The following wonky rumination is written largely as an exercise for me to sharpen and deepen my thoughts on a matter about which there is a great deal of confusion and sloppy thinking, even among professional economists. In the following (which is beneath the fold) I repeat some points that I’ve made elsewhere.
On page 57 of the 1976 volume 2 of his Law, Legislation, and Liberty – a volume subtitled The Mirage of Social Justice – F.A. Hayek wrote (emphasis added):
[W]ithin a spontaneous order the use of coercion can be justified only where this is necessary to secure the private domain of the individual against interference by others, but … coercion should not be used to interfere in that private sphere where this is not necessary to protect others. Law serves a social order, i.e. the relations between individuals, and actions which affect nobody but the individuals who perform them ought not be subject to the control of law….
Libertarians and classical-liberals will read this passage – which is a restatement of a main point of John Stuart Mill’s 1859 On Liberty – and nod their heads in agreement. I, too, so nod my head.
But Progressives (and others who are especially skeptical of individuals constrained in their actions only by why Hayek calls “the rules of just conduct”) will insist that Hayek’s point has almost no real-world relevance. Specifically, Progressives will claim that Hayek’s statement refers to a set of actions so small as to be insignificant. Actions which affect nobody but the individuals who perform them are very rare. These actions include such choices as the color of your underwear, the color of the walls of your clothes closets, and the names you give to your pets. Beyond these choices and a handful of similarly insignificant ones, every choice you make affects somebody – and usually several somebodies, most of whom are strangers – beyond yourself.
This fact about the vast majority of human actions is a key lever used by Progressives and other statists to justify collective micromanagement of individual choices.
How should the classical liberal, the libertarian, and the free-market conservative respond? The answer, I think, is to clarify and nail down the meaning of the phrase “affect nobody but the individuals who perform them.” If this phrase is read as referring to individual physical, economic, or psychological consequences, then Progressives have a strong point. But if this phrase is read instead as referring to the rules of social engagement that each person in the society reasonably expects to guide his or her and other individuals’ actions, then Progressives’ attempt to render Hayek’s point irrelevant fails.
After having purchased apples from Jones for ten years, Smith suddenly stops buying Jones’s apples and starts purchasing apples instead from Williams. Smith’s action clearly affects somebody other than the individual who performed it; Smith’s action affects Jones, and negatively so.
The typical economist – doing what economists call “welfare analysis” – does not deny that Smith’s choice negatively affects Jones. Indeed, the typical economist describes Smith’s action as imposing on Jones a “negative externality.” But, adds this economist quickly, this negative externality is “pecuniary” rather than “technological.” No real resources are directly destroyed, altered, or interfered with. This externality is transmitted through the price system. And as a matter of policy this externality is acceptable because it is offset – indeed, almost certainly more than offset – by the positive pecuniary externality enjoyed by Williams (who, as a result of Smith’s choice, sells more apples).
Using what economists call the Kaldor-Hicks-Scitovsky criterion, because Williams and Smith could still be left better off as a result of Smith’s decision by fully compensating Jones’s for her loss, pecuniary externalities are ones that government has no need to prevent. Even if (as is nearly always the case) Jones in fact receives from Smith and Williams no compensation for her loss, the fact that society as a whole is made wealthier as a result of Smith’s decision means that there’s no need for government intervention.
At this point economists start talking about real-world markets being incomplete and imperfect, and note – sometimes with ‘tisk-tisking’ – that in such a world there is no guarantee that actions that create pecuniary externalities do not make society as a whole poorer. Pecuniary externalities thus are rendered by real-world ‘imperfections’ into something akin to technological externalities. At least in principle, therefore, in this imperfect world of ours the case for government intervention to prevent pecuniary externalities might be as strong as is the case for government intervention to prevent technological externalities.
But deep problems infect this conventional manner of thinking about so-called “externalities.” They are a phantom of abstract modeling done by economists with too little appreciation of the role played in reality by rules, expectation, and the law of property, contract, and tort.
My point is easy to see using the apple example.
When Jones chose to set up shop as an apple merchant, she – who we must presume to be a reasonable person in modern commercial society – knew from the start that she might not ever get enough customers to enable her to remain in that line of work. She knew also that, even if she does get enough customers to remain in that line of work, she might in the future lose so many of these customers as to cause her to get out of that line of work. In short, from the start Jones anticipated – or, as a reasonable person, should have anticipated – the prospect of losing customers.
Among the rules to which Jones agreed, if only implicitly, was that she is free to compete for customers and so too are other merchants free to do the same. Said differently, among the rules to which Jones agreed is that her freedom to compete for customers is combined with customers’ freedom to choose to accept or to reject her offers. And given that these rules prevail, Jones’s expectations must reasonably be assumed to be in accord with them.
Smith’s decision to buy fewer apples from Jones did not change the rules to which Jones agreed. In this sense Smith’s decision is strictly personal. In this sense, Smith’s decision did not affect Jones, for it did not affect the rules under which Jones conducts her affairs. The possibility of losing Smith’s patronage, having been known by Jones from the start, did not affect Jones when judged from the ex ante perspective. Such a possibility, having always been present and part of Jones’s reasonable expectations, simply materialized. Its prospect having been present from the start, Smith’s decision can reasonably be said not to affect Jones.
At this stage a distinction much-used by James Buchanan becomes helpful. The distinction is choosing moves within a given set of rules versus choosing among different rules. (Buchanan’s labels here were, respectively, “post-constitutional decision-making” and “constitutional decision-making.”)
For example, given the existing rules of the National Football League, teams that score touchdowns usually choose to kick the ball through the goalposts for one “extra point” rather than try to run or pass the ball across the goal line for two “extra points.” The reason is that the odds of a successful kick are much higher than are the odds of a successful attempt at a two-point conversion. Buchanan would note that the team that chooses between a one-point or a two-point conversion attempt makes a decision that affects it – that is, that team – but does not affect the rules of the game. This team’s decision, whatever it might be in a particular circumstance, while obviously affecting the opposing team in a literal sense, does not affect the opposing team in any way that can be said to have wronged it or denied it of any interest to which it had a legitimate claim. The touchdown-scoring team’s extra-point decision is thus, in this sense, a purely personal one.
Back now to the apple-market example. Smith might change the rules that he personally chooses to follow as guides for his behavior as a consumer. That’s Smith’s business and Smith’s business alone. But as long as Smith plays by the rules prevailing in the market, any change in his conduct as a consumer is purely personal.
I note in closing that in the indented quotation near the start of this rumination, Hayek describes law as governing “the relations between individuals.” Most people will rightly find this description, at least as far as it goes, to be unobjectionable. Yet to play this governing role well, law certainly need not ensure against any individual ever being put by the actions of other individuals into a materially worse position – or, as economists would say, into a position yielding less utility than was yielded before.
What the law in any free society in fact regards as the interests of an individual to be protected is not synonymous with that individual’s “utility function.” A person does not obtain a property right in levels of aspired-to utility. Nor does a person obtain a property right in levels of achieved utility. More prosaically, the law protects an individual’s right to pursue happiness and not to obtain happiness or to maintain, without risk of decrement, any level of happiness once obtained.