Naked Economics: Undressing the Dismal Science pdfdrive com

York Times reported that this settlement was believed to be the first deal by a
company to dissolve an entire town. “It will help the company avoid the
considerable expense and public-relations mess of individual lawsuits, legal and
environmental experts said.”
Coase made one final point: The transactions costs related to striking this kind
of deal—everything from the time it takes to find everyone involved to the legal
costs of making an agreement—must be reasonably low for the private parties to
work out an externality on their own. Stuart and I can haggle over the fence in
the backyard. The American Electric Power company can manage to strike a
deal with 221 homeowners. But private parties are not going to work out a
challenge like CO
2
emissions on their own. Every time I get into my car and turn
on the engine, I make all of the six billion inhabitants of the planet slightly worse
off. It takes a long time to write checks to six billion people, particularly when
you are already late for work. (And it’s arguable that some people in cold
climates will benefit from climate change, so maybe they should pay me.) The
property rights related to greenhouse gases are still ambiguous, too. Do I have
the right to emit unlimited CO
2
? Or does someone living in a Pacific island
nation have the right to stop me from doing something that might submerge their
entire country? This is one conflict that governments have to tackle.
But let’s back up for a moment. Government does not just fix the rough edges
of capitalism; it makes markets possible in the first place. You will get a lot of
approving nods at a cocktail party by asserting that if government would simply
get out of the way, then markets would deliver prosperity around the globe.
Indeed, entire political campaigns are built around this issue. Anyone who has
ever waited in line at the Department of Motor Vehicles, applied for a building
permit, or tried to pay the nanny tax would agree. There is just one problem with
that cocktail party sentiment: It’s wrong. Good government makes a market
economy possible. Period. And bad government, or no government, dashes
capitalism against the rocks, which is one reason that billions of people live in
dire poverty around the globe.
To begin with, government sets the rules. Countries without functioning
governments are not oases of free market prosperity. They are places in which it
is expensive and difficult to conduct even the simplest business. Nigeria has one
of the world’s largest reserves of oil and natural gas, yet firms trying to do
business there face a problem known locally as BYOI—bring your own

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infrastructure.
6
Angola is rich with oil and diamonds, but the wealth has
financed more than a decade of civil war, not economic prosperity. In 1999,
Angola’s rulers spent $900 million in oil revenues to purchase weapons. Never
mind that one child in three dies before the age of five and life expectancy is a
shocking forty-two years.
7
These are not countries in which the market economy
has failed; they are countries in which the government has failed to develop and
sustain the institutions necessary to support a market economy. A report issued
by the United Nations Development Program placed much of the blame for
world poverty on bad government. Without good governance, reliance on
trickle-down economic development and a host of other strategies will not work,
the report concluded.
8
The reality is that nobody ever likes the umpire, but you can’t play the World
Series without one. So what are the rules for a functional market economy? First,
the government defines and protects property rights. You own things: your
home, your car, your dog, your golf clubs. Within reasonable limits, you can do
with that property as you wish. You can sell it, or rent it, or pledge it as
collateral. Most important, you can make investments in your property having
full confidence that the returns from that investment will also belong to you.
Imagine a world in which you spend all summer tending to your corn crop and
then your neighbor drives by in his combine, waves cheerily, and proceeds to
harvest the whole crop for himself. Does that sound contrived? Not if you’re a
musician—because that is pretty much what Napster did by allowing individuals
to download music without paying any compensation to the musicians who
created it or to the record companies that owned the copyrights. The music
industry successfully sued Napster for facilitating piracy.
Property rights are not just about houses, cars, and things you can stack in a
closet. Some of the most important property rights involve ownership of ideas,
artwork, formulas, inventions, and even surgical procedures. This book is as
good an example as any. I write the text. My agent sells it to a publisher, who
contracts to have the book printed and distributed. The book is sold in private
stores, where private security guards are hired to handle the massive, potentially
unruly crowds trying to get a signed copy. At every juncture, only private parties
are involved. These would appear to be straightforward market transactions;
government could only get in the way. Indeed, I might curse the government for
taxing my income, taxing the sale of the book, even taxing the salary that I pay
the nanny to look after my children while I write.
In fact, the whole transaction is made possible by one thing: copyright law,
which is a crucial form of property right for those of us who write for a living.

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The United States government guarantees that after I invest my time in
producing a manuscript, no company can steal the text and publish it without
compensating me. Any professor who photocopies it to use it in a class must pay
the publisher a royalty first. Indeed, the government enforces similar rights for
Microsoft software, and a related property right, a patent, for the pharmaceutical
company that invented Viagra. The case of patents is an interesting one that is
often mischaracterized. The ingredients in Viagra cost pennies a pill, but because
Pfizer has a patent on Viagra that gives it a monopoly on the right to sell the
product for twenty years, the company sells each pill for as much as $7. This
huge markup, which is also common with new HIV/AIDS drugs and other
lifesaving products, is often described as some kind of social injustice
perpetrated by rapacious companies—the “big drug companies” that are
periodically demonized during presidential campaigns. What would happen if
other companies were allowed to sell Viagra, or if Pfizer were forced to sell the
drug more cheaply? The price would fall to the point where it was much closer
to the cost of production. Indeed, when a drug comes off patent—the point at
which generic substitutes become legal—the price usually falls by 80 or 90
percent.
So why do we allow Pfizer to fleece Viagra users? Because if Viagra did not
get patent protection, then Pfizer never would have made the large investments
that were necessary to invent the drug in the first place. The real cost of
breakthrough drugs is the research and development—scouring the world’s rain
forests for exotic tree barks with medicinal properties—not making the pills
once the formula is discovered. The same is true with drugs for any other illness,
no matter how serious or even life-threatening.
*
The average cost of bringing a
new drug to market is somewhere in the area of $600 million. And for every
successful drug, there are many expensive research forays that end in failure. Is
there a way to provide affordable drugs to low-income Americans—or poor
individuals elsewhere in the world—without destroying the incentive to invent
those drugs? Yes; the government could buy out the patent when a new drug is
invented. The government would pay a firm up front a sum equal to what the
firm would have earned over the course of its twenty-year patent. After that, the
government would own the property right and could charge whatever price for
the drugs it deemed appropriate. It’s an expensive solution that comes with some
problems of its own. For example, which drug patents would the government
buy? Is arthritis serious enough to justify using public funds to make a new drug
more affordable? How about asthma? Still, this kind of plan is at least consistent
with the economic reality: Individuals and firms will make investments only
when they are guaranteed to reap what they sow, literally or figuratively.

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I once stumbled on a curious example of how ambiguous property rights can
stifle economic development. I was working on a long story on American
Indians for The Economist. Having spent time on a handful of reservations, I
noticed that there was very little private housing stock. Tribal members lived
either in houses that had been financed by the federal government or in trailers.
Why? One principal reason is that it is difficult, if not impossible, to get a
conventional home mortgage on an Indian reservation because the land is owned
communally. A tribal member may be given a piece of land to use, but he or she
does not own it; the Indian Nation does. What that means to a commercial bank
is that a mortgage that has fallen delinquent cannot be foreclosed. If a bank is
denied that unpleasant but necessary option, then the lender is left without any
effective collateral on its loan. A trailer, on the other hand, is different. If you
fall delinquent on your payments, the company can show up one day and haul it
off the reservation. But trailers, unlike conventional housing, do not support
local building trades. They are assembled thousands of miles away in a factory
and then transported to the reservation. That process does not provide jobs for
roofers, and masons, and drywallers, and electricians—and jobs are what
America’s Indian reservations need more than anything else.
Government lowers the cost of doing business in the private sector in all kinds of
ways: by providing uniform rules and regulations, such as contract law; by
rooting out fraud; by circulating a sound currency. Government builds and
maintains infrastructure—roads, bridges, ports, and dams—that makes private
commerce less costly. E-commerce may be a modern wonder, but let’s not lose
sight of the fact that after you order khakis from Gap.com, they are dispatched
from a distribution center in a truck barreling along an interstate. In the 1950s
and 1960s, new roads, including the interstate highway system, accounted for a
significant fraction of new capital created in the United States. And that
investment in infrastructure is associated with large increases in productivity in
industries that are vehicle-intensive.
9
Effective regulation and oversight make markets more credible. Because of
the diligence of the Securities and Exchange Commission (SEC), one can buy
shares in a new company listed on the NASDAQ with a reasonable degree of
certainty that neither the company nor the traders on the stock exchange are
engaging in fraud. In short, government is responsible for the rule of law.
(Failure of the rule of law is one reason why nepotism, clans, and other family-
centered behavior are so common in developing countries; in the absence of
binding contractual agreements, business deals can be guaranteed only by some

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kind of personal relationship.) Jerry Jordan, former president of the Federal
Reserve Bank of Cleveland, once mused on something that is obvious but too
often taken for granted: Our sophisticated institutions, both public and private,
make it possible to undertake complex transactions with total strangers. He
noted:
It seems remarkable, when you think about it, that we often take
substantial amounts of money to our bank and hand it over to people
we have never met before. Or that securities traders can send millions
of dollars to people they don’t know in countries they have never been
in. Yet this occurs all the time. We trust that the infrastructure is set in
place that allows us not to worry that the person at the bank who takes
our money doesn’t just pocket it. Or that when we use credit cards to
buy a new CD or tennis racquet over the Internet, from a business that
is located in some other state or country, we are confident we will get
our merchandise, and they are confident they will get paid.
10
Shakespeare may have advised us to get rid of all the lawyers, but he was a
playwright, not an economist. The reality is that we all complain about lawyers
until we have been wronged, at which point we run out and hire the best one we
can find. Government enforces the rules in a reasonably fair and efficient
manner. Is it perfect? No. But rather than singing the praises of the American
justice system, let me simply provide a counterexample from India. Abdul
Waheed filed a lawsuit against his neighbor, a milk merchant named Mohammad
Nanhe, who had built several drains at the edge of his property that emptied into
Mr. Waheed’s front yard. Mr. Waheed did not like the water draining onto his
property, in part because he had hoped to add a third room to his cement house
and he was worried that the drains would create a seepage problem. So he sued.
The case came to trial in June 2000 in Moradabad, a city near New Delhi.
11
There is one major complication with this civil dispute: The case had been
filed thirty-nine years earlier; Mr. Waheed was dead and so was Mr. Nanhe.
(Their relatives inherited the case.) By one calculation, if no new cases were
filed in India, it would still take 324 years to clear all the existing cases from the
docket. These are not just civil cases. In late 1999, a seventy-five-year-old man
was released from a Calcutta jail after waiting thirty-seven years to be tried on
murder charges. He was released because the witnesses and investigating officer
were all dead. (A judge had declared him mentally incompetent to stand trial in
1963 but the action was somehow lost.) Bear in mind that by developing world