Man, Economy, and Liberty

2

Prisoner’s Dilemma, Transaction Costs, and Rothbard

Roger A. Arnold

There is today no better known, more articulate, or more persuasive expositor of the case against government than Murray Rothbard. In a world where surely 999 out of every 1000 persons readily accept the need for government—in much the same way that they accept the need for the absolute essentials of life: food, water, and air—Murray Rothbard has the uncanny knack of shaking their (heretofore unexamined) acceptance of government. He does so by combining refreshingly clear writing, finely crafted logically-deduced conclusions, intermittent thought-provoking questions (“Why is it ethically better to follow the wishes of the greater as against the lesser number? What’s so good about the greatest number?”), an ability to find the usually hidden weak point in an opponent’s argument and draw it out in the open where it is thoroughly thrashed, and an uncompromising dedication to the cause of liberty that can be felt and is appreciated, at an intellectual level by some and at a subconscious level by others.

Part of Rothbard’s continuing, long, impressive, and interdisciplinary career may be seen in terms of his replying to, and disposing of, the dozen or so major reasons and arguments put forth to support the notion that the State is necessary. In retrospect, we would have to conclude that some of these reasons and arguments have been more difficult to dispose of than others. One that has been particularly difficult purports that government is necessary in situations where game-playing is present (of the iterated prisoner’s dilemma variety), or where high transaction costs exist, or where game-playing and high transaction costs exist together. In fact, we may note that the arguments for the State fall into one of two broadly-based categories. There are those arguments which, on the surface, stress the need for the State on grounds that it will do good, prevent bad: but below the surface they appear to be motivated by the desire for pure redistribution or by paternalism. Simply put, the arguments are based on a desire to “take from others,” or to have others “do what they should be doing.” In the former, one person is the pawn of another: in the latter, one person is the “adopted adult-child” of another. In both cases, one person’s will is subject to that of another’s. Once this is pointed out, as Rothbard so often does, the argument loses much of its moral force; individuals who continue to advance it are finally seen for what they are.

There is another argument for the State that is not so easily disposed of. This argument emphasizes that there are times when large majorities, if not everyone, would prefer certain goods and services, but because of free-rider problems, high transaction costs, strategic game-playing, etc., such goods and services can only be brought about through the imposition of taxes, thus implying the need for the State. When the argument is constructed in terms of “everyone” wanting X but no one being able to obtain it (because of the problems cited above), the State is thus seen as an agent that helps individuals obtain what they want, and not as an agent aiding one group of persons at the expense of another group. As noted above, this construction of the argument is harder to dispose of than the former argument for the State. Murray Rothbard has directed his attention to this argument, but not usually within the same framework of analysis used by the proponents of the argument. This turns out to mean that there is scant mention of “prisoner’s dilemma” and “high transaction costs” within the works of Rothbard. Some critics have noted this and then continued on to argue that prisoner’s dilemma and high transaction costs present a problem for Rothbard’s no-government position. A major objective of this paper will be to show that the overall Rothbardian economic and political philosophical framework provides a strong reply to these critics.

The plan of the paper is as follows: First, to outline and discuss in greater detail (than above) the argument that purports the State as necessary on PD (prisoner’s dilemma) and TC (transaction costs) grounds. Second, some general criticisms of this argument will be made. Third, Rothbard’s position on PD and TC problems will be noted and amplified.

The State as “Market Mechanism”

The point in the argument we wish to discuss in detail is commonly made through a story-example. It goes something like this: Consider a community of 1000 persons. Every individual in the community wishes to have good X, but unfortunately the ordinary market mechanism has not provided it. The reason might be that individuals are engaged in strategic game playing, behavior they can realize reduces the probability of achieving their ends, yet behavior they do not seem capable of freeing themselves from. Or it might be that the costs (usually called “transaction costs”) to realizing an exchange are so high that the exchange will not be realized. Lastly, it might be a combination of both: game-playing and high transaction costs. In any case, since it appears that individuals can not obtain good X through the ordinary forces of (voluntary) supply and demand, something beyond this is needed. Often that “something” is government; government, through its levying of taxes, collects the necessary funds to provide good X, and in the process overcomes any game-playing behavior and/or high transaction costs. We conclude that when the market fails, government must rise to the occasion. And in that government aids individuals in obtaining what they want (but do not seem to be able to get), government is seen as something of a “market.” Simple market exchanges ($1 for one apple) allow individuals to move to higher utility levels; complex “market exchanges” through government (taxes for roads), so the argument goes, do the same. On the surface, government coerces (“pay those taxes, or else!”); further below, it is seen as the visible manifestation of voluntary agreement.

On one level, it is an appealing argument. First, it paints government as a market mechanism of sorts, and therefore not much of a different animal than we are used to. Second, its policy conclusion appears reasonable: government should only do what the simple market mechanism cannot. Third, it is built on identifiable phenomena, that is, most individuals realize that game-playing is evident in real life, and that transaction costs sometimes do exist. For these reasons in particular, the argument has become widely accepted, even amongst those whose work is noted for pointing out the “costs” associated with government and who have taught us much about “government failure.” For one, the two major roles of the State—usually noted as “protective” and “productive”—both may be seen as tied to the solution to the prisoner’s dilemma problem. With respect to the protective State, consider the discussion of two (generally considered) free-market economists, Richard McKenzie and Gordon Tullock, in their text, Modern Political Economy.

They speak of two individuals, Fred and Harry, who live alone on an island. At first Fred and Harry have no behavioral rules to naturally divide their spheres of interest. Soon each learns that he has two options he can follow: one, he can steal from the other, or two, he can choose not to steal. If both find it advantageous to steal, and do not feel a conscience cost high enough to outweigh the benefits, then both will become involved in theft. Soon after they realize that theft, and the protection from theft, is expensive: it diverts resources away from production. Realizing this, they agree on certain rights, on a social contract. But once this is done, Fred and Harry find themselves with an incentive to cheat on the agreement. Each has two options: either to respect the other’s rights, or to violate the other’s rights. Here, then, is a prisoner’s dilemma setting. It so turns out that each alone is better off if the other respects his rights while he violates the other’s rights. Attempting to minimize the maximum loss in utility that can occur, each violates the other’s rights. The result is that they are once again back to where they started, where each is stealing from the other. McKenzie and Tullock then go on to generalize this situation to a large numbers setting, and state: “To prevent violations, both of offensive and of defensive nature, a community may agree to the establishment of a police, court, and penal system to protect the rights specified in the social contract.”1 While McKenzie and Tullock do not explicitly state that the police, court, and penal system should be provided through the State, as opposed to privately, it is clear that this is their intent. We see that here the protective role of the State is justified on prisoner’s dilemma grounds.

This is also the case with respect to the justification of the productive role of the State. It is argued that the State is necessary to impose the taxes that are necessary for the provision of goods that exhibit “publicness.” The reasoning is as follows: first, a public good is identified: call it X. Second, the point is made that if X is consumed by one it is available for consumption by all. Third, because of the second point, consumers will become free riders. There is here a prisoner’s setting in that each person who benefits from X has the option to pay or not pay for it, the best outcome for each individual being where he does not pay and all others pay. However, behaving in a manner to bring this outcome about is said to end with no one paying for the good. The way out is to opt for state-imposed taxation. Assuming everyone benefits from good X, and would end up paying a dollar tax equal to or less than the marginal benefit of the good, then it is better to have state-imposed taxation and X than to be without taxation and not have X. Notice again that the State is here justified on grounds that it does what simple supply and demand cannot. Also, in that individuals are getting through government what it is they want, the government is seen as a “market mechanism” of sorts.

The same theme often exists in the transaction-costs argument for the State. With respect to the productive role of the State, it is often argued that a good, such as X again, will not be produced because of the high transaction costs involved. It is often argued the following way: One thousand persons want X, but a potential supplier finds it too costly to obtain the agreement of, and payment from, all 1000 persons; consequently he does not provide X to these persons. The solution? The State should detour around the high transaction costs. It should provide X, tax people into paying for it, and that is that. We see then that the productive role of the State is often justified in terms of game-playing (prisoner’s dilemma) and high transaction costs.

Besides being used to justify the productive role of the State, the transaction-costs argument is also used to justify the wealth-maximizing role of the State. This is perhaps most clearly seen in the work of Richard Posner. Posner, drawing on the highly-idealized Coasian setting—where there are zero transaction costs and no income effects—argues that government, through the courts, ought to assign property rights to the party who would buy them, and place liability (in liability cases) on the party who could have averted the accident at lower cost.2 According to Posner, such arrangements are consistent with what individuals would voluntarily agree to amongst themselves if high transaction costs did not get into their way.3 Once again, the subtle message is that government, through its court system, is justified on the grounds that it does what the market wants do to (but somehow can not).

Criticisms of the PD and TC Justifications of the State

Can the State in its protective, productive, and wealth-maximizing roles be justified on PD (prisoner’s dilemma) or TC (transaction costs) grounds? The answer is “yes,” if and only if those who advance the argument for the State and certain State actions based on PD and TC grounds can prove that the state is what they say it is: a “market mechanism” through which individuals increase their utility levels. James Buchanan defines the condition that must be met before the State can be justified. He notes: “The justification for all collective action, for government, lies in its ability to make men better off.”4 It needs to be proved that the State makes men better off. So far, it has only been asserted that it does. To their credit, the proponents of the PD and TC justifications have pointed out that game-playing and transaction costs exist, but this is not enough to justify the State. Additionally, they implicitly argue that the coercion the State imposes is voluntarily agreed to, that is, individuals agree to it, seeing it as the only way to obtain what they (all) want, and that the benefits of the byproducts of the coercion—e.g., protection (of rights), production (of public goods), and wealth maximization—are greater than the costs of coercion. First, the agreement spoken of has never been witnessed. Second, telling a story where the benefits of the byproducts of coercion appear to be greater than the costs of coercion is not the same as proving that they are. The justification of the State based on PD and TC grounds is weak.

Contrast the unproved PD and TC justification of the State and of the coercion implicit in the State with Murray Rothbard’s attempts to prove that the State cannot be justified. Stated differently, contrast the unproved PD and TC justification of the State that makes men better off with Rothbard’s attempts to prove that the State makes men worse off. In Power and Market, Rothbard provides a framework in which a long list of activities of the State are categorized and analyzed. A major conclusion of the analysis is that the State decreases social welfare. The reasoning is as follows: One, the State uses coercion. Two, if individuals are coerced it follows that they are doing something they wouldn’t be doing.5 Three, one can not get more utility from doing something he wouldn’t be doing than doing something he would want to do. We conclude that the State decreases utility levels—if not of all persons, of at least some. And as long as we can not measure whether the “winners” gain more in terms of utility than the “losers” lose, we cannot guarantee that there is even, at minimum, a net gain to having the State.

The often-cited retort by the persons who put forth either the PD or TC justification of the State, is that Rothbard does not see that individuals may voluntarily agree to the State in their attempt to make themselves better off.6 Whether this is or is not the case is not relevant to the discussion. As we noted above, the point is that this agreement has not been witnessed, nor has it been proved that the benefits of the byproducts of coercion are greater than the costs of coercion. In short, if we accept Buchanan’s criterion for the justification of the State—“The justification … for government, lies in its ability to make men better off”—then we would have to admit that since those who advance the State on PD and TC grounds have not proved that “men are made better off” through the State, it follows that they have not justified the State. In contrast, Rothbard does seem to have proved that the State is capable of making persons worse off. The PD and TC justification of the State, attempting to get at the idea that through the State persons are made better off, is not as strong an argument for the State as Rothbard’s argument that coercion decreases social welfare is against the State. This does not mean to suggest that there is no justification of the State, only that the attempt to justify the State based on PD and TC grounds, with the underlying theme that individuals are made better off through the State, has not been proved conclusively, or even to the degree that Rothbard has proved that individuals are made worse off through the State, and therefore presently must be judged a failed attempt.

Eliminating PD and TC Problems at any Cost?

Where PD and TC problems exist, the State has been proposed as the solution to the problems. Little thought has been given to other possible ways of dealing with them. It is analogous to a person having a high fever and only a medical doctor being considered as capable of bringing the fever down. No one and nothing else is considered.

We put forth the question to focus our attention on the alternatives: Are there ways other than a State’s dealing successfully with prisoner’s dilemma and transaction costs? We hold that there are. Furthermore, we hold that these ways are implicit within the Rothbardian framework of analysis although they have not been (to my knowledge) directed or proposed as a possible solution to the PD and TC problems at hand. We shall return to this main point after a short detour.

Consider a potential exchange in which high transaction costs are identified. Next, we ask ourselves, is the existence of high transaction costs reason enough to do anything in order to reduce them? If the answer is yes, then we must conclude that nothing is as bad as living in a world where high transaction costs exist. This implies that all else is secondary to a world of zero transaction costs. Put this way, it is perhaps easier to put the whole discussion of high transaction costs in perspective. If the answer to our question is no, then it follows that some things are more important to us than ridding the world of high transaction costs.7

We can say the same about prisoner’s dilemma settings. Once the PD problem has been identified, is this reason enough to do anything to successfully eliminate it? If the answer is no, then it follows that some things are more important to us than ridding the world of PD settings. One point and one question naturally emerge from our questions and answers: We are not only concerned with reducing high transaction costs and eliminating prisoner’s dilemma settings, but in how each objective is met. Besides, if there are some things more important to us than ridding the world of high TC and PD settings, then what are they? Recognition of our point and an attempt to answer our question comprise a direction that a close reading of Rothbard would cause us to push the discussion of PD and TC in. But it is also a direction that those persons who justify the State on PD and TC grounds choose not to be pushed in. For example, where in the literature on PD and TC is there anything but the sketchiest discussion of the importance of the way in which PD and TC problems are solved? Where is there any discussion of the trade-offs involved in reducing transaction costs or eliminating prisoner’s dilemma settings?

Non-Governmental Solutions to PD and TC Problems

In order to make the world a better place in which to live, Rothbard puts emphasis on two important factors: reason and persuasion. Reason is necessary in order to discover what the good life is comprised of. In Rothbard’s words, “… what ends man should pursue that are most harmonious with, and best tend to fulfill, his nature.”8 Once this is known, persuasion is then necessary to convince others, to educate others, as to the ingredients of the good life for themselves and others. One wonders if there is a solution to PD and TC problems that is characterized by reason and persuasion, as opposed, say, to the activities of the State. We hold that there is.

Consider PD problems first. By now it is well-known that under certain conditions, the strategy of “tit-for-tat” solves the prisoner’s dilemma problem.9 Stated differently, tit-for-tat is a strategy which can under certain conditions bring forth cooperation without any central authority, without a State. We shall first speak of the characteristics of tit-for-tat, and of its role in bringing forth ethical behavior, and then compare it to the state as a solution to PD problems.

Robert Axelrod has described tit-for-tat as “nice, retaliatory, forgiving, and clear. Its niceness prevents it from getting into unnecessary trouble. Its retaliation discourages the other side from persisting whenever defection is tried. Its forgiveness helps restore mutual cooperation. And its clarity makes it intelligible to the other player, thereby eliciting long-term cooperation.”10 Contrast the essence of tit-for-tat with golden-rule behavior. A person exhibiting tit-for-tat behavior responds “in kind.” If someone does X to him, he does X back; if someone does Y to him, he does Y back.

A person who exhibits golden-rule behavior does to others what he wishes others to do to him. He does not, in contrast to tit-for-tat behavior, respond “in kind.” If X is done to him, and he does not want others to do X to him but would prefer Y, then he will do Y.

The question emerges: Which type of behavior, tit-for-tat or golden-rule, is more likely to bring on the golden-rule world: where individuals behave to others as they would have others behave to them? It may appear paradoxical, but nevertheless it is true: golden-rule behavior does not bring on a golden-rule world, because it is consistently exploitable. Individuals who exhibit golden-rule behavior are easily taken advantage by others who do not. Furthermore, the latter group is not retaliated against by the former group (and therefore feels no cost to its actions) because the former group would not act in a way that it wouldn’t want others to act towards it. Tit-for-tat behavior is more likely to bring on a golden-rule world. The reason is simple: It signals that to get good, one must give good. There is a boomerang effect: what one gives, one gets back. The golden-rule world is brought about through pure self-interest. We need to note two points before we continue: First, under certain conditions, tit-for-tat has been shown to solve the PD problem. Second, tit-for-tat behavior is capable of bringing on an outcome—a golden rule world—that one might have thought could only have been brought about by golden-rule behavior.

Turn now to the State as the solution to the PD problem. With the State, not only is the PD problem solved in a non-voluntary or less voluntary way (depending on whether or not one believes the State is agreed to), but there is no desirable byproduct: such as the golden rule world. It may be that the time that elapses between when a PD problem is identified and it is solved is shorter when the State is the solution than when tit-for-tat is, but surely consideration should also be paid to the way in which the PD problem is solved, as well as to the intended and unintended consequences of the particular solution.

We need now ask: Suppose there are instances where tit-for-tat cannot solve a particular PD problem, what then? Do we turn to the State, or do we simply allow the problem to exist? In such instances, the State would appear to be the only solution to the problem. Even if we accept this as fact it does not, per se, justify the State, for not all problems are worth solving. When all is said and done, the cure might turn out to be worse than the sickness. As Rothbard has pointed out numerous times, it is not likely that the State will do only what it is told to do, much like a disobedient servant. With time, it will expand. As Rothbard notes, “… it is in the economic interest of the State rulers to work actively for such expansion.”11 Casual empiricism confirms this.

The Rothbardian approach to solving PD problems—discernible from a close reading of his works—is that truly voluntary solutions such as tit-for-tat need to be emphasized, not only because of their desirable quality of voluntariness but because they often generate desirable unintended consequences. And if, by chance, they do not work, this is not reason enough to justify the State, for there are strong logically-deduced reasons and empirical evidence to support the hypothesis that the State will not solve one problem without creating another.

Transaction Costs and Subjectivism

While most economists today will admit that cost is subjective, few will raise the red flag when cost is spoken of as if it were not. One of the few, and perhaps the most vocal, is Murray Rothbard. Without Rothbard to continually remind us that cost is subjective, and to point out when and where policy proposals are based (sometimes even unbeknownst to the framers of the proposals) on the assumptions that costs are not subjective, many of us would fall into numerous traps. The lesson we should learn, once and for all, is: Proposals, conclusions, and advice that either assert or assume that cost is not subjective ought to be discarded. With respect to our discussion of the State, any transaction cost-justification of the State directed to either the issue of its existence, or to the issue of what the State ought to do (once it exists), is immediately invalidated if it asserts or assumes that transaction costs are not subjective. But, of course, this is precisely what all those who justify the State on transaction costs grounds do. How else could they propose the State to do this or that when transaction costs are “high”?

Our points are simple. All costs, no matter what names we attach to them, are subjective; therefore they are unmeasurable. Given this, it does not make sense to say that transaction costs are high, or low, or somewhere in between. We conclude that the argument that purports to justify the State’s existence, or State interventions, on the grounds that transaction costs are high makes as much sense as an argument that purports to justify the State on the grounds that Tuesday follows Monday.

Of course, even if we assumed that it made sense to speak of high transaction costs there could still be no reasonable transaction cost-justification of the State or its actions without a way of our telling how high transaction costs need to be before the State is warranted. If one person states that potential exchange X is not being actualized because of high transaction costs, would we conclude that transaction costs are high enough for the State to step in? Of course, no matter who, or what group, were to decide such matters, the potential for abuse would exist and is likely to be acted upon.

Concluding Remarks

The Rothbardian framework, in which the need to prove the assertions made is stressed, the unintended consequences of natural market forces are noted, and the subjectiveness of cost is realized, provides a solid response to those persons who see the State as a “market mechanism.” It is farfetched to believe that simply because prisoner’s dilemma settings and transaction costs exist that individuals will voluntarily agree to the State, and that there are no other ways besides the State to deal with these problems—assuming, of course, that dealing with them is considered worthwhile.

When it comes to prisoner’s dilemma settings and transaction costs, Rothbard is satisfied to admit that both may exist, but he is not so quick to jump on the bandwagon of persons calling for the State to deal with them. Instead, he asks if PD problems might not be solved in a voluntary way, realizing that not only is the voluntary way the way of liberty, but that it is also often the way of desirable unintended consequences. As to high transaction costs, he notes that cost is subjective, unmeasurable, and that there really is no way of our deciding when transaction costs are high enough to warrant anything other than a “hands off” policy. Rothbard’s prescription is to let entrepreneurs deal with transaction costs much as they deal with production costs, or any other kind of costs.

In a world where the State plays a big part in our lives, and where individuals unthinkingly accept that there exist good reasons for its being, and where arguments are easily swallowed if they simply appear to be relevant, Murray Rothbard is there urging us to stop, to check around, to ask a few hard questions, and then, proceed with caution. When it comes to something as important as whether or not the State is legitimate, and how much personal liberty we shall have, this is extremely good advice. Thankfully, Murray Rothbard has been there for us leading the way: asking the hard questions, picking apart the weak arguments, making the strong points, and raising the red flags. The cause of liberty cannot say it has no champions.

Notes

1. Richard McKenzie and Gordon Tullock, Modern Political Economy: An Introduction to Economics (New York: McGraw-Hill, 1978), p. 82.

2. For a thorough discussion of the Posner position, see his Economic Analysis of the Law (Boston: Brown and Company, 1972).

3. Consider the following statement as illustrative of this position. Posner states, “Suppose the rule were that a magazine could not sell the list of its subscribers to another company for purposes of soliciting unless the subscribers consented. It would be costly to obtain such consent, so if we are reasonably confident that the value of the list to the purchaser ordinarily is greater than the cost to the subscribers of the slight impairment of their interest in being let alone by direct-mail advertisers, we would want to assign the property right to the magazine,” ibid., p. 33.

4. James M. Buchanan, The Bases of Collective Action (Morristown, N.J.: General Learning Corporation, 1971), p. 2.

5. Rothbard puts it this way: “Coercive intervention … signifies per se that the individual or individuals coerced would not have done what they are now doing were it not for the intervention,” Power and Market (Kansas City, Kans.: Sheed Andrews and McMeel, 1977), p. 70.

6. The statement by H. E. Freeh, III is representative of the sentiments of the group that advances this position. It is: “… individuals may all be better off by agreeing to be coerced,” “The Public Choice Theory of Murray N. Rothbard: A Modern Anarchist,” Public Choice 14 (September 1973): 150.

7. Consider a specific example to make the points clearer. Ten thousand individuals live in a particular area. Someone believes that the 10,000 individuals all want good X, but because of the “publicness” of X, and because of high transaction costs, there is no agreement as to how X will be paid for. In order to reduce the transaction costs, someone proposes that 6,000 of the 10,000 individuals should be killed. This act will reduce transaction costs but it is unlikely that individuals who value human life will find it an acceptable means of reducing transaction costs. The point being that we are not simply concerned with reducing high transaction costs, but in how they are reduced, too.

8. Murray Rothbard, The Ethics of Liberty (Atlantic Highlands, N.J.: Humanities Press, 1982), p. 10.

9. For a complete discussion of the tit-for-tat strategy, see Robert Axelrod, The Evolution of Cooperation (New York: Basic Books, 1984).

10. Ibid., p. 54.

11. Rothbard, The Ethics of Liberty, p. 176.