Freedomnomics: Why the Free Market Works and Other Half-Baked Theories Don't by John Jr. (books that read to you TXT) 📕

Government attempts to solve free-riding problems are typical examples of the state’s economic inefficiency. In fact, we’ve grown so accustomed to the inadequacies of government that we typically use different standards for evaluating private and public spending. For example, economists deem private markets to be efficient when the cost of an additional unit of some product reflects how much buyers value it. But when is that ever a consideration in government spending? Just look at tax payments generally: the top 5 percent of income earners pay 57 percent of federal income taxes, while the bottom 50 percent pay just 3.3 percent.15 In a democracy, those who provide little of the government’s income have more of a say—in the form of their combined votes—over how to spend government funds than those who provide most of the money. Of course, this is not to suggest that the votes of big taxpayers should be weighted more than those of smaller ones. It’s just to point out that government spending is inherently inefficient because those who actually pay for most government services are not the ones who determine how the money is spent.

This helps to explain why government intervention is so often inefficient. 16 In private markets, you can’t get people to pay more for a product than they value it. If the asking price is too high, they simply say “no.” But there is no similar limitation on the government, which pays for things by levying taxes. And taxes are coercive—you can’t refuse to pay taxes just because the government is paying more for something than you value it.

Take government programs such as flood insurance. These aren’t like traditional private insurance programs where people are charged according to the risk they represent. Private insurance companies closely match the premiums to the risk level or else they quickly go out of business. If they charge too much, their customers go elsewhere. If they charge too little, they lose money. While things have improved somewhat in recent years, for decades the government insurance programs charged everyone the same amount regardless of risk. The government charged the same flood insurance premiums for beachfront houses as it did for homes in the middle of the desert. As late as June 30, 2005, the Congressional Research Service was still reporting on the “repetitive loss problem,” where people in high risk flood areas paid such low flood insurance premiums that they would keep on rebuilding only to have their homes repeatedly swept away.17 As USA Today noted, “One Houston property valued at $114,480 has filed for losses 16 times and received $807,000 in total payments.”18

Only the government can continually get away with this kind of wastefulness—a private insurance company that was this profligate would be driven out of business. Democratic Congressman Earl Blumenauer (Oregon) put it succinctly: “The federal government is aiding and abetting patterns of living that are unsustainable and draining significant resources.”19 By creating insurance programs with below-cost premiums, the government allowed its insurance clients to free-ride off the American taxpayers.

Many economists have pointed out severe problems caused by the government’s inability to set prices correctly. Indeed, some blame the bankruptcies seen during the savings and loan crisis of the 1980s on the extremely low prices charged by the government for deposit insurance at risky banks. The bailout ultimately ended up costing taxpayers over $175 billion.20

If charging too low a price will create market distortions, then handing out services for free—which the government often does—will really create some perverse incentives. For example, government search-and-rescue teams frequently decline to charge anything for their services. These expeditions can be extremely expensive, with use of a helicopter costing $10,000 per day.21 Even worse, free rescue services give hikers and mountain climbers an incentive to take more risks. In December 2006, a large-scale search and rescue operation was undertaken at Oregon’s Mt. Hood to find three climbers stranded on the mountain. Tragically, one hiker was found dead, while the other two were never discovered. In light of the incident, Oregon lawmakers floated the idea of requiring high-altitude climbers to wear electronic locators. The proposal was opposed by climbers, who argued the devices would cut down on the “adventure” and the “beauty” of the sport’s danger.22 Perhaps after getting stuck with a $10,000 rescue tab, climbers might think twice about the kind of risks they take.

The government’s difficulty in getting prices right is vividly illustrated in the application of eminent domain—laws that allow the government to confiscate homes in order to clear the land for other developments. The government—as well as private developers—face considerable economic problems when trying to clear out homes from a certain area. Suppose that a developer needs to tear down the houses on an entire block in order to build a skyscraper. The obvious approach would be to buy everyone’s house, but this doesn’t always work. Some homeowners with a sentimental attachment to their property will even refuse offers that far exceed the fair market value of their homes. In this case, developers who are unwilling to pay exorbitant amounts have little choice but to look elsewhere for their project.

Other homeowners might act strategically, hoping that by refusing early offers, they will entice much higher bids later. This presents a complex problem, for a single hold-out could stymie the project. Eminent domain seeks to solve this problem by forcing owners to accept the “fair market value” of their property. The government offers the fair market value—the price for which similar nearby houses have sold—and if the homeowner refuses, the government can pay this price anyway and seize the property. The recent U.S. Supreme Court decision Kelo v. New London decreed that eminent domain, until then usually invoked to allow for government projects such as highways and railroads, can also be enforced for private development projects if the local authorities determine that the projects will benefit the wider community.23

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