This week I have a question from Sergio from Brazil. He says (edited for clarity),
I enjoy reading the articles from FEE. I live in Brazil, a socialist country with de facto tyranny where individual rights are not respected. I have lived in such a system, where the force plays an important role in society. Thus the mechanisms of free market were totally neglected by the people. I always felt alone as a classical liberal, until I found FEE. I’ve been thinking about this “force” mechanism, which is used by most countries around the world. This mechanism is less effective than the free market solution. I always have felt that people would choose free market over socialism, but lately I was haunted by a question. If free market is so superior to force in allocating resources, why did the Roman Empire use an army instead of trade? I mean, wouldn’t trade bring more wealth to Roman people?
Sergio asks an interesting question. If the free market system generates more wealth than government systems of command and control, why would societies frequently use systems of command and control?
Positive Sum Games vs. Zero Sum Games
To solve this puzzle, we need to clarify the difference between two different types of interaction: positive sum and zero sum.
An example of the first is typical market interaction. Imagine you go to the store to buy a new phone. When you trade your $500 for a phone, it must be the case that you valued the phone more than $500, at least in that moment. If this were not the case, you wouldn’t have purchased the phone voluntarily.
So you’re better off. Does this mean that the store is worse off? Certainly not. The owner of the store that sold you the phone must also be better off for the transaction—else they would not have sold it.
In other words, when you voluntarily purchase or sell something, both members of the transaction are made better off. Economists call this a “positive sum” game because both members of the transaction receive a positive benefit.
Real data confirm this. The Fraser Institute’s Economic Freedom of the World Index highlights that countries that allow more free voluntary exchange are richer and healthier.
But positive sum interactions aren’t the only kind. Consider the relationship between a thief and victim. Imagine on the way to the store you get mugged. You lose $500, and the thief gains the same amount. This is a zero sum interaction where the thief’s gain is offset by your loss. One person is materially improved at the expense of another.
In reality, you could argue this sort of interaction is even negative sum. Likely thieves must spend time and resources to successfully steal money. So not only do you lose $500, but the thief only gains $500 minus the cost of stealing the money.
In short, extractive interactions like theft are bad for the wealth of society whereas productive, win-win interactions like commerce grow the wealth in society. So where does the state fit in?
The Extractive State
In theory, it’s possible that the state can be involved in the productive process. Anytime the state prevents theft or helps private actors uphold their exchange agreements, it can be part of growing the size of the economic pie.
However, as Sergio points out, states often take on the role of the thief. To return to our prior example, imagine the thief, after stealing your $500, hands you an old flip phone. Does the fact that you received a good from the thief mean this was a productive exchange?
Of course not! You didn’t want to buy a flip phone yourself, and wouldn’t have used your money that way. You’re still worse off after the thief took your money.
Many of the government’s operations follow this same logic. Money is taken involuntarily via taxation and, in exchange, taxpayers receive goods they may or may not have purchased otherwise.
Here is our puzzle. If positive sum transactions are more associated with economic growth, why would rulers and politicians pursue negative sum transactions? If trade makes Rome wealthier than conquering, why does the Roman empire choose to conquer instead?
Our puzzle is resolved with the following observation—there is nothing that requires the incentives of politicians to be aligned with the incentives of “society as a whole.”
For many years, economists who studied government did so from the perspective that government existed to maximize the well-being of society through a mathematical equation economists call a “social welfare function.”
Now economists didn’t claim to have access to a social welfare function which matched the world perfectly, but they did operate as if the central role of government was to maximize the social welfare function. In these models, the government weighed all the costs and all the benefits of spending and taxation. This approach to viewing the state has been dubbed the “fiscal brain” view of the state.
That is, until Nobel-prize winning economist James Buchanan pointed out that this is not necessarily the case. Politicians, like all other private actors, may put their own interests in front of the interest of society as a whole.
In contrast to the “fiscal brain” view, Buchanan proposed the individualistic approach which treats politicians as being driven by their own self interest with limited knowledge rather than as omniscient, omnipotent, and benevolent defenders of the public good.
This individualistic view of politics as an exchange process between politicians and others is at the heart of what is now called Public Choice economics.
And here is the answer to our question. Even though free markets and free exchange may be in the best interest of society as a whole, politicians do not necessarily absorb a large benefit from improving society as a whole. Like the thief, politicians may be able to improve themselves materially by conquering others and extracting their wealth.