenomena in terms of differentials in the cost of information, differentials in transactions costs, and inherent conflicts of interest built into political decision-making processes. To exhort the individual citizen to make investments in knowledge comparable to those of lobbyists and political crusaders (both of whom have much lower costs per unit of personal benefit) is to urge him to behavior that is irrational, if not physically impossible in a twenty-four hour day. What might be possible, at lower cost, is an awareness of this problem inherent in political decision making, when choosing among modes of decision making.

The competition of political opponents tends to mitigate these problems somewhat, but the terms of this competition are quite different from the terms of economic competition. Political knowledge is conveyed by articulation, and its accurate transmission through political competition depends upon the preexisting stock of knowledge and understanding of the receiving citizen. Economic knowledge need not be articulated to the consumer, but is conveyed — summarized — in the prices and qualities of goods. The consumer may have no idea at all — or even a wrong idea — as to why one product costs less and serves his purposes better; all he needs is that end-result itself. Someone must of course have the specific knowledge of how to achieve that result. What is crucial to economic competition is that better and more accurate knowledge on the part of the producer is a decisive competitive advantage, regardless of whether the consumer shares any part of that knowledge. In political competition, accurate knowledge has no such decisive competitive advantage, because what is being “sold” is not an end-result but a plausible belief about a complex process.

Because of differences in the cost of judging processes versus the cost of judging end results, it is even more important in political than in economic processes to have feedback from the diffused individuals who receive the consequences to the few who made the decisions that produced the consequences.

Where political decision making is broadly defined to include judicial decision making, feedback from those affected is even less effective. Moreover, the cost of a court’s monitoring the consequences of its own decisions could easily be prohibitive, and especially where the consequences include effects on people not party to the legal action, but whose whole constellation of expectations have been changed. However difficult it may be to directly know what is going on in someone else’s mind — such as changing expectations — it has concrete consequences which take place long before the future events contemplated. Restrictions on the future use of property is a reduction in its present value, since one component of its present value is its future saleability. In short, a reduction in property rights is a partial confiscation of property; to take away 10 percent of the value of land is economically no different from taking away 10 percent of the land itself.

Similar reasoning applies to other restrictions on other values not expressed in money terms. Changing expectations of future social relationships of school children bring forth varying present reactions of parents. In some cases, these present reactions may be more vehement than after the future event actually arrives — as claimed by some supporters of “busing,” for example — but this merely illustrates the correspondence between economic and noneconomic translation (or inherent equivalence) of future expectations into present costs or benefits.

JUDICIAL PROCESSES

Judicial decision making is made necessary by the insufficiencies of language, even if everyone were willing to obey the law as he understood it. Political leaders cannot exhaustively specify the application of the principles they legislate. Moreover, the people may choose to bind themselves and their political surrogates in advance, during presumably more sober periods, against actions they might take in rash moments. This simply means that, beyond some point, flexibility of decision making is deemed harmful and the rigidities of Constitutional limitations are preferred within that range of decisions. This parallels the economic law of diminishing returns, under which a given input has varying effects on output over different ranges, including — beyond some point — a negative effect. If flexibility is considered as an input in decision-making processes, then it too, clearly, has a range within which it is enormously valuable, another range within which it is more moderately valuable, and another range within which it is positively harmful. Otherwise we would leave ourselves unlimited flexibility to take the most sweeping and drastic actions on the basis of the most transient 51 percent majority. Instead special rigidities — “rights” — are deliberately built into the system to apply to such things as life, liberty, and property, where our primary interest is in security rather than in fine tuning the social mechanism to capture fleeting advantages.

Even as compared to formal economic or political processes, judicial decision making tends to be more categorical, rather than incremental. Not only do criminal cases tend to be dichotomized into guilty or innocent, and appellate decisions into constitutional or unconstitutional, the legal precedents apply to all similarly circumstanced individuals — where the similarity is in those articulated characteristics documentable to third parties, whether or not these are the characteristics most behaviorally determinative or philosophically crucial. By contrast, informal social processes can adjust the time, scope, and degree of specialness of treatment of the salient characteristics of each individual person and each episode, as determined by closer knowledge, unrestricted by the inherent limitations of articulation or of secondhand data filtered through legal rules of evidence.

No such close weighing of incremental costs and incremental benefits can be expected in judicial processes whose social benefits take the rigid form of “rights” applicable to categories, and costs take the form of correspondingly rigid obligations. In short, judicial decision making especially at the appellate level, consists of “package deals,” in which the package is quite extensive in time as well as space, and has contents which are homogeneous only with respect to articulated, documentable variables — and may be quite heterogeneous with respect to all other behavioral or philosophical considerations.

Given the inherent factor of scarcity, any kind of economy tries to maximize the output from its given inputs — or, in other words, to get the most value for its costs. Because resources have alternative uses, and because alternative products produce consumer satisfaction, substitution is a crucial factor of economic life, both in production and in consumption. We have already noted how the same ingredient can go into many different products. It should also be recognized that many different products can be ingredients in a consumer’s sense of well-being. We normally think of physically similar things as substitutes: Plymouths and Chevrolets, rye bread and whole wheat, vodka and gin, etc. But in fact people may choose between spending their disposable cash on adding another room to the house or on taking a vacation abroad, between stocking their wine cellar and buying a season’s pass to the baseball games, or between retiring early and sending a child to college. The particular nature of the satisfactions need not be the same.

Substitution does not imply perfect substitutions. There are all degrees of substitutability: most people would consider two pints of milk as a perfect substitute for a quart of milk, but would consider a cold shower a very poor substitute for sex. How well one thing substitutes for another cannot be determined by how similar they are in physical characteristics, or indeed, by any purely objective criteria. Economists define substitutability in terms of people’s subjective preferences as revealed by their overt behavior. If a rise in the price of coffee causes people to buy more tea, then economically speaking, we can say that they are substitutes without having to investigate the chemical or physical characteristics of either. Similarly, if an increase in the price of stereo equipment causes people to buy more clothes instead, then economically these two goods are substitutes, without regard to their material disparities or even the implausibility of the connection.

Substitution takes place in production as well as consumption. Electric wires can be made of copper, steel, or aluminum, and the proportions of the three vary according to the relationship of their respective costs. Again, substitutes need not be perfect substitutes; the weight advantage of aluminum is more important for some purposes, while for other purposes any price differential will cause the immediate substitution of steel or copper. Through substitution, an economy can — in effect — transform one product into another by shifting some of their common inputs. For example, the economy can easily accomplish the old alchemists’ dream of transforming lead into gold by simply shifting the labor, machinery, and managerial skills used to make lead into the production of gold instead. From an economic point of view, it does not matter that this is not “really” transforming one metal physically into another. What matters is that a reduction in the output of one leads to an increase in the output of the other. In World War II, we transformed our automobiles and refrigerators into tanks and airplanes by this very process of redirecting resource inputs into other product outputs.

Neither in production nor consumption does substitution imply total substitution. More likely, it means an incremental substitution, accepting somewhat less of one thing in order to get somewhat more of another. We almost never have to attempt anything as difficult as deciding categorical priorities — whether vegetables are more important than shoes, or vacations more important than music. Moreover, because we usually decide to have some of each option, even the relative importance of each possible choice changes as the respective quantities that we already have change. For example, if we had a dozen oranges and a bushel of apples, we would probably be less interested in another bag of apples than in another bag of oranges, and we might give up either for one pineapple or a pound of grapes, even though we might have the opposite preferences if we started from a position in which we had no fruit at all, or in which we had a bushel of oranges and ten pounds of grapes. In other words, substitution ratios are incrementally variable rather than categorically fixed.

Simple as all this is, it goes completely counter to rhetoric that is often heard, and sometimes heeded, about the urgent need to “establish priorities” either nationally or in a business or other organization. At the instant that such rhetoric is uttered, there may indeed be an urgent need for more of one thing at the expense of something else, but it is only a matter of time before the changing proportions of the two things change the relative urgency of adding more of each. Categorical priorities ignore this fact, unless they are very flexible and reversible — in which case they are not really “priorities.” But because sober analysis seldom has the appeal of ringing rhetoric, priorities often do get established, and outlive the necessities that gave rise to them. One of the major problems of public policy is to determine what kinds of social institutions lead to flexible and reversible transformations, which permit continuous adjustment to changing circumstances, and which kinds of institutions lead to enduring categorical priorities, which can become as counterproductive under new circumstances as they may have been necessary under the old.

COSTS AND VALUES

Once it is clear that an economy — any kind of economy — is basically a system of rationing inadequate supplies, and a system of incremental substitutions, the concept of “cost” assumes a new significance. The cost of any good is the cost of its ingredients, and their cost, in turn, is whatever alternative good had to be foregone in order to use them where they are used. For example, the real cost of a piece of cheese is the ice cream or powdered milk that could have been produced with the same original resource. Indeed, if more cows had been slaughtered instead of being kept alive for their milk, there would have been more steaks, baseball gloves, and other cowhide products, so that the real cost of yogurt includes catchers’ mitts.

This is not merely a philosophical way of looking at things. It is the way economies operate in the real world. If the demand for yogurt increased many times, yogurt production would absorb milk that would otherwise have gone into ice cream, cheese, and other dairy products. This would cause more cows to be used to increase total milk production and fewer to be slaughtered — and this in turn would mean less cowhide and higher prices for catchers’ mitts. In an economy not coordinated by prices but by government directives, the same end result could occur through an issuing of orders by a central economic planning board, and the more stringent rationing of catchers’ mitts would be accomplished by waiting lines or waiting lists instead of by higher prices. The physical dissimilarities between dairy products and cowhide products has nothing to do with their substitutability in the production process. How much, and in which direction, the incremental substitution takes place depends upon their respective values. These values are wholly subjective. To say that people want more yogurt is to say that yogurt has become more valuable to them. Either statement conveys exactly the same information. There is no “objective” value of yogurt which could be determined in a chemical laboratory or under a microscope, nor would any political or philosophical process determine what it is “really” worth.

Value being ultimately subjective, it varies not only from person to person but from time to time with the same person, and varies also according to how much of the given good he already has. Obviously a man in the desert dying of thirst would sacrifice much more for a glass of water than he would in his home, with water available from his faucet. In short, even for the same individual, the value of water can vary from virtually everything he has down to zero — or even below zero, since he would pay to have water taken away if his basement were flooded.

The cost of a given good can be determined in purely physical terms. If so many gallons of milk are required to produce ten pounds of yogurt, and if we know how much ice cream could have been produced with that same amount of milk, then we know the physical rate at which ice cream can be “transformed” into yogurt through incremental substitutions in the production process. However, this statement of physical possibilities says nothing about how much yogurt will in fact be produced relative to ice cream. That depends also on the relative values of these goods to their respective consumers. The knowledge of these changing values may be transmitted by price fluctuations in a market economy, or by voting changes in a politically-controlled (“planned”) economy, or by direct orders in a nondemocratic, politically-controlled economy (communism, fascism, etc.).

In other words, while an individual or an economy may appear at first to be weighing the subjective value of a good against its objective cost, ultimately what is being weighed is the subjective value of one good against the subjective value of another good. Faced with identical technology and resources setting the limits of what is possible at a given time, different combinations of goods may be produced, according to the subjective preferences of the decision makers, whether those decision makers are consumers, central planners, or royalty. None of these differing assortments of goods — and therefore different resource uses — need be more “efficient” than any other. Efficiency in turning inputs into outputs can be measured only after specifying the subjective values involved. Even in the apparently objective physical sciences this is also the case. The objective “efficiency” of an automobile engine can be determined only after specifying the subjectively determined goal as the forward movement of the automobile. Otherwise, every engine is 100 percent efficient in the sense that all the energy input is used, either in the forward motion of the car, overcoming the internal friction of engine parts, or in random shaking of the automobile.

Although neither value nor efficiency is wholly objective, the idea that they are dies hard. Denunciations of “inefficiency” and “waste” are often nothing more than statements of a different set of preferences. Schemes to turn particular decisions or processes over to “experts” who will promote scientifically neutral “efficiency” are often simply ways of allowing one group of people to impose their subjective preferences on others. For example, proposals for a city-manager form of government to take municipal decisions “out of politics” are in reality proposals to make local decision making responsive to a different set of interests other than the general electorate. The merits of such a change can be debated from various viewpoints in particular cases, but the point here is the inaccuracy of the usual description of what is going on, and the misconceptions (or dishonesty) behind such descriptions. As a mechanism for the utilization of knowledge in society the city manager arrangement screens out some of the knowledge (from the electorate), allowing more weight to the knowledge of others who have greater access to, or implicit control over, the administration.¹

AVERAGE VERSUS INCREMENTAL COSTS

When people casually speak of “the” cost of producing something, they usually mean the average cost — that is, the total cost of running the enterprise divided by the number of units of output it produces. But for actual decision-making purposes at any given time, the incremental cost is more crucial. The total cost of running an airline obviously includes the cost of airplanes, but in deciding whether or not to make a particular flight, what matters at that point is whether the incremental cost of that flight will be covered by its incremental value to the passengers, as revealed by what they are willing to pay for it. This question has to be faced whether the airline is a private company in an unregulated economy, a government-owned enterprise in a socialist state, or any other combination of economic and political institutions. The mechanisms by which the decision is made will be different, and of course the actual decision may be influenced or even determined by the nature of the institutional mechanism, but the point here is that the problem itself is independent of institutions, and institutions can be assessed in terms of how well they resolve the problem.

An airplane which would otherwise remain idle on the ground during a particular time has a very low cost in the economic sense of cost as a foregone alternative. If a plane that would otherwise remain in a hangar overnight is instead brought out at midnight to fly a party of vacationers to a nearby resort, the cost of this short flight that does not interfere with its other schedule of flights is much less than the “average” cost of an airplane flight. In this case, the incremental cost of the flight is little more than the cost of fuel and a flight crew, since the plane itself is there for another purpose anyway. In a price-coordinated economy, the amount of payment by the passengers required to induce the airline to fly under these conditions will tend to be much lower than the amount required to induce the same airline to set aside planes to fly the same distance on a regular schedule. For the latter decision, the passengers would have to pay an amount sufficient to cover not only the fuel and flight crew but to cover also the cost of the plane itself and the airline’s various “overhead” expenses. In an economy coordinated by government decisions, the same economic resolution would be efficient, though it would have to be reached institutionally through a political or administrative process. Whether the same resolution would be reached in fact would depend upon the extent to which the particular institutional arrangements convey the same knowledge of consumer preferences (incremental trade-offs) and production costs (incremental trade-offs), and whether that knowledge was conveyed in a form that was “effective” in the sense of constituting a personal incentive to the decision maker.

It often costs much more to make a commitment in advance to produce a given good or service than it does to produce the same good or service with equipment already provided for other purposes. In some substitutions incremental costs are less than average costs — sometimes only a tiny fraction of average costs. By the same token, if the existing equipment is already being used at its normal capacity, the additional use may cost even more than the normal use, as in the case of additional demand for electricity at a time when the generators are already straining. The difference between average cost and incremental cost is crucial not only in economic institutions in various economic systems but it is also crucial in political, legal, and other systems as well. The incremental cost of a telephone’s ringing may be quite low to a resting and slightly bored housewife, but may be maddeningly high to a housewife who is already simultaneously coping with a crying baby, a pot boiling over on the stove, and a fight among her other children. The incremental cost of making certain precedent-setting judicial decisions is not simply the cost in that individual case but the cost of committing legal institutions to settling similar future cases on a similar basis. This cost may be hundreds or thousands of times as large as the individual decision in itself. Looked at another way, where certain decisions may be made in any of a number of different institutions within a given social system, the institutional location of that decision-making process may raise or lower the costs entailed by large multiples of what is involved in the individual decision as such.

DIMINISHING RETURNS

Instead of looking at the efficiency of an economy in terms of how much input is required per unit of output — that is, the cost of production — we can look at how much output can be obtained from a given input. In both ways we can see that there is no fixed relationship between input and output but some general patterns that need to be kept in mind in discussions of economic systems — or even legal, political, and social systems. Generally, the pattern has been that increasing one input while other inputs remain constant, usually increases output — at first faster than the one input is increased, then in proportion, then slower, and finally there is an absolute reduction of output when the one input is added in unlimited quantities. The question is, why this pattern exists.

A lone man farming a vast expanse of land has a limited number of options as to how he will work this land. He may spread his labor thinly all over the whole land area, spending a substantial part of his workday walking over this area instead of actually tilling the soil, or he may decide that he will get more total output by cultivating only half of the land, putting more intensive labor there and cutting back on the amount of his walking from place to place, letting more of his energy go into the actual cultivation. Which of the two approaches he will use will depend on how the various considerations balance out in the individual case. The point here is merely to illustrate the kinds of options he has as a lone farmer (input), which can be compared to the options when there are two units of the same input — that is, two farmers on the same land.

While one farmer could either cultivate the whole land area as one unit or cultivate half the area and leave the other half uncultivated, two farmers have the option of cultivating all the area as a unit or cultivating both halves as separate units. That is, two farmers can either do what one farmer would have done or can, in addition, do things which one farmer could not have done. This is true also in the details of the work. For example, in transporting small objects into an area out in the field, two farmers may choose either to carry them or to throw them to one another. A single farmer has only the first option. In carrying heavy and/or awkward loads, one farmer is limited to getting grips in two places no further apart than the span of his arms; two farmers working together can get two sets of grips with each set being much further away than one person’s arm span. In short, within a range of work activities, two farmers have all the options available to one farmer, plus some other options as well. How often they will choose to work separately and how often as a team depends upon what the advantages are in practice. The crucial point however is that more options generally mean better results, where the larger number of options includes all the smaller number of options. This principle has wide applications within economics and beyond economics, as will be seen in later discussions.

In the case of two farmers on a large tract of land, they can each do whatever one farmer could do and together they can do things that neither could do alone. In the absence of offsetting problems, we would therefore expect two farmers to produce more than twice the output of one farmer on the same ample expanse of land. In short, we may expect a rising output per unit of the input. For similar reasons, we might expect three farmers to also increase output more than in proportion to the increased input, since more elaborate organization of the inputs is now possible. How long the output would increase more than in proportion to the input would depend upon many specific facts, but what is important here is why it could not continue increasing this way forever. Beyond some point, the land would become crowded with people, and their getting into each other’s way and distracting one another’s attention would begin to offset the organizational advantages.

If the two farmers had been sharing the output as partners, they would — automatically, and perhaps even without thinking about it — have been monitoring each other’s work, reducing the prospects of one’s taking it easy at the expense of the other. The ease of monitoring and the certainty of being monitored would guard against the level of effort falling below the two farmer’s own best judgments of the balance between ease and output. But when the number of farmers reached a hundred, no single farmer could equally easily watch the other ninety-nine, nor would each farmer be equally sure that his relaxations of effort would be detected by the others.

Even if all one hundred farmers had identical notions of how much output was worth how much effort, each farmer individually would have an incentive to put forth less than this effort, since his own individual shortcomings would have very little relationship to his own individual share of the output. They might all “know” in an abstract sort of way that the total effort was related to the total output, and so all might desire to keep everyone’s performance up to par, but there is a great difference between this desire — even if universally shared — and an organizational way of achieving it. At the very least, devising and maintaining an organized system of monitoring cannot be free, and whether it would repay its cost is an empirical question. Monitoring costs (either the costs of monitoring or the loss of output if not monitored) are an additional factor offsetting the possibilities of rising output per unit of input.

The original assumption that larger numbers of people meant additional options without an offsetting loss of other options is only approximately true for small numbers of people. Crowding, distraction, and monitoring costs offset the gains made possible by cooperative organizational work. As more and more inputs are added, beyond some point, the negative factors outweigh the positive advantages, and there is a falling ratio of output to input. This is the law of diminishing returns — a basic economic principle, with implications that go far beyond economics.

The law of diminishing returns applies to inanimate inputs as well. Although some amount of fertilizer on the land may have a small incremental effect on the size of the crop, and twice as much may cause the increment to be more than twice as great, beyond some point more fertilizer no longer increases the crop in equal proportions, and it is even possible to reduce the crop with excess fertilizer.

Economic decision making within the constraints of a price system with profits and losses seldom leads to production in the region where more input leads to absolutely diminishing output. There is obviously no point spending hard cash for inputs whose incremental effect will be negative. However, this is not to say that such results do not happen, when the incentives in the particular decision-making process make it rational for the individual decision maker, however detrimental it may be to “society,” which is not a decision-making unit.

Internal communication systems in large organizations are often open to many individuals who may wish to send memoranda, announcements, official documents, paychecks, survey questions, or plain gossip. The number and frequency of such internal communications influences how much attention the average recipient pays to each item. Infrequent arrivals of internal mail are likely to receive more attention per unit than a flood of material arriving every few hours. In other words, the law of diminishing returns operates, so that beyond some point there are diminishing increments of attention as the quantity of mail increases. With a sufficient inundation, there will be less total attention paid — less information effectively received — than if fewer communications had been sent. The situation can reach this level of absolutely diminishing returns only because there are virtually no costs to the numerous individual decision makers who decide whether to add more material to the internal communications system. They may all know that the recipients’ attention and patience are already strained, but each individual sender also knows that his action alone will have very little effect on that. As long as it is worth the bother of typing or mimeographing, the sender has every incentive to send, because part of the costs created by his decision will be externalized to others, in the form of generally diminished attention. When they all do it, they all lose — but this happens only because “all” is not the decision-making unit.² A more serious social problem arises when whole institutions have incentives to push their activities well past the point of incrementally diminishing returns, into the region of absolutely diminished returns.

Among the constraints affecting economic trade-offs are those which depend on time. The choice between spending money on entertainment today and using that money to buy seeds to plant apple trees is not only a choice between two different sets of benefits; it is a choice among benefits to be received at two very different times. Other things being equal, the present is always preferred to the future, if only because life itself is uncertain and the future may never come, for the individual decision maker. Looked at another way, future benefits must be greater than present benefits to make it worthwhile to wait.³ There is some level of difference that will make present and future benefits equally valuable to a particular individual at a particular time. How much difference and how much time are matters that vary from person to person and vary incrementally with the same person. To someone dying of thirst a gallon of water right now might be more valuable than a swimming pool two years from now, even though the same person under normal conditions would prefer to wait for the pool. In short, with intertemporal substitutions, as with substitutions at a given time, there is no such thing as “the” rate of substitution, either in production or consumption. There is also no such thing as “the” value of a given object, for the time when that object is to be received changes its value. A swimming pool right now would be more valuable than a gallon of water even to a man dying of thirst. Clearly, then, it is more valuable than a swimming pool two years from now. More generally, any given asset is of greater value, the sooner it is to be received. The legal right to that asset can be sold for more in the market, the sooner it will become available. Apple trees that are half grown will sell for more than apple trees that were just planted, and apple trees that are fully grown will sell for the highest price of all, even if the only differences among these trees are the times when they were planted — which is to say, the time left before they produce apples.

Like so many important economic principles, the discount for time is so simple that it is readily forgotten in the rush of practical decisions or at the sound of heady rhetoric. For example, state and municipal governments in financial distress may unilaterally postpone payment on their bonds, with the assurance that those bonds will later be paid off “in full.” But even if this promise is carried out to the letter in money terms, the very fact that the bonds are paid off later means that they are not paid off “in full.” A hundred dollars three years from now is worth nearly twenty-six dollars less than a hundred dollars today, when the interest rate is 8 percent — and this does not even allow for inflation. In other words, a three-year postponement is economically the same as a confiscation of about one-fourth the value of the asset, even if there is no inflation. With even mild inflation, it can easily amount to a confiscation of, or default on, a third or more of the total amount entrusted to the government by those who bought its bonds.

Merely moving any asset backward and forward in time changes its value substantially. This is demonstrable with economic assets measured in money, but the principle applies far more broadly in social institutions in general: “Justice delayed is justice denied” is an old legal axiom — and “the law’s delay” is an expression that goes back at least as far as Shakespeare.⁴ The dispatch or delay inherent in various institutional processes can be equally (or more) important than the end result conventionally expressed as if it were a constant value. The popular habit of referring to a fixed dollar amount, or a given physical thing, or a particular social outcome, as if these were also fixed values, without regard to the time involved, means more than intellectual confusion. It means opportunities for rule changes affecting “only” time to make major arbitrary changes in people’s fate. Merely by such apparently innocuous decisions as changing the effective date of a law, modifying the retirement age, or lengthening a waiting period, the government can transfer billions of dollars around the economy, including directing some of it towards itself. Merely by lending to enterprises (including government-run enterprises) at an artificially low interest rate, the cost of their whole operation can be grossly misstated and a venture made to appear to be “paying its own way” — on paper. The movement of assets through time is a two-way movement. Not only may present benefits be postponed; future benefits may be moved forward into the present — at a discount corresponding to the interest premium paid (in market transactions) for postponement. An agricultural society can eat up the seeds needed for the next crop, increasing current food consumption at the expense of future food consumption. A nation may reduce its ability to defend itself militarily, thereby gaining additional consumer or governmental spending power in the present, at the expense of either higher military expenditures or forced capitulations in the future. The individual may gain in various ways by betraying his pledges and obligations, at the expense of lower future benefits from activities requiring credibility.

INVESTMENT AND DISINVESTMENT

Moving assets from the future to the present is never costless to the recipient, just as moving assets from the present to the future is never costless to the donor. The process of transforming current assets into future assets is known in economics as “investment.” However, the process itself extends far beyond financial activities. When someone carefully puts his things away, at home or at work, he is deliberately sacrificing present time that could be used for other activities in order to require less time to find his things again in the future. When someone takes the trouble (and sometimes pain and embarrassment) to make his feelings clear to someone else, it is a deliberate loss of present psychic well-being in order to forestall a greater loss of future psychic well-being through misunderstandings. The purpose is to have a greater net psychic well-being over the relevant time span, just as the purpose of financial investments is to have a greater net worth over some relevant time span. The essential similarity between financial and nonfinancial “investment” processes has been noted by such economists as John Stuart Mill in the nineteenth century and Adam Smith in the eighteenth century, but it has been only the past generation of economists who have elaborated theories of “human capital” in its various forms of education, health care, migration, and other activities designed to enhance future well-being of either a financial or a psychic nature, so the term “disinvestment” can also apply to moving assets from the future into the present, without regard to whether financial or psychic assets are involved. Such phrases as “burning the candle at both ends,” “a short life and a merry one,” “eating up your capital,” or “living off future generations” all refer to similar processes although measured in different units. Most expressions describing disinvestment have pejorative connotations, but there is nothing intrinsically wrong with a ninety-year-old man’s selling some of his half-grown apple trees to pay for current expenditures on things to promote his present health, comfort, and happiness. To try to hold the trees until maturity might make less sense.

Disinvestments made by a given decision maker for himself must be distinguished from disinvestments made for him by others. The legal system provides safeguards against private individuals’ disinvesting someone else’s assets. However, there is no legal protection against the government itself doing the same thing. For example, governments’ inflationary policies may disinvest part of any financial assets set aside for one’s old age, leaving less future real assets in the hands of the individual who saved them and putting more present real assets in the hands of the government that issues the inflated currency. The transfer is no less real for having been implicit and therefore not subject to constitutional limitations on confiscation of property “without due process of law.” Probably more assets have been confiscated this way than by the exercise of government’s right of “eminent domain” under constitutional guarantees. Nor are those who have lost their savings predominantly wealthy people with large bank accounts or stocks and bonds. Much saving takes place in forms not usually thought of as savings — life insurance and employee pension funds, for example. Through pension funds, American workers own a higher percentage of the total industrial assets of the United States than do workers in an avowedly communist nation like Yugoslavia.⁵ The confiscation of employee pension fund assets through inflation is not so much a redistribution from one income class to another as it is a redistribution from the pensioners’ future assets to the government’s present assets.

RISK

The element of time introduces the element of risk. Perhaps the most fundamental risk is that we may not live through the time required to see a given economic activity concluded and remunerated. Many other risks exist, of partial or total loss of whatever is invested, or even losses extending beyond the initial investment to reach other personal assets to cover damages or other liabilities incurred in the process of unsuccessfully seeking gain.

Although risks may be calculated mathematically, as in the actuarial tables of life insurance companies, the cost of a given risk is no more objective than any other cost. Some people can sleep soundly with their rent unpaid, and creditors threatening to repossess their car or attach their salary. Other people worry about their money in a government-insured bank account. In between are numerous gradations of individual concern for a given risk, and therefore a different psychic cost paid in carrying that risk, or different financial costs paid to reduce the risk. For example, bondholders may accept a lower rate of return than stockholders as the price they pay to reduce the risk of losing their investment.

The godlike approach to analyzing “society” and its (metaphorical) behavior often overlooks risk, the subjective nature of risk, and/or the wide variation of its cost among individuals. In the area of risk, as in some other areas, the diversity of individuals invalidates reasoning based on figures of speech about a society acting as if it were a single decision maker. With a given objective likelihood of various undesirable events, the costs of these risks to society at large can vary enormously, according to which particular members of the society are carrying how much of these various risks. If risky activities like drilling for oil wells (most wells have no oil) were financed by nervous people, the cost would be much higher than if such activities were financed by devil-may-care types who are happy to be able to dream of striking it rich some day. For an optimal distribution of risks, knowledge must somehow be communicated through the system as to who is more willing and who is more reluctant to bear the various levels of risk which are inherent in undertaking different economic (or other) activities. This kind of knowledge is far too specific and changing to be reduced to a science or to be mastered by “experts.”

Each individual is of course an expert on his own degree of aversion to risk, and knows how much he wants to put aside for a rainy day, and roughly how he wants to distribute those savings as between cash in his pockets, deposits in an insured bank account, payments into a pension plan, investments in low-risk bonds, or speculation in oil or commodity futures. (For most people, zero is the amount that they are willing to risk on the last two activities.) On the other side of the market are numerous people who are knowledgeable about the specific techniques of producing specific things — that is, people who have the most accurate knowledge of just how risky particular ventures happen to be and what payoffs could be reasonably expected. In other words they know how much they can afford to pay in return for the use of resources needed to carry out their economic activities. They will try to pay as little as possible, just as creditors or investors will try to get as much as possible, but each knows how far he is prepared to go in a given direction. Each is an expert in his own situation, however little he may know about the other’s situation, and the process of haggling for a deal — either directly or through such intermediary institutions as banks, insurance companies or mutual funds — is essentially a communication of social knowledge, each fragment of which originates with the individual who is in a position to know the most that is known on his tiny part of the subject.

This knowledge is never perfect, nor can it be, regardless of the kind of political or economic institutions in a particular country. From this process emerges a sorting out of those activities involving the least risk, being financed (at lowest costs) by those least willing to bear risks and most willing to leave the big payoffs to those ready to take big gambles. This need not involve direct individual investment in specific economic enterprises, and usually does not. Incoming funds (savings deposits, insurance premiums, etc.) are pooled by intermediary institutions and the overall risks reduced further by spreading the investments around in numerous, relatively safe, ventures which pay modest amounts for the use of the money to buy the resources they need. Although the transactions are usually between impersonal organizations, the very personal aversion to risk of those supplying the money is the controlling factor. A bank cannot bounce a depositor’s check for his rent because the bank itself has “insufficient funds,” due to risky investments that did not work out. An insurance company cannot refuse to pay for a policy-holder’s operation or funeral because the oil drilling it financed did not turn up any gushers. Any such result in these kinds of institutions — patronized by people averse to risk — would bring on the immediate destruction of the financial institution itself, and probably criminal investigation of its officials. On the other hand, nothing nearly as dire happens when a corporation reduces (or skips) a dividend payment to its stockholders, whose risk taking is understood by all to be part of the reason why they receive dividends at all. And for people investing in wildcat oil drilling operations, there may not be much likelihood of their getting anything at all on any predictable date, and with only the hope of a magnificent payoff now and then. In short, though these various financial organizations have no feelings, their behavior is constrained by the different feelings of those who supply their respective investment funds.

No single individual, nor any collection of individuals, could have in their heads all the complex technical information on production processes and the nuances of personal feeling involved in matching millions of investment sources and users. The most efficient and imposing bank, corporation, or government bureau has only scratched the surface. The astronomical amount of knowledge in the whole system is sorted and coordinated in fragments by the simple process of each transactor seeking the best deal from his own subjective viewpoint and not necessarily (or even usually) by knowing why the deal that suits him best emerged as it did from the millions of other possibilities in the market.

While risk may be easy to understand by considering formal organizations and transactions designed primarily to deal with risk, its effects are pervasive far beyond such situations. Anyone who buys an automobile knows (or discovers) that he is not really buying transportation, but is in fact buying a given probability of transportation on given occasions. If he keeps the car long enough, there will be occasions when he has to walk or take the bus or get a ride with a friend. He may do this voluntarily, as an investment, by leaving his car in the shop for regular maintenance, or he may forego that investment for the present benefits of constant use of the automobile, and involuntarily walk, take a bus, etc., at a later time when the car breaks down as a result of lack of maintenance. Cars which are very similar in the quality of ride, convenience of operation, or aesthetic considerations, may sell for very different prices if they differ substantially in their respective probabilities of continuous service — that is, if they differ in the frequency of breakdowns or the amount of maintenance required. These may be differences in brands of cars or differences in the same car purchased new and used. In either case, cars’ price differences need not reflect transportation differences, but may reflect simply risk differences. As in the case of other kinds of risks, however objective the probabilities may be, the costs of risk are highly diverse with respect to individual situations and subjective preferences. An auto mechanic or someone else who is handy with tools may find the cheapness of a particular car more than compensates its special troubles, while a heart surgeon with no understanding of engines may find a car that won’t start an intolerable problem when he has to rush to treat someone in the intensive care ward.

The fact that costs differ vastly with respect to individual knowledge and preferences creates an opportunity for people who specialize in bearing particular kinds of risks. A farmer may have considerable knowledge of how to grow a particular crop, but little knowledge of the economic data or complex principles which cause the prospective price that he can expect for his harvest to vary by large amounts as of planting time. Someone else who has specialized in studying the economic facts and principles may have a much narrower range of expectations of future prices for that crop, even if he could not actually grow the crop himself if his life depended on it. Either individual could directly acquire the knowledge that the other possesses by investing the time needed for both the theoretical understanding and the practical experience to apply it. A less costly alternative may be to transact with one another on the basis of their existing knowledge. The farmer can reduce his risk at the cost of selling his crop during the planting season for somewhat less than the average of his range of expectations of prices at harvest time. If he thinks the price of his produce is going to range somewhere between sixty cents apiece and a dollar apiece, he might consider eighty cents apiece as his best guess, but accept seventy-eight cents apiece as a guaranteed price in advance — in effect paying someone else two cents apiece to take the risk off his hands. The buyer may accept this if he has either a more optimistic estimate, or reason to have much more confidence than the farmer in the same estimate of eighty cents apiece, or merely stronger nerves.

Buying for a guaranteed price and selling at whatever price later emerges in the market is a way of earning a residual claim to the difference. This residual claim may be a positive amount or a negative amount, as many a bankrupt speculator has learned. People who are not pure speculators may nevertheless engage in economic speculation as a part of their normal activities. A farmer who plants in the spring without any guaranteed price for his harvest the following fall is working as a speculator as well as a farmer, whether he thinks of it in those terms or not. A student who chooses to study for a particular profession is also speculating on the state of that profession in future years, as well as on what his own values will be in future years, since changing values may make him dissatisfied even if the profession itself is exactly as he foresaw it. Perhaps the greatest speculation of all is bringing a child into the world, where he may become the pride and joy of your life or cloud or destroy whatever happiness you may find from other sources.

One of the most basic and pervasive social processes is the sorting and labeling of things, activities, and people. This includes everything from the sex separation of bathrooms to municipal zoning ordinances, air traffic control, and racial segregation. Even the changing moods and circumstances of a given individual are sorted and labeled by those who deal with him, in order not to talk to or interact with him in particular ways “at the wrong time.” Sorting and labeling processes involve a trade-off of costs and benefits. In general, the more finely the sorting is done, the greater the benefits — and the costs. Beyond some point, making the sorting categories finer would not be worth the additional cost — for the particular decision-making purpose. For example, if we find boxes of explosives stored in an area where we were planning to hold a picnic, that may be sufficient reason to locate the picnic elsewhere, without inquiring further as to whether the explosives are dynamite or nitroglycerin, though that distinction might be important for other purposes at other times.

The general benefits of sorting and labeling must be distinguished from the special benefits of qualitative selectivity. A basketball coach can select a taller sample of boys from a given population, but the average height of the whole population is unaffected by whether or not they are sorted and labeled. From a social point of view, what matters most are the benefits of sorting and labeling given things, activities, and people in society as a whole.

There can be a substantial difference in value between a sorted and an unsorted collection containing the same quantities of identical items. If a flood sweeps through a supermarket, washing all labels off the canned goods, the cans will have to be sold at a fraction of their original prices, if not thrown away. No customer will pay anywhere near the full price for an unlabeled can which could turn out to contain vegetables, fish, or coffee. The supermarket will then have to buy more canned goods from wholesalers to restock their shelves, paying large sums of money to replace the unlabeled canned goods with new canned goods with the same identical contents as the old, but more valuable solely because of having been sorted and labeled. In a similar way, there may be a net social gain when people who like a quiet contemplative life sort themselves out from those who enjoy rousing parties and/or motorcycles — even though there are the same numbers of each kind of person after the sorting as there were before. The demand for retirement communities, for apartment developments catering to young singles, and other specialized communities is one indication of gains merely from sorting and labeling a given population.

Among the costs of sorting and labeling is a loss of diversity. That cost differs from person to person, according to tastes and preferences. It also varies incrementally with how much diversity an individual already has. An elderly person who works among younger people and has frequent visits with offspring and grandchildren may prefer the day-to-day tranquility of living among contemporaries, without fear of becoming wholly isolated in an unnaturally homogeneous environment. More generally, the need for diversity is itself not homogeneous, but varies from person to person and varies incrementally with the circumstances of the same person. There is a sorting and labeling of people by the extent to which they wish to be sorted and labeled. The coexistence of both specialized and general communities is one indication of this.

Sorting and labeling, whether of people or of things, is a sorting and labeling of probabilities rather than certainties. We believe, with varying degrees of confidence, that a certain person would like a certain Christmas gift, or would be amused by a certain remark, or be pleased with a certain action. We never really know and the very fact that there are such words in the language as disappointment, regret, etc., is testimony to the pervasiveness and persistence of this feature of the human condition.

ORGANIZATIONS

Despite the elusiveness of certainty, the remarkable success of such things as franchise operations is evidence of the value of merely reducing the range of uncertainty. A “Holiday Inn” is not necessarily better or worse than any other hotel. There are undoubtedly many independent hotels that are better and worse (by whatever standard) than the average Holiday Inn, or even better or worse than any Holiday Inn. Moreover, Holiday Inns vary among themselves. Yet the fact that thousands of hotel owners are willing to pay in various ways for the privilege of using this franchise designation means that the economic value of a given physical structure is greater with a Holiday Inn sign in front of it than without it — and that in turn means that millions of travelers are more likely to stop there for some reason. These travelers are also aware that there are better and worse hotels; all that the sign does is reduce the range of uncertainty as to quality and price. The value of the franchise, and its spread internationally, is evidence that this is no small consideration. The growth and prosperity of many other franchising corporations in various fields suggests that this form of sorting and labeling is of great value to customers, especially in a highly mobile society where individual knowledge of individual establishments is rare or more costly.

Many people are uneasy with the thought of making decisions on the basis of merely probabilistic indications like franchise names, and especially with the idea of sorting and labeling people by one or a few characteristics. The only reason for doing so in either case is the cost of alternative procedures, with finer categories, which might produce incrementally more accurate predictions. Yet the large number of people murdered by spouses each year suggests that even the most intimate knowledge of other people will not produce certainty as to their future behavior. The only question is — how much more knowledge (risk reduction) is worth how much more cost? Obviously this varies with the decision. No one wants to select a spouse on the basis of crude rules of thumb, but then neither does anyone want to put the same amount of thought into selecting a television program that he or she puts into selecting a mate. The argument here is not in favor of crude decision-making processes. The argument is simply that the fineness of the sorting and labeling process is incrementally variable with respect to both costs and benefits, so that it must stop somewhere short of the quality of decision-making that is possible, and so must — and should — make “avoidable” mistakes.

Looked at another way, “avoidable” mistakes are not necessarily a condemnation of a decision-making process — if alternative processes which would have avoided these particular mistakes in these instances would also have cost so much in so many other instances (either in money or in other mistakes) as to outweigh the costs of the “avoidable” mistakes. Decision-making processes are often judged by standards which ignore this simple fact. This is done not only by naive people but even by experts. For example, an experienced traveler who has been through a given area many times may be able to select local hotels, restaurants, and auto rental agencies much more advantageously than by relying on franchise names, and may be able to factually demonstrate the superiority of his choices to the other choices which he disdains. Yet if his disdain extends to the method of choice (franchise names in this case) he is very mistaken. Experts who loftily dismiss the public’s method of choice in many areas often fail to consider the cost of knowledge. By definition, the expert has already paid these costs in the past, and the incremental cost to him of making individual choices after that is virtually zero. Nothing is easier for an expert than to show instances where things, activities, and people were misjudged. What is misleading is to imply that therefore wrong methods of sorting and labeling were used.

PEOPLE

There is a fatal charm about the idea of “judging each person as an individual.” Our sympathies immediately go out to the person who has been “wrongly” denied a job, credit, college admission, or an opportunity to participate in some activity because that person fails to meet certain “arbitrary” requirements, but demonstrably should have been acceptable because of other considerations. An onlooker may find it silly that a department store clerk will not accept a personal check from a Rockefeller but will accept a credit card from an unemployed laborer. But the real question is whether credit policies shall be made by specialists higher up in the organization and passed down as rules restricting the discretion of lower level employees, or whether the financial future of the organization shall be put in the hands of store clerks and rest on their personal assessments of customer credit worthiness.

The variation in the fineness of sorting categories, from one organization to another in the same field, is sometimes cited as proof of the irrationality or arbitrariness of the rules of the organization with the coarser sorting procedure. But acceptance of a Rockefeller’s personal check by the owner-operator of a small retail shop is no reason why a department store clerk should accept it — given that there are very different knowledge costs when the immediate salesperson and the financially responsible official are one and the same person, compared to the situation where the two functions are performed by different individuals widely separated in a large organization. Similarly, a student with modest S.A.T. scores may be rejected by a large and mediocre state university and yet be accepted by a higher-quality small college which takes into account other evidences of his intellectual ability. Neither institution’s admissions procedure may be defective. A state university admissions committee with over 100,000 applications to go through in a few weeks may have to immediately reject all those below some cutoff score, in order to give any personal attention at all to choosing among those remaining. However, a college with a total enrollment of 500 students may be able to give all applicants individual consideration from start to finish, at relatively little cost. Neither process is inherently more efficient. What would be more efficient would be for Rockefellers without credit cards to shop in places where officials empowered to approve checks are near at hand, and for talented youths with low scores to apply to colleges where applications from such persons can be accurately assessed more cheaply.

Most objections to sorting and labeling in general — and particularly to the sorting and labeling of people — are based on ignoring the costs of knowledge, or ignoring differences in the cost of knowledge between one decision-making process and another. Even objections on purely moral grounds to “discrimination” against various groups often turn out to involve ignoring knowledge costs. When an individual from a group with a certain behavior pattern has a very different behavior pattern himself, judging him according to the group pattern, and making decisions accordingly, may impose serious costs on that individual. It also imposes costs (foregone opportunities) on the other person who made the incorrect assessment — and therefore provides an incentive for seeking alternative methods of assessment, if such are available at a cost commensurate with the benefit. However, insofar as the factual basis of the group assessment is accurate, the only cost paid by the group as a whole are costs created by its own behavior.

Those group members who do not in fact create such costs may pay a high price for being in the same category with others who do — and the cost-creators in turn pay correspondingly less than the costs created by their own behavior. It might be desirable from a moral or political point of view that public policy diffuse those costs over the general population rather than leave them concentrated on blameless individuals in the same category. That is a question of policy which depends on more variables than those being considered here. For the present analysis, the point is that group discrimination — costs imposed by group A as a whole on group B as a whole — is not proved by showing (in retrospect) that individuals of identical relevant characteristics are treated differently (in prospect) when they come from group A rather than group B. The two individuals may have identical probabilities of repaying credit, abstaining from violence, being a considerate neighbor, and contributing intelligent ideas. But only God can know that in advance free of charge. The cost of knowledge of these individuals’ characteristics may be very different when the individual comes from Group A than from group B, if these two groups as a whole differ in any of these characteristics.

Psychological and political “realities” often lead to rhetoric which camouflages, or even boldly misstates, the causes of cost burdens, as well as the nature of proposed remedies. For more than a century, individuals fleeing ethnic ghettos have bitterly complained of resistance to their movement into other neighborhoods as an imposition of costs on the whole group from which they were fleeing by those groups toward whom they were fleeing. This pattern has occurred repeatedly, from the time of the Irish immigrants in the middle of the nineteenth century to blacks, Hispanics, and others today.

But no amount of impersonal phrasing about wanting to escape “slums” or the “conditions” there can change the basic fact that what is being attempted is to move away from people whose behavior is regarded as offensive. For exactly the same reason, there is resistance or flight by those in surrounding neighborhoods. Painful as this situation is for all concerned, it is made even more difficult to resolve when the rhetorical misstatement of it becomes a basis for insisting that not only the cost-bearing victims among the excluded group but also the cost-creating members of the same group be relocated. Sometimes this goes beyond the “fair housing” approach of creating a legal right to relocate anywhere on one’s own initiative, to a government policy of creating financial incentives to undo sorting and labeling by deliberately locating subsidized housing in neighborhoods different from those normally inhabitated by the tenants — or even more directly, forcing excluded groups to relocate by demolition of their dwellings by “urban renewal.”

At some point in these political developments, those who believe the rhetoric literally may be puzzled to find themselves opposed by those excluded people who were initially their allies. Cost-bearing members of excluded groups are often much clearer as to what they are doing in trying to sort themselves out from cost-creating members of the same group. The last thing they want to do is to import into their new environment the same cost-creating people whom they have fled. When the building of low-income housing projects in middle-class neighborhoods has been bitterly opposed by blacks already living in such neighborhoods, many white liberals have been shocked by the apparent inconsistency of such behavior with the rhetoric which they and middle-class blacks have shared in earlier struggles for “fair housing” laws. The middle-class blacks are, however, behaviorally consistent in continuing to sort and label by social characteristics (other than race) even if this means opposing former white allies to whom rhetorical consistency is more important.

In short, even the principal victims of that form of social sorting and labeling known as racial segregation do not object to sorting and labeling, as such, but object instead to racial segregation for preventing them from sorting and labeling on other (nonracial) bases. Students of black social history have long noted the difficulties of the small black middle class in attempting to preserve and perpetuate its values and behavior patterns while surrounded by people with very different values and behavior patterns, whom they were forced to live among because the larger society’s sorting and labeling categories were coarse enough not to go beyond race. Objection to sorting and labeling, as such, is an entirely different phenomenon, supported by an entirely different group of people, and taking many forms: objections to school grades, occupational hierarchies, institutional authority, I.Q. tests, and all forms of address, attire, residence or work place differentiation of status or function. Even among individuals, organizations, and whole societies which have cast away particular forms of sorting and labeling, substitute forms reappear, even amidst the most ostentatious egalitarianism. Everyone may be called “comrade,” but some comrades have the power of life and death over other comrades.

The advantages of sorting and labeling may sometimes be mistakenly ascribed to other factors. For example, one of the important things an education system does is to sort and label people, and they may be more valuable to an employer because they have been sorted and labeled, rather than simply because of the education as such. The difference between a “dropout” and a graduate is not merely that one has somewhat more information than the other, as a result of staying in an educational institution longer. Dropouts as a group tend to differ from graduates as a group in perseverance, regularity, and discipline — qualities of value even in jobs where the difference in information between the two groups is of little or no significance. Statistics on income differences between dropouts and graduates often arbitrarily attribute the higher income of the graduate to the value of the education, especially when the statistics are quoted by educational institutions seeking larger appropriations, grants, and public donations.

One of the functions of the “publish or perish” policy of many universities is that it forces faculty members to sort and label themselves by exhibiting their professional abilities before their peers. It is not necessarily publication, as such, that is rewarded but rather that the sorting and labeling of scholarly ability is facilitated by publication. A string of mediocre publications may in fact be damaging to the individual, though valuable to the profession in sorting and labeling its members. Those who cannot meet even the minimum standards to be published in any scholarly journal obviously fall at the bottom of the sorting categories. In addition, there is a hierarchy of standards among the many academic journals in any given field, and some articles and books are judged more impressive than others by their scholarly audience.

Those academics with substantial ability and little desire to publish may be “underrated” by this system, but this reflects in part the high cost which their reticence imposes on institutions which must sort and label faculty members by some system for the apportionment of rewards. If those with such reluctance to publish are willing to forego the reward in order to avoid the bother, it may be a perfectly rational result for both the institution and the individual. The question of the relative weight of publication and other factors — teaching, administrative responsibilities, etc. — is a different question. The “publish or perish” policy implies only that scholarly ability is one essential characteristic that must be sorted and labeled.

The general social benefits of sorting and labeling must be sharply distinguished from the differential gains of those judged favorably or those who interact with favorably judged individuals. Sorting and labeling does not in itself change the characteristics of the people, activities, or things that are sorted and labeled. The differential gains of the “winners” are offset by the corresponding disadvantages of the “losers.” General social gains come from the greater ease of matching individuals and circumstances, so as to maximize benefits and minimize costs. Just as there is a greater demand for canned goods as a whole when they are individually labeled than when the labels have been washed off, so there is a greater demand for a labor force whose individual characteristics are known to some degree than when every employment decision has a wide penumbra of uncertainty about it. Even the “losers” in a sorting process may end up better off than they would have been without sorting. It is not a zero-sum process. Those social classes or ethnic groups whose behavior patterns are offensive to others may find a more sympathetic reception among neighbors who share their values and priorities. For purposes of understanding the value of sorting and labeling, it is unnecessary to agree with any particular set of values as to what is a “better” or “higher” standard. It is enough that there are different values, so that sorting people out can improve everyone’s position by their own respective values.

THE FINENESS OF SORTING

Finer sorting categories are not always preferable, even in those cases where they are available at no additional cost. Contrast the situation of “group punishment” for individual misconduct, as in small military units, with group punishment in countries where family honor is a paramount consideration. When a misdeed is committed by some unknown member of a given platoon or squad, the military authorities may choose to punish the whole platoon or squad, merely as a result of the high cost of acquiring knowledge of the individual culprit — especially in cases where the other members of the unit know who the culprit is, and will punish or control him socially or otherwise, even though they might not be willing to tell on him to the authorities. However, in countries where family honor is sacred, the whole family may be punished by shame, even though everyone knows the identity of the particular individual who was guilty of the misdeed. In the latter case, larger sorting categories (the family) are used even though finer categories (the individual) are available at no additional cost. The social purpose is not so much retrospective justice as prospective control. Individuals’ conduct can be controlled more effectively by those most intimately familiar with them than by public institutions. The cost of knowledge is far cheaper to family members than to either policemen or to courts, who must filter documentable allegations through rules of evidence, losing much knowledge in the process. Moreover, the range of sanctions are far more finely graduated in the family, and can be invoked in advance of any wrongdoing by raising the child to feel guilt or pride in behavior that would reflect shame or honor on the family.

Clearly, there is a loss of retrospective justice when individual B is shamed (punished) for conduct by individual A, especially if B is a contemporary rather than a parent, and still more so if B is a member of a subsequent generation, and therefore lacked any control over the past acts for which he is sharing the punishment. Offsetting this is the gain in social control, which apparently is considerable. One indication of the effectiveness of sorting and labeling by family rather than by individual is the vast difference in juvenile delinquency between American teenagers in general and teenagers of Oriental ancestry living in the same society, subject to the same temptations and public constraints. The virtually nonexistent delinquency among Japanese-American and Chinese-American youngsters has long been noted by those studying these groups, despite high and rising delinquency rates among American teenagers all around them.

Recent outbreaks of delinquency and violence among Chinatown youth gangs only highlight the factor of family honor as a control. These youth gangs have arisen since the arrival of large numbers of Chinese refugees from Hong Kong, where they were “Westernized” (i.e., atomized) before arriving in the United States. Neither Chinese genes nor Chinese culture in general seem to be related to control of delinquency, which seems to depend upon a whole social fabric building on family honor — a fabric destroyed as refugees tore themselves loose from their environments in China and converged on Hong Kong, where they arrived as individuals or as isolated families, and lived in a Westernized culture further undermining whatever remained of their original social values. Chinese-American delinquents and youth criminals are overwhelmingly of recent Hong Kong origin. Similarly, among Japanese-Americans, studies indicate that the rare young delinquents among them tend to come from outside the Japanese-American community. The virtual nonexistence of juvenile delinquency among those raised in the traditional Oriental community in the United States is striking evidence of the social effectiveness of sorting and labeling by larger units which are able to exert internal control over the individual better than public institutions can.

Similar principles have been involved in the Americanization of nineteenth century Jewish immigrants. When the massive immigration of Eastern European Jews to America began in the 1880s, there was already a small German-Jewish community in the United States, and they were alarmed at being categorized with their co-religionists from a wholly different cultural and socioeconomic background. Yet despite their initial efforts to disassociate themselves from the Eastern European Jews, the public at large tended to lump all Jews together, and to become more anti-Semitic as a result of the new unassimilated arrivals. Again, despite the retrospective injustice of such gross sorting and labeling categories, this provided an incentive for the more Americanized, cultured, and economically successful German Jews to assume some responsibility for helping the Eastern European Jews toward similar success and acceptability in their new culture. Similar things have happened in other ethnic groups: the Urban League played an acculturating role among blacks and the Catholic Church among the Irish, for example. Partly this was philanthropic, but partly also it was enlightened self-interest on the part of more fortunate members of a group who realized that they were inevitably being categorized with the rest of a group that was unacceptable to the larger society. Judging each person “as an individual” would have removed this incentive. The position here is not to claim that sorting and labeling categories should be larger than the individual. The point is simply to bring out the social trade-off that is involved between retrospective individual justice and prospective social control.

Similar principles apply in the very different world of organized crime. From the point of view of career criminals, there is some optimal quantity of violence associated with economic crimes, such as robbery. With zero violence and zero threat of violence, no one would turn over his economic assets to the criminal. But beyond some point, violence causes public outcries which bring more police power to bear in a given sector, reducing crime opportunity for other criminals as well as for the one who committed some “senseless” violence against an economic crime victim. Where each criminal is a separate decision-making unit, these external costs of his crime have no deterrent effect on his conduct. When crime is organized into larger units, however, these larger units have an incentive to minimize public outcry per unit of economic crime, which usually means reducing the amount of “senseless” violence against the victims. In short, with organized crime as with Oriental families, internalizing the external costs created by individuals means greater social control and greater responsiveness to public reactions which might safely be ignored by an individual malefactor whose identity was unknown to authorities or whose guilt would be difficult to establish through formal legal processes. In both cases, the source of this greater control is the lower cost of knowledge by those with whom he is closely associated. The relative abandon with which organized crime figures kill each other only reinforces the point; there is little or no public outcry at the death of a mobster.

Time is perhaps the ultimate constraint. Few things can be done instantaneously, and with unlimited billions of years virtually anything is possible. Even complex human beings may evolve from an initially lifeless planet. On a more mundane level, the cost of constructing a house literally overnight would be many times the cost of constructing the same house in the normal time or constructing it in whatever “free time” was available sporadically over the next decade.

Time is, of course, never free. Its value is whatever alternative opportunities must be foregone in order to use it for a particular purpose. The value or cost of time is often overlooked, as among bargain hunters who ignore the time spent searching for “bargains” (not simply the time spent finding the things actually purchased, but the time spent looking at the whole array of possibilities from which the purchased items were selected), or waiting for service in low-priced stores, or seeking frequent repairs for low-priced items with less durability. The “same” merchandise generally sells for a higher price in stores with a more varied stock (of brands or sizes), more (or better) salespeople, and more numerous cash registers, with correspondingly shorter lines at each — all of which save time. It is not really the same merchandise because what is being purchased is not simply the physical item but also the associated services required for its discovery and use.

Another way of looking at this is that every item has both a money price and a time price, and it is the combination of the two that is its full cost. Since the value of time varies from person to person, in terms of his foregone opportunities (whether earnings or other activities), this invisible combined price may be equalized by competition while the visible money price components remain disparate. Flea markets, for example, incur virtually no costs of stocking a standard selection or wide variety of given items, nor for various after-sales services, and the consumer pays low money costs and high search costs to get what he wants, or pays other intangible costs by not getting exactly what he wants in the condition that he wants. At the other end of the spectrum is the more elaborate kind of department store, with personnel trained to explain and demonstrate the intricacies and nuances of the specific kind of merchandise in their respective departments, a wide range of brands, qualities, and sizes of each commodity stocked, and with defective items sorted out for return to the manufacturer, whether discovered by the store before display or returned by the customer for a refund after the sale. Where on the spectrum between these two kinds of sellers a particular buyer will go depends on his own incremental trade-off between time and money, determined largely by his income and impatience. In this context, persistent money price differences for the “same” merchandise sold at different kinds of stores do not prove the consumers “irrational,” nor the merchants dishonest, nor the economy noncompetitive.

In social as in economic processes, the value of anything varies with the time at which it becomes available. This applies both to benefits and to costs. Swift punishment for criminals has long been recognized as a more effective deterrent than the same punishment applied after much delay. By implication, a lesser punishment applied immediately — the old fashioned “curbstone justice” once applied by the policeman on the spot — may be as effective as a harsher punishment applied after years of “due process.” Due process may be preferred for its greater accuracy, objectivity, or dignity, but the point here is that there is a trade-off, based on the varying cost of punishment to the recipient according to its location in time.

In economics, a financial increment or decrement accompanies transfers of given physical or money units back and forth through time. The absence of explicit interest payments in social trade-offs does not mean that the same principle is not at work. Because imprisonment is costly to the taxpayers as well as to the criminal, a shorter sentence begun soon that is as effective as a longer sentence begun later means money savings for a given deterrent. Alternatively, the law could retain the same length of sentence and achieve more deterrence for a given amount of money, if that was preferred. In other words, the implicit “interest” received by the public for moving imprisonment forward in time can be either in money or in kind. Conversely, losses incurred by moving imprisonment backward in time by lengthening legal “due process” may also be costly both in money and in kind, including crimes committed by criminals free on bail, awaiting trial or appeal.

TIME HORIZONS

In social trade-offs in general, the diminishing value of deferred benefits or costs is often referred to in terms of the time required for such benefits or costs to reach the vanishing point as influences on present decision making. This period is the individual’s “time horizon.” Time horizons are subjective. They vary not only from individual to individual, but from one socioeconomic class to another, among ethnic groups, or among age brackets. Ironically, older individuals may have longer time horizons than younger, more impetuous, individuals, even though, objectively, younger people generally have more years of life ahead of them. But older people’s plans often extend well beyond their own life span, as in decisions made for their children’s well-being — the preservation of an estate, or in extreme cases, suicide by parents who consider themselves “burdens” to their children (once generalized among Eskimos) — or the older person’s time horizon often includes concern for their own good name after death which serves as motivation for decisions involving philanthropy, religious conversion, or a place in history. For younger people the end of their own life is often beyond their time horizon, and these post-death concerns still more so. It may well be that the time horizon lengthens with the birth of children and the assumption of a parental outlook, not only as regards one’s own children in particular but posterity in general. Whatever the cause, a time horizon extending beyond the lifetime of the individual becomes a spontaneous moral control on individual action, analogous to moral constraints extending in space at a given time.

Differences in time horizons among social groups change the effectiveness of social policies involving either benefits or penalties, especially when one social group, with a given time horizon, predominates among the policy makers and another social group, with a different time horizon, predominates among those to whom the policy applies. For example, “job training” programs which require present efforts to increase prospective employment and earnings sometime in the future may prove relatively ineffective with age, ethnic, or socioeconomic groups with short time horizons. Participation in such programs may be based on such current opportunities as these programs present, and maximizing benefits at least cost may mean maximizing in the short run sense of doing as little as possible to receive the financial or other immediate benefits from the program — which is to say, preparing for future employment as little as possible. The attempt to use such future-oriented programs as means of luring present-oriented youngsters away from crime runs up against the fact that “most crimes are committed opportunistically by youths who want small amounts of money right away.”² A job training program may well increase the youth’s earnings ability by many times what he can successfully steal, provided that both calculations are made over a long enough time span, but if his time horizon is shorter than the program, none of its future benefits may enter his calculation — which may nevertheless be as rational within his time horizon as the opposite result is for those with a longer time horizon. No one has an unlimited time horizon, and there is no logically compelling objective reason for preferring one time horizon to another.

Jobs are a meaningful alternative to crime when the jobs have similarly short time dimensions. The availability of casual, day-to-day jobs is apparently inversely correlated with petty crime rates. Where the opportunity for such pickup jobs is reduced — as by bad weather — petty crimes tend to increase, since people who live from day to day “have to eat” when the jobs stop and seldom have much money saved.³

One of the reasons why relatively simple precautions reduce the incidence of crime is the short time horizon of many criminals. Almost no feasible precaution can make it impossible to steal, break-in, or victimize by violence. But merely by raising the immediate cost — in time, effort, or risk — it discourages many whose aversion to perseverance and postponed benefits is part of the reason for their being criminals. Few homes are burglar-proof and few people mugger-proof, but the incidence of burglary is much lower in New York than in Los Angeles while the incidence of mugging is just the reverse, because access to New York apartments is usually a little more difficult than in Los Angeles (due to architectural style differences) and access to people to mug is somewhat more difficult in Los Angeles (due to fewer pedestrians in residential neighborhoods). Apparently criminals are rational within their framework. One of the reasons for the absence of simple precautions is the subsidization of losses: insurance policies spread and thus minimize the impact of the cost of theft; police property recovery costs paid for by the taxpayers likewise reduce the connection between carelessness and consequences; “victim compensation” policies by government extends this externalization of costs still further. Insofar as individual precautions merely cause the criminal to turn to someone else as an easier victim, the private benefits exceed the social benefits. An argument might be made for legal compulsion to reduce vulnerability in general — antitheft devices in cars, better locks required by building codes, brighter lighted streets, etc. — but since such requirements would be categorical rather than incremental, they could easily go past the point where the benefits balanced the costs.

THE ANIMISTIC FALLACY

From the point of view of the social utilization of knowledge, time permits entirely different methods for the production and distribution of knowledge from those usually conceived of, and does not depend upon articulation, rationality, cognition, or any of the other formal processes taught in academic institutions. With unlimited time, either the processes of nature or the competition among men may lead to an intricate pattern of results unplanned by anybody. The fitness or accuracy of these systemic adaptations may be revealed primarily — or even exclusively — in results rather than in articulated rationality. But because man insists on some articulated explanation after the fact, an explanation which overlooks the crucial role of time may emerge as a wholly different — and wholly fallacious — depiction of what has happened.

Perhaps the simplest and most psychologically satisfying explanation of any observed phenomenon is that it happened that way because someone wanted it to happen that way. This applies not only to social phenomena but to natural phenomena as well. Primitive peoples explained the movement of leaves on a tree by some spirit or god who wanted the leaf to move, had the power to make it move, and so it moved. The analogy of this to purposeful and deliberate human activity is obvious. It is only at a much more developed state of reasoning that the movement of leaves is explained by wind currents of a nonpurposeful (but also nonrandom) nature, based on differences in air pressure. The more primitive kind of explanation remains a more spontaneous or “natural” kind of explanation — one that arises first in a wide variety of areas, and is later abandoned only when forcibly displaced by a demonstrable alternative. Some events are in fact the result of purposeful activity toward the goal achieved, but the general presumption that this must be the case can be classified as “the animistic fallacy.”

The animistic fallacy has had many great, historic forms — in religion, in biology, and in economics, for example. Time is a crucial ingredient in the alternative, systemic or evolutionary, explanations of the same phenomena. The religious “argument from design” for the existence of God asserted that the observed nonrandom pairings of environments and creatures, the male and female sexes, the cooperating organs of the body, etc., all proved that a purposeful intelligence had designed the universe to fit together. Even such philosophic skeptics as David Hume and John Stuart Mill found these arguments weighty. After Darwin’s theory of evolution provided an alternative explanation of the same natural phenomena, even religious believers no longer rested their beliefs on the animistic “proof” of the existence of God. Darwin was a landmark, not only in the history of biology, but in the history of intellectual development in general. He showed how — with sufficient time — nonpurposeful activity could lead to nonrandom results: he divorced order from “design.” Yet the animistic fallacy would say that the absence of “planning” must lead to chaos — and the economic and political consequences of that belief are still powerful today.

Animistic explanations require little or no time for the events they postulate to take place — only six days for the creation of the world, in one religious version, and in principle omnipotence could have made it happen in an instant. Evolutionary explanations, on the other hand, necessarily imply sufficient time for initially random events, behavior, or individuals to be sorted out by environmental forces in such a way as to leave a surviving population with nonrandom characteristics adapted to the environment. Initial mutations may happen to range from beneficial to fatal, but surviving mutations tend to represent improved adaptations to the environment. After millions of years of natural selection, what will be observed will be primarily surviving mutations. One may choose to regard the process as a whole as Providential without committing the animistic fallacy of asserting that the observed order could only be a result of deliberate design.

SYSTEMIC ANALYSIS

Social phenomena may also be explained either animistically, from the intentions of the individuals involved, or in terms of the mutually constraining complex of relationships whose results form a pattern not necessarily similar to the intentions of any of the individuals involved. The animistic fallacy is not the exclusive property of either the political left or right. Conservative economists of an animistic bent explain rational behavior in a timeless context, sometimes with the moral conclusion that the wise are rewarded for their foresight and the unwise penalized for their lack of it — that “supernormal brains” explain large profits for example. On the left, social planners eager to save the world from “chaos” engage in another form of the animistic fallacy. Both approaches ignore time, for there is no selective adaptation process to take place. However, the animistic fallacy is rejected decisively by such ideologically disparate figures as Adam Smith and Karl Marx, both of whom analyzed in systemic terms.

Smith had no faith whatever in the intentions of businessmen, whom he characterized as mean and rapacious,⁴ but argued that the characteristics of a market economic system would lead to beneficial results which were no part of the intention of those acting within the system.⁵ Karl Marx, of course, had a far less benign view of the results of a capitalist system, but he — like Smith — analyzed the results in terms of the presumed characteristics of the system, not the apparent intentions of individual capitalists. In the preface to the first volume of Capital, Marx dismissed any idea of explaining the capitalist system by capitalists’ intentions.⁶ Engels sweepingly rejected that approach with respect to social phenomena in general, “for what each individual wills is obstructed by everyone else, and what emerges is something that no one willed.”⁷

Attempts to explain striking differences among social groups (class, ethnic, regional) at a given point in time often lead to the animistic fallacy. The relative success or failure of these groups — whether measured in money or such social variables as family stability or crime rates — is often attributed to some merit or demerit on their part or on the part of some other group (including “society”) in dealing with them. “Ability” or “discrimination” are thus among the first explanations seized upon, much as primitive man explained the rustling of leaves by someone’s deliberate moving of them. But once it is clear that results observable at a given point in time may be part of a process that stretches far back in time, it is no longer automatically necessary that their current situations be a result of either meritorious or unworthy actions by contemporaries — either group members or others. Differences in cultural values, for example, have deep roots in centuries past and profound impact on current behavior.

Groups from an agricultural background have classic patterns of problems when transplanted to an urban, industrial and commercial environment. A social history of the Irish peasants who immigrated to American cities in the nineteenth century reads remarkably like a preview of the history of blacks from the rural South in those same cities in the twentieth century.⁸ The many historical, genetic, and other differences between the two groups only makes their parallel patterns all the more remarkable. Conversely, it is virtually impossible to explain the profound differences between contemporary Italian and Jewish immigrants in their responses to schools, libraries, and settlement houses⁹ in terms of any contemporary differences in their socioeconomic conditions in the nineteenth century immigrant neighborhoods where they lived side by side. But even the most casual acquaintance with the histories of Jews and southern Italian peasants in earlier centuries shows how far back these cultural patterns go.¹⁰

Many of the attitudes, beliefs, and emphases of agrarian peoples are quite reasonable as adaptations to an agrarian environment, however counterproductive these approaches may turn out to be in an urban commercial setting. A fatalistic view of the future, for example, is fully understandable in a culture where people’s whole lives hinge on the random variability of the weather. It is a challenge to try to find any group which emerged from centuries of agrarian life and became a success in an urban environment in one or two generations. Conversely, the long-urbanized Jews, who became the most successful of all American ethnic groups in the cities in which they concentrated, had an almost unbroken record of failure in agrarian undertakings in various parts of the United States.¹¹ Generalized “ability” or “discrimination” seem to offer little explanation of such social phenomena, as compared to the explanation of evolutionary adaptation. For other social phenomena, the results may be different.

The point here is not to deny any effect of intentional actions, or even to claim that these are necessarily less than the effects of evolutionary social processes. The point is to challenge the presumptive priority of timeless, intentional explanations — i.e., the animistic fallacy. It is plausible but false to say that “decisions made at random, or without any relation to each other do not fall into any pattern.”¹² Darwin demonstrated that falsity in biology, and such disparate thinkers as Adam Smith and Karl Marx have rejected the same fallacy in analyzing social processes.

One of the most important political trade-offs is between the amount of freedom and the amount of other characteristics desired in a society. The problem is made more difficult by intellectual ambiguities and philosophical disagreements that have long surrounded the very meaning of freedom: “We all declare for liberty; but in using the same word, we do not mean the same thing.”⁶ This is at least as true today as when Abraham Lincoln said it.

Freedom here will refer to a social relationship among people — namely, the absence of force as a prospective instrument of decision making. Freedom is reduced whenever a decision is made under threat of force, whether or not force actually materializes or is evident in retrospect. This prospective definition of force is essential to avoid such absurdities as concluding that armed robbery does not usually involve force. Force here is not used metaphorically, however, to refer to benefits so enticing as to make the decision a foregone conclusion. A special wariness is necessary in discussions of freedom, not only because of the inherent problems of the concept, but also because an Orwellian Newspeak has made it fashionable to describe the trade-off of freedom for other things as an expansion of “new freedoms” or of freedom in some “larger” sense. The incremental trade-off of freedom for other things is accepted by everyone except a pure anarchist. But the extent of this historic trade-off is too momentous an issue to be concealed or confused by pretty words.

Force is the antithesis of freedom, but force must be used, if only to defend against other force. Force used against murder, for example, includes not only such force as may be used by police intervening to prevent a murder, or to capture a murderer, but also force applied to innocent third parties who may be detained or subpoenaed as witnesses or forced by law to serve as jurors. It is not an absolute sacrifice of freedom nor an absolute prevention of murder. But it is simply an incremental trade-off at varying rates, and the question at any given point is how much more freedom are we prepared to sacrifice for how much prospect of reducing the murder rate — or how much more freedom are we going to demand at the cost of how many more lives of murder victims? Trade-offs involving freedom are often painful, if only because only other urgent needs are considered worthy of weighing and balancing with it.

The government is the general repository of force — whether that government be democratic, totalitarian, feudal, etc. Totalitarian governments, by definition, have no significant trade-offs of freedom left to consider, since freedom has already been sacrificed for some alternative consideration, whether rhetorical or material. Democratic governments are constantly weighing incremental trade-offs toward or away from freedom. Indeed, democracy itself is a consideration that is traded against freedom, and at one time this trade-off was both recognized and feared.⁷ Contemporary opinion often simply incorporates freedom into the very definition of democracy, so that a government that eliminates freedom is not “really” democratic. This trade-off, too, is much too important to be dealt with by verbal sleight of hand. To include freedom in the very definition of democracy is to define a process not by its actual characteristics as a process but by its hoped-for results. This is not only intellectually invalid, it is, in practical terms, blinding oneself in advance to some of the unwanted consequences of the process.

A lynch mob may be a more accurate expression of the majority will than a court of law — especially an appellate court of appointed judges — and yet lynch mobs are condemned and “law and order” upheld because certain freedoms are deemed more important than democracy. Democratic institutions will be defined here to mean institutions which carry out the popular will in its decisions — whether those decisions be wise or foolish, generous or oppressive. When the undemocratic governments of the Reconstruction era in the South were replaced by governments more responsive to the majority, the minority suffered oppression and terror on a scale seldom seen in modern civilization. Such residual protection as the black minority retained came largely from sources having little to do with political democracy — notably markets,⁸ morality,⁹ and appellate courts.¹⁰

When freedom is conceived of as a relationship among people, trade-offs of freedom for material goods, scientific progress or military power, for example, become quite explicit, instead of being subsumed under a general expansion of “freedom” as sweepingly redefined. The growth of the decision making powers of government may facilitate various specific forms of material progress — even if at the expense of material progress in general — while reducing freedom. That trade-off needs to be made explicit. It is instead muddied over by those who define freedom as options (freedom to)¹¹ — and who have many options to promise in exchange for our freedom. The options approach asks, “What freedom does a starving man have?” The answer is that starvation is a tragic human condition — perhaps more tragic than loss of freedom. That does not prevent these from being two different things. No matter what ranking may be given to such disagreeable things as indebtedness and constipation, a laxative will not get you out of debt and a pay raise will not insure “regularity.” Conversely on a list of desirable things, gold may rank much higher than peanut butter, but you cannot spread gold on a sandwich and eat it for nourishment. The false issue of ranking things cannot be allowed to confuse questions of distinguishing things.

The mere fact that something may outrank freedom does not make that something become freedom. Moreover, in social trade-offs as in economic trade-offs, all rankings or preferences are incremental at a given point and changeable at other points. Nothing desirable at all is categorically less desirable than something else. Food may be incrementally preferable to any amount of freedom to a starving man, but that does not mean that dessert after a banquet is incrementally preferable to the freedom to go home at the end of the evening. The great social desiderata are so frequently discussed in categorical language that it is easy to forget their incremental nature — and to talk nonsense with seeming profundity as a result. Both Adam Smith and John Rawls made justice the primary virtue of a society,¹² but their meanings were not only different but nearly opposite, because one was speaking incrementally and the other was speaking categorically. To Smith some amount of justice was a prerequisite for any of the other features of society to exist,¹³ but he was far from believing that all increments of justice invariably outranked increments of other things, and in fact he regarded such a belief as counterproductive and doctrinaire.¹⁴ To Rawls, justice is categorically paramount in the sense of not being incrementally inferior to any other consideration, so that one consideration of justice may be sacrificed only to another consideration of justice, but not to any other desired goal.¹⁵ According to Rawls, a policy that benefitted all of the human race except one person should not be adopted, no matter how much they were benefitted, nor even if the one person were completely unharmed, because that would be an “unjust” distribution of the benefits of the policy. Perhaps not many people are likely to agree with Rawls’ conclusion, but many use the same arbitrarily categorical approach to social analysis which led logically to such conclusions.

When two things have to be traded off against one another, it is necessary to understand clearly (1) that they are in fact two different things, and to consider (2) explicitly on what terms we are prepared to incrementally trade the one for the other. Nothing is gained by claiming — or insinuating — that both are the same thing, or that one is just more of that thing than the other. At least nothing is gained from the standpoint of rational decision making. In political reality, much is gained by those who wish to take the decision making power of others into their own hands. Much verbal sleight of hand is practiced with such statements as “security is merely an aspect of freedom.”¹⁶ Freedom has cost too much blood and agony to be relinquished at the cheap price of rhetoric.

NONGOVERNMENTAL “POWER”

Not only is freedom confused with other things, so too is its opposite, force. The widespread recognition of the need to use force to counter other force is used to justify expanding governmental force to counter things that are not force at all, but are called force metaphorically for the sake of justifying coercive action against them. Attacks on economic “power” are a common form of justification for expanded government force.

Often the rhetoric is preserved by such devices as referring to a firm’s retrospective percentage of sales during a given period as a share of the market they “control,” as if in some prospective sense. Metaphors and vague definitions are used to justify an expansion of government power which is neither vague nor metaphorical but very concrete. But with power as with freedom, a sufficiently wide or vague definition brings in many examples. What is crucial in judging such an example is distinguishing between (1) situations in which an individual’s options for dealing with alternative transactors are forcibly reduced or eliminated, and (2) situations in which a given transactor adds so much more to his options than anyone else that acceptance is a foregone conclusion. A monopoly or cartel reduces the consumers’ options, while a successful competitor adds to those options. Reducing consumers’ options requires not simply raising one’s own price — anyone can do that — but forcibly keeping others from entering the competition and undercutting that price. This usually requires either an exclusive franchise from the government, or some law or regulation limiting competition. These government created monopolies or cartels are the beneficiaries of governmental force, not its target. The situation of the transactor who offers better terms than others may seem to be a strange candidate for a “power” menace to be combated by government, though in reality many regulatory and antitrust activities do just that, as will be seen in Chapter 8. The point here is simply that a trade-off involving more use of force in economic decision-making is denied by depicting governmental force as merely an offset to existing private force, with no net increase.

DEMOCRACY

Democracy has been defined here by its characteristics as a process, not by its hoped for results, such as freedom, the dignity of the individual, or other benefits expected or alleged. Whatever the merits of democracy, it has its institutional limitations and operates within an area of circumstantial constraints — like all other political, economic, and other systems. The open endedness of hopes has sometimes led to the view that a majority can or should have whatever it wants — a view defined here as “the democratic fallacy.” The democratic fallacy implicitly presupposes unconstrained circumstantial options, so that if a majority does not get what it wants, it can only be a result of some denial of their democratic rights in some intentional sense. Choice through the ballot box has often been equated with choice through the market. But inherent constraints mean that democratic governments have no wider array of options to offer than anyone else — regardless of what options many may believe to exist — and that one crucial difference between ballots and prices is that prices convey effective knowledge of inherent constraints, while ballots do not. If I desire a Rolls Royce and simultaneously a normal standard of living, the price tag on the automobile immediately informs, convinces, and virtually coerces me to the conclusion that these two things are inconsistent. But if I believe simultaneously in a large military arsenal, low taxes, a balanced budget, and massive social programs, there are no constraints on my voting that way. Some time after a voting decision, it may become apparent that what was asked or promised did not in fact materialize, but this can easily be blamed on the dishonesty of political candidates, with no greater public awareness that the set of options simultaneously desired was inherently unrealizable from the outset. Instead of feedback to the voters to reduce their desired set of options to what is simultaneously realizable, the message may be to choose different persons as leaders, or different ideologies, movements, etc., in order to continue pursuing that same set of options. Indeed, when social progress is viewed retrospectively, it is often regarded as axiomatically attributable to such insistence on better things, rather than to technological and organizational advances over time which created wider arrays of options from which to choose. It is as if the historic increase in the Gross National Product was incidental to a rising living standard caused by political activity.

The question here is not whether voters have a right to choose whatever they want. Voters can only choose process characteristics and hope for results. Consumers buy results and leave the process to those with specialized knowledge of such things. There is no argument here for denying voters their democratic choices. The point is merely to claim that the terms of the choice are readily misstated politically. The prevalence of inflation among the most diverse kinds of governments and across thousands of years of history, suggest that no small part of the political art consists in misstating options and in trying to give the appearance of simultaneously satisfying competing claims when they cannot be satisfied in reality.

A more extreme version of the democratic fallacy goes beyond the idea that a majority can or should have whatever it votes for, to claim the same right for particular minority subsets of the population. It is regarded as a “failure” of a democratic system — or as showing that the system is not “really” democratic — when determined, conscientious people cannot get what they want through legitimate channels. Justifications for law breaking (extending in principle all the way to terrorism) by frustrated insurgents are based on this premise. In this version of the democratic fallacy, the ignoring of inherent constraints within which all decision-making processes function is simply extended to ignoring all other people’s desires as an obvious (and valid) reason why a particular subset’s desires were not achieved.

Sometimes the subset is presumed to know the majority’s “real” interests better than the majority itself, and so is acting democratically in some “larger” sense. This confuses the characteristics of a hoped-for result with the characteristics of a decision-making process. Numerous subsets’ hoped-for results are preferable to the majority’s perception of things, in the view of those subsets. Democracy is simply one decision-making process for resolving such conflicts among disparate perceptions. To resolve the conflicts by other processes — including violence — is to trade off democracy for something else. To conceal that trade-off by calling that something else “democracy” too is to ignore the fact that virtually all political systems or movements are ostensibly for the benefit of the people. The hoped for results of kings, emperors, military juntas, and various dictators would thus all have to be called “democratic” in some “larger” sense.

Like other trade-offs, the trade-offs involving democracy are frequently denied or misstated by including other things in a wider ranging and more vague definition of democracy. “Participatory” democracy has arisen in this way, as another concept defined by hoped for results rather than by characteristics of the process itself. In principle, participatory democracy is distinguished from, and complementary with, representative democracy. In a representative democracy when the voters choose surrogates who actually make the decisions, the surrogates may either be or become part of a small set of people with interests and perspectives different from those of the public at large. The theory behind “participatory” democracy is that more decisions should be made by the public itself directly rather than through representatives. To this end, numerous local boards, commissions, councils, or advisory participants of one sort or another are to have “input” into the decision-making process. The implicit assumption of the theory is that there will be not merely more numerous decision makers but more representative ones. But, turning from hopes to institutional mechanics, there is usually nothing to lead institutionally toward that result, and much to lead in the opposite direction. Those individuals who have the leisure, the education, and the inclination to “participate” may be very unrepresentative of the public. In practice, participatory democracy means that broadly elected representatives are to share power with self-selected representatives of narrow vocal constituencies. From the standpoint of the institutional transmission and authentication of knowledge, it means that instead of having insiders judge processes and outsiders judge results, some outsiders are to judge and change processes on the basis of their part-time experience on the inside and their unrepresentative interests on the outside. It is essentially an incremental trade-off of the public’s right to decide by elected representatives for a self-selected constituencies’ opportunity to be insiders.

Whatever the substantive merits or demerits of particular trade-offs involving freedom, force, or participation, the crucial point is to see the trade-offs as trade-offs, rather than as they are sometimes depicted, as simply “more” freedom or democracy as conveniently redefined.

Rights have already been noticed as rigidities (Chapter 2). They are also boundaries limiting the exercise of governmental power and carving out areas within which individual discretion is free to shape decisions. In addition to these Constitutional rights of citizens in general, there are special rights, such as the right of exclusive use of specific things (property rights) or rights arising from specific reciprocal commitments (contracts) and rights created by specific legislation (employment rights, housing rights, etc.). By “rights” here is meant legal entitlements, regardless of their moral merits. Rights in this sense are simply factual statements about the availability of state power to back up individual claims. They are simply options to use governmental force at less than its cost of production — ideally at zero cost. In reality, some cost of time and effort are required even to phone the police, and to vindicate many rights a long and costly legal battle up through the appellate courts may be necessary. Where a right worth X (in money or otherwise) would cost 2X to vindicate, then for all practical purposes such a right does not exist for the individual. Where most of the cost falls on the government, the trade-off is between the social costs involved in a particular violation of individual rights — i.e., the effect on other people of letting such violations go unpunished — compared to the costs of enforcement.

Social trade-offs are involved in the creation of rights, the defining of rights, and the assigning of rights to individuals. When a given kind of activity is dealt with by the creation of rights rather than by alternative decision-making processes, there is a loss of flexibility (incremental adjustment) and reversibility. Something that is incrementally preferable at a given point becomes categorically imposed at all points by the force at the disposal of the government. Insofar as the law of diminishing returns applies to social as well as economic processes, this means that many benefits are pushed to the point where they cease to be benefits and may even become counterproductive.

PROPERTY RIGHTS

The creation of rights involves questions not only of whether to create rights as a mode of dealing with a particular trade-off, but to whom to assign such rights as are created. Property rights involve both kinds of decisions. Many things are left unowned — wild animals or birds, fish in the sea, human beings, air and sunshine — because the enforcement of property rights is deemed either impracticable or undesirable. Ideas cannot be copyrighted for both reasons, whereas a given permutation of words can be copyrighted, both because it is feasible to determine authorship and because it is deemed more important to provide a prospective reward as an incentive for future writing than to incrementally increase the circulation of existing writings by eliminating royalty charges.

Property rights in general must be distinguished from the particular form of property rights in so-called “capitalist” countries. A socialist government also owns property. If socialism meant literally an abolition of property rights, rather than their reassignment, then any individual citizen would be free to build a house, ride a horse, or play baseball on land that the government had set aside for growing food, and life would become impossible in such a society. But, in reality, whether under capitalism or socialism, property rights are basically rights to exclude — meaning in operational terms, the availability of governmental force to eject and/or punish others for using the same property without permission. However, the right to exclude does not mean that exclusion will result. Rights to exclude are negotiable in market economies, and may be sold or rented, in whole or in part. Property rights are also divisible among decision-making units. One person or organization may own the right to farm a given field while another decision-making unit owns the right to the minerals underneath and still another owns the right to string electric wires overhead. Almost never does one property owner own every conceivable use of a given property. An owner of a mountain does not own the right to fly over the mountain, nor does he own the right to every stream that originates in his mountain, in the sense of being able to dump anything that he wishes into those streams.

Whether in a socialist or a capitalist context, a property right is a differential privilege¹⁷ of some to exclude others from decisions or activities involving some physical or intangible object of value. This differential privilege is not personal; the current owner can have last week’s owner jailed for trespassing. In a socialist or communist society, a deposed official dare not presume to continue directing enterprises formerly under his control. The basis for a property right is therefore not an individual attribute or merit but social expediency. The social question then is — what is to be gained or lost by defining a property right, and on what basis should the right be assigned, and shall it be transferable? The defining and assigning of property rights goes on in all kinds of societies — in socialist societies the assignments are based on political election or appointment, until further notice — while transferability at the discretion of individual transactors is the defining characteristic of capitalist processes.¹⁸

To define a property right is to carve out and tie into a package various possible activities associated with a given object of value. It is essentially a judgement that certain decisions go together, in the sense that different decisions about each of the activities separately are unlikely to be as socially beneficial as decisions about the set of activities collectively. If separate property rights to a living hog’s head are defined independently of property rights to his heart, stomach, or hind legs, so that these rights can be held by different decision-making units, it is unlikely that the hog will live an optimal length of time from the viewpoint of the production of pork chops, ham, and chitterlings. If the owner of the hog’s heart removed his property, the value of all the other property would be reduced. If these separate property rights are transferable, it obviously would be to someone’s self-interest to acquire these separate, risk-ridden rights at values greater than they have to the separate owners, and combine them into one, far less risky right to the whole hog. In other words, the right to the whole hog is more valuable than the sum of the rights to all his parts. The definition of a property right is therefore an important step, especially in systems which forbid subsequent transfer of these rights.

In feudalistic systems, where land is inherited as an indivisible property required to remain with a given family (entails), the whole society loses if those lands are in parcels so small or so situated that they are far less productive than if they could be combined into larger units or traded off to get contiguous parcels, or if land served by a given stream were under the same decision-making unit. Conversely, a property may be too large to be effectively managed by one decision-making unit, so that it would produce more output for the society at large if it were under several decision-making units. These problems are not unique to feudalism. Wherever the initial definition of property rights is imperfect — which is to say, wherever it is done by human beings — and subsequent transfers are prohibited or restricted, similar problems arise. A socialist government may, for example, “entail” a whole industry to one planning commission, leading to avoidable “mistakes” in the industry which are not the result of stupidity or perversity but merely due to the high cost of monitoring the property as defined. Were the property transferable, it would be more valuable in smaller units — more valuable not only to the buyers but to society at large.

Leaving property rights wholly undefined is even more disastrous than imperfectly defining them. Wild animals are often hunted to extinction precisely because they do not belong to anyone. They can by fiat or metaphor be said to belong to “the people,” but unless it is feasible to apply force to exclude poachers, there is no property right in reality. It is precisely those things which belong to “the people” which have historically been despoiled — wild creatures, the air, and waterways being notable examples. This goes to the heart of why property rights are socially important in the first place. Property rights mean self-interested monitors. No owned creatures are in danger of extinction. No owned forests are in danger of being leveled. No one kills the goose that lays the golden eggs when it is his goose. Even chickens who lay ordinary eggs are in no danger of being killed before their replacements have been provided. No logging company is going to let its own forest become a mass of stumps, though it may do that on “public” land.¹⁹

By creating monitors with a vested interest in the maximization of a given set of values, property rights reduce the social cost of monitoring efficiency. In systems of nontransferable property, the monitor’s incentives are to maximize those values realizable during his own tenure, whether as inheritor of an entailed estate or as a member of a modern planning commission with a fixed term. Where the property is transferable at will, the present value of a property at any given time includes future values realizable long after the time horizon (or even lifetime) of the existing property holder, who therefore has no incentive to restrict his maximization to the short run. In socialist systems, property transfers take place through political decisions to replace members of the planning bodies or to reorganize the planning structure itself. The property itself never belongs to those individuals, but they benefit both financially and psychically from managing it, and visibly successful management may create a capital gain in the form of increased likelihood of promotion to higher levels of pay or power. All of this provides short-run incentives for short-run maximization of politically visible values. Morality, ideology, or a sense of history must then be relied upon as incentives for longer-run maximization policies. That such incentives apply to only a limited number of individuals, or to individuals in only a limited number of positions of historic visibility, may be indicated by the fact that long-run investments in the Soviet economy are directed by only a few people at a time. Under short-run incentive structures, individual decision-making units tend to avoid technological innovations with short-run costs and long-run benefits “as the devil shies away from incense,” to quote Soviet Premier Brezhnev in a complaint about Soviet managers.²⁰

Because property rights are essentially rights to exclude, with the aid of force supplied by the government, the costs to be weighed in this social trade-off are the costs paid not only by those excluded but by the society at large. Indeed, when an economy is recognized as a rationing scheme that must deny most things to most people (few individuals could afford to buy one of every item produced in the whole economy), this question reduces to the losses sustained by society at large. Patent rights exclude alternative producers from supplying the patented goods, reducing competition and the efficiency which depends on it. Copyrights reduce the dissemination of knowledge and entertainment, by pricing some potential users out of the market with royalty requirements. With both patents and copyrights, it is not the royalties actually paid that constitute the social loss; these are only internal transfers. It is the transactions that do not take place because of prospective royalty charges that constitute the net social loss. The cost of policing property rights is also a social consideration involved in a trade-off against the benefits. The whole costly apparatus of title records, title search, civil court systems, marshals for evictions, etc., are part of the cost of property rights in general, and of highly fragmented property ownership in particular. The costs may also include losses to those individuals intended to be benefitted.

Rights in general may be conferred for individual as well as social benefit. Property rights are intended to secure gains to society at large, including numerous persons who own no significant property. This point is insisted upon in socialist ideology, where the government holds property rights “for the benefit of the people,” but it is also implicit in capitalist private property right law as well, where it is the social expediency rather than the individual gain that is the controlling rationale.²¹ However, there are many rights intended to benefit primarily or exclusively those to whom the rights directly apply. Civil rights laws, for example, are generally intended to benefit racial or ethnic minorities, and minimum wage laws are generally intended to benefit low-wage employees. The appropriate question here is the trade-off of costs and benefits for those subsets of the population, as well as for the population at large.

EQUAL RIGHTS VERSUS SPECIAL RIGHTS

While all forms of society require some set of dependable expectations enforceable by group pressure or force, in many nations it is not enough that rights exist; they must, in principle, also be equal rights. Equality as a legal or political principle does not depend upon a belief in empirical equality of any sort. Quite the contrary. If it were literally true that “all men are created equal,” there would be no case for equal protection of the law, or perhaps even for laws at all. If every person had exactly the same intelligence, strength, aggressiveness, organizing ability, etc., there would be no need for the law to protect one from another, because one would never be in a position to successfully take advantage of the other. Even though a coalition of such equal individuals could overwhelm any isolated individual, they would all be equally capable of foreseeing this and organizing counter coalitions to offset that danger. It is precisely the inequalities of people which makes the equal protection of the law so important — that there must be an overwhelming organized force ready to be thrown into the balance, so that a weak little old lady shall have as much right to live as the most stalwart young man or that frauds that deceive the unwary shall not be immune to retribution by officials who are more knowledgeable.

There are, of course, few people who are equal in any empirical sense. Most people who are considered equal are usually regarded as such because they have offsetting inequalities — that is, neither of them is superior in every aspect, nor are they equal in every aspect. In this context, “equality” over all depends upon what weights are arbitrarily assigned to the various traits in which one or the other predominates. So too would any general notion of “superiority” or “inferiority.” All these attempts to sum up disparate characteristics ignore the diversity of personal values which makes it impossible to have objectively recognized, fungible units in which to add up totals. Most of us would give a heavy weight to the fact that individual A is not a homicidal maniac, while individual B is, and so prefer A even if B were universally recognized to have more charm or beauty. But there are few traits on which there is similar agreement, even as regards rank ordering, much less relative weights.

Where a particular segment of the population has different rights from the general population at large — either explicitly or in practice — the costs of transacting with that segment will tend also to be different. Anyone with a choice of transacting with illegal aliens, ordinary citizens, or persons with diplomatic immunity, would face different risks (costs) of legal liability against himself and different prospects of seeking legal redress for any damages he might suffer from individuals from each of these respective groups. If the individuals in these three categories were otherwise identical, any prospective transactor — whether as a prospective landlord, employer, or spouse — would face the least risk of legal trouble from an illegal alien and the most from someone with diplomatic immunity. The abuses suffered by the former and inflicted on others by the latter are both notorious. What is important here is not this retrospective experience of these two special groups, but what that implies more broadly for prospective behavior in society at large. The more special rights are created for any particular groups, the higher the transactions costs of dealing with that group and the fewer transactions that group will be able to consummate. Special health and safety legislation for youths or women make youths or women less desirable employees than others and thereby reduces their employability. This is not a phenomenon of private capitalist employers only. Soviet managers have avoided hiring younger workers whenever possible for the same reason.²² As rights of legal redress for fired workers have grown, so have hiring requirements, to eliminate many who would otherwise be employable if the employer did not need a higher level of assurance before assuming the increased risks of legal liability for firing.²³ Relatives often have special rights on a job, without any explicit agreement to that effect; antinepotism rules make them less employable to avoid these costs.

Consumer rights raise the price paid for products and services, since higher quality, or greater producer liability, both have costs. The question is whether the amount by which the price is raised is more or less than the increased value created by the rights. If the increased quality or enlarged responsibility of the seller were worth it, there would be profit incentives for the producer to raise his quality, responsibility, and price together without consumer protection laws. It has long been common for stores with easy return, money back policies and free repair services to charge more than stores that sell “as is.” Some stores even sell service contracts separately, so that the same physical item can be bought at two different prices from the same dealer with two different levels of dealer responsibility. Those for whom the price differential is sufficient incentive to speculate in consumer appliances can buy without the service contract, and others can substitute money for boldness incrementally. These subjective differences in the costs of risks are ignored when laws in effect prescribe categorically how much liability insurance must be sold with each product. Assurances that the consumer must “really” be better off this way can seldom be checked empirically. One large historical instance of imposed product quality “improvement” occurred when the British Parliament in the nineteenth century imposed higher health and comfort standards on ships carrying Irish emigrants. In view of the foul and disgusting state of the ships at that time, it might seem to be a foregone conclusion that this was a net benefit. Yet the records show that the Irish rushed to get on ships heading out before the law became effective — and the outflow of emigrants slackened immediately thereafter.²⁴ The cost of the higher quality was apparently weighed differently by the Irish themselves than by the British Parliament.

Perhaps the crucial problem involved in creating special “rights” is that they typically involve reducing the set of options available to the transactors, without any offsetting increase in other options. There is no reason to believe that people will generally make a better set of choices out of a smaller set of options, where the larger set includes all the options in the smaller set. If the purpose is in fact to deny the ostensible beneficiaries their choice and substitute someone else’s choice, that is another matter.

Because the negative impact of special legal rights on the recipients is seldom recognized by the voting public, this cost seldom serves as a restraint on political decision making. Indeed, the creation of rights is less constrained than the creation of other ostensible benefits for special constituencies. While political benefits can usually be expected to increase voter support among the recipients, they lose voter support among those who pay the costs — either the taxpayers in general or others on whom the burdens are placed. Rights, however, cost the taxpayer little more than the paper and ink needed for printing them. From a politicians’ viewpoint, rights are therefore a virtually ideal benefit to confer on special constituencies. Where the rights’ social costs consist largely of a reduction in would-be transactions affected by the rights, what matters politically is whether those tangibly benefiting from the improved terms of the transactions (minimum wage laws, rent control) can perceive their offsetting losses from reductions in the number of transactions consummated (unemployment, housing shortages), and whether the other transactor can be publicly discredited (“exploiting” employers or “greedy” landlords). Where the terms are more visible than the number of transactions, and the other transactor is politically vulnerable, there is little constraint on the proliferation of special rights for special groups.

The trade-off between equal rights and special rights is often denied by the same verbal methods used to obscure the trade-off between freedom and other values. The two things being traded off are simply put under one label, so that special rights for special groups are described as simply equal rights in some “larger” or “truer” sense, and instead of a trade-off there is — rhetorically, at least — simply an expansion of the one benefit. This verbal sleight of hand avoids confronting the costs of special rights both to society and to the supposed beneficiaries.

GENERAL RIGHTS

Where certain general rights involve virtually universal desire — such as the desire not to be murdered — incorporating it into specific law eliminates the transactions costs of pointlessly litigating anew each time the net harm of the individual act, in a common-law approach without any explicit law against murder. Making price fixing illegal per se similarly spares courts repeated reruns of introductory economics in antitrust cases. It may seem like a strange and weak justification for enacting basic rights into law that this will save a little court time. Such laws, however, transmit virtually unanimous knowledge — not only about the abhorrence of the crime but about the determination to act against its perpetrators. No such information either exists, or would need to be transmitted if it did, in cases involving voluntary transactions. If it were somehow impossible to kill anyone except with his own voluntary cooperation, the case for laws against murder would be much weaker than it is, and there might be something to be said for litigating each episode from scratch to determine what harm had been done.

Even laws against murder are subject to diminishing returns, and ultimately negative returns. A terminally ill patient who has permanently lost consciousness may be kept organically “alive” for months or years after his brain is dead, as insurance against a murder or manslaughter charge against the doctor or hospital authorities. Other terminally ill patients whose only consciousness is of overwhelming pain may have their agony artificially prolonged for the same reason, even though drugs are available to relieve this pain — with the side effect of shortening their “life.” The economic ruin of a patient’s family or the suffering of the patient himself are the implicit “premium” paid for this “insurance” policy against homicide charges. It is an external cost to the decision-making medical authorities, and so does not constrain their behavior. Disproportionate as the costs and benefits might be in any individual case — the costs to the patient and his family being so much more than the benefits to the doctor — the larger social question is how many people would take on the care of terminally ill patients (or patients who might become terminally ill) if it meant facing daily prospects of homicide charges from more humane medical procedures?

The tragedy is implicit in the categorical nature of laws in general, and homicide laws in particular. The legal system is still wrestling with the problem of trying to introduce some incrementalism into this area — for example, with individual court orders to disconnect life saving equipment from terminally comatose patients, essentially dead people whose organs and medical bills are being prolonged. But the psychic and legal costs of obtaining such court orders make them practically unavailable to many people. The point here is not to “blame” anyone. Quite the contrary. This situation is a tragedy in the classic sense of a humanly unavoidable devastation. It may even be that there is no real “solution” that would not open the way to the deliberate sacrifice of other sick people for their estates, their organs, or to simply be rid of an inconvenience.

The law against murder has been used as an illustration of the diminishing returns to laws and policies in general, precisely because it is one of the most universal of all laws, occurring in the most diverse social and legal systems and enduring through the ages. There is no distracting side issue of the desirability of the goal. Diminishing returns and negative returns to such an essential law are a sobering indication of the limits of any law or policy — and of the limits of knowledge, on which decisions depend. Even if, at a given juncture, it is obvious to the patient, his family, and the doctor that suffering should not be artificially and pointlessly prolonged, the transmission of that knowledge in categorically articulated terms documentable to third parties is what determines whether the murder laws will apply.²⁵ In general, diminishing returns and the limits (costs) of knowledge inhibit the application of all laws and policies, however obvious or desirable their goals might seem.

Where the basic general rights involved are rights against the government — as in the Bill of Rights — saving transactions costs is no small consideration, given the gross disproportion between the resources of the government and those of a private individual. Putting the burden of proof on the government likewise saves transactions costs. Without such rights and with no burden of proof difference, each person would have to litigate against general government arguments as to his harmfulness until his money ran out and then plead no contest. Saving transactions costs is saving the rights themselves from meaninglessness.

Time is important in many ways in political decision making, including the time horizons of decision makers and voters, the time dimension of interest groups, and problems created by arbitrary divisions of the time continuum for political assessment purposes.

Because politicians’ own time horizons are so short, the voters’ longer time horizons are crucial for transmitting a more farsighted perspective to government decision making. But time increases the cost of political knowledge and the cost of effective feedback to decision-making individuals or institutions. Consequences that take much time to become visible are less likely to be understood by the average voter in retrospect, and given the turnover of elected and appointed officials, the prospect of long run negative consequences may be little or no deterrent to an individual decision maker at the time the political decision is made. Where there is an enduring political party apparatus — a “machine” — concerned about its long-run office-holding prospects, the external costs of individual decision making may be internalized to some extent and enforce a somewhat longer time horizon than otherwise. However, with the growth of “independent” or individualized (perhaps “charismatic”) politicians, the political time horizon tends to shrink back to the individual’s own office-holding years. It may be significant, for example, that New York City’s financial crisis of the 1970s grew out of policies and practices adopted during the administration of one of its most charismatic and independent mayors during the 1960s, and that the contrasting financial solvency of Chicago at the same time was maintained in one of the last bastions of municipal machine politics.

Members of a political machine have a large investment in its future election prospects, which correspond with their own individual prospects of advancing up the seniority ladder to higher office. The more independent the individual politician is, the less is his fate tied to the long run consequences of his decisions in a particular unit of government. Negative consequences after he has departed that unit can even be used as evidence of his superiority to his successors. What matters to the independent political decision maker is how his current decisions in his current position promote his immediate prospects for higher positions elsewhere. If a given set of policies enhance a mayor’s presidential prospects, the possible damage of those policies to the city after he is in the White House is hardly a political deterrent.

The effect of a party apparatus, in contrast to a charismatic leader, can be seen in nondemocratic states as well. The incumbent leader of the Soviet Union at any given time could make himself more popular by liberalizing government restrictions or by reducing military spending and allowing the people’s standard of living to rise accordingly. The immediate dangers to his own regime during his own term of office could be minimal, and yet the larger dangers to the internal and external goals of the Communist party could well be sufficiently serious to cause that party to depose the leader for even trying to initiate such reforms. A party with a longer time horizon requires more pervasive control than an individual with only his own term of office to consider. Nonparty dictatorships in noncommunist countries may be equally (or more) authoritarian, but they are seldom as pervasively totalitarian, in the sense of intruding as far into private lives, religious beliefs, or the indoctrination of children. Nonparty dictatorships are therefore more subject to change, if only on the death of the individual dictator, as in Spain or Portugal.

TEMPORAL BIAS

We tend to conceive of various interest groups — the steel industry, agriculture, construction workers, doctors, ethnic minorities, etc. — as integrally persisting through time, and of various special interest legislation or policies as being for the benefit of such groups as enduring entities. In reality, however, the constant turnover of individuals and/or organizations in particular sectors makes possible sharp divergences between the interests of the incumbents as of a given time and the enduring interest group of which they are a transient part. For example, laws making it difficult for employers to fire anyone are an obvious benefit to existing employees. But such laws create incentives for such employers to raise hiring standards and to substitute capital for labor incrementally — both actions raising the unemployment rates among workers subsequently entering the labor force. The net result can be a reduction in employment opportunities for “labor” over time, though an immediate gain in employment opportunities for incumbent employees. It may be a perfectly rational goal for incumbent employees to seek such laws protecting jobs and for incumbent politicians to pass such legislation. Many of those whose future job prospects are being traded off for present advantages are too young to vote or have not yet been born. Similarly, state laws often protect incumbent corporate managers from “takeover” efforts by other corporations which might fire them after buying the business. From a social point of view, it may make little sense to protect less efficient executives from more efficient executives. However, it is incumbent management which decides where to locate corporate headquarters and installations, and those states which shield incumbent management by obstructing “takeover” efforts have an advantage in attracting taxpaying and job creating businesses. It is a perfectly rational decision for states to do so, even when it is against the national interest. In short, it is perfectly rational for incumbent labor and incumbent business to seek goals which are antithetical to the economic interests of labor and business as long run interest groups. And it is equally rational for incumbent politicians to accommodate them with laws that are in no one’s long run interest.

It might seem as though, when the transient representatives of an enduring group are replaced by a new generation, existing legislation adapted to the previous generation would be repealed. But such adjustment to later feedback is inhibited by differences in the cost of knowledge to incumbents and nonincumbents. First of all, incumbents know who they are individually, what they have in common, and what they have at stake. People who might have become doctors if the A.M.A. did not restrict entrance to medical schools, or who might have created an entirely different kind of railroad if the Interstate Commerce Commission did not control that industry, will never know that with anywhere near the same certainty — that is, with anywhere near as low a cost of knowledge. An incumbent need only be sane to know what his occupation is, and only moderately intelligent to realize what he and his cohorts could lose under alternative institutional arrangements. But someone who finds that dishwashing is the best job he can get cannot know that he could have become a construction foreman if the construction union did not restrict entry. Even if he could know, he could not locate all the other individuals who might have been his co-workers or employers in the hypothetical construction industry as it would have existed without union restrictions, so that they might form a counteracting special interest group. Similarly, all the potential executives, investors, employees, and subcontractors of the kind of railroad companies that could have come into existence without I.C.C. regulations face incredible costs of knowledge in trying to locate one another, even if each somehow knew that he was personally one of the losers from I.C.C. policies.

This temporal bias as between existing and prospective members of an interest group is sometimes further accentuated when a new set of interested third parties is created by legislation establishing institutions to regulate, promote, or otherwise interact with the interest group in question — for example, the Civil Aeronautics Board, the Agriculture Department, and similar governmental organizations linked to given industries. They are linked not to the industry or interest group as it might evolve on its own, with an ever changing mix of organizations, people, and power relationships. They are linked to a large extent to incumbent organizations and individuals in the industry or interest group. Normal displacement of such organizations and individuals by new competitors as time goes on is therefore often resisted by them through political, governmental actions. Incumbent businesses may be saved from bankruptcy by restricting the entry of rivals, forbidding or inhibiting price reductions by other incumbents with lower costs, or holding back technological innovations that threaten the continued profitability or survival of incumbents with older technologies.

Much political discussion of competing interest groups overlooks the competition among temporally separated segments of the “same” interest group. Temporal bias affects not only the division of costs and benefits within such an interest group, but the effect on the economy or society at large of the later direction taken by such groups under constraints established to benefit the first generation of incumbents sufficiently well organized to achieve their political goals.

The bias of political decision making in favor of incumbent decision makers in nonpolitical institutions is part of a more general temporal bias of political decision making, whose time horizon tends to be bounded by the next election. Insofar as the voters’ time horizons extend further, on particular issues, the political decision may reflect long run considerations on those particular issues. However, for the voters’ time horizons to effectively control political decision making requires that the voters be able to foresee the long run consequences of current policies. For some policies this is more feasible than for others. For many policies, including economic policies, the long run consequences involve technicalities seldom understood outside the circle of specialists. Moreover, empirical feedback can correct initial understanding only to a limited extent, since individual decision makers have often gone on to other (usually higher) positions on the strength of what was once believed about their decisions, and if it was difficult for voters to understand what was done when it was done, that difficulty may be even greater when trying to recreate the initial situation in voters’ minds years later in order to reassess the options chosen. This is not impossible, however, when the initial decision involved corruption that was later exposed (Teapot dome) or a war growing out of previous appeasement (Neville Chamberlain). The point here is simply that the knowledge costs insulate long run decisions from voter feedback to some degree, and that in the absence of voter feedback, there is no institutional incentive for elected officials to take a view that extends beyond the next election. Just how short a time horizon this is may be indicated by the fact that the average time remaining before the next election is one year for an American congressman and three years for a U.S. Senator. Of course, earlier in their terms they have more time remaining before the next election, but later they have correspondingly less. Their term of office — as of the day they take office, two years and six years respectively — gives the maximum time horizon, but the average time horizon is only half of that.

Time is especially important in economic decisions involving “fixed costs” — that is, costs that do not vary in the short run. Bridges, bus lines, and hospitals, for example, have large fixed costs for their basic structure and equipment relative to the other kinds of costs — such as labor costs — which vary with the use of the facility or service. Municipal bus lines can continue to operate without adding to taxpayer’s burdens, as long as the fares cover the short run costs, such as the cost of gasoline and the bus drivers’ pay. For the longer run, however, the fares would also need to cover the fixed costs of replacing the buses as they wear out. At a given point in time, the need to raise bus fares to cover both kinds of costs can be politically denied without fear of feedback within the elected officials’ time horizon. As long as the existing fares continue to cover the cost of gasoline, bus drivers’ salaries, and similar short run costs, fare increases can be postponed without any immediate reduction in the quantity or quality of bus service or any increase in taxes — regardless of how inadequate the fare may be for replacing the buses themselves when they wear out. That is a problem for future bus riders, future taxpayers, and future administrations. For the present, there are obvious political gains to be made from a humane stance of protecting the public (or the poor) from higher fares. When the buses age and begin breaking down, leading to more overcrowding in the remaining buses, longer waits between buses, and less comfortable buses, this affects not only the transportation system but the whole social ecology of the city. Those who find the municipal transit system intolerable have incentives to use their own automobiles and/or move out to the suburbs. Seldom will the voters who elected a champion of the bus riders’ cause in a given year connect that event with an accelerating exit to the suburbs and a shrinking municipal tax base a decade later.

INHERENT CONTINUITY AND ARBITRARY DISCRETENESS

Time increases the cost of political knowledge in many other ways. The inherent continuity of time must be arbitrarily broken up into discrete units for political decision making and voter assessment purposes. This means that what happens within those arbitrarily discrete units of time assumes an importance in a given system of incentives and constraints out of all proportion to its importance in the longer, continuous stream of time. Other, nonpolitical institutions suffer similar problems, but often also contain mechanisms for bringing the weight of the excluded future to bear during the arbitrarily selected current period. Corporate stockholders, for example, not only consider the annual dividend but the current price of the stock itself, which reflects future prospects of the company as evaluated in the market. A mother not only considers the current fact that a piece of candy will stop her child’s crying; because she is going to be the child’s mother for the indefinite future (i.e., socially and emotionally responsible for the same unit over time), she also has to consider the longer run effect of giving him candy on his nutritional, dental, and psychological future.

Among the social costs of an arbitrary discreteness of time in a given system is an ease of misstatement (high costs of voter knowledge) through choice of temporal units. These include not only short-run maximization at long-run costs, but also highly variable interpretation of long-run trends. For example, as of 1960, the growth rate of the American economy could be anywhere from 2.0 percent per annum to 4.7 percent per annum, depending upon one’s arbitrary choice of the base year from which to begin counting.²⁶ The growth rate of the American economy was a major political issue in that year’s presidential election campaign, and the high cost of voter knowledge was therefore of major potential political impact. Since the “normal” growth rate had been about 3 percent, economic growth under the incumbent administration was either above or below normal, depending on the year from which the counting began. Nor was this a peculiarity of 1960: for the previous presidential election year (1956) the corresponding range of growth rates would have been from 2.1 percent to 5.1 percent depending on the arbitrary choice of base year, and for the election year before that (1952) the possible range was from 1.3 percent to 5.3 percent.²⁷ Any of these administrations could have been either a great success or a great failure by this criterion, depending upon the arbitrary choice of temporal units. Internationally, the Soviet government has long impressed many people around the world with Russian economic growth rates based on 1926 as a base year, when the same statistics would have translated into far lower growth rates if 1913 had been chosen instead. Considering the enduring world-wide comparison of Soviet type systems with Western and other alternative systems, the high cost of temporal knowledge can have very weighty consequences for mankind.

Political, and especially legal, decision making tends toward categorical rather than incremental decisions. Partly this is due to the fears engendered by the overwhelming power of government, which is allowed to function only under numerous safeguards — which is to say, numerous limitations on the discretion of individual decision makers. These fears come not only from the public subject to governmental power in a democratic system, but also from leaders — democratic or nondemocratic — who fear political repercussions from decisions made by anonymous lower level officials too numerous to monitor, as to their exercise of discretion. Numerous and relatively inflexible rules reduce the cost of monitoring, by reducing the basic question to whether or not established procedures were followed. Individual discretion may not be wholly banished as a consideration, but “a government of laws and not of men” is in part a cost saving device. Looked at another way, in a world of zero cost knowledge (omniscience), there would be no need for any rules to guide either the initial decision maker or any higher officials who might subsequently review his decision. Both the initial decision and any subsequent review of it could be in general terms of how intelligently some issue could be resolved. But initial and reviewing officials and the general public all accept some trade-off of discretionary flexibility for institutional dependability and insurance against discriminatory use of the vast powers of government. “Red tape” is an implicit premium paid for this “insurance.”

Governments can and do combine discretionary decision making and dependable rules, but neither can go to its logical extreme without destroying the other, and there are trade-offs at all points in between. Traffic is usually regulated by wholly arbitrary priorities established mechanically by traffic lights at intersections, without any regard to whether the traffic in one direction has more personally or socially justifiable reason to go first. Clearly there will be times when someone who is due at an important meeting (to himself or society) will sit waiting impatiently for the light to change while someone else who is merely out for a joyride proceeds across the intersection. Traffic laws, like all other arbitrary rules, imply such social “inefficiencies” — and imply also a decision that the costs of eliminating the “inefficiencies” too far exceed the benefits to even try. As a safety valve for extreme cases, the traffic laws themselves incorporate exceptions for emergency vehicles whose sirens convey the knowledge that an exception is about to occur. Arbitrary, categorical or “bureaucratic” rules in general cannot be criticized as wrong merely because some individual consequences are sometimes nonsensical as compared to what an intelligent and impartial person would have decided in the light of all the facts of the particular case. Neither the facts, nor intelligence, nor impartiality, are free goods. Categorical rules are a recognition of this and an attempt to economize on the resources available in the light of their costs. The case for incremental or discretionary decision making is a case for accepting the risks of discriminatory, unintelligent, or corrupt decision making. Such a case can be made in specific instances. What is important is to understand the trade-off.

POLITICAL MACHINES

Much of the history of municipal reform politics in the United States is a history of a shifting trade-off between unresponsive, bureaucratic, “good government” and corrupt political machines flexibly attuned to the general priorities and personal urgencies of the citizens. Supporters of reform movements have tended to be upper-class people with the education, experience and influence to penetrate the bureaucratic maze, while corrupt machines stayed in power by adjusting categorical rules to the needs of desparately vulnerable people who could hardly understand the language of official “good government,” much less cope with its complexities. Corrupt political machines play much the same role in politics as middlemen in economics. They were corrupt because the law sanctioned no such role, much less the personal enrichment that went with it.

In democratic countries, political machines are, among many other things, mechanisms for economizing on the cost of knowledge, and especially its effective transmission. Just as the least technically knowledgeable consumers rationally sort by brand name (including franchises), rather than attempt finer sorting by detailed product characteristics which they are not qualified to judge before purchasing, so those less politically knowledgeable vote for or against the political machine according to their perception of its performance, rather than rely on their knowledge of specific candidates and issues. This provides an incentive for political “bosses,” with greater knowledge of individual office holders and specific issues, to monitor both in such a way as to maximize the long run public acceptance of the machine, just as name brand products manufacturers or franchising organizations have an incentive to engage in quality control as surrogates for consumers who lack their special knowledge.

In none of these cases does quality control imply perfect quality, nor is it clear that it would be socially optimal to seek maximum product quality (or even minimum variation in quality) rather than optimum product quality variation in view of costs. Political machines are particularly liable to financial corruption, to varying degrees — especially when representing constituencies to whom such corruption is less shocking than it is to social critics or to classes who would not be attracted to a machine in any case. Quality control is not according to some abstract ideal, but according to those qualities actually valued by the relevant constituency.

The particular era of machine politics domination, and the social classes and ethnic groups to whom they appealed, all highlight the high knowledge cost of its alternative — “rational” or bureaucratic “good government.” Political machines were at their peak from about the middle of the nineteenth century to the middle of the twentieth century — at a time when ethnic (including religious) divisiveness among voters made public trust difficult, when few of the ethnic minorities had the leisure, the education, or sometimes even the knowledge of English to cope with the organs of government that vitally affected their daily lives. Police protection, garbage collection, schooling for their children, and many other governmental responsibilities were in the hands of people and organizations that were incomprehensible, uncontrollable, and often openly contemptuous of the unwashed, polyglot populations of many large cities. The cost of transmitting these latter groups’ knowledge of consequences effectively to decision-making points through the formal political and bureaucratic maze was far higher than the cost of centering attention and loyalty on some political “boss” who could override, circumvent, or otherwise “corrupt” the formal processes to get done what had to be done. Very often these political bosses literally spoke their language, and made it their business to understand intimately their constituents’ lives, and the things that were important and unimportant to them. By contrast, reform or “good government” political leaders were usually distant, aloof, prosperous Anglo-Saxons who knew little about the cultural mosaic of the big city slums except that it was foreign and therefore “wrong.” In short, reform or “good government” politicians were largely ineffective as conduits for the knowledge of governmental impact on the lives of the kind of people who turned to political machines. It was not simply that the masses were “ignorant” and “misled” as the reformers tended to view it. Being ignorant and therefore subject to misleading might imply much random political behavior, but not the overwhelming loyalty to one political machine that characterized immigrant ghettos. The value of these political machines to culturally bewildered and economically desperate people is only underscored by the financial corruption of machine politicians, who were re-elected by voters generally well aware of these illegalities.

The social composition of the supporters and opponents of political machines suggests another important trade-off: between the comprehensiveness of the law and its comprehensibility to the public. The more thoroughly and specifically law attempts to cover contingencies, the more complex the law becomes and the less understood it is. Since law is intended not merely to retrospectively judge behavior but to prospectively guide it, it fails in this latter — and larger — function to the extent that the public cannot figure out what the law expects or requires of them.

The optimal mixture of comprehensiveness and comprehensibility for the more affluent and more educated classes obviously involves more complexity than the optimal mixture from the standpoint of those with simpler financial arrangements and less training in verbal complexities of the sort found in laws and legal documents. The trade-off tends to be biased toward complexity, not only by the greater influence of the affluent, but also by the rationalistic assumption that more (or more precise) articulation is “a good thing” — without regard to diminishing and negative returns. But the failure of the law to explicitly cover contingencies does not imply greater uncertainty, chaos, or litigation. Those with more complex affairs can produce their own contractual complexities within the framework of simple general law. There is a social trade-off between legal complexities produced at public expense and those produced at private expense.

BUREAUCRACIES

Political decision making tends toward the categorical in another sense as well. Specific governmental organizations do not simply administer to some generalized well-being of the public, as various social or economic units are free to do. That is, nongovernmental units are usually free to determine their own respective degrees of specialization, and to change these over time as they see fit. Wells Fargo used to run the “pony express,” but now they have abandoned this and conduct more or less conventional banking activities instead. A baby food manufacturer may diversify its activities to include life insurance, and a bowling equipment manufacturer can produce motor vehicles as well. A typical mother changes her whole routine and role several times as a child proceeds from infancy to adulthood. By contrast, a governmental agency has a specific set of assigned activities to pursue, rather than a general goal to maximize, such as profit making or family well-being. Governmental agencies are generally authorized to carry on processes rather than to achieve results. If the postal officials were to become convinced that communications could be vastly improved by a large-scale shift from the use of letters to the use of telephones, telegraph, and various forms of person-to-person radios, it would still have no authority to use the money at its disposal to subsidize these latter activities instead of carrying the mail. If there were a government baby food producing agency, it could not decide on its own that a point had been reached at which some of its money should be incrementally redirected toward life insurance, as Gerbers has done; a government photographic agency could not decide to produce raincoats, as Eastman Kodak has done.

Given categorical mandates and the law of diminishing returns, it is virtually inevitable that governmental agencies would eventually end up doing things which seem irrational as isolated decisions. The aggrandizement familiar in all kinds of human activities — from the dressing of babies to the spread of multinational corporations — applies as well to governmental agencies. But where other expansions are constrained not only by budget limits but also by incremental returns from other lines of activity, governmental agencies with mandated activities have every incentive to push those particular activities as far as politically possible — even into regions of negative returns to society. This is especially apparent in preventive activities, designed to contain various evils. As those evils are successively reduced, either by the agency’s own activity or by other technological or social developments, the agency must then apply more activity per residual unit of evil, just in order to maintain its current employment and appropriations level. If the agency is supposed to fight discrimination against minorities, it must successively expand its concept of what constitutes “discrimination” and what constitutes a “minority.” Urgent tasks such a securing basic civil rights for blacks ultimately give way to activities designed to get equal numbers of cheerleaders for girls’ high school athletic teams.²⁸ A nongovernmental organization, such as the March of Dimes, could — as it did, after conquering polio — turn its attention to other serious diseases, but if it had a government mandate strictly limited to polio, it would have little choice but to continue into such activities as writing the history of polio, collecting old polio posters, etc., while children were still dying from birth defects or other maladies. The point here is not that the leaders of the March of Dimes were either more intelligent or morally superior to the leaders of government agencies. The point is that a non-governmental organization subject to feedback from donors or customers has incentives and constraints that lead to institutional decisions more attuned to rational social trade-offs.

More diversified government agencies — such as the Department of Health, Education, and Welfare — have opportunities to change the internal mixture of its activities in response to changing social priorities, but only to the extent that the HEW leadership is in a position to impose agency-wide considerations on the “warring principalities” under its nominal control. By the same token, private organizations supported by a narrow constituency — such as the NAACP Legal Defense Fund supported by affluent white liberals²⁹ — may pursue certain activities well into the region of diminishing returns from the viewpoint of its ostensible beneficiaries (blacks) or the society at large, however important its historic mission may have been in the past. In short, it is not the political versus the private control of organizations which is crucial. It is the scope of the organization’s mandate, and what that implies about its likelihood of pursuing some activity past the point of negative social returns. The safeguards required for the use of massive government power and huge sums of government money often confine the decision makers’ discretion to a given line of activity and contain numerous rules within that activity. Moreover, because taxpayers cannot monitor numerous government agencies the way donors, customers, or family members monitor fewer and closer activities, the feedback to nongovernmental organizations is usually faster and more effective in diverting their efforts into new areas as the most urgent needs in the original area are met.

Bureaucracies, by definition, are controlled by administrative or political decisions, not by incentives and constraints communicated through market price fluctuations.³⁰ While an ordinary business enterprise is constrained to keep its costs of production below the value of the output to the consumer — and has incentives to keep it as far below as possible — such incentives and constraints are not merely absent in a bureaucracy but are replaced by other incentives and constraints tending in the opposite direction. The rank and pay of a bureaucrat is determined by his degree of “responsibility” — in categories documentable to third parties judging a process rather than a result. He is paid by how many people he manages and how much money he administers. Overstaffing, “needless” paperwork, and “unnecessary” delays may be such only relative to social purposes — not relative to the incentives established. Every “needless” employee is a reason for his superior to get a higher salary; so is every “wasted” expenditure, and every “unnecessary” delay preserves someone’s job. The more “channels” the citizen has to go through, the more work is generated for the organization. For a bureaucrat assigned a given task (result), the incentive is to require as many people and as much money as possible to achieve that result. What is politically possible depends upon how visible his costs are, not their magnitude in relation to the value of the result. Moreover, the bureaucracy can expand the demand for its services by simply pricing them below cost. There is no such thing as an objective quantifiable “need” for anything. When the price is lower, a larger quantity is demanded. Profit-and-loss constraints mean that a private business can expand its sales this way only as long as its price covers its costs of production. A government bureaucracy, which can dispense its goods or services below cost — including at zero price, in some cases — can always demonstrate a large “need” for its output, and therefore a “justification” for a large staff and budget.

It has been claimed that bureaucratization in general cannot proceed to lengths that are counterproductive, either in terms of organizational efficiency or their limitations on individual freedom, in a democratic country. Otherwise, a “bureaucracy-wrecking” party could be elected,³¹ with the support of “every citizen who believed he was paying more to support wasteful bureaus than he was receiving from those minorities-serving bureaus that benefitted him directly.”³² This would be true if knowledge were costless. But one cannot destroy “bureaucracy” in general, but only specific and highly disparate bureaucracies. If government is not a zero sum game, there may be substantial benefits to avoiding anarchy, and these benefits shield specific inefficiency from a broad axe attack on government bureaus. More narrowly, each bureau’s activities may produce some benefit, even if some bureaus as a whole produce no net benefits. For a citizen attack on wasteful bureaus to succeed requires knowledge of the point at which benefit turns to waste or counterproductive activity. Even the most bitter critic of the Food and Drug Administration’s policies retarding the introduction of lifesaving drugs may hesitate to destroy the whole agency and allow all kinds of poisons to find their way into our food and water supply. As long as bureaucratic waste or restriction stays within broad limits, and shields itself from specific detection, it may persist indefinitely despite its incremental costs exceeding its incremental benefits — as the voters would judge these, if they knew. The contrary view is a special case of the democratic fallacy, which equates market decision making under explicit cost constraints expressed in price tags with vote casting on the basis of plausibility and with high knowledge costs per voter.

INSTITUTIONAL CHANGES

The difference between incremental and categorical decision making has implications not only for the location of given kinds of decisions inside or outside government; it has implications for how and where government decisions can most effectively be located. Periodic campaigns to “reform” or “streamline” the government bureaucracy under some “rational” plan to “end duplication” look very different within this framework. Duplication, for example, means that similar processes or results in a given field are obtainable through different organizations, usually located within larger and more diversified organizations with ostensibly differing purposes. The Veteran’s Administration and the Public Health Service both operate hospitals, for example. Often this means that a given citizen has the choice of where to go with the same problem, whether that problem be consumer fraud, antitrust violations, or cases of racial discrimination. When duplication means individual choice, a set of unpaid “unmonitored monitors” has been created, able to effectively constrain the behavior of each agency with the implicit threat of going to some other agency if the same service is not provided as well. The economies of scale that might (or might not) result from consolidating the activity must be weighed against the higher costs or lower quality that are apt to result when monitors become a captive audience for a government monopoly instead. Moreover, the location of similar activities within a variety of conglomerate government organizations means that the phasing out of the activity becomes more feasible within a decision making unit that has other activities which can absorb the people and the appropriations. A more rationalistic plan of gathering all like activities into an agency devoted solely to that activity means in fact creating incentives to keep that activity alive as long as possible and to pursue it as far as possible, with little or no regard for social costs and benefits. The costs of duplication at a given time must be weighed against these longer run costs of consolidation.

Political decision making tends to be categorical rather than incremental in another sense as well. The programs of government officials or political candidates tend to be expressed in categorical rather than incremental terms. The lifeblood of politics is popular emotion, and categorical declarations capture that emotion. No one is going to man the barricades for a little more of A and a little less of B. Nor are they even likely to ring door bells on cold election nights for such incremental considerations. Therefore political activity — whatever its substantive or ideological content — has built-in incentives for categorical presentation of alternatives. The competition among political groups does not therefore bring to bear more accurate knowledge, as in economic competition, but promotes exaggerated hopes and fears — and sometimes deeds. Nor is this a transient pre-election phenomenon. Once such categorical exaggerations have been set in motion, they become incentives and constraints on subsequent policy making, in even the most totalitarian regimes. The press in a free country is to some extent a constraint on the categorical rhetoric of politics in government, but the selling of newspapers to subscribers and news programs to advertisers also depends on maintaining a certain level of public excitement which is also promoted by categorical clashes. There is little incentive for any institution to promote an incremental approach to political decision making.

The government tends to categorical decision making not only because of the incentives it faces but also because of the incentives it creates for those outside government. By conferring a valuable right on some group at the expense of some other group(s), the government provides an incentive for expensive, internecine struggles to be the group that receives rather than gives. Naked group struggles, openly recognized as such, would provide the basis for incremental adjustments of competing claims. But in order to get more public toleration for private interest, the dispute is verbally or ideologically transformed into a clash of principles — which must then be resolved categorically. All-or-nothing decisions raise the stakes, and the resources devoted to being the winner, and lower the probability of a socially optimal result from this socially disruptive process.

There is clearly some optimal level of change and of the divisiveness that accompanies it. With everyone paralyzed by fear of divisiveness, no change would ever have taken place — politically, economically, or socially — and we would all be still living in the caves. But if every change immediately set off new struggles to change that change, the relative merits of each of the successive states might mean less than the incessant turmoil. Whatever the optimal rate of change for a given political entity as a whole, that optimal rate for a given political practitioner or party is likely to be greater, since he can gain as the ostensible champion of whatever group he selects or creates by his divisiveness.