Cowen Essay, Research Paper

Outline of a Critique of Tyler Cowen’s “Law as a Public Good” *-1. Summary of Cowen’s ArgumentMany critics of free-market anarchism have argued thatcollusion rather than competition would prevail, making anarchism nomore attractive than government. However, up to now very littleattempt has been made to justify this claim. On its face, the idea thatdefense services are a natural monopoly is highly implausible, asDavid Friedman points out in his _Machinery of Freedom_. It is for this reason that Tyler Cowen’s recent critique ofanarchism is a major contribution to the debate. For in his “Law as aPublic Good: the Economics of Anarchy,” Cowen puts forward apowerful reason to buttress the view that collusion would prevail. There are certain industries, which we may call network industries,that have a peculiar feature: competing firms must also cooperate (tosome extent) with their supposed competitors in order to be inbusiness in the first place. Normally, competitors have no reason totrade with each other — why should one supermarket have anydealings with another? But this is not always the case: in industrieslike credit cards, banking, and franchises, competing firms must alsocooperate. The member banks of VISA, for example, all require theservices of the VISA central computer, and all depend upon theacceptability of VISA cards in general. In banking, one vital aspect ofthe business is check-clearing done through clearinghouses: each bankmust be willing to honor its competitors’ checks and be willing tobalance accounts via a clearinghouse. The case is similar withfranchises: while individual restaurants don’t need to contract witheach other, all of them need to contract with the central McDonald’scorporation, which in turn sets common standards. Well, so what? Why does it matter that in certain industries,competitors must also cooperate to a limited extent? The answer isthat this industry structure can make collusion work. The usualchecks on collusion are cheating and new entry. But a network canpunish cheating by expelling non-colluders from the network, therebyputting cheaters out of business. Similarly, the network could refuseto admit new entrants, thereby preventing new entrants from gettinginto the business. The network short-circuits the market checks oncollusion. The network could also solve other checks on collusion suchas the hold-out problem: recalcitrant members could be punished byexpelling them from the network. (A fourth problem — which wemay call the “division of spoils problem” — is that it is difficult forcolluders to decide who gets what cut of the monopoly profits. Largefirms often favor the status quo, small firms want to grow, etc. It doesnot seem that network industries would have any special ability tosolve this problem.)What does all this have to do with the viability of free-marketanarchism? Cowen’s answer is that the defense industry is a networkindustry. Just like the industries discussed earlier, defense firmsmust cooperate with their competitors (to a limited extent) in order todo their job. In the event of a dispute, competitors must agree toarbitrate with their rivals in order to preserve peace. (Moreover, allof the advocartes of anarchism have forcefully argued that any sensiblebusinessman would do precisely that.) But the very possibility ofpeaceful cooperation between competitors indicates that we have anetwork industry on our hands; and such a network, immune to theusual checks against collusion, is likely to suppress competition in themutual interests of the members. In particular, since the defenseindustry, taken as a whole, has a near-monopoly on force, the entiresociety would be in danger should the various firms in the industrysucceed in colluding. The united defense industry could do whatever itwanted. Anarchy would be transformed in a state of the worst sort. So much for describing Cowen’s theory. It has, I believe, anumber of gaps in it; moreover, these gaps, while not individuallydecisive, add up to a fairly strong critique. As a caveat, these pointsare somewhat speculative, and I would not commit to them withoutfurther research on network industries in general. Let us exploreeach of these points in turn. 2. Competing NetworksFirst of all, Cowen neglects the possibility of competingnetworks. Granted, that collusion within a network can work; but is itthe case that every industry with network properties automaticallygets just one network? One obvious counter-example is the creditcard industry. VISA, Mastercard, Discover, American Express, andother competing issuers exist. Some of these, like VISA andMastercard, are actually just networks for member banks who do thereal work of issuing the credit cards; clearly, the credit card industryhas strong network features. But nevertheless, competition exists. Now it is quite possible that the intra-network competition that existsis due to the influence of the antitrust laws; if VISA tried to set commoninterest rates and annual fees for all VISA card issuers, it might finditself in court. But inter-network competition seems to be standard,uncoerced competition. You might reply that the competing networks of credit cardissuers don’t need to deal with each other, whereas competing networksof defense firms do. I’m not sure if the premise is correct; I suspectthat VISA and Mastercard accept payments from one another and haveother dealings with each other. But in any case, once we are down to afairly small number of firms, it is possible to cooperate without amega-network. With a small number of firms, bilateral contracts oreven simple repeat can more than suffice to yield cooperation. Yet thisform of cooperation doesn’t seem to lend itself to the attendant collusionthat Cowen discusses, since there would be no monolithic network topunish non-colluders; there would only be six, eight, ten, or twentyroughly equal bargainers trying to reach a limited understanding. Topunish non-colluders would be to provide an uncompensated publicgood to the industry as a whole. 3. Two (Inconsistent) Systems of Belief AboutPrivate Supply of Public Goods; Self-Interested vs. Altruistic BoycottsCowen rightly points out the contradiction between two widely-held libertarian beliefs: first, that collusion is impossible; second,that voluntary efforts can solve the public goods problem. Clearly,since the former is just a species of the latter (collusion is a publicgood for all members of an industry) the beliefs are incoherent. Right?Well, not necessarily. Let us distinguish between two kinds ofboycotts: self-interested and altruistic. A self-interested boycottmight be a boycott against cheaters or thieves. Once you learn that aperson is a cheat or a thief, you don’t need to be coerced to get you torespect the boycott: it is in your interest. We may contrast this with aboycott again, say, uncharitable people. Just because someone isuncharitable doesn’t make them worse customers. A boycott like thiswould indeed need coercion (or at least strong ideological motivation)to work. This distinction shows a problem with one of Cowen’sarguments. As he puts it, “If the network can implement successfulsanctions against outlaws, however, the network can also implementsuccessful sanctions against potential competitors. If punishingpotential competitors is too costly, punishing outlaws is too costly.”(p.259) However, punishing outlaws is surely a self-interestedboycott: dealing with them is likely to get you or your employeeskilled. But punishing collusion is an altruistic boycott: it benefits thewhole industry, not the individual firm doing it (which actually losesout by refraining from a profitable trade). Since collusion is rarelythe kind of thing motivated by ideology, coercion would be necessary tomake it work. The theory that boycott can squelch open violence andoutlawry without facillitating collusion is therefore consistent. As an aside, it seems to me that what Cowen refers to as a”suspension of quality competition” (p.259) is actually an aspect ofquality, since it brings about the peaceful and orderly settlementprocedure that customers want. And it should probably not be thoughtof as collusion, since by conforming to common standards the firmsbenefit themselves by benefiting their customers, not by hurting them. It is also not collusive in another sense, since the firms that cheatwould actually hurt their interests. A self-interested boycott is allthat is needed to enforce adherence to common rules of law andprocedures. 4. Networks by DegreesA closely related problem is that Cowen seems to think thatbeing a network industry is an all-or-nothing thing. But in reality,industries have network properties to varying degrees; there arestrong networks and weak networks. In general, the stronger anetwork, the easier it will be for it to make not only self-interestedbut also altruistic boycotts stick; and the weaker a network, the moreit will have to rely on self-interested boycotts and despair of the use ofaltruistic ones. Let us take a few examples. Credit cards seems to be a greatcase of a really strong network industry. It would be impossible for asingle bank to enter the market on its own and try to set up a newcredit card. It would have to negotiate with millions of establishmentsto accept its card, build up a customer base, get a central computer toprocess claims swiftly, and so on. For this reason, banks must issuetheir cards via a network that takes care of these problems for it. Andif a network became displeased with a bank, it could expel it from theindustry by simply expelling it from the network. In sum: thenetwork could apply a stinging sanction to members who didn’t takepart in an altruistic boycott (e.g., to enforce collusion), so it couldprobably make such a boycott work. From personal conversation, I learned that Cowen thinks thatbanks are another strong network industry. I am open to thepossibility, but it doesn’t seem too likely. Clearing checks is only oneof the many things that banks do; a bank could continue most of itsactivities no matter what the network (in this case, the clearinghouse)threatened. Moreover, this seems like another industry in whichcompeting networks are quite feasible: there might be twenty regionalclearinghouses that settle their accounts with each other via bilateralcontracts, or just by repeated relationships rather, rather than with ameta-network. In fact, unless the history books lied to me, the freemarket prior to 1913 obstinately refused to produce a nationalclearinghouse, so the Federal Reserve Act had to create one by law. How did clearinghouses handle inter-regional clearing before the Fed? I don’t know, but I guess that they handled it by bilateral contracts. Now maybe at that time, clearinghouses were local natural monopolies;but in modern times, especially with new communications andcomputer technology, it seems that banks could easily contract withany willing clearinghouse to represent its interests, regardless of itslocation. So the likelihood that banks could organize an altruisticboycott (e.g., to enforce collusion) seems low. To take a third instance, consider professsional associations. Itis hard to be an economist without joining the AEA. Yet the AEA hardlyseems to have effectively enforced collusion in, say, hiring — eventhough it would probably have fewer antitrust problems than a for-profit firm. Why is this? I would suggest that professionalassociations are a weak kind of network: if they tried to impose costs onits members, the consequences of withdrawal would not be very severefor the withdrawers. Members with tenure, for example, might justlaugh. Most of the benefits that the AEA provides — a place to meet anddiscuss — could be carried on with some inconvenience outside of thenetwork. It seems highly unlike that anything more than self-interested boycotts could work in such a network. In sum, then, networks vary in strength from strong to weak;and while all networks can easily apply self-interested boycotts, ittakes a fairly strong network to enforce altruistic boycotts. 5. Factors Tending to Make a Network Strong or WeakNow let us consider the crucial question: would the defenseindustry be a strong or weak network? This is somewhat related to thequestion of competing networks, but it is sufficiently different to beworth discussing on its own. What factors contribute to the strength or weakness of anindustry’s network structure? This another area where I would like todo more empirical research, but I have some preliminary ideas tothrow out. It will be noticed that typically, the same factors that makea network weak also make it more likely that there will be no networkat all, but instead a lot of bilateral contracts. a. Let us call the first factor “the degree of interrelatedness”for want of a better term. The intuitive idea this that in somenetworks, every firm has dealings with every other firm in virtuallyevery time period. In banking, for example, every bank has checks

going to or from a huge number of other banks. In a professionalsociety, in contrast, members might only deal with a small fraction ofthe membership. It seems likely that the higher the degree ofinterrelatedness, the stronger the network. b. Closely related is the “lumpiness” of inter-firm relations. If firms deal with each other rarely but their deals are large, bilateralcontracts and the like may work better than a network. In contrast, alarge number of small deals make a network more efficient. We canthink of the same fact in another way. If deals are lumpy, then anetwork would involve wasteful transactions costs, since every firmwould be paying to make it possible to deal with every other firm, eventhough such deals rarely materialize. In contrast, if deals are lesslumpy, firms waste transactions costs by negotiating a new deal witheach trading partner. c. Networks that provide services vs. networks that justcoordinate cooperation. The VISA corporation has a giantsupercomputer that processes the hundreds of millions of monthlyVISA transactions at a very low per unit cost. No individual membercould afford/find it profitable to buy such a computer. VISA alsoinvests in a brand name, common advertising, etc. In short, there issomething more this network than just the members: there arecommon resources that the network as such owns, and which it isuniquely able to supply. In contrast, other networks have few or nocommon resources; instead, they just coordinate the cooperation of themembers. A professional association is probably a good example: itdoesn’t supply its members with anything significant; it just solvesthe coordination problem by announcing a single time and place forgathering, letting people spread information, and so on. Networks thatprovide services are probably much more able to enforce altruisticboycotts than networks that just coordinate cooperation. d. The extent to which inter-firm cooperation is based onconsciously-designed terms vs. evolved traditions. The VISAcorporation is an enormously complex, designed institution. It wasconsciously worked out to solve certain problems, and appears torequire fairly frequent modifications, modernizations, and so on. Incontrast, some kinds of cooperation are based more on tacit, evolvedunderstandings — e.g., don’t use violence first, be polite, reciprocatefavors. Networks based on explicit design are probably stronger, sincethey are the only cheap remedy for high transactions costs. But ifcooperation is based largely on evolved tradition, then the network islikely to be weaker; tradition in a sense substitutes for formal (andcostly) negotiation. e. The extent to which firms have other activities for which thenetwork is unnecessary. Credit card issuers simply can’t do businessunless they are in a network; but members of professional societies,banks, and other network industries do a lot of non-network things too. Banks, for example, could still take savings and make loans even ifthey broke with their clearinghouse; professionals could still get jobseven if they didn’t attend conventions, and so on. The more non-network substitute lines of business the firms have, the weaker theirnetwork will be. f. The final point is not so much a point about the power of anetwork, but rather a point about how likely a network is to usewhatever power it has. Some kinds of collusion are easier to enforcethan others: if the product is homogeneous, monitoring is cheap, and soon. With heterogeneous products and expensive monitoring, collusionmay not work even if the power to enforce it exists. (See section 3 forwhy this factor preventing collusion wouldn’t similarly prevent allorder.) For example, malls forms a kind of network: no store cantrade in a mall unless they have the permission of the mall owners. Now since the cross-elasiticities of demand for the goods sold indifferent stores are probably significant, it is clear that in theory allof the stores could make money money if they colluded (a little bit –otherwise people would go to a different mall); and since they are in acommon network, this would be feasible. But to my knowledge, no malldoes this. Presumably, goods are too heterogeneous (clothes substitutefor each other, but there is a huge variety of types of clothes) andmonitoring costs are too high (prices need to go up and down, it wouldtake a lot of watchdogs, etc.). Perhaps there are other factors, but I can’t think of any rightnow. 6. The Defense Industry: Strong or Weak Network?Given this rough outline of factors tending to increase anddecrease the power of a network, where does the defense industry windup? I think that it winds up on the low end in almost every case. a. Degree of interrelatedness. Most crime is local; and mostinternational crime consists in the drug trade and other activities thatwould presumably be legal in an anarchist society. So it is likely thateach defense firm will have almost all of its dealings with other localfirms. L.A. might have, say, 20 firms, each of which would have toarbitrate many conflicts with each other; but they would probablyhave very few conflicts to work out with Boston firms, since very fewcriminals travel from Boston-L.A. to commit crimes (or vice versa). Cowen himself concedes this point without admitting its fullsignificance: “international criminal and legal relations are a verysmall part of the activities of, say, the American and Canadiangovernments. The benefits of forming a world government to moreefficiently deal with Americans who murder Canadians are relativelysmall.” (p.263) International crime is a minor problem becauseinter-local crime in general is a minor problem. If most crime islocal, then networks (if they exist) will probably be local too, so atleast a national monopoly wouldn’t arise. Moreover, free entry wouldbe harder to deter if whatever collusion existed were local, since thepossibility of massive retaliation would not be present. It would not bethe System vs. a lone rebel firm, but a conflict between roughly equalnetworks who would prefer live-and-let-live to fighting. b. Lumpiness. Again, this seems to hold. Once you consideronly crimes with victims, you will be surprised to find out how fewcrimes there actually are in each locality. Moreover (and this isperhaps an aspect of lumpiness), each alleged crime is likely to bedifferent from every other: particular circumstances of time, place,evidence, witnesses, and so on must be considered to reach the outcome. It is unclear why a network’s transactions costs would be lower than iftwo firms just worked it out for themselves. In contrast, thetransactions costs of highly standardized credit card deals can bereduced a lot by a network, since they can all be treated alike. TheVISA central computer handles millions of transactions, each of themnearly identical; it average transactions costs are much lower than ifeach firm did it. But it is difficult to see how a central trial systemwould resolve cases at lower costs. (Maybe if Landes&Posner wereright that providing efficient rules of law is a pure public good wouldthis be the case. See my thesis “The Economics of Non-State LegalSystems,” sections 3.1-3.8 for my doubts.)c. Would defense networks provide services or just coordinatecooperation? Since the main thing that the network is supposed to do iscreate orderly channels to resolve disputes between clients of differentfirms, it seems like the defense network’s chief business is the second. Cowen points out that criminal files, extradition rights, and the likemight be provided by the network. Quite possibly, but it still seemslike the defense network mainly tries to reduce the transactions coststhat firms would incur if they all made bilateral contracts with eachother. d. Would industry standards be designed or evolved? To a largeextent, the latter. We have a huge body of customary and common law,business practice, and so on; we also have widespread adherence tosome simple norms of conduct. So I think that the standards for inter-firm relations would be basically set by our traditional practices: notstarting conflicts, compensating the injured, fair trials, and so on. This is just a big parts of our cultural background and no one (in theirprivate role, anyway) really wants to re-negotitate it. So thenetwork’s contribution to reducing transactions costs wouldn’t be thatbig. There might be some designed aspects that would require formal(and high t.c.) negotiations, but we may reasonably doubt thir extent. It seems likely that designed innovations would be largely intra-firm. e. Extent of other activities. Defense firms would do a lotbesides work out trials of accused criminals. They would patrol areas,guard buildings, walk people home, check out false alarms, and supplya long list of other defensive services that people would want. Thisbodes well for anarchy for two reasons. First, the power of thenetwork is less when firms have easy substitutes lines of business. Second and more importantly, even if Cowen were entirely right aboutthe collusive tendencies of the arbitration side of business, that wouldbe just a tiny sub-market in the broader defense industry. Theweapons would not be monopolized, because only one part of the defenseindustry would tend to monopoly/cartelization. And if that sub-marketstarted to act like a state, people would still have many defensivealternatives. f. Heterogeneity and monitoring costs. To begin with, is clearlyeasier to enforce rules against violence and stonewalling than it is toenforce collusion; the former would be a self-interested boycott, thelatter an altruistic one. Violence is more obvious than non-collusion. And given differences in location, quality, market niche, andso on, heterogeneity could be a big carrier to collusion even if thegeneral Cowen picture is correct. 7. Ideology: Deus ex Machina?Cowen argues that to use libertarian ideology to prevent hisscenario is just a deux ex machina. Perhaps. But suppose that it wereargued that ideology is also necessary sustain government. Many socialtheorists have said as much (Hume, la Boetie, Hayek, Mises, and lotsmore). In this case positing libertarian ideology as one check on abuseof power becomes more reasonable. As I suggested in conversation with Cowen, people seem tobehave “altruistically” (”ideologically” might be a more neutral word)in one sphere of life but not the rest. In their role as privateindividuals, people give huge amounts of money to charity. But veryfew businessmen run their businesses like charities, even if they arecharitable people. (Even there, though, most people wouldn’t murderfor a living, even if the pay were good.) Perhaps this is a way to solveCowen’s paradox, that if private supply of public goods works, thencollusion works, and if collusion doesn’t work, then private supply ofpublic goods doesn’t work either. If people are (somewhat) ideologicalqua private individuals, but profit-maximizing qua businesspeople,then both good results (non-collusion and private supply of publicgoods) can spring from the same group of people. Another related observation: While in their business rolespeople are probably less charitable than in their private roles, mostbusinesspeople still feel somewhat constrained by morality. Mostwouldn’t murder or steal to increase profits. In a way, the businessrole tends to relax some, but not all, of the moral constraints that theyfeel as individuals. (Not that this is a bad thing — I agree with MiltonFriedman that managers should be charitable with their own money,not their stockholders’.) Compare this to the governmental role: thisseems to relax almost all of the moral constraints that people feel. Itis a truism that the gentlest people will kill for their governments;but how many would kill for their employers? So perhaps this isanother reason (and not just a deus ex machina) to think thatideological constraints on abuse of power would work better in ananarchist society. 8. My Picture of AnarchyLet me outline my picture of the defense industry in ananarchist society, to contrast it with Cowen’s. There would probablybe a middling number (10? 20? 30?) of weak networks; the networkswould be bound to each other by bilateral contracts. Basic standardslike adherence to peaceful and orderly procedures, willingness tonegotiate, fair trials, and so on would be enforced by self-interestedboycotts. Collusive standards, in contrast, would probably be too hardto enforce for all of the reasons suggested. It also seems likely thatlocal firms might have more precise and detailed contracts with eachother, since most crime is local in nature. The incentive to form networks above the local level wouldcome from the desire for extradition and the like. This is a prettyminor benefit, but probably worth pursuing. (After all, ostracizingdangerous criminals is another sort of self-interested boycott.) PeterKurrild-Klitgaard suggested to me that there would be manyoverlapping jurisdictions, and I am inclined to agree with him. The worst that could happen is that the criminal arbitrationside of business would become a collusive network; but this would stillleave open competition and protection from well-armed firms in otherlines of business that have no need to network with each other (as Isuggested: armed guards, patrols, etc.). But that is not too likely; notonly are internally collusive but externally competing networkspossible; but for the reasons stated above, the networks are likely tobe too weak to enforce internal collusion either. Admittedly, this is a speculative picture; but so is Cowen’s. Precise predictions of market structure are not forthcoming, but somepredictions make more sense than others. Despite my view thatCowen’s critique of free-market anarchism is the best yet, I must saythat his prediction is much too pessimistic.