Why Friedman, Schwartz and Hamilton were wrong about October 1931. (1931, pt. 3 of 4)

First a few interesting links:

1.  Adam Smith did favor laissez-faire.

Mark Thoma recently linked to a Gavin Kennedy post that argued Adam Smith did not favor laissez-faire.  I don’t agree.  The evidence cited was a one page list of government interventions that Smith favored.  The US, by contrast, has enough government interventions to fill a New York City phone book, if not a small library.  And the US is regarded by the Europeans as “unbridled capitalism.”  Even Hong Kong intervenes in far more ways than Adam Smith contemplated.   Of course Smith was not an anarchist, he did favor some government intervention in the economy.  But relative to any real world economy, his policies views were extremely laissez-faire. 

I see this as a common cognitive bias.  The Gavin Kennedy list posted by Thoma certainly looks impressive, but when you think more deeply about the issue it is a trivial set of policies.   I’m reminded of what happens when I discuss Singapore, which usually ranks number two in the world in lists of economic freedom.  People will often respond by telling me about all the ways the Singapore government intervenes.  My response is “so what?”  They could intervene in a 1000 different ways and still be vastly more laissez-faire than the US government.  Laissez-faire is a relative concept, and always has been.  I’ve read The Wealth of Nations, and Adam Smith is clearly a pragmatic libertarian.

2.  Tim Duy nails the Fed:

I also discovered this link in Thoma’s blog.  Worth reading.

3.  The FT says fiscal policy won’t work, try raising NGDP instead.

But they don’t tell us how to raise NGDP.  If fiscal policy is off the table, are there any other suggestions?

4.  Better 13 months too late, than never.

President Obama may finally be getting around to filling the three vacancies at the Board of Governors.  This would give him a majority in setting interest rates.  (Note, the FOMC may be less important in the future.  The interest rate paid on bank reserves will be the new policy tool, and it will be set by the Board, not the FOMC.)

Thanks to JimP for both the 3rd and 4th links.  Here’s a new view of what went wrong in October 1931.  (Not that new, I published it in the 1990s.)

5.f  The First Dollar Panic

           It is not particularly surprising that the Dow declined by less than one percent on September 21st, the averages had already declined 8.2 percent over the previous two days in apparent anticipation of the British devaluation.[1]  What was surprising, however, was the 25.4 percent plunge in the Dow between September 23 and October 5, 1931.  Although theory suggests that asset prices should respond immediately to news, the extraordinary rapidity of this decline, and its close proximity to the British devaluation, makes it unlikely that the two events were completely unrelated.

[1]  This decline was presumably due to the perception that the British devaluation would force countries remaining on the gold standard to adopt more contractionary monetary policies.

The 7.1 percent drop in the Dow on September 24, 1931 was the tenth largest decline in history, and on the following day the NYTheadline announced “Sales Of Gold Upset Money Market Here; Stock Prices Break”.  Is there a plausible link between the gold outflow and the decline in the Dow?  We have already seen that gold flows, by themselves, provide no information regarding the stance of world monetary policy under an international gold standard.  A gold flow from the U.S. to France could be caused either by a reduction in the U.S. gold ratio (i.e. an expansionary policy in the U.S.), or an increase in France’s gold ratio, (a contractionary policy in France.)

We now know that the late-1931 gold flows were associated with sharp increases in the gold ratios of the gold bloc countries, as world monetary policy tightened sharply after the British devaluation.  The subsequent increases in the U.S. discount rate were merely the symptom of this tightening.  If one views the behavior of (the gold bloc) central banks in terms of a profit-maximizing model where low nominal interest rates and fears of subsequent devaluations lead central banks to sell foreign assets for gold, then the dollar crisis should have been fully discounted by September 21st.  Alternatively, if the markets viewed the interwar central banks as having some ability to cooperate in the pursuance of other goals such as macroeconomic stability, then it is not surprising that Wall Street apparently failed to immediately anticipate all of the repercussions associated with of the British decision to devalue the pound.

The increasing maldistribution of gold (i.e. rising gold reserve ratio) was not the only fallout from the German and British crises.  A number of other countries followed Britain’s lead in leaving the gold standard, and during the fall of 1931 there were fears that the U.S. might do the same.  This climate of uncertainty led to an increase in the private hoarding of gold, and the world monetary gold stock declined in July, September, and October 1931.[1]  Private gold hoarding provides a second mechanism by which the German and British currency crises depressed aggregate demand throughout the world.

Einzig (1937) reports weekly forward exchange rate data for six currencies. The dollar/pound exchange rate shows the dollar slipping from a premium to a discount against the pound during October 1931.  Unfortunately, Einzig does not report forward data for the U.S. dollar price of gold.  However there was no realistic prospect of a revaluation in the gold bloc currencies, and thus we can use the forward premium on the French franc (and three-way arbitrage) to estimate a lower bound for the discount of the forward dollar against gold.  Using this procedure, the U.S. dollar sold at a forward discount against the franc throughout October 1931, with the three month forward discount peaking at close to 2 percent on October 17.

[1]  There had been no monthly declines during 1930, or during the first half of 1931.

One problem with forward exchange rate data is that it provides no information regarding fears of a devaluation occurring more than three months into the future.  Long-term bond prices can provide some indication of investor perceptions about the long run soundness of the dollar.  Friedman and Schwartz (p. 319) note that the prices of long-term U.S. Treasury bonds declined sharply during the final quarter of 1931.  They indicate that some observers attributed this decline to fears of huge budget deficits produced by radical Congressional spending bills, but then argue that a more likely explanation is that banking difficulties led banks to sell bonds in order to accumulate excess reserves.  One problem with Friedman and Schwartz’s hypothesis is that the price of French government bonds (also payable in gold) did not decline substantially during this period.  Thus, their hypothesis requires the existence of some degree of market segmentation.

An alternative hypothesis is that devaluation fears led to an increase in either the inflation premium or the default risk on U.S. Treasury bonds.[1]  We don’t know if investors did draw this distinction between U.S. and French government bonds, but subsequent events show that it would have been sensible for them to have done so.  Less than two years later the U.S. dollar was devalued, the gold clause was abrogated, and U.S. inflation did accelerate vis-a-vis French inflation.  It is also significant that the price of U.S. Treasury bonds (3% coupon, due 1951-55, henceforth ‘T-bonds’) remained remarkably stable throughout the turbulent period from September 15 through September 23, never varying by more than 2/32 of a point on any given day.  Then on September 24, the very day the heavy gold outflows began, the price of these bonds dropped from 99 15/32 to 99 3/32, the beginning of a decline that would take price below 90 by October 19, 1931.

One of the most interesting aspects of the October bear market in Treasury bonds was the contrasting reactions of the U.S. and (continental) European press.  The U.S. financial press was perplexed by the sharp decline in T-bond prices.  During earlier stages of the Depression, T-bonds had often rallied when stock, corporate bond, and commodity prices were declining.  Thus, the October 17 issue of the NYT (p. 23) noted that “the fluctuations [in T-bond prices] were as confusing as they were incomprehensible to the rational mind”.  The decline in T-bond prices could conceivably have been due to the unusual circumstance of a discount rate increase during a period of economic weakness.  But the press knew that that explanation was inadequate.  The fact that French bond prices were stable during this period indicated that there was a decline in investor perceptions of the soundness of U.S. Treasury obligations.  Rather than confront this issue head-on, an October 11 NYT headline argued that a French “Campaign of Insinuation Leads Public to Believe We Plan Wholesale Inflation”.

[1]  This would be viewed as an increase in default risk if one viewed U.S. Treasury bonds as being payable in gold, and an increase in inflation risk if one viewed the bonds as being payable in dollars.  Hamilton (1988) looks at short term T-bill yields, and comes to a similar conclusion.  Also see Wigmore (1985, pp. 215-16.)

These rumors were attributed to a lack of understanding on the part of Europeans of the American banking system in general, and in particular, to a lack of understanding of a recent policy initiative of the Hoover administration.  On October 6, 1931, President Hoover had proposed the creation of a “National Credit Corporation” to provide up to $500,000,000 in loans to ailing banks and the Dow soared 14.9 percent on the news, which was second only in size to the 15.3 percent rise after the 1933 bank holiday.  On October 8 the Dow jumped another 8.3 percent and on the following day the NYT headline reported “Further Moves Considered by Hoover, Including Federal Reserve Revision”.  Commodity prices also increased sharply during this period.[1]

Hoover’s initiative was prompted by the unprecedented amount of U.S. currency hoarding associated with the British devaluation and the subsequent  banking panic.  In just the five weeks from September 16 to October 21, the U.S. currency stock rose by nearly 10 percent.  During a period of declining prices and output, an increase of this magnitude meant a significant slowdown in currency velocity, and the money multiplier.  The situation was so tense that weekly changes in the currency stock became front page news in the NYT![2]  European rumors regarding the dollar appear to have been motivated by both the Hoover banking initiative, and also by massive gold outflows coinciding with a huge increase in the currency stock.

As with the debt moratorium, the National Credit Corporation proved to be ineffective, probably due to the mistaken assumption that the banking crises resulted merely from a lack of liquidity.  Nevertheless, the Wall Street reaction suggests that investors understood the deflationary impact of currency hoarding, and that a proposal that offered even a hope of reflation could have a major impact on real stock values.

The two discount rates increases of October 1931 are widely viewed as a major policy error by the Federal Reserve.  Hamilton (1988. p. 83) called their impact on the economy “devastating”, and Temin (p. 29) also thought that they depressed the economy.  Friedman and Schwartz (p. 317) argued that the increase “contributed to a spectacular increase in bank failures.”  Yet in contrast to the other major monetary shocks of 1931, the reaction of the stock market to the two discount rate increases was, if anything, slightly positive.[3]

[1]  In the absence of any “supply-side” news, these commodity price increases were also attributed to Hoover’s announcement.  French stock prices fell sharply.  This presumably reflects the fact that a major devaluation has an adverse affect on those nations remaining on the gold standard.

[2]  The October 30 NYT headline read “Currency Is Abated; Gold Drain Wanes”.

[3]  The first discount rate increase (from 1.5 to 2.5 percent) was announced at 3:30 P.M. on October 8th, and the Dow decreased just over one percent on the following day.  A week later, the Dow actually increased 3.8 percent after an additional one percentage point increase in the discount rate.

One explanation for this non-reaction is that investors did not view the discount rate as an important policy indicator.  Yet the two previous increases in the discount rate (on July 11, 1928 and August 8, 1929) were associated with major stock market declines.  Another possible explanation is that the increases in the discount rate were anticipated, particularly in light of the ongoing gold outflow.[1]  The October 16th NYT (p. 1) did indicate that investors were anticipating a discount rate increase, but also indicated that although the stock exchange was closed, in the over-the-counter market “bank stocks went soaring after the news was flashed at 3:30”, a clear indication that the increase was at least partially unexpected and/or larger that anticipated.  And the yields on short-term T-bills and T-notes jumped sharply on the day after each of the discount rate increases, another indication that the increases were partially unexpected.[2]

When viewed from the perspective of Bernanke’s “multiple monetary equilibria” hypothesis, the market reaction to the discount rate increases is not surprising.  Investors may have realized that during this tense period the expansionary impact (on the gold ratio) of a low discount rate would be more than offset by the contractionary effects stemming from a loss of confidence in the dollar, which could have led to more gold hoarding.  In any event, the discount rate increases were successful in restoring confidence in the dollar, and after October 1931 there was a modest reduction in currency and gold hoarding.  Stock prices rose significantly during early November.[3]

The various market responses to different types of monetary policy news suggest that investors focused on areas where policy discretion could make a meaningful difference.  Although Hoover’s banking initiative was not successful, the subsequent impact of the Federal Deposit Insurance Corporation shows that the potential existed for banking reforms to influence the level of currency hoarding.  And the sharp increase in the gold reserve ratio within the gold bloc represented a discretionary policy choice for these gold-rich nations.  Conversely, proposals that the Fed engage in modest open market purchases; were viewed as being even less feasible than had been the case prior to the British devaluation.[4]

[1] French officials pressured the U.S. take steps to restore confidence in the dollar.  In return, the French agreed to repatriate their gold holdings at a measured pace.

[2]  The yield on T-notes with a maturity of 3 to 9 months rose from a range of .76 to 1.15 percent on October 8th, to between 1.66 and 2.08 percent on October 9th.  The yields then increased from a range of 1.86 to 2.23 percent on October 15th to between 2.26 and 2.81 percent on October 16th.

[3]Wigmore (1985, p. 217) is one of the few to dissent from the standard view, arguing that monetary policy was loose during this period.  Despite the large gain in stock prices, I wouldn’t go that far.  The Fed had two options (tight money or a run on the dollar); neither option was very appealing and neither would have meant policy was expansionary.

[4]  The November 7, 1931 issue of the CFC (p. 3029) discusses a proposal by Irving Fisher for more open market purchases to boost the economy.

Along with the various international monetary crises, the political situation during October 1931 was disturbed by the onset of the Sino-Japanese war and by Nazi agitation in Germany.  In addition, currency realignments were leading many nations to impose retaliatory tariffs, further reducing the prospects of international monetary cooperation.[1]  Even proponents of cooperation such as Gustav Cassel felt that it was now too late for an institution such as the BIS to coordinate an expansionary monetary policy.[2]  Paul Einzig argued that following the international monetary crisis of 1931 central bankers had not acted as autonomous economic policymakers, but rather had substituted gold for foreign exchange reserves much as “ignorant and illiterate depositors do in times of panic.”[3]

5.g  More Problems in Germany

Equations 7 and 8 from Table 5 show that movements in the price of YPBs continued to be strongly correlated with the Dow during the final three months of 1931.  The October 17th CFCnoted that problems in Germany were depressing U.S. stock prices on October 13, 14, and 15.  Less clear, however, is the mechanism which was continuing to link these two markets.  The financial press suggested that Wall Street was concerned about the large quantity of short-term credits that U.S. banks had extended to German firms and municipalities.  Many of these credits were frozen by a “standstill agreement” in the wake of the German exchange crisis of July 1931.  Because these credits were dollar denominated, a major German devaluation would have greatly increased the debts in mark terms, and almost certainly would have led to widespread defaults.  This may explain why the price of YPBs declined so sharply during the British exchange crisis of September 18-19.  Many European nations immediately followed Britain off the gold standard, and investors were naturally concerned that German would be the next “domino” to fall.

By November 7, 1931, the YPBs had regained all of the ground lost between September 23 and October 6, and two days later, the Dow also regained its September 23 peak.  Then, between November 9 and December 17 the Dow fell by nearly 37 percent, and from November 7 to December 17 the price of YPBs plunged by more than 48 percent, both reaching their yearly low on the same day.

[1]  Those who would argue that the higher tariffs, rather than monetary shocks, can explain the 1931 stock market decline must contend with the fact the British stock prices rose sharply following the devaluation, despite the fact that Britain now faced higher tariff barriers on the continent.

[2]  Cassel (1936) blamed the depression on the hoarding of gold by the U.S. and France.

[3]  Einzig (1933, p. 14.)  Hawtrey expressed similar views.

During mid-November a number of NYTreports indicated that Wall Street was continuing to be affected by the reparations dilemma and/or the deteriorating situation in Germany.  The new British tariffs were hurting German exports, and Germany was again requesting a reduction in its war debts.  On November 27, the price of YPBs fell 3.9 percent in reaction to an uncompromising speech by French Premier Laval.[1]  The Dow fell 2.8 percent.

During December 1931, five months after the German exchange crisis began, German news was still dominating the front page of the NYT.  On December 4, the price of YPBs declined 8.5 percent and the Dow dropped 3.3 percent.  The following day the NYT (p. eight) reported that “Bank Stocks Break on German Rumor” (that the gold standard would be abandoned.)  On December 5, the price of YPBs jumped 17.6 percent, the Dow rose 3.9 percent, and the next day’s NYT (p. 14N) noted that “Traders took heart on the news that the slogan of the Hitler party will be: ‘private debts – yes; reparations – no!'”.

Several December 11th headlines in the NYT reported another major initiative by President Hoover: “Hoover Wants War Debt Board Revived”, and “Hoover Debt Stand Hailed in Europe”.  Unfortunately, there was a great deal of hostility to the plan in Congress, and in contrast to previous Hoover initiatives, this plan failed to boost stock prices.  The next day the NYT (p. 11N) noted that “It was pointed out yesterday that several news developments which formed the bases for substantial upturns during the last year were regarded as of paramount importance when they first made their appearance, although subsequent events showed that their significance had been greatly exaggerated.”  That is quite an understatement.

During mid-December, stocks and YPBs continued to fall as the hostility of Congress to further debt relief dominated the headlines.  Finally, on December 18, the Dow rebounded 8.9 percent and the price of YPBs jumped 14.2 percent.  The financial press attributed the dramatic (midday) rally to concurrent Congressional testimony by banking expert Thomas W. Lamont.  Lamont suggested that the German debt situation was not as serious as had been rumored, and bank stocks experienced especially impressive increases.  Of more importance, however, was the dramatic rise in the prices of industrial and railroad stocks, and commodities.  These increases suggest that the debt problems were perceived as affecting not just bank earnings, but more broadly, the entire monetary sector and thus total aggregate demand.

[1] He indicated that France would not allow private German debts to take precedence over war reparations.

Where’d that annoying smiley face come from?



35 Responses to “Why Friedman, Schwartz and Hamilton were wrong about October 1931. (1931, pt. 3 of 4)”

  1. Gravatar of david david
    5. March 2010 at 10:10

    People will often respond by telling me about all the ways the Singapore government intervenes. My response is “so what?” They could intervene in a 1000 different ways and still be vastly more laissez-faire than the US government.

    … the Singapore government outright owns 60% of its national GDP. What possible measure of “intervention” would identify this as laissez-faire?

    I mean, it is true that Singapore regulates the remaining 40% less than other countries do – and thereby gains a high position on economic freedom lists – but I submit it is already far behind on the laissez-faire count. Achieving a market-like economy by owning the most of the market and instructing it to function as such is not quite the same as a market economy.

  2. Gravatar of Lorenzo from Oz Lorenzo from Oz
    5. March 2010 at 12:44

    David: it depends a bit how it manages that 60%.

    Scott: the smiley face normally comes from have a : with a ) right next to it in the text.

    On laissez faire, the real breakthrough will be to get folk to stop describing President Hoover as either a practitioner or an advocate of laissez faire.

  3. Gravatar of scott sumner scott sumner
    5. March 2010 at 14:16

    David, The Singapore government “owns” Singapore Airlines. But Singapore Air is not protected from foreign competition (like American airlines are) and does not receive subsidies from the government. US airlines have received many billions in subsidies.

    De jure: US airlines are private and Singapore Air is nationalized.

    De facto: Singapore has a much more free market airline industry than the US does.

    In any case, my point is actually strengthened if you are right. If the second most free market economy in the world is actually pretty socialist, then Adam Smith’s policies seem even more laissez-faire by comparison.

    Lorenzo, I know about the 🙂 symbol, but it does not appear in my text in the place where the smiley face shows up in the post. Indeed it doesn’t appear anywhere in that paragraph. I can’t get rid of it.

    I agree that Hoover was far more interventionist than Harding and Coolidge. And of course even they had lots of flaws. (Didn’t both Harding and Coolidge support protectionism and prohibition?)

  4. Gravatar of Patrick R. Sullivan Patrick R. Sullivan
    5. March 2010 at 14:21

    David Friedman offers a way to evaluate Hoover’s commitment to laissez faire in the IBD:

    From 1920 to 1921, the unemployment rate increased by 6.5 percentage points and prices fell by more than 10%. Seen without the benefit of hindsight, it was obviously the beginning of a depression. Comparing the increase in unemployment and decrease in prices from 1920 to 1921 to the almost identical figures for 1930 to 1931, it was going to be a Great Depression.

    President Harding acted as President Hoover is supposed to have acted. By 1923, federal expenditure had been reduced to about half its 1920 level. The table shows the result. The unemployment rate that peaked at 11.7% in 1921 had fallen, by 1923, to 2.4%. One year of high unemployment instead of 11 years under Hoover and then Roosevelt.

    It was the Great Depression that didn’t happen.

  5. Gravatar of 123 – TheMoneyDemand 123 - TheMoneyDemand
    5. March 2010 at 17:12

    3. re FT link
    Here are some more sentences by Tim Bond not in FT excerpt that make it clear what he had in mind :
    “Obviously, the implication here is that as governments move towards spending discipline,
    overall monetary conditions need to be more stimulative than might otherwise have been
    the case. The crucial point is that government expenditure discipline and easier-thanotherwise
    monetary conditions are two side of the same coin. One cannot postulate
    spending restraint without simultaneously adjusting monetary conditions expectations in an
    easier direction.”

  6. Gravatar of david david
    5. March 2010 at 17:20

    Scott, a 2004 labor dispute between SIA and its pilots had Lee Kuan Yew himself returning to the spotlight to intervene. In the context of modern Singapore politics, this is as if Washington, Lincoln, and Jesus Christ all appeared in DC to mediate a UAW dispute. The (also state-owned) media editorialized carefully in favor of government positions, which varied at different points of the dispute. You mentioned the distinction between de facto and de jure management, but if you make your argument based on de facto management control, I think you may be overlooking the many, many other de facto ways the government then supports government-linked companies.

    Like, say, not-so-subtly implying a return to the elder Lee era of detaining troublesome labor or business leaders without trial (there are not many ways to interpret Lee announcing that “[we] are prepared as a government to go to the brink”). This is a government which doesn’t have to legislate in order to apply coercion; it already has the legislation and political tradition it needs to do so with just a verbal warning.

    True, the government often uses its powers to emulate a market outcome (or what it thinks is a market outcome; read about how it set rail and bus transport policy). The practical reasons for this are obvious; Singapore is too small to resist international market conditions. But this is explicitly the government deciding outcomes here; if the market appears to move towards an undesirable situation, the government will act to move conditions towards some other situation it prefers more (see: the ratings battle earlier in the decade between Mediacorp and SPH Mediaworks. Note that the government technically owned both but chose to mediate via other means anyway; this is indicative of how management is carried out in Singapore).

    American libertarians complain about Kelo. Singapore invokes eminent domain as national policy – the URA is de facto manager of all land – and only began to pay market rate when foreign investors complained in 1994 (this was the explicit reason given in the state media, in fact – to ease foreign investor concerns).

    In short: moving from de jure to de facto really doesn’t help your assertion that Singapore is laissez-faire, or even just more so than the US government. I venture that you hear more about the interventions from Washington more than you from Parliament House, though – so from far away all you hear are the abstract principles guiding policy rather than details of said policy. But on the ground intervention is very common.

    On Adam Smith: how do you read “pragmatic libertarian” in an advocacy of subsidizing select industries or tariff policy? I mean, the entire philosophy here is different.

  7. Gravatar of Mikko Mikko
    5. March 2010 at 22:54

    I don’t know who your target audience with the book is, but I would still like to give my comments. I consider myself an educated layman, having read some economics and being able to go through relatively heavy duty science books in various subjects (and having read quite a few ones on economics).

    That said, I find the texts quite heavy. If you are writing primarily for economists (comparison to Friedman’s and Schwarz’s book on monetary policy in US) then the heaviness may be warranted. But even then, the chapters and sections would benefit from some sort of introductory material that explains what to look for when reading through all that data.

    My two cents,

  8. Gravatar of Daniel Klein Daniel Klein
    6. March 2010 at 06:02

    On Adam Smith, I agree. There is much wrong with Kennedy’s reading and treatment of Smith.

  9. Gravatar of scott sumner scott sumner
    6. March 2010 at 07:16

    Patrick, I partly agree with that post:

    Hoover did spend much more than Harding, and the Depression was much worse under Hoover.

    But, there seems to be an implication that the extra spending under Hoover made the Depression much worse. I doubt that. Nevertheless, Keynesian fiscal stimulus doesn’t do much good.

    Keynesians would also point to Hoover’s tax increases. The problem with that argument is that Keynesians also insist that taxes have a much smaller multiplier effect than government spending. So in my view the difference between the two depressions also supports the supply-side view of high marginal tax rates. MTRs were cut under Harding, and more than doubled under Hoover.

    Of course the big difference between the two cases was monetary policy, NGDP fell much more sharply in 1929-33.

    123, Thanks, I assumed the original must have included something like that. I just thought it was weird the FT didn’t mention that point. It makes their summary appear weirdly incomplete.

    David, I think you misunderstood my argument. I did not mean to suggest that every single statement in Adam Smith’s nearly 1000 page book was consistent with most economist’s view of laissez-faire. But that’s not the issue. Here is an analogy: Most people consider North Korea to be a very hard core communist economist system. Yet there are a few private markets allowed in North Korea. Does that mean it is not a hard core communist country? Of course not.

    I’d say the same about laissez-faire. And recall that not everyone even agrees with what the term “laissez-faire’ means. Most economists who are viewed as being libertarians, such as Milton Friedman, would actually support with many of the items on the list. Friedman favored having the government guarantee property rights, and also favored government subsidies for education. I don’t know his view on patents, but many libertarians favor patents.

    Friedman would not favor subsides to textiles and weaving, but my point was that a few minor deviations from laissez-faire are trivial compared to what occurs in “capitalist” countries like the US, where 1000s of industries are subsidized by the government, not just two. Many of the items, such as fireproof walls between buildings are really of trivial importance compared to the gross distortions imposed by our current government. BTW, Friedman also favored having the US government being a monopoly producer of money, just as Adam Smith did.

    Tariffs need to be understood in context. Even people like Milton Friedman favored some sort of taxes. In those days there was no such things as income taxes, and it was very difficult to collect taxes in a non-distortionary way. Many less developed countries found it easier to collect taxes at the border. Sure, a VAT would have been more desirable in principle, but the administrative problems for doing a VAT in a fairly primitive economy were formidable.

    Regarding Singapore, I believe the government of Hong Kong also controls all the land, and HK is usually considered the most laissez-faire country in the world. I agree that there are areas where Singapore in more interventionist than the US. But overall I think they are less so. They spend about 1.2% of GDP on governemtn run health care, Whereas we spend about 8% of GDP. And the private part of US health care is far less market-oriented than in Singapore, as they rely on HSAs, whereas US tax policy herds us into inefficient insurance plans. Our tax system is massively more distortionary and interventionist than the Singapore tax system. We have far more barriers to trade and investment flows than Singapore.

    But I agree this is a judgment call. I would point out that the two free market think tanks that do systematic surveys agree with me, both the Fraser Institute and the Heritage Institute rank Singapore much more free market than the US.

    And once again, the more I am wrong about Singapore and HK, the more Adam Smith’s views look laissez-faire by comparison.

    Mikko, Thanks, that’s something I am working on in the revisions. I agree it is a problem. I should add however, that part of the problem is that I jump right into chapter 4, without including the first three chapters. These explain how to interpret the information in the narrative chapters (4-12) Nevertheless, I need to do a better job of putting in reminders about what the data means, as the narrative progresses.

    This post starts off right in the middle of the British crisis, so that might make it seem somewhat disorientating

    Daniel, Thanks. I should add that I haven’t read Kennedy’s work, and am merely commenting on the items contained in Mark Thoma’s post.

  10. Gravatar of Paul Johnson Paul Johnson
    6. March 2010 at 13:06

    I am uncomfortable with comparing Singapore to the US, UK and so forth. Their situation is so unique – not just the geography but the melding of Confucianism with British rule of law – that it’s not clear what a ranking on any scale of economic freedom means.

  11. Gravatar of 123 – TheMoneyDemand 123 - TheMoneyDemand
    6. March 2010 at 14:14

    “Thanks, I assumed the original must have included something like that. I just thought it was weird the FT didn’t mention that point. It makes their summary appear weirdly incomplete.”
    FT Alphaville is a blog, and they simply copied the first page of Tim Bond’s strategy paper, and improperly called it a summary. This is what happens when you blog 20 posts every day.

  12. Gravatar of Bill Stepp Bill Stepp
    6. March 2010 at 19:03


    Here is a good way to think about laissez faire. Read art. 1, section 8 of the U.S. Con-job-stitution.
    I call it the government monopoly clause, although it’s obviously incomplete. For instance, it doesn’t mention public education, which Smith favored. (You can’t be in favor of that and be for l-f, period.)
    If you’re in favor of any of the government functions outlined in the Con-job, you’re not in favor of l-f.
    Smith was not an advocate of l-f.
    As for MF’s view of patent, he mentioned it favorable in _Capitalism and Freedom_. He was on board as a signer of Lawrence Lessig’s brief to the SCOTUS in the _Eldred_ copyright case, but he wasn’t an advocate of abolishing copyright, as Lessig wasn’t and still isn’t. Lessig’s missive argued in favor of paring copyright’s role.
    L-F is roughly anarchy plus the constable. And I say get rid of the latter by tossing him into the nearest ditch, at least if he doesn’t agree to take his hand out of the fisc’s taxpayer-filled-up till.

  13. Gravatar of Bill Stepp Bill Stepp
    6. March 2010 at 19:04

    “favorably” for “favorable”

  14. Gravatar of pireader pireader
    6. March 2010 at 21:27

    Professor Sumner– Adam Smith did favor laissez-faire.

    In 1776, when Smith published The Wealth of Nations,the UK was the richest country in the world, with a GDP per capita of ~$2000/yr. Much (most?) of the population of ~15 million supported itself through subsistence farming. There just wasn’t much economy to intervene in.

    Today, our population is 20+ times as large, and our GDP per capita is 20+ times as high. Is the level of government intervention 400 times, or even 20 times, what it was in Smith’s advocacy?

  15. Gravatar of scott sumner scott sumner
    7. March 2010 at 09:04

    Paul, I agree that it is difficult to come up with a convincing index of economic freedom. I cited the only two indices that we have, but I’d be happy with taking an agnostic position on the issue. What I don’t accept is when people call the Singapore’s economic system “very interventionist.” My response is: Compared to what?

    123, Yeah, I agree. I was just sort of making a joke, it wasn’t intended as criticism of the FT, as I think everyone knew they meant to imply monetary policy was the way to go.

    Bill, I agree that L-F is anarchy plus the constable. My point is Smith favored something pretty close to L-F. In the real world of economics, nothing is ever completely pure.

    pireader, I’m not sure population is the right scale variable. Is the US 10 times as interventionist as Canada, 60 times as interventionist as Denmark, and 1000 times as interventionist is Iceland? Clearly not. All 4 countries have government retirement programs, incomes taxes, etc.

    I do agree that we have more complexity in our economy than they did, and I think that’s a good point. But there is nothing in the Wealth of Nations that leads me to believe Smith would favor much of the absurd government intervention that we actually have. We have an economy where people need a license to cut people’s hair, or to be an interior designer.

    And even if you are right, there is then no evidence either way, certainly not enough to claim Smith opposed laissez-faire.

  16. Gravatar of StatsGuy StatsGuy
    7. March 2010 at 19:09

    I always chuckle at people who compare HK and Singapore to the US… Both are huge ports controlling access to vast trading regions.

    Imagine if New York City was exempt from Federal Taxes (or, equivalently, received the same amount in transfers as the Federal govt. extracts in rents)… The circumstantial specifics around the rise of both nations creates a situation where the positive externalities of strong property rights (e.g. becoming a safe haven for capital) far outweigh any losses. They are the modern day equivalent of merchant prince city states – the Florence and Venice of today. Moreover, their rise was heavily subsidized (for instance, by externally funded defense) and their property rights imposed by undemocratic processes (military and/or external occupation).

    Moreover, to say that the govt. in Singapore has little influence over industry because it rarely needs to flex its muscle is precisely backwards. The fact that it rarely needs to flex its muscle demonstrates just how much power it really has.

    The economic surveys that push Singapore etc. to the top of the “liberty list” generally seem to have a particular agenda. I wonder how the following comports with Cato’s understanding of “liberty”:

    “There are strict penalties for possession and use of drugs as well as for trafficking in illegal drugs. Trafficking charges may be brought based on the quantity of illegal drugs in a subject’s possession, regardless of whether there is any proven or demonstrated intent to distribute the drugs. Convicted offenders can expect long jail sentences and heavy fines. Singapore has a mandatory death penalty for many narcotics offenses. Singapore police have the authority to compel both residents and non-residents to submit to random drug analysis and do not distinguish between drugs consumed before or after entering Singapore in applying local laws.

    Visitors should be aware of Singapore’s strict laws and penalties for a variety of actions that might not be illegal or might be considered minor offenses in the United States. These include jaywalking, littering and spitting. Singapore has a mandatory caning sentence for vandalism offenses. Caning may also be imposed for immigration violations and other offenses. Commercial disputes that may be handled as civil suits in the United States can escalate to criminal cases in Singapore and may result in heavy fines and prison sentences.

    There are no jury trials in Singapore. Judges hear cases and decide sentencing. The Government of Singapore does not provide legal assistance except in capital cases; legal assistance may be available in some other cases through the Law Society.

    There are strict penalties for those who possess or carry arms, or who commit crimes with arms. Singaporean authorities define “arm” as any firearm, air-gun, air-pistol, automatic gun, automatic pistol and any other kind of gun or pistol from which any shot, bullet or other projectiles can be discharged or from which noxious liquid, flame or fumes can be emitted, and any component part thereof. This definition also includes any bomb or grenade and any component part thereof. The unlawful possession of any arm or ammunition could result in imprisonment and caning. Any person convicted of committing a crime with an arm could receive punishment which could result in the maximum penalty of imprisonment for life and caning.

    Engaging in sexual conduct with children or using or disseminating child pornography in a foreign country is a crime, prosecutable in the United States. In Singapore, local law prohibits causing or encouraging prostitution of, or engaging in sexual relations with, a female below the age of 18. An indecent assault against anyone, male or female, regardless of age, is also prohibited. Those convicted of facilitating or abetting the prostitution of any woman or girl could be sentenced to imprisonment of up to five years and a fine or both. If the crime involves a female below the age of 16, the offender faces an additional charge carrying a possible sentence of imprisonment of up to three years and a fine or both.

    Singapore enforces strict laws pertaining to the propriety of behavior between people and the modesty of individuals. The Singaporean law “Outrage of Modesty” is defined as an assault or use of criminal force on any person intended to, or knowing it to be likely to, outrage the modesty of that person. Penalties may include imprisonment for up to two years, a fine, caning, or a combination thereof. Men are sometimes accused of inappropriately touching other people, often women, resulting in their prosecution and punishment under this Singaporean law. ”



  17. Gravatar of scott sumner scott sumner
    7. March 2010 at 19:59

    Statsguy, Yes, it is widely known that Singapore has repressive laws in a wide range of areas. I believe Cato claims they have economic freedom, not political freedom.

    Despite Singapore’s small size, the small government model they use is transferable to big countries like the US. There is no reason why we couldn’t have free trade, get rid of taxes on capital, have very low taxes on labor, have universal health coverage, etc. We simply don’t want to do it.

    As far as military spending is concerned, just because we waste 4% of GDP on the military, doesn’t mean other countries are getting a free ride. Perhaps they are wise enough to not spend so much as we are. In Singapore’s case, however, they spend as much, so they certainly are not free riding on the US.

    BTW, Before we criticize Singapore too strongly for its caning and lack of jury trials, perhaps we should recall that France also lacks jury trials. And the United States has 400,000 innocent people rotting in prison for the “crime” of using drugs. In my view we can learn a lot by looking at the best practices of other countries, even if they (like us) aren’t perfect in all respects.

  18. Gravatar of anon/portly anon/portly
    7. March 2010 at 21:13

    On Gavin Kennedy, I self-interestedly recommend this:


    (If anyone actually checks this out, the 1st and 3rd italicized paragraphs are Kennedy’s words).

    Note: sooner or later I think I can provoke belittlement with a comment on this blog also. I am oh-fer so far but I will try harder.

  19. Gravatar of mbk mbk
    8. March 2010 at 02:11

    About economic freedom index rankings, the people who compile these yearly 150+ country reports just don’t appear to go into much detail about the countries they are profiling. They seem to just take some standard statistical data and line them up in a worksheet, whether they mean the same thing in detail or not.

    Scott, what is your meaning of “interventionist” especially re: the US, besides recent crisis driven bailouts? I would define “intervention” in the economy as something more than just market distortion through taxation, though in reality this can be quite drastic too.

    I’d draw the line at direct government economic ownership or subsidy, basically, what Hayek would call “arbitrary” preferences given to one economic actor over the other. And here the US doesn’t look so bad. Yes, in some areas of economic life the US has incredibly byzantine and costly regulations that can even surpass Europe’s. EPA regulations come to mind, with the IRS not far behind. US tax codes are extremely complex. But are regulations and taxes “interventions” in that sense? They hit all actors the same (OK not all actors are equally vulnerable so they still distort). The US also subsidizes quite some directly, and differentially, but its government share of GDP is lower – thus its direct interventions must also be lower – than that/those say, of most European countries.

    Asia has yet entirely different economic structures and comparisons are especially difficult. Say Singapore, it indeed has much simpler, and clearer tax codes than the US and lower direct taxation, but higher indirect taxation on selected items such as say, cars (currently 120% of the car’s open market value in excise duty and additional registration fees). Singapore does have a goods and services tax (GST) on sales and imports, and it is not too different in level (7%) from US sales taxes, though lower than Europe’s 20% de facto VAT standard. Direct corporate subsidies in Singapore are usually limited to things such as corporate and personal skills upgrading (training programmes for employees and management for instance) although in the aftermath of the 2008 crisis there were direct salary subsidies for not firing employees (some sources claim direct government stimulus per GDP was amongst the highest worldwide post-2008 but I don’t have the reference now). In normal times the government plans up to 10-20 years ahead for specific numerical goals it intends to achieve in terms of population, land, education, and economic sectors it either wants to develop, or scale down.

    All in all it’s hard to reach a blanket conclusion about “intervention” across countries if you look at the specifics. All countries intervene in their economies, and the cliches US vs Europe vs Asia often just express different wordings, not different realities. Frankly the difference between 30+% (US) and 40+ % (most European countries) government share of GDP isn’t really a conceptual quantum leap.

  20. Gravatar of The fiscal battle heats up. Business versus …. who? « Freethinking Economist The fiscal battle heats up. Business versus …. who? « Freethinking Economist
    8. March 2010 at 03:29

    […] that nominal demand be targetted while we are still in a slump.   I am thinking in particular of Scott Sumner, who has noted this piece in FT Alphaville, calling for faster nominal growth (but not explaining […]

  21. Gravatar of scott sumner scott sumner
    8. March 2010 at 05:42

    anon/portly, I read the entire post, and I agree with you.

    mbk, I think you misunderstood my comment. I did not mean to suggest that taxes are the only way the US government regulates. There are also many barriers to entry into various industries, as well as all sorts of other regulations in industries such as banking, health care, agriculture, etc. Many industries are subsidized, and there are some price controls. Some industries are owned by the government.

    You said;

    “The US also subsidizes quite some directly, and differentially, but its government share of GDP is lower – thus its direct interventions must also be lower – than that/those say, of most European countries.”

    I agree that we intervene less than many European countries, but not necessarily for the reasons you indicate. In northern Europe you have more privatization of government services than the US (postal, airports, airport security, passenger rail, water systems, highways, Medicare, vouchers for K-12, etc.) So spending as a share of GDP is not the only variable of importance. Denmark spends a lot but otherwise is relatively laissez-faire.

    You said:

    “All in all it’s hard to reach a blanket conclusion about “intervention” across countries if you look at the specifics. All countries intervene in their economies, and the cliches US vs Europe vs Asia often just express different wordings, not different realities. Frankly the difference between 30+% (US) and 40+ % (most European countries) government share of GDP isn’t really a conceptual quantum leap.”

    I don’t disagree with this, indeed I don’t even recall talking about the government spending share of GDP in Europe. There are a few European countries where government spending is roughly at US levels. I also agree that Singapore has high taxes on cars (for externality reasons) Their overall tax burden is far lower than in the US, and their system is far simpler. I should add, however, that almost all countries have far simply tax systems than the US. In Sweden they simply send you a bill, you don’t even have to figure out your taxes.

    I have spoken highly of the Singapore payroll tax cuts on labor during recessions. This helps overcome the “sticky wage problem” and makes recessions less severe than otherwise. They can afford this as the government runs huge surpluses during normal years. This is not a demand stimulus, it is a supply-side stimulus.

  22. Gravatar of StatsGuy StatsGuy
    8. March 2010 at 08:46


    4% of GDP on defense…

    1) Singapore does, Hong Kong certainly did not.

    2) The notion that Singapore’s 4% is sufficient to provide its own defense is more than questionable. From an absolute perspective, this totals less than 10 billion dollars, and unlike the US there is no armed population to form into a “citizen militia”.

    My argument that Singapore is free-riding is based on the following assumptions. Please challenge the ones you disagree with:

    1) Singapore does not have strong mutual defense pacts
    2) Singapore is not capable of unilaterally repelling possible agressors
    3) The world is a dangerous place

    I have no doubt that there’s a lot we could learn from Singapore. Certainly, there are specific economic policies we could borrow. But I am confused about the notion that we could port Singapore’s government model…

    You state: “the small government model they use is transferable to big countries like the US.”

    My initial reaction was to disagree violently, but I realize I’m probably missing your intent. Do you have something in mind – and do you mean a specific institutional structure, or the general method by which Singaporean government has been run for the last 30 years?

    Also, generally – I’m uncertain how to reconcile many of Singapore’s policies even with “economic liberty”. For instance, the aggressive intrusion of criminal law into contract law.

    Singapore isn’t a private contract utopia. It’s an example of an efficient statist regime (exactly what many libertarians believe should be impossible).

    Indeed, you mention the payroll tax management (achieved with huge surpluses, essentially nationalized savings, which BTW are re-invested by the state-run “corporation”). This is precisely the sort of _fiscally)_ active management of the private economy that a statist would defend, and a libertarian should abhor.

    “Privatization” and “libertarian” policies seem to have far, far, far less to do with Singapore’s success than efficient and uncorrupted government, along with very long term state-managed savings/investment policies. But all CATO sees through its tinted glasses is “strong property rights”.

  23. Gravatar of ssumner ssumner
    9. March 2010 at 06:15

    Statsguy, There’s a reason why Switzerland wasn’t occupied in WWII. In an absolute sense their military was much smaller than France’s, but in a relative sense it was bigger (I think, at least in recent years it has had a formidable military.) I think that tells us something about why Singapore’s military is sufficient. (or Israel’s)

    The size of the military one needs is relative to the gains foreign countries percieve from occupying your country. With a few obvious exceptions such as oil-rich Kuwait, those gains are usually small for small countries.

    BTW, Wasn’t Singapore a member of SEATO?

    I don’t think the world as a whole is a very dangerous place any longer. Most wars are now civil wars, I doubt Singapore would be invaded even if it lacked US protection. Which country would be a plausible invader of Singapore? Kuwait was a special case, as it contains oil which could be looted. And invasion of Singapore would kill the goose that laid the golden egg.

    If the US vanished tomorrow, smaller peaceful countries would have an incentive to stop free-riding on us, and form alliances for mutual defence. For instance, even the non-US part of NATO has a vastly bigger military than any other military force on the planet. We obviously have a much bigger military than we need to protect ourselves or our allies from foreign invasion.

    You said;

    “Also, generally – I’m uncertain how to reconcile many of Singapore’s policies even with “economic liberty”. For instance, the aggressive intrusion of criminal law into contract law.
    Singapore isn’t a private contract utopia. It’s an example of an efficient statist regime (exactly what many libertarians believe should be impossible).
    Indeed, you mention the payroll tax management (achieved with huge surpluses, essentially nationalized savings, which BTW are re-invested by the state-run “corporation”). This is precisely the sort of _fiscally)_ active management of the private economy that a statist would defend, and a libertarian should abhor.”

    Why do you assume that I don’t abhor many of Singapore’s policies. Did I ever say that? I abhor lots of government policies in all countries, including the US. It’s a question of the lesser of evils. I consider forced saving to be very much the lesser of evils to high taxes. I would like to see the US adopt Singapore’s forced saving plan, and then get rid of taxes on capital, simplify our tax system, and have very low tax rates on consumption. You mention their large budget surpluses, I like that idea much better than budget deficits.

    You also act like CATO plucked their ranking out of mid-air. They rely on 10 categories, and do lots of number crunching. The Heritage Institute uses a completely different methodology, one that ranks many countries far differently than the Cato/Fraser survey. Yet they also put Singapore number two. If Singapore is such a libertarian horrorshow, as you suggest, why would two different free market think tanks rate them so highly? You’d think they’d want to adjust the formula so Singapore rated lower, so that we didn’t copy all their horribly un-libertarian policies. I just can’t see any motivation for the bias you claim here.

    Here’s what I’d like to see us adopt from Singapore:

    1. Very low government spending as a share of GDP.
    2. No taxes on capital
    3. Free trade and free capital flows
    4. Low and simple taxes on consumption.
    5. Universal health care achieved through HSAs
    6. Self-insurance against unemployment
    7. Replace social security with private accounts, fully funded.
    8. Don’t subsidize government-own companies, make them compete.
    9. High taxes on negative externalities
    10. Set the payroll tax rate at a lower level when unemployment is temporarily inflated due to sticky wages.
    11. High levels of immigration

    I would also like to see the US break up into 50 countries with an average population of 6 million, which is slightly more than Singapore.

  24. Gravatar of StatsGuy StatsGuy
    9. March 2010 at 09:27


    “There’s a reason why Switzerland wasn’t occupied in WWII. In an absolute sense their military was much smaller than France’s, but in a relative sense it was bigger (I think, at least in recent years it has had a formidable military.) I think that tells us something about why Singapore’s military is sufficient. (or Israel’s)”

    Let’s leave aside Hitler’s particular relationship with the Swiss, which is full of all sorts of conspiracy theories. Let’s focus on one simple fact: In Switzerland and Israel, the policy on gun ownership is – um, different.


    I’ve made the case for defense being cheaper than offense elsewhere, but this would require arming the citizenry. Compare the Swiss gun laws to the Singaporean gun laws. Singapore’s system was built on a high degree of top-down social control, which is anathema to a swiss system of personal firearms. This may change in the future, but that’s how Singapore emerged.


    Cato and Heritage – I don’t consider these institutions all that libertarian. There is a difference between libertarian and “pro-business”, which is exactly how Singapore prefers to describe itself.

    I certainly would love to see the US break into 50 countries, with 50 distinct currencies – among other things, I’m tired of subsidizing low income conservative areas which complain that I am paying their taxes for them. But please note that your point 11 (high levels of immigration) is absolutely different from “free immigration” or movement of people.

    Looking at that list of 11 items, and Singapore’s unique history (and leadership model), I’d suggest that Singapore is an interesting marriage between Plato and Adam Smith. I rather suspect that the only way to achieve all of those 11 items in your list would be to adopt the Singaporean political solution as a transition mechanism. That is, benevolent tyranny, and hope we get a decent tyrant.

  25. Gravatar of scott sumner scott sumner
    10. March 2010 at 09:31


    I prefer the Swiss approach to the Singapore approach, but I still think Singapore has done enough to prevent invasion, even w/o US protection. BTW, I tend not to believe conspiracy theories.

    You said;

    “Cato and Heritage – I don’t consider these institutions all that libertarian. There is a difference between libertarian and “pro-business”, which is exactly how Singapore prefers to describe itself.”

    The Cato Institute is as libertarian as you can get. As far as I know they oppose all pro-business policies that are not consistent with free markets. I don’t know much about Heritage, but my guess is that their economic views are libertarian, not pro-business. Pro-business groups like some of the old line manufacturing organizations (NAM, etc) tend to be protectionist. That’s definitely not Cato, and probably not Heritage either.

    You said;

    “Looking at that list of 11 items, and Singapore’s unique history (and leadership model), I’d suggest that Singapore is an interesting marriage between Plato and Adam Smith. I rather suspect that the only way to achieve all of those 11 items in your list would be to adopt the Singaporean political solution as a transition mechanism. That is, benevolent tyranny, and hope we get a decent tyrant.”

    The evidence suggests exactly the opposite. Democratic countries tend to have economic models more similar to Singapore than non-democratic countries. I remember in the 1970s conservatives said the free market is best, but you need someone like Pinochet to get there. Then a few years later virtually every democratic countriy in the world started privatizing, deregulating and slashing tariffs and high MTRs. We still have a long way to go, but I don’t despair about getting there under democracy. In any case, we have no choice but to try, as democracy is here to stay.

    We aren’t subsidizing the poor states quite as much as you think. It is very likely that if you had 50 different countries the tax gaps would be even larger, and the flows of highly productive labor from states like Califormia to Texas would be much larger. But I agree with your general point, that there is some subsidy, and it is undesirable. If you look at that New Yorker article on McAllen’s Medicare system, that fiasco could only exist under a federal structure. The state of Texas (if independent) would not waste so much money in that poor area.

  26. Gravatar of StatsGuy StatsGuy
    11. March 2010 at 11:37


    “democracy is here to stay”

    Um, OK. You really are an optimist.

    On Cato/Heritage. The case for Heritage being libertarian (rather than conservative) is virtually non-existent. Consider:


    The views of Heritage occasionally overlap with Libertarian ideals in the same way that the US and the Soviet Union were allies in WWII.

    You have a better case for Cato, and certainly for specific members of Cato, although the Institute very nearly lost its soul in 2004-2006 when the Republicans seemed politically dominant. Yet Cato eventually had a “come to jesus” moment. For example:


    But, note the date – November 10, 2008. It’s a little easier to break with the party in power when it’s no longer in power.

    Let me sum up by combining all of the points above into a near truism:

    “Hypocrisy is here to stay.”

  27. Gravatar of ssumner ssumner
    11. March 2010 at 12:02

    Statsguy, The Cato people were strong critics of Bush. I belong to Cato, and was constantly getting anti-Bush material in the mail from them. I have absolutely no idea about what you are talking about. They opposed virtually everything Bush did. The war in Iraq, the homeland defense stuff, NCLB, the Medicare drug bill. You name it, they opposed it. It’s hard to think of a single significant Bush measure they supported. They opposed his bailouts in 2008. They opposed him in his first year in office, and his last year in office. Around 2004-05 they were constantly sending me material complaining that spending was rising at the fastest rate since LBJ was in office. It was non-stop complaints about Bush.

    Your link to Heritage is completely irrelevant to the argument. No one disputes that Heritage is highly non-libertarian on social issues, it is the economic issues we were talking about. I see no reason to believe the Heritage is anti-market, except perhaps on social issues like drugs and prostitution. If you have the evidence, I’d like to see it.

    Am I correct in assuming that you don’t follow these groups very closely? To say the Cato Institute was non-libertarian in 2004-06 is rather bizarre. They are as close to libertarian as any group in America, and always have been.

    Regarding democracy, I am not an optimist, I am a realist. I can’t envision any other system replacing it.

  28. Gravatar of StatsGuy StatsGuy
    11. March 2010 at 16:10

    As I said, Cato is better than Heritage, but it had some uncertain moments in the Bush reign during which it was unclear which faction would win. I do think, in the end, the true libertarians won (and by 2008 this was obvious) – but it was not clear at the time this would happen. An external view:


    Heritage has a poor record of consistency even on economic liberty. Consider the Heritage case for Tort Reform. Tort Reform is essentially a process of putting legal limits on common law – on the right of individuals to exercise civil recourse. Yet Heritage strongly endorsed it, explicitly recognizing that it limited individual economic liberty, and making a utilitarian/practical argument. For example:


    I personally find utilitarian arguments compelling, but you have to admit the inconsistency. Why do SOME economic arenas (e.g. an individual’s right to sue) need sharp limits on civil rights for utilitarian reasons, but in other arenas common law is sacrosanct (even if there are very strong utilitarian reasons to intervene)? Heritage seems to pick and choose when it stands by its ideals, and these inconsistencies seem to be uncannily aligned with the Republican party.

    Go figure…

  29. Gravatar of scott sumner scott sumner
    11. March 2010 at 19:20

    Statsguy, If what you say is true then it sounds like in 2005 the Cato Institute was much more strongly opposed to the Iraq war than the Democratic Party in the US Senate. In other words, they were mostly antiwar, far to the left of the Democratic Party (which mostly supported the war.) Is that your argument? If so I agree. But it still doesn’t show the Republicans are pro-business, as I don’t see any evidence the neo-cons are motivated to support wars in order to help by corporate interests.

    I support tort reform because it helps consumers. I don’t think lawsuits hurt business very much, they just pass on the costs to consumers (that’s on average; obviously in the short run a huge lawsuit can hurt an individual business, just as taxes may be absorbed by business in the short run, but consumers in the long run.)

    I am certainly not opposed to all lawsuits. For instance, if there is a breach of contract people should be able to sue. I object to laws that prevent producers of inherently risky activities from being able to offer customers contracts that restrict the customers right to sue when things don’t go well, but there was no intentional harm done (or gross incompetence, like a drunk doctor.) I’d love to be able to sign a contract offered by my doctor, or a ski slope, promising not to sue. Why do I wish I could sign such a contract? Because it would allow me to buy the service at a lower cost. And I have no interest in suing. And I hate preventive medicine, which is often wasteful and harmful. But under our system those sorts of contracts are mostly unenforceable. There’s your real restriction on economic freedom. Our out of control legal system is itself a product of bad government regulations.

    The real problem on the right isn’t the think tanks, which are dominated by idealistic individuals, it’s the Republicans in Congress. There is your pro-business right-wingers who oppose free markets. Over at Econlog there was a recent post pointing out that one of the bloggers (Kling I think) said he found more support for abolishing Fannie and Freddie at a left wing conference he visited, than among Republicans in Congress. There’s the real problem.

  30. Gravatar of StatsGuy StatsGuy
    12. March 2010 at 11:52

    I agree with most of what you said – and your critique of the Dems in 05.

    In terms of the liberty issues associated with signing contracts that waive rights, I’m not sure how much this would accomplish – courts have the power to overrule contract provisions based on court opinions about fraud/transparency etc. in the contract. Moreover, it’s relatively easy under common law to argue that a contract is not valid if it’s signed in an improper state of mind or under duress (aka, you’re delusional or suffering a heart attack). So I’m not sure how much this would clean up lawsuits, vs. just move the domain of the tort into the validity of the contract. In practice, that domain is _incredibly_ subjective and dependent on the luck of the draw (vis a vis which judge you pull). It’s difficult to predict what would happen in a market with extreme information asymmetry with a common law framework – I’m not sure who it would advantage more, or whether it would lead to more or fewer suits. But that wasn’t the position of Heritage – the position of Heritage wasn’t to remove limits on contracts, but to impose new limits on contracts.

    In practice, right now, it’s very hard to win a suit, and the profits of malpractice insurance companies have increased much faster than premiums for the past several years. As the Heritage article even notes, only 2% of gross errors actually make it to torts. I’ve seen this with my own parents.

  31. Gravatar of TravisA TravisA
    12. March 2010 at 19:53


    I found the market rally after the two increases in the discount rate perplexing, especially considering that the Fed should have been easier during this time period. A devalued dollar would have been a good thing, right?

    What do you think would have been the reaction of the market to a devaluing the exchange rate for the dollar vs gold at this time (just as Roosevelt did)? Do you think the market would have fallen due to gold hoarding?

    By the way, I think the smiley face is connected to the lack of a page number after p. in your quote from the NYT and/or lacking a closing paren.

  32. Gravatar of scott sumner scott sumner
    13. March 2010 at 07:08

    Statsguy, When I’ve traveled to other countries, even developed countries, I’ve often notice a much greater freedom to take risks. I presume that is due to companies being less afraid of lawsuits. As far as I know, no other country has a tort system as out of control as ours. So I refuse to believe that reforms to our system wouldn’t work. If they can work elsewhere, why can’t they work here? If you arrive at a ski slope and are asked to sign a contract promising not to sue if you have an accident, how is that mental duress?

    I have been told by someone I trust that people are not allowed to sign away their right to sue in America, that the contracts are not enforced. I am not saying we should eliminate lawsuits, but if we reduced them to the level of Australia or Canada or Europe, I think we’d be much better off. If you read publications from other countries, like The Economist, they think our tort system is completely nuts. Are they wrong? Is the rest of the world crazy or are we crazy? I think you know my answer.

    TravisA, That’s a very good answer. All I can tell you is that I found actual devaluations were very bullish for the stock market, but uncertainty about the dollar was bearish. Here is my take, for what it’s worth. At low interest rates people are willing to hold non-interest-bearing assets like gold as a hedge against devaluation risk. Even if the risk of devaluation is small, people will tend to hoard gold, which is deflationary. In that case the negative impact of gold hoarding outweighs the positive impact of a slightly higher expectation of devaluation. In addition, most investors knew that Hoover was unlikely to devalue, and it was still 18 months before the next president took office. So I think fear of uncertainty was an issue. There was no confidence in the long term soundness of the dollar, but also not much expectation of a quick devaluation. The most likely outcome was chronic dollar uncertainty until a new administration took office. If that was the fear, they were right. There were further dollar crises in 1932 and early 1933, and yet Hoover did not devalue. Either extreme would have been better—no fear of devaluation, or immediate actual devaluation. The uncertainty was the worst of all possible worlds. This is just a hypothesis, but the data connecting dollar crises with falling stocks in 1931, 1932, 1933, and 1937 are so strong, it’s the only explanation I find plausible.

  33. Gravatar of scott sumner scott sumner
    13. March 2010 at 07:15

    travisA, Thanks for the tip. There was no mistake, I had written (p. 8), and it interpreted 8) as a smiley face. So I changed it to (p. eight). The smiley face is gone.

  34. Gravatar of StatsGuy StatsGuy
    14. March 2010 at 18:30

    ssumner –

    Please note, I am NOT arguing for or against more/less litigation. I am observing that litigation (that is, use of courts as a remedy rather than administrative law) is the natural consequence of a system that puts a premium on personal liberty.

    This is not endemic of “modern” America. This is endemic of AMERICA ITSELF.



    Note the rates of lawsuits (especially litigation for debt) in colonial times. Staggeringly high. This rate was brought down by MORE regulation, not less. (Including the forced professionalization of the bar, and efforts to make legal action more difficult for normal people to prosecute – remember, in early colonial times most torts were litigated by individual people). The presumption that current litigation is caused by overregulation is inconsistent with longitudinal data.

    Instead of using longitudinal data, you rely on comparative data – but here, one must ask _why_ litigation is more difficult in other countries – it’s because the legal systems elsewhere are specifically designed to discourage it. In England, for example, the huge difference is in WHO BEARS the cost – notably, England is a high risk system in which the loser bears the cost of litigation for both parties. In the US, each person bears the cost of their own defense (unless they specifically sue for costs). I think it would be hard to argue the difference in torts reflects the relative lack of regulation in the UK vs. the US.

    In any case, you seem to agree with my main point – in arguing for tort limits, Heritage is making an argument _against personal economic liberty_, in essence arguing for laws to limit common law rights. As a utilitarian or a pragmatist – you or I might agree with this objective – but Heritage is still making an anti-libertarian argument (not just in the social sphere, but economically too).

    Heritage is a conservative organization, NOT a libertarian one – even in the economic sphere. You seem to agree with this point, just as I agree with you that we have too much litigation.

  35. Gravatar of scott sumner scott sumner
    16. March 2010 at 10:52

    Statsguy, You said:

    “Heritage is a conservative organization, NOT a libertarian one – even in the economic sphere. You seem to agree with this point, just as I agree with you that we have too much litigation.”

    I said exactly the opposite, I said the Heritage appears to support free market economic ideas. It is the social sphere where they are conservative, not the economic sphere. i am pretty sure they are fairly libertarian in their economic views.

    You are right that tort lawyers have run amuck in this country ever since colonial days. But the problem has gotten much worse in my lifetime. I once belonged to a sports club where members would have drinks after the game. In the summer we’d go swimming in a pool after the game. Gradually these options were removed due to fear of lawsuits. What if someone drowns? What if someone gets drunk and gets in an accident? We are pathetically risk averse in this country. As a result we have lost many freedoms that other countries still have. I felt much freer when I lived in Australia. I certainly don’t associate our tort law with liberty.

    Again, I believe people should be able to sue when there is a breach of contract, but we’ve gone way overboard.

    I am certainly not for restricting people’s rights. I am saying that people should have the right to sign a contract waving one’s right to sue the sports club if I got drunk and got in an accident. Because I don’t have that right in America, I have lost many liberties that people in other countries still enjoy. I consider that view to be fully consistent with libertarianism and utilitarianism.

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