Free Market Incentives Foster Service to Others

Howard Baetjer: All right, having discussed two of the three, what are for me, foundational principles, that help explain why free markets, free economies are good for human flourishing, we’re going to go on now to the third.

So we’ve talked about the great importance of market prices which communicate dispersed [00:00:30] knowledge to everyone, so that we can stay well coordinated, the importance of profit and loss in guiding entrepreneurial ingenuity, now we’re going to go on to the next one of these has more to do with incentives than it does with knowledge. When I talk about prices I’m talking about the knowledge involved in prices. When I’m talking about profit and loss, [00:01:00] I’m thinking about the information content in that feedback. The market process does do very well to provide useful information, it also does well to provide good incentives.

These next two lectures, this next portion of the course, has to do with the incentives that are inherent in different institutions and in particular I’m going to offer for your consideration a strong [00:01:30] claim, and that claim is that the incentives inherent in market institutions are much more conducive to people paying attention to the well-​being of others, than the incentives inherent in governmental institutions and interventions.

Here’s a way to look at it sort of graphically. Over here on this side we’ve got the institutions of civil society: Private ownership, [00:02:00] freedom of exchange and along with freedom of exchange, an idea I’ve been developing a lot lately, regulation by market forces. These two certainly go together. If we are really fully free to exchange what is ours with others who wish to exchange with us, than the government can’t very well restrict that. Any restriction on that voluntary exchange is going to be an interference with the freedom [00:02:30] of exchange. So if you don’t have government regulation in that sense, government restriction and interference with what you can do. And the only kind of regulation you’re going to have available is regulation by market forces. It’s an idea I’ve been developing and some articles. I think it’s very, very important, but for the purpose of this lecture, what I’m going to do is basically make two presentations.

The first is going to contrast the incentives inherent [00:03:00] in private ownership vs. the incentives inherent in government ownership. Then we’ll go on to the incentives inherent in freedom of exchange versus those inherent in restriction of exchange in government regulation. I’m going to make the claim that the incentives for people to pay attention to the well-​being of others are much stronger on this side of the range.

Civil society free market institutions [00:03:30] almost require people to pay attention to others in order to get what they want for themselves because others don’t have to deal with them. If you want to make use of someone else’s property you have to make it worth her while. If you want to exchange with someone you have to offer her something that’s going to be useful enough so that she’ll participate. So that’s really what I called the invisible hand principle in an [00:04:00] earlier lecture. If you want more for yourself in a free exchange economy you’d better pay attention to what other people want or they won’t interact with you. In that setting, people have a very strong incentive to pay attention to what others care about and value.

On the other hand, when you have government intervention, when you have governmental force used, even if the intention and the goal is to make things better off for people. Human beings, [00:04:30] being what they are, are tempted to use that intervention for short cuts and get what they want independently of what others want by getting some governmental action that favors them at other’s expense. That’s the overall plan. Okay?

Now we’re going to start with the institutions of private ownership versus government ownership and look at the incentive inherent in those. That’s this lecture. [00:05:00] I want to begin right away with a case study and ask you some questions about it. Then I’ll give you a contrasting case study and ask you some questions about that and I’ll try to make my point out of these two case studies.

The first case is that of The Tongass National Forest in Alaska. The Tongass is the largest temperate zone rain forest in the world. It’s the [00:05:30] largest national forest in the American National forest system. It’s about the size of West Virginia.

It’s the largest temperate zone rain forest in the world. There are larger tropical rain forests but there’s no bigger rain forest in the cool areas of the world. Some details about it: It’s a habitat for Sitka Spruce that tower 500 feet in the air, Sitka black-​tailed deer. There are otters in the streams. [00:06:00] It’s habitat for wolverines. It’s one of the most important spawning grounds for all pacific salmon, ’cause there are so many streams and inlets and waterways on that very much indented coast of Alaska. As a national forest that area of land is meant to be a land of many uses [00:06:30] as the Forest Services motto goes.

In addition to the environmental amenities of the Tongass, for about four decades, for a long time until about 10 years ago, there was major logging operation going on in the Tongass also. The way it worked was the private logging companies would lease from the Forest Service, permission to go into the forest and cut down the timber. They would pay for the privilege of going in and cutting the timber. [00:07:00] The Forest Service built the roads and managed this operation.

Unfortunately, the logging operation was very environmentally destructive. They cut a lot of the old growth timber. The logging activity would lead to erosion which would silt up the streams, make it more difficult for the salmon to come up and spawn. In some dreadful cases they found the simplest way to get the timber out of the forest [00:07:30] was to drag them behind these great big machines and just drag them down the stream beds. That had the consequence of making the stream beds, which in their natural state have trees falling into them that dam up the water and make little pools where the salmon can rest … No pools, no trees down. They were just sluice ways and so it was very difficult for the fish to get upstream to spawn. There was clear cutting which was ugly and a variety of environmental problems.

[00:08:00] You’re taking your notes on paper, we’re sitting at what looks like a wooden table. We need wood products and so it makes sense that to do logging, even if it’s ugly, where the benefit of the timber exceeds the cost of getting it out of the forest. But, in the case of the Tongass, listen carefully to this lest you think you misunderstand, the cost of [00:08:30] building the logging roads into the forest, a cost which was borne by the Forest Service and then by the tax payers therefore, the cost of building the logging roads in and managing the logging program, far exceeded the market value of the timber that came out. The Forest Service lost about .80 or .90 cents on every dollar.

We had this very environmentally damaging operation [00:09:00] going on at a loss. The question I want you to consider is why. Why? Who would be behind that? And I’ll give you a little suggestion about how … A quick and dirty way I think about public policy. If I want to understand a public policy I ask myself two questions. First of all, what are the interest groups fundamentally involved here? What are the interests that are most affected? Second, what are their incentives? [00:09:30]

So you might consider that. What are the interest groups most involved in this logging program? Who are the people who have the most at stake with it and what are their incentives? Consider that now and try to give me an explanation why congress would renew this logging operation at a bad loss with great environmental damage, year after year after year.

Fortunately, [00:10:00] they’ve ended it almost entirely now but it went on for a long time. Why did it happen? Okay, let everyone think for a moment. Okay, go ahead.

Student: The benefits of the logging operation, that is the revenue they made were all concentrated in the logging company. Whereas the cost -

Howard Baetjer: Okay so the logging companies certain … the logging [00:10:30] interests, including the sawmills benefited greatly.

Student: Whereas the costs were diffused among all of the taxpayers.

Howard Baetjer: Okay, good, that’s right, that’s true. Who else in addition to the logging companies benefited. Let me be clear. The logging companies benefited by having the roads built for them. If this was privately owned land and they had to build the roads, they would have declined to do that because the roads were more expensive than the value [00:11:00] of the timber out. I’ll add to that quickly. Partly it’s because that area has boggy soil and logging roads have to support big trucks that carry tons and tons of logs. So these were big, substantial roads and in an area with lots of streams and inlets and so on. They had to build a lot of bridges. Steel bridges, big major bridges to carry … It was very expensive but they didn’t pay for it. Okay?

You’ve given me one interest group. I’m looking for two [00:11:30] other interest groups here behind this. The logging companies clearly benefit because it’s profits where it would have been losses. Who else is involved?

Student: Road builders and I assume local politicians who can give jobs to their people building the roads.

Howard Baetjer: Okay, good for you, the road builders, I think they’re like sort of the logging interests, yes. But local politicians, not just local politicians. And you’re right that it’s jobs for the logging companies and the sawmills, but I don’t think [00:12:00] local politicians because the local politicians have no authority over a national program. But you’re warm.

Student: Of course the representatives in Congress can get the benefit for their district and also the other incentive group I’m thinking about is the Forestry Service itself. It wants to expand it’s budget to …

Howard Baetjer: Good for you, you’ve got it exactly. You’ve got it exact. So the other two interest groups are Congress and the Forest Service. What’s in it for Congress? [00:12:30] Well, Senator So-​and-​so, Congressman So-​and-​so, the logging companies, the American Lumberman’s Association, invites them to be our speaker, all expenses paid of course, in our annual meeting at the beautiful island of Maui and we’d give you an honorarium for your speech. So there are political contributions from the logging interests to the members of congress who will support this program. There aren’t enough congressmen in [00:13:00] Alaska and the other timber states to sustain this but they do a little bit of, “You scratch my back, I’ll scratch yours,” with congress people from other states in exchange for supporting their programs and we can see how it’ll go.

So it’s votes, it’s political contributions to congress. That’s what’s in it for them. But how ’bout … The Forest Service, what did you say? What’s in it for the Forest Service?

Student: Well, they want to expand their budget and their influence.

Howard Baetjer: They want to expand their budget, they want to expand their jobs. [00:13:30] So there’s jobs and budget for the Forest Service, they build the roads. It’s jobs and revenue for the timber companies. It’s contributions for congress. And that’s what sustains this. Meanwhile, what’s happening to the forest? It’s being pillaged. It’s being despoiled.

Now here’s the key question for the purposes of this lecture. Who owns the Tongass? I’m looking for three different but equivalent answers. Who [00:14:00] owns the Tongass?

Student: Two of them are nobody and everybody.

Howard Baetjer: Two of them are nobody and everybody.

Student: The other one would be the government.

Howard Baetjer: The government. What everybody owns, nobody owns and the government really has the say over it. The argument I want to make is that when the government owns it, or everybody owns it, or nobody owns it, the incentives to look after it are not very strong. The problem with the Tongass, I submit to you, [00:14:30] is that it’s government owned and lacks the incentives that are inherent in private ownership.

Let’s get at that with a contrary case. A similar case. It’s similar in being an environmental case, but different in some fundamental ways. This is the case of The Rainey Wildlife Sanctuary in Coastal Louisiana. This is 26, 800 acres of marshland. [00:15:00] It is owned by the Audubon Society. What is the Audubon Society interested in, primarily? Named for James Audubon.

Student: It’s conservationism.

Howard Baetjer: For primarily birds. They’re the big bird watching society in the world, I think. James Audubon was a wonderful ornithologist. The Rainey Wildlife Preserve is owned by the Audubon Society. It was given to them by the Paul J. Rainey family and it’s [00:15:30] a wonderful marshland, wildlife sanctuary. Among other things it’s the stopping over grounds for hundreds of thousands of Snow geese who migrate from northern Canada to the southern hemisphere each year. A habitat for all sorts of wonderful water birds. At the same time, for a very long time, there was in the Rainey Wildlife Sanctuary, an [00:16:00] oil and gas production operation. Oil companies were in there with they’re … They had their drilling rigs in there and they built wells and the wells produced oil and gas in the wildlife sanctuary owned by one of the major conservation groups.

The question to you is how did the oil company get into the wildlife sanctuary? What happened so that came to be? Think about that a little bit. Again, think about the [00:16:30] incentives of those primarily effected. Who are the groups primarily effected? What are their incentives? How do you suppose an oil company was admitted onto the land, a wildlife sanctuary, land owned by a conservation group? What do you think.

Student: The conservation group has an interest in keeping the sanctuary fairly pure so the oil company’s only going to be admitted if, 1) they can pay a lot of money towards conservation [00:17:00] and 2) the conservation group has some kind of guarantee that it’s not going to despoil the sanctuary.

Student: Exactly the same point.

Howard Baetjer: Exactly the same point.

Student: It has to be mutually beneficial for both parties.

Howard Baetjer: Okay, other comments, other suggestions here? You’ve gotten it, you’ve gotten it pretty well gentlemen, good. Usually when I ask this question to my classes, first of all, someone says, “Well, there must have been some government intervention to force them [00:17:30] in.” In this case, as far as I know there was no government intervention. What there was, was a contract.

The way I like to imagine it, just to entertain myself, is that initially you can imagine the oil company approaching the officers of the Audubon Society saying, “Can we come into your wildlife sanctuary and drill for oil?” They think, “Oh my God, that’s the last thing we want, the oil companies are like the devil to us, get lost!” But then oil companies come back and say, “Our geologists believe there’s a fortune in oil [00:18:00] and gas down there and we will pay you very substantial royalties.” Then you can imagine the conservationists were taking a deep breath and thinking, “Oh my God, all right, come into the office, let’s talk about it.” The provisions of the contract would include very large royalties and Will, you’re right. The Audubon Society is a non-​profit group, they can’t pay the royalties out to their members. What did they do with the royalties?

Student: They probably used them for furthering their [00:18:30] conservation efforts.

Howard Baetjer: That’s right. They used them to improve the quality of the wildlife sanctuary and they used them to buy and preserve additional land. There’s a very strong advantage in the revenue to the oil company. As I understand it also, there were various safety considerations. I don’t know this for a fact, but I expect they required the oil company to post a bond so that if there was a spill of some kind the money was already there to clean up. The oil company [00:19:00] offered to shut down during nesting season, so there wouldn’t be any disturbance during nesting season. They had the ability to drill at an angle so they said to the Audubon Society, “You tell us the least sensitive places to site the rigs and within limitations we can site the rigs there and get to the oil and gas deposits.” The roads, the heavy roads they need for their equipment, they said, “We don’t care how long and winding the roads are, tell us where you’d like them so that we avoid the sensitive places.”

[00:19:30] All these arrangements were made and as I understand it there was never any safety problem, there was never environmental damage and it was a source of very significant revenue to the Audubon Society.

Similar question to what I asked you a while ago. Who owns Rainey Wildlife Sanctuary?

Student: The Audubon Society.

Howard Baetjer: The Audubon Society. It’s privately owned. The [00:20:00] idea I want you to consider is that the difference in the very satisfactory use of Rainey for dual use, not just as a wildlife sanctuary but also as a source of oil and gas with which we can heat our homes, is a consequence of the incentives in private ownership.

In private ownership the incentives are very different from those in public ownership. When you have private owners [00:20:30] the private owners enjoy the profits or suffer the losses. Therefore, they bear the opportunity cost of use. If it’s true, as I like to imagine that initially the Audubon Society told the oil company to get lost, that was a costly decision to them. That would be millions in royalties given up. They feel the millions of royalties ’cause they own it and they have the opportunity to enjoy those royalties. So they pay attention to it and they have a strong incentive to be good [00:21:00] stewards, to make all possible good use of the land that they own.

By contrast, the public administrators who administer the Tongass, are not owners. They have no profit and loss stake in the land. They get paid a salary independent of profit or loss and that program made massive losses for decades, but it didn’t come out of the pockets of those who were making the decisions. So they did not bear the [00:21:30] opportunity costs of use. The taxpayers did. And because they don’t feel the opportunity costs, they don’t see the possible benefit, the profits that come from good management, they have an incentive to use the resources to protect their turf, to benefit themselves politically, independent of the good resource itself.

That’s my first point about the benefits of private ownership. [00:22:00] Private owners have a strong incentive to be good stewards of what they own. Public administrators, non owners, don’t have that profit and loss incentive to be good stewards.

That’s one thing to be said for private ownership. It promotes stewardship.

Next point I want to make, the second point about the benefits of private ownership, has to do with the performance of the private owners, the performance in doing their job, and we’ll contrast that with the performance of the public administrators [00:22:30] who manage publicly owned land.

In government managed, government owned things, because there’s tax money coming in to cover it, there’s less of a connection between performance and funding. That gives less of an incentive to do a good job. That’s the point here. Let’s look at it with another example.

I spent two years in Scotland as a student, made friends there with a guy named Donald Henry, and we talked about politics. [00:23:00] When I came back to Scotland after being at home in the summer, Donald’s eyes twinkled and he looked at me and he said, “Howard, I have a story for ya, you’re going to like this.”

I wish I could do the Scottish accent well. I said, “Okay Donald, what was it?”

He says, “Well, this past summer I didn’t have a job so I signed on.” I said, “You signed on, Donald?” “Aye, to the dole.”

“The dole, Donald?”

“Aye, aye, that’s our unemployment service.”

“Oh, okay, go ahead then.”

[00:23:30] “So I signed on but then I got a job. Well, I kept my appointment at the dole office. I didn’t feel too good about it. I’m standing there in line and getting closer and closer to the window and I’m feeling more and more guilty and finally I get there, the lady’s counting out these pound notes, I couldn’t stand it any longer and I said to her, ‘No, I don’t deserve it. I have a job.’ Guess what she said to me? ‘Oh, go on Dearie, [00:24:00] everybody does it,’ ” and she pushed the money his way.

How well is that woman performing in her job of getting money to the unemployed? Not very well. How strong an incentive does she have to make sure the money just gets to the unemployed? When she performs badly like that, what’s likely to happen to her job?

Student: Nothing.

Howard Baetjer: Nothing. What’s likely to happen to the funding of the enterprise she works with? [00:24:30] What’s going to happen to the funding of the Scottish unemployment system?

Student: Might actually go up.

Howard Baetjer: Maybe it’ll go up or stay the same, but it won’t be cut because it comes from the taxpayers. So the government administrator doesn’t have a strong incentive to do a good job because the funding is going to be largely independent of performance. By contrast, consider the case of Children’s Scholarship Fund Baltimore which is a non-​profit I helped to start in my hometown of Baltimore. We give [00:25:00] partial scholarships to low income Baltimore families who want to get their kids out of the bad public schools and into some of the good little, often church private schools, in the area.

How careful do you suppose we are to check the tax returns and make sure that the applicants for our scholarships are actually low income people. Do you think we are careful about, very careful, sort of careful, or not very careful?

Student: I would guess very careful.

Howard Baetjer: Very careful. Why [00:25:30] would we be so careful to make sure that we perform well and get the money to those who really need it?

Student: Because you have a vested interest. If you don’t screen everyone correctly you’ll either lose money or …

Howard Baetjer: That’s it. Why would we lose money?

Student: It’s not even necessarily your own narrow self interest but you wanted the money to go to low income people and if it goes to high income people they’re taking advantage of you.

Howard Baetjer: Well, that’s true, but similarly the lady at the Scottish dole [00:26:00] office probably wants the money to go to the unemployed, but we have to be more careful because if the word gets out, that we’re not being careful, our donors will cut us off. I raised money in Baltimore long enough to tell you it is a jungle. There are all these good enterprises out there going to the same donors and you’d better have a good story to tell and you’re funding from your donors depends very much on how well you use those funds. So there’s again, there’s this close performance and funding. [00:26:30] And Children’s Scholarship Fund is a privately owned, privately operated, private sector operation, that can’t use the tax system to get it’s funding. We have a stronger incentive for good performance in our job.

That’s the first main point in this. The incentives in the institution of private ownership are such as to give people strong incentives to do a good job, to perform well in their obligations to others.