Archives For Knowledge Problem

Following is the second in a series of posts on my forthcoming book, How to Regulate: A Guide for Policy Makers (Cambridge Univ. Press 2017).  The initial post is here.

As I mentioned in my first post, How to Regulate examines the market failures (and other private ordering defects) that have traditionally been invoked as grounds for government regulation.  For each such defect, the book details the adverse “symptoms” produced, the underlying “disease” (i.e., why those symptoms emerge), the range of available “remedies,” and the “side effects” each remedy tends to generate.  The first private ordering defect the book addresses is the externality.

I’ll never forget my introduction to the concept of externalities.  P.J. Hill, my much-beloved economics professor at Wheaton College, sauntered into the classroom eating a giant, juicy apple.  As he lectured, he meandered through the rows of seats, continuing to chomp on that enormous piece of fruit.  Every time he took a bite, juice droplets and bits of apple fell onto students’ desks.  Speaking with his mouth full, he propelled fruit flesh onto students’ class notes.  It was disgusting.

It was also quite effective.  Professor Hill was making the point (vividly!) that some activities impose significant effects on bystanders.  We call those effects “externalities,” he explained, because they are experienced by people who are outside the process that creates them.  When the spillover effects are adverse—costs—we call them “negative” externalities.  “Positive” externalities are spillovers of benefits.  Air pollution is a classic example of a negative externality.  Landscaping one’s yard, an activity that benefits one’s neighbors, generates a positive externality.

An obvious adverse effect (“symptom”) of externalities is unfairness.  It’s not fair for a factory owner to capture the benefits of its production while foisting some of the cost onto others.  Nor is it fair for a homeowner’s neighbors to enjoy her spectacular flower beds without contributing to their creation or maintenance.

A graver symptom of externalities is “allocative inefficiency,” a failure to channel productive resources toward the uses that will wring the greatest possible value from them.  When an activity involves negative externalities, people tend to do too much of it—i.e., to devote an inefficiently high level of productive resources to the activity.  That’s because a person deciding how much of the conduct at issue to engage in accounts for all of his conduct’s benefits, which ultimately inure to him, but only a portion of his conduct’s costs, some of which are borne by others.  Conversely, when an activity involves positive externalities, people tend to do too little of it.  In that case, they must bear all of the cost of their conduct but can capture only a portion of the benefit it produces.

Because most government interventions addressing externalities have been concerned with negative externalities (and because How to Regulate includes a separate chapter on public goods, which entail positive externalities), the book’s externalities chapter focuses on potential remedies for cost spillovers.  There are three main options, which are discussed below the fold. Continue Reading…

So I’ve just finished writing a book (hence my long hiatus from Truth on the Market).  Now that the draft is out of my hands and with the publisher (Cambridge University Press), I figured it’s a good time to rejoin my colleagues here at TOTM.  To get back into the swing of things, I’m planning to produce a series of posts describing my new book, which may be of interest to a number of TOTM readers.  I’ll get things started today with a brief overview of the project.

The book is titled How to Regulate: A Guide for Policy Makers.  A topic of that enormity could obviously fill many volumes.  I sought to address the matter in a single, non-technical book because I think law schools often do a poor job teaching their students, many of whom are future regulators, the substance of sound regulation.  Law schools regularly teach administrative law, the procedures that must be followed to ensure that rules have the force of law.  Rarely, however, do law schools teach students how to craft the substance of a policy to address a new perceived problem (e.g., What tools are available? What are the pros and cons of each?).

Economists study that matter, of course.  But economists are often naïve about the difficulty of transforming their textbook models into concrete rules that can be easily administered by business planners and adjudicators.  Many economists also pay little attention to the high information requirements of the policies they propose (i.e., the Hayekian knowledge problem) and the susceptibility of those policies to political manipulation by well-organized interest groups (i.e., public choice concerns).

How to Regulate endeavors to provide both economic training to lawyers and law students and a sense of the “limits of law” to the economists and other policy wonks who tend to be involved in crafting regulations.  Below the fold, I’ll give a brief overview of the book.  In later posts, I’ll describe some of the book’s specific chapters. Continue Reading…

UPDATE: I’ve been reliably informed that Vint Cerf coined the term “permissionless innovation,” and, thus, that he did so with the sorts of private impediments discussed below in mind rather than government regulation. So consider the title of this post changed to “Permissionless innovation SHOULD not mean ‘no contracts required,'” and I’ll happily accept that my version is the “bastardized” version of the term. Which just means that the original conception was wrong and thank god for disruptive innovation in policy memes!

Can we dispense with the bastardization of the “permissionless innovation” concept (best developed by Adam Thierer) to mean “no contracts required”? I’ve been seeing this more and more, but it’s been around for a while. Some examples from among the innumerable ones out there:

Vint Cerf on net neutrality in 2009:

We believe that the vast numbers of innovative Internet applications over the last decade are a direct consequence of an open and freely accessible Internet. Many now-successful companies have deployed their services on the Internet without the need to negotiate special arrangements with Internet Service Providers, and it’s crucial that future innovators have the same opportunity. We are advocates for “permissionless innovation” that does not impede entrepreneurial enterprise.

Net neutrality is replete with this sort of idea — that any impediment to edge providers (not networks, of course) doing whatever they want to do at a zero price is a threat to innovation.

Chet Kanojia (Aereo CEO) following the Aereo decision:

It is troubling that the Court states in its decision that, ‘to the extent commercial actors or other interested entities may be concerned with the relationship between the development and use of such technologies and the Copyright Act, they are of course free to seek action from Congress.’ (Majority, page 17)That begs the question: Are we moving towards a permission-based system for technology innovation?

At least he puts it in the context of the Court’s suggestion that Congress pass a law, but what he really wants is to not have to ask “permission” of content providers to use their content.

Mike Masnick on copyright in 2010:

But, of course, the problem with all of this is that it goes back to creating permission culture, rather than a culture where people freely create. You won’t be able to use these popular or useful tools to build on the works of others — which, contrary to the claims of today’s copyright defenders, is a key component in almost all creativity you see out there — without first getting permission.

Fair use is, by definition, supposed to be “permissionless.” But the concept is hardly limited to fair use, is used to justify unlimited expansion of fair use, and is extended by advocates to nearly all of copyright (see, e.g., Mike Masnick again), which otherwise requires those pernicious licenses (i.e., permission) from others.

The point is, when we talk about permissionless innovation for Tesla, Uber, Airbnb, commercial drones, online data and the like, we’re talking (or should be) about ex ante government restrictions on these things — the “permission” at issue is permission from the government, it’s the “permission” required to get around regulatory roadblocks imposed via rent-seeking and baseless paternalism. As Gordon Crovitz writes, quoting Thierer:

“The central fault line in technology policy debates today can be thought of as ‘the permission question,'” Mr. Thierer writes. “Must the creators of new technologies seek the blessing of public officials before they develop and deploy their innovations?”

But it isn’t (or shouldn’t be) about private contracts.

Just about all human (commercial) activity requires interaction with others, and that means contracts and licenses. You don’t see anyone complaining about the “permission” required to rent space from a landlord. But that some form of “permission” may be required to use someone else’s creative works or other property (including broadband networks) is no different. And, in fact, it is these sorts of contracts (and, yes, the revenue that may come with them) that facilitates people engaging with other commercial actors to produce things of value in the first place. The same can’t be said of government permission.

Don’t get me wrong – there may be some net welfare-enhancing regulatory limits that might require forms of government permission. But the real concern is the pervasive abuse of these limits, imposed without anything approaching a rigorous welfare determination. There might even be instances where private permission, imposed, say, by a true monopolist, might be problematic.

But this idea that any contractual obligation amounts to a problematic impediment to innovation is absurd, and, in fact, precisely backward. Which is why net neutrality is so misguided. Instead of identifying actual, problematic impediments to innovation, it simply assumes that networks threaten edge innovation, without any corresponding benefit and with such certainty (although no actual evidence) that ex ante common carrier regulations are required.

“Permissionless innovation” is a great phrase and, well developed (as Adam Thierer has done), a useful concept. But its bastardization to justify interference with private contracts is unsupported and pernicious.

In Part One, I addressed the argument by some libertarians that so-called “traditional property rights in land” are based in inductive, ground-up “common law court decisions,” but that intellectual property (IP) rights are top-down, artificial statutory entitlements.  Thus, for instance, libertarian law professor, Tom Bell, has written in the University of Illinois Journal of Law, Technology & Policy: “With regard to our tangible rights to person and property, they’re customary and based in common law. Where do the copyrights and patents come from? From the legislative process.” 2006 Univ.Ill. J. L. Tech. & Pol’y 92, 110 (sorry, no link). 

I like Tom, but, as I detailed in Part One, he’s just wrong in his contrast here between the “customary” “common law” court decisions creating property versus the  “legislative process” creating IP rights. This is myth masquerading as history. As all first-year property students learn each year, the foundation of Anglo-American property law is based in a statute, and many property rights in land were created by statutes enacted by Parliament or early American state legislatures.  In fact, the first statute — the Statute Quai Empotores of 1290 — was enacted by Parliament to overrule feudal “custom” enforced by the “common law” decisions at that time, creating by statutory fiat the basic foundational rule of the Anglo-American property right that property rights are alieanable.

As an aside, Geoff Manne asked an excellent question in the comments to Part One: Who cares? My response is that in part it’s important to call out the use of a descriptive historical claim to bootstrap a normative argument. The question is not who cares, but rather the question is why does Tom, Jerry Brito and other libertarians care so much about creating this historical myth, and repeatedly asserting it in their writings and in their presentations? The reason is because this triggers a normative context for many libertarians steeped in Hayek’s theories about the virtues of disaggregated decision-making given dispersed or localized knowledge, as contrasted with the vices of centralized, top-down planning. Thus, by expressly contrasting as an alleged historical fact that property arises from “customary” “common law” court decisions versus the top-down “legislative processes” creating IP, this provides normative traction against IP rights without having to do the heavy lifting of actually proving this as a normative conclusion. Such is the rhetorical value of historical myths generally — they provide normative framings in the guise of a neutral, objective statement of historical fact — and this is why they are a common feature of policy debates, especially in patent law.

What’s even more interesting is that this is not just a historical myth about the source of property rights in land, which were created by both statutes and court decisions, but it’s also an historical myth about IP rights, which are also created by both statutes and court decisions. The institutional and doctrinal interplay between Parliament’s statutes and the application and extension of these statutes by English courts in creating and enforcing property rights in land was repeated in the creation and extension of the modern Anglo-American IP system.  Who would have thunk?

Although there are lots of historical nuances to the actual legal developments, a blog posting is ideal to point out the general institutional and systemic development that occurred with IP rights. It’s often remarked, for instance, that the birth of Anglo-American patent law is in Parliament’s Statute of Monopolies (1624).  Although it’s true (at least in a generalized sense), the actual development of modern patent law — the legal regime that secures a property right in a novel and useful invention — occurred entirely at the hands of the English common law courts in the eighteenth century, who (re)interpreted this statute and extended it far beyond its original text.  (I have extensively detailed this historical development here.)  Albeit with some differences, a similar institutional pattern occurred with Parliament enacting the first modern copyright statute in 1709, the Statute of Anne, which was then interpreted, applied and extended by the English common law courts.

This institutional and doctrinal pattern repeated in America. From the very first enactment of copyright and patent statutes by the states under the Articles of Confederation, and then by Congress enacting the first federal patent and copyright statutes in 1790, courts then interpreted, applied and extended these statutes in common law fashion.  In fact, it is a cliché in patent law that many patent doctrines today were created, not by Congress, but by two judges — Justice Joseph Story and Judge Learned Hand.  Famous patent law historian, Frank Prager, writes that it is “often said that Story was one of the architects of American patent law.”  There’s an entire book published of Judge Learned Hand’s decisions in patent law. That’s how important these two judges have been in creating patent law doctrines.

So, the pattern has been that Congress passes broadly framed statutes, and the federal courts then create doctrines within these statutory frameworks.  In patent law, for instance, courts created the exhaustion doctrine, secondary liability, the experimental use defense, the infringement doctrine of equivalents, and many others.  Beyond this “common law” creation of patent doctrines, courts have further created and defined the actual requirements set forth in the patent statutes for utility, written description, enablement, etc., creating legal phrases and tests that one would search in vain for in the text of the actual patent statutes. Interestingly, Congress sometimes has subsequently codified these judicially created doctrines and sometimes it has left them alone.  Sometimes, Congress even repeals the judicially created tests, as it did in expressly abrogating the judicially created “flash of genius” test in § 103 of the 1952 Patent Act.  All of this goes to show that, just as it’s wrong to say that property rights in land are based solely in custom and common law court decision, it’s equally wrong to say that IP rights are based solely in legislation.

Admittedly, the modern copyright statutes are far more specific and complex than the patent statutes, at least before Congress passed the American Invents Act of 2011 (AIA).  In comparison to the pre-AIA patent statutes, the copyright statutes appear to be excessively complicated with industry and work-specific regimes, such as licensing for cable (§ 111), licensing for satellite transmissions (§ 119), exemptions from liability for libraries (§ 108), and licensing of “phonorecords” (§ 109), among others.  These and other provisions have been cobbled together by repeated amendments and other statutory enactments over the past century or so.  This stands in stark contrast to the invention- and industry-neutral provisions that comprised much of the pre-AIA patent statutes.

So, this is a valid point of differentiation between patents and copyrights, at least as these respective IP rights have developed in the twentieth century.  And there’s certainly a valid argument that complexity in the copyright statutes arising from such attempts to legislate for very specific works and industries increases uncertainties, which in turn unnecessarily increases administration and other transaction costs in the operation of the legal system.

Yet, it bears emphasizing again that, before there arose heavy emphasis on legislation in copyright law, many primary copyright doctrines were in fact first created by courts.  This includes, for instance, fair use and exhaustion doctrines, which were later codified by Congress. Moreover, some very important copyright doctrines remain entirely in the domain of the courts, such as secondary liability. 

The judicially created doctrine of secondary liability in copyright is perhaps the most ironic, if only because it is the use of this doctrine on the Internet against P2P services, like Napster, Aimster, Grokster, and BitTorrent operators, that sends many libertarian IP skeptics and copyleft advocates into paroxysms of outrage about how rent-seeking owners of statutory entitlements are “forcing” companies out of business, shutting down technology and violating the right to liberty on the Internet. But secondary liability is a “customary” “common law” doctrine that developed out of similarly traditional “customary” doctrines in tort law, as further extended by courts to patent and copyright!

As with the historical myth about the origins of property rights in land, the actual facts about the source and nature of IP rights belies the claims by some libertarians that IP rights are congressional “welfare grants” or congressional subsidies for crony corporations. IP rights have developed in the same way as property rights in land with both legislatures and courts creating, repealing, and extending doctrines in an important institutional and doctrinal evolution of these property rights securing technological innovation and creative works.

As I said in Part One, I enjoy a good policy argument about the value of securing property rights in patented innovation or copyrighted works.  I often discuss on panels and in debates how IP rights make possible the private-ordering mechanisms necessary to convert inventions and creative works into real-world innovation and creative products sold to consumers in the marketplace. Economically speaking, as Henry Manne pointed out in a comment to Part One, defining a property right in an asset is what makes possible value-maximizing transactions, and, I would add, morally speaking, it is what secures to the creator of that asset the right to the fruits of his or her productive labors. Thus, I would be happy to debate Tom Bell, Jerry Brito or any other similarly-minded libertarian on these issues in innovation policy, but before we can do so, we must first agree to abandon historical myths and base our normative arguments on actual facts.

New York Times columnist Gretchen Morgenson is arguing for a “pre-clearance”  approach to regulating new financial products:

The Food and Drug Administration vets new drugs before they reach the market. But imagine if there were a Wall Street version of the F.D.A. — an agency that examined new financial instruments and ensured that they were safe and benefited society, not just bankers.  How different our economy might look today, given the damage done by complex instruments during the financial crisis.

The idea Morgenson is advocating was set forth by law professor Eric Posner (one of my former profs) and economist E. Glen Weyl in this paper.  According to Morgenson,

[Posner and Weyl] contend that new instruments should be approved by a “financial products agency” that would test them for social utility. Ideally, products deemed too costly to society over all — those that serve only to increase speculation, for example — would be rejected, the two professors say.

While I have not yet read the paper, I have some concerns about the proposal, at least as described by Morgenson.

First, there’s the knowledge problem.  Even if we assume that agents of a new “Financial Products Administration” (FPA) would be completely “other-regarding” (altruistic) in performing their duties, how are they to know whether a proposed financial instrument is, on balance, beneficial or detrimental to society?  Morgenson suggests that “financial instruments could be judged by whether they help people hedge risks — which is generally beneficial — or whether they simply allow gambling, which can be costly.”  But it’s certainly not the case that speculative (“gambling”) investments produce no social value.  They generate a tremendous amount of information because they reflect the expectations of hundreds, thousands, or millions of investors who are placing bets with their own money.  Even the much-maligned credit default swaps, instruments Morgenson and the paper authors suggest “have added little to society,” provide a great deal of information about the creditworthiness of insureds.  How is a regulator in the FPA to know whether the benefits a particular financial instrument creates justify its risks? 

When regulators have engaged in merits review of investment instruments — something the federal securities laws generally eschew — they’ve often screwed up.  State securities regulators in Massachusetts, for example, once banned sales of Apple’s IPO shares, claiming that the stock was priced too high.  Oops.

In addition to the knowledge problem, the proposed FPA would be subject to the same institutional maladies as its model, the FDA.  The fact is, individuals do not cease to be rational, self-interest maximizers when they step into the public arena.  Like their counterparts in the FDA, FPA officials will take into account the personal consequences of their decisions to grant or withhold approvals of new products.  They will know that if they approve a financial product that injures some investors, they’ll likely be blamed in the press, hauled before Congress, etc.  By contrast, if they withhold approval of a financial product that would be, on balance, socially beneficial, their improvident decision will attract little attention.  In short, they will share with their counterparts in the FDA a bias toward disapproval of novel products.

In highlighting these two concerns, I’m emphasizing a point I’ve made repeatedly on TOTM:  A defect in private ordering is not a sufficient condition for a regulatory fix.  One must always ask whether the proposed regulatory regime will actually leave the world a better place.  As the Austrians taught us, we can’t assume the regulators will have the information (and information-processing abilities) required to improve upon private ordering.  As Public Choice theorists taught us, we can’t assume that even perfectly informed (but still self-interested) regulators will make socially optimal decisions.  In light of Austrian and Public Choice insights, the Posner & Weyl proposal — at least as described by Morgenson — strikes me as problematic.  [An additional concern is that the proposed pre-clearance regime might just send financial activity offshore.  To their credit, the authors acknowledge and address that concern.]

Obama’s Fatal Conceit

Thom Lambert —  21 September 2011

From the beginning of his presidency, I’ve wanted President Obama to succeed.  He was my professor in law school, and while I frequently disagreed with his take on things, I liked him very much. 

On the eve of his inauguration, I wrote on TOTM that I hoped he would spend some time meditating on Hayek’s The Use of Knowledge in Society.  That article explains that the information required to allocate resources to their highest and best ends, and thereby maximize social welfare, is never given to any one mind but is instead dispersed widely to a great many “men on the spot.”  I worried that combining Mr. Obama’s native intelligence with the celebrity status he attained during the presidential campaign would create the sort of “unwise” leader described in Plato’s Apology:

I thought that he appeared wise to many people and especially to himself, but he was not. I then tried to show him that he thought himself wise, but that he was not. As a result, he came to dislike me, and so did many of the bystanders. So I withdrew and thought to myself: “I am wiser than this man; it is likely that neither of us knows anything worthwhile, but he thinks he knows something when he does not, whereas when I do not know, neither do I think I know; so I am likely to be wiser than he to this small extent, that I do not think I know what I do not know.”

I have now become convinced that President Obama’s biggest problem is that he believes — wrongly — that he (or his people) know better how to allocate resources than do the many millions of “men and women on the spot.”  This is the thing that keeps our very smart President from being a wise President.  It is killing economic expansion in this country, and it may well render him a one-term President.  It is, quite literally, a fatal conceit.

Put aside for a minute the first stimulus, the central planning in the health care legislation and Dodd-Frank, and the many recent instances of industrial policy (e.g., Solyndra).  Focus instead on just the latest proposal from our President.  He is insisting that Congress pass legislation (“Pass this bill!”) that directs a half-trillion dollars to ends he deems most valuable (e.g., employment of public school teachers and first responders, municipal infrastructure projects).  And he proposes to take those dollars from wealthier Americans by, among other things, limiting deductions for charitable giving, taxing interest on municipal bonds, and raising tax rates on investment income (via the “Buffet rule”).

Do you see what’s happening here?  The President is proposing to penalize private investment (where the investors themselves decide which projects deserve their money) in order to fund government investment.  He proposes to penalize charitable giving (where the givers themselves get to choose their beneficiaries) in order to fund government outlays to the needy.  He calls for impairing municipalities’ funding advantage (which permits them to raise money cheaply to fund the projects they deem most worthy) in order to fund municipal projects that the federal government deems worthy of funding.  (More on that here — and note that I agree with Golub that we should ditch the deduction for muni bond interest as part of a broader tax reform.)

In short, the President has wholly disregarded Hayek’s central point:  He believes that he and his people know better than the men and women on the spot how to allocate productive resources.  That conceit renders a very smart man very unwise.  Solyndra, I fear, is just the beginning.