Burying Bentham

Note:The following is a copy of the research paper I submitted for my Econ 840: Law and Economics I course with Professor Charles K. Rowley. There is also a Google Docs version of this that is more footnotes-friendly.

1776 would be remembered as the year that the Declaration of Independence was written and the United States of America was formally launched as a nation. Many economists would also remember it as the year that Adam Smith's magnum opus An Inquiry into the Nature and Causes of the Wealth of Nations was published, marking the birth of the field. On top of these historic events, the great philosopher David Hume passed away, and a young Jeremy Bentham published A Fragment on Government. These three men--Smith, Hume, and Bentham--would all have a tremendous impact on the development of economics.

If Adam Smith was the intellectual father of economics, then Jeremy Bentham may be regarded as its spiritual father. In the Fragment, Bentham distinguished between the expositor who explains what is, and the censor who explained what ought to be¹. Bentham set out to be the latter, while he would undoubtedly have branded Smith as the former. Under the influence of these two men, economics grew into a field at once blessed with powerful analytical tools, and cursed with utilitarian assumptions that seemed inextricably intertwined with the basic theories that developed.

Indeed economics continues to feel the conflict between the expositor and the censor, the positive and the normative. Well, with respect to Milton Friedman², I contend that there is no such thing as a normative economics. So long as economic analysis confines itself to questions of what is, it faces the same challenges faced by any science. When the analysis turns to what ought to be, however, it is no longer a matter of economics but of moral philosophy, a subject on which no one is a scientist and everyone is an expert.

Though the censor and the would-be normative economist will remain a fact of life and the field, they need not be so confused and jumbled into the core analysis as they have become. The goal of the present analysis, then, is to set out to clear up the misunderstanding that has resulted from these attempts at joining the is with the ought. I will begin with a brief history of these two threads in economics. This will lead into a discussion of Welfare economics and Ronald Coase, the father of the Law and Economics movement.

I hope to demonstrate that economics has no need of the normative. Difficult though the challenges of a field which studies patterns of human behavior might be, great scholarship has already been done and the economist has always held a certain distinction from any other brand of social scientist. It is time to work off the stigma of theories formulated based on clear value assumptions. It is time to honor the serious science which has already been accomplished, and focus on the tasks that remain. It is time to remove what's left of Bentham from the grounds of the University College London and bury him once and for all.


I. The Instrumentalist and the Consequentialist

The trouble began with Bentham, and a misreading of Hume.

David Hume wrote that justice had as its "sole origin" the "public utility". Here he meant utility in the traditional sense--IE, usefulness, or practical value³.

Bentham was very taken with this line of thinking. A characteristically long footnote in A Fragment on Government praises Hume at length for correctly asserting that "the foundations of all virtues are laid in utility". He also makes a quick reference to Helvetius by way of qualifying the compliments for Hume. The qualification is revealing: Hume did admit that there were some personal qualities in people that were often labeled as virtue that did not necessarily have any practical merit for society as a whole. Helvetius, and Bentham later, argued that this exception was no exception at all, as the only true virtues were those derived from their public utility⁴.

In this qualification, which Bentham intended only to be a small comment on someone who was largely an intellectual hero of his, in fact measures the vast chasm between what Hume was actually saying and what Bentham understood him to be saying.

Nowhere in his analysis of morals did David Hume make an argument about what men ought to do or what law or morality ought to be dictated by. His analysis of morality and justice are instrumental; he asks why people believe some things to be immoral, why government and law takes the forms that it does. His conclusion concerning the utility of these things has nothing to do with utilitarian ethics as Bentham would develop them later.

To understand this, it might help to understand Hume's argument concerning causation. In the first book of A Treatise of Human Nature, he argues that men cannot prove the existence of causation--that reason is impotent to do so, either in a definite or even a probabilistic manner. However, a belief in causation is imposed upon us by nature, because basic survival would be impossible without such a belief. If I did not believe that pulling a door would cause it to open, I would sit here in my room and starve to death for lack of an idea of how to get out. Before any action can take place there must be some underlying assumption of causation underlying it⁵.

We believe in causation, therefore, because believing it is useful to us; we would perish without it. Our sense of right and wrong, and of justice, are useful in the same sense--though in this subject he speaks of its usefulness to a group, community, or nation rather than its usefulness to individual survival. He even analyses the incentive for individuals to cheat the system; for though everyone is better off if everyone plays by the rules, an individual may be much better off if everyone plays by the rules but him⁶.

In short, Hume made an instrumental analysis of human beliefs, institutions, and traditions. Bentham, on the other hand, understood "public utility" in a moral sense; that is, Hume said that public utility was the origin of virtue, while Bentham argued that it should be.

Hume would serve as a mentor and friend to Adam Smith, who is considered to be the founding father of economics. Bentham would convert James Mill to utilitarianism. Mill's own contributions to economics were not insubstantial⁷, but his influence on the development of the field was as nothing compared with his son, John Stuart Mill. J. S. Mill's Principles of Political Economy became the standard text for economic education for many decades⁸. So well beyond Bentham's direct personal influence, went his indirect influence through the son of his student, who would become the top man in the field of his day and remained a devoted utilitarian.

It is thanks to Bentham, and J. S. Mill, that we now have to endure the twisting of the word "utility" from "usefulness" to a more sophisticated sounding word for "pleasure" that rational economic man seeks to "maximize". For a time economists even believed that this fictionalized utility was something that could be measured and that the absolute amount of utility could be compared between individuals. This, at least, was laid to rest by Vilfredo Pareto, who argued that utility could be expressed as ordinal preferences of relative magnitudes, but could not be measured in absolute cardinal terms. However, Pareto took one normative criteria—Bentham's “greatest happiness for the greatest number”--and put in its place the concepts of efficiency and optimality that have continued to plague attempts at positive analysis in economics.

For a rationalist theory of what ought to be is wholly unnecessary for the pursuit of knowledge concerning what is⁹. Friedman expressed a clear understanding of this in his famous essay on methodology, but the mistake persists none the less. Paul Samuelson could not help but proceed from describing what a public good is to what government policy ought to be on the subject¹⁰. Richard Posner wholeheartedly expounds Pareto-like wealth-maximization as a moral principle¹¹. Steven Shavell, a powerful analytic thinker and great pioneer in Law and Economics, spends inordinate amounts of time describing what trade-offs in law are and are not efficient, and assures his readers that there is little need for income redistribution by legal means since a tax credit can accomplish it more effectively¹². Public Choice genius Gordon Tullock begins one essay by promising to earnestly try to avoid analysis based on ethical premises. In the very next sentence, he begins to describe how he will use the tools provided by Pareto, as well as offer some slight improvements on them¹³.

What follows will be an analysis of externalities and the commons, with an attempt to siphon out the normative assumptions on which they were developed.


II. Returning to the Commons


The concept of positive and negative externalities, first pioneered by A. C. Pigou¹⁴, have become a staple of modern economic theory. The idea being that economic activities can have spillover effects above and beyond the costs borne and benefits reaped by the parties to the transaction. A factory which pollutes the air may impose costs that are not borne by decisionmakers in the firm, or consumers that purchase their product. In such a situation Pigou imagined that there existed a gulf between the private costs of production, and the cumulative social cost. His solution was to impose a tax upon the party creating the negative externality in order to force them to bear the full costs of their activities and reduce their output to a socially optimal level. In addition, those beneficial activities that were underperformed because the decisionmakers did not capure the full benefits—positive externalities—were supposed to be subsidized.

Ronald Coase, in a paper so widely cited it hardly bears mentioning¹⁵, effectively demonstrated that externalities could only occur in the commons, or when transactions costs were very high. If transactions costs were low enough, the mere assignment of property rights would create an invariance of outcomes; the resources would flow to their most valued use through bargaining.

Stripping away the normative content of nearly a century of welfare economics is no small task, so let's take this one step at a time. The first thing that must go is the notion of a “most valued use” for a resource. James Buchanan correctly pointed out the curiosity of this assumption, calling Coase an objectivist “in the sense that, to him, 'efficiency' in resource use has an existential reality independent of the market exchange process.”¹⁶

A firm commitment to methodological individualism—that is, the assumption that only individuals make decisions, bear costs, and capture benefits—the notion of a “most valued use” in aggregate terms is just as problematic as Pigou's slippery and immeasurable concept of “social cost”. As we shall see in a moment, a cost is a cost is a cost.

Through Coase it does become clear that externalities only occur in a commons. What he did not seem to realize is that all human activity occurs in a commons. This seems counterintuitive to the student of economics who has been taught that once property rights have been assigned you are no longer in a commons. Yet the very assignment of those property rights imposes costs and provides benefits. Who has the property right over legal authority? Who “owns” the common law system, which emerged over the course of centuries?

The price system itself operates in a commons. When a competitor enters the market and drives down the price, he imposes a cost on the incumbent firms. When fifty people beat my brother to the video game store at five in the morning, and the store ends up only having forty-nine of the Wii consoles he was willing to get up so early for, a cost was imposed on him by the two people ahead of him in line. When early-adopters buy the lower-tech, more expensive prototypes of new technology and thereby finance the development of cheaper, more advanced derivative technology, the latecomers receive a benefit. Externalities, which are nothing more special than third-party effects, are inescapable.

There is no escaping the commons, but that does not bring us back to the world of Pigovian taxes. Once the nature of the commons becomes clearer, the notion of using the category of “negative externality” for what ought to be taxed is impossibly enormous. Pigou was thinking of specific activities such as air pollution or sound pollution. Yet given the actual range of effects that can be properly categorized as these third-party effects, choosing any specific one to tax or subsidize becomes entirely arbitrary. Pollution is all very high-minded, but what of beauty? Ought the ugly to be taxed whenever they come out in public, to discourage them from imposing the cost of seeing their faces on other people? Ought the beautiful to be subsidized for the equal and opposite reason?

Consider a more uncomfortable example: in the 1950s if an African-American family moved into a white suburban neighborhood, you could almost quantify the negative externality that it imposed on the local residents because of their prejudice. You could quantify it because house prices would fall, as the people sold their homes to move to what they considered to be a “nicer” neighborhood, but could not fetch a good price because people didn't want to pay as much to live in the same neighborhood as a black family. In retrospect, A Raisin in the Sun, the Lorraine Hansberry play, had a sort of horrifying case of Coasian bargaining: a representative of the neighborhood offered to buy the house from the African American family using funds that had been pooled together by the neighbors.

Pigou was led astray because of a very utilitarian notion that there existed a social calculus of costs and benefits. Societies do not bear costs, however—only individuals can do that.

This brings me to the next point: the equivalence of different classifications of costs. Pigou believed that externalities were a special sort of cost because they typically affected third-parties. For Coase, transactions costs held a strong interest which spanned the decades between his first landmark paper¹⁷ and “The Problem of Social Cost”. Many economists consider taxes to be a special category of cost as well.

The implications of hard methodological individualism is that there are no theoretical distinctions between any kind of cost. Economic theory states that an increase in the cost of an activity will decrease the amount of that activity that is performed, all things being equal. Beyond that, there is little to add. The various taxonomies of cost are useful for locating costs that might otherwise have gone unnoticed, but the manner in which a transactions cost effects the individual's behavior is identical to a negative externality of equal magnitude. As Posner elegantly demonstrated, regulation and taxation are identical in their effects¹⁸. As I stated to earlier when I alluded to this, a cost is a cost is a cost.

The same holds true for the whole range of benefits, external or otherwise. Whether a profit comes from fair dealing within the price system, or stealing someone else's property, a benefit is a benefit is a benefit.

Taking into account the unity of costs, benefits, and the notion that all human activity occurs in a commons, we would conclude that the price system is just one mechanism by which decisions concerning resources are made. Other mechanisms include the common law system, local and federal governments, and deference to people in traditional roles in leadership, to name just a few.


III. The Price System and the Economic Analysis of the Law


Thomas Sowell once argued that, for the economist, it is not what the decision is that matters, but who decides¹⁹. When speaking of the price system as one mechanism among others, I refer to processes in which individual decisionmakers have discretionary authority over resources, subject to some constraint. It becomes a “process” rather than simply a “situation” when those constraints are systematic. A judge has it within his authority to decide how and whether costs will be imposed on the parties at a trial, but his decision is subject to the particular constraint of his peers in the court, and, often, subject to the scrutiny of the higher courts. The judge is one decisionmaker contributing to the processes that make up the legal system.

The legal system did not come into economics in a really explicit way until fairly late in the history of the field. This is not to say that it was nonexistent; simply to make the uncontroversial point that the modern field of Law and Economics did not come into being until more than halfway into the twentieth century.

What economists have primarily focused on for the lion's share of the field's history is the price system. It is for this reason that, before the modern dualism of microeconomics as opposed to macroeconomics, the name given to what was taught in an economics classroom was price theory.

Classic price theory deals with individuals who have certain resources—be they land, capital, or merely their own skills—and desire resources that they do not have, or a larger quantities of the ones that they do. These individuals face a number of constraints in this system. First there is the obvious finite amount of resources that they have available to them at the outset. The number of other individuals that they will have the opportunity to trade with is also an important constraint; Adam Smith referred to this as the “extent of the market”²⁰. The charateristics of those individuals is also a constraint; their own resources, skills, and preferences will provide the framework for what a single individual can and cannot hope to accomplish by engaging in trade. Finally, it is assumed that trades are voluntary. Economists were aware of theft and coercion of course, but generally what they have called the price system is limited to those trade decisions made of the free will of the individuals involved.

During the nineteenth century and the early twentieth, analysis did not take externalities into account. Nevertheless, price theory developed a number of elegant and very powerful tools for understanding the world. The graph of the supply and demand curves is simple enough to teach in undergraduate principles courses and yet powerful enough to be used, in some variation, for the highest level of technical analysis. Popularized by Alfred Marshall²¹ a full thirty years before Pigou's Wealth and Welfare, it is useful for intellectual activities ranging from the effects of a price ceiling set below what would clear in the market, to the effects of technological innotion and income increases on the quantity of a good that is bought and sold.

In fact, it is not clear what the insights provided by Pigou or even Coase could add to the analysis of the price system. The law of demand simply states that the quantity of a good that is purchased is inversely correlated to the price of that good. The reasoning behind this, implicitly or explicitly, is the basic notion of scarcity. No matter how much Jones may want an iPod, his net wealth is finite. How many iPods Jones purchases, in other words, is not merely a factor of how many he wants, but of how much Apple asks for it and how much he is capable of offering. Externalities do not add anything to this analysis. The level of Jones' wealth is determined by what he owns, what his income is, and what his costs are. Given the equivalence of costs, the principle is the same whether Jones bears the costs associated with rent, paying taxes, or paying more in medical bills as a result of inhaling pollution. Pigou's theory of externalities has nothing to do with the operation of the price system and everything to do with desired outcomes of that system, taking it well beyond descriptions of what is and into the scientifically erroneous realm of what ought to be.

Once the economist ventures out of the realm of voluntary exchange, these third-party effects become a chief component of the engine of analysis. Pigou's normative argument relies on the assumption of something operating outside of the price system which can impose costs and provide benefits to those individuals that are still inside. Though approaching the subject from a Pareto-normative position, Coase correctly asserted that individuals within the price system are able to minimize negative externalities and maximize positive externalities, just as they do with other costs and benefits. Under certain circumstances, this requires no particular innovation, but simply contractual agreements between the interested parties. This is only possible, however, if those interested parties have the property rights to use their resources in the manner specified by such a contract.

While Pigou invoked something outside of the price system, it was Coase who brought the role of law and the courts into the analysis explicitly. The price system does not exist in a vacuum, he pointed out; people can only trade if they have property, and defining what property is and how it may legally be used is the task of legal institutions. Price theory had treated property rights as a given; the fact that courts often have to determine the property rights on a case-by-case basis posed a lot of challenging questions. The economic analysis of the law, or the field of law and economics, has developed as an attempt to answer those questions. The answers have suffered from the same bundling of utilitarian goals with instrumental observations, if anything, more often than the typical price theorist.

The economic analysis of the law has typically addressed the legal system in terms of how it can promote efficiency. It began with Coase, who argued that when transactions costs are low enough, the price system will allocate resources efficiently even if you take externalities into account, no matter who the courts assign the relevant property rights to. When they are high, this invariance does not hold. A great deal of discussion has focused on what the efficient assignment of rights is, or whether in some cases it might be more efficient to use liability rules as effectively a case-specific Pigovian tax²², and various other alternatives.

What is remarkable is the depth and breadth of positive economic theory that has been developed, almost as a byproduct of this explicitly stated normative goal. The analysis of liability rules as something that ought to be used in certain cases also developed a formal analysis of the effects of those rules on the decisions made by the individuals they would apply to. Shavell offers an fantastic analysis of the difference between laws that attempt to prevent an action from being taken in the first place through incentives such as fines and liability rules, and those set up to deter people from being able to take undesirable actions in the future²³. It is unfortunate for economic theory that he spends so much of his sharp intellect pursuing arguments about when laws ought to take a particular strategy; then again perhaps the possibility of presenting one's normative beliefs in the form of scientific analysis was sufficiently enticing to draw him into the field in the first place. That is a question which is well beyond the scope of the present analysis to address, however.


IV. Closing the Circle: Public Choice and the Unity of Systems


In reality speak of the price system and the legal system as if they were divisible entities is a useful fiction, and one which may not even be necessary on instrumental grounds. These systems are not different states of matter; they are unified in the reality that each individual decisionmaker must face. Each individual must make choices, given their present level of wealth, and the costs and benefits associated with any decision that they make. These costs can come from voluntary transactions, external effects of third-party behavior, direct taxation, robbery, or physical violence, to name a few. The benefits can come from working to make income, stealing, elevating one's reputation, and so on.

In fact, the costs and benefits need not have any relation with other individual human beings. Whether a cost is imposed by a judge or by a meteor impacting the planet is of no relevance to the economist analysing individual decisions. Some would argue that humans' ability to influence one another, especially officials, could justify treating human-based costs and benefits differently. This argument lacks substance, however, for individuals may invest in offsetting any sort of cost. They may bribe politicians to get more favorable regulation or they may hire contractors to build an underground home to avoid being killed by a meteor. The manner in which costs and benefits effect individual behavior is uniform across systems and across origins.

Classical price theory began to shed light on a specific set of costs and benefits. Law and economics integrated third-party effects, as well as the costs and benefits of specific legal institutional arrangements, into the analysis of human behavior. With the rise of Public Choice Theory, economists have even begun taking into account the costs and benefits faced by individual decisionmakers in government institutions. This takes economics as a field closer to encompassing all of the costs and benefits that human decisionmakers face in making choices. The individual bears the costs and benefits that come as a consequence of decisions made in all subsections of human behavior, public and private. There is an underlying unity among them, for that very reason.

A great deal of work remains, however, and even Public Choice does not completely close the loop. So before wrapping up the present analysis I would like to offer a modest suggestion to the economists of today and tomorrow. Before jumping to arguments about what government policy ought to be or whether markets ought to be held accountable to some efficiency criterion, perhaps it would be best to ask why policy is what it is and why there are variations across different regions, nations, and cultures. As fantastic as the economic analysis of the law has been, it has spent a great deal of time discussing whether common law or civil code systems are more efficient, when it may have been more useful to ask why they existed in the first place. Why human societies do not develop uniform legal institutions, why common law and civil code did develop when and where they did.

The truth is ever allusive but I firmly believe there are many economists who have and continue to move us ever closer to it. I believe we will be better equipped to move forward if we cast advocacy out of technical discussions where it has no place. The reputation of economics as a field could be much improved if not for the pseudoscientific morality espoused in public by many prominent economists, and moreover the jumbled patchwork of normative and positive clouds economists' abilities to ask questions that are relevant as scientific enquiry.

Everyone has their beliefs and there will always be a place for advocacy when put in discretionary or advisory positions. When engaging as analysis as scientists and scholars, however, it is more effective and more honest to leave out the discussions of ought in favor of discussions of is. We need not emulate Hume in every aspect of our lives, but the field of economics would be much enhanced if we would just bury Bentham and focus on the challenges ahead.

This work is licensed under a Creative Commons Attribution 3.0 United States License.