# The Myth of the Myth of the Market

Matt Yglesias argues that there is no such thing as a “market distribution” of wealth, because most wealth would not exist without the state. He lists “a few minor exceptions” to the maxim that market solutions are efficient:

— The air pollution impacts of modern electrical power generation, industrial activity, and transportation can’t be efficiently bargained away because the transaction costs are way too high.

— So-called “public goods” like basic scientific research or musical recordings will be underproduced absent some combination of state subsidy and state-created intellectual property monopolies.

— Basic infrastructure (roads, electrical lines, sewers) won’t be provided properly without some eminent domain and they won’t be priced correctly due to the monopolistic nature of the market.

— Absent deposit insurance and regulation, banks will be subject to runs and economically destructive panics.

— Without a central bank minding the store properly, the entire macroeconomy will fall into periodic recessions lasting months or years.

Since these five factors color all market activity, Matt says, there is no such thing as pure market activity, and therefore no distribution of wealth that would result if there were no government provision of pollution abatement, public goods, and so on.

In my view, Matt’s argument is not compelling. Take first his list of “minor exceptions” to the general rule that markets work best. Do we need state intervention to keep air pollution down to acceptable levels? There has never been a completely laissez-faire society that has had dirty air, so it is difficult to say. What we do know from the work of Elinor Ostrom is that we don’t need state intervention in all cases to solve problems associated with water usage or overfishing, which are structurally similar to that of air pollution (i.e., they have high transaction costs). It turns out that the threat of state-sanctioned violence is not the only solution to repeated prisoner’s dilemmas, even when transaction costs are high, either in theory or in practice.

What about other public goods? It is strange to me that Matt chose copyright protections for musical recordings as an example, because I might favor eliminating such protections even as a matter of marginal policy reform. If musicians could no longer make money from selling recordings, they would still produce recordings as advertisements for their live performances. Musicians would tour more, and the live music scene might become more vibrant. It’s not at all clear to me that it would be worse than the status quo. I don’t favor eliminating government funding for basic research, and indeed, at the margin, I would favor more such funding. But similarly, without government subsidies, research would still occur, philanthropists would still donate to universities, and so on. While the result may be some modest “underproduction” of basic research, it still seems unlikely that but for government funding of basic research, we would be living in caves.

I’ve never understood the argument about roads, since as best I can tell, roads have always existed, even in cases in which governments did not have transportation policy. The common law, which itself originated without the state, seems to have made adequate allowance for solving the anticommons problem via various kinds of easements and property rules. Matt also argues that private infrastructure would be monopolistically priced, but I think he fails to consider the possibility of customer-owned mutuals as an alternative to both government and for-profit firms.

Without deposit insurance, would banks face constant runs and panics? This is at best controversial among monetary historians. Modern economists tend to blame bank failures during the Great Depression more on restrictions on interstate banking and the concomitant lack of geographic diversification than on the lack of deposit insurance. New Zealand does not today have deposit insurance; it is not a financial hellscape. If deposit insurance were eliminated, banks would become more sober, prudent institutions than they are today, which may not be such a bad outcome. I favor the elimination of federal deposit insurance, and I don’t think I am very alone. Certainly, it is not one of my most out-of-the-mainstream policy views.

I confess to chortling a little at Matt’s line about central banks. Months or years of recession?! Unimaginable. With central banks in charge, the US is experiencing a years-long slump, Japan is experiencing a decades-long stagnation, and Europe is…fucked. Central banks were also at the helm during the Great Depression. My monetary policy views are conventional, but the central banking track record is not something I would try to draw attention to were I taking Matt’s side of this argument.

None of this is to say that we would all be immensely wealthy in a world without government intervention. The way Matt structures his argument, I don’t have to make that claim. All I need to show is that but for government intervention, we would not be dramatically worse off than we are now, which I think I have done. It seems worth mentioning, in addition, that government sometimes makes us worse off as well as better off. For example, government regulation of pollutants can and often does exceed anything resembling the welfare-maximizing amount. Governments produce public bads as well as goods, such as war, genocide, the new Jim Crow (to say nothing of the original), and immigration restrictions. Transport policy is often counterproductive, and infrastructure resources such as spectrum and airspace are often misallocated or otherwise mismanaged, relative to a common law approach. Financial regulation seems to do more to enrich Wall Street than protect the public. And as I said above, government policy caused the Great Depression and the Euro crisis, as well as innumerable other financial disasters. These costs are significant. Immigration restrictions alone cut global output in half. On top of all this is the deadweight loss of taxation, which is substantial.

What is most unfortunate about Matt’s list is how widely accepted it is. He says you can find it in “a really banal mainstream neoclassical economics textbook,” and he is right. Textbook economics presents a simple model of the world and draws conclusions from that model that are frequently at odds with reality. Most textbooks try to convince the reader of the benefits of economic analysis, not to educate the reader about the limits of the models they present. Real world institutional analysis is much more complicated, messy, and context-dependent than Matt’s textbook allows. We can and should use the tools in the textbook to illuminate our work, but applying them as Matt does to create a universal theory of the (non)existence of a market distribution of wealth seems misguided.

# Copyright Reform and the Incentive to Create

Mercatus has a new book out on copyright, edited by Jerry Brito, called Copyright Unbalanced: From Incentive to Excess. I am pleased to be one of an otherwise-illustrious group of contributors.

I expect that the book will create some controversy in policy circles. In this post, I want to address what is likely to be a knee-jerk response from our critics, that copyright reform will substantially decrease the incentive to produce creative works.

Content creators anticipate that their products will generate some amount of revenue each year after they are released. The expectation is generally that the creative work will generate the highest revenue in the first year, and less revenue in each subsequent year. To model this revenue stream, I’m going to assume exponential decay. Exponential decay lets us pick a half-life, $h$, and assume that $h$ years after the work was released, it will generate revenue at half the initial rate. After $2h$ years, it will generate revenue at one-fourth the rate, and so on.

In year $t$, the revenue that the content creator will receive if there is copyright is $e^{\frac{-t \ln2}{h}}$ times the initial revenue. Consequently, the total revenue that a copyright holder will receive over the life of a 95-year copyright term is

$\sum\limits_{t=0}^{94} e^{\frac{-t \ln 2}{h}}$

times the initial revenue.

However, content creators prefer revenue now to revenue 90 years from now. In order to calculate the present value of this revenue stream, we need to apply a discount rate $r$. The ex ante value of the revenue stream generated by the 95-year copyright term is therefore

$\sum\limits_{t=0}^{94} \dfrac{e^{\frac{-t \ln 2}{h}}}{(1+r)^t}$

times the initial revenue.

And of course, this calculation generalizes to different copyright terms. If we returned to a 28-year term, as Tom Bell advocates in his chapter of our book, the ex ante revenue stream would be valued at

$\sum\limits_{t=0}^{27} \dfrac{e^{\frac{-t \ln 2}{h}}}{(1+r)^t}$

times the initial revenue.

We’re now at a point where we can start to run some numerical calculations based on plausible values for $h$ and $r$. What is a reasonable ex ante expectation about the half-life of the revenue stream of a new creative work? I expect that for our book, the half-life will be something like 1 year or less; we will probably sell less than half as many books in the second year the book is out as in the first. But let’s not use $h=1$. Let’s estimate that $h=10$ to be extremely conservative and generous to our critics.

What about $r$? Again, how about if we are conservative and give $r$ a low value, like $r=0.02$?

Now we can run some calculations. Using the values above, the ex ante present value of a 95-year copyright is around 11.726 times the initial revenue. The ex ante present value of a 28-year copyright is around 10.761 times the initial revenue. Consequently, shortening the copyright term from 95 years to 28 years (less than 30% of the current term!) retains about 91.8 percent of the incentive effect of the current copyright term.

It is unlikely that such a small decrease in the present-value of the revenue stream would reduce the amount of content production by much. To the extent that content producers cannot or do not substitute easily into other fields, they would simply take the 8.2 percent decline in compensation per project as a decrease in wages (not the end of the world), and there would be no decline in content production. To the extent that content producers can substitute into other fields, we would get less content, but we would also get more of other stuff—the welfare effects of less content are ambiguous, since there is a knowledge problem regarding the optimal amount of content.

If you want to do the calculation with different half-lives and interest rates, be my guest. I am confident that for all plausible values of $h$ and $r$, you will find that shortening the copyright term will have at most a modest effect on the incentive to create.

How about the value of the public domain? This is a little harder to model, because we care about the ex post value of works, not just the ex ante expectation that content creators have. In practice, there turn out to be works with much longer half-lives than others. This fact complicates any back-of-the-envelope calculation. We also don’t know exactly by how much content creation would fall.

But let’s abstract from this and model the value of the public domain as the revenue stream for a given project that otherwise would have gone to copyright holders above. One difference for the public domain is that it no longer makes sense to discount the stream of value—future generations aren’t sitting around, waiting to be born so that they can watch Star Wars for the first time. Therefore, normalized to our original, first-year revenue stream, an estimate of the value of the public domain under a 95-year term is

$\sum\limits_{t=95}^{\infty} e^{\frac{-t \ln 2}{h}}$.

Under a 28-year term, the value is

$\sum\limits_{t=28}^{\infty} e^{\frac{-t \ln 2}{h}}$.

Plugging in the value we selected earlier for $h$, 10, the former expression yields around 0.021 and the latter about 2.144. In other words, the value of the public domain would be around 100 times higher per creative work if we shortened the term to 28 years. Again, this value is highly dependent on our selection of $h$, but the reason I am doing these calculations is so that my critics can repeat them with values they find more plausible, if they so choose.

This analysis has been highly stylized, but it is also extremely conservative. The half-life of most creative works is probably much shorter than 10 years, and when valuing an uncertain revenue stream, most artists—and even content corporations—probably discount at a rate of higher than 2 percent. The value of the public domain has been understated in this analysis, because there are many works that turn out ex post to have longer half-lives (but it is still the ex ante estimate of value that matters for investment). I have also not factored in the gains from those derivative works that are impossible under the current regime due to transaction costs, or the savings in enforcement costs from having a shorter time during which enforcement is necessary, or indeed, many of the other issues discussed in our book.

I would be interested in reading further analyses like the one above from anyone who supports the current copyright term or a longer one. How do you justify such a long term? You don’t have to use my assumptions, just make your own explicit so that people can see what they are and quarrel with them. How many fewer works do you really think would be created if we shortened the term from 95 years to 28 years? Would we really be worse off? Please show your work.

In honor of the SOPA blackout, here are some thoughts on copyright law. But first, a brief detour into murder law.

There are a positive number of murders each year. If we put more resources into investigating and prosecuting murders, there would be fewer murders. Nevertheless, it is not at all clear that we are spending too little on murder. The optimal number of murders is positive, not zero. The best policy with respect to murder is to try to maximize the net benefits of the policy, not to minimize murders.

Suppose a new technology were introduced that made it easy to get away with murder (e.g., David Friedman’s plan for Murder Incorporated). This technology makes it extremely costly, though, say, not impossible, to stop murders from occurring. What happens to the optimal amount of murder enforcement? The amount that must be spent to deter each murder has gone up, so the price of deterrence has gone up. Consequently, society should aim to deter fewer murders. Under some extreme circumstances, we might even be better off if murder were legalized (and if people were advised to just be more polite to each other).

Similarly, whatever your prior belief about copyright enforcement, the Internet has made it easier to get away with copyright infringement. The amount that must be spent to deter each instance of copyright infringement has increased. Consequently, society should aim to deter fewer instances of copyright infringement, not more instances as SOPA supporters advocate.

In fact, the cost of deterrence has increased so much that we should begin to rethink copyright law. We could increase the benefits of deterrence if we targeted only high-value infringements. This means that we should shorten the term of copyright, since high-value IP tends to be newer IP (in fact, copyright terms have increased in recent decades, a move in the wrong direction). We might consider expanding “fair use” copyright exemptions to include more non-commercial uses, since commercial infringements are more likely to diminish the value of a copyright. Most importantly, we should withdraw public resources from the enforcement of IP violations. Private enforcement through the tort system has a built-in safety valve: when the cost of enforcement rises, people will do less of it. But the criminal system is essentially a public subsidy for enforcement; no wonder that pro-copyright factions are attempting to criminalize copyright infringement through SOPA and other legislation.

The bottom line is that recent expansions of copyright terms and enforcement powers get the comparative statics exactly backwards. In an age of costly enforcement, it’s time to give up, at least at the margin, on copyright. And at the margin, content creators should just be more polite to content consumers.

# E-Book Miscellany

1. I very much want a Kindle, but…
2. I am afraid of being locked into a vendor or technology. I currently buy almost all my books from Amazon.com with very little comparison shopping because I know that Amazon faces a pretty elastic demand curve. If I buy a Kindle, I will have only one source for in-copyright books, and Amazon may not always have an incentive to keep prices low. If I invest in a Kindle library, then I will always have to have a Kindle, even if some superior e-book reader comes along.
3. Digital rights management is such a pain. My current book-reading habits include “borrowing” books from parental libraries. Non-transferability is the reason that e-books are so cheap relative to regular books, but I think I would rather pay full book price for an e-book if it included full rights of resale and transfer. The hypothetical used e-book market would of course be more efficient and liquid than the used paper book market, due to lower transaction costs.
4. Of course, even if I bought a Kindle, nothing would stop me from raiding parental paper book libraries.
5. From what I understand, Amazon has not yet perfected the within-household e-book syncing paradigm. Suppose I have an iPhone with the Kindle app on it, and both I and my wife have Kindles. Amazon offers an optional service that syncs the last page you were on across devices, so I can start a book on my Kindle and pick up in the same place on my iPhone if I am standing in line somewhere. As it stands (correct me if I am wrong), I cannot sync just my iPhone and my Kindle without syncing my wife’s Kindle also. This is troubling since there are several books in my house with both His and Hers bookmarks in them.
6. The existence of e-books makes me wish even more that copyright terms were shorter, say, 20 years. Every book published before 1990 would be a free download, and I doubt that the incentive to write books would be too adversely impacted.
7. There ought to be a way to upgrade my paper book library into a digital library. I mail a book back to the publisher and they give me a free e-book of the same title. Provided I pay the shipping costs and a small fee for processing, why should they be unwilling to do this? Taking a used book out of circulation means more new book sales.
8. Think about e-books, the real estate market, and Caplan’s Jock/Nerd theory of history. Crudely, assume every nerd has a room in his house devoted to books, and every jock does not read or own books. Other things equal, nerds will need larger houses. Now e-books come along, and nerds can fit that entire room into one or two e-book readers. This is a change that benefits nerds to the tune of tens of thousands of dollars in real estate costs alone. To the extent that nerds demand less housing, it could result in lower housing prices for jocks as well, but this effect would be modest compared to the effect on nerd welfare. The invention of e-books is the revenge of the nerds.