by Richard A. Epstein
My last column for Defining Ideas, “Franklin Delano Obama,” stressed the dangers of Franklin Roosevelt’s “Second Bill of Rights,” which was long on rights but short on any articulation of their correlative duties. Roosevelt’s program works well everywhere except in a world of scarce resources, which, alas, is the only world we will ever know.
Fortunately, Roosevelt quickly met with some determined intellectual resistance. In 1944, when Roosevelt unveiled his “Second Bill of Rights,” Friedrich von Hayek, an Austrian economist, political theorist, and future Nobel Prize winner, wrote The Road To Serfdom. That book rightly became a sensation both in England and in the United States, especially after the publication of its condensed version in The Reader’s Digest in April 1945. Hayek’s basic message was the exact opposite of Roosevelt’s. He was deeply suspicious of government intervention into markets, thinking that it could lead to economic stagnation on the one hand and to political tyranny on the other.
Hayek has never been out of the news. But, right now, his name has been batted around in political circles because Paul Ryan, the Republican Vice-Presidential nominee, has acknowledged that he regards Hayek as one of his intellectual muses. That observation brought forward in the New York Times an ungracious critique (called “Made in Austria” in the print edition) of both Hayek and Ryan by Adam Davidson, a co-founder of NPR’s Planet Money. Davidson’s essay reveals a profound misunderstanding of Hayek’s contribution to twentieth-century thought in political economy.
Davidson leads with a snarky and inaccurate comment that, “A few years ago, it was probably possible to fit every living Hayekian into a conference room.” But it is utterly inexcusable to overlook, as Davidson does, Hayek’s enduring influence. A year after the Road to Serfdom came out, Hayek published his 1945 masterpiece in the American Economics Review, “The Use of Knowledge in Society,” which has been cited over 8,600 times. In this short essay, Hayek explained how the price system allows widely dispersed individuals with different agendas and preferences to coordinate their behaviors in ways that move various goods and services to higher value uses.
Alas, Davidson’s dismissive account of Hayek does not mention even one of Hayek’s major contributions to weaning the United States and Great Britain from the vices of centralized planning. Thus Hayek’s 1940 contribution to the “Socialist Calculation” debate debunked the then-fashionable notion that master planners could achieve the economic nirvana of running a centralized economy in which they obtain whatever distribution of income they choose while simultaneously making sound allocations of both labor and capital, just like in Soviet Russia.
Hayek exposed this fool’s mission by stressing how no given individual or group could obtain and organize the needed information about supply and demand conditions throughout the economy. The virtue of the price system was its use of a common unit of measurement—money—to allow various actors to compete for a given resource without having to lay bare why they need any particular good or service. The seller need only accept the highest bid, without nosing around in other people’s business. The interaction between buyers and sellers allows for constant incremental adjustments of both price and quantity. Old information gets updated in a quick and reliable way, thereby eluding the administrative gauntlet of the socialist state.
Hayek vs. the Academic Establishment
To put Hayek’s sophistication in perspective, just contrast his work with the dominant intellectual attitudes of the time. One of Hayek’s many shrewd observations in The Road to Serfdom was that a public highway system succeeds because the government only sets the rules of the road while allowing individual choices to determine the composition of the traffic.
That position was in fact not altogether true in the United States at the time, for the Interstate Commerce Commission issued licenses, thus determining which trucker could carry tomatoes from San Francisco to Chicago; and the Civil Aeronautics Board determined which airline carriers could fly passengers from New York to Boston. That government control over routes resulted, predictably, in the cartelization of these key markets, which in turn led to higher costs and fewer choices for consumers.
Yet this dubious system received spirited intellectual support from people who should have known better. For example, in the pivotal 1943 case of National Broadcasting Company v. United States, Justice (and former Harvard Law professor) Felix Frankfurter examined what it meant for the Federal Communications Commission to assign frequencies to different broadcasters serving the “public interest, convenience or necessity.” Like the progressive he was, Frankfurter committed, in a few terse paragraphs, all the intellectual sins against which Hayek inveighed.
Frankfurter thought himself too sophisticated to accept the laissez-faire position that the FCC should be treated “as a kind of traffic officer, policing the wave lengths to prevent stations from interfering with each other.” His grander vision “puts upon the Commission the burden of determining the composition of that traffic,” because “the facilities of radio are not large enough to accommodate all who wish to use them.”
Frankfurter’s view was a disastrous mistake precisely because no one at the FCC ever had any idea of who should get which frequency and for what purpose. The FCC’s endless comparative hearings, first to allocate unused frequencies for limited periods of time, and then to pass on renewal licenses, were exercises in futility. Was it more important for a licensee to commit to broadcasting public affairs shows or to have strong ties to the local community? Endless hours of deliberation squandered precious public resources on the impossible instead of just selling off these frequencies by auction.
Ironically, in the end, markets did correct the foolishness of these administrative assignments, for the FCC rules let the lucky recipient of the initial license sell it off after waiting a year, thus pocketing revenues that should have gone into the public treasury. Just removing the middleman could have stopped the charade. The errors of Frankfurter’s reasoning were first exposed by a law student, Leo Herzel, in 1951, and then by the Nobel Prize–winning economist Ronald Coase in his classic article on the Federal Communication Commission. Auctions have become routine for the FCC spectrum today. Score one for Hayek, zero for Frankfurter.
Monopolies and Competition
A second influential illustration of how far off the mark academics were on the operation of markets was Friedrich Kessler’s article in the 1943 issue of the Columbia Law Review, “Contracts of Adhesion—Some Thoughts about Freedom of Contract” (Kessler was one of my professors at Yale Law School). Written during the middle of World War II, Kessler, a German refugee and contracts scholar of great distinction, took it upon himself to warn the United States of the dangers that standardized contracts posed to the economic marketplace and to the health and safety of society as a whole.
The phrase “contract of adhesion” was meant to show that the party who wrote the standard form for the other party gave only a take-it-or-leave-it choice. From that observation, Kessler claimed, freedom of contract was only a “one-sided” privilege, which allowed “enterprisers to legislate by contract . . . in a substantially authoritarian manner,” given the “innate trend of competitive capitalism toward monopoly.”
The clear implication of Kessler’s warning was that massive government intervention had to counteract the power of private legislation. Missing from his analysis, however, was any explanation as to why competition had to move to monopoly, for, as Hayek rightly stressed, any system that allows free entry of new firms will prevent established firms from raising their prices above the competitive level. Nor should the standard form contract in a competitive industry be thought of as anything other than a transaction costs–saving device that helps sellers and consumers alike.
A standard form contract reduces the time for dickering, and it leaves consumers with the option to just say no if the price is too high. Naïve customers who use these contracts enjoy some added confidence that they have gotten the same deal as established customers. The dangers of monopoly do not arise from standardization, but from collusion, which the antitrust laws can address. Kessler’s views unfortunately spurred on a wave of anticompetitive consumer protection laws, which raised prices and reduced innovation, by putting new entrants at a tactical disadvantage relative to the incumbents who are better equipped to jump through regulatory hoops.
The last of my three illustrations is George Orwell’s respectful but critical book review of The Road to Serfdom. Orwell claimed that Hayek “does not see, or will not admit, that a return to ‘free’ competition means for the great mass of people a tyranny probably worse, because more irresponsible, than that of the State. The trouble with competitions is that somebody wins them.” Actually people keep entering competitions in order to win. But what Orwell never grasped was that his example ignores the key fact that voluntary contracts produce win/win results.
The party who loses the race may well have enjoyed the competition. Or, he may have calculated from the ex ante perspective that the chances of winning justified the risk that he took. What is so tragic about Orwell’s remark is that it lends credence to the dangerous proposition that all business deals produce only some winners but many losers, which of course gives a handy and ubiquitous reason for regulating them all.
Hayek vs. Hayek
Hayek then was light years ahead of his contemporaries in understanding how a market economy ought to work. To be sure, Hayek wrote many things that have been subject to revision. Hayek placed too much faith in local knowledge and individual intuition as sources for rationality in market places. It turns out that the decentralized use of formal business strategies backed by large data sets can displace, and in financial markets often has displaced, the unguided seat-of-the-pants trader. Hayek also placed too much faith in the powers of “spontaneous order” to produce optimal market results. He failed to note how market success often depends on the use of intermediate institutions, often private in nature, to set and revise the customs and conventions under which trading takes place.
Most ironically, Hayek was too skeptical of government central planning to decide, for example, the location of public highways and parks: Planning public spaces is a tractable problem even if planning an entire economy is not. To be sure, the English Constitution developed over centuries by a combination of decisive moments (the Magna Carta of 1215 and the Bill of Rights of 1689, for example). But the American Constitution was “constructed” in a form that did not fit the Hayekian prescription for a sound gradualist political order.
And, most of all, Hayek did not see that his support for unemployment insurance and publicly provided health care could produce programs far larger and more dangerous than could be imagined, which led me to warn against the dangers of “Hayekian Socialism.” Even the devoted Hayekians who dispute that charge know that Davidson was just wrong when he attributed to Hayek “an unfettered faith in the free market and objection to big government.” What Hayek actually believed in was strength of markets subject to a cautious willingness to accept limited government. On that premise, Paul Ryan has indeed chosen the right intellectual forebear.
Richard A. Epstein, the Peter and Kirsten Bedford Senior Fellow at the Hoover Institution, is the Laurence A. Tisch Professor of Law, New York University Law School, and a senior lecturer at the University of Chicago