Freedomnomics: Why the Free Market Works and Other Half-Baked Theories Don't

Moore, popular authors have found plenty of buyers for the argument that nearly all corporations are committing crimes.4
But are free market economies really based on fleecing the consumer? Is the U.S. economy truly just a giant, Hobbesian free-for-all that encourages duplicity in our everyday transactions? Is everyone from corporate CEOs to your local car salesman really looking to make a buck at your expense?
The analysis presented in this book, based on dozens of economic studies spanning my entire career, hardly fits in with the conventional wisdom these days. Sure, some people will always lie or cheat—that’s just human nature. But a close study reveals that these problems are by no means systemic in the market—in fact, they’re relatively rare. For every Enron, there are thousands of companies of all sizes in America that play by the rules, simply trying to make a profit by supplying people with something they want. As we shall see, there is a reason why gas prices spike even before a natural disaster hits, why monopolies exist in our economy, and why liquor is so expensive at bars and restaurants. The answer is a little more complex than “corporate greed,” but all these examples are really just instances of a free market acting efficiently.
This reflects one great benefit of a free market—it creates incentives for people to behave honestly. Consumers don’t like to be cheated—when they think they’re being swindled, they take their business elsewhere. Companies and individual entrepreneurs who treat consumers right, however, stand to make big profits from satisfied, repeat customers.
A major deterrent to cheating, often overlooked by critics of the free market, is the importance of maintaining a good reputation. When a company commits fraud, most of its lost revenue stems from its damaged reputation—not government fines or legal actions. So even without the threat of criminal charges, there are big incentives for corporate shareholders to keep their executives and accountants honest. As technology improves, companies are developing incredibly inventive ways to profit from their reputations. For example, consider eBay, the Internet auction site. Even in its anonymous forums, sellers develop reputations by allowing customers to rate their transactions. Studies show that having a good reputation allows an eBay seller to charge higher prices.5 Whether on-line or on the street, there is money to be made by behaving honestly.
Reputations keep people honest in all kinds of realms besides business. This is even evident among politicians—possibly one of the few professions that popular opinion holds in lower esteem than corporate executives.6 Conventional wisdom holds that politicians en masse are subservient to special interests that provide the money to ensure their re-election. But do politicians really base their votes on the wishes of their donors? If that were the case, shouldn’t we see retiring legislators in their last term break away from special interests, whose money they no longer need for re-election?
Yet, we do not see this at all. Politicians tend to vote the same way throughout their career regardless of the onset or ending of donations, even in their final terms. Could it be that politicians, deep down, believe in the “special interests” they support? Is it really impossible to imagine that a congressman from Michigan supports the automotive industry not because of its donations, but because he actually believes that the industry is critical to America’s future?
In discussing campaign financing, most observers bemoan the problem of “too much” money in politics while avoiding the really key question: Why are so many individuals and interest groups sinking so much more money into politics than before? The answer is that the government is spending much more than it did previously. With so much government money at stake, a lot more people are going to try to influence how it’s spent.
This leads to another interesting question: What has caused the sky-rocketing growth in the size of government over the last century? Believe it or not, women’s suffrage appears to be the biggest factor. Granting women suffrage explains at least a third of the expansion in the size of government.
Misunderstanding incentives—those that make companies charge high prices, keep firms and politicians honest, and encourage politicians to vote in certain ways—frequently leads to demands for more government regulations. Since the market seems to be failing, the government is asked to step in and make things “fair.” But government intervention often only succeeds in making things worse. From campaign finance laws to rules for gaining a professional license, government regulation tends to hinder free competition. This often reflects the unique incentives that the government itself has. For example, because government-run firms frequently are more interested in market share than profits, they are more likely than private firms to engage in predatory pricing.
Crime is another subject where this book will draw some unconventional conclusions. Criminals have something in common with everyone else—they make decisions based on incentives. Analyzing these incentives gives us a good indication of what policies will work in fighting crime. This approach helps to explain one of the great riddles that bedevil criminologists—what caused the dramatic fall in crime rates in the 1990s? The answer lies in a mix of policies—the more frequent use of the death penalty, higher arrest rates, and the spread of concealed-carry laws. Perhaps more surprising are the policies that didn’t work—gun control bills and “broken windows” policing methods had negligible effects, while the adoption of certain kinds of affirmative action programs in police departments actually had a detrimental effect. What’s more, contrary to a well-publicized argument in Freakonomics, legalized abortion was not the single biggest factor in reducing crime in the 1990s. Instead, this book will demonstrate that by increasing the number of out-of-wedlock births, abortion significantly increased crime.
Incentives in Academia: a Personal Experience
I have been amazed by the constant resistance in academia to the idea that free market policies make people wealthier. If we look at the incentives of academics, we find that there’s an understandable reason for their viewpoint: much of the funding