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Austrian School vs. Law & Economics on Air Pollution

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In a recent article, I contrasted the Austrian School approach to product safety with the “Law & Economics” tradition that is associated with the Chicago School and UCLA. In today’s article I will show the contrast on the issue of air pollution. Again we will see that not only is the Austrian approach more technically accurate, but it also sounds less shocking to non-economists.

The Law & Econ Approach to Air Pollution

The motivation for my article was a Vox interview over the summer of Suresh Naidu, a Columbia economics professor who was a co-author on a paper quantifying the influence that the Law & Economics tradition has had on American judges. As the Vox summary explains, Naidu and his co-authors

studied the Manne Economics Institute for Federal Judges, a program offering economics instruction to federal judges so that they could incorporate economic reasoning into their papers. Launched in 1976 by the legal academic Henry Manne with support from corporations and conservative funders like the Olin Foundation, the institute was one of the most effective disseminators of Law and Economics, a movement in legal academia that sought to incorporate analysis of economic efficiency and incentives into the study of the law.

The Manne seminars featured big guns, including Paul Samuelson (so they weren’t all right-wingers) but also those skeptical of typical business regulation, such as Milton Friedman, Harold Demsetz, Martin Feldstein, and Armen Alchian. For our purposes in the present article, I want to focus on this portion of the Vox interview:

Dylan Matthews

You had some really eye-popping examples in the paper about pollution.

Suresh Naidu

Yeah, and it kind of reveals...sometimes when you take economics too literally, it leads you into kind of very sociopathic ways of thinking about things.

We have quotes from Armen Alchian, who said, “Give me a capsule that will magically clean all the air in Los Angeles....Beg me to crush it....I won’t crush the capsule. Because if I do, poor blacks will have to pay $20 a month more for land rental....The black in Watts, already used to living with bad air, loses his discount for doing that.”

And that’s just this idea that if you clean up the pollution, more people will want to live there and that will drive up the housing prices, making the people that are already used to pollution worse off.

I think that’s the kind of reasoning you’ll find in a lot of what the Manne teachers were teaching, as well as, “Here’s why a lot of regulation by the EPA [Environmental Protection Agency] might not be the most efficient way of reducing environmental damages…and maybe people don’t value environmental damage that much anyway.”

The above Alchian anecdote is a perfect illustration of what I meant in my earlier article when I said that the Law & Econ scholars sometimes make deliberately “shocking” arguments. They no doubt do this in order to capture the attention of students (or readers in the case of written material), but the strategy backfires if they offend the non-economist while getting the economics wrong. In that case, the shocking (and erroneous) argument only serves to confirm the average Joe’s suspicion that these right-wingers aren’t really principled, but instead are just mouthpieces for big business.

In other words, it’s ironic when the Law & Econ scholar deliberately picks an example where the average person will think, “That can’t be right!” when the average person is correct—in this case, Alchian’s argument isn’t right.

Now to be fair, I’ll first explain where Alchian is coming from, so the reader can understand the logic behind his claims. However, I will then show why Alchian’s conclusion is wrong—both from an Austrian but even from a Law & Econ perspective, once you plug in more realistic assumptions. The entire episode underscores my theme, that the Austrian School—despite its critics—actually delivers more “commonsense” results than the Law & Economics tradition.

In short, it’s entirely understandable when Naidu says in the Vox interview, “It’s a definite red flag when you take economics too literally, it leads you into kind of very sociopathic ways of thinking about things.” But the right fix isn’t to take economics less literally; the solution is to fix the economics.

Explaining Alchian’s Argument

Unfortunately we don’t have access to all of Alchian’s argument; even in the actual paper from Naidu and co-authors, they don’t give any more details about what he said in his lecture. However, I think it’s fair to say that Alchian was advancing an argument similar to the one Steve Landsburg spelled out methodically in his delightful book The Armchair Economist. The interested reader can see Landsburg’s specific version, and my critique, in this earlier Mises.org piece, but for our purposes I will summarize what I took Alchian to be arguing.

First, let’s assume all Americans have equal preferences regarding the tradeoff between higher apartment rental prices and the amount of air pollution. Then in equilibrium, once everyone is content to remain where he or she is living, it must be the case that cities with relatively polluted air (like Los Angeles) have lower apartment rental prices—other things equal—compared to cities with relatively pristine air (like Bozeman).

Now if we abstract away from other idiosyncratic differences (like work skills and family location), it must be the case that in the long run, every American is indifferent between living in Los Angeles and Bozeman. In particular, it can’t possibly be the case that people living in L.A. “wish they could live in Bozeman where the air is cleaner,” because hey—you’re allowed to move. So it must be the case that the advantages of living in L.A. versus Bozeman are enough to just offset the relatively dirtier air, because otherwise people would move from L.A. to Bozeman. And likewise, it can’t be the case that people in Bozeman are thinking, “Wow, I wish I could live in L.A. where I would see movie stars all the time,” because they are allowed to move. The fact that they stay put in Bozeman means that its advantages—such as the pristine air—are enough to compensate for the lack of movie stars and palm trees.

Now suppose along comes Armen Alchian, and he has the option of crushing a capsule that will cleanse the air in L.A., so that it becomes as pristine as that in Bozeman. If Alchian goes ahead and crushes the capsule, what will happen?

At first, there will be a clear benefit to everybody living in L.A. All of the original advantages of L.A. will still be there, plus the air will now be cleaner.

However, this benefit for the average L.A. resident—so would argue Alchian—will be fleeting. Before crushing the capsule, everybody was indifferent between living in L.A. and Bozeman. But now that L.A.’s air is clean, people clearly prefer L.A. to Bozeman, and so some start moving. Apartment rental prices in L.A. will go up, and apartment rental prices in Bozeman will drop, until a new equilibrium is restored, in which nobody wants to move.

Once the dust settles, the average person in L.A. must be just as well off as the average person in Bozeman. NOTE: Up till this point in the argument, I am generally fine with everything, given the assumptions about “indifference” and so forth. But now we’ve come to the chain in the logic where I think Alchian missteps. Because he presumably assumes that the people in Bozeman haven’t been helped by the magic capsule that cleaned the air in L.A., and since we’ve shown that the people in the two cities must be equally happy, it must be the case that the capsule didn’t help the average resident in L.A. after all.

So what happened? Surely cleaning the air in L.A. had some effect! And yes it did. I believe Alchian would argue that in the new equilibrium, the owners of real estate in Los Angeles have benefited while the owners of real estate in Bozeman have lost. But their tenants haven’t been affected one way or the other. In particular, the average person in L.A. enjoys cleaner air than before, but also pays higher rent that exactly counterbalances that benefit.

And now, one last complication to complete Alchian’s argument. In the above, we assumed that everyone had identical tastes for air pollution. But now let’s be more realistic, and assume that people who have grown up in a polluted city have a greater tolerance for it. In that case, they would actually be hurt by crushing the capsule, because now they must pay higher apartment rents in exchange for breathing cleaner air. But since these people were the ones who originally chose to live in L.A. with its dirtier air but correspondingly discounted apartment rents, they are hurt by being effectively forced to instead pay higher rent for cleaner air. When faced with that choice initially, they opted to stay in L.A. and decline the offer. But by crushing the capsule, we are paternalistically making the choice for them.

The Flaw in Alchian’s Argument, Even on Its Own Terms

I hope I have fairly summarized the gist of Alchian’s argument that he presented in his Law & Economic seminar. Now what’s interesting is that I can show it’s wrong, even on its own terms.

Specifically, for the argument to go through, we must assume that crushing the capsule in L.A. does nothing to affect the average person in Bozeman. Yet that’s incorrect. As my recapitulation above showed, the increase in rental prices in L.A. must be occurring because more people try to move from Bozeman to L.A., once the air has been cleaned. But if rental prices are going up in L.A. because of the capsule, they must be going down in Bozeman.

Therefore, the average renter in Bozeman is also helped by crushing the capsule in L.A. People who choose to remain in Bozeman now enjoy all of its original advantages (including pristine air), and their rent just went down.

Now if people were identical, it means the people in L.A. would similarly benefit—because remember, people can move between the two cities, so it must be the case that they are equally attractive, all things considered. That is, in the scenario where every renter is identical, it must be the case that crushing the capsule in L.A., although it led to higher rental prices, did not fully offset the benefit of clear air. So the people living in L.A. after the capsule experiment must be better off, too.

Once we make things more realistic by assuming people have different tastes, it’s harder to see, but I don’t think it overturns the result. Although rental prices have risen in L.A., they shouldn’t have risen so much as to fully swamp the benefits of the now-cleaner air.

In short, once we do the analysis correctly, we see that Alchian is simply wrong to claim that crushing the capsule will make the average renter in L.A. worse off. He’s right that the average renter won’t enjoy the full (gross) benefits of the cleaner air, as the landlords in L.A. will now enjoy higher rental income (along with cleaner air). But to repeat, since the average renter in Bozeman now must clearly be better off, and since renters could always choose to move between cities, I think it must be the case that the average renter in L.A. is now better off, too—even though some of the initial gain has been shared with the landlords in L.A.

A Reductio Ad Absurdum

To really drive home the flaw in Alchian’s argument, consider a different scenario. Suppose someone crushes a capsule that causes the sea level off the coast of California to fall, so that now people can build apartments on the new land. Would this help or hurt renters?

A strict application of Alchian’s argument would say renters will be hurt. After all, originally people could have chosen to live underwater, but given their preferences over rental prices and being covered in sea water, they chose not to. Now that the sea water has been removed, it is much easier to breathe, and so people move into the region, driving up rental prices. Did I just “prove” that the average renter was hurt?

Of course not. A simple way to understand this latter scenario is that the available quantity of land (of given characteristics) increased, driving down the equilibrium price of renting on that land. So tenants are better off.

Likewise, removing the pollution from the air around L.A. increases the quantity of land (of given characteristics) and drives down rental prices, making the tenants better off. The analysis is more complicated when you have different preferences among the tenants, but it still seems reasonable to conclude that all the tenants benefit from having an option—namely, living in a city with cleaner air—that is cheaper than it was before. (To really cinch the argument, consider that residents of L.A. can move to a polluted city in Mexico, which now has slightly lower rental prices too, as some of its people moved to L.A. to take advantage of the cleaner air.)

The Austrian Approach

Now the standard Austrian approach to air pollution and regulation rejects the bean-counting of winners and losers, and instead embraces a property rights approach. The classic work here is Rothbard’s essay. The interested reader can peruse his work for the full story, but the quick version: The standard Austrian approach is to define ownership rights, and how to handle situations where (say) someone’s smoke particles cross onto another’s property, where concepts like “invasion” or “aggression” are not so clear-cut as in the case of a person driving his car into your porch.

Conclusion

In this essay, I’ve illustrated another example where the Law & Economics approach picks a deliberately “shocking” example that apparently shows the counterintuitive nature of economics, but in fact merely shows that the Law & Econ scholar reached the wrong conclusion using faulty assumptions. In the case of air pollution, the Austrian approach, in contrast, is much less likely to yield the shocking conclusion that cleaning the air in L.A. would make its residents worse off.

Robert P. Murphy is a Senior Fellow with the Mises Institute. He is the author of many books. His latest is Contra Krugman: Smashing the Errors of America's Most Famous KeynesianHis other works include Chaos Theory, Lessons for the Young Economist, and Choice: Cooperation, Enterprise, and Human Action (Independent Institute, 2015) which is a modern distillation of the essentials of Mises's thought for the layperson. Murphy is co-host, with Tom Woods, of the popular podcast Contra Krugman, which is a weekly refutation of Paul Krugman's New York Times column. He is also host of The Bob Murphy Show.

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