volume 60, no 5 june 2010 · edited by jonathan bean dred scott’s revenge:a legal history of race...

Features8 Federal Deposit Insurance: A Banking System Built on Sand by Warren C. Gibson

14 The Myth of the Model by Max Borders

19 The New Financial Imperialism by Robert Stewart

23 Producing Jobs:Thoughts on Obama’s Plan for Small Businesses by Bruce Yandle

27 Are Welfare State Orphans in Good Hands? by James L. Payne

31 Orient Express to Hell by James Bovard

35 R. C. Hoiles and Public Schooling by Wendy McElroy

Columns4 Ideas and Consequences ~ The 1932 Bait-and-Switch by Lawrence W. Reed

17 Thoughts on Freedom ~ The Private Provision of Public Goods

by Donald J. Boudreaux

25 Our Economic Past ~ Comparing the Great Depression to the Great Recession

by Burton W. Folsom, Jr.

29 Peripatetics ~ Jefferson’s Economist by Sheldon Richman

39 Give Me a Break! ~ The Right to Work by John Stossel

47 The Pursuit of Happiness ~ Drugs, Economics, and Liberty by Walter Williams

Departments2 Perspective ~ “What Sort of Despotism Democratic Nations Have to Fear”

by Sheldon Richman

6 Nuclear Energy Should Be Subsidized? It Just Ain’t So! by Art Carden and Mike Hammock

Book Reviews

42 Obamanomics: How Barack Obama Is Bankrupting You and Enriching His Wall Street

Friends, Corporate Lobbyists, and Union Bosses

by Timothy P. Carney Reviewed by George Leef

43 The Case for Big Government

by Jeff Madrick Reviewed by Robert Batemarco

44 Race & Liberty in America:The Essential Reader

edited by Jonathan Bean

Dred Scott’s Revenge: A Legal History of Race and Freedom in America

by Judge Andrew Napolitano Reviewed by Roger Clegg

45 Financial Fiasco: How America’s Infatuation with Homeownership and Easy Money

Created the Economic Crisis

by Johan Norberg Reviewed by Waldemar Ingdahl

Page 42

Page 31

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VOLUME 60, NO 5 JUNE 2010

Itook that title from volume 2, section 4, chapter 6 ofAlexis de Tocqueville’s Democracy in America ( 1840).Considering what has been happening legislatively

(and not just in the last year-plus), it seems like a goodtime to revisit Tocqueville’s writing about democraticdespotism.

He notes that despotism in a constitutional republicwould be different from what it was in the Romanempire. How so? “[I]t would be more extensive andmore mild; it would degrade men without tormentingthem.”

Specifically: “Above this race of men stands animmense and tutelary power, which takes upon itselfalone to secure their gratifications and to watch overtheir fate.That power is absolute, minute, regular, provi-dent, and mild. It would be like the authority of a par-ent if, like that authority, its object was to prepare menfor manhood. . . .”

But that is not its object. Rather, “it seeks, on thecontrary, to keep them in perpetual childhood. . . .For their happiness such a government willinglylabors, but it chooses to be the sole agent and theonly arbiter of that happiness; it provides for theirsecurity, foresees and supplies their necessities, facili-tates their pleasures, manages their principal con-cerns, directs their industry, regulates the descent ofproperty, and subdivides their inheritances: whatremains, but to spare them all the care of thinkingand all the trouble of living?”

He goes on with an almost spooky prophecy:“After having thus successively taken each member

of the community in its powerful grasp and fashionedhim at will, the supreme power then extends its armover the whole community. It covers the surface of soci-ety with a network of small complicated rules, minuteand uniform, through which the most original mindsand the most energetic characters cannot penetrate, torise above the crowd. The will of man is not shattered,but softened, bent, and guided; men are seldom forced

2T H E F R E E M A N : w w w. t h e f r e e m a n o n l i n e . o r g

“What Sort ofDespotism DemocraticNations Have to Fear”

Perspective

Published byThe Foundation for Economic Education

Irvington-on-Hudson, NY 10533Phone: (914) 591-7230; E-mail: [email protected]

www.fee.org

President Lawrence W. ReedEditor Sheldon Richman

Managing Editor Michael NolanBook Review Editor George C. Leef

ColumnistsCharles Baird David R. Henderson

Donald J. Boudreaux Robert HiggsStephen Davies John Stossel

Burton W. Folsom, Jr. Thomas SzaszWalter E.Williams

Contributing EditorsPeter J. Boettke Dwight R. Lee

James Bovard Wendy McElroyThomas J. DiLorenzo Tibor Machan

Joseph S. Fulda Andrew P. MorrissBettina Bien Greaves James L. Payne

Steven Horwitz William H. PetersonJohn Hospers Jane S. Shaw

Raymond J. Keating Richard H.TimberlakeDaniel B. Klein Lawrence H.White

Foundation for Economic Education

Board of Trustees, 2009–2010Wayne Olson, Chairman

Harry Langenberg Walter LeCroyWilliam Dunn Frayda Levy

Jeff Giesea Kris MaurenEthelmae Humphreys Roger Ream

Edward M. Kopko Donald Smith

The Foundation for Economic Education (FEE) is anonpolitical, nonprofit educational champion ofindividual liberty, private property, the free market,and constitutionally limited government.

The Freeman is published monthly, except for combined January-February and July-August issues. Views expressed by the authors do not necessarily reflect those of FEE’s officers and trustees. To receive a sample copy, or to have The Freemancome regularly to your door, call 800-960-4333, or e-mail [email protected].

The Freeman is available electronically through products and serv-ices provided by ProQuest LLC, 789 East Eisenhower Parkway, POBox 1346, Ann Arbor, Michigan 48106-1346. More informationcan be found at www.proquest.com by calling 1-800-521-0600.

Copyright © 2010 Foundation for Economic Education,except for graphics material licensed under Creative CommonsAgreement. Permission granted to reprint any article from this issue, with appropriate credit, except “The Right to Work.”

Cover: Jon Payne [flickr]

3 J U N E 2 0 1 0

P E R S P E C T I V E : “ W h a t S o r t o f D e s p o t i s m D e m o c r a t i c N a t i o n s H a v e t o F e a r ”

by it to act, but they are constantly restrained from act-ing. Such a power does not destroy, but it prevents exis-tence; it does not tyrannize, but it compresses,enervates, extinguishes, and stupefies a people, till eachnation is reduced to nothing better than a flock oftimid and industrious animals, of which the govern-ment is the shepherd.”

Tocqueville also sees the paradoxes of democracy.How relevant they still are:

“I have always thought that servitude of the regular,quiet, and gentle kind which I have just describedmight be combined more easily than is commonlybelieved with some of the outward forms of freedom,and that it might even establish itself under the wing ofthe sovereignty of the people.

“Our contemporaries are constantly excited by twoconflicting passions: they want to be led, and they wishto remain free.As they cannot destroy either the one orthe other of these contrary propensities, they strive tosatisfy them both at once. They devise a sole, tutelary,and all-powerful form of government, but elected bythe people. They combine the principle of centraliza-tion and that of popular sovereignty; this gives them arespite: they console themselves for being in tutelage bythe reflection that they have chosen their own guardians.Every man allows himself to be put in leading-strings,because he sees that it is not a person or a class of per-sons, but the people at large who hold the end of hischain.” (Emphasis added.)

Tocqueville concludes,“Thus their spirit is graduallybroken and their character enervated. . . . It is indeeddifficult to conceive how men who have entirely givenup the habit of self-government should succeed inmaking a proper choice of those by whom they are tobe governed; and no one will ever believe that a liberal,wise, and energetic government can spring from thesuffrages of a subservient people.

“A constitution [that is] republican in its head andultra-monarchical in all its other parts has alwaysappeared to me to be a short-lived monster.”

Tocqueville might have had his timing off, but witha fiscal crisis on the horizon—the product of a bloatedwelfare state, an aging population, and a lacklustereconomy mired in corporatism—the “monster” is introuble. Is it too late to turn things around?

* * *One of the most politically safe government pro-

grams today is federal insurance of bank deposits. Yetthere was a time when the idea of underwriting reck-less bank behavior was thought so ridiculous that evenPresident Franklin D. Roosevelt opposed it. WarrenGibson explores the FDIC.

It’s not what we don’t know that gets us into trou-ble. It’s what we think we can model but can’t. MaxBorders explains.

The leading countries’ pressure on offshore financialcenters—that is, low-tax jurisdictions that respect peo-ple’s privacy—is nothing less than an updated versionof imperialism. So says Robert Stewart.

President Obama insists he wants to help small busi-ness create jobs. He even has a program for that. Is thereless here than meets the eye? Bruce Yandle thinks so.

Americans rightly have an intuition that bureaucra-cies are inept. So why would the adoption of childrenbe trusted to one? James Payne wants to know.

Once upon a time, central and eastern Europe wereruled by brutal and incompetent communist regimes.And back then, when the World Bank thought Roma-nia had an enlightened despot, James Bovard took a lit-tle tour. He reminisces inside.

One of the founders of the modern libertarianmovement was a newspaper magnate named R. C.Hoiles. Nothing raised his ire like government-runschools.Wendy McElroy tells why.

And if that’s not enough, there are the columnists:Lawrence Reed looks back at FDR’s great bait-and-switch in 1932. Donald Boudreaux considers the pri-vate provision of public goods. Burton Folsom seesominous parallels between Roosevelt and Obama. JohnStossel is outraged that we need government permis-sion to pursue many occupations.Walter Williams wantsno part of the “war on drugs.” And Art Carden andMike Hammock, encountering the argument that gov-ernment should underwrite investments in nuclearpower, proclaim,“It Just Ain’t So!”

Books on Obamanomics, big government, race,and the financial mess come under our reviewers’scrutiny.

Sheldon [email protected]

B Y L AW R E N C E W. R E E D

The 1932 Bait-and-Switch

Ideas and Consequences

Harry Truman once said, “The only thing newin the world is the history you don’t know.”That observation applies especially well to

what tens of millions of Americans have been taughtabout Franklin Delano Roosevelt, the man underwhom Truman served as vice president for about amonth. Recent scholarship (including a highlyacclaimed book, New Deal or Raw Deal, by FEE seniorhistorian Burton Folsom) is thankfully disabusingAmericans of the once-popular myth that FDR savedus from the Great Depression.

Another example is a 2004 articleby two UCLA economists—HaroldL. Cole and Lee E. Ohanian—in theimportant mainstream Journal of Polit-ical Economy. They observed thatFranklin Roosevelt extended theGreat Depression by seven long years.“The economy was poised for abeautiful recovery,” the authors show, “but that recovery was stalledby these misguided policies.”

In a commentary on Cole andOhanian’s research, Loyola Universityeconomist Thomas DiLorenzopointed out that six years after FDR took office, unem-ployment was almost six times the pre-Depressionlevel. Per capita GDP, personal consumption expendi-tures, and net private investment were all lower in 1939than they were in 1929.

“The fact that it has taken ‘mainstream’ neoclassicaleconomists so long to recognize [that FDR’s policiesexacerbated the disaster],” notes DiLorenzo, “is trulyastounding,” but still “better late than never.”

Part of the Great FDR Myth is the notion that hewon the presidency in 1932 with a mandate for centralplanning. My own essay on this period (“Great Mythsof the Great Depression”; www.tinyurl.com/7eecje)

argued otherwise, based on the very platform andpromises on which FDR ran. But until a few monthsago I was unaware of a long-forgotten book that makesthe case as well as any.

Hell Bent for Election was written by James P. War-burg, a banker who witnessed the 1932 election andthe first two years of Roosevelt’s first term from theinside. Warburg, the son of prominent financier andFederal Reserve cofounder Paul Warburg, was no lessthan a high-level financial adviser to FDR himself.Disillusioned with the President, he left the administra-

tion in 1934 and wrote his book ayear later.

Warburg voted for the man whosaid this on March 2, 1930, as gover-nor of New York:

The doctrine of regulation andlegislation by “master minds,” inwhose judgment and will all the peo-ple may gladly and quietly acquiesce,has been too glaringly apparent atWashington during these last tenyears.Were it possible to find “masterminds” so unselfish, so willing to

decide unhesitatingly against their own personalinterests or private prejudices, men almost godlike intheir ability to hold the scales of justice with an evenhand, such a government might be to the interests ofthe country; but there are none such on our politi-cal horizon, and we cannot expect a complete rever-sal of all the teachings of history.

What Warburg and the country actually elected in1932 was a man whose subsequent performance lookslittle like the platform and promises on which he ran


Lawrence Reed ([email protected]) is the president of FEE.

In 1932, the countryelected a man whose subsequentperformance lookslittle like the platformand promises onwhich he ran.

and a lot like those of that year’s Socialist Party candi-date, Norman Thomas.

Who campaigned for a “drastic” reduction of 25percent in federal spending, a balanced federal budget,a rollback of government intrusion into agriculture,and restoration of a sound gold currency? Rooseveltdid.Who called the administration of incumbent Her-bert Hoover “the greatest spending administration inpeace time in all our history” and assailed it for raising taxes and tariffs? Roosevelt did. FDR’s runningmate, John Nance Garner, even declared that Hoover“was leading the country down the road to socialism.”

Copying Hoover and the Socialists

It was socialist Norman Thomas, notFranklin Roosevelt, who proposed

massive increases in federal spendingand deficits and sweeping interven-tions into the private economy—andhe barely mustered 2 percent of thevote. When the dust settled, Warburgshows, we got what Thomas promised,more of what Hoover had been lam-basted for, and almost nothing thatFDR himself had pledged. FDRemployed more “master minds” toplan the economy than perhaps all previous presidentscombined.

After detailing the promises and the duplicity, War-burg offered this assessment of the man who betrayedhim and the country:

Much as I dislike to say so, it is my honest convic-tion that Mr. Roosevelt has utterly lost his sense ofproportion. He sees himself as the one man who cansave the country, as the one man who can “save capi-talism from itself,” as the one man who knows what isgood for us and what is not. He sees himself as indis-pensable.And when a man thinks of himself as beingindispensable . . . that man is headed for trouble.

Was FDR an economic wizard? Warburg revealsnothing of the sort, observing that FDR was “undeni-ably and shockingly superficial about anything thatrelates to finance.” He was driven not by logic, facts, orhumility but by “his emotional desires, predilections,and prejudices.”

“Mr. Roosevelt,” wrote Warburg, “gives me theimpression that he can really believe what he wants tobelieve, really think what he wants to think, and reallyremember what he wants to remember, to a greaterextent than anyone I have ever known.” Less charitableobservers might diagnose the problem as “delusions of grandeur.”

“I believe that Mr. Roosevelt is so charmed withthe fun of brandishing the bandleader’s baton at the head of theparade, so pleased with the picturehe sees of himself, that he is nolonger capable of recognizing thatthe human power to lead is limited,that the ‘new ideas’ of leadershipdished up to him by his brightyoung men in the Brain Trust arenothing but old ideas that have beentried before, and that one cannotuphold the social order defined in

the Constitution and at the same time undermine it,”Warburg lamented.

So if Warburg was right (and I believe he was),Franklin Delano Roosevelt misled the country with hispromises in 1932 and put personal ambition and powerlust in charge—not a very uncommon thing as politi-cians go. In any event, the country got a nice little bait-and-switch deal, and the economy languished as aresult.

In the world of economics and free exchange, therule is that you get what you pay for.The 1932 electionis perhaps the best example of the rule that prevails all too often in the political world:You get what youvoted against.

T h e 1 9 3 2 B a i t - a n d - S w i t c h

FDR misled thecountry with hispromises and putpersonal ambitionand power lust in charge.

5 J U N E 2 0 1 0

In a March 5 Los Angeles Times op-ed, “Jump-start-ing Nuclear Energy” (www.tinyurl.com/yb6ot4z),Greenpeace founder Patrick Moore, who now co-

chairs the Clean and Safe Energy Coalition, lauds theObama administration for its decision to “guaranteeloans for two advance-design nuclear plants in Geor-gia.” Nuclear energy diversifies ourenergy portfolio and doesn’t pollutethe air the way fossil fuels do. We certainly should eliminate barriers toits use.

But that doesn’t mean federal loanguarantees are in order.

Government should not be tryingto pick winners and losers in theenergy industry. If one company hasits loans backed by the government,other companies without guaranteeswill have trouble borrowing capital.Bureaucrats don’t know and can’tknow whether (or in what combination) nuclearenergy, biodiesel, ethanol, solar energy, hydroelectricity,fuel cells, or any other alternatives are “best” for meet-ing our energy needs. This information can onlyemerge through market competition.

This is not just about energy.We don’t know—onceand for all—the best way to build a computer chip.Wedon’t know the ingredients for the next tasty trend infood.We’re ignorant about a lot of things we would liketo know. Markets—and competition—produce theinformation that allows us to make decisions. But gov-ernments distort it by intervening in the capital mar-kets, by doing things like guaranteeing loans toparticular firms.

In other words, we do not find the best way to builda computer chip by having the government offer loanguarantees to firms that use particular productionprocesses.We let firms compete for customers, and in afree market without government interference, firmsearn profits when they use resources wisely and pro-

duce things people want at pricesthey are willing to pay.

Solving these problems—what toproduce and how—requires informa-tion embodied in prices. Few of usbuy golden faucets, because they’retoo expensive. Prices help producersdecide whether to use gold or steel, ortry to come up with something bet-ter. F. A. Hayek called competition a“discovery procedure.” As they com-pete with one another for profits,firms discover the best way to producethings. The firms that can maximize

the difference between the price of what they produceand the cost of producing it will survive and thrive;those that cannot must change or perish.

Energy prices might not reflect the full costs of pro-duction and consumption.There are additional costs—the harm caused by air pollution or climate change (ifthat’s what’s going on)—that producers do not pay butare imposed on the public generally. Therefore theyproduce too much energy from dirty sources like coaland too little energy from clean sources like nuclear

Nuclear Energy Should Be Subsidized?It Just Ain’t So!


B Y A R T C A R D E N A N D M I K E H A M M O C K

Art Carden ([email protected]) teaches economics at Rhodes Collegein Memphis. Mike Hammock ([email protected]) is aNashville-based economist.

We certainly shouldeliminate barriers tothe use of nuclearpower. But thatdoesn’t mean federalloan guarantees are in order.

7 J U N E 2 0 1 0

power. It is intuitively appealing, therefore, to have thegovernment simply pick a cleaner energy source andsubsidize it. But this is a mistake that leaves too manyquestions unanswered. It is a mistake for the same rea-son that it would be a mistake to order all chip manu-facturers to use a 32-nanometer process, or subsidizecake makers that use margarine: The government is inno position to know if these are the best processes toproduce the desired results. A 32-nanometer processwould be expensive overkill for a pocket calculator, andmany people prefer cakes made with butter.The marketreaches these conclusions by punishing firms thatignore them.

Similarly, we do not know how much more nuclearpower to use, how many more plants to build, and atwhat point we should start using other energy sourcesinstead.

Firms competing in truly free mar-kets will find the best ways to getdesired results. Competition forces theanswers on them.

What About Externalities?

But what about those costs thataren’t reflected in prices, the

ones from so-called externalities likepollution?

In principle there are better alter-natives to government interventions that choose win-ners and losers.While far from ideal, pollution could betaxed or tradable permits to emit certain pollutantscould be established. Power companies with dirtierplants would suddenly find themselves at a disadvantageversus other companies with cleaner plants and wouldhave an incentive to shift toward cleaner energy. Pollu-tion-reduction mechanisms we haven’t even imaginedcould emerge as firms search for ways to reduce theirpollution costs. Maybe nuclear power would makehuge gains in the resulting competition; maybe itwould not. We cannot know, but we can say that theresulting victors in that competition will be the energyproviders that found ways to reduce pollution at thelowest cost.

These are superior, more market-oriented alterna-tives, but their effective implementation rests on simi-larly implausible assumptions about the policymakers’knowledge and incentives. They assume we know (orcan know) all the relevant external costs of pollution.They further assume we know (or can know) thesocially optimal level of emissions that would prevail inthe absence of externalities. They also assume thatpeople acting through the political process areimmune to the perverse incentives the programs cre-ate. At various times and places environmental initia-tives have been co-opted by special interests.Thus weshould keep in mind that even more market-orientedregulations will be difficult to get right.There’s no realsubstitute for the free market.

We can take other actions in addition to thosedesigned to internalize the external-ities. For example, government-granted advantages for other forms of energy production should berepealed—the special tax treatmentfor oil exploration, wind, and ethanolshould be eliminated. Instead of tar-geted favors, taxes should be cutacross the board. We should removeregulatory barriers that make it hardto start new power plants but easy tokeep innovative competitors out.

And, importantly, special limited tort liability must notbe permitted for nuclear power or anyone else; thus thePrice-Anderson Act, which was passed in 1957 toencourage civilian nuclear power, should be repealed.

The government should stop trying to pick winnersand let the competitive process sort things out.

Moore argues that the nuclear plants will createjobs, but this is a canard.When the government assumesa company’s risks, it does not create net new economicactivity. It merely reallocates it from one line of pro-duction to another. Having government-guaranteedloans for a nuclear power company means other busi-nesses go without loans. Without undistorted prices,profits, and losses, there is no way to know whethervalue has been created or destroyed.

N u c l e a r E n e r g y S h o u l d B e S u b s i d i z e d ? I T J U S T A I N ’ T S O !

The governmentshould stop trying to pick winners andlet the competitiveprocess sort things out.

Federal deposit insurance grew out of a turbulenttime in American history: the Great Depression.During two waves of bank failures in the 1930s

an astonishing 9,000 banks closed and millions ofdepositors lost some or all of their savings.The FederalDeposit Insurance Corporation (FDIC) began opera-tions in 1934, insuring deposit accounts up to $5,000per person (roughly $80,000 in today’s money).

The bank failure ratethen dropped dramaticallyand never again rose any-where close to the level ofthe 1930s. And such bankfailures that have occurredhave cost insured deposi-tors nothing; many unin-sured depositors weremade whole as well. Bankruns are a distant mem-ory, revived occasionallyby reruns of It’s a Wonder-ful Life.

Yet it may be prema-ture to pronouncedeposit insurance a suc-cess. It can take a long time for an unsustainable pro-gram to unravel: Witness Social Security andMedicare. Seventy-five years after the start of SocialSecurity and 45 years into Medicare, it’s commonknowledge that both programs are headed for a finan-cial cliff. A closer look at deposit insurance will showcracks in its edifice, raising questions about its sustain-ability as well as the distortions that it has introducedinto the economy.

Before we take that closer look we might askwhether, as is widely assumed, the bank failures of the1930s were an example of unregulated free marketsrun amok. During that time, as Milton Friedman andAnna Schwarz pointed out in their classic, A MonetaryHistory of the U.S., the number of bank failures inCanada was exactly zero. Canada is closely linked tothe United States economically and culturally, making

this episode as near to acontrolled experimentas any macroeconomistcould wish for.

The difference?Canada had just tennationwide banks withabout 3,000 branches,while branch bankingacross state lines, andoften within states, wasprohibited by U.S. law.Thus smaller communi-ties could only beserved by relativelyweak, poorly capitalizedbanks. A hailstorm

might be enough to topple the local bank in a smallfarming community as surely as if it were built fromstraw.

The banking system was also caught in the down-draft of a plummeting money supply.When banks holdonly a fraction of their liabilities as reserves, deposit

B Y W A R R E N C . G I B S O N

Federal Deposit Insurance:A Banking System Built on Sand


Warren Gibson ([email protected]) teaches engineering at Santa ClaraUniversity and economics at San Jose State University.

inflows cause the money supply to multiply, but thereverse happened during the Depression as worrieddepositors began to cash out their accounts.The econ-omy could have adjusted to a declining money supplyin one of two ways: either by lowering prices and wagesor by Federal Reserve injection of new money.Hoover’s jawboning and Roosevelt’s New Deal legisla-tion precluded the first solution, while the Fed, out ofignorance or confusion, failed to inject new money.With economic adjustment prevented by governmentpolicies, a vicious cycle of souring bank loans, liquida-tion of deposits, further declines in the money supply,and more business failures took hold.

Interestingly, Milton Friedman and Murray Roth-bard, both free-market economists, reached oppositeconclusions about the decliningmoney supply. While Friedmanblamed the Fed, Rothbard celebratedwhat he saw as the people’s attempt tooverturn fractional-reserve banking,which he believed is inherently fraud-ulent. Either way, the fingerprints ofgovernment were all over the bankfailures of the 1930s and the GreatDepression generally.

With the failure of so many banks,U.S. Representative Henry Steagallvigorously pushed deposit insurancelegislation. Franklin Roosevelt wasamong his opponents. Indeed, whenasked about guaranteeing bankdeposits four days after his inaugura-tion in March 1933, Roosevelt said heagreed with Herbert Hoover: “I cantell you as to guaranteeing bankdeposits my own views, and I thinkthose of the old Administration. Thegeneral underlying thought behindthe use of the word ‘guarantee’ with respect to bankdeposits is that you guarantee bad banks as well as goodbanks.The minute the Government starts to do that theGovernment runs into a probable loss. . . . We do notwish to make the United States Government liable forthe mistakes and errors of individual banks, and put apremium on unsound banking in the future.”

FDR was right. Deposit insurance generates moralhazard: an incentive to engage in more reckless behav-ior when one’s misdeeds are covered by someone else.Bank managers tend to make riskier loans than theywould without insurance, and depositors don’t worryabout the lending practices of the banks they patronize.Currently many people, including me, buy bank certifi-cates of deposit through online brokers, perhaps noteven learning the name of the bank that got ourmoney.The magic letters FDIC are all we look for.

Savings & Loan and Moral Hazard

The savings and loan crisis of the late 1980s saw acatastrophic explosion of moral hazard. Deregula-

tion had lifted interest rate caps for S&Ls and allowedthem to expand from residentialmortgages into commercial and con-sumer lending. Competitive pressuressent managers scrambling into thesemarkets, which were mostly unfamil-iar to them, while at the same timethey had to compete vigorously fordeposits. With deposit insuranceoffered to all chartered institutionsregardless of risk, S&Ls made manypreposterous loans.When the dust set-tled, roughly half had failed.A massivetaxpayer bailout followed and, as veryrarely happens to failing governmentagencies, the Federal Savings and LoanInsurance Corporation was abolishedin 1989—though its responsibilitieswere shifted to the FDIC.

Moral hazard is an aspect of allinsurance, public or private. But pri-vate insurance companies, if theywish to survive and prosper, must findways to limit policyholders’ risky

behavior. Deductibles, copays, threats of cancellation,and rewards for prudent behavior return some mone-tary incentive to policyholders. In addition, insurancecompanies try to educate policyholders about prudentbehavior. Crucially, in a free market private insurancecompanies’ profit-and-loss statements tell whetherthey’re getting it right. Government agencies lack

9 J U N E 2 0 1 0

F e d e r a l D e p o s i t I n s u r a n c e : A B a n k i n g S y s t e m B u i l t o n S a n d

Four days after taking office, FDRendorsed Hoover’sview and said,“We do not wish tomake the UnitedStates Governmentliable for the mistakesand errors ofindividual banks, andput a premium onunsound banking inthe future.”

profit-and-loss discipline and are inevitably subject topolitical pressure.The FDIC’s legally mandated require-ment to hold reserves to back its liabilities may resem-ble market discipline, but as we shall see, when themandate was violated, no one lost his job and noinvestors lost any capital.

Private insurance companies invest most of theirreserves in productive activities such as corporate secu-rities or real estate.They count on earnings from theseinvestments to balance low or even negative returns ontheir pure underwriting activities. The FDIC, by law,holds its reserves in the form of Treasury securities.Any alternative would certainly be riskier and morepolitically charged. Yet we must recognize that thisarrangement, as with the SocialSecurity Trust Fund, is merely apass-through of the FDIC’s liabil-ities to U.S. taxpayers.

The FDIC reserve fund iscalled the Deposit InsuranceFund (DIF). For most of its his-tory, the DIF was kept within itsstatutory limit, which has variedover time but is currently a rangeof 1.15 to 1.25 percent of insureddeposits. At least, that’s the statu-tory range. It’s actually essentiallyzero. But are the statutory num-bers the right ones? No one canbe sure, but again, the FDIC lacksa profit motive to help get it right.

A spate of bank failures in 2008 and 2009, while farless severe in number and magnitude than in the 1930s,left the DIF with no unencumbered assets at all. Thepace of bank failures continued during the first threemonths of 2010, while the number of problem bankson the FDIC’s secret list jumped 27 percent in thefourth quarter of 2009, to 702. In short, the FDIC is introuble.

A restoration plan has been proposed to get the DIFback to 1.15 percent of insured deposits by about 2017,a date that has been pushed back more than once.Theplan relies heavily on an assumption that the economywill soon resume robust growth and that “only” about$100 billion in failure costs will be incurred between

2009 and 2013, with most of those costs coming in2010. For the shorter term, the proposal calls on com-mercial banks to prepay their deposit insurance premi-ums through 2011. When they do so, a new asset willappear on their balance sheets: a prepaid expense. Togain their acceptance and cooperation, the FDIC pro-poses that this prepaid expense be counted as an assetthat is just as safe as U.S. government securities andtherefore does not require additional capital backing.This shuffle will be pretty much a wash for the com-mercial banks, and the upshot is that the FDIC willindirectly borrow its own future premium income,hoping that income will materialize in amounts suffi-cient not only to cover future bank failures but also to

rebuild the DIF. We shall see.The DIF is not the FDIC’s

only problem. When closing afailed bank, the agency tries to sellas many of the bank’s assets as pos-sible, including branches, loans,and securities holdings. TheFDIC’s goal is usually to make alldepositors whole, not just insureddepositors. It sometimes takes pos-session of assets for which it can’tget an acceptable bid. In doing soit acquires assets that are difficultto evaluate and thus greatly com-plicate estimates of future liabili-ties.

Disguised Risk

Now let’s take a longer look at the business of bank-ing. The very words we use, like “bank” and

“deposit,” can distort our thinking. The word “bank”comes from the bench or counter where medievalmoney changers did business. The word “deposit” sug-gests something like an ore deposit in the ground: theminerals are there and can be gotten out. We think ofbanks as custodians of our money, keeping it safe for usand making it available whenever we need it. But pres-ent-day banks are not deposit banks, locking our moneyaway in a vault as the term would suggest, but rather loanbanks. Most of our deposits are loaned out and not all ofthem could be redeemed on short notice. This works


Wa r r e n C . G i b s o n

Ken Yee [flickr]

fine as long as there is no large and sudden short-termdemand for withdrawals. But we have come to believe, inpart due to misleading terminology, that we can haverewards without risk. Interest paid on bank deposits isnow essentially zero but as depositors, we still reap bene-fits such as ATMs and online banking with no fee and noapparent risk. In short, as in so many areas of contempo-rary life, we have been led to expect something for noth-ing.

Thus proper labeling could help rationalize banking.Those who want utmost safety in the form of truedeposit banking should be free to pay for it with feesfor storage of their currency or gold. Liability insurancefor true custodial service should be very cheap. Thosewho wish to entrust their money to loan bankingshould accept the risk, and if theywant insured accounts, they—nottaxpayers—should be prepared to payfor the insurance, at least indirectly.

While there is nothing inherentlywrong with loan banking, we get toomuch of it when it is disguised asdeposit banking and backed by mis-priced and politically motivated gov-ernment insurance. The result is abanking system that is more highlyleveraged than it otherwise would be.This in turn increases the severity ofbusiness cycles—booms and busts.

FDIC Incentives

Back to the FDIC.As we have seen, banks pay for itsservice in the form of insurance premiums. Cover-

age is not mandatory, so the organization looks some-what like a private business. But in fact it is a monopolysupplier to banks (with a parallel institution servingcredit unions). Private competitors are locked out, per-haps not by statute, but by the FDIC’s implicit andexplicit backing by the Treasury (explicit in the form ofa line of credit). Without a profit motive, the FDIClacks the incentive to serve its bank customers and itsindirect depositor customers by offering innovativeservices with effective moral-hazard controls.

Though the FDIC lacks market incentives, it isawash in political incentives. Thus in 2008 Congress

voted for an increase in deposit coverage from$100,000 to $250,000 with little or no discussion of thecosts of this move. This “temporary” increase has beenextended once and will likely become permanent.Members of Congress are of course motivated by thecampaign contributions of bankers and others, and maynot know or care about the long-term consequences ofsuch actions.

Private Options

How might private firms handle bank deposit insur-ance? Before the government takeover of the

banking system, private clearinghouses sometimes pro-vided mutual aid among member banks. The SuffolkBank in Boston was a notable example in the early

1800s. It supported country banks inNew England for many years by clear-ing their transactions and acceptingtheir currency at par. It earned a profitdoing so.

But could private firms ever be bigenough to provide bank deposit insur-ance in today’s multitrillion dollareconomy? Reinsurance firms offerevidence that they could. As theirname indicates, General Re and othersuch firms insure insurance compa-nies. Who insures the reinsurancecompanies? No one. Absent govern-ment intervention, these firms wouldexperience diseconomies of scale

when they grow too large, provided it is clear that theywould not be in line for a government bailout shouldthey get into difficulty.

Failure is an important aspect of the free market.Economist Joseph Schumpeter’s pithy phrase “creativedestruction” captures this notion and reminds us thatfailures, which will always be with us, should be liqui-dated so that others can pick up the remains and applythem to more promising enterprises. Shouldn’t this ideaapply to banks as well? Rothbard actually celebratedoccasional bank runs as a way of putting the fear ofGod into bank managers and depositors alike. Amaz-ingly, Roosevelt’s initial response to the deposit insur-ance proposal echoed Rothbard’s: “There are

11 J U N E 2 0 1 0

F e d e r a l D e p o s i t I n s u r a n c e : A B a n k i n g S y s t e m B u i l t o n S a n d

Make no mistake,our current bankingsystem is, and haslong been, a cartel run for the mutualbenefit of Wall Street financiers andtheir regulators in Washington.


undoubtedly some banks that are not going to pay onehundred cents on the dollar.We all know it is better tohave that loss taken than to jeopardize the credit of theUnited States Government. . . .”

Washington-Wall Street Banking Cartel

Make no mistake, our current banking system is,and has long been, a cartel run for the mutual

benefit of Wall Street financiers and their regulatorfriends in Washington. Case in point: Goldman Sachsand Morgan Stanley were allowed to convert to bankholding companies so that they could receive federalbailout money.The $180 billion AIG bailout providedGoldman with 100 cents on the dollar for its holdingsof AIG credit default swaps.

Let us not be so naive as to believe that governmentdeposit insurance is any different. Any benefit this sys-tem provides to small depositors is incidental to its realobjective: to serve the cartel.

The banking system is in need of real reform. Moreregulation? More virtuous regulators? Only the naive,the ignorant, or the disingenuous can believe theseanswers in the face of regulation’s long history of fail-ure, the practical impossibility of detailed oversight, andthe perverse political incentives that always operate.The solution lies not in wiping out risk—there can beno real economic growth without risk. Instead, weneed rational incentives: Let risks be borne by thosebest able and willing to take them.

Wa r r e n C . G i b s o n


Most people don’t notice it, but “model” maybe the most dangerous word in the Englishlanguage right now. Models justify a lot of

the bad policies that have been, or soon will be, foistedon us. For example, what was used to justify the fiscalpolicy of the big “stimulus”? That’s right. And as Iwrote this, “experts” were using models to gear us upfor another one.

More than a year after the original“stimulus,” not only are economistsnowhere near consensus about itseffects but few if any of the modelsused to justify it have turned out tobe right. Obamanomic adviserChristina Romer, for example, hascome under heavy criticism becauseher team’s plan has performedabysmally.The model behind the planpredicted unemployment would peakat 8.3 percent. It exceeded 10 percentbefore dropping back slightly. Indefending her plan she appealed tocounterfactuals—that is, how badthings could have been without it.That her team failed to reach its rosytargets, she says, “prevents peoplefrom focusing on the positive impact.” But did Romerever consider the possibility that her model was justwrong?

When it comes to prediction and explanation,macroeconomic models are often just as bad after thefact as before it. There are just as many debates ragingabout the effects of the “stimulus” as explanations of the crisis used to justify it. Consensus consistently

eludes us.Almost all the arguments presuppose models.There are Keynesian models, “new” Keynesian mod-els, and unbranded models proffered by leading eco-nomic lights like Harvard’s Robert Barro. Comparative analyses of these positions offer little except further evi-dence that, as Stanford’s John Taylor writes, “[T]here isno consensus.”

But why? These people aren’t stu-pid. I’d like to suggest in nontechni-cal terms why the problem might bewith the models themselves.

“Mainstream macroeconomics is‘hydraulic,’” writes recovering ma-croeconomist Arnold Kling at Econ-Log. “There is something called‘aggregate demand’ which you adjustby pumping in fiscal and monetaryexpansion. I wish to reject this wholeconcept of macroeconomics.” I thinkhe’s right. In fact, as I’ve argued inthese pages before, economies are notpumps to be primed, but economicecosystems (“Black Swans, Butter-flies, and the Economy,” March 2009;www.tinyurl.com/crea2y). Econo-mists are thus notoriously bad at pre-

dicting, much less planning, economies. That’s whynext-generation economics must focus on the funda-mentals—namely, the rules that give rise to successfulentrepreneurship and sustainable growth. Not aggre-gates. Not models. Rules.

B Y M A X B O R D E R S

The Myth of the Model

Max Borders ([email protected]) is a writer living in NorthCarolina. He blogs at maxborders.com.

In 1949, Bill Phillips tried to model the economyusing this hydraulic contraption.Science Museum / Science & Society Picture Library

15 J U N E 2 0 1 0

T h e M y t h o f t h e M o d e l

“Institutions form the incentive structure of a soci-ety and the political and economic institutions, in con-sequence, are the underlying determinant of economicperformance,” said Douglass North in his Nobel Prizelecture. And he’s not alone in the wilderness. JamesBuchanan, another Nobel Prize winner, says econo-mists are simply asking the wrong questions:

How do markets work? Standing alone, this is aninappropriate and unanswerable question. It must bereplaced by the question: How do markets workunder this or that set of constitutional and institu-tional constraints? Economists’ scientific expertisecan be brought to bear on the predicted effects ofalternative sets of constraints. The relevant questionis not how this or that outcome may be put in placethrough possible collective or polit-ical action. The question becomesinstead, how can this or that set ofconstraints be predicted to operateso as to allow the generation of anorder that meets certain criteria ofdesirability? The difference betweenthe two methodological stancesmay appear minor, but much ill-advised effort might be avoided ifeconomists would recognize thelimits of their own discipline.[“Economists Have No Clothes”;www.tinyurl.com/yd3tmab]

Buchanan not only laments the poor framing ofeconomic questions, but also says that even thoseattempting postmortems of the 2008-09 financial crisishave been “embarrassed by their inability to offer ‘sci-entific’ explanations.”Those who’ve dared to come for-ward have offered little more than warmed-overKeynesian nostrums. Just think of folks like Romer,Paul Krugman, and Joseph Stiglitz—all of whom haverecommended various versions of doubling down onthe failed policy.At the end of their yellow-brick road?A curtain, behind which lies a model, behind which liesan agenda.

So what do all these macroeconomic models have in common?

• They’re rendered either in impenetrable math orwith sophisticated computers, requiring a lot ofpopular (and political) faith.

• Politicians and policy wizards hide behind thisimpenetrability, both to evade public scrutiny andto secure their status as elites.

• Models vaguely resemble the real-world phenom-ena they’re meant to explain but often fail to trackwith reality when the evidence comes in.

• They’re meant to model complex systems, butsuch systems resist modeling. Complexity makesthings inherently hard to predict and forecast.

• They’re used by people who fancy themselvesplanners—not just predictors or describers—ofcomplex phenomena.

None of this is to argue weshould do away with measurement.Temperature, blood pressure, andother indicators are all useful datafor telling whether you’re healthy.But using proxy measures to deter-mine an economy’s health is a farcry from using models to reducedynamic systems to steady-statesnapshots.

What does this mean for eco-nomics as a discipline? I think it’stime we admit many economists arejust soothsayers.They keep their jobs

for a host of reasons that have less to do with accuracyand more to do with politics and obscurantism. Indeed,where do you find them but in bureaucracies—thosegreat shelters from reality’s storms? Governments anduniversities are places where big brains go to be grandand weave speculative webs for the benefit of the few.

And yet “ideas have consequences.” Bureaucraciesare power centers. So we have a big job ahead of us.We’ve got to do a seemingly contradictory thing andmake the very idea of complex systems simple. Howbest to say it? Economists aren’t oracles? Soothsaying isnot science? Ecosystems can’t be designed?

“The very term ‘model’ is a pretentious borrowingof the architect’s or engineer’s replica, down-to-scale ofsomething physical,” says Barron’s economics editor,

At the end ofmacroeconomists’yellow-brick road? A curtain, behindwhich lies a model,behind which lies an agenda.


M a x B o r d e r s

Gene Epstein. “These are not models at all, but justequations that link various numbers, maybe occasion-ally shedding light, but often not.”

Take this as a throwing down ofthe gauntlet. Macroeconomic wizardsowe us more than the circular justifi-cations for cushy jobs.

Likewise, we have to explain that ascientist’s model, while useful in lim-ited circumstances, is little better thana crystal ball for predicting big phe-nomena like markets and climate. It isan offshoot of what F.A. Hayek calledthe “pretence of knowledge.” In otherwords, modeling is a form of scien-tism, which is “decidedly unscientificin the true sense of the word, since itinvolves a mechanical and uncritical application ofhabits of thought to fields different from those in whichthey have been formed” (www.tinyurl.com/ybjtur2).A model is thus a cognitive shortcut for both the wonk

and the journalist, the latter of whom wants to peg hisstory to something authoritative the wonk has to pro-vide. At the receiving end of this wonk-writer alliance

are the rest of us—with little besidescommon sense as a shield. And Idon’t mean this as populism. It israther a defense against scientismlaunched from the turf of Austrianeconomics.

Complex phenomena can becounterintuitive. Sometimes theyrequire scrutiny by experts to makesense of them. Notwithstandingtheir expertise, experts are just asoften wrong as right. Can we basepolicy decisions on what amounts tocoin flips? Models are a means of

making the most fragile of hypotheses seem strong andsubstantive. But the only thing we can really predict isthat they’ll eventually shatter.

A model is a cognitive shortcut forboth the wonk andthe journalist, thelatter of whom wants to peg his story to something authoritative.

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B Y D O N A L D J . B O U D R E A U X

The Private Provision of Public Goods

Thoughts on Freedom

Nobel laureate economist Elinor Ostrom’simportant work shows that people are verygood at using voluntary action to solve prob-

lems that economics textbooks insist require the force-ful hand of government. Producing “public goods”(such as irrigation systems for a community of farmers)often promises large enough gains to stir the creativejuices of people—who, given enough freedom ofaction and security of rights, thenfigure out how to cooperate toprovide them. This cooperationoften takes different forms fromwhat we witness in markets fortypical private goods (such asshoes).

Along similar lines otherscholars over the years have dis-covered countless historicalexamples of the successful privateprovision of public goods. Some-times it is achieved by firms seek-ing monetary profit, while othertimes it is achieved by peoplecooperating for gains that are realbut not monetized or exchangedin conventional markets.

The discovery of any suchinstance always surprises the typi-cal economist, whose thinking isstymied by too many wrongheaded models of eco-nomic interaction.

Perhaps the most surprising of these discoveries isthe issue of private currencies (or “free banking”). F. A.Hayek, George Selgin, and my George Mason Univer-sity colleague Larry White led the way in showing notonly that sound money can be supplied privately butthat it has been supplied privately—most notably inScotland from 1716 until 1844.

What about roads?Limited-access highways are no problem. Private

highway builders can erect tollbooths at entrances andexits and charge for use of their roads. No free riderswill thwart builders’ efforts to collect payment fromwilling customers.

Local city streets are different. Having tolls at eachintersection seems awfully inconvenient.

One way of solving the prob-lem of privately supplying localcity streets was seen in St. Louis.As reported by historian DavidBeito:

“In 1867, property on BentonPlace, the first private street in St.Louis, went on the market. Thestreet had been subdivided a yearearlier by Montgomery Blair,who had been Postmaster Gen-eral under Abraham Lincoln.Blair entrusted design of thestreet to Julius Pitzman. By the1870s, at least four other privatestreets ringed Lafayette Park.Pitzman laid a park median onthe street, a feature emulated bylater private places. Every lotextended to the center of themedian. Following the pattern of

Lucas Place [a St. Louis street with some private char-acteristics], each deed carried restrictions, including asetback from the street of twenty-five feet. Business useand multifamily housing were not prohibited, however.The restrictions provided for the annual election of

Donald Boudreaux ([email protected]) is a professor of economics atGeorge Mason University, a former FEE president, and the author ofGlobalization.

Reston, Virginia’s public services are delivered by a privatecompany and governed by the consent of homeowners.Joshua Davis


D o n a l d J . B o u d r e a u x

three commissioners by the lot owners. The commis-sioners had authority to maintain the street, street light-ing, the park median, sewers, and the alley by levying anannual assessment of fifty cents per front foot on eachproperty. Armed with private-street ownership, BentonPlace’s residents enjoyed a range of powers not pos-sessed [by residents of nonprivate streets].The commis-sioners, exercising their proprietary rights, erected agate at one end of the street and a retaining wall at theother. They could deny access to the alley or parkmedian to residents delinquent in their assessments tothe street association.”

Note that the private payments for this private streetwere simultaneously also payments for several otherpublic goods that people value: sewerage, a park, andstreet-cleaning services, among oth-ers. By bundling these public ameni-ties into a single package—namely,title to property on Benton Place—the developer was paid for providingthis range of public goods. Personswho didn’t buy property on BentonPlace and live up to their expressagreement to pay annual assessmentsgot no residential rights to live there.

Note, too, that Beito does not callthe assessments “taxes.” He’s right notto do so. Everyone who bought prop-erty on Benton Place expressly agreedto pay the assessments according to the contractualagreements they signed with the developer.These pay-ments, therefore, were made voluntarily.

Modern Examples

Columbia, Maryland, and Reston,Virginia, providemore recent examples of cities whose infrastruc-

tures were built and supplied privately. In both cases,private developers—James Rouse in Columbia andRobert Simon in Reston—planned and constructedthe streets, sewer lines, and parks. They then sold realestate that included a prorated portion of the infra-structure’s cost.

Obviously these developers also had incentives toprovide high-quality infrastructure.Were the streets toofew, the park too small, the sewer lines too narrow, the

maximum prices that buyers would pay for homes inthese towns would have been lower.

Interestingly, not only was physical infrastructureprovided privately in Reston and Columbia, so, too,was perhaps the most important public good of all: law.By buying real estate in Reston or Columbia, a buyeralso expressly agreed to abide by the town’s bylaws,which serve as constitutions. They specify limits onproperty use (for example, no old cars on cinder blocksin front yards) as well as procedures for making futurecollective decisions that affect all residents. Unlike con-stitutions and statutes chosen by majoritarian voting,these rules have the actual unanimous consent of thepeople they govern.

In our 2002 paper, “Contractual Governments inTheory and Practice,” Randy Hol-combe and I called the rule-makingprocedures and agencies formed bysuch constitutions “contractual gov-ernments.”We explained:

A single owner who intends to subdi-vide property and sell individualparcels forms the typical contractualgovernment. The owner’s motivationis to increase the value of the parcels.As such, the creator of the contractualgovernment has an incentive to createconstitutional rules with the highest

value. . . .The entrepreneur who forms a contractualgovernment is a residual claimant whose incomedepends on the production of efficient constitu-tional rules. In municipal government, in contrast,there is no residual claimant. Mayors, city managers,and town-council members may have some incen-tive for making efficient decisions, but not the directincentive that they would have if they were able tocapture the profit from efficient decisions directly, asis the case with contractual governments. Thus, adirect incentive exists to produce efficient constitu-tional rules under which a contractual governmentwill operate, unlike the situation that exists withmunicipal governments.

Sounds like a pretty good system.

Unlike constitutionsand statutes chosenby majoritarian voting,these rules have theactual unanimousconsent of the peoplethey govern.

19 J U N E 2 0 1 0

The Britannica Concise Encyclopedia defines imperi-alism as “the policy of extending a nation’sauthority by territorial acquisition or by the

establishment of economic and political hegemonyover other nations. Because imperialism always involvesthe use of power, often in the form of military force, itis widely considered morally objectionable, and theterm accordingly has been used bystates to denounce and discreditthe foreign policies of their oppo-nents.”

For example, Britain colonizedNorth America, and what nowconstitutes the United States, until1783 when the Brits were kickedout because out they imposed hightaxes.The Declaration of Indepen-dence had it exactly right: “He[King George III] has erected amultitude of New Offices, andsent hither swarms of Officers toharass our people, and eat out theirsubstance.”

Today, the United States makesGeorge III look like a piker. It isamazing how, with respect to taxesand freedom, the U.S. government has copied and oftenbeen more ruthless than the British Empire.As a conse-quence, the extent to which economic liberty has beendestroyed in America and what is now the EU is almostbeyond belief. It is as if the American and French revolutions never took place, or took place to providecradle-to-grave management by government over our lives.

The U.S. governments—federal, state, and local—find that extracting 35–40 percent of incomes is notsufficient. They need more to continue their marchtoward the perfect welfare state and, in the case of thenational government, military dominance of the world.As a result the tax burden under which the averageAmerican suffers is now about 20 times higher than

under George III.The EU countries are even

worse, with governments raking inaround 50 percent of national out-put. Even Louis IV of France wouldnow be viewed as a benevolentuncle compared to that. The U.S.and EU governments intrude on thefinancial lives of citizens in everyconceivable way, from taxes to regu-lations to absurd laws that shape andcontrol their citizens.

Empire of the Welfare State

The welfare state, even morethan the war on drugs or

organized crime, drives the finan-cial imperialism of the U.S. andEurope. Financing the welfare

states—most of them are technically bankrupt becauseof the huge costs of Social Security, public-sector pen-sions, medical care, and aging populations—createsmassive problems, so the United States and Europe lookhungrily abroad for more money.

B Y R O B E R T S T E W A R T

The New Financial Imperialism

Robert Stewart ([email protected]), a retired business executive, is adirector of several Bermuda companies and investment funds, and the author of A Guide to the Economy of Bermuda.

New Napoleon: Jeffrey Owens leads OECD’s attemptto foist high-tax policies on low-tax jurisdictions.OECD.org


R o b e r t S t e w a r t

Thomas Paine, who wrote of “the greedy hand ofgovernment, thrusting itself into every corner andcrevice of industry,” would be astounded at today’s situ-ation. Some taxpayers subsidize other taxpayers, or paytaxes that they later themselves get back as subventions,or pay for services they do not want or even positivelyoppose. Industry after industry is regulated by millionsof bureaucrats and thousands of pages of regulations.

Not content with levying excessive taxes on their cit-izens at home, large governments using the Organisationfor Economic Co-operation and Development (OECD)have in their sights the tax policies of small and less-influential countries whose cardinal sin is to siphon offrevenues or poach wealthy taxpayers.

Instead of fighting Britain, the United States hasnow joined hands with its formercolonial oppressor and several otherEuropean countries in seeking to pre-vent a major threat to their treasuries.(For some examples see DanielMitchell’s July/August 2009 Freemanarticle, “In Praise of Tax Havens,”www.tinyurl.com/l2crab.) What isthe nature of this threat?

There are a number of countries,disparagingly called tax havens (oroffshore financial centers), most ofthem small and insignificant, such asBermuda, Monaco, Liechtenstein, andCayman, that are allegedly sabotagingthe grandiose plans of the United States and the Euro-pean Union to create their utopian welfare states andundermining expensive military ventures in obscureplaces like Iraq and Afghanistan.

What on earth can these toe-holds on the worldatlas be up to?

According to a March 2, 2009, floor statement ofSenator Carl Levin of Michigan on the introduction ofthe “Stop Tax Haven Abuse Act,” (an earlier version ofwhich was supported by then-Senator Obama) a taxhaven is a foreign jurisdiction that maintains corporate,bank, and tax secrecy laws and industry practices thatmake it difficult for other countries to find out whethertheir citizens are using the tax haven to cheat on theirtaxes. He went on to say “that secrecy breeds tax eva-

sion. Tax evasion eats at the fabric of society, not onlyby starving health care, education, and other neededgovernment services of resources, but also by under-mining trust—making honest folks feel like they arebeing taken advantage of when they pay their fairshare.”

It is dubiously alleged that offshore tax abuses costthe U.S. treasury an estimated $100 billion each year inlost tax revenues. (As Mitchell says, “That number isphony.”) “Tax havens are engaged in economic warfareagainst the United States, and honest, hardworkingAmericans,” Levin said. The implication is that nocountry should derive a comparative economic advan-tage from its fiscal policies and that such policies shouldbe harmonized with countries like the United States.

An appropriate response might bethat this $100 billion is channeledfrom tax havens into productiveinvestment that creates jobs, wealth,and opportunities for Americansrather than disappearing into the rat-hole of government spending. Or thattax policy should not be decided byOECD bureaucrats.

Truly in many ways the world haschanged—and not always for the bet-ter—during the past two centuries.High taxes are good, and low taxes arebad now. Freedom to spend yourmoney in the way you deem best is

no longer a virtue but a sin. Diversity is out, homo-geneity in. Millions of people in the United States andEurope now depend on taxing others in order to enjoyincome, medical care, and unemployment and otherbenefits.

The greatest enemy of the modern State is not theterrorist, criminal, hoodlum, or even the foreign aggres-sor; it is the citizen who simply wants to keep his ownincome or to protect his own wealth.“Need” is definedas getting your hands on other people’s money, andgreed has come to mean the natural desire to protectyour own property and assets from sequestration bygovernments.

The jihad against low-tax jurisdictions and theimperialist tax policies being implemented by the

The greatest enemyof the modern Stateis not the terrorist,but the citizen who simply wants to keep his ownincome or to protecthis own wealth.

21 J U N E 2 0 1 0

T h e N e w F i n a n c i a l I m p e r i a l i s m

United States and the European Union have at leastfour adverse consequences.

Privacy is reduced. Increasingly, the right to be leftalone or to tell the government,“Mind your own busi-ness,” is seen as a quaint throwback to the eighteenthcentury. But is not the principle a fundamental part ofprivacy and liberty?

The enjoyment of financial and personal privacy isthe essence of a free and civilized society. Freedommeans the right to spend your own money as you likeand to talk to your lawyer or banker without fear he isa government agent.

Government power is increased. The tax laws of mostcountries are voluminous, so much so that even taxlawyers and accountants have trouble interpreting them.Everyone breaks them inadvertently.The more laws, thegreater is the power of government, and proportionatelythe freedom of the individual is dimin-ished. John Mitchell, the attorney gen-eral under President Nixon, is allegedto have said to his boss, “Let me knowwho you wish to be arrested, and I willfind a law he has broken.” He likelywouldn’t have to look further than thetax code. For anyone.

The sorry and tragic history ofgovernment power is that it is likely tobe abused, and the likelihood, or eventhe certainty, of abuse grows alongwith that power.This point was made early on after thecreation of the income tax, when Richard E. Byrd,speaker of the Virginia House of Delegates, predicted,“[A] hand from Washington will be stretched out andplaced upon every man’s business. . . . Heavy finesimposed by distant and unfamiliar tribunals will con-stantly menace the taxpayer. An army of Federal offi-cials, spies and detectives will descend upon the state.”

The income tax changed the relationship betweenthe taxpayer and government.Taxpayers are allowed toretain a portion of their earnings as pocket moneywhile the government filches the rest. Freedom tospend hard-earned wages is at the discretion of the taxauthorities.

Capital investment is reduced. One of the fundamentaland settled propositions of sound economics is that the

standard of living of everyone depends on capitalinvestment, which today is not only tools, factories, andequipment, but human capital. Capital investmentrequires resources not consumed but saved. Ludwig vonMises said it best: “The confiscation of business profitsdoes not benefit the masses. It prevents the efficiententrepreneur from expanding his efforts to supply theconsumers in a better and cheaper way, and it sheltersthe less efficient against the competition of more effi-cient newcomers. It substitutes rigidity and immutabil-ity for progress and continuous improvement.”

Inhibiting, through punitive taxation, the productionof wealth in order to create the impression of equality isnot humanitarianism but simply stupidity because itmakes everyone less well-off—especially the poor.

Tax policy is “harmonized,” that is, “cartelized.” Taxharmonization is the equivalent of tax bullying. The

hypocrisy of governments’ bullyingtax havens is appalling. If the OECDtax systems were mild, most peoplewho now use tax havens wouldn’tbother.

The belief that tax harmonizationis sound public policy has its genesisin the mistaken belief that govern-ment spending is good and privatespending is bad. This is the privateaffluence/public squalor argumentsanctified by the 1958 publication of

The Affluent Society by the late John Kenneth Gal-braith—patron saint of political big spenders. However,history tells us that when you leave people alone andkeep taxes low, economies flourish and people prosper.If the ability to avoid taxes were impossible, a tyrannicalregime could squeeze the taxpayer orange until the pipssqueaked.

Guilt by Lack of Association

One of the latest stunts of the OECD is to com-pel offshore financial centers to sign tax infor-

mation exchange agreements (TIEA), under whichauthorities in these centers can be forced to provideinformation. Failure to sign a sufficient number ofTIEAs can place a jurisdiction on a blacklist.This is abully-boy tactic.

If the ability to avoidtaxes were impossible,a tyrannical regimecould squeeze thetaxpayer orange untilthe pips squeaked.


R o b e r t S t e w a r t

Appearing on the blacklist means that there is astrong suspicion that monkey business is going on, andthat the low-tax jurisdiction is using improper secrecyto shelter potential money launderers, terrorists, taxevaders, and other assorted financial riffraff. However,the pristine reputation of the United States has beenundermined lately by research con-ducted by Jason Sharman of GriffithUniversity on Australia’s Gold Coast.Sharman tested the difficulty in set-ting up anonymous bank accounts invarious places around the world,including tax havens. The higheststandards of probity were small islandtax havens, while the lowest standardsarose in Somalia and the UnitedStates, where service providers wereprepared to set up anonymous bankaccounts without proper identification. This led Jean-Claude Juncker, prime minister of Luxembourg, to

state,“If there must be a blacklist, then America shouldhave its place on it.”

Tax competition compels governments to think morecarefully before spending the public’s money and freesentrepreneurs for greater access to investment funds.Contrary to common belief, low-tax jurisdictions do not

siphon off capital from high-tax areas,but allow a better and more effectivemeans of making investment decisions.

The Bible established a tax rate of10 percent, known as the tithe. Thatshould be enough for governments.There is little hope for optimism onthat score.

Low-tax countries are an affront tohigh-tax countries that believe theyhave a right to tell the rest of theworld how to live. So high-tax coun-

tries try to force their tax regimes on everyone else.That is financial imperialism.

Tax competitioncompels governmentsto think morecarefully beforespending the public’s money.

23 J U N E 2 0 1 0

The ears of small business America must haveperked up when President Obama spoke aboutthat critically important sector in his State of

the Union address. Mine certainly did. Here’s when itreally got interesting: “I’m . . . proposing a new smallbusiness tax credit—one that will go to over one mil-lion small businesses who hire new workers or raisewages. While we’re at it, let’s also eliminate all capitalgains taxes on small business investment, and provide atax incentive for all large businesses and all small busi-nesses to invest in new plants and equipment.”

Later the President explained therewould be a $5,000 tax credit foremploying an additional worker, for-giveness of the employer’s 6.2 percentportion of Social Security payroll taxesfor newly added salaries and othersalary increases, an end to capital gainson investment, and continuation ofrapid write-offs for new capital invest-ment, all to be targeted to businesseswith 50 or fewer workers.

Mr. Obama was right to be concerned about smallbusinesses. According to ADP’s latest report, firms withfewer than 50 workers employed some 48 million peo-ple in December 2009; those with more than 50 had 60million on the payroll. So America’s small businessesemploy close to half the workers in the economy. Buttheir hiring plans have been decidedly bleak.

On first hearing the President’s message, and cap-tured by the moment, I shouted out, “Right on! Nowwe are getting somewhere.” According to press reports,I was not alone in my enthusiastic reaction. John Arens-meyer, CEO of Small Business Majority, happily said,

“These tax credits are simple and straightforward,and will support small businesses to generate the jobs Americans so desperately need. And they’ll start doingit now.”

My response must have come from a stored-up lovefor small businesses that goes back more than 40 years.But after settling back in my chair, I had other thoughtson the matter. Let me explain.

For some 15 years, starting when I was still a collegestudent in 1952, I was a part-owner of a small businessenterprise, which in 1967 had about 50 employees. As

corny as it may sound, I still remem-ber what it takes to make a payroll onFriday night. I understand how hardit is to generate enough additionaldependable business to add just onemore employee. And I know howgreat it feels to bring one on and tointroduce the new employee to theteam members he or she will join. Ialso know how much it hurts every-one in the firm to cut back, to have

to fire a good worker because business has fallen off.Because of the pain that goes with layoffs, I know howcareful one will be before hiring another worker. In thecase of small business, that person is likely to be afriend, former colleague, or family member. Also, if thefirm employs ten people, which is common, adding onemore amounts to a 10 percent increase in personnel.

B Y B R U C E YA N D L E

Producing Jobs: Thoughts on Obama’s Plan for Small Businesses

Bruce Yandle ([email protected]) is Alumni Distinguished Professor ofEconomics Emeritus, Clemson University; Distinguished Adjunct Professorof Economics, Mercatus Center, George Mason University; and SeniorScholar, PERC. A version of this article originally appeared atTheFreemanOnline.org

America’s smallbusinesses employclose to half theworkers in theeconomy.


And that ain’t hay, especially in a recession when youare not sure if the next month will be your last.

I hope that some of Mr. Obama’s close advisersknow these things as well as, if not better than, I do. Iam betting they do.

No one in his right mind wants to bring on a newemployee only to face the plight of having to pass outmore pink slips. Before hiring that one person I wouldwant to see a lot of black ink on the operating state-ment, not just one or two profitable months. Because ofthis, I don’t think a $5,000 tax credit will get the jobdone.What we need is some certainty.

This seemed to be a base concern when Susan Eck-erly, senior vice president, federal public policy, of theNational Federation of IndependentBusiness, was asked about the Obamatax credit. She indicated that smallbusinesses wouldn’t start hiring untilearnings improved. “An employer isunlikely to hire someone just to get a$5,000 credit,” she said. When I readEckerly’s comments I was reminded ofa wise guy’s response to tax incentivesthat allowed a firm to “to take it offyour income tax.”The response:“Firstoff, I’ve got to have income.”

Obama wants to see one million new employeesadded to the ranks of America’s small businesses. I do aswell. But adding just one new full-time hire when yourtoes can barely touch the bottom in a recession’s deepend is risky business, and for one major reason. At thispoint there is no way to know what really lies ahead;there is no way to distinguish between stimulus and thereal economy. Too many policy boulders are beingdropped in the water. One can hardly determine theeffects of one before another one is thrown in the pool.

There was stimulus one. Then stimulus two. Andnow talk of stimulus three. There was TARP. Cash for

Clunkers. Cash for Appliances. First-Time Homebuyertax credits. Health care revision. Copenhagen. Cap andtrade. Jobs programs. Financial reform. Each announcedin short succession. The effects of some of these pro-grams are so large that they are readily seen in GDPand construction data. By some counts, about half of2009’s fourth quarter 5.7 percent GDP growth isexplained by Cash for Clunkers, a program that cameon like gangbusters and then faded into oblivion.

Imagine yourself as owner of a small business with20 employees who’s trying to decide if you shouldbuild up inventories again, hire one or two people, andlease another pickup truck.Would you make your deci-sion on the basis of the fourth-quarter GDP numbers?

Would you base your plans on theexplosion of existing home sales thatfollowed the First-Time Homebuyerstimulus? Most likely not. I’ll bet youwould wait so that you could get abetter fix on the real economy.

Perhaps we need six months ofpolitical silence.

When I think about the situationand Mr. Obama’s proposal, I wonderif it might be better to expand thenoble elements of his idea to all busi-

nesses, small and large, and do so permanently. Insteadof having a complicated jobs-based tax system, why notjust cut the marginal tax rate? And instead of allowing atemporary moratorium on capital gains taxes for smallbusinesses, why not just abolish capital gains taxes for allbusinesses? Doing this would put an end to trying todetermine what is stimulus and what is real and whatmay change at the end of the year.

There is a supply side to the economy that wants tospring forward.A growing economy will produce morejobs. This is the time to give a nudge and then standback and let the real economy recover.

Adding just one newfull-time hire whenyour toes can barelytouch the bottom ina recession’s deep endis risky business.

B r u c e Ya n d l e

25 J U N E 2 0 1 0

B Y B U R T O N W. F O L S O M , J R .

Comparing the Great Depression to the Great Recession

Our Economic Past

President Obama has often remarked that theGreat Recession (2008–10) is the greatest eco-nomic crisis since the Great Depression. It’s

interesting to study the many parallels between theGreat Recession and the Great Depression.

Causation. The main causes of both crises lie inactions of the federal government. In the case of theGreat Depression, the Federal Reserve, after keepinginterest rates artificially low in the 1920s, raised interestrates in 1929 to halt the resulting boom. That helpedchoke off investment. Also, President Hoover signedinto law the sky-high Smoot-Hawley Tariff, which sti-fled trade and damaged American exports throughoutthe 1930s. Finally, the President signed a large taxincrease into law in 1932, whichhalted entrepreneurship.

The seeds of the Great Recessionwere planted when the government inthe 1990s began pushing homeown-ership, even for uncreditworthy peo-ple, with a vengeance. Mortgage-backed securities built on dubiousmortgage loans became “toxic” when the housing mar-ket took a downturn, and many American banks vergedon collapse.The government’s urgent desire to bail outvarious banks and corporations created uncertainty andinstability, and this may have widened the recession.

Massive federal spending. Presidents Roosevelt andObama responded similarly to the crises. They talkedabout balancing the federal budget, but insteadresorted to massive spending. Earlier presidents, likeCleveland and Harding, cut spending when the nationwas threatened with economic hardship. Hoover wasthe transition president, running deficits with recordspending on public works, the first federal welfare program, and the first large-scale federal farm pro-gram. The results were budget deficits and 25 percentunemployment.

President Roosevelt became Hoover on steroids.FDR and his advisers, despite some early moves to cutspending and control the deficit that Hoover leftbehind, decided that ever-larger federal spending wouldtrigger economic expansion and pull the country outof its economic slump.Thus Roosevelt began the Agri-cultural Adjustment Act (AAA), which paid farmers notto produce, and then expanded Hoover’s Reconstruc-tion Finance Corporation, which provided bailoutmoney to large banks and corporations. He alsoexpanded spending on public works and targeted largesubsidies to various special interests.

President Obama, who often cites FDR, followedhis example of targeting spending to interest groups.

He signed into law a $787 billionstimulus package that sent tax dollarsto various cities and voting groupsacross the nation. He later supportedan expensive “jobs bill” that wouldsend money into key congressionaldistricts. The President also cam-paigned for a cap-and-trade bill and

universal health coverage, both of which promised toincrease the federal debt substantially. In fact, theincrease in federal debt under Obama and Roosevelt issimilar.The national debt more than doubled in Roo-sevelt’s first two terms, and it is projected to doubleagain in eight to ten years.

Spending fails. After the large increases in federalspending under Roosevelt and Obama, unemploymentremained high. In the 1930s unemployment fluctuated,but recovery never occurred. In April 1939, toward theend of Roosevelt’s second term, unemployment wasalmost 21 percent. Treasury Secretary Henry Morgen-thau complained,“We are spending more than we have

Burton Folsom, Jr., is a professor of history at Hillsdale College and authorof New Deal or Raw Deal? He blogs at BurtFolsom.com.

President Rooseveltbecame Hoover on steroids.


B u r t o n W. F o l s o m , J r.

ever spent before and it does not work.” Nonetheless,almost all of FDR’s programs continued—usually withannual budget increases.

When Obama took office unemployment was at 8percent, and in the next year it steadily increased toover 10 percent before falling back just under thatmark. He and his advisers were puzzled that largespending increases did not slash unemployment, and heargued that his spending was saving jobs that wouldotherwise have been lost.

Critics of Roosevelt and Obama insisted that it wasimpossible to spend our way out of a recession. Duringthe New Deal, economics writer Henry Hazlittobserved that public-works spending destroyed as manyjobs as it created.“Every dollar of government spendingmust be raised through a dollar of taxation,” Hazlittemphasized. If the Works Progress Administrationbuilds a $10 million bridge, for exam-ple,“the bridge has to be paid for outof taxes. . . .Therefore for every publicjob created by the bridge project aprivate job has been destroyed some-where else.”

Tax rates raised. During the GreatDepression Roosevelt raised bothincome and excise taxes. In 1935, with FDR’s push,the top marginal tax rate hit 79 percent. Few paid thatrate, but thousands of Americans were in the 50-per-cent bracket. Entrepreneurs had to hand over morethan half of any income above a certain level. Facingdisincentives to make capital investments, many entre-preneurs used their wealth cautiously—investing intax-exempt bonds, art collections, and foreign banks.Little wealth went into creating jobs, so high unem-ployment persisted. During World War II FDR raisedtaxes further, to 94 percent on all income over$200,000.

Most of the tax hikes under Obama are planned forthe future.Thus far we have seen proposed tax hikes onproducts such as cigarettes, liquor, plane tickets, and softdrinks. He wants the tax cuts enacted under PresidentBush to expire. That will mean a spike in the capitalgains tax, the income tax, and the estate tax. As FDR

showed, tax hikes eventually follow large spendingincreases.

Scapegoats. The sequence of massive federal spend-ing followed by a lack of recovery plus tax hikes ispoison for a politician. Therefore Roosevelt soughtscapegoats to explain his failure. Wall Street bankerswere his favorites. He called them “economic royal-ists” and blamed them for causing the Great Depres-sion. He also blamed America’s top businessmen forinstigating a “capital strike”—they were refusing toinvest in order to make him look bad. FDR thenlaunched IRS investigations of key Republicans andused the newspapers to encourage hostility towardthese targets.

Obama has followed FDR’s playbook of attackingWall Street bankers and various corporate leaders. Hecondemns the raises these bankers sometimes receive

and the profits earned by some largeoil companies and health insurancecompanies.

Such emphasis on “class warfare”may be an inevitable part of redistrib-uting wealth from one group toanother. Perhaps Roosevelt andObama believed that by increasing

envy and resentment toward some Americans, theycould capture the votes of larger groups of Americansand thereby win reelection (in FDR’s case there is evi-dence of this). True, this strategy guarantees that manywealthy Americans will attack any president who usesclass warfare, but the campaign for redistribution willalways supply large amounts of money to subsidizefavored groups.

When Roosevelt was reelected in 1936 SenatorCarter Glass,Virginia Democrat, admitted, “The 1936elections would have been much closer had my partynot had a 4 billion 800 million dollar relief bill as cam-paign fodder.”

Obama may be hoping his “stimulus” package andhis health insurance bill will generate similarly largesupport among Americans receiving federal benefitsand that these voters will go to the polls to overwhelmthose who are paying the bills.

Obama has followedFDR’s playbook.

27 J U N E 2 0 1 0

On February 22, a court in suburban Washing-ton, D.C., passed judgment in one of themost horrendous cases of child abuse in mod-

ern times. Renee Bowman, the adopting parent ofthree girls, had for years starved, neglected, and beatenthem, while keeping them locked night and day in their bedroom. She choked two of the girls to death,put their bodies in plastic bags, and stored them in the freezer. The third girl escaped by jumping from a window.

At first glance, these child murdersmay seem an inexplicable, isolatedtragedy; a closer look reveals that thisoutrage was constructed, piece bythoughtless piece, by the modernwelfare state.

In It for the Money

The first error came with theselection of Bowman as the

adoptive parent. She was obviously anegligent and seriously derangedperson who never should have been approved for adoption. Well,who approved her? The adoptionhad been supervised from start to finish by a govern-ment agency, the District of Columbia’s Child andFamily Services. In theory, it was supposed to estab-lish that Renee Bowman was a suitable parent. Inpractice it didn’t even notice, or care, that she had a criminal record—she threatened a 72-year-old with bodily harm—a rather glaring instance of “government failure” by this notoriously incompe-tent agency.

The next link in the tragedy concerns Bowman’smotivation for adopting the children. If she did not lovechildren, if she saw them as a burden, why had shebothered with the expense and effort of adoptingthem? The answer is money. In 1980 Congressapproved a subsidy program to provide payments toparents who adopt children from foster care. I’m surelawmakers thought it was a useful idea. If the federalgovernment can buy tanks and bombs, after all, whycan’t it buy adoptions?

Well, it does buy adoptions, butnot high-quality ones.Worthy parentsadopt out of love, conviction, enthusi-asm, and dedication. They are willingto make real sacrifices for their chil-dren. Putting money on the tablechanges the mix of motivations. Yes,loving parents will still appear, butinsensitive people who view childrenas an economic commodity also comeforth. Renee Bowman was one ofthese insensitive, grasping types. Shewas being paid $2,400 a month by thefederal government to be listed as themother of these three girls; altogether

she collected $152,000. “This woman was in it for themoney,” said the prosecutor at the trial.“And by killingthe children, keeping them literally on ice, the moneycontinued to flow.”

B Y J A M E S L . PAY N E

Are Welfare State Orphans in Good Hands?

Contributing editor James Payne ([email protected]) has taught politicalscience at Yale,Wesleyan, Johns Hopkins, and Texas A&M. His latest bookis A History of Force: Exploring the Worldwide Trend AgainstHabits of Coercion, Bloodshed, and Mayhem. This article firstappeared at TheFreemanOnline.org.

Worthy parents adoptout of love, con-viction, enthusiasm,and dedication.Putting money onthe table changes themix of motivations.


J a m e s L . P a y n e

Keeping Adoptions Low, Abuse High

Officials point out that without adoption subsidiesto attract parents, children would languish in the

state foster care systems.There’s some truth to this, butit exposes another flaw in the state system of handlingorphans. A survey by the National Center for HealthStatistics found there were nearly 600,000 womenseeking to adopt children, a figure over four times thetotal of 129,000 children in foster care available foradoption.The oversupply of willing parents holds for allcategories of children, including older children, blackchildren, and children with disabilities. But under gov-ernment management, adoption from foster care hasbecome a tortuous, burdensome process demeaning toprospective parents. The governmentagencies are so focused on trying toapply a host of bureaucratic regula-tions that they repel many, especiallyindependent-minded individuals criti-cal of silly red tape and micromanage-ment. The result is that childrenremain stuck in foster care. Even so,hundreds of thousands of peoplewould like to adopt them.

The severity of government impediments to adop-tion was documented by a study undertaken in 2005 byListening to Parents, a nonprofit research group. It fol-lowed 1,000 prospective parents who called a publicchild-welfare agency seeking to adopt. Out of this ini-tial group, only 36 adoptions occurred.

Having inadvertently contrived a deplorably lowadoption rate, government sought to correct the prob-lem by applying government’s inevitable fix-all: throw-ing more money at the problem, in the form ofadoption subsidies. They created a situation of moralhazard where a person like Renee Bowman mightadopt children primarily for the money, and, lackinglove and a sense of responsibility, might neglect andabuse them.

Bowman’s was not an isolated case. Washington Postcolumnist Courtland Milloy reported in February 2009that in the previous eight months at least seven adoptedchildren in D. C. had been killed, their adoptive parents

charged or suspected in the homicides. And those arejust the murder cases—that we know about. Given the number of children in Washington, D. C.’s adoptionsubsidy program, it’s fair to wonder if neglect and abuseshort of murder are far more widespread than anyonewould like to imagine

This brings us to the most shocking failure in thissorry episode. After the deadly consequences of themisguided adoption subsidy became screaming head-lines, officials did nothing! They didn’t close down theprogram.They didn’t fire, fine, or imprison employeesresponsible for the miscues. They didn’t resign inshame and embarrassment. Jobs and careers depend onthis program: It’s in officials’ economic self-interest to

downplay its problems. The same istrue of the pressure groups that rep-resent parents taking the subsidy.Their attitude was captured by aWashington Post reporter:“Even withlimited oversight, most children endup in safe and supportive families,advocates said.”

In the old days, before we gothardened to welfare-state abuses, wewould have said that a system that

resulted in even one murdered child was unacceptable.Today, the self-interested participants of the welfarestate are content with a program where “most” of thechildren aren’t slain.

The solution to the travesties being committed bygovernment child welfare agencies lies right before us:Move away from the welfare state as fast as we can.Turn the problems of orphans, foster care, and adop-tion back to private charitable and commercial enti-ties, unsubsidized by tax money and largelyunregulated.

Will errors occur in this voluntary system?Undoubtedly they will, but they wouldn’t be met withinstitutional shrugs of the shoulders.The voluntary sys-tem would have this advantage: If a private agency wasimplicated in a tragic malfunction, donors and cus-tomers would be free to turn away from it and theagency would disappear.

Even after themurders wererevealed, officials did nothing.

29 J U N E 2 0 1 0

B Y S H E L D O N R I C H M A N

Jefferson’s Economist

Peripatetics

In 1817 the Frenchman Destutt de Tracy (1754–1836)published his Treatise on the Will and Its Effects.Thomas Jefferson was so enthusiastic about Tracy’s

book that he had it translated, then edited and revisedthe translation himself. He renamed it A Treatise onPolitical Economy.

Why was Jefferson so excited about the work? Itcontains a clear appreciation of the free society thatwould have excited anyone with Jefferson’s philosophi-cal and political proclivities. Let’s have a look at some ofwhat Tracy had to say.

We should first note that Tracy anticipated (thoughimperfectly) key insights of the Austrian school of economics, which would come intobeing a little more than half a cen-tury later at the University of Viennaunder Carl Menger. The classicalschool of economics associated withAdam Smith’s The Wealth of Nations(1776) leaned on an objective theoryof value; the value of goods was saidto be determined by the amount oflabor embodied in them. Exchangefor Smith consists of the trading ofequivalents (measured in labor time). But here’s Tracy,four decades later, stating something very close to thesubjective utility theory of value that would mark theAustrian school’s revolutionary approach to economics:

In general we may say that whatever is capable ofprocuring any advantage, even a frivolous pleasure, isuseful. . . . [T]he measure of the utility of a thing, realor supposed, is the vivacity with which it is generallydesired. . . . Now, how are we to fix the degrees of athing so inappreciable as the vivacity of our desires?We have, however, a very sure manner of arriving atit. It is to observe the sacrifices to which thesedesires determine us. . . . [A]n exchange is a transac-

tion in which the two contracting parties both gain.Whenever I make an exchange freely, and withoutconstraint, it is because I desire the thing I receivemore than that I give; and, on the contrary, he withwhom I bargain desires what I offer more than thatwhich he renders me.

Thus, contra Smith, Tracy understood that peopleexchange unequal things on the basis of differing assess-ments of their utility, or usefulness.

And like a good proto-Austrian who understandsthat the future is uncertain,Tracy hastens to add:

In truth it is possible that, in anexchange, one of the contractors, oreven both, may have been wrong todesire the bargain which they con-clude. It is possible they may give athing, which they will soon regret, fora thing which they will soon cease tovalue. It is possible, also, that one of thetwo may not have obtained for thatwhich he sacrifices as much as hemight have asked, so that he will suffer

a relative loss while the other makes an exaggeratedgain. But these are particular cases which do not belongto the nature of the transaction.

As a result of his insights,Tracy has a distinctive wayof describing society:

Society is purely and solely a continual series ofexchanges. It is never anything else, in any epoch ofits duration, from its commencement the mostunformed, to its greatest perfection. And this is the

Sheldon Richman ([email protected]) is the editor of The Freeman andTheFreemanOnline.org.

Destutt de Tracy’streatise contains aclear appreciation ofthe free society.


S h e l d o n R i c h m a n

greatest eulogy we can give to it, for exchange is anadmirable transaction, in which the two contractingparties always both gain; consequently society is anuninterrupted succession of advantages, unceasinglyrenewed for all its members. . . .

It is this innumerable crowd of small particularadvantages, unceasingly arising, which composes thegeneral good, and which produces at length thewonders of perfected society.

Those are some of the fundamentals of Tracy’s posi-tive economics. From there he moves on to normativeeconomics, or political economy. Given what he hassaid already, we should not be surprised that heembraces freedom and property:“[S]ociety should have for its basis,the free disposition of the faculties ofthe individual, and the guarantee ofwhatever he may acquire by theirmeans; then every one exerts himself.One possesses himself of a field bycultivating it, another builds a house,a third invents some useful process,another manufactures, another trans-ports; all make exchanges; the mostskilful gain, the most economicalamass.”

Tracy points out that land is a keysource of income that in a free soci-ety competes with employers for labor, maximizingworkers’ bargaining power by providing an alternativeto wage employment.

[S]o long as society has not occupied all the spaceof which it may dispose, all still prosper with care;for those who have nothing but their hands, andwho do not find a sufficiently advantageous employ-ment for their labour, can go and possess themselvesof some of those lands which have no owners, andderive from them a profit so much the more consid-erable, as they are not obliged to lease or buy them.Accordingly care is general in new and industriousnations. But when once all the country is filled,when there no longer remains a field, which belongsto nobody, it is then that pression begins.Then those

who have nothing in advance, or who have too lit-tle, can do no otherwise than put themselves in thepay of those who have a sufficiency.They offer theirlabour every where, it falls in price.

Curiously, Tracy does not acknowledge that landmay become unavailable not because of populationdensity but because the government has seized it andgiven it to the nobles or cronies. In fact, this happenedrepeatedly in England. State-sponsored “land monop-oly” and the exploitation it made possible were deepconcerns of libertarians from the early nineteenth cen-tury into the twentieth century.

Tracy understood that through government inter-vention class conflict emerges, as own-ers of land and capital seek advantageover those who labor for them:

After the free disposition of hislabour, the greatest interest of thepoor man is that this labour should bedearly paid. Against this I hear violentoutcries. All the superior classes ofsociety—and in this view I even com-prehend the smallest chief of a work-shop—desire that the wages should bevery low, in order that they may pro-cure more labour for the same sum ofmoney; and they desire it with so

much fury, that when they can, and the laws permitthem, they employ even violence to attain this end,—andthey prefer the labour of slaves, or serfs, because it isstill at a lower rate.These men do not fail to say, andpersuade, that what they think is their interest, is thegeneral interest; and that the low price of wages isabsolutely necessary to the development of industry,to the extension of manufactures and commerce,—in a word, to the property of the state. [Emphasisadded.]

Thus the State is implicated in class conflict, a theme that originated not with Marx but with earlylibertarians.

In future columns, I’ll examine Tracy’s views ongovernment spending and borrowing.

Tracy points out that land is a keysource of income that in a free societycompetes withemployers for labor,maximizing workers’bargaining power.

31 J U N E 2 0 1 0

In 1986 and 1987 I slipped behind the Iron Curtaina few times to study economic perversity and polit-ical slavery. In November 1987 I flew into Hungary

before heading on to the most repressive regime inEurope.

The train from Budapest to Bucharest, Romania,was called the Orient Express. The original OrientExpress began in the 1880s and connected Paris toConstantinople. The menu on thetrain’s first run included oysters,turbot with green sauce, chicken “àla chasseur,” fillet of beef with“château” potatoes, and a buffet ofdesserts. In the communist rendi-tion of the Orient Express, therewas no food on the train in Roma-nia, though a few morsels may havebeen available in Hungary.

I had a cabin to myself as thetrain rolled southeast fromBudapest. I had been told that ifborder guards found a map ofRomania or any other dubiouspapers, I could be arrested ordenied entry. So late at night, near-ing the Romanian border, I studiedthe documents one more time,drilling into my head the things thatI should be looking for.Then I tore everything up andthrew it out the train window, piece by piece.

Shortly after midnight the train lumbered to a stopin Transylvania, at the Hungary-Romania border.The scene had all the ambience of the original 1932Dracula movie. I didn’t hear wolves howling, but the

mountain terrain, low-hanging fog, and military guards with German shepherds circling the train time andagain sufficed.

My cabin was searched four times, with each teamoutdoing its predecessors. The mattresses on the bunkbeds were jostled, and practically every cubic inch ofspace was poked or prodded.

The final inspection was supervised by a cute (bysocialist standards) military officer.Perhaps the authorities thought Iwould confess my perfidy to theopposite sex. Nope: I was justanother tourist heading to the “Parisof East Europe,” as Bucharestpreened in pre-communist times.Except that there were almost zerotourists in a land renamed “theEthiopia of Europe.” (I entered thecountry illegally—relying on an eas-ily acquired tourist visa, instead ofenduring the hassles and delays for ajournalist visa.)

After the final search, guardsbolted my cabin shut from the out-side. The pseudo-luxury train hadofficially been converted into atraveling jail. But at least the intel-lectual-political virus was quaran-

tined. My American passport had earned me specialtreatment. I just leaned back and counted my bless

B Y J A M E S B O VA R D

Orient Express to Hell

Contributing editor James Bovard ([email protected]) is the author ofAttention Deficit Democracy,Terrorism and Tyranny, Lost Rights,and other books.

Ceausescu, the World Bank’s darling, had to fleehis former subjects by helicopter when his government broke down.Denoel Paris


J a m e s B o v a r d

ings: In Western Europe they charged double for aprivate cabin.

The Orient Express was no longer an express after itentered Romania, taking 13 hours to go roughly 400miles and running far behind schedule.

Everywhere were signs of a government increas-ingly fearful of its people. Throughout Transylvaniaradio towers were surrounded by military guards andbarbed wire. The train stopped at Brasov, a medievalcity renamed Stalin City in 1950. A dozen years later,as friction rose with Moscow, Brasov regained its old name. Shortly before I passed through, thousands of workers responded to wage cuts by ransacking communist party offices and killing two governmentmilitia men.

Romania looked double-damned by governmentplanning and political meddling.There were horse-drawn wagonsnext to spewing factories and hugeapartment complexes. Many peoplehad abandoned their slipshod carsafter government sporadically bannedthe sale of gasoline for private vehicles.

Around nine the next morning,there was a rapping on my cabindoor—like someone sending a secretmessage. I heard someone struggling with the boltedlock. The door popped open, and half a dozen ragtagRomanian workers poured in. They had heard therewas a foreigner—perhaps an American—confined onthe train. They obviously knew how to overturn thebolt that sealed the door.The workers stared at me likeI was E.T., and it probably wasn’t just because of the oldcanvas hat I was wearing.Two of them leaned over andpawed/stroked my leather boots—eyes wide in amaze-ment. Leather boots had apparently become the sametype of luxury there that full-length mink coats were inAmerica. Yet, in the pre-communist era, leather bootswere probably routine for factory and farm workers.Wecommunicated with simple gestures since I did notspeak Romanian and they spoke no English. Theyseemed full of goodwill, but vanished after a few min-utes—perhaps fearful of being caught talking to a foreigner.

Starved Into Submission

The workers were likely no fans of NicolaeCeausescu, the communist dictator who made

Romania the most barbaric and repressive regime inEurope. Though Romania had been a breadbasket ofEurope before World War I, food had become as rare ashonest economic statistics. The communists destroyedhundreds of square miles of prime farmland to erectfactories and open-pit mines. The governmentresponded to food shortages with a publicity campaignon the danger of overeating. The government alsorevved up advertising in western nations toutingRomania’s “world famous” weight-loss clinics.

Ceausescu seemed determined to starve the peopleinto submission. Romanians were forbidden to receivefood shipments from foreigners. Visitors were stopped

at the Romanian border and deniedentry if they attempted to bring in achocolate cake or bubble gum.

The government put almost allinvestments into heavy industry—theultimate source of bragging rights forcommunist leaders. But roughly halfof Romanian factory output was soshoddy it was ready for the junk heapas soon as it left the gate.

Romanian industry was alsoextremely inefficient, consuming up to five times asmuch energy per unit of output as western factories.The government compensated by cutting off electricityto people’s homes for up to six hours during the win-ter and permitting only one 25-watt light bulb per room.

The health system was collapsing, and the infant-mortality rate was so high the government refused to“register” children as being born until they survivedtheir first month. The government also routinely cut off power to hospitals, which had caused a thousanddeaths the previous winter.

The Darling of the World Bank

Yet some western experts thought Ceausescu wasthe greatest thing since sliced bread.A 1979 World

Bank report, the “Importance of Centralized EconomicControl,” praised the Romanian regime for pursuing

Everywhere weresigns of a governmentincreasingly fearful ofits people.

33 J U N E 2 0 1 0

O r i e n t E x p r e s s t o H e l l

“policies to make better use of the population as a factor of production [by] stimulating an increase inbirth rates.”

And how did the benevolent ruler do this? By pro-hibiting distribution of contraceptives and banningabortions. These policies turned Romania into theworld capital of abandoned babies.

Finally arriving in Bucharest, I learned that theHotel Intercontinental was the only place westernerswere allowed to stay. After I checked in, a beefy thirty-ish woman came up and asked in a gravely three-pack-a-day voice:“Would you like to have some company?”

I said no, and got away from her quick.The Roman-ian government was famous for using its intelligenceagents as prostitutes. The woman had the hotel stakedout, hoping to gather information from visitors or toentice them into behavior that could be videotaped andused to betray them.

I checked into my room, whichlooked like it was custom-designedfor surveillance. I flipped on the TV set and saw choruses of peasantsand workers in overalls listlessly waving flags and singing the praises of Ceausescu, the self-proclaimed“Genius of the Carpathians,” as thecamera zoomed in for close-ups ofthe great man’s face.

Fascinating stuff, but the plot line was a bit flat, so Isought entertainment elsewhere.

When I visit a new city I love to spend hours walk-ing around—getting a feel for the turf. I stopped at theconcierge desk at the Hilton and asked for a street mapof downtown Bucharest. I figured it might have a walk-ing guide to the Greatest Triumphs of Ceausescu-ismwithin an eight-block radius of Communist Partyheadquarters.

The guy grimaced and eyed me like I had asked fora detonator for a bomb strapped underneath my over-coat.

“For what do you need a map?”“Because I want to see the city’s landmarks.”“We have no maps. If there is some place you want

to go, you tell me what it is and I will tell you how toget there.”

“Where is the old part of the city?” I asked, know-ing that most of it had been razed to make room for the ugliest “socialist realism” monoliths outside ofNorth Korea.

The concierge scowled and muttered something—perhaps the Romanian slur for vexatious foreigners. Myhunch was this guy didn’t make a living from tips.

On the street many people darted their eyes away—as if looking at foreigners might cause leprosy. I hadheard that it was a crime for Romanians to talk tostrangers. But a few people summoned up a hodge-podge of broken English, pleading for a pack of Kent cigarettes to bribe doctors to treat their sick children. The Romanian currency was practicallyworthless. The only things with value were westerngoods, like those Kents, which circulated as a black-market currency.

I stepped into the largest depart-ment store in Bucharest; it was dark,dank, and miserable. Sales clerkslounged on piles of new clothingheaped on the floor. One of the mainattractions in the store: incrediblyrickety baby carriages—the kind touse when you want to kill your kidand sue the pants off somebody.Except that this government never

had any liability to its victims, no matter how manyperished from its products or policies.

I passed by the boarded-up front door of an ancientchurch, standing naked amidst construction projectsthat had razed its surroundings. Many Romanians fret-fully crossed themselves as they passed the church.

The U.S. embassy was surrounded by Romaniantroops with machine guns to prevent Romanians fromentering and asking for asylum.

Like other communist regimes, Romania was aneconomic theocracy. The government used its iron fist to make sure everything happened according to the Plan. For instance, the 1986-90 five-year plandecreed that Romanian scientists would make 4,015discoveries, of which 2,423 would result in new prod-ucts by Romanian businesses. It’s not surprising that the regime “planned” creativity, since it considered itself omniscient.

The only things withvalue were westerngoods, such as packsof Kent cigarettes.


J a m e s B o v a r d

Romania was one of the World Bank’s favoriteregimes, receiving more than $2 billion between 1974and 1982. It predicted in 1979 that Romania would“continue to enjoy one of the highest growth ratesamong developing countries over the next decade . . .and become an industrialized economy by 1990.” Butmuch of Romania’s apparent economic growth was theresult of World Bank aid.The more handouts it gives acountry, the easier it becomes to portray the nation as asuccess story. Then-World Bank president RobertMcNamara cited Romania to tout his own “faith in thefinancial morality of socialist countries.”

Human Resources

The World Bank also praised the Romanian regimefor its ability to “mobilize the

resources” required to boost eco-nomic growth. In reality this merelymeant that the government couldbrutalize its subjects to squeeze out“surpluses” to lavish funds on WorldBank-approved industrial enter-prises. Ceausescu was doing thesame thing Stalin did in the 1930s,when he starved up to ten million peasants to squeezefarmers to generate surpluses to build new factories.

The Romanian regime also “mobilized resources”by pawning its ethnic German and Jewish inhabitants.(West Germany would pay money for each ethnic Ger-man released from Romania). International agreementsbanned slave trading in the nineteenth century, but sell-ing human beings in the twentieth century was okay ifthe receipts went for progressive purposes.

The World Bank never cut Ceausescu off; instead, heceased borrowing after he became convinced that west-ern debt was a curse on his country.

As I knocked around Bucharest I assumed I wasbeing followed. Roughly one in 15 Romanians wasworking as a government informant.

From my experience elsewhere in the East Bloc, Iknew that pulling out a notebook set off the alarm

bells. Instead, I jotted down notes on the palm of myhand. Such behavior was likely to be seen as merelyweird not menacing. Single words served me as pegs tolater pull up a strand of facts and thoughts.

Late the next afternoon I arrived at Bucharest’s mainairport to fly to Frankfurt. I noticed that most of thebusinessmen ahead of me were openly giving a pack ofKents to each guard or other dreg at the four differentsecurity checkpoints.

I had bought a couple cartons of Kents before goingto Romania, and I was soon passing out cigarette packsto airport guards like an old widow tossing candy tokids on Halloween.

I saw one or two German businessmen yanked asidefor more invasive searches. As I passed the last check-

point, I thanked my lucky stars that Ihad avoided such depredations.

That Lufthansa jet on the tarmac wasthe prettiest thing I had seen since theOrient Express crossed the Romanianborder.

There was one graying soldier stand-ing about 20 yards from the plane. Iheld up my passport, and he waved

me on.I had almost reached the gangway when I heard:

HALT! I turned and saw the guard running toward me, his

submachine gun bouncing off his ample belly.Puffing a bit, he caught up to me, grabbed my left

arm, yanked it back, and pointing at my palm,demanded to know:

“WHAT IS THIS?!!!?”I looked at my hand, then I looked at the guard.“It’s ink.”He paused, squinted, nodded his head knowingly,

and then waved me on to the plane.Two years later, 5,000 Romanians were killed dur-

ing an uprising that overthrew the government.WhenCeausescu and his wife were summarily executed onDecember 25, 1989, it was probably the best Christmaspresent Romanians ever received.

Romania was one ofthe World Bank’sfavorite regimes.

35 J U N E 2 0 1 0

In a letter dated May 23, 1946, the libertarian pub-lisher R.C. Hoiles wrote to Leonard E. Read, whowould establish the Foundation for Economic Edu-

cation later that same year. Hoiles advised Read onwhat he believed was the underlying cause of America’salarming shift from individual liberty toward socialism:

I am inclined to think that thegrass roots of our trouble is ourtax-supported school system. It isteaching by example that mightmakes right; that the end justifiesthe means; that there is no lawsuperior to the will of the major-ity. How can we expect the youthof the land, when the public gen-erally believes in tax-supportedschools, to believe in freedom, theAmerican way, or a definite lim-ited government?

In place of a tax-funded and com-pulsory school monopoly, Hoilesargued passionately for a voluntary,private system. It was an argument hesustained throughout his long,remarkable life.

Raymond Cyrus Hoiles (1878–1970) epitomizes theAmerican dream. Born into comfortable but modestcircumstances, he rose through hard work and merit.Athis death at the age of 91, his corporation, FreedomNewspapers, Inc., owned 16 daily newspapers, includ-ing the influential Orange County Register (originally theSanta Ana Register), with a collective circulation of over

half a million.The California Press Association honoredhim posthumously as a “Great Crusader for IndividualFreedom” who was respected for “his conservatism.”

Hoiles is often mischaracterized as conservative.At aquick glance the confusion is understandable. For onething, Orange County, California, became a center ofconservatism in the decades following World War II.As

the county’s foremost newspaper,the Register often ran conservativecolumnists and letters to the editor.But it was Hoiles’s libertarian voicethat dominated through editorials.

Hoiles insisted the editorial pagewas “a daily school room madeavailable to its subscribers.” In thatschoolroom Hoiles taught what hecalled “voluntaryism.” A November1953 editorial, “Articles of Faith,”distilled its essence:“[A] governmentis a good government that only doeswhat each and every individual hasthe moral and ethical and just rightto do.” If it was not right for an indi-vidual to take money by force, thenit was not right for a government todo so in the name of “taxation.”

Another of the “Articles” stated, “I have faith that ourgovernment would better protect every person’sinalienable rights if it was supported on a voluntarybasis rather than by taxes.”

B Y W E N D Y M C E L R O Y

R.C. Hoiles and Public Schooling

Contributing editor Wendy McElroy ([email protected]) is anauthor, the editor of ifeminists.com, and a research fellow for theIndependent Institute in Oakland, California.

R. C. HoilesPhoto courtesy Orange County Register


W e n d y M c E l r o y

Perhaps no single issue better captures the libertar-ian spirit of Hoiles than his feisty stand on education.The “Articles” declared, “I have faith that we will bebetter educated by voluntary, competitive schools thanby government schools.”This statement must have star-tled conservatives who viewed the public schools as asuccess story. Indeed, a then-favored conservative strat-egy was to enter school board races. By contrast, Hoilesinsisted he had no more right to vote for a school offi-cial than he did to vote for a trustee within a govern-ment-owned brothel. (Perhaps for shock value, Hoilesrepeatedly compared public schooling to prostitution;he once declared,“A house of prostitution is voluntary,grade school is not.”)

Opposition to tax-supported schools became adominant theme in Hoiles’s writing;his last editorial in the Register dealtwith “something-for-nothing schoolsthat have had a great influence in con-ditioning pupils to believe in some-thing for nothing.” On occasion,Hoiles even found it necessary todefend the considerable amount ofspace school issues occupied in hispaper. On October 15, 1945, hewrote,“The amount of space the Reg-ister is devoting to the junior collegebond issue might cause some to thinkwe are overestimating the importanceof the issue. There is nothing moreimportant than the principles back of the issue.”

An Integrated System of Belief

The “principles back of the issue” involved an inte-grated system of beliefs about government, society,

morality, and human nature.Hoiles rooted his theory of government in the Dec-

laration of Independence—a document he quoted fre-quently—namely, that government derives its justpower from the consent of the people and ultimatelyfrom the consent of the individual himself, who pos-sesses inalienable rights.

“Articles of Faith” expressed this theory of society:“[G]aining understanding of nature’s laws is the bestway to be useful to one’s self and to his fellow man.”

One of nature’s fundamental laws was “the superiorityof voluntary, competitive human endeavor over com-pulsory activity.” Freedom of association, including afree market, fueled the goodwill that civil societydepended on; forced association destroyed it.

Hoiles based his morality largely on the Ten Com-mandments and insisted on “a single standard”: Every-one without exception should act according to thesame moral code. What was wrong for a private indi-vidual was equally wrong for a government official. In alater policy statement, Hoiles offered the essence of thisuniversal code: the Ten Commandments, the GoldenRule, and the Declaration of Independence.

His theory of human nature stressed the perfectibil-ity of man through effort and the exercise of moral

character. He believed this per-fectibility resided in each humanbeing, which seemed to make himsomewhat blind to differences ofrace, gender, and social status. Formeremployees often commented on howhe would engage a janitor in intellec-tual discussion as quickly as he woulda writer.

Hoiles’s evolution on educationbegan in a “little red schoolhouse”across from his family’s large farm-house in Alliance, Ohio, where, helater explained, he learned “that theState, or a majority of citizens, had

the right to use taxation to support the public schoolsystem.” His school texts exposed the political “error”of the divine right of kings but “they never explainedthe error in the divine right of the majority. It simplysubstituted the divine right of the majority for thedivine right of kings.” Nor did his school books explain“the basic principle that governments derive their justpowers from the consent of the individual; that thegovernment had no right to do anything that each andevery individual did not have the right to do. Instead,they had to teach that the government or the localschool district, if the majority so willed, had a right toforce a Catholic parent, or a childless person, or an oldmaid, or an old bachelor to help pay for governmentschools. . . .”

Hoiles repeatedlycompared publicschooling toprostitution; he oncedeclared,“A house of prostitution isvoluntary, gradeschool is not.”

37 J U N E 2 0 1 0

R . C . H o i l e s a n d P u b l i c S c h o o l i n g

At the same time as they legitimized taxation, how-ever, Hoiles’s teachers spoke of the Ten Command-ments, including “Thou shalt not steal” and “Thou shaltnot covet.” He observed wryly, “[T]he governmentschool I attended made no attempt to be consistent andteach me to recognize contradictions.” The contradic-tions did not surprise Hoiles, who explained, “Theycannot teach the single standard of rightness becausethey are practicing a double standard.”They could notteach moral values “any more than a robber can teachhonesty.”

Hoiles’s higher education must have also imbuedhim with skepticism about government education.Theknowledge he valued most had been self-taught andcame from experience. While studying electrical engi-neering at the Methodist Mt. Union College(Alliance), Hoiles worked part time at his brotherFrank’s daily paper, the Alliance Review, and discoveredwhat became a lifelong passion for thenewspaper business. Hoiles must havewondered if his college education hadbeen wasted. Later in life he com-plained of the common perceptionthat “going through the public schoolsand colleges is education.”

In 1932 Hoiles temporarily left thenewspaper business and began to readinsatiably. Even though he had shownlittle interest in philosophy to date, he acquired thebackground to sprinkle future writing with quotationsfrom an amazing range of authors: from Frédéric Bastiatto Ayn Rand, from John Locke to Spinoza.

The most influential was Bastiat. In a 1955 editorialHoiles wrote,“He was the first man who awakened meto the errors, taught in government schools and moreProtestant colleges, that the state doing things that wereimmoral if done by an individual made these actsbecome moral. In other words, he was the first man thatpointed out that there was only one standard of rightand wrong.”

In 1935, at 56, Hoiles arrived in Orange County,where he had purchased an established newspaper.Withhim, Hoiles brought not only his family but also anevolved philosophy of freedom, which he aggressivelyapplied, especially to public education.

A September 3, 1946, editorial in the Register titled“Most Sacred of All Popular Idols, Government Educa-tion,” typifies both Hoiles’s style and content inapproaching the issue.The editorial is clearly answeringcritics who argued that public education is a necessarygood because it leads to a literate population.

Hoiles opened by quoting an anonymous “lover offreedom” (Leonard Read) who defined the proper roleof government as a “restraining force rather than a forceto compel people to do good.” Considering govern-ment education from this angle, the “lover of freedom”concluded “it has all the characteristics of other formsof socialism.”

Some people, Hoiles continued, may see little differ-ence between the earliest “red schoolhouses” that werevoluntarily supported and the subsequent tax-fundedones. “True,” he stated, “the socialism incident to the‘little red school’ was only a slight departure from the

procedure of a few neighbors pool-ing their resources, voluntarily, toemploy a teacher to instruct theirchildren. But once the socialisticprinciple is admitted, once the idea issanctioned of using government’spowers of coercion to take the fruitsof the individual’s labor for the ‘col-lective good,’ there is no logical stop-ping point.”

Hoiles went on to quote Isabel Paterson’s The God ofthe Machine: “There can be no greater stretch of arbi-trary power than is required to seize children from theirparents, teach them whatever the authorities decreethey shall be taught, and expropriate from the parentsthe funds to pay for the procedure.” Thus, continu-ing the quote, “[n]eighborly, small-scale socialism ineducation has expanded and developed until today we are faced with the disaster of national socialism ineducation.”

The “disaster” was partly economic. Hoiles cited sta-tistics showing how the costs of educating one individ-ual had increased more than ten times from 1880 to1940, with no corresponding increase in quality.Indeed, quality had declined—partly due to increasedbureaucratization, partly to the severing of connectionbetween a teacher’s wages and his or her need to satisfy

Modern teachersneed only to satisfythe government, theirsource of income.


customers (the parents and children). Modern teachersneeded only to satisfy the government, their newsource of income.

“Government educators are becoming less and lessservants of those from whom revenues are extracted orfrom whom their pupil raw material is conscripted,”Hoiles wrote. “More and more they are becomingvested interests, concerned with their own employmentand tenure. More and more they are allying themselvesas a pressure group with other bureaucratic interests.More and more they are using their strategic positionto turn the minds of the young towards statism andinterventionism.”

Attacking on yet another front, Hoiles explained theterrible impact that government teachers have on thecharacter development of children. “Itake the stand against tax-supportededucation because I believe . . . that theadvantage of being able to read andwrite is far outweighed by the destruc-tion of individual initiative, enterpriseand responsibility brought about bygovernment education’s poison of sta-tist psychology. Practically every youthin the land is a socialist at heart. Howcan he help but be unless he comesfrom a family that is steeped in thebelief in true liberty and the dignity ofman and recognizes that multiplying arobbery does not make it right?”

It is not possible to understand thepassion with which Hoiles and other advocates of indi-vidual freedom addressed public education withoutestablishing the context. In the early twentieth century,education in America underwent a political revolution,becoming the lynchpin of the Progressive Era—aperiod of social reform, from the 1880s to the 1920s.Acentral tenet was that government needed to play alarger role in solving social problems and in promotingthe “social good.” “Popular,” or public, education wasviewed as a prerequisite and the key to reconstructingsociety by molding generations to come. In his water-shed book, Democracy and Education (1916), John Deweyadvocated using popular education as a conscious toolto remove social evil and promote social good. Slowly,

the classical curricula that aimed at rigorous educa-tion—such as familiarity with Latin, a stress on his-tory—were replaced by programs aimed at creating“good citizens.”

Hoiles was outraged by his children’s curriculum.In a 1961 editorial he reminisced about an incidentinvolving his daughter Jane. After reviewing one of herschool textbooks, he appeared before the directors ofthe Santa Ana Chamber of Commerce to protestagainst school books that “set forth the principles ofKarl Marx.” Hoiles’s purpose was not to ban or censorbut to assert a parent’s right to guide his children’s edu-cation. Nevertheless, the book was pulled.

Why, then, did Hoiles’s children attend publicschool? He told a Newsweek reporter, “There was no

place else to send them.”A particularly provocative strategy

of his was spelled out in the May 23letter to Read. Hoiles explained, “Ihave repeatedly offered a member ofthe Board of Education in Santa Ana,who is a preacher, $100 if he wouldpublicly attempt to harmonize tax-supported schools with quotationsfrom Jesus. He will not undertake it. Ialso made the offer to the superin-tendent of schools. He will notundertake it.” Hoiles wondered if heshould up the ante to $500 and con-struct the discussion as a debate, per-haps with Isabel Paterson, Rose

Wilder Lane, or Read himself. Hoiles considered theoffer a fail-proof maneuver. If the preacher accepted,the flaws in his argument would be exposed. If herefused, then the refusal would “cause the people of thecommunity to wonder . . . whether tax-supportedschools are doing what they think they are doing.”

R.C. Hoiles died on October 30, 1970, at 91.Withinhis lifetime he made no lasting impact on publicschooling. But times change. Current discontent withgovernment education is so deep and widespread thathomeschooling has become a phenomenon and othersgrasp at any route out. I can only imagine Hoiles’sresponse to a revival of his moral crusade against publicschooling.

“I believe that theadvantage of beingable to read and writeis far outweighed bythe destruction ofindividual initiative . . . brought about bygovernmenteducation.”

W e n d y M c E l r o y

39 J U N E 2 0 1 0

B Y J O H N S T O S S E L

The Right to Work

Give Me a Break!

The people of Louisiana must sleep soundlyknowing that their state protects them from . . .unlicensed florists.

That’s right. In Louisiana, you can’t sell flowerarrangements unless you have permission from the gov-ernment. How do you get permission? You must pass atest graded by a board of florists who already havelicenses. To prepare for the test, you might have tospend $2,000 on a special course.

The test requires knowledge of techniques thatflorists rarely use anymore. One question asks the nameof the state’s agriculture commissioner—as though youcan’t be a good florist without knowing that piece ofvital information.

The licensing boarddefends its test, claimingit protects consumersfrom florists who mightsell them unhealthyflowers. I understand theestablished florists’ wishto protect their profes-sion’s reputation, but inpractice such licensinglaws mainly serve tolimit competition. Mak-ing it harder for new-comers to open florist shops lets established florists hogthe business.

Other states are considering adopting Louisiana’slicensing law, but before any do, I hope that the law willbe stricken. The Institute for Justice, a public-interestlaw firm, has challenged the licensing in court, saying it violates liberty and equal protection, and so is uncon-stitutional.

“One of the most fundamental tenets of the Ameri-can dream is the right to earn an honest living withoutarbitrary government interference.What could be more

arbitrary than saying who can and who cannot sellflowers?” IJ President Chip Mellor says.

Other states have their own sets of ridiculous licensing rules. In Virginia, you need a license to be ayoga instructor. Florida threatened an interior designerwith a $25,000 fine if she didn’t do a six-year appren-ticeship and pass a test, at a cost of several thousand dollars. Fortunately, the Institute for Justice got that law overturned.

I’m rooting for IJ because licensing interferes withthe freedom to make a living, harms consumers by lim-iting competition, and protects established firms. It’s anold story. Established businesses have always used gov-

ernment to handcuffcompetition. Years ago,small grocers tried toban supermarkets. A&Pwas going to “destroyMain Street,” the gro-cers cried. Minnesotalegislators responded totheir lobbying by pass-ing a law that forbadesupermarkets to holdsales. Consumers werehurt.

What about Doctors and Lawyers?

Okay, while licensing of florists, interior designers,and yoga teachers is ridiculous, what about more

important professions, like law? Surely people needprotection from people who would practice law with-out a license. Again, I say no. The lawyers’ monopoly on helping people with wills, bankruptcies, and

John Stossel hosts Stossel on Fox Business Network and is the author ofMyths, Lies, and Downright Stupidity: Get Out the Shovel—WhyEverything You Know is Wrong. Copyright 2010 by JFS Productions,Inc. Distributed by Creators Syndicate, Inc.

Hey buddy, you got a license for those begonias?plantasyflores [flickr.com]


divorces is just another expensiverestraint of trade.

David Price recently spent sixmonths in a Kansas jail because hewrote a letter on behalf of a man whowas wrongly accused of practicingarchitecture without a license. WhenPrice refused to promise never to“practice law” again, a judge sent himto jail.

All he did was write a letter. Pricedidn’t misrepresent his credentials.However, he did save a man from pay-ing $3,000 to a lawyer. Perhaps thatwas his real offense.

Competition is better than government at protect-ing consumers from shoddy work. Furthermore, licens-ing creates a false sense of security. Consider this:Whenyou move to a new community, do you ask neighbors

or colleagues to recommend doc-tors, dentists, and mechanics eventhough those jobs are licensed? Ofcourse. Because you know that evenwith licensing laws, there is a widerange of quality and outright quack-ery in every occupation. You knowthat licensing doesn’t really protectyou.

A free competitive market forreputation protects consumers muchmore effectively than governmentcan. Today, online services likeAngie’s List (www.angieslist.com)make it even easier for consumers to

get better information about businesses than govern-ment licensing boards will ever provide. We do needprotection from shoddy businesses. But it’s freedom andcompetition that produce the best protection.

J o h n S t o s s e l

Start your weekday morning with

One click of the mouse … and FEE’s popular news e-commentary will come to your computer five days a week.

Subscribe online: www.thefreemanonline.org or e-mail: [email protected]!

Competition is betterthan government atprotecting consumersfrom shoddy work.Furthermore,licensing creates afalse sense of security.

41 J U N E 2 0 1 0

Book Reviews

Obamanomics: How Barack Obama Is BankruptingYou and Enriching His Wall Street Friends,Corporate Lobbyists, and Union Bossesby Timothy P. CarneyRegnery • 2009 • 256 pages • $18.45

Reviewed by George Leef

In his previous book, The BigRipoff (reviewed in the June

2007 Freeman), author TimothyCarney launched an attack on twoof America’s preeminent politicalmyths—that the Democrats are“the party of the little guy” and theRepublicans are “the party of freeenterprise.” Both notions are useful

to candidates in the endless quest for votes, but both areoverwhelmingly false. Yes, some Democrats deeplybelieve that all they do is helpful to Americans strug-gling to get by, and some Republicans really want tomove towards laissez faire. Party leaders, however, areremarkably similar in their embrace of a corporativephilosophy (or perhaps we should say, strategy) thattrades favors to well-established institutions inexchange for campaign support.

With Obamanomics, Carney narrows the focus of hismicroscope to explain, as the book’s subtitle says, “howBarack Obama is bankrupting you and enriching hisWall Street friends, corporate lobbyists, and unionbosses.” Under Carney’s high magnification, Obama’scampaign rhetoric that he would kick out the special-interest lobbyists and only listen to the voice of thepeople is exposed as a fantastic prevarication. Not onlyhave the lobbyists not been kicked out, they have beenwelcomed in like long-lost children.

Many Americans will instinctively recoil from Car-ney’s argument. They believe something like this:“Obama is for more government economic control andbusinesses want less control because they favor freemarkets.” Carney blows that idea to smithereens, show-ing that big business generally does not want free mar-

kets (which are unpredictable due to competition andconsumer sovereignty) and likes regulations to suppresscompetition and guarantee profits.The key point of thebook is that big business doesn’t lobby for free markets;it lobbies for government favors.

Carney produces a mountain of evidence to supporthis case. To begin with, campaign contributions frombig businessmen (and of course other moneyed groups,including lawyers and unions) flooded into Obama’s2008 campaign far more freely than into the campaignof the ostensibly pro-business candidate, John McCain.People associated with Goldman Sachs were majorcampaign contributors, with their money flowing intothe Obama treasury at a ratio of four to one overMcCain.That was not an anomaly. Contributions frommany industries went lopsidedly to the supposedly“anti-business” candidate.

The standard line from the media about this, whenit was noted at all, was that these commercial giantswere just buying “access” with the probable winner toensure that they wouldn’t be treated too harshly in thecoming administration. Carney refutes that notion bypointing out that Obama had long been cozy with cer-tain corporate interests (such as ethanol) and that evenin their inchoate stages, Obama’s policy initiativespromised steady, predictable revenues for certain busi-nesses and industries. They weren’t just buying access.They were eagerly supporting the candidate mostinclined to their corporatist desires.

After his election Obama’s policies suited manyindustries just fine. The prodigious “stimulus” packagewas manna from heaven for those whose lobbyistsknew how to direct the flow of federal dollars. “Withmore than 800 lobbyists working on it,” Carney writes,“the stimulus particularly benefited the tech industryand its representatives.” As one corporate insider hequotes said, green lobbyists went into a “feedingfrenzy.”

Instead of resources flowing into businesses to pro-duce goods and services that consumers wanted,resources were directed into politically connected firmsto produce things that appeal to politicians (or perhapsproduce; some of the “stimulus” projects have sincebeen shown to be fraudulent). The impact of Obama-nomics, Carney concludes, is to shift economic power


Book Reviews

“from consumers, workers, and investors to politiciansand bureaucrats.”

Readers will find their blood pressure rising as Car-ney takes us through the vast corporate welfare tuckedinto ObamaCare, the environmental crusade’s “cap andtrade” legislation, Obama’s favoritism toward theUnited Auto Workers and the car companies it hasdone so much to ruin, the administration’s fondness forregulations that help big business stifle competitionfrom smaller rivals, and, perhaps most disgustingly of all,the Wall Street bailout. “Conservatives like to think ofWall Street as a bastion of capitalism, but that imageignores the ways in which our financial sector dependson government protection,” Carney observes.

We are mired in recession, and mountains of gov-ernment debt will soon hit us like an avalanche. WillAmericans fall for the deception that returning to pros-perity depends on still more of the statism that hasbrought us to this dire situation? If they’ve read Obama-nomics, they won’t.

George Leef ([email protected]) is book review editor of The Freeman.

The Case for Big Governmentby Jeff MadrickPrinceton University Press • 2008 • 224 pages • $22.95

Reviewed by Robert Batemarco

Could it be that our alreadyimmense government is still

too small? That’s what some people,including economic journalist JeffMadrick, would have us believe.

The first sentence of The Case forBig Government reads, “It is conven-tional wisdom in America today thathigh levels of taxes and government

spending diminish America’s prosperity.” While this is,indeed, wisdom, it is hardly conventional, at least in ournational and state capitals, and that wisdom has not hada meaningful role in policy for over 80 years.

From that sentence on it’s all downhill. The book’stheme is that principled calls to limit government’spower to benefit the few at the expense of the many are

nothing but rigid ideology, which must now make wayfor “pragmatic solutions.” Of course, such “pragmatism”has long been a cover for removing all restraints ongovernment power and trusting that those who wield itwill do the right thing. To prove my point, Madrickfavorably cites Alexander Hamilton’s view that laissezfaire “was to be respected but to be violated when nec-essary.”Translation: It is to be routinely violated.

The book is divided into three parts.The first recapshow well “pragmatic” government has served us in thepast (according to Madrick anyway); the second aversthat change is inevitable and sees more governmentpower as the only way to deal with it; the finale lays outthe specific policies the author believes will cure ourills. Naturally, all call for further expansions of govern-ment power to tax and control us.

What passes for analysis in this book is an embar-rassment. Inconsistencies abound. For instance, theauthor correctly asserts that flexible labor markets areindispensable for economic growth, yet two pageslater he endorses a higher minimum wage and thereinvigoration of labor laws to facilitate the spread ofunions into new industries. He also demonstrates dif-ficulty distinguishing free-market rhetoric from free-market policies. He correctly points out that theReagan and Bush administrations practiced Keynes-ianism, yet blames their nominally laissez faire policiesfor our recent stagnation. Since Keynesian policies arethe antithesis of laissez faire, one cannot logicallyblame problems originating from those policies on laissez faire.

Madrick invariably fails to appreciate the implica-tions of the things he does get right. For instance, headmits that the post-World War II demobilizationspurred a recovery rather than the relapse into depres-sion unanimously expected by those who relied onKeynesian analysis, yet he doesn’t acknowledge thatthis is strong evidence of just how mistaken that analy-sis is. He also admits that governments err and that theprograms they create tend to live forever, but he givesthem a pass since businesses too make errors and are ashard to shut down. Not only is that last statement fac-tually inaccurate—faltering businesses are much easierto shut down than wealth-draining government pro-grams (56 percent of new businesses fail within four

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years; the number of government programs that haveever been terminated is miniscule)—but the exampleshe gives, such as Chrysler, are still in business onlybecause of government bailouts.The attempt to equatebusiness fallibility with government blundering isabsurd.

In setting forth his wish list in part 3, Madrickasserts that giving the federal government control overan additional 5 percent of our GDP will do noharm—in other words, it has no opportunity cost. Heoffers no theoretical basis for that assertion. Much ofthe evidence he cites in support of particular pro-grams is provided by some of the likely beneficiaries.Madrick sees only the nice hoped-for results andnever realizes that politically connected big businessand big labor groups will gain the most from mush-rooming government.

Worst of all, however, Madrick is blind to the factthat expansion of government means contraction ofliberty. The big-government policies he advocates won’t just waste resources; they will also further whittleaway at our freedom. Look at the authoritarian detailsof the recent “health care reform” legislation, such asthe mandate for individuals to purchase insurancewhether or not they want it, and you see that big gov-ernment is not a kindly uncle.

I could go on, but that should suffice.The underly-ing problem not only of this book, but also of would-be central planners of every stripe, is the denial of theprimordial fact of scarcity. Madrick’s frequent denunci-ations of “the age of limits” can mean nothing else.Since scarcity and the human actions to deal with it arethe ultimate foundations of economics, the case for biggovernment is based not on economics but rather onspecial pleading devoid of principle and logic.

Robert Batemarco ([email protected]) is senior director of business insightsat a marketing research consultancy in New York City.

Race & Liberty in America: The Essential Readeredited by Jonathan BeanUniversity Press of Kentucky/Independent Institute • 2009 •352 pages • $42.50 hardcover;$21.20 paperback

Dred Scott’s Revenge: A Legal History of Race andFreedom in Americaby Judge Andrew NapolitanoThomas Nelson • 2009 • 320 pages • $25.99

Reviewed by Roger Clegg

Two recent books criticize racialdiscrimination from a classical-

liberal perspective.The first, Race & Liberty in America,

is an anthology edited by JonathanBean, a professor of history at SouthernIllinois University. It includes dozens ofselections, from 1776 to today, arguing

eloquently for colorblind equality before the law andagainst slavery, Jim Crow, and racial preferences (affir-mative action). Fittingly, Bean also includes much fromthe immigration context. (Bean earlier authoredanother important book in this area, Big Government andAffirmative Action: The Scandalous History of the SmallBusiness Administration. )

In his introduction,“Civil Rights and Classical Lib-eralism,” Bean notes that, given the domination todayof “the politically correct view that left-wing liberals orradicals completely dominated the struggle for racialfreedom,” it is no surprise that “classical liberals are theinvisible men and women of the long civil rights move-ment.” Bean illuminates their role in the fight againstgovernment discrimination.

Some of the names and selections in the book areunsurprising. There are several pieces by FrederickDouglass, for example, and the “I Have a Dream”speech by Martin Luther King, Jr. But there are alsosome surprises, like the excerpts from Warren Harding,Calvin Coolidge, and Herbert Hoover. Most of the


Book Reviews

pieces pertain to the oppression of blacks, but there areseveral excellent ones regarding government discrimi-nation against Asians, especially the Chinese.The pointis unmistakable:Those who hold a principled belief inliberty oppose all government oppression.

Especially useful are the selections Bean includesthat show how the business community, so oftenaccused of being in favor of racial discrimination,often opposed it. A series of letters regarding imposedsegregation in trolley cars, for example, proved to be aneye-opener.

Bean balances readable and relatively short excerptswith intelligent commentary in the introductions.Thebig message of the book is that many of our greatthinkers shared the vision that equality and progresswill result from freedom, not the heavy and coercivehand of the State.

That’s also the thrust of Dred Scott’s Revenge:A LegalHistory of Race and Freedom in America by AndrewNapolitano, a former New Jersey state judge and fre-quent commentator on the Fox News Channel.Napolitano claims in his introduction,“The real culpritthroughout our racial history has been the govern-ment,” and his book accordingly documents and con-demns a variety of bad government policies and actionsfrom the colonial era to today.

Freeman readers will not be surprised to hear thatgovernments, rather than the private sector, have beenthe most systematic and powerful purveyors of racismand discrimination. (This theme is both explicit andimplicit in Bean’s book as well.) Conversely, slavery,Jim Crow regulations, and our current mania for racialpreferences would have been much more difficult orimpossible under a system that limited governmentpower to its proper defensive functions and maximizedindividual freedom.

In other ways, too, there is considerable overlap inthe two books. Both Napolitano and Bean abhor racialdiscrimination as not only unconstitutional but deeplyimmoral as well.

Despite the fact that I’m sympathetic to Napoli-tano’s instincts, I cannot recommend his book for anumber of reasons. He believes courts should ignorethe Constitution if it is inconsistent with the judge’sview of what natural law requires, which is an endorse-

ment of judicial activism. His historical arguments con-flate the failure of federal government interventionwith active discrimination. And sometimes Napolitanotries to get by with assertion where proof is called for.

So the cost-conscious libertarian (is there any otherkind?) should purchase Bean’s book rather thanNapolitano’s. To be fair, no matter how persuasiveNapolitano’s opinions were, they would not be as valu-able as the treasury of original sources that Bean hascompiled. Napolitano himself—as well as Shelby Steele,Richard Epstein, Linda Chavez, Stephan Thernstrom,and Ward Connerly, among many others—favorablyblurbs Bean’s book, calling it “a history buff ’s dream,”and he’s right.

Roger Clegg ([email protected]) is president and general counsel of theCenter for Equal Opportunity in Falls Church,Virginia.

Financial Fiasco: How America’s Infatuation withHomeownership and Easy Money Created theEconomic Crisisby Johan NorbergCato Institute • 2009 • 186 pages • $21.95

Reviewed by Waldemar Ingdahl

Free-market greed stands accusedof undermining the world

financial system, but that is a mis-taken analysis, writes Johan Nor-berg. The Swedish author madefamous by his book In Defence ofGlobal Capitalism is back to providean explanation for the currentfinancial crisis.

Many factors led to the global financial fiasco,Norberg writes, including a naive policy that priva-tized profits and socialized losses, risk-taking based onblind faith in computer models’ ability to predict themarket, and a false sense of security bred by govern-ment assurances that the taxpayers would back up badloans. This brought an unsustainable growth of assetsand liabilities.

The title of the Swedish original (which I read) is APerfect Storm, an expression describing an event where arare combination of circumstances drastically aggravates

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a bad situation. That certainly describes the financialimplosion that began in 2007. Norberg explains theevents leading to the credit crunch through one chill-ing example after the other. The conscious actions offinancial, political, and bureaucratic decision-makersand consumers might not have been too dangerous inthemselves, but in combination they proved utterly disastrous.

According to Norberg, after the dot-com bubbleand 9/11, Federal Reserve Chairman Alan Greenspanacted to avoid a recession by stimulating the economywith record-low interest rates in a sort of “pre-emptiveKeynesianism.” But the Fed misjudged the state of theeconomy and kept the interest rates down far too long.Effective interest rates actually turned negative, buildingthe momentum for another bubble.

The low rates encouraged even greater risk-taking,not to mention a mountain of debt passed on to thefuture. Instead of going into a recession, the globaleconomy saw an artificial, temporary rise in prosperity.China’s policy of keeping its currency undervalued tostimulate its exports while pumping its surplus of capi-tal into U.S. bonds supported the process and hid theimbalances created by the Fed.

Predictably, artificially low interest rates inflated thereal estate market. No sector of the economy is moresensitive to interest rates than real estate, and Americanpoliticians put massive pressure on two government-sponsored enterprises, Fannie Mae and Freddie Mac, tolower their standards to enable vast numbers ofunsound mortgages. The resulting foreclosures willleave a terrible mark in the minds and on the creditreports of millions.

Norberg is no less critical of the actions of the WallStreet capitalists. Weak oversight of money placed ininvestment and pension funds, coupled with hugebonus systems, encouraged shortsighted gambling withother people’s money. Lurking behind all that was theassumption that there was little risk because the mort-gage-backed securities were implicitly guaranteed bythe federal government.

In the public debate following the credit crunch,many argued as if the financial markets were ruled bylaissez faire, but the credit-rating agencies had an oli-

gopoly due to regulations. Such regulations break downthe barriers between the government and the market.The problem was not too little regulation. Rather, itwas faulty regulation upheld by a multitude of nationaland international agencies. Tough international bankregulations punished traditional banking, while pushingbad loans into a shadow banking system to avoid trans-parency.

Financial Fiasco ends on a pessimistic note, predictingthat we will see extensive, long-term governmentinvolvement in the financial sector for years to come.“Create a crisis, and people will give you more powerto fight it,” Norberg writes. He points to the risk thatpolitically well-connected corporations and interestgroups will not only further distort competition (as inthe case of TARP), but also cause new losses andcrashes. Politicians in many European countries havealready subtly begun to require that banks concentratelending in their national economies. A growing finan-cial protectionism would throw more gravel in thefinancial machinery. We might also see a new wave oftrade protectionism.

The book’s most important lesson is that the prob-lem isn’t the current recession, but the previous boom.It was during the boom that poor investments weremade based on hidden inflation and far too optimisticforecasts. The recession is the cure, when labor and capital are reallocated to better uses and produc-tivity improves.

In its brevity, the book provides an interesting,accessible explanation of the reasons for and conse-quences of the financial crisis. It would have bene-fited, however, from specific recommendations onhow to get to a freer economy.What must we do—orundo—to prevent politicians from repeating theboom and bust cycle? There is a dire need for a soundpolicy, but unfortunately hasty and simplistic “solu-tions” based on populist slogans have prevailed. Nor-berg says that people must realize that government hasits limitations, but he doesn’t tell us just where weshould draw the line.

Waldemar Ingdahl ([email protected]) is president of Eudoxa,a think tank in Stockholm, Sweden.


Book Reviews

B Y W A LT E R E . W I L L I A M S

Drugs, Economics, and Liberty

The Pursuit of Happiness

Only a few people would dispute that narcoticscan harm people, whether that harm is in theform of damage to the body, mental and

physical dependency, or threats to social relationships.However, there is not nearly as much consensus as towhat the correct public response to narcotics use andsales is. Ideas range from decriminalization to the cur-rent outright prohibition.

Let’s start by acknowledging that there is no ques-tion whatsoever that the sale and use of narcotics in ourcountry could be virtually eliminated. It could beaccomplished at a monetary cost far less than the hun-dreds of billions spent so far in thenation’s “war on drugs.” We could suspend habeas corpus and constitu-tional guarantees against unreasonablesearches to more easily gather evidenceon people who use or sell drugs. Wecould make those arrested bear theburden of proof of innocence and onconviction summarily execute them.Countries with far less wealth and farfewer police resources than ours have used that strategyto reduce drug use, and so could we.Thankfully, I thinkmost Americans would, and should, recoil in disgust atthat kind of drug-war strategy. So we have to examineless draconian measures. A few thoughts on the eco-nomics of drug trade might give us guidance.

There’s no mystery why people use mind-alteringdrugs: It makes them feel good, at least temporarily.That’s not only true of cocaine, heroin, and marijuana;it’s also true of mind-altering products like cigarettes,cigars, coffee, tea, wine, and whiskey. There’s consider-able evidence that many people prefer their vices in adiluted form. Hence the popularity of filtered ciga-rettes, light beer, wine coolers, and mixed drinks. Thesame seems to be true, at least to some extent, aboutillicit drugs.

When what are seen as vices are legally prohibited,supply responses change people’s behavior. Imaginethere’s a supplier of illegal marijuana. Government stepsup its efforts to stop its supply by increasing interdic-tion efforts, along with stiffer fines and prison sen-tences. Which is easier to conceal and transport—amillion dollars’ worth of marijuana or a million dollars’worth of cocaine? Obviously, it’s cocaine because thereis far less bulk per dollar of value. Thus one effect ofprohibition is the tendency toward increased sales anduse of more-concentrated forms of drugs that caninclude products such as crack cocaine, ice, and meth.

Another impact of prohibition ison prices. To supply the addictionneeds of those who are not able topay the prohibition-induced higherprices of cocaine, producers will seekto find cheaper substitutes such ascrack. This is borne out by the factthat crack is far more popular amongpoorer addicts than wealthier ones.

Invitation to Make a Killing

Illegality, high prices, and high profits, coupled withgreater government drug-interdiction efforts, also

encourage entry by suppliers who are more ruthlessand innovative, and who have a lower regard for civil-ity and the law. Panty-waisted, petty, and otherwiselaw-abiding practitioners are ousted. In addition,since the courts are unavailable to enforce agree-ments made among traders, as in the case of legaltransactions, disputes are more likely to be settledthrough violence.

Yet another supply response to prohibition, largelyignored in the drug debate, is the inevitable tendency

47 J U N E 2 0 1 0

Walter Williams is the John M. Olin Distinguished Professor of Economicsat George Mason University.

Prohibition increasessales and use of more concentratedforms of drugs.

toward corruption of public officials.Today’s drug trade,like the Prohibition liquor trade, could not flourishwithout official corruption. It’s not difficult to see howpolice officers, customs inspectors, and other law-enforcement officers earning $50,000, $60,000, or$70,000 a year could succumb to the temptation of$5,000 or $10,000 bribes to look the other way. Nodoubt there are elected officials who are also temptedby bribes. Even otherwise law-abiding nondrug-usingparents are quieted by money and expensive gifts fromtheir children who are involved in the drug trade.

The war on drugs restricts supply and raises prices.When one drug operation is busted up, another oneemerges virtually overnight to take its place.When theDEA, FBI, and local police make a big drug bust, law-abiding citizens should not be jubilant. Instead, theyshould expect higher prices, leadingto more ruthlessness among drugusers and buyers, more crime andcorruption, and greater social costs.

Sanctioning Civil Rights Abuses

Another very dangerous cost ofthe war on drugs is that it has

given respectability to the violation ofour constitutional guarantees. Civil-forfeiture laws have been enacted, inclear violation of the Fifth Amendment, under whichproperty can be confiscated without due process.A par-ent can have his automobile or house confiscated if,even when unbeknown to the parent, his offspring usesit in connection with drug use or sales. Anti-money-laundering laws violate our rights to privacy in ourtransactions. Murderers and rapists have been freedfrom crowded prisons to make room for nonviolentdrug users.

From the demand, or personal use, side of the drugissue, what should we do? Lysander Spooner(1808–1887), one of the great American thinkers of thenineteenth century, suggested that while vices may beself-destructive or offensive, like all peaceful, voluntaryactivities they should remain outside the province oflaw and government. The vices Spooner referred to

include “gluttony, drunkenness, prostitution, gambling,prize-fighting, tobacco-chewing, smoking and snuffing,opium-eating, corset-wearing, idleness, waste of prop-erty, avarice, hypocrisy, etc., etc.” Spooner added that ifpractitioners of these and other vices cannot bereformed voluntarily, if they go on to what other mencall destruction, then they must be permitted to do so.He reminds us that the maxim of law is there can be nocrime without criminal intent to invade the propertyor person of another.

People practice vices for what they perceive as theirown happiness—not to violate the rights of another. Ina free society people have the right to destroy their ownlives but not those of others. When government coer-cion is used to promote virtue, there cannot be liberty.However, there is conduct that people might engage in

under the influence of narcotics, suchas impaired driving, robbery and bur-glary to fund their habit, and otheracts that threaten the rights of others.Such acts are already criminal andshould be punished.

We Americans have to ask our-selves if there is a better way to dealwith the drug problem. I think thereis. We need to focus more on thedemand side of the drug problem.

After all, most people don’t use marijuana, cocaine, andheroin.The reason they don’t has nothing to do with itsprice or the fact it’s illegal. Their decision has muchmore to do with their values and common sense.Rather than near-exclusive reliance on the law andgovernment, I believe greater and longer-lasting gainscan be made through civil society, where we can cajole,admonish, and teach people about the destructiveeffects of narcotics—and ostracize them if necessary.

It is foolhardy to have a public policy that forcespeople hell-bent on destroying their own lives tobecome violent criminals and destroy the lives of innocents in the process. It is also foolhardy for societyto create circumstances in which official integrity iscompromised and our constitutional guarantees areviolated.


Wa l t e r E . W i l l i a m s

The war on drugs hasgiven respectability to the violation ofour constitutionalguarantees.

volume 60, no 5 june 2010 · edited by jonathan bean dred scott’s revenge:a legal history of race...

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