Government Externalities and the Friedman Criterion – Econlib

Does government intervention create its own externalities (or neighborhood effects)? Many economists think so and the question appears especially important in the current storm of dirigisme. Sixty years ago, Milton Friedman defended the idea in his influential book Capitalism and Freedom. A mainstream neoclassical economist and moderate classical liberal, Friedman wrote (p. 32):

Our principles offer no hard and fast line how far it is appropriate to use government to accomplish jointly what is difficult or impossible for us to accomplish separately through strictly voluntary exchange. In any particular case of proposed intervention, we must make up a balance sheet, listing separately the advantages and disadvantages. Our principles tell us what items to put on one side and what items on the other and they give us some basis for attaching importance to the different items. In particular, we shall always want to enter on the liability side of any proposed government intervention, its neighborhood effects in threatening freedom, and give this effect considerable weight. Just how much weight to give to it, as to other items, depends upon the circumstances. If, for example, existing government intervention is minor, we shall attach a smaller weight to the negative effects of additional government intervention.

This is an important reason why many earlier liberals, like Henry Simons, writing at t time when government was small by todays standards, were willing to have government undertake activities that todays liberals would not accept now that government has become so overgrown.

Technically, externalities are usually modelled as non-intentional effects of activities carried on for other purposes. Otherwise, everything that imposes indirect costs or benefits on somebody would be an externality; pretty much all activities would fall in that category. It seems to follow that the typical government intervention should not count as a positive or negative externality, because it is explicitly designed to create benefits for some groups and impose corresponding costs on others. However, if it also has indirect consequences on everybodys liberty, it can be considered as creating freedom externalities, as Friedman suggests. (In this perspective, a government intervention whose purpose is to increase government power and to decrease individual liberty would not generate freedom externalities, but only direct freedom costs.)

Does growing government intervention, besides increasing freedom externalities, also increase their rate of increase, as the Friedman criterion above seems to say? For any individual, the cost of a given intervention in terms of his own individual liberty will conceivably be larger the higher is the starting level of government intervention and power. One reason would be that, at higher thresholds of power, the more likely an additional intervention will combine with existing controls to give irresistible power to government and seriously undermine the liberty of the subject (or citizen). If government surveillance is widespread, for example, the more likely a new public morality or lifestyle law can be used to harass unpopular minorities. Another reason is simply that, as individual liberty decreases, the more an individual will find the remainder valuable.

Note how in other to avoid the serious problem of cost-benefit analysiswhich is that no scientific basis exists for weighing the benefits of some individuals against the costs imposed on otherwe should formulate the problem of freedom externalities la James Buchanan: each individual estimates his own cost and benefit from a given intervention and can be presumed to consent to it only if, for him, the latter is larger than the former. The only assumption made here is that, everything else equal, no individual wants to be more oppressed; oppression is a cost, not a beneficial or neutral condition. If some individuals like to be slaves for the mere pleasure of servitude, freedom externalities are not unambiguously positive or negative. The problem then becomes more complicated.

Considering only negative freedom externalities, Friedmans warning is valid: the higher the level of government intervention, the larger are the negative freedom externalities of any new proposed intervention. I suggest that it is not easy today to find any new government interventionor at least any net interventionthat would survive the Friedman criterion.

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Government Externalities and the Friedman Criterion - Econlib