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Home | Mises Library | The Fallacy of the 'Third Way'

The Fallacy of the 'Third Way'

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Tags Taxes and SpendingU.S. HistoryPolitical Theory

08/14/2016David Gordon

The authors of American Amnesia, well-known political scientists from Yale and Berkeley, argue that supporters of the free market have forgotten a fundamental truth. Defenders of the market often point to the “Great Fact,” as the distinguished economic historian Deirdre McCloskey terms it, i.e., the amazing increase in human well-being and wealth that began about two hundred years ago, when trade and production in parts of Europe and America became freer than ever before. Does this not make manifest the virtues of the free market? Our authors do not think so. It is the “mixed economy” of government and business that has accomplished the real economic miracle.

They explain in this way what they have in mind: “The political economist Charles Lindblom once described markets as being like fingers: nimble and dexterous. Governments, with their capacity to exercise authority, are like thumbs: powerful but lacking subtlety and flexibility. … Of course one wouldn’t want to be all thumbs. But one wouldn’t want to be all fingers, either. Thumbs provide countervailing power, constraint, and adjustment to get the best out of those nimble fingers.” (Lindblom, by the way, was so long ago as 1951 a target of William Buckley’s God and Man at Yale: Lindblom used some of the same anti-market arguments that our authors deploy here.)

Such is their thesis: what is the evidence for it? “An American born in the late nineteenth century had an average life expectancy of around forty-five years, with a large share never making it past their first birthdays. Then something remarkable happened. In countries on the frontier of economic development, human health began to improve rapidly, education levels shot up, and standards of living began to grow and grow. … With the United States leading the way, the rich world crossed a Great Divide — a divide separating centuries of slow growth, poor health, and anemic technical progress from one of hitherto undreamed of material comfort and seemingly limitless economic potential. … Public health measures made cities engines of innovation rather than incubators of illness. … Investments in science, higher education, and defense spearheaded breakthroughs in medicine, transportation, infrastructure, and technology.”

The authors’ argument has moved rather too quickly. From the fact that government built something, it hardly follows that the unhindered market could not have achieved the same task, and perhaps better as well. A parallel “argument” will make clear the problem with the “mixed-economy” thesis. Much of the rise of America to industrial supremacy occurred during periods of high protective tariffs. Does this not show that the free market ought to be combined with protection for American industry?

Indeed some, such as Edward Luttwak in The Endangered American Dream and Martin Sieff in That Should Still Be Us, have argued in precisely this way; but the great majority of economists think otherwise. Economic theory shows the benefits of free trade. If America and other countries became prosperous under high tariffs, there is excellent reason to think that economic progress would have been even greater without them. What Sir Arthur Eddington said of physics applies to our case: “it is … a good rule not to put overmuch confidence in the observational results that are put forward until they have been confirmed by theory.”

And are there not excellent reasons from economic theory that show that the free market works better than the state? As Ludwig von Mises again and again pointed out, capitalism is a system of mass production for the masses. Businesses prosper to the extent that they meet the wishes of consumers; those that cannot do so cease to exist and their resources pass to the hands of others.  By contrast, there is no mechanism to eliminate state-controlled enterprises that fail: the state can continually prop them up through taxes.

Hacker and Pierson might respond that I have ignored a main part of their case. They do have a theoretical argument in favor of government investment in public health, science, and education. The market cannot unaided deal adequately with externalities and public goods, and these occur in the types of government investment that they support. “Many important goods in a society are ‘public goods’: they must be provided to everyone or no one. … In the case of public goods, it is difficult to create an effective market.

The second big case of failure — and it is really big — involves markets that produce large effects on people who are neither buyers nor sellers. Economists call these … ‘externalities.’” 

I do not propose here to discuss problems with standard public goods theory, on these, Murray Rothbard’s “Toward a Reconstruction of Utility and Welfare Economics” is an indispensable guide. Instead, let us, just for the sake of argument, for the moment accept the standard theory and see what happens.  According to our authors, “The market won’t produce pure public goods at all. Most products yielding positive externalities can sustain private markets (for example, purely private education markets), but these markets will generally be much smaller than we should want them to be.”

This is a distorted account of the standard theory. It is true of this theory that, where positive externalities are present, the market fails to produce the “optimal” amount of the good or service. But it is not a consequence of the standard view that the market produces a “much smaller” amount than the optimum. To show that would require a detailed investigation of the extent of the externalities: it does not suffice merely to utter the word “externalities” to make the case for intervention.  Further, why assume that the state would produce the “optimal” amount? What reason is there to think that the state could calculate the relevant externalities or that, even if it could, its activities would be bound by their limits?

When the authors tell us that a lighthouse is the “classic example” of a public good that the market cannot supply, readers familiar with the relevant literature will be unable to suppress a smile. More generally, it hasn’t been proved that any “pure public goods” exist. The authors also unaccountably think that the free market cannot respond adequately to negative externalities. “A hundred years ago, individuals and companies were free to dump raw sewage into municipal water supplies: it took government’s coercive powers to stop the lethal practice.” Surely the problems here stem from inadequate definition of property rights, not market “failure.”

Theory does not support the authors’ case for the mixed economy, and neither do the facts. According to Hacker and Pierson, scientific research and inventions require extensive government support; but they ignore evidence to the contrary. Murray Rothbard notes in Science, Technology, and Government, “The myth has arisen that government research is made necessary by our technological age, because only planned, directed, large-scale ‘team’ research can produce important inventions or develop them properly. The day of the individual or small-scale inventor is supposedly over and done with. And the strong inference is that government, as potentially the ‘largest-scale’ operator, must play a leading role in even non-military scientific research. This common myth has been completely exploded by the researches of John Jewkes, David Sawers, and Richard Stillerman in their highly important recent work. ”

The case is even worse for Hacker and Pierson as regards public education. They claim that there are positive externalities involved in education, but they do not mention the existence of negative externalities in this area.  If, for example, you have an advanced degree, you may be harmed by the fact that many others have such degrees as well. This may make it much more difficult for you to obtain a job. Milton Friedman once thought that positive “neighborhood effects,” his term for externalities, justified a government subsidy for education; but thinking about negative externalities made him change his mind. Of all this our authors seem blissfully unaware.

Much of the book consists of an attack on those who venture to oppose government programs like the Affordable Care Act. These dreadful obstructionists are either hardcore or softcore Randians who dare to put their selfish wish for material gain above the common good. They and others are the amnesiacs who “have never been good at acknowledging government’s necessary role in supporting both freedom and prosperity.”

Unfortunately for our authors, these contentions about the obstructionists do not follow, even if one accepts the view that a mixed economy is necessary. From the “fact,” in my view the opposite of the truth, that government provision of certain services is necessary, it does not follow that one ought  now to favor the extension of the government’s activities. How many of the Republicans whom our authors excoriate, one wonders, wish to do away altogether with the mixed economy? The fact that most of them vote for billions of dollars in government programs, albeit in lesser amounts than “progressives” would like, suggests that they too support a mixed economy.  This to my mind is an unfortunate fact, but it is a fact nonetheless.

Thus, the authors have failed to make a case for the mixed economy and also failed to show that large numbers of people have forgotten this case. Despite the eminence of the authors, and their book’s fifty-nine pages of notes, American Amnesia is a work of propaganda, not of scholarly inquiry.

Note: The views expressed on are not necessarily those of the Mises Institute.
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Cite This Article

David Gordon, "The Fallacy of the 'Third Way'," The Austrian 2, no. 4 (2016): 12–14.

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