Is ThereValueinRevisiting theLehmanCollapse?...in Lehman Brothers. The initial chapters focus on the buildup in size of Lehman in the run-up to its ultimate failure, how Bear Stearns

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Is There Value in Revisitingthe Lehman Collapse?✒ REVIEW BY VERN MCKINLEY

The failure of Lehman Brothers and the ensuing fallout remainhot topics of conversation in the world of finance nine yearsafter the investment bank came crashing down. The principals

who decided to allow Lehman to fail have issued their respective mem-oirs, arguing their options were limited and awkwardly attempting to

V ER N MCK INLEY is a visiting scholar at the GeorgeWashington University Law School and author of FinancingFailure: A Century of Bailouts (Independent Institute: 2012).

reconcile the decision on Lehman with theirchoice to bail out Bear Stearns and AIG.

Apart from the principals, analysts fallinto two predominant camps on Lehman.One argues that allowing failure was theright call but the decision was part ofsuch a confused and inconsistent policyapproach that the subsequent decision tobail out AIG and other institutions wipedout any benefit derived from the Lehmanfailure in combating moral hazard. Theother camp claims the government shouldhave propped up Lehman like it did somany other large institutions, althoughin truth most in this camp did not cometo that conclusion until after the key deci-sions were made in mid-September 2008.

Into this thicket, Oonagh McDonaldenters to shed light on the failure, the fall-out, and in particular the question of valueof the Lehman asset portfolio. McDonaldis a former member of the United King-dom parliament and author of severalbooks, including most recently Fannie Maeand Freddie Mac: Turning the American Dreaminto a Nightmare. I got a preview of LehmanBrothers: A Crisis of Value at a small gather-ing just before its release, during whichshe made herself available to discuss herresearch and respond to questions.

She really folds two books into onein Lehman Brothers. The initial chaptersfocus on the buildup in size of Lehmanin the run-up to its ultimate failure, howBear Stearns and Lehman shadowed each

other operationally, the Securities andExchange Commission’s efforts at apply-ing a supervisory framework to the invest-ment banks, and finally what McDonaldcalls the “Fateful Weekend” when LehmanBrothers unraveled. The second half ofthe book, with a few exceptions, focuseson matters of valuation: theso-called destruction of valuethat bankruptcy spawned,how Lehman internally val-ued its own assets, and theprocess of measuring andmonitoring value. As promo-tional materials for LehmanBrothers gravely summarize it:“On September 12th, 2008,Lehman Brothers was valuedat 639 billion US dollars. OnMonday 15th September, itwas worth nothing.”

To bail or not to bail / McDon-ald accepts the narrativethat it was a big mistake tolet Lehman fail, claiming, “Itwas the lack of understand-ing of the linkages which led to the calam-itous decision to allow Lehman Brothersto fail.” She further notes:

The costs of “No bail-out” were fargreater than [U.S. Treasury SecretaryHenry] Paulson, [Federal Reserve BoardChairman Ben] Bernanke and [NewYork Federal Reserve Bank PresidentTim] Geithner could ever have envis-aged for a single moment. If they had

been aware, as they should have been,of at least some of the possible effects,then it is entirely possible that LehmanBrothers would have been rescued.

This quote, combined with her favorablequotation of a description of the after-math of failure as “Armageddon,” makesclear that she would have sided with thosewho, mostly after the fact, argued thatintervention would have been better thanallowing Lehman to fail. McDonald doesnot trace in detail her “linkages” argu-ment.

She makes a clearer argument when sheenters the well-trodden ground of whetheror not the Federal Reserve had legal author-ity to bail out Lehman. Bernanke, Paulson,and Geithner all contended that the Fedcouldnot lendwithoutareasonableexpecta-tion of payment, and in the case of Lehman

they could not reach thatrelatively low bar. McDonaldfavorably quotes Tom Russo,general counsel for LehmanBrothers, in this regard, “Anycourt would have deferredto the Federal Reserve on aninterpretation of its statu-tory powers, especially giventhe unprecedented circum-stances.” She then concludesthat the argument on lack ofpowers “appears to be a posthoc view.” I would agree withthat conclusion.

She also judges ratherharshly Paulson’s zigging andzagging on whether to lend toAIG in comments made a fewdays after the fall of Lehman:

“The rescue of AIG took place on 16 Sep-tember, and made a nonsense of Paulson’sstand on moral hazard and no more govern-ment bailouts.” On point again.

McDonald dedicates quite a bit of ink tothe March 2008 failure of Bear Stearns, not-ing that the expectations were that LehmanBrothers would likely be the next domino tofall as indicated by the 20% drop in its stockthe day after the bailout of Bear Stearns.She is right that Bear Stearns should have

Lehman Brothers:A Crisis of Value

By Oonagh McDonald

274 pp.; ManchesterUniversity Press, 2016

SPRING 2017 / Regulation / 49

been a red flag for Lehman and the marketshould not have been surprised by its fail-ure. But she fails to point out that it wasthe contrasting and perplexing way thatthe financial authorities handled Bear andLehman that threw the market into tur-moil, not the fact that Lehman was sometype of trigger in and of itself.

She makes a curious distinction atpoints throughout the book on thisissue. She argues that Lehman Brotherswas not the “cause” of the crisis but it wasthe “trigger.” This would have been moreconvincing with some evidence of a knock-on effect of Lehman Brothers’ failure in theform of financial institutions that failed asa result of its collapse, but McDonald doesnot provide such evidence.

Trimont and Repo 105 / The valuation chap-ters that take up much of the rest of thebook are a focal point primarily because ofthe over-valuation of Lehman’s real estate–related assets. These chapters are a difficultread as McDonald goes into excruciatingdetail to explain various appraisal andvaluation guidelines of the federal bank-ing agencies and the Financial AccountingStandards Board Fair Value MeasurementStandard. I admit that I had not previ-ously given much thought to this aspect ofLehman’s failure. McDonald traces muchof the problem with the valuation work toTrimont, Lehman’s real estate adviser, andtheir flawed methodology for determin-ing the potential success of a project. Themethodology did not take into accountthe overall deteriorating mortgage market.

McDonald also explains that the myste-riously named “Repo 105” was a techniquethat Lehman Brothers used to manipulatethe extent of leverage reported in its finan-cial statements. Unfortunately, she does soby jumping into the topic without much inthe way of background, such as the fact thatthis method was specific to Lehman. I didfind useful her comparison of Lehman’scalculated leverage as presented using Repo105 and adjusted figures without. I shouldnote that there didn’t seem to be that muchdifference. Unfortunately, she does not givean example of how the Repo 105 technique

was used to dress up Lehman’s balancesheet, background that would have been anice way to ease into the topic.

This is a problem throughout the book.There are almost no explanatory tables orcharts, which would have been a nice wayto break up the unending recitation of theissues. The only exception is an organo-gram of Lehman’s corporate structure atthe very end of the book.

“Destruction of value” describes thevalue that Lehman’s creditors saw vanishbecause of the way the firm was unwoundin bankruptcy, what McDonald and oth-ers have called a “disorderly” bankruptcy.This loss is estimated to have been $150billion as compared to what would havebeen achieved in a more “orderly” bank-ruptcy. “That’s $150 billion of value out ofpension funds and savings,” she writes. Butthis conclusion is problematic given thedifficulty in picturing the perfect, orderlybankruptcy proceeding. As reform mea-sures go, McDonald places a lot of hope intwo Dodd-Frank provisions to improve thechances of retaining value in future bank-ruptcies of financial institutions, one onorderly liquidation authority and anotheron recovery and resolution plans.

Final thoughts / The last chapter of LehmanBrothers is a curious diatribe on the efficientmarket hypothesis, a chapter that seemsentirely out of place in the progression ofthe book. McDonald relies on supportersof heavy-handed government interventionfor this chapter. First, Joseph Stiglitz: “TheChicago School bears the blame for provid-ing a seeming intellectual foundation forthe idea that markets are self-adjusting andthe best role for government is to do noth-ing.” Second, George Soros: “On a deeperlevel, the demise of Lehman conclusivelyfalsifies the efficient market hypothesis.”

The book does not break much groundin the way of original research that was notavailable for other books that addressedLehman Brothers. McDonald relies mostheavily for her source material on AntonValukas, who was appointed by the Lehmanbankruptcy court to report on the causesof filing. She cites his work dozens of timesthroughout the book.

The approach that McDonald pursuesin blending the historical details on thefailure of Lehman with a separate focuson valuation of assets was an ambitiouseffort. Unfortunately, it was not alwaysexecuted very well.

Charting the Genesis ofRegulatory Excess✒ REVIEW BY SAM BATKINS

Can we thank the disputed 1876 presidential election betweenRutherford B. Hayes and Samuel Tilden for the modern admin-istrative state? Not directly, but in 1877, when the election and

the somewhat forgotten case of Munn v. Illinois were decided, bothproved pivotal to establishing Congress’s current power to regulatecommerce “affected with a public inter-est.” Many argue the Progressive era orNLRB v. Jones and Laughlin Steel (1937) gavebirth to the modern regulatory environ-ment. However, the legal genesis mighttrace back decades earlier.

SA M BATK INS is director of regulatory policy at theAmerican Action Forum.

In Limiting Federal Regulation, Paul Bal-lonoff tracks the rise of congressionalpower back to Munn, in which the U.S.Supreme Court ruled that governmentcan regulate prices without infringingon sellers’ property rights. Examiningthe rise in federal power through thelens of the patent clause, he blends a

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wealth of historical and some contem-porary examples to argue that had theSupreme Court ruled in favor of Munninstead of the state, “we might today befree of much of the regulatory burden ofmodern government.” His arguments arehistorical and legal in nature, and providean important understanding of when andhow government veered toward frequentintervention.

Opening for Congress / As Ballonoffnotes, Munn dealt with state, not federal,power—Illinois wanted to set a maximumprice on what agricultural storage andtransport firms could chargefor their services. It wassomewhat understood thatstates had a general patentpower to promote scienceand commerce throughcopyright, but there wasplenty of dispute arisingfrom Congress’s general reg-ulatory power. The decisionin Munn held that the opera-tion of a grain elevator con-stituted business “affectedwith a public interest.” Thus,states had general power toregulate this activity. Thiscase gave rise to modern util-ity regulation.

The book traces the deci-sion in Munn to Congress usurping fed-eral power without explicit constitutionalauthority. Shortly after the decision,Congress created the Interstate Com-merce Commission via the 1887 InterstateCommerce Act. Ballonoff concludes thatthe lack of general patent power and thelimitations of the “general welfare” and“necessary and proper” clauses precludemuch of Congress’s power to regulatecommerce and, by extension, the almostcountless regulatory agencies that sprungup through congressional delegation.Munn provided a way around that lack ofauthority.

Although much of the book is a his-torical and legal review of expansive federaland state power, Ballonoff takes care to

incorporate some contemporary examples,including the U.S. Environmental Protec-tion Agency’s “Clean Power Plan” and theAffordable Care Act. He views the formeras an unconstitutional usurpation because“Congress can neither create rewards norimmunities for the promotion of com-merce and the manufacture of electricity.”Likewise, he views state involvement inhealth care and the 10th Amendment asfirm bars against increased federal regula-tion of health care.

Compromise of 1877 / Libertarians andconservatives who have studied constitu-

tional law might find little todisagree with in this book.Many make the argumentthat much of the adminis-trative state is unconstitu-tional or at least should nothave been delegated in thefirst instance.

These arguments aren’tnovel, but the historicalapproach Ballonoff takesdoes offer a new perspec-tive on this debate. Nascentconstitutional scholars areoften taught about the“Switch in Time that SavedNine,” when the SupremeCourt, under pressure fromPresident Franklin D. Roo-

sevelt’s court packing plan, succumbedand began allowing New Deal legislationto pass constitutional muster. However,Ballonoff makes the point that the rootsof modern congressional power trace backto the regulation of grain elevators in Illi-nois, long before the New Deal, and to thestrange juxtaposition of the Hayes-Tildenpresidential battle.

Of the latter, Tilden, a Democrat fromNew York, bested Hayes, a Republicanfrom Ohio, by 3% the popular vote, thanksin part to Southern Democrats’ suppres-sion of Republican voters. However, Hayesappeared to have the upper hand in theElectoral College. The so-called Compro-mise of 1877, an unwritten agreementbetween the two political parties, permit-

ted Hayes to take the Electoral College vic-tory in return for the withdrawal of federaltroops from Florida, Louisiana, and SouthCarolina, where they protected Republicanstate governments and voters. The resultwas a Hayes presidency in exchange forthe departure of white Republicans anddisenfranchisement of black Republicansin the South.

Interestingly, Munn and the electionwere intertwined. At the time, SupremeCourt Justice David Davis, viewed as a non-ideological independent, was appointedto a 15-member Electoral Commission tosettle the election. Shortly before, Daviscast a vote in favor of state power in Munn.As the commission pursued a compromise,the Illinois legislature selected him to servein the U.S. Senate. The independent Davisthen resigned his Supreme Court commis-sion and Republicans selected one of theirown to fill the seat, helping to pave the wayfor the 1877 Compromise.

Learning from past mistakes / The newTrump administration has vowed toprune the U.S. regulatory state. The his-tory Ballonoff outlines in this book andthe failed attempts at regulatory reformshould help to inform the current debate.

In general, never trust regulators toimplement reform aimed at curbing fed-eral regulation. If regulatory moderniza-tion is to succeed, there must be eithercarrots or sticks to nudge the administra-tive state toward “regulatory management”over the bureaucratic status quo. Stickscould take the form of heightened judicialreview of agency actions, or the diminu-tion of pay for officials, or lower agencybudgets. Carrots, as Hoover Institutionscholar Adam White has outlined, couldgrant agencies more deference for carryingout regulatory reform proposals and nodeference for trying to avoid it.

Whatever the approach Congress andthe administration take, they will haveample historical examples to guide themtoward a solution that could prove farmore durable than the patchwork messthat continues to produce 80 major regula-tions annually.

Limiting FederalRegulation

By Paul Ballonoff

132 pp., CreateSpace,2016

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Tyler Cowen, Semi-Persuasive Futurist✒ REVIEW BY DAVID R. HENDERSON

Tyler Cowen, a prolific author and blogger and an economicsprofessor at George Mason University, has written yet anotherbook, The Complacent Class. In it, he argues that America has

become complacent and that complacency has good and bad effects.He strongly believes that our complacency contains the seeds of its owndestruction. America, he argues, will facetough challenges and our complacencywill make dealing with them difficult.

Cowen argues that our decisions,although “economically and indeedsocially rational,” have “made us morerisk-averse and more set in our ways, moresegregated, and they have sapped us ofthe pioneer spirit that made America theworld’s most productive and innovativeeconomy.” He makes a good point. Butmany of the crucial decisions behind theproblem are ones made by government.At times he recognizes that fact, but atother times he downplays or omits it alto-gether. Along the way, as is typical of mostof Cowen’s work, he has or reports inter-esting insights: on the serious problemscaused by building restrictions, on incomemobility, on how U.S. governments haveslowly eroded free speech, and on why hethinks that crime will increase. Sometimes,though, he misfires: on income mobility,on the effect of reduced geographic diver-sity on mobility, on free trade, and on stan-dards of living.

Gridlock / Consider two of the major prob-lems that Americans now face daily: highhousing costs and slow traffic.

Cowen nails the causes and effects ofhigh housing costs. He points out thatrestrictions on building have driven hous-ing prices sky high in many major cities,

especially in coastal California and theNortheast. Somewhat disappointingly,although his claims are generally well-cited,he doesn’t mention the path-breakingwork by Harvard economistEdward Glaeser and Whartoneconomist Joseph Gyourko,which shows the high pricesare indeed due to a scarcity ofbuilding permits rather thana scarcity of land. (See “Zon-ing’s Steep Price,” Regulation,Fall 2002.)

However, Cowen goesbeyond that fact to makeanother important point:those high housing costshave discouraged movementby workers to those citiesand have kept them in lower-productivity jobs elsewhere.The overall negative effecton productivity and out-put is huge. He cites a 2015National Bureau of EconomicResearch paper by University of Chicagoeconomist Chang-Tai Hsieh and Universityof California, Berkeley economist EnricoMoretti, who find that lowering regulatoryconstraints in those cities to the level ofregulation in the median-regulated city inthe United States “would expand [thosehigh-cost cities’] work force and increaseU.S. GDP by 9.5%.”

On traffic, Cowen writes, “Traffic getsworse each year and plane travel is if any-thing slower than before.” True. But whydoes traffic get worse each year? One’s

knee-jerk response would be to say thatit’s because more people are driving. Butmore people are going to Starbuck’s eachyear, too; yet has the wait at Starbuck’sincreased? Not that I can see. Whataccounts for slow traffic on roads but not“slow traffic” at Starbucks? Starbucks isprivate and for-profit, and it has the rightincentive to expand and manage traffic,whereas roads are generally provided bygovernment and government has littleincentive to manage traffic well. That’s whyso few roads are toll roads with congestionpricing. One little-known fact is that stategovernments were starting to move in thedirection of toll roads in the 1940s andearly 1950s. But President Eisenhower puta stop to it with his interstate highway sys-

tem, 90 percent of which wasfunded by gasoline taxes. It’shard to compete with heav-ily subsidized roads. Disap-pointingly, in light of theproblems caused by lack oftolls, Cowen cites the high-way system as a big success.

Less successful are othermodes of transportation.He laments the fact that thenumber of bus routes hasdecreased, that “Americahas done little to build upits train network,” and thatAmerican cities “haven’tbuilt many new subway sys-tems in the last thirty-fiveyears.” That last lament wasshocking because subways,except in high-density cities

such as New York, are notoriously costlyand inefficient.

Cowen extensively discusses mobility,both income mobility and physical mobil-ity within the country. His discussion is amix of tight reasoning and some confu-sion.

His strongest, best-argued point is that“America’s income mobility is in realitymuch higher than standard measures indi-cate.” Why? He explains with an illustrativeexample: members of a poor householdin Mexico might make only a few thou-

DAV ID R . HENDER SON is a research fellow with theHoover Institution and professor of economics in theGraduate School of Business and Public Policy at the NavalPostgraduate School in Monterey, Calif. He is the editor ofThe Concise Encyclopedia of Economics (Liberty Fund, 2008).

The Complacent Class:The Self-DefeatingQuest for the AmericanDream

By Tyler Cowen

231 pp.; St. Martin’sPress, 2017


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sand dollars a year. If the family movesto the United States, the household headmight make $22,000 a year at a “medio-cre” job. He has moved way up the incomescale. Moreover, he probably sends a fewthousand dollars a year back to relativesin Mexico, which doesn’t matter for U.S.income mobility but does matter for worldincome mobility.

When Cowen sticks with the more nar-rowly defined measures of income mobil-ity, though, he errs. He points out correctlythat traditionally measured U.S. incomemobility, which rose for a long time, hasleveled off in recent years. But, he says,“that means Americans are more likely to‘stay put’ in their educational, social, andincome classes than before.” No, it doesn’t.If income mobility stays constant—that’swhat “leveled off” means—then Americansare as likely to stay put as they were before.

Cowen claims that reduced Ameri-can geographic diversity has reducedgeographic mobility. Each region of thecountry “has its shopping malls, its hos-pitals, and its schools in what is now anationally recognizable sameness.” There-fore, he claims, people have less reason tomove from one region to another. But itcould just as easily go the other way. Whatif the fact that one region is more similarto another than it used to be makes peoplemore comfortable moving? Indeed, Cowenhimself seems to doubt his own conclusionbecause just five pages later he argues thata Mexican moving from Houston to Chi-cago will find familiar foods, familiar faces,and a support network, and these similari-ties encourage Mexicans to move. That’smy view, too, but it contradicts Cowen’searlier view.

Government constraints / One of theareas in which I found Cowen depress-ingly persuasive is on free speech. Hedocuments how over the last few decadesgovernments have used force to bluntand marginalize protests. A major legalchange that helped cause this, he writes,was the Supreme Court’s “public forumdoctrine.” For people to be free to speakin a physical area, he writes, interpreting

the Supreme Court’s decisions, “that areashould be a properly designated forumfor speech.” Cowen notes that the famous1963 March on Washington, at whichMartin Luther King Jr. gave his “I Havea Dream” speech, “enjoyed a freedom ofmovement that today would be very dif-ficult to reproduce.”

Cowen also believes that crime, whichhas fallen for a few decades, is on the riseand will continue to grow. The form, hesays, will change, with more crime beingcommitted in cyberspace. He’s almost cer-tainly correct. He also believes that “thenext crime wave is going to break the inter-net, or at least significant parts of it.” Hedoesn’t address the extent to which cyber-crime is due to government regulation. Weknow that the National Security Agency,for example, has the ability to observe ourpersonal lives. Will cybercrime hackers fig-ure out ways to get the data that the NSAhas on us?

One factor that could substantially pro-tect us is encryption. Yet Federal Bureau ofInvestigation director James Comey hasbeen hostile to encryption, and in 2016 twoU.S. senators, Democrat Diane Feinsteinand Republican Richard Burr, introduceda bill to undercut encryption so that thegovernment could have access to people’sdocuments and communication. Thatwould facilitate cybercrime but, disap-pointingly, Cowen doesn’t mention thesehostile government attitudes.

Economists, caring as they do aboutoverall economic well-being, tend toapplaud free trade even when firms reducelabor costs by outsourcing. But Cowen isamazingly lukewarm on the gains fromoutsourcing. Cost-cutting developments,he writes, “build America’s productivefuture less than coming up with neat andnew ways of doing things, such as har-nessing electricity, developing antibiotics,or inventing automobiles.” But whetherthat’s true depends on the degree of costcutting. And what if American firms devel-oped antibiotics by outsourcing to lower-cost outfits in, say, India? He sees outsourc-ing as “a way of keeping the status quo inplace—for some, that is—at lower cost to

owners of capital and privileged workerswho have kept their incumbent status.”Actually, that’s not true. By definition,outsourcing improves on the status quo.

Note, also, in the quote directly above,Cowen’s use of the word “privileged.” Thisis not his only use of that term in the book.Elsewhere he discusses “the privilegedclass,” whose members are “usually welleducated, often influential, and typicallystand among the country’s highest earn-ers.” But what makes them privileged? Henever says. Cowen seems to use “privileged”as a synonym for “wealthy.”

Cowen worries, quite rightly, about theincreasing percentage of the federal gov-ernment’s budget that is likely to be spenton three programs: Medicare, Medicaid,and Social Security. One reason for hisworry, though, is that when a problemarises somewhere in the world—for exam-ple, “military crises in the Baltics and theSouth China Sea at the same time”—theAmerican government “probably wouldneed more resources” to deal with it.Nowhere in the book does he even hintthat maybe the U.S. government havingmore resources helped lead to some of theproblems in the world. If the U.S. govern-ment hadn’t had the slack to invade Iraqin 2003, for example, that country wouldalmost certainly be in better shape than it’sin, and the Islamic State would not evenexist. The Islamic State is an outgrowth ofal Qaeda in Iraq, which itself didn’t existuntil the Iraqi occupation had been goingon for a year and half. “Ultimately peaceand stability must be paid for,” he writes(italics in original) “with real resources,with tax revenue.” Something closer tothe opposite is the truth: war must be paidfor. So avoiding war and letting countriesaround the world deal with their own con-flicts rather than interfering in them ismore likely to create peace for us and iscertainly likely to allow deficit reductionsand even tax cuts. And maybe even a littleless domestic surveillance.

Related to his concern about too littlespending on the military is his concernabout Americans’ distrust of government.He notes a recent Pew poll that “found that


only about 19 percent of Americans feelthey can trust government always or mostof the time.” The data, he says, “are not socheery.” But he never considers whetherthat distrust is justified. In the late 1950s,he writes, 77% of respondents trusted thegovernment. He seems to think that’sgood. Remember that this is the govern-ment whose FBI tried to persuade MartinLuther King Jr. to commit suicide.

Why does Cowen think that trust ingovernment is good? Because, he writes,among other things it led to Americanssupporting the moon program, the inter-state highway system, and “even the Rea-

gan military buildup.” But were those goodthings? Cowen doesn’t even make the case.The one I’m most familiar with, the Rea-gan military buildup, wasted hundreds ofbillions of dollars.

The subtitle of The Complacent Class is“The Self-Defeating Quest for the Ameri-can Dream.” Maybe Cowen can argue thatthe American dream is harder to achieve—although in this era in which almost every-one over 20 has a pocket computer, that’san uphill argument. But he can hardlyargue—and doesn’t even try to—that pur-suing the American dream is self-defeating.Which is fortunate.

Power to the Knowers!✒ REVIEW BY PIERRE LEMIEUX

Therecentpresidentialelectioncampaignremindedusofanoften-neglected fact: libertarianism has both a populist and an elitiststrand.Thepopulist strandwasrepresented(perhapswithaven-

geance) by those libertarians who supported populist Donald Trump.A representative of the elitist wing would be H.L. Mencken, the early

PIER R E LEMIEUX is an economist affiliated with theDepartment of Management Sciences of the Université duQuébec en Outaouais. His latest book is Who Needs Jobs? Spread-ing Poverty or Increasing Welfare (Palgrave Macmillan, 2014).

20th-century journalist and critic, whodenounced democracy as “the theorythat the common people know what theywant, and deserve to get it good and hard.”No doubt, Mencken would see Trump asan exemplum.

Jason Brennan’s Against Democracycomes from the same perspective asMencken. It is a well-argued and challeng-ing book.

Ruled by ignoramuses / The author, a lib-ertarian philosopher and professor inthe McDonough School of Business atGeorgetown University, starts by analyz-ing the irrationality of voters, in the tradi-tion of Geoffrey Brennan, Loren Lomasky,Ilya Somin, and Bryan Caplan. But Bren-nan’s critique goes further.

It is quite obvious that some peopleknow more than others. And some know

that crime has decreased since the 1990s,and knows virtually nothing about thepolitical parties’ platforms. Voters tendto cast their ballots for the better-lookingcandidates. More than a quarter of Ameri-cans don’t know which foreign state thecolonists fought during the RevolutionaryWar. These are just a few examples.

Brennan divides the electorate intothree categories. Most voters are “hob-bits,” who know nothing about politicalissues and social science. The rest—includ-ing “many, perhaps most libertarians”—are mostly “hooligans,” people who havestrong, irrational, and biased views. Finally,“vulcans” are the small number of voterswho know the facts and theories and ana-lyze policies rationally. Only vulcans “canexplain contrary points of view in a waythat people holding those views would findsatisfactory”—what Caplan has called “theideological Turing test.”

The mistakes that democratic electoratesmake are systematic; they are not randomand don’t cancel each other. For example,“the U.S. public as a whole makes systematicmistakes about economics, including mostof the mistakes [Adam] Smith warned usnot to make back in 1776.”

The nature of democratic voting doesnot encourage voters to learn. This isbecause the individual voter will have anactual influence on the result only if therewould otherwise have been a tie in the vote.

In any large group of elec-tors, the probability of a tieis infinitesimal. Dependingon the assumptions made,this probability, and thusthe probability of a singlevoter changing the result ofthe vote, is at most equal tothe probability of winningthe lottery jackpot. Have youever met anyone who can say,“Without my vote, the otherpresidential candidate wouldhave been elected”?

Thus, most voters spendlittle time gathering and ana-lyzing information about theissues or candidates. Since the

very little; they ignore simple, relevant factsand do not understand the general theories(in economics, political science, philosophy,etc.) necessary to interpret those facts. Any-body who reads this article must agree thatwe—my readers and I—know things thatothers do not know, and wealso admit that others knowthings that we don’t. We haveto start from there. AgainstDemocracy helps.

Brennan cites much evi-dence of ignorance, cogni-tive biases, and groupthinkamong the general electorate.The typical American doesnot know which party con-trols Congress, has no idea ofthe broad distribution of thefederal budget (for example,people typically think thatforeign aid makes up 28% ofthe federal budget, while it iscloser to 1%), doesn’t know

Against Democracy

By Jason Brennan

304 pp.; PrincetonUniversity Press, 2016

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individual voter knows that his own votedoes not count, it is rational for him toremain ignorant and to think irrationally.He can indulge in his biases or follow hispolitical tribe. For the same reason, as evi-dence shows, the voter who has an opinionwill not vote his interest but his opinion.For example, he tends to be nationalistbecause he mistakenly believes that thiswill further the common good.

The consequence is that an ignorantelectorate elects ignoramuses to coercivelyrule over us. Even the voters who vote forwhat they think is the “common good” willoften harm those they want to help.

Despite its deification, democracy is notthe right to govern oneself, but the powerto rule others. And it is against justice tobe ruled by an incompetent government.

Here comes epistocracy / To solve this prob-lem, Against Democracy argues for “epistoc-racy,” that is, “the rule of the knowledge-able” or, more exactly, the distribution ofpolitical power, including the right to vote,in their favor. (In ancient Greek, epistememeans knowledge.) Just as physicians mustdemonstrate their knowledge and compe-tence before they may practice medicine,citizens who want to vote should have toprove a minimum level of knowledge oranalytical competence.

A “license to vote”—or to cast multiplevotes—would be granted to citizens whosuccessfully pass an exam showing they aresufficiently knowledgeable—for example,the civics test portion of the U.S. citizen-ship exam. Another means to this endwould be to create an “epistocratic coun-cil” that would have the power to veto anydemocratic decision. Whatever the means,the principle is that there is no right tovote, except for the informed voters.

Brennan emphasizes that his choice ofepistocracy over democracy is instrumental:better political decisions would be madethis way. Individuals would get what they’dreally want if they understood the facts andconsequences of different policies.

The author of Against Democracy criti-cizes the philosophers who believe thatdemocracy is necessary to symbolize and

implement the equal dignity of individu-als. He writes:

Democracy does not empower individuals.It disempowers individuals and insteadempowers the majority of the moment.In a democracy, individual citizens arenearly powerless. (emphasis in original)

He believes that individuals, includ-ing minority individuals, would be bet-ter treated in an epistocratic regime. Forexample, “U.S. voters tend to be ignorantof the effects of the drug war on minorities… and how being ‘tough on crime’ tendsto cause disproportionate harm to minori-ties.” Brennan also argues that democraticpolitics appeals to people’s baser instincts,“makes us worse,” and “tends to make ushate each other.”

His proposed regime is not as radicalas it appears at first glance. It can be inter-preted as democracy corrected by a knowl-edge requirement. The current democraticregime already includes epistocratic ele-ments such as the courts. “Most epistocratsalso want the rule of the many,” he writes,but of “the many-but-not-quite-everybody.”

He wants prudent, experimental, andgradual moves toward (more) epistocracy.He explains that if voters are incompetentto choose policies, they may be competentto establish general standards of politicalcompetence. “Whether we should preferepistocracy to democracy is in part anempirical question, which I am not fullyable to answer,” he writes in the last chap-ter of Against Democracy.

Epistocratic problems / There are manyproblems with epistocracy. I see threemain ones.

The first is hubris. Even if we grant theeasy point that “We the People,” taken ina collective sense, don’t know what we’retalking about, it does not follow that someelites know what is good for the rest of us.It may be true regarding some genuinepublic goods, but it is certainly not truewith regard to most government interven-tions. Regarding personal tastes (is darkchocolate better than white chocolate?)and most personal goals, the Latin dictum

espoused by economists applies: De gustibusnon est disputandum (“There is no disput-ing about tastes”). This objection becomesmoot if epistocracy produces a minimumstate, but this is what remains to be proven.

Brennan claims that “the case for epis-tocracy does not rest on the authority tenet;it is based on something closer to an anti-authority tenet” (emphasis in original). Healso argues that “as people … become moreinformed, they favor overall less governmentintervention and control of the economy.”But we are not sure that this is how an epis-tocratic system would actually develop.

The second problem is that epistocracywould further promote a society wherethe individual is trained to request per-mits and licenses. “The unequal distribu-tion of power on the basis of competenceseems elitist,” Brennan writes, “but it is notinherently more elitist than the unequaldistribution of plumbing or hairdressinglicenses.” There probably are better rea-sons to regulate the right to vote than theright to, say, repair a leaky toilet, but anylicense analogy plays into the hands of theregulatory state. Proponents of parent-ing licenses invoke the example of drivers’licenses; indeed, raising children certainlyhas more social consequences than drivinga clunker. We have to escape the licensinglogic, not give it another lease on life.

It is one thing to make the easy argu-ment that some people know things thatothers don’t. It is another to believe that, inthis Brave New World, everybody has to betrained before he gains the right to do some-thing. From this point of view, John StuartMill’s idea of giving additional votes to citi-zens with certain academic degrees is a moreattractive idea than setting a formal systemof state exams for political competence. Buteven this form of epistocracy is risky.

A third problem is that we have triedepistocracy and found it does not work asin Brennan’s model. From the Progressiveera to our own days, academics, high-levelbureaucrats, and pundits—in brief, theintelligentsia—have constituted an infor-mal epistocracy, in cahoots with the state.Imagine what would have happened to theSecond Amendment if the reigning intel-


ligentsia had had still more power. Imaginewhat would happen to the First Amend-ment if the high priests of college politicalcorrectness were to form the government’sepistocratic council. Imagine the propo-nents of the parenting license among thetop epistocrats of the future. If a mild levelof epistocracy has not worked, it is not clearthat more of the same is the solution.

Classical liberal solution / An alternativesolution, which is the classical liberal solu-tion, is to limit the scope of state action.If the state did little, the damage doneby political ignorance would be limited,especially in a representative democracy,and more to the point in a republic basedon the division of power. Brennan doesnot disagree with this, but he believes thatmore epistocracy would lead us to less gov-ernment, which is a contentious claim.

Power to the knowers? No. But power tothe ignorant neither. Some mild epistocraticelements could be added to the currentpolitical system. State propaganda shouldnot actively encourage the ignorant to vote.(An ignorant nonvoter is more respectablethan an ignorant voter.) If politically palat-able, a poll tax would reduce the electoralparticipation of those who vote only to fol-low the crowd and entertain themselves.(Brennan hints at a similar measure.) Thevoting age could be raised.

Libertarian economist and politicalphilosopher James Buchanan’s way ofconceiving the foundations of classicalliberalism may be useful here: “Each mancounts for one, and that is that,” he wrotein The Limits of Liberty (University of Chi-cago Press, 1975). Is Brennan too quick todiscard the symbolic value of democracy?What is the best form of government (if weneed any) to protect individual liberty? Onthese deep issues, political philosophersdisagree after 2,500 years of analysis anddebate. This observation does not invali-date the necessary pursuit of truth, but itdoes cast further doubts on epistocracy.

Perhaps libertarians should be contentto dwell somewhere between wild populismand undisguised epistocracy. This may bethe true lesson of Against Democracy.

WhoWill Nudge the Nudgers?✒ REVIEW BY PHIL R. MURRAY

David Halpern heads the United Kingdom’s Behavioural InsightsTeam, also known as the “Nudge Unit.” It was originally a partof the UK government but now is a partly private entity. “This

book,” he writes of Inside the Nudge Unit, “is about the application of psy-chology to the challenges we face in the world today.” He is dedicatedto applying behavioral psychology as a“tool” of government. “Love it, or hateit,” he declares, “nudging is here to stay.”

Richard Thaler, professor of economicsand behavioral science at the University ofChicago, and Cass Sunstein, professor oflaw at Harvard, introduced the idea of nudg-ing to the public in their 2008 book Nudge.(See “A Less Oppressive Paternalism,” Sum-mer 2008.) Halpern explains, “A ‘nudge’is essentially a means of encouraging orguiding behaviour, but with-out mandating or instructing,and ideally without the needfor heavy financial incentivesor sanctions.” As such, nudg-ing seems harmless.

Opposition arises, how-ever, from those who seenudges as too tame, as wellas those who see nudging “assome kind of pernicious formof meddling.” To illustrate theformer view, take the exampleof an anti-litter campaign thatpaints footsteps on a sidewalkto show the way to a garbagecan. The nudge supposedlyencourages people to disposeof litter properly; critics ofthe effort would prefer a lawthat prohibits littering anda fine for those who disobey.To illustrate the latter criticism, take the“midata clause,” which “gave the Secretaryof State for Business [in the UK govern-ment] the power to require firms to allowtheir customers access to their own con-

sumption data in ‘machine-readable form.’”This nudge supposedly helps consumersmake more informed decisions in the mar-ketplace, for instance by showing themwhich nearby supermarket sells selecteditems at the lowest prices or with the leastcarbon footprint. The secretary could notunilaterally impose this regulation. “But,” asthoughitwerea featureandnotabug,Halp-ern writes, “this sword of Damocles had analmost immediate impact, encouraging at

least some companies to com-ply before they were pushed.”Perhaps he chose his wordspoorly, but he appears to besaying that nudging workedin this case because the nud-gees, if you will, feared being“pushed.” That undermineshis argument that nudging isa noncoercive tool of govern-ment and gives ammunitionto his opponents who fearthe “sinister” application ofnudging.

Government nudges / Mostof the book is about seem-ingly uncontroversial nudg-ing. Halpern begins with ahistory of such policies. Oneearly example was Frederickthe Great, who wanted his

Prussian subjects to produce and con-sume potatoes. Initial coercive effortsfailed. However, by growing potatoes forhis own consumption and feigning to pro-tect his crop from theft, he successfullygenerated covetousness in his subjects andnudged them into producing and con-

PHIL R . MUR R AY is a professor of economics at WebberInternational University.

Inside the Nudge Unit:How Small ChangesCan Make a Big Dif-ference

By David Halpern

383 pp.; W.H. Allen,2015 & 2016

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suming spuds for themselves. Anotherexample, Halpern tells us, is the paintedlines on a road, which were an early nudgeto promote traffic safety; rumble strips area more recent nudge.

Turn now to policy nudges that relatespecifically to the work of the Nudge Unit.The author is proud of nudging more peo-ple to save. The Nudge Unit did this by“changing the default.” Employers usedto invite their workers to participate inpayroll deduction savings plans, but thedefault was no participation. Participa-tion required a modest initiative to signup. The UK government passed legislationthat switched the default to participation.Employers henceforth “automatically” puttheir workers in savings plans. The workersretained the right to “opt out,” but thatchoice would now require the modest ini-tiative. The effect, Halpern reports, is that“more than 90 percent of eligible workerschose not to opt out.” If these workers con-tinue to save over the long run, they will bein better financial shape when they retire.

“Still, just because changing the defaultworks,” he wonders, “is it what peoplereally want?” Indeed, people might say theywould like to save more but, when yokedto do so, regret it. But this regret doesn’tappear to be happening. Halpern quotesHarvard economist David Laibson onAmerican attitudes to similar initiatives:

It is hugely popular. US survey data sug-gests that 9 out of 10 workers who haveexperienced the pension opt-out sup-port the changes in 401k defaults. Andeven among the small minority who doopt out, more than 7 out of 10 of themstill think the opt-out is preferable to anopt-in arrangement.

Halpern is also proud of nudgingdelinquent taxpayers. To pull this off, theNudge Unit borrowed a principle of psy-chology from Robert Cialdini, emeritusprofessor of psychology and marketing atArizona State University. Halpern outlinesCialdini’s principle: “Social norms, and theinferred behavior of others, are powerfulinfluences on our behaviour.” This nudgenotified delinquent UK taxpayers that

“nine out of ten taxpayers paid on time.”Implementing this nudge was complex,based on a hallmark of the Nudge Unit’swork: the randomized controlled trial.Researchers mailed a standard letter toover 8,000 delinquent taxpayers remindingthem to pay up. They mailed another let-ter, “adding the single (truthful) line that‘nine out of ten taxpayers pay on time,’” toanother group of about 8,000 delinquentpayers. Some 33.6% of the control grouppaid up; 35.1% of the latter group paidup. “This might not sound a lot,” Halpernrealizes, “but if you are in the business ofgathering hundreds of millions of poundsor dollars, and the marginal cost of theintervention is essentially zero, then thisis very valuable indeed.” This story contin-ues. Researchers mailed three other typesof letters with alternative wording basedon social norm theory, and found that theycould coax even more late payers to pay up.

Nudges or markets? / Although Halpernis proud of the Nudge Unit’s accomplish-ments, he is not arrogant. He makes thisclear by eschewing “the God Complex: thetendency we all have to believe that whatwe think and do is right.” A better wayof thinking, which he encourages every-one to adopt, is this: “I don’t know—but Iknow how we can find out.’”

The way to find out is through theaforementioned randomized controlledtrial (RCT). Consider the use of an RCT tolearn the most effective way of encouragingmore people to donate their organs. TheNudge Unit was given the opportunity topresent British car owners—upon comple-tion of their annual online registration—aproposal to donate. Researchers “brain-stormed” to compose a “control” webpagethat some car owners would see, plusseven others “each based on one or morebehavioural effects” that were intended toincrease participation.

The beauty of the RCT is that theydidn’t have to guess which webpage wouldinduce most people to join the register;testing would show that. The control pagestated, “Please join the Organ Donor Reg-ister.” Of more than 100,000 British car

owners who saw that, 2.3% opted to signup. The biggest response came from thosewho saw the control message plus this: “Ifyou needed an organ transplant wouldyou have one? If so please help others.” Ofthe more than 100,000 who viewed thatpage, 3.2% signed up. “This is equivalent,”Halpern calculates, “to around 100,000extra people joining the register a yearcompared with the control.” The trial alsoshowed that those who viewed a webpagewith “a picture of happy, healthy people”induced a smaller proportion to join thanthe control webpage. This is humble pie for“leading behavioural scientists and policyexperts” who predicted the picture wouldprompt more people to donate.

What is missing from Halpern’s discus-sion of nudging more people to donateorgans is the prospect of a market fororgans. We can be confident that a well-informed policy analyst understands thepromise a market holds for reducing ashortage of human organs. In the case ofe-cigarettes, we might expect him to givethe market process more of the credit itdeserves. “The battle over e-cigarettes,”as Halpern sees it, “illustrates a classictype of policy: deciding what the posi-tion should be on whether to allow orrestrict an activity or product, ultimatelyexpressed through regulation and law.”E-cigs caught the attention of behavioralscientists because their research shows that“it is much easier to break a habit, or shifta behavior, by introducing a substitutebehavior rather than simply extinguish it.”In other words, e-cigs offered a new wayto quit smoking by substituting them fortraditional cigarettes.

The Nudge Unit supported a market; therole of government would be “to make surethat e-cigs didn’t have other toxins, and thattheyhadenoughnicotine inthemtobeeffec-tive.”Healthofficials, reluctant toallowindi-viduals another way to obtain a nicotine fix,and producers of nicotine patches and gum,resentful of new competition, resisted. Facedwith resistance, the Nudge Unit examined“quit rates of smokers.” Quit rates amongsmokers using “nicotine replacement ther-apy” (patches and gum) had been declining


from the late 2000s through 2014. However,the quit rate for users of e-cigs ramped upfromabout5%in2011toabout30%in2014.The quit-rate data helped convince UK offi-cials to allow e-cigs on the market withoutonerous regulation.

Permitting the market to operate is sofar a successful policy. “Depending on yourassumptions,” Halpern reports, “estimatessuggest that from 20,000 to 200,000 extrasmokers are quitting a year as a result ofthe availability of e-cigs in the UK alone.”On that basis, he broaches the possibilityof prohibiting traditional cigarettes. Per-haps he attributes too much credit to thesuccess of e-cigs to “an argument basedon behavioural science principles” and notenough to the market because the NudgeUnit would not have had quit-rate data toexamine without a market. And if we areto believe that nudgers respect the freedomto choose, why flirt with a ban?

Why trust nudgers? / Behavioral science isHalpern’s hammer, and real-world prob-lems are the nails. The author sees applica-tions everywhere. At the individual level,behavioral principles imply that workerslooking for jobs should disregard “whatthey had done last week” in order to focuson “what they would do next week.” On amacroeconomic level, they overcome thepessimism that grips an economy dur-ing recession and influence businessesto adopt “government growth-relatedschemes.” Halpern and colleagues evenmanaged to persuade UK officials to pro-duce data on “subjective well-being” andgear policy toward increasing it. If thepublic embraces his enthusiasm for “awell-being viewpoint,” we can expect poli-ticians to start taking credit for increasesin the index of life satisfaction duringtheir tenure. At this point, one begs toknow, is nudging a panacea?

Fortunately, Halpern recognizes that“there are real dangers in getting too car-ried away with thinking that nudges arethe answer to everything.” He engages criti-cism from three sources: “the right,” “theleft,” and “liberals and democrats.”

Right-wing critics view nudging as a

threat to freedom. He takes their challengeseriously. He vows that the Nudge Unitwill tell the truth, deliberate in the publiceye, and submit to “checks and balances.”For instance, “an academic advisory panel”provides feedback and ethical advice.

Left-wing critics view nudging as insuf-ficiently aggressive to achieve their pater-nalistic goals. If my impression is correct, hehas little interest in this critique. Nudgers,by nature, prefer subtle forms of persua-sion over blunt mandates and prohibitions.Nudges influence behavior at the margin,he explains, and he describes how they may

work in both the short and long run.On behalf of “liberals and democrats,”

the author asks, “Why should we trust thenudger to know better?” and “Who nudgesthe nudgers?” Not only liberals and demo-crats want answers to those questions.

“Ultimately,” Halpern concludes, “you—the public, the so-called ‘ordinary citizen’—must decide what the objectives, and limits,of nudging and empirical testing are.” Thisis a tall order. We are already busy dealingwith government interventions in the mar-ket; we now have the job of checking govern-ment interventions into our minds.

Smarter to Be Lucky✒ REVIEW BY GEORGE LEEF

In our increasingly competitive world, the greatest rewards don’tnecessarily go to those who are objectively the best, but often tothose who happen to be lucky. The documentary Virtuosity, which

I recently chanced to see, drove that point home.

GEORGE LEEF is director of research for the James G.Martin Center for Academic Renewal.

The documentary is about the 2013Cliburn International Piano Competi-tion, named for the late Van Cliburn. TheCliburn is one of the foremost musicalcompetitions in the world. Thirty superbpianists entered and played for a jury con-sisting of internationally renowned musi-cians. After the first round, only 12 werechosen to continue on. The second roundwinnowed the field to six finalists.

Those six all played superbly, as you cansee and hear in Virtuosity, but prizes wentto only three: third to Sean Chen of theUnited States, second to Beatrice Rana ofItaly, and first to Vadym Kholodenko ofUkraine. For those three, and especiallyKholodenko, the awards boosted theircareers into orbit.

But were they really better than the oth-ers? If a juror or two had felt just slightlydifferently along the way, any of the 27 also-rans might have taken one of the awards.Kholodenko, Rana, and Chen, on the otherhand, might have gone back home to their

previous lives, hearing friends say, “Betterluck next time.”

Who happens to come away with life’sbig prizes, pianistic and otherwise, is thesubject of Robert Frank’s recent book, Suc-cess and Luck. Frank, a professor of econom-ics and management at Cornell University,has spent decades thinking about the roleof luck in our society. More than 20 yearsago he co-authored the book The Winner-Take-All Society, arguing that the developedworld’s markets are increasingly “winner-take-all,” in which one person or companyrakes in almost all the rewards of successwith little left for the rest of the field. Inhis latest book, Success and Luck, he returnsto this theme and explains why he finds itproblematic.

Small differences, big rewards / “In recentyears,” Frank writes, “social scientists havediscovered that chance events play a muchlarger role in important life outcomes thanmost people once imagined.” Despite theAmerican belief in meritocracy, he arguesthat success and failure “often hinge deci-

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beyond a certain point, bigger housesmake people any happier. Once housesreach a certain size, further increases insquare-footage merely shift the frame ofreference that defines adequate.

While the rich are engaged in a sortof arms race to out-do each other, publicinvestment suffers, he claims. ChannelingJohn Kenneth Galbraith’s complaints inThe Affluent Society (1958), Frank sees anAmerica in which the wealthy are livingit up at the expense of a starving publicsector. He employs this analogy to makehis point: we are like a driver who has a$300,000 Ferrari that bumps along on pot-hole-ridden roads when we could insteadhave a $150,000 Porsche that we drive on

perfectly smooth roads.We suffer from a huge

infrastructure def icit ofsome $3.6 trillion but, Frankargues, the rich fail to under-stand that they were justlucky and therefore opposepaying the higher taxes thatwould lead to better roads forall, better education for every-one’s children, and so on. Inshort, we’d all be better off—even the rich—if they paidmore in taxes and stoppedtheir wasteful spending.

Several glaring problemsbeset his argument.

First, all of that needless(to Frank) spending by therich provides the income for

many people who are not rich. Consider theoutlandish Manhattan weddings that nowcost on average $76,000. Frank sees waste-ful one-upsmanship, but to the companiesemployed and their workers, that’s themoney that pays the bills. The de-escalationof the arms race on weddings, houses, cars,boats, etc., that Frank wants would inflictserious pain on many Americans whoselivelihoods depend on rich people spendingmoney on their lifestyles.

Second, it isn’t true that the super-richhave dug in their heels to oppose any andall tax increases on them. A great many

sively on events completely beyond anyindividual’s control.” The actor BryanCranston, for example, is now enjoying abooming career, his high demand a resultof his starring role as methamphetaminekingpin Walter White in the TV seriesBreaking Bad. Frank points out that Cran-ston was only offered that role after JohnCusack and Matthew Broderick turnedit down. Yes, Cranston is a fine actor, butwithout that lucky break he would havebeen remembered for the respectable butnot landmark role of father Hal in thecomedy series Malcom in the Middle.

The business world, Frank contends,is full of such good-luck stories. In themarket for tax preparation software, forinstance, numerous programs that wereperfectly capable once competed. Butowing to some favorable reviews, Intuit’sTurbo Tax eventually came to dominatethe field. “Its developers profited enor-mously, even as those whose programswere almost as good were being forced outof business,” Frank laments.

Of course, it has always been true thata few lucky ones manage to reap greatrewards even though they were little ifany better than their rivals. But Frankmaintains that the march of technologyis magnifying the gap between winners andlosers in such varied fields as law, medicine,sports, journalism, retailing, and even aca-demia. In a revealingly egalitarian passage,he writes:

It’s one thing to say that someone whoworks 1 percent harder than others or is1 percent more talented deserves 1 per-cent more income. But the importanceof chance looms much larger whensuch small performance differencestranslate into thousand-fold differencesin earnings.

Much ado? / But is the “winner-takes-all”trend really becoming more pronounced?For all of his anecdotes, Frank’s claim thatit is rests on nothing more than his ipsedixit. The same technological change thatallows some to get exceptionally wealthyis also making markets open to far morepeople than ever before: publishing, for

example. It also allows competitors toerode the positions of the lucky win-ners more rapidly than ever. This part ofFrank’s case, I would say, is doubtful.

The key questions remaining are whythis trend (assuming it exists) is harm-ful and what the author proposes to doabout it.

One reason why the trend is harmful,according to Frank, is that the quest forgreat success “may encourage people tocompete where they have no realistic pros-pects.” True enough, but hasn’t that alwaysbeen so? For the last century, vast numbersof young Americans have, for example,devoted a great deal of time and energy toperfecting their jump-shots, fastballs, andtackling even though the chance of mak-ing it into one of the majorleagues (with a multi-million-dollar contract) is vanishinglysmall. Many others have triedto “make it big” in music oracting, even though the oddsof success are similarly micro-scopic. And still more, luredby the possibility of giganticprofits, have tried to inventthings and market them, butlike the rivals to Turbo Tax,failed. Frank focuses only onthe business failures, but evenwhen people don’t achievetheir dreams, they usuallygain from their efforts inways that make future suc-cess more likely. As ThomasEdison said of his manyunsuccessful experiments, “I didn’t fail,but learned what didn’t work.”

But there is a far bigger problem accord-ing to Frank: the few plutocratic winnersdamage the nation with their prodigiousspending on mansions, hyper-expensivecars, over-the-top weddings, and so on. Allof that conspicuous consumption reallydoesn’t make them happier, he claims:

Wealthy Americans have been buildingbigger mansions simply because they’vereceived most of the country’s recentincome gains. Yet there’s no evidence that,

Success and Luck:Good Fortune and theMyth of Meritocracy

By Robert H. Frank

187 pp.; PrincetonUniversity Press, 2016


of America’s billionaires are supportersof leftist politicians who have pledgedto make the rich pay much higher taxes.Something other than insatiable greed ofthe 1 Percenters is necessary to explainwhy the tax code lets them keep so muchof the money they’ve been lucky enoughto acquire.

Third, Frank’s proposed tax transfer ofmuch of the wealth of the lucky few to thegovernment would not produce the socialbenefits he envisions. That is because heassumes that if the federal treasury had bil-lions more, the politicians and bureaucratswould spend it wisely to give us smoothroads, strong bridges, efficient passen-ger rail, and above all, good schools foreveryone. That is to say, Frank exhibits thestandard “liberal” wishful thinking thatwe can solve our problems by just spend-ing enough on them. Could this eminenteconomist be unfamiliar with the publicchoice critique of government spending?Is he unaware that many of the school dis-tricts that spend the most per student haveconsistently poor results? Apparently so.

Frank’s proposed solution to the allegedproblem that the lucky are “taking” toomuch of society’s income and squanderingit is not to ramp up the highest income taxbrackets, as you might suppose. Rather, hewants to replace the progressive income taxwith a progressive consumption tax. Thatchange would, he contends, reduce waste-ful consumption spending (especially bythe super-rich) while encouraging savingand investment.

Actually, there is much to be said forshifting away from the income tax andinto a consumption tax. But the case forthat doesn’t have anything to do with luckor the “expenditure cascades” of the rich.Frank is prescribing a helpful medicinebased on an erroneous diagnosis of thepatient’s condition.

Success and Luck is not without its usefulinsights. Foremost among them is Frank’spoint that the “college earnings premium”that many educators site as proof that weneed to put more young people throughcollege is a mirage. That “premium” exists,he notes, only because a small number of

college graduates have enjoyed spectacularearnings. For most college grads, earningsare modest and haven’t grown much. Com-ing from a college professor, that’s quite arebuke to the crowd calling for the UnitedStates to regain the world’s top spot withregard to the percentage of the populace

with college degrees.Nevertheless, the book’s big point is one

that gives aid and comfort to redistribution-ists who will use almost any argument tojustify expansion of the state. “You just gotlucky” works just as well for them as anotherrecent claim: “You didn’t build that.”

DAV ID R . HENDER SON is a research fellow with theHoover Institution and professor of economics in theGraduate School of Business and Public Policy at the NavalPostgraduate School in Monterey, Calif. He is the editor ofThe Concise Encyclopedia of Economics (Liberty Fund, 2008).

The Restless Judge✒ REVIEW BY DAVID R. HENDERSON

Probably the best-known current federal judge who is not aSupreme Court justice is Richard Posner, who has been ajudge on the 7th Circuit since 1981. Posner is known for his

judicial decisions, his crystal-clear writing style in those decisions,and his prodigious output: over 40 books and hundreds of articlesin law reviews, economics journals, andpopular publications.

Given his importance in both academiaand the federal courts, we have been due fora book that tells us more about the man.In most of the important ways, WilliamDomnarski’s Richard Posner is that book.

Domnarski, a lawyer himself, showsobvious respect for his subject, callingPosner “the Wayne Gretzky of appellatejudges.” He spent three years researchinghis subject and interviewed over 200 peo-ple, including Posner. He studied Posner’searly history. He also read all of Posner’sthousands of decisions and much of hiscorrespondence. As a result, we get a goodidea about how Posner’s mind works andhis various attitudes.

Domnarski details the judge’s thinkingin dozens of his decisions, telling us Pos-ner’s bottom line and, in many cases, howhe reached his conclusions. For example,we get to see the strong role that economicanalysis and broader social science play inhis court decisions.

We see Posner call out various judgesfor intellectual laziness. He tangles withthe late Supreme Court Justice and his for-

mer University of Chicago colleague, Anto-nin Scalia. He acerbically dresses downsome police officers who have violateda defendant’s Miranda rights. He confi-dently reaches conclusions about publicpolicy based on his largely self-taught eco-nomic understanding.

Unfortunately, we often don’t get to seehow Posner reaches his conclusions. As aneconomist, I usually was able to fill in theblanks, but many readers will not. Fillingin the missing arguments would probablyhave added 20% to the book’s length and soit’s understandable that Domnarski didn’tdo so. In the age of the Internet, though,there’s an easy fix: put in links to a specialwebsite that details Posner’s reasoning.

Beyond advocacy / In the opening chapter,Domnarski describes Posner as a star stu-dent from an early age: in public school,then as an undergraduate literature majorat Yale, and finally as a law student at Har-vard. Posner then took some fairly impor-tant jobs in federal government agenciesin the 1960s. Before reaching age 28, whileat the Office of the Solicitor General underPresident Lyndon Johnson, he had arguedsix cases before the Supreme Court.

Posner, it turns out, “practiced his oralarguments to his cat.” However, Domnar-ski writes, those arguments “had as much

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ner’s reasoning on various court cases,he generally does a good job. Take, forexample, Vande Zande v. State of WisconsinDepartment of Administration, a case underthe Americans with Disabilities Act involv-ing a paraplegic employee. The act requiresan employer to “reasonably accommodate”employees with disabilities. Posner pointedout that reasonable care is not the samething as maximum care. Drawing on neg-ligence law, in which the issue of reason-ableness arises, Posner wrote that “similarreasoning could be used to flesh out themeaning of the word ‘reasonable’ in theterm ‘reasonable accommodations.’” Ifthere were no limitations, Posner argued,employers could be faced with “potentiallyunlimited financial obligations to 43 mil-lion disabled persons.” This unlimitedobligation would impose “an indirect taxpotentially greater than the national debt.”Posner concluded that there was no basisin the law’s language or history for con-cluding that Congress’s intention was “tobring about such a radical result.”

Sharp critic, fawning worshipper / Onepleasurable (to me) part of the book con-sists of portions of Posner’s letters to Uni-versity of Chicago philosophy professorMartha Nussbaum. Apparently, after shehad criticized “Chicago-style economics,”Posner wrote in response, “Your acquain-tance with economics seems so distinctlysecond-hand.” After she had argued forrent control, he wrote, “Not to seem tooimpertinent, it seems to me that your viewsof rent control stem from ignorance of alarge economic literature about it.” Indeed.In response to her claim that Americansfeel inferior because they lack culture andare familiar only with economics, movies,and Wagner, Posner wrote, “Leave out eco-nomics and Wagner, and it’s still wrong. Idon’t think you know what country andcentury you’re living in.”

One fact that surprised me—because Ihave not followed Posner closely—is thathe is an “uncritical, fawning worshipper”(Posner’s own words) of Justice Oliver Wen-dell Holmes. Posner edited and wrote a longintroduction to The Essential Holmes, a book

influence on the Justices as they had onthe cat.” Said Posner, “Whatever droveSupreme Court decisions, it wasn’t thelawyers’ advocacy.” That was one reasonhe left his job with the solicitor general.

But then he got lucky—if luck is theright word to apply to someone who worksvery hard, thinks for himself,and searches out interest-ing intellectuals. In 1968he joined the Stanford LawSchool faculty and met AaronDirector and George Stigler.Director, the older brotherof Milton Friedman’s wife,Rose, had moved to Stanfordin 1965. While at the Univer-sity of Chicago Law School,he had started the Journal ofLaw & Economics and was oneof the founders of the field oflaw & economics.

While you won’t findDirector’s name as an authorof many important works, heis often in the acknowledge-ments as the person who came up with theidea that led to this or that path-breakingarticle. One early such article was John S.McGee’s “Predatory Pricing: The Case ofStandard Oil of New Jersey.” In it, McGeefound—as Director had suspected based ona priori economic reasoning—that StandardOil had not engaged in predatory pricing.

Stigler, an economics professor at theUniversity of Chicago, spent part of everywinter at Stanford. (For some reason,Domnarski never mentions that bothDirector and Stigler worked at Stanford’sHoover Institution.) Stigler was arguablythe leading economist in industrial orga-nization at the time. Posner used his timewith Director and Stigler well, soaking uptheir insights. His conversations with themprofoundly affected his career.

He moved to the University of ChicagoLaw School in 1969. There, he becamethoroughly familiar with the law & eco-nomics literature and started making hisown contributions. And those contribu-tions didn’t take long. In 1971 he startedthe Journal of Legal Studies. By 1973 he had

published his first magnum opus, EconomicAnalysis of Law. The book made a big splashat the time, earning many reviews, andestablished Posner as one of the leadingscholars in law & economics.

In 1981, President Ronald Reaganappointed him to the 7th Circuit, based in

Chicago. From then on, whatmade the biggest splasheswere Posner’s opinions inmany of his thousands ofdecisions. And his promi-nence and ability as a judgeled to opportunities to writeabout policy issues, judicialand otherwise.

In 1988, for example, ChiefJustice William Rehnquistappointed him and 14 other“judges, legislators, academ-ics, and lawyers” to the FederalCourts Study Committee. Theimpetus for the committeewas the congestion and delayin cases that federal courtswere experiencing. Posner and

Larry Kramer, future dean of Stanford’s LawSchool, wrote their subcommittee’s report.It included a number of recommendationssuch as, in Domnarksi’s words, “establish-ing a $10,000 minimum for federal tortclaims” and repealing the Jones Act, whichrequires that all goods shipped between U.S.ports be carried on U.S.-built ships staffedwith U.S. citizens and permanent residents.

Domnarski doesn’t explain why theymade those recommendations. As aneconomist, I think I can fill in some of thereasoning. The purpose for the $10,000minimum would presumably be to “notmake a federal case,” to use an old expres-sion, out of relatively small claims, thusfreeing up valuable court time. The JonesAct is one of the laws that informed econ-omists especially hate because it makesshipping very expensive. Foreign shipscan’t deliver freight to two different U.S.ports in one voyage. Instead they mustbreak bulk in one port and then use U.S.ships to take the cargo to the other port.The economic inefficiency is obvious.

When Domnarski does spell out Pos-

Richard Posner

By William Domnarski

289 pp.; OxfordUniversity Press, 2016


Working Papers ✒ BY PETER VAN DORENA SUMMARY OF RECENT PAPERS THAT MAY BE OF INTEREST TO REGULATION’S READERS.

Air Pollution“The Mortality and Medical Costs of Air Pollution: Evidence from

Changes in Wind Direction,” by Tatyana Deryugina, Garth Heutel,

Nolan H. Miller, David Molitor, and Julian Reif. November 2016. NBER

#22796.

Reducing exposure to fine particulate matter (PM 2.5)accounts for 90% of the estimated benefits of conven-tional federal air pollution regulations. This has raised

questions about the reliability of those benefit estimates; are theytoo optimistic?

The estimates of the mortality benefits of PM 2.5 reductionused by the U.S. Environmental Protection Agency come fromtwo studies, commonly referred to as the American Cancer Soci-ety Study and the Harvard Six Cities Study. Both have been thesubject of much methodological criticism.

Economists have responded to the methodological weaknessesof those studies by investigating the results of natural experimentsin which people are exposed to pollutants in a manner that isplausibly random. One such research design involves randomchanges in prevailing wind direction that briefly expose differentpopulations of people to pollutants. I described one such study inmy Winter 2015–2016 Working Papers column. Here is another.

The authors argue that changes in wind direction affect subse-quent short-term morbidity and mortality only through exposureto air pollution. They examine three-day mortality and morbidityeffects among Medicare patients at the county level from 1999 to2011. A 1 microgram per cubic meter (μg/m3) increase in PM 2.5for one day causes 0.61 additional deaths per million elderly dur-ing the next three days, 2.7 life-years lost per million beneficiaries,and 2.3 additional emergency room visits per million elderly, cost-ing $15,000 per million elderly. At $100,000 per statistical life year,they estimate that the mortality cost of a 1 μg/m3 increase in PM2.5 is $270,000 per million elderly, an order of magnitude higherPETER VAN DOREN is editor of Regulation and a senior fellow at the Cato Institute.

of excerpts from Holmes’s decisions andletters. What did Posner think of Holmes’smajority opinion in the infamous Buck v. Bellcase, which upheld the constitutionality ofcompulsory sterilization? On his assump-tion that Carrie Buck was “feeble-minded,”Holmes wrote his famous line, “Three gen-erations of imbeciles are enough.” AlthoughPosner loved the rhetoric, he did criticize“the reasoning and the result.”

He is a harsh critic of federal judges,arguing that many of them are lazy andthat they should write their own decisionsrather than have their clerks write them.Two famous judges whom he takes on arecurrent Chief Justice John Roberts and thelate Justice Antonin Scalia. In a 2012 articlein Slate, after Scalia had dissented from partsof the majority opinion that invalidatedsome provisions of an Arizona law on immi-gration, Posner raked Scalia over the coals.Scalia had written, “[Arizona’s] citizens feelthemselves under siege by large numbers ofillegal immigrants who invade their prop-erty, strain their social services, and evenplace their lives in jeopardy.” Wrote Posner,“But the suggestion that illegal immigrantsin Arizona are invading Americans’ prop-erty, straining their social services, and even

placing their lives in jeopardy is sufficientlyinflammatory to call for a citation to somereputable source of such hyperbole. JusticeScalia cites nothing to support it.” Asidefrom his question-begging use of “hyper-bole”—if it were hyperbole, one would behard put to find a “reputable source” tosupport it—Posner made a good point.

In my view, Posner was at his finest in his2014 United States v. Slaight opinion revers-ing the conviction of Michael Slaight forreceipt and possession of child pornography.The police had clearly denied Slaight hisMiranda warning, and Posner saw throughit. Dismissing the police argument that theywanted to interview Slaight at the policestation rather than at his home becausehis windows were covered with trash bags,blocking the sunlight, he wrote sardoni-cally that “the officers gave no reason whyan interview, unlike painting a landscape,requires natural rather than artificial light.”As to their argument that the house “hada strong smell of cats,” Posner, who to hiscredit is pro-cat throughout the book, wrotethat “police smell much worse things inthe line of duty.” The final two sentences ofhis decision are terse and beautiful: “Thesefacts are incontrovertible and show that the

average person in Slaight’s position wouldhave thought himself in custody. Any otherconclusion would leave Miranda in tatters.”

Central planners / There is no mention inthe book of any basic insights from pub-lic choice in Posner’s decisions or writings.Indeed, there is no evidence that he under-stands and applies such insights. At timeshe comes across as someone who has muchmore faith in government officials thanseems justified. Whether it’s his advocacy ofa domestic intelligence agency in RemakingDomestic Intelligence or his support of Keynes-ian economic policies in A Failure of Capital-ism, Posner shows little inclination to thinkthrough some of the perverse incentives thatgovernment officials might have when carry-ing out the programs he advocates.

Posner has shown that he can attributebad incentives to the police, but he doesn’tworry enough, in my view, about the incen-tives and motives of employees of intelli-gence or fiscal agencies, among others. Inhis mind, there is more than a little beliefin the benevolence—and competence—ofcentral planners. Still, Domnarski’s bookreminds me that I’m glad that Richard Pos-ner is in this world. R


I N R E V I E W

than the cost of the additional emergency room visits.From 1999 to 2011, average PM 2.5 concentrations declined by

3.65 μg/m3. According to the estimates of the paper, this reductionwould result in 150,000 extra life-years annually, which if valued at$100,000 per life year would equal $15 billion in annual benefits.The EPA estimates that the annual compliance costs of the 1990Clean Air Act standards were $44 billion in 2010. This suggeststhe PM 2.5 regulations do not pass a cost–benefit test.

Health Care Expenditures“Do Certificate-of-Need Laws Limit Spending?” by Matthew D.

Mitchell. November 2016. SSRN #2871325.

From 1965 until the early 1980s, Medicare encouraged healthcare capital expenditures because of its “cost-plus” reimburse-ment framework, which guaranteed federal payments above

the marginal cost of a service. As a result, many providers wereaccused of wastefully overinvesting in capital, at the public’s expense.

Rather than change the incentives in this reimbursementframework, the federal government responded by mandatingthat states enact Certificate of Need (CON) laws. The laws wouldrequire health care providers to seek approval from state boardsbefore making major capital investments. The thinking was thatsuch oversight would reduce unnecessary capital expenditures.CON critics, on the other hand, charged that the laws discour-age both market innovation and competition, resulting in higherprices and lower service quality.

Medicare changed its reimbursement practices in the mid-1980s and repealed the CON requirements in 1987. But 35 statesand Washington, D.C. still have CON requirements. This papersurveys the refereed literature on the effects of CON programs todetermine if they did, indeed, reduce wasteful expenditures andhealth care costs. The papers overwhelmingly conclude that CONprograms increase per-unit costs and expenditures because theyrestrict entry and reduce health care competition.

Payday Lending“Much Ado about Nothing? Evidence Suggests No Adverse Effects

of Payday Lending on Military Members,” by Susan Payne Carter and

William Skimmyhorn. March 2015.

“Access to Short-term Credit and Consumption Smoothing within

the Paycycle,” by Mary Zaki. March 2016. SSRN #2741001.

Congress effectively banned payday lending to active mem-bers of the military in 2007. Prior to 2007 some stateshad payday lending bans while others did not. The ini-

tial assignment of soldiers to training bases at the start of theirmilitary service is random; some were assigned to bases in statesthat allowed payday lending, others were assigned to bases in

states that did not. These facts allow the authors of these papersto conduct an assessment of how the end of payday lending forthose affected by the federal ban affected outcomes relative tothose soldiers who never had access to payday lending becausethey served in a state with a preexisting ban.

The first paper found no differences in separation from serviceor denial of security clearances because of bad credit among thosewith and without access to payday lending.

The second paper examined commissary purchases. After theban, sales on paydays at bases were 21.74% higher than sales onnon paydays. Before the ban, sales on paydays at bases near paydayloan outlets were only 20.14% higher. There was a 1.6% smallergap between payday and nonpayday sales when troops had accessto payday loans. Payday loans allow members of the military tosmooth their consumption across the paycycle.

Airline Mergers“Are Legacy Airline Mergers Pro- or Anti-Competitive? Evidence

from Recent U.S. Airline Mergers,” by Dennis Carlton, Mark Israel, Ian

MacSwain, and Eugene Orlov. October 2016. SSRN #2851954.

Arline mergers have reduced the number of legacy airlinesfrom six to three. Delta and Northwest have mergedunder the Delta name, United and Continental under

the United name, and American and US Airways under Ameri-can. Airlines are also now profitable for the first time in decades.Many armchair antitrust observers have thus concluded that themergers were anticompetitive, harming consumers while pump-ing up airline profits.

The authors of this paper attempt to determine if this is thecase. If the mergers had anticompetitive effects, routes on whichthe merged airlines competed directly (overlap routes) shouldsee fare increases and output reductions (flight frequency and/orpassenger loadings) relative to non-overlap routes.

The authors confirm that fares and output on controls andtreatment routes were statistically similar pre-merger. On aver-age across all three mergers, fares on overlapping routes decreased6.2% post-merger relative to control routes. Passenger loadingsincreased 12.4% and available seats increased 23.8%. Prices wentdown and output went up. The mergers were not anticompetitive.

Energy Standards“Energy Efficiency Standards Are More Regressive than Energy

Taxes: Theory and Evidence,” by Arik Levinson. December 2016.

NBER #22956.

Economists recommend that policymakers combat nega-tive externalities like pollution by changing prices ratherthan implementing “command-and-control” regulation.

A tax on harmful air emissions, for instance, would encourage


polluters to find the most efficient ways to reduce their emissions,whereas specific emissions control requirements—scrubbers, forinstance—would fail to distinguish more efficient means of pol-lution control.

Unfortunately, legislatures almost always enact regulationrather than taxation; politicians would prefer to be seen mandat-ing “clean” technologies rather than adopting new taxes. But manypoliticians claim that this policy choice is for a more high-mindedreason: taxes are regressive, while mandates are more even-handed.Is this justification sound?

This paper examines the distributional effects of one specificcommand-and-control regulation: Corporate Average Fuel Econ-omy (CAFE) standards. These standards mandate that automakers’model-year vehicles, as a group, meet a minimum fuel-efficiencystandard. The author, Arik Levinson, endeavors to determine ifCAFE standards are less regressive than a similarly effective fuel tax.

Levinson first points out that a discussion of the distributionalimplications of taxes is incomplete without discussion of how theresulting revenues are used. The most affluent households have 10times the income of the least affluent, but use only four times moregasoline, so a gasoline tax would be regressive in the sense that theaffluent would pay a lower percentage of their income. But if theproceeds from that tax were rebated equally to all households, thenthe overall tax-plus-rebate program would be progressive because

Our Abbey has been making caskets for over a century.

We simply wanted to sell our plain wooden caskets to pay for food,health care and the education of our monks.

But the state board and funeral cartel tried to shut us down.

We fought for our right to economic libertyand we won.

I am IJ.

www.IJ.org Institute for JusticeEconomic liberty litigation

Abbot Justin BrownCovington, Louisiana

low-income households would get back more money than they paid.The author then demonstrates that efficiency standards are

equivalent to a tax on inefficient appliances. In the case of cars, adirect tax on energy use is a tax on gallons of gasoline used whilethe tax-equivalent of CAFE standards is a tax on gallons used permile. Thus Levinson says that for any given use of the revenue (orimaginary revenue equivalent in the case of CAFE standards), thequestion is whether the direct tax increases faster with incomethan the “efficiency standard–equivalent tax.” Affluent householdsuse four times as much gasoline as poor households, but affluenthouseholds use only three times the gasoline per mile as poorhouseholds. Thus the gas tax goes up faster with respect to incomefor affluent households than the tax-equivalent cost of efficiencystandards with respect to income.

Since 2011, efficiency standards for cars have varied with thesize of the “footprint” of the vehicle. Larger vehicles have morelenient standards on gasoline use. More affluent people buy largervehicles. Levinson demonstrates that the net effect of the newfootprint CAFE standards is to make efficiency standards evenmore regressive relative to a gas tax.

He concludes that on a revenue-neutral basis, a gasoline taxwould indeed be regressive. But the old CAFE standards were moreregressive than a gas tax would be, and the new footprint CAFEstandards are even more regressive. R

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