CHAPTER 12 THE ECONOMICS OF VIOLENT INTERVENTION IN THE MARKET Chapter Summary

In this chapter we analyze (using economic science) the effects of violations of property rights, and in particular the effects of State action, i.e., institutionalized and widespread violations.

Intervention is the intrusion of aggressive physical force into society. Autistic intervention occurs when the aggressor uses force on an individual such that no one else is affected. Binary intervention occurs when the aggressor establishes a hegemonic relationship between himself and the victim. Triangular intervention occurs when the aggressor uses force to alter the relations between a pair of subjects.

The free market maximizes ex ante utilities and has mechanisms to promote ex post fulfillment of these plans. In contrast, each act of government intervention always harms at least one party, and moreover suffers from indirect consequences that further distort the economy.

A price control involves the use of force to alter the terms on which individuals exchange goods or services. Maximum prices lead to shortages, i.e., situations where quantity demanded exceeds quantity supplied. (A prime example is the shortage of apartments due to rent control.) Minimum prices lead to surpluses, i.e., situations where quantity supplied exceeds quantity demanded. (A prime example is the unemployment due to the minimum wage.)

Both taxation and government spending distort the economy; the former drains resources away from the private sector while the latter distorts resource allocation away from what it otherwise would have been. There can be no such thing as a neutral tax, because taxation is coercive and thus differs fundamentally from a voluntary price. A so-called flat tax is not the equivalent of a price, because in the market rich customers do not pay in proportion to their income. A head tax would be closer, but it too is coercive; some taxpayers would be forced to fund certain government activities that they abhor.

It is a myth that taxes on a firm can be “passed on” to customers. If firms could really do this—i.e., raise prices to generate extra revenues to offset a new tax—then why didn’t the firms do it before? It is true that a tax will eventually raise prices paid by consumers, but this is achieved by lowering profitability and hence supply, which then raises the equilibrium price.

Economists often try to gauge the “productive contribution” of government activities by the size of its expenditures. Yet this is directly opposite from the market approach, where value is gauged by how much customers spend on products, not by how much the business itself spends in making them!

In a credit expansion the government artificially lowers the interest rate, thereby spurring investment in higher stages of production. There is a temporary “boom” period of illusory prosperity. With no genuine increase in saving, the capital structure becomes unbalanced and eventually entrepreneurs realize that their plans cannot be fulfilled. The “bust” ensues when businesses discontinue the unprofitable lines and resources must be reallocated to their proper uses.

Chapter Outline

1. Introduction

The bulk of the book has concentrated on the free society, in which everyone respects property rights. In this chapter we analyze (using economic science) the effects of violations of property rights, and in particular the effects of State action, i.e., institutionalized and widespread violations. Note that economics does not “assume” laissez-faire at any point, but instead objectively demonstrates the outcomes of both free and coercive institutions.

2. A Typology of Intervention

Intervention is the intrusion of aggressive physical force into society. The economic analysis of “private” coercion is the same as government coercion, but we focus on the latter because of its greater prevalence and number of apologists. Autistic intervention occurs when the aggressor uses force on an individual such that no one else is affected. Binary intervention occurs when the aggressor establishes a hegemonic relationship between himself and the victim. Triangular intervention occurs when the aggressor uses force to alter the relations between a pair of subjects.

3. Direct Effects of Intervention on Utility

In a free market, people only participate in an exchange if they believe they will benefit; thus the market “maximizes” ex ante utility of everyone in society. Any intervention, in contrast, increases the utility of the aggressor and necessarily reduces the utility of the affected subjects.

4. Utility Ex Post: Free Market and Government

People always expect to benefit from voluntary exchanges, and in practice they usually will do so. In particular, inept businesses soon go bankrupt while entrepreneurs who make good forecasts earn profits. In contrast, in the government sector there are no mechanisms to minimize error. When a government policy fails in its stated objectives, the politicians do not necessarily suffer and the voters may not be sophisticated enough to perceive the true causes of the failure. (A good summary is at the bottom of p. 891.)

5. Triangular Intervention: Price Control

A price control involves the use of force to alter the terms on which individuals exchange goods or services. When the government sets a maximum price (or price ceiling), it threatens force against anyone caught charging a price above a specific amount. Maximum prices lead to shortages, i.e., situations where quantity demanded exceeds quantity supplied. (A prime example is the shortage of apartments due to rent control.) When the government sets a minimum price (or price floor), it makes it illegal to pay below a certain price. Minimum prices lead to surpluses, i.e., situations where quantity supplied exceeds quantity demanded. (A prime example is the unemployment due to the minimum wage.)

6. Triangular Intervention: Product Control

Product control regulates the product itself, or the people involved in the exchange. (In contrast price control regulates only the terms of trade.)

7. Binary Intervention: The Government Budget

When analyzing the effects of government taxation and spending, we need to use both a partial and general equilibrium approach (p. 910); a tax will (a) make the taxed item less attractive and (b) make the consumers poorer and so affect other markets too. Both taxation and government spending distort the economy; the former drains resources away from the private sector while the latter distorts resource allocation away from what it otherwise would have been.

8. Binary Intervention: Taxation

A. Income Taxation

Taxation penalizes production; it shifts resources from taxpayers to tax-consumers. Just as a parasite must take care not to kill its host, there is an upper limit on taxation. Even if formally neutral with regard to consumption and saving, the income tax tends to raise time preferences by reducing everyone’s level of (lifetime) income.

B. Attempts at Neutral Taxation

Rothbard defines a neutral tax as “a tax which would affect the income pattern, and all other aspects of the economy, in the same way as if the tax were really a free-market price.” There can be no such thing, because taxation is coercive and thus differs fundamentally from a voluntary price. A so-called flat tax is not the equivalent of a price, because in the market rich customers do not pay in proportion to their income. A head tax would be better (in this respect), but it too is coercive; some taxpayers would be forced to fund certain government activities that they abhor.

C. Shifting and Incidence: A Tax on an Industry

It is a myth (in both mainstream economics and the public at large) that taxes on a firm can be “passed on” to customers. If firms could really do this—i.e., raise prices to generate extra revenues to offset a new tax—then why didn’t the firms do it before? It is true that a tax will eventually raise prices paid by consumers, but this is achieved by lowering profitability and hence supply, which then raises the equilibrium price.

D. Shifting and Incidence: A General Sales Tax

Even in the “obvious” case of a general sales tax, it is simply not true that businesses can pass on price hikes to customers. What happens instead is that the tax is shifted backward to the imputed DMVPs of the factors of production. Thus a firm reacts to a new tax not by raising its prices to customers, but by lowering its payments to factor owners.

E. A Tax on Land Values

Many analysts think that taxes on land do not distort, since (unlike other resources) land cannot shift out of a taxed industry. This is not true, because land owners provide a definite service by discovering and allocating land to the highest bidders. If the government imposed a 100 percent tax on ground rents, it is true that the real estate would not physically disappear. But the affected owners would certainly stop advertising the parcels in the hopes of finding higher bidders, and no one would try to find new plots of land.

F. Taxing “Excess Purchasing Power”

Keynesians suggest taxation as a remedy for price inflation, by “sopping up” excess purchasing power. This suggestion has several flaws: Why are higher prices considered more burdensome than higher taxes? Also, why would the government’s action reduce aggregate demand, since the government spends its tax revenues anyway? It also overlooks the fact that cause of price inflation is government inflation of the money supply.

9. Binary Intervention: Government Expenditures

A. The “Productive Contribution” of Government Spending

Economists often try to gauge the “productive contribution” of government activities by the size of its expenditures. Yet this is directly opposite from the market approach, where value is gauged by how much customers spend on products, not by how much the business itself spends in making them! So-called government “investment” is misnamed because there is no reason to believe such projects will serve the future consumption desires of consumers.

B. Subsidies and Transfer Payments

Subsidies distort resource allocation relative to the free market outcome. It is particularly ironic when the government subsidizes activities that it (allegedly) wishes to minimize, such as poor relief.

C. Resource-Using Activities

Beyond its depletion of scarce resources that consumers would have preferred in other lines, government provision of goods and services is deficient because it often charges artificially low prices. For example the chronic water and electricity shortages in summer months, as well as everyday traffic jams, are due to below-equilibrium prices for these crucial goods.

D. The Fallacy of Government on a “Business Basis”

Government can never be run “as a business” because its revenues are obtained through coercion. Moreover, its enterprises often enjoy monopoly privileges.

E. Centers of Calculational Chaos

Even small-scale government enterprises are subject to Mises’s critique of socialism. By severing the link between customer and revenue, government officials have no feedback mechanism and cannot decide, even ex post, if they are performing properly.

F. Conflict and the Command Posts

Government enterprises necessarily cause conflict. For example, consider the controversies over religion in government schools. By its very nature, the government acts on behalf of “society” and thus the lack of unanimity on a given issue will lead to strife.

G. The Fallacies of “Public” Ownership

Government enterprises are not “public” despite the common terminology. Citizens can test this theory by trying to exercise control over, or sell their shares in, “public” schools or “public” parks.

H. Social Security

Funds taken as “premiums” for social security schemes are not in fact invested, but instead are spent on immediate consumption by the government. Such schemes are not true insurance.

I. Socialism and Central Planning

The extent of socialism is overestimated in formally socialist countries such as the Soviet Union because of black markets and foreign prices for capital goods, while it is underestimated in formally capitalist countries such as the United States because of government lending to business. In the present analysis, a centrally planned economy can be viewed as a centrally prohibited economy.

10. Growth, Affluence, and Government

A. The Problem of Growth

Government efforts to stimulate “growth” lower utility because they force people to shift consumption from present to future beyond what their personal time preferences dictate. The Austrian understanding of the heterogeneous capital structure also shows the danger of arbitrary government “investment” in particular capital goods.

B. Professor Galbraith and the Sin of Affluence

In the early twentieth century capitalism allegedly provided too few goods, while the more modern objection is that it provides superfluous goods (at the expense of the “public sector”). If, as Galbraith claims, businesses can simply create wants through seductive advertising, why do they spend so much money conducting research on consumer tastes?

11. Binary Intervention: Inflation and Business Cycles

A. Inflation and Credit Expansion

Inflation is any artificial increase in the money supply. Credit expansion is a particular type of inflation where the new money enters the economy through the credit market. All inflation raises prices and distorts the market, but credit expansions are particularly pernicious as they cause the boom-bust cycle.

B. Credit Expansion and the Business Cycle

In a credit expansion the government artificially lowers the interest rate, thereby spurring investment in higher stages of production. There is a temporary “boom” period of illusory prosperity. But unlike a genuine expansion spurred by actual saving, in the case of credit expansion the capital structure becomes unbalanced and eventually entrepreneurs realize that their plans cannot be fulfilled. The “bust” ensues when businesses discontinue the unprofitable lines and resources must be reallocated to their proper uses.

C. Secondary Developments of the Business Cycle

The demand for money may be affected during the course of the business cycle, and this can make the adjustment process more difficult.

D. The Limits of Credit Expansion

Under a commodity standard, credit expansion is naturally limited by the need for redeemability. Even under a fiat standard, individual banks always face the possibility of a run. However, central banking greatly expands the scope for credit expansion.

E. The Government as Promoter of Credit Expansion

The government promotes credit expansion by weakening the above checks. For example, government guarantees of bank deposits lowers the likelihood of runs, and central banking allows a uniform credit expansion on the part of all member banks.

F. The Ultimate Limit: The Runaway Boom

In the face of hyperinflation, the public’s demand for the fiat money drops precipitously, causing prices to rise even more than one would expect from the increases in supply. In extreme cases the currency will be abandoned altogether.

G. Inflation and Compensatory Fiscal Policy

The various government programs to “fight inflation” are absurd, since (price) inflation is caused by the government’s expansion of the money supply.

12. Conclusion: The Free Market and Coercion

Contrary to popular opinion, the free market is not chaotic and harmful, but rather results in the best possible achievement of orderly commerce and psychic utilities for all members of society. In contrast, each act of government intervention always harms at least one party, and moreover suffers from indirect consequences that further distort the economy.

APENDIX A:
Government Borrowing

Government borrowing is not inflationary per se; it merely diverts spending from private capital goods to projects favored by the government. However, to the extent that government borrowing is financed through credit expansion, inflation is a common side effect. Government borrowing is harmful because it siphons funds that would otherwise have gone into private investment.

APENDIX B:
“Collective Goods” and “External Benefits”: Two Arguments for Government Activity

Mainstream economics justifies government measures in the case of “public goods,” which are those goods that cannot be excluded from nonpayers, and which can confer benefits on additional users without diminishing their usefulness to others. Prototypical examples of public goods are national defense and lighthouses. This theory is open to severe criticism, because many so-called public goods (national defense, roads) do not actually fit the criteria. In any event, even if such a public good exists, it does not follow that government must provide it.

Another popular justification concerns positive (negative) “externalities,” where the market actions of two individuals have spillover effects on third parties. On moral grounds, what is the problem if someone benefits from the voluntary actions of other people? From an economic standpoint, this approach too is flawed because it would include all sorts of things not normally considered a “market failure.” For example, every time someone invests and increases the capital stock, this provides a positive externality on all workers. Should they therefore have some of their wages diverted to the investor?

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Notable Contributions

• Rothbard’s typology of intervention is original.

• Rothbard’s analysis of the welfare effects of markets versus intervention (pp. 879–85) is based on his impressive work, “Toward a Reconstruction of Utility and Welfare Economics.”

• Unlike many other free market economists, Rothbard (pp. 918–19 and pp. 962–73) does not exhibit an arbitrary “pro-growth” bias.

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Technical Matters

1. In footnote 1 (p. 875), Rothbard is a bit loose and seems to imply that praxeology and economics are synonymous terms. Strictly speaking, economics is a subset of praxeology, which is the science of human action (p. 74). Even so, Rothbard’s position vis-à-vis Edwin Cannan is still correct, for “violent interrelations”—particularly those created by the State—are certainly forms of action with catallactic effects.
2. In his discussion of monopoly grants (a form of product control) Rothbard apparently uses the same analysis that he earlier (chapter 10) took pains to destroy. However, as he points out (p. 903), the crucial distinction is that there really is a free market price and output to use as a benchmark against the outcome after the government privilege is granted. In contrast, on the free market there really is no such alternative “competitive” price and output with which to compare the “monopoly” outcome.
3. The discussion on pp. 905–06 highlights the fact that monopoly returns are capitalized into the value of assets such that the rate of return is the same as in any other line; that is, there are no lasting monopoly profits, even in this case where “monopoly price” is meaningful.
4. A mainstream economist might defend the orthodox treatment of tax incidence (pp. 927–34) by arguing that Rothbard is overlooking the changed incentives after the imposition of a tax. For example, it is true that producers could not raise prices before the tax, because if any did so, others would undercut him. But after the tax this may no longer be true; all producers in the affected industry can raise prices because no one can operate profitably at the old price. (See question 9 below.)
5. In footnote 12 (p. 1003), Rothbard clarifies that his “natural rate” is the rate of return earned by businesses on the market, and is different from the loan rate of interest. (It is thus what Böhm-Bawerk means by the originary rate of interest.) In contrast, Knut Wicksell (as well as other Austrian expositions) uses the term “natural rate” to mean simply the free market rate, i.e., the rate that would prevail were it not for distortionary credit expansion.

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Study Questions

1. Give an example of each of the three types of interventions (pp. 877–78).
2. Why does Rothbard say voluntary exchanges always increase utility? Doesn’t the displaced businessman lose when his product is rendered obsolete by the competition? (pp. 882–83)
3. Can some private parties gain from a triangular intervention?
4. What is Gresham’s Law? (p. 899)
5. Give some examples of product control (pp. 900–07).
6. If domestic competitors can eliminate the benefits from tariffs (p. 906), why do firms clamor for protectionist measures?
7. Summarize the objections to the “cost principle” in taxation (pp. 922–23).
8. Summarize the objections to the “benefit principle” in taxation (pp. 923–24).
9. Rothbard argues that a tax cannot be shifted forward because none of the determinants of price (supply and demand for money, etc.) has changed (pp. 927–31). Rothbard instead claims that a tax can be shifted backward in the form of lower factor payments (p. 932). But couldn’t someone argue that none of the determinants of wages, rents, etc. has changed? After all, if businesses can simply pass a tax backward, then why didn’t they cut their employees’ wages before the tax?
10. Summarize Rothbard’s critique of Galbraith (pp. 973–88).

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