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The Opportunity Costs of “Free”

P.J. O’Rourke once quipped, “If you think health care is expensive now, wait until you see what it costs when it’s free.” The truth behind O’Rourke’s humor is the opportunity cost of “political free.”

Even relatively bright people who have never studied economics realize that behind the government’s redistribution of wealth are huge opportunity costs both for citizens who actually pay for the government’s giveaways and for the people who receive them.

Resources are scarce and something can only be free if there is no opportunity to have or do anything else (Lee, 1999). When a poor person decides to have children and take welfare, this person narrows or even eliminates his/her opportunity to do something more productive like working, improving him/herself, getting away from the despair and dependence that comes with the government running his/her life.

One of this article’s authors had the opportunity to sit in a local Social Security office to correct a wrong birth date in the Social Security records. This necessitated waiting in a room full of entitlement recipients who were there for their monthly government check. It was fascinating and sad to see how miserable these people were as they waited to get a check for living expenses from the government. They resented being there, having to wait for and deal with the indifference of Social Security employees. Once the check was cashed, the relief and joy would last only until the money was gone. We doubt the government, and certainly not the welfare recipients, factored this wasted time and personal humiliation as the opportunity costs of being financially rescued by the federal government.

Government riding to the rescue of people unable/unwilling to take care of themselves is fraught with paradox. The term “rescuing” comes from the therapeutic literature where a therapist rescues a patient who is in trouble (see Watzlawick, Weakland & Fisch, 1975). A new problem often arises because the person being rescued resents the fact that the rescuer has it together enough to be able to help them and the rescuer resents the fact that the person(s) he has rescued doesn’t appreciate his/her help.

An Economic View of Political Free

Like lemmings to the sea, the Western world has responded to political promises of free things, both from their governments and from business in unprecedented ways. We spent several months traveling around Europe during the past two summers and when we quizzed people about how they liked their health care system the vast majority replied: “Well … it’s free!” But is it really? Most Europeans work until at least July for their governments and in Scandinavia personal income tax, payroll, and VAT taxes hover in the 80 percent range. Europeans also freely admitted that the wealthy in their countries who have cancer or heart illness frequently travel to the U.S. to pay for and receive lifesaving treatment.

Mises (1990, p. 51) warned us about the “ineradicable scarcity of time as well as resources” and cautions us to act wisely in the choices we make. The use of “free” is fundamentally a rhetorical trick that has been used by dictators, despots, and unscrupulous marketers for many, many centuries. In Predictably Irrational, Dan Ariely (2008, p. 55) warns us about the high price of zero cost, pointing out that free is an emotional hot button—a source of irrational excitement, but seldom free. In a September 24, 2012 front page Wall Street Journal story by Robin Sidel titled “‘Free’ Checking Costs More” the author reports that banking customers flock to banks to get their “free” checking account, then are shocked to learn that their free account requires hundreds of dollars to be deposited and remain in the bank in a non-interest-earning account.

Free is also a key component of the populist rhetorical arsenal and not just from the Hugo Chavez’s of the world. Political progressives on both sides of the aisle in American politics continue to use “free” to gain advantage with voters. Interestingly, the Federal Trade Commission publishes a guide §251.1 warning consumers of the use of the word “free” in selling things (http://ftc.gov/bcp/guides/free.htm).

“(2) Because the purchasing public continually searches for the best buy, and regards the offer of ‘Free’ merchandise or service to be a special bargain, all such offers must be made with extreme care so as to avoid any possibility that consumers will be misled or deceived.”

We assume this regulation would put former Speaker of the House, Nancy Pelosi, at odds with the FTC when, after the Supreme Court upheld the individual mandate part of the Universal Health Care Bill, she urged young people, particularly the artistic types, to quit their jobs and pursue their passions because their health care would be free from now on. Governments around the world have offered free benefits to its citizens for centuries, something that Greece has honed to a new social science.

The Origins of Free

Aristotle in his Politics believed that human existence is inherently political and set forth the idea that books should be free. But since all resources are scarce, the offer of free goods or services, especially from the government, should sound an alarm. Mises (1944, p. 84) warned us that governments pretend to have mystical powers “to accord favors out of an inexhaustible horn of plenty. It is both omniscient and omnipotent. It can be a magic wand creating happiness and abundance. The truth is that the government cannot give if the government does not take from somebody. A subsidy [benefit] is never paid by the government out of its own funds; it is at the expense of the taxpayer …”

We must understand that the allure of “free” to both rule makers and those to whom it chooses to give benefits, takes away the good sense of both sets of people. When states or nations transfer benefits to their citizens for free as the Soviet Union did until several decades ago and both Greece and the United States are doing now (Eberstadt, 2013, p. A13), they eventually collapse under the weight of their own debt.

Sowell (2009) warns us that all government benefits have real costs, and the only question is to whom? He ties the recent housing boom and bust directly to Congress’s desire to guarantee mortgages to people who wanted to own a home, but who couldn’t qualify or pay for home mortgages they could afford. These so-called beneficiaries of government wisdom and largess lost everything when the market turned sour as did many lenders.

The financial devastation in this country has been greater than anything since the Great Depression. The Wall Street Journal (July 13, 2012, p. A10) opined that with the crushing effects of the real estate bust still being felt across the U.S., the federal government is now pressuring banks like Wells Fargo to ensure there are no disparate lending outcomes for Blacks or Hispanics, when compared to a statistical model of what the government estimates should have occurred with minority borrowers. Smaller banks that aren’t too big to fail are responding by stopping their mortgage lending to almost everyone.

Lest we be accused of placing the sole responsibility for giving economic benefits to special interests at the feet of Democrats, Sowell (2006, p. 106) also points to the fact that President George W. Bush placed tariffs on foreign steel in 2002 (to gain support from voters in Pennsylvania and West Virginia) and this had a direct dislocation for thousands of small and medium-sized businesses who use steel and had to pay for the rise in prices caused by the tariff. Many said it was the equivalent of fuel hikes for the airlines.

The $64,000, if not the $4 trillion question is why seemingly intelligent people buy political promises of free stuff at face value from both sides of the political system in America? The cynical answer is that 90 percent of American’s must be ignorant. A more informed explanation lies deeper. To answer this question we delve briefly into two branches of science: Neurophysiology and Behavioral Economics. These disciplines show us how the human brain is wired and how the economic pricing slight-of-hand can turn even very smart people into the great economic unwashed.

Neuroscience

Homo sapiens have a bi-lateralized brain that gives us the ability to engage in some pretty outrageous mental gymnastics. For most people, the left side of the brain tends to be the analytic processing center, and controls the functions of logic, language (grammar, vocabulary, and literal meanings), science, and math (Dehaene, Spelke, Pinel, Stanescu & Tsivkin, 1999). The right side of the brain is the creative processing center for most people that controls passion, metaphorical language, artistic and musical abilities, intuition and gestalt (Hines, 1987).

The populist politician is able, through language and sophistry, to appeal to both sides of the brain in such a way where many people feel no disconnect between free and health care, housing, school lunches, education, or cell phones. This happens in much the same way that skillful marketers convince intelligent people to believe that a product is free or can be returned at no cost. At times both politics and marketing are indistinguishable in creating and fulfilling human need.

Through the use of cleverly constructed appeals (attributed to sophists by the ancient Greeks), man’s left-brained skeptical nature (that nothing is really free) can be short-circuited. He is left believing that because it is so necessary/humane/ just/moral (pick one or more), things must really be free. This rhetorical slight-of-hand was first introduced by Aristotle and is called identification. It plays to our right brain and lowers the processing of our left brain. It is also the foundation of Neurolinguistic Programming that uses people’s language and behavior to put them in a low-level hypnotic state, overcoming their resistance to the other person (Rossi, Erickson-Klein & Rossi, 2008).

This is precisely how so many people respond to television and Internet ad promises like “Our free offer is available to everyone and will make you stronger, healthier, happier, thinner, more comfortable, more curvaceous, etc.” To lower the left brain’s resistance to the message’s impossibility, the marketer/politician invokes opposition, the suggestion that “our competitors, or the other party, don’t want you to have strength, health, happiness, svelteness, sexiness, comfort, etc., because they don’t care about you like we do, or they are simply deceiving you.”

Behavioral Economics and other Research

There has been more than a decade of research on “free” things in the behavioral economics literature led by Dan Ariely and his colleagues. (Editor’s Note: “Behavioral economics” is misnamed, as it is actually a branch of psychology, and not true economics, as defined by Mises; but its findings are interesting nonetheless.) Experiments were conducted on smart people (students from MIT, UC Berkeley, and Duke) testing the unique power of “free stuff.” The study that makes our point most succinctly involves a test on students at a MIT cafeteria who were buying food. The first test was an offer at the cash register to buy a Hershey’s Kiss for 1¢, a Lindt truffle for 14¢, or neither. This first trial saw 30 percent of the students buy the Lindt truffle at 14¢, 8 percent bought the Hershey’s kiss for 1¢, and 62 percent bought nothing. After a 30-minute break and presumably a new crowd of students, the researchers then dropped the price of each candy by 1¢, a monotonic transformation of the prices. The Hershey’s Kiss was now 0¢ and the Lindt truffle was 13¢. This time 31 percent of the students took the Hershey’s kiss at 0¢, only 13 percent bought the Lindt truffle at 13¢, and 56 percent bought nothing. The allure of a “free” Hershey’s Kiss made bright students buy significantly fewer Lindt truffles and chose significantly more Kisses.

The authors conclude: “… zero price has a special role in consumers’ cost-benefit analysis. ... Not surprisingly, when the cost is zero, many more students take candy than when the price is positive” (Shampanier, et. al, 2007, pp. 749-750).

There appears to be cognitive magic in things that are offered for “free.” As Mises and the concept of opportunity cost reminds us, free is not really free and costs are often spread to others who may not even be interested in the free offer. Kinsella (2005) discusses how the idea of “free” in patent law can alter the elements in the transaction, making patent benefits actually become costs. While registering a patent is a relatively de-minimus legal cost, defending the exclusive patent rights may be cost prohibitive for any but the largest corporations. Salerno (2012) reminds us that in the early 70s there was a group of new age libertarians who believed that the “Information Age” presaged a world without scarcity. Like patents, Salerno argues there are also no free information clouds; it takes huge physical space, energy, and expertise to run the World Wide Web, YouTube, Dropbox and all of the information platforms people take for granted.

We can see from this why political populists make such a lasting impression. Going back to Ariely (2008) points to the fact that by our very nature, mankind is wired to compare. Certainly free health care sounds like a much more attractive deal than finding a job and purchasing medical insurance, particularly when you don’t have to pay any taxes. Welfare and disability compare favorably to working a full-time job, or even looking seriously for one.

Ariely (2008, pp. 4-19) discusses the sleight-of-hand trick of using a “decoy” to make your alternative appear relatively superior. An example of this trick has been used by Democrats (though Republicans are just as good at it) in the response they have given to Paul Ryan’s desire to reform Social Security and Medicare. The former head of the Government Accountability Office, David Walker, a Democrat, has been giving presentations to Americans since 2007. He says, and he should know, that both Social Security and Medicare/Medicaid are broke and the Federal Reserve simply prints more money to prop them up. Despite this and a 20/20 news segment on Walker, Democrats are screaming that Paul Ryan wants to take away Social Security and Medicare by reforming it. Given that alternative, who among the tens of millions of Americans on or about to be on Social Security wouldn’t think the status quo, no matter what David Walker says, is a superior alternative?

Conclusion

The bottom line in America is that if you want people to adopt your political ideas and vote for you, give them free stuff. This wasn’t lost on Venezuelan dictator Hugo Chavez recently when he won a relatively close reelection after giving away free housing and appliances (Luhnow & De Cordoba, 2012). Politicians of both persuasions use free benefits to build their constituencies and then extend the free benefits to an even wider group. As long as those benefits are for the seemingly disadvantaged or needy, the press will give the programs great coverage and the political promoters become public heroes instead of the public pariahs Mises argues they really are.

There is no doubt that we are weaning the American people off ambition, hard work, and entrepreneurship, while creating an entitlement mindset among an increasing number of our citizens. We do it under the allure of free things and the blanket of social justice which the White House now refers to as “sustainability”—a telling title intentionally creating an even wider identification with the welfare state and lifestyle, while taking us light years away from free markets and free people..

[For more from Pettegrew and Vance on this topic, see "The High Cost of "Free".]