0:33 Intro. [Recording date: February 11, 2014.] Russ: Our topic for today is a philosophical one--it's classical liberalism. I'm in favor of limited government; I want to know what I should call myself. Sometimes I call myself a classical liberal. It is my preferred title, but it confuses people. Sometimes I call myself a libertarian--sometimes a 'small-l libertarian' to distinguish myself from the Libertarian Party. Sometimes I call myself a free market capitalist or a Smithian or a Hayekian economist. And people call me a right-winger or conservative. I don't think I'm either of those things. I want to hear what you are, Richard, and why; and I'm going to see where I fit in and what I agree and disagree with. Guest: Well, first of all there is really a terminological gulf, and this is what I think is the fundamental ambiguity. There are many issues in which there are subsets--that classical liberals and the hard-line libertarians are in agreement. And therefore the differences between them simply disappear when you start to take on many progressive policies. The grounds on they may be opposed will differ from group to group, but the fact of the opposition is going to be very strong. So, for example, there is neither the classical liberal nor the libertarian believes that the government ought to support or prop up [?] any monopoly institutions where it is possible to have a competitive industry. And so, at that particular point, both are in favor of a smaller government. The classical liberal says: Monopoly has changed output for the worse so therefore when the government spends money to create a worse situation, it's a clear no-starter. The libertarian says: The government is using force to interfere with advantageous relationships; we don't care about the consequences; don't give me all this fancy economics stuff; we're just against it. So, one of them tends to be more consequentialist--that's the classical liberal--the other tends to be more deontological--that turns out to be the hard-line libertarian. Russ: You meant the classical liberal. Guest: Yeah. The term libertarian covers both of these things when you are dealing with these external debates. But when you start to get a little bit more philosophical, trying to figure out how small the small government ought to be, how the government ought to be put together, the difference between the deontological approach to the hard-line libertarian, and, it turns out, the relatively consequentialist approach of the classical liberal lead to some serious differences over a wide range of issues. I'll just mention--for example, the hard-line libertarian says: You guys want to get together to restrict output? It turns out that that's a contract like any other contract. You enforce contracts, you enforce that contract. The common law took the position these contracts are contracts in restraint of trade, and its preferred [?] was not to enforce those contracts, even though it did not impose criminal sanctions on the parties who entered into it. The modern antitrust guy says: You know what? We have the Sherman Act, and we are going to punish this civilly and criminally, because we think these cartels can endure longer that might otherwise be the case, even if the agreements turn out to be unenforceable in terms of the legal system. So what happens is, you have three kinds of approaches there. The libertarian, who just doesn't think of this as a problem and whose basic attitude is: we've got free entry, that will take care of itself. And the classical liberal says: I really like unenforceability because it will tend to increase the decay. And then some of the hard-line modern economists come along and say: The Sherman Act is a pretty good thing on this stuff. To which some classical liberals like myself will say: You really have to worry about the probable enforcement with the antitrust laws; increase in the size of government. Are you really sure you need this thing, and if so, are you going to do it correctly? And I think the answer is, if you get the right people running the system of the antitrust law, it's fine; if you get the wrong people running the system of the antitrust law, it's horrible. And then there is a very difficult political judgment as to whether you think good guys or bad guys are going to be running the system. So the [?] it seemed with the people like Bob Bork, is they really did focus this field on the cartel-like activities of various [?] departments, which reduced the error rate. The danger, of course, is that you will get some other administration that will believe that predation is the dominant offense, so when people start getting better products at lower prices, this now becomes ruinous competition, and then you are right back into the Progressive mode because the ruinous competition theme is one that is very dominant in their work. So there are profound differences in methodology. There are profound differences with respect to the actual consequences of the difference between these two systems.

5:29 Russ: So, let's stick with competition as an example; and I want to turn eventually to intellectual property, where it also of course raises its head. In the case of competition and this question of enforcing cartels, you made the point that it depends on whether you think the good guys or the bad guys, whether good people or bad people are going to run the apparatus. Don't we want a system that doesn't require good people? Isn't that the essence of what we want to worry about ex ante? Guest: That's exactly the right attitude to have, because if you remember the situation, it's the famous line of Madison that says: Enlightened statesmen may not always be at the helm. So what you try to do is put government in a place where it can go through choppy seas with essentially inferior leadership. That is absolutely the first-best solution if you can get it. But unfortunately, one of the difficulties of the libertarian position that I think classical liberalism was sensitive to is that you are going to have to put people in the flesh there, and you are going to get yourself a random draw. And that if in fact you consistently get people at the bottom, no set of rules are going to be able to save you from the depredations that they will impose. So what you need to do is to understand that you need sound institutions that hopefully will put forward strong people into various kinds of public offices. Which means you have to create a whole culture of achievement which allow these people to flourish. You can survive the occasional bad guy, but you can't survive lots of bad people in these offices. One of the things that I try to emphasize all the time is that the reason we have such intense battles over ideas is that we understand that there are many people who are moved by ideas and will try to implement them in a decidedly non-public-choice way, if in fact they are put into positions of power. But the basic point [?] is still true; one of the reasons we want a Constitution which is both classical liberal with enumerated powers, with separation of powers in the government, with federalism and all the rest of that stuff, is, if you are going to have procedural safeguards of the kind you are talking about, they are going to work better if there are fewer unappropriated rents sloshing out there for political activists to get. So what happens is the classical liberal Constitution that I talk about in my book has at least a two-part strategy. And one of them is what you try to do is to shrink the things that are up for grabs in the public space. And then secondly what you try to do is to get a robust set of government institutions so that you can slow down the process of lawmaking, using as your sort of global background presumption that a statute shall be pursued bad unless shown to be a good. Which means that you want to slow things up by having veto gates[?] rather than rushing it through under a parliamentary [?] Russ: Well, I like that, and we'll come back to it, but I want to stick for a minute with the public choice issue that you raised. When we talk about the wrong people or the right people being in charge of a regulatory system, there are two kinds of good and bad. There is incompetence versus skill. Then there is corrupt versus honest. Guest: There's a third one. Which is the right vision versus the wrong vision. Russ: Okay, yeah, cool. Guiding principles, how they are implemented, whether they are implemented at all, might be one way to think about it. Here's the issue I have. You raised the, I think, the provocative idea, which, as somebody who deals in ideas I find very appealing--the idea that ideas are important because we can have people stand for something. We can have people put forward, not just be a technocrat, but actually be somebody that has a vision that we could decide to embrace through it, an election or through some other mechanism. The problem I have is I can't think of any empirical examples of somebody in a position of power where their principles cause them to do something that are politically unattractive. I'm sure there are some. Maybe you can think of them. I'm going to give you a couple of examples and then maybe you can tell me why those examples are not representative. So, my favorite example, I've mentioned before on this program, is Alan Greenspan. Alan Greenspan was a man of ideas. He was an acolyte of Ayn Rand; he clearly believed and I think still believes that he is a free market classical liberal. When he was put in charge of one of the most powerful parts of the U.S. government, which is the Federal Reserve--he was put in charge and since he was Chair, he didn't have absolute authority; he had some constraints on him. But when he had significant power in that office, he was not a particularly free market guy. He used the price of credit and the quantity of money to move things around to benefit, I think, the investor class. Worse than that, he supported the bailout of banks in 1995--just one example; I'm sure there are others. When Mexico was going bankrupt, it's creditors, many of them were American banks, and he said we have to support Mexico and guarantee their debt because it's a horrible thing to do that but it's the best of a bad lot. But of course what he was doing there was serving, I believe, his political interests, which were the New York banks--American banks, especially those near the Federal Reserve. So I don't see him, despite his incredible investment in ideas--that didn't constrain him at all. Similarly, Ben Bernanke--I think people would have been shocked, if in advance of Ben Bernanke's appointment to the Fed, if you'd asked him: if there is a really bad recession, do you think you'll increase the Fed's balance sheet by trillions of dollars, implement quantitative easing, support the guarantee of creditors to the banks that had made bad loans so that they'd get 100 cents back on the dollar? 'Oh, no, come on. Bernanke would never do that.' But he did. So, where is the hope for this utopian ideal that you put forward. Guest: Well, let me put it this way: I don't think it's utopian. But I think it's extremely difficult to implement. And if the reason I wrote the book on the Classical Liberal Constitution is I believe all the ideas that I stand for have been slipping into the background and in [?] a muscular progressivity. Now the real asymmetry here is that you face political heat if you are a small government type and somebody demands that you do something to aid them. But if you are a progressive who believes that you ought to aid people anyhow, it's much easier for you to align your ideals with the [?] political necessities. So, take somebody who is really consistent with these views and have a legislative program of this sort--go back to Woodrow Wilson. You know, this guy wrote books on Congressional governance and so forth; he was very much a fan of a unitary system; he believed in the expertise of administrative agencies. Essentially was pro-labor, anti-business. And he gets into this, and all of a sudden you start to see the Federal Trade Commission; you start to see the Clayton Act, which has an exemption from the [?] for the labor unions and the agricultural cartels, and then has an expansion of the potential liability with respect to companies merging that might not have been caught by the Sherman Act. So I mean, you can see people like that. On the other side, remember the early Reagan--I think it's fair to say that he came in with a fairly coherent ideology. I think he stuck it through to the beginning and did fairly well. Another one of my favorite presidents was widely reviled and completely misunderstood, is you start with Warren Harding, and he had to face one of these recessions in 1921 when he came into office. He did exactly the opposite of what Bernanke did--he kept the money supply relatively tight; the interest rates fairly high [?]; it turned out you bled out all of the difficulties associated with the system and the recovery began in 1922, 1923. He's remember for Albert Fall and the Teapot Dome Scandal. He's not remembered for having Andrew Mellon as the Secretary of Treasury and Charles Evans Hughes as the Secretary of State. And even his rather dubious Attorney General, which is Harry Daugherty, learned from the Wilson mistakes and pardoned Eugene V. Debs, who had been convicted under Wilson, who was a xenophobe when it came to all these national security kinds of issues. So, I mean, I do think you can find it. In my view you'll tend to find them largely, not exclusively, in the Republican Party, because I think they are more committed to small government. Russ: They more committed to talking about it. Guest: Well, no, no. I think these guys were committed to doing it. I mean, look, they are all facing adverse forces. And, people ask me what do I think the great achievement of Reagan was: I think in the first two years, he faced down the FAA (Federal Aviation Administration) strike and all the rest of it. But essentially his really fairly strong convictions after his political damage made that he changed the second derivative--so he increased the size of government at a slower rate. I think Bill Clinton to the extent that he supported free trade did so against the opposition of his party and was clearly right in so doing. I think he was wrong with respect to taxes, and so forth. But generally speaking if you ask me to rate his government, [?], I think he was actually better on many of these issues than others. In fact, to give you my hope for a decent America, strangely enough it relies largely on centrist Democrats, of whom there are very few today, combining with sort of moderate Republicans. And what they are supposed to do is support a market economy and try to keep the welfare state under control. And that means free states, free trade, relatively flat taxes. You don't want to have too many positive rights being created out of this system, and you want to deregulate labor markets. And then you have some kind of a transfer program on top of it. And mind you, this is not very stable. The only stable solution is one that you can't get to, which essentially has strong pro-market capitalism and the only public expenses are designed to improve infrastructure and maintain other standard kinds of public goods. I'm in favor of that in principle. I don't believe it's ever going to be obtained. So my question is how to make incremental improvements in the current system. Or more often, to fight bad ideas in the opposite direction. Minimum wage is a danger; living wage, which is 50% higher, is even more dangerous bill. You read something like a NY Times editorial on this, they say, well, in real terms the minimum wage compared to what it was in 1938 should be $18, so why are you guys complaining? My view is they made a mistake with the Fair Labor Standards Act back in 1938 when they put this in there, and I just don't want to compound the error when we are going forward today. So, unfortunately, Russ, given the current political configuration, most of my sort of practical levers are essentially designed to stop the expansion of government. There are very few levers I see now where it's going to be possible to reduce the size and scope of government, by which I mean something as simple as flattening the tax or removing or expanding the exemptions under the estate tax.

16:27 Russ: I'll give a cheerful perspective--kind of, sort of--and then I want to get back to some basics. But I do want to mention that demographics may be destiny. And if we are, I think, somewhat gridlocked in responding to the demographic change, which appears to be the case, it's going to be very difficult to roll back any of the health care for the elderly or Social Security for the elderly. That money will eat up a very large portion of government spending, leaving very little left for other types of mischief. And if you ask me--I'm not crazy about the health care part, as a soon-to-be 65-year old; God willing in 6 years I'll hit 65--but transfers between working people and old people are going to be limited by the political process. I think the political process will limit those. But they'll be out there. I agree with you; I don't think we can get rid of Social Security. But it's not the worst thing the government does. Health care I think is a little more destructive. I think that's a little more unhealthy--literally. But the worst--a lot of things the government does now, it won't be able to afford. And it will be interesting to see how the political process--I hope we both live long enough to see how the political process deals with that. Guest: Well, we're seeing it now. Look at Detroit. You are seeing the case of a city that has great expectations going into bankruptcy. And you know, it's a combination of ruinous policies, large public sector, endless transfer payments, job programs, and so forth, with the highly successful UAW (United Auto Workers) essentially driving down the number of jobs in Detroit and throughout Michigan to a fraction of what they were. People said we've saved General Motors. We have not saved it for the 85 or 90% of the workers who actually lost their jobs, in terms of total payrolls, 1979 when the favorable settlement was reached. Now, I think some of that reduction would have taken place in any event, so I don't want to attribute it all to unionization. But there is certainly the case that a firm which essentially has to pay all-in $75 an hour for a worker as opposed to one that has to pay, all-in, $45 an hour, is losing a lot of costs that they can't make up with efficiencies in other areas. So I think we've already seen that. If you look at the pension crisis in California, both at the state level and also the city level, God knows how many billions of dollars, probably $100 billion or more, are wrapped up in unfunded liabilities. And yet you see fierce resistance by unions and to some extent by the state officials against trying to trim this kind of operation. And what you've already seen is the consequences of it: most of these governments have had to cut back their police forces, their welfare services, their park departments--all kinds of standard activities--in order to make sure that the absolute priority given to these kind of pension obligations under the current laws as they see it are in fact going to be enforced. This is not coming in the future. It's coming. Yes, when you speak to younger people, as I do--I have three children--I mean, the tax burden doesn't escape them. They realize that the liabilities they have today are real, fixed, and finite, but large; and the benefits tomorrow are speculative and uncertain and may never materialize. Russ: That kind of sums it up. Guest: They don't see this as a bargain for them. They see this as an exaction. Look, I mean, I still have a standing government to the commission of Social Security--and health--I'm almost 71. And I say, I will give you all the money you've managed to take from me, and I will give you all the future benefits that you've promised to me, if you'll just leave me alone on Social Security and Medicare. I still might guard myself as actually better off because one of the things that's so crazy about this, particularly if you earn a decent income, as I'm fortunately able to do in this crazy environment, is that if you start to work past 70 years of age, getting Medicare on one hand, and you are paying much more in on the Medicare tax on the other hand, so what happens is you are a net transfer-or rather than a net transferee. I'd rather be a net transferor than a net transferee, but I'd rather be rid of the whole thing. But they don't let you out of it. In fact, I was involved in a lawsuit once where we tried to argue correctly--I have no doubt--that you ¬could opt out of Medicare Part A for hospitalization without having to repay all your Social Security benefits and abandon all other future Social Security benefits. But the government issued a rule saying only a cranky libertarian would believe in that kind of position. And they forced the tie-in. So what they are doing is they are basically saying if people want to get out of this system and sacrifice their benefits, they just don't want to be in the Medicare system, they can't do it. Unless they want to pay what turns out to be on average a quarter of a million dollars for the privilege of opting out of Medicare. Russ: I just want to say, I'm very pleased that EconTalk doesn't increase your tax burden in any way. Guest: Well, I'm not so pleased about that. But you know what--let me phrase it this way. I'm an academic. One of the things you learn to do as an academic is to do a lot of public speaking for free. It is in fact part of my job, as far as I see it. So I'm more than happy to do it. I mean, there are people who actually pay to get you to come and give lectures. But you asked me to pick up the telephone; you didn't ask me to go out to Topeka. Russ: That's right. And I prompt you for conversation. Which doesn't--you don't need much prompting, I have to say.

22:11 Russ: Let's get back to some of the basic philosophical issues, political economy issues. You've written that the key challenge facing any system of government and any philosophy of government is creating social order. What do you mean by that, and why does the classical liberal and hard-line libertarian vision struggle with that issue? Guest: Well, first of all, social order it seems to me requires two things, one of which the classical liberal and the hardcore libertarian are in line with. Which is that you have to have a mutual renunciation of the use of force as a tool in ordinary social arrangement. And everybody understands if you could get this by voluntary agreement, generally speaking your giving up the right to kill any random person is worth not very much, but what you really care about is making sure that no random person is going to kill you. But at this point it takes a Coasean turn, because the cost of running this system of universal agreement is impossibly high to achieve, even though the gains from achieving it are very, very great. So what the standard political philosophers did was to invent a social contract which was imposed abstractly or hypothetically, which required this by way of a bargain. And the reason we call it a 'social' contract is because there is no real consent. The reason we call it a 'contract' is because we are confident no matter what the differences in human temperament, talents, or strengths, everybody is better off in uncertain proportions with respect to this rule. And that's the great argument of Thomas Hobbes. Now the question then is how do you implement that particular situation. And unless you have a force at the center [?] it's going to completely dissipate. But if you have a force at the center [?], the great risk is that tyranny will now displace anarchy. And the hard problem for a Hobbesian, for a Lockean, for an anarchical libertarian, is to figure out how you get those institutions in the middle which [?] and monopoly of force in them become a well-disciplined regulated monopoly, and that's what the Constitutional separation of power, all the rest of that stuff, is designed to achieve. I must stress, because you are a pessimistic guy in the abstract and rightly so, most efforts to put these institutions together fail; and in my view, if the only thing you have are legal constraints of bone against bone [?] they will fail as well. Now, ultimately success of institutions depends not only on their proper formulation, but on having a culture of cooperation and compliance to make it work. I think the classical liberal tends to be more sensitive to these various institutional and cultural issues than the hard-line libertarian, who doesn't want to choose between attitudinal preferences and saying any of them are better than any of the others. So that's the first half of it. The second half of this is a decent social order, requires that you start to have coordination between private individuals in order to get themselves going. And there's no question that the libertarian is right on this one as well--that the first and best system for getting social cooperation is to have a strong regime of freedom of contract, which allows people to pick their trading partners and put the rules together. And that the only way this system works is to have a state which is strong enough to make sure that others can't interfere with the contract. That's the force problem again. And then secondly strong enough so that it enforces the contract should one party opportunistically [?] to its form try to [?]. So now at this point they are both the same. So where is the difference? Well, there is nothing in the libertarian arsenal of tricks, which has been the control of force or the enforcement of voluntary agreements, that gets you a tax system. And how do you get that tax system? How do you design those public institutions? That is something where the classical liberal will do better. Now, when you say that you are in favor of taxation, what it means is you can exchange for, under the classical liberal formulation, the return of a package of goods and services from the state that exceed the amount of the taxes given. Now, these things are very hard to measure, particularly on the benefit side. And so every serious classical libertarian [liberal?--Econlib Ed.] has gravitated towards a proportionate tax on either income or consumption as a way to minimize political discretion, to give you the freedom you need to raise the amount of revenues that you start to need. And in effect to make sure there is going to be no kind of lobbying by private individuals in an effort to dump liabilities on their opponents and secure benefits to themselves. Now, you can have a flat tax state like Illinois, which is a complete fiscal mess. But one of the things that you know, as messy as it is, the Governor there and a lot of other people there are saying, We'd do a lot better in this state if we had progressive taxes like the great state of New York and the great state of California. And my view of course is that's exactly the opposite situation. Essentially what happens is the classical liberal doesn't say, I'm against all taxes; doesn't say that we want to shrink the government to the size of a [?] or something like that. But what it says is: We want to have a tax which is broad, non-discretionary, with some discretion on how you raise and lower taxes but let every citizen know that they are going to have to pay their proportionate share of the gain based upon their income so there is some kind of brake on what is going to be done. And then have institutions of limited government with Constitutional protections of private property, freedom of religion, and freedom of contract to get there. And hey, if you look at our original Constitution, as augmented by the Bill of Rights, it doesn't do this 100%. It makes many structural errors. It has several moral travesties in it, having to do with slavery, the fugitive slave laws, and the 3/5ths bills and so forth. But if you actually put the structure together, take the parts that have survived, understand them in terms of the general game plan, you can figure out what a sensible system of government is going to look like. And for characters in 1787 sitting in a cold room in Philadelphia that figured this out on the fly with all the political pressures on them, turns out to be one of the greatest intellectual and statecraft [?] achievements of all time. Russ: Bravo. Yes. I agree.

28:35 Russ: I'm going to ask you then, ask where the role of limited government starts and stops. But before we do that--that will be our next topic--I want to get to a famous Supreme Court case I don't fully understand, and I know that you do. And help educate me and our listeners about this, which is the Lochner vs. New York case of 1905. Explain what that is and why it is reviled by so many people; why you seem to like; and what it has to do with, if anything, our conversation. Guest: Okay, sure. First of all, I think the first thing to note about this case is its title. It's Lochner--he was the employer of a bunch of workers in some kind of a factory, baking bread, I think it was. And then on the other side, it's New York. That's the State. This is a criminal case. And what they are doing is they are suing Mr. Lochner for either a fine or perhaps a jail sentence. And his crime is to essentially employ his bakers with their consent for more than 10 hours a day and 60 hours a week. And so these are maximum hour laws. And the progressives love these laws. They were championed by people like Felix Frankfurter with a passion which is almost hard to imagine today on the grounds that they are protecting [?] workers from exploitations by their employer. Now, the first piece about the story which is a little bit odd is it turns out none of the employees are protesting. They'd worked under these arrangements for a long time with Mr. Lochner and are apparently happy with their lot. If you then start looking at macro-data to see what happens with this exploitation, it's exactly what the competitive economist will tell you, is that these wages tended to rise slowly with productivity; nothing fancy, but steady and sure. And that the number of hours worked, ironically, during this period started to drop down because as the wages got higher, the workers decided that they would prefer a little more time and leisure; and they and their employers can make bargains for this. So if you actually look at this as a market phenomenon, there is tremendous social progress in the very period for which the progressives are claiming exploitation is the norm. And my favorite measure on this, Russ, is life expectancy. In 1900, about 46 years, 47 years, for men and for women, roughly the same. By 1920 it was up to 54. Now you don't get that by exploiting workers. The only way you can move those aggregates up is to also move people at the bottom. And what drives it is in effect higher incomes, which allow you to get better food, and huge technical advances--in that period chiefly with the discovery of the various vitamin deficiency diseases like pellagra and beriberi. And the simple cures from them that don't require an FDA (Food and Drug Administration) or anybody in order to do something. So the picture on the ground is pretty good. But now what happens is: Why do you bring this suit? And the reason it was brought was that these particular bakers were in competition with union bakers. And union bakers in fact had different modes of production. They had a crew that came in the afternoon and baked the bread and went home; and then they had a crew in the morning that came in and packaged the bread and distributed it to their customers. But what Lochner's bakers did, was essentially they slept on the job. So they got in, did some work, went to sleep, got up again; and if you count the sleepless part of the work period they are always in violation, comfortably, of the maximum hour laws. So what you do is you have one mode of production which is differentially impacted by neutral, [?] neutral set of laws that are passed to drive them out of business. And Peckham, who came from New York State sort of understood all of this as part of the political economy. Russ: That's the Justice, right? Justice Peckham. Guest: Right. Justice Rufus Peckham. He was from New York. He was a very complicated man. He was no free market fanatic in the sense that when you read his really strong antitrust positions and opinions, like in the Trans-Missouri case, the guy was relentless in his pursuit of cartelization. So, I mean, he did not see Lochner as a cartel case. And of course he's right. The New York Times when it wrote about the decision after it struck down the [?], this was in April or May of 1905, it called it a blow against union dominance, or words to that effect. Because what happened is the unions were the chief force trying to stop rival competitors from taking place. So there is if you are just doing the economics of this thing a standard public choice gambit[?] in which powerful organized interest groups are able to impose neutral statutes that don't hurt themselves but wreak havoc with the production methods of other people who supply cheaper labor and better goods at lower prices. Which is what we want in a market economy. Now, you've got to get this into the Constitution. And at this particular point it's very difficult. The way in which the Constitution protects contracts is, to put it mildly, obscure at best. In 1873 or so there is a case called Slaughterhouse, and what it decided was that the so-called privileges or immunities clause of the 14th Amendment, which says that 'no state shall make any law that abridges the privileges or immunities of the citizens of the several states or the United States,' and clearly this was meant to be a kind of general charter of liberty, including employment liberty with respect to ordinary workers. But the Slaughterhouse case essentially made it very narrow so that the only privileges that were protected were those to use a navigable servitude on public waters and [?] petition the national government and withdrew from the labor markets. It wasn't over, however, because there is something known as the due process clause of the 14th Amendment, which says 'nor shall any person be deprived of life, liberty, or property without due process of law.' In the 1890s this clause became the source of two movements. One is the whole movement about rate regulation, which became a big issue then, but now subject starting in 1890 to Constitutional oversight on the grounds that if you get people to invest in heavy fixed equipment-- Russ: We're talking about railroads, typically now. Guest: Railroads and public utilities of all sorts. But there is a risk of confiscation because their variable costs are very low and their front-end fixed costs are very high. And so therefore, if you give them only enough to cover their variable costs after they committed the stuff in the ground, they won't quit so long as they get that little extra fraction. And so the due process clause got read to mean 'without just compensation.' Now, this same argument is taken over by Peckham again into the law of contracts, where he says: the right to have life, liberty, property without due process of law--liberty, he says, means that you have the right to pursue the ordinary businesses and trades of a successful economy without undue interference by the state, unless they give you just compensation, or they take from you [?] which of course in these regulatory situations they never do. So the argument on Constitutional grounds is that the due process clause was only a procedural mechanism, had nothing to do with substantive rights. The counterargument was if you left the privileges/immunities clause in place, you wouldn't have had to get this second best solution. The other argument was that if you go back to earliest statutes, there is at least some evidence in the pre-Civil War period, that due process was read capaciously[?] as saying, you know what, if there's any statute which is so warped substantively, we'll assume that it wasn't passed with due process. So there's this huge Constitutional legitimacy argument in which I think is kind of a standoff as to who is right and who is wrong.

36:35 Russ: Let me ask you to pause there for a second; let me make sure I understand what you are saying. So we have a bunch of workers in a bakery who are working more than 10 hours a day. It could be, as you point out, because they were sleeping. But it could have been they just worked really hard. It was 1900; in 1905 there wasn't--I think the average work week was about 60 hours in America at the time. Guest: Yeah. And tending downward. Slowly but downward. Russ: So in the New York statute, it was 10 hours a day, 60 hours a week, were the maximums. And these bakers were violating that. Now the question is, do they have a Constitutional right to work there, and does the employer have a Constitutional right to have them work there, more than 10 hours. Guest: That's right. Russ: And the question came down to whether, if you want to say the answer was yes, you could either use the privileges and immunities clause of the 14th Amendment? Guest: Yeah, but that was basically precluded. Russ: But that was gone. That had been eviscerated by this Slaughterhouse case. So they were stuck--Rufus Peckham, who thought this was a good idea that these guys could work 60 hours plus a week and that New York statute wasn't really Constitutional, he was forced to argue that this was a violation of due process. That's what you're saying. Guest: That's right. Now we haven't finished the story. Russ: Okay, keep going. Guest: It's a hard story. There is with respect to every individual substantive guarantee in the Constitution, an offsetting principle was called the police power. And the police power, which was widely understood at the time, allowed the state to propose regulation and derogation of freedom of contracts if it was designed to protect either the health or the safety of workers. There were other provisions about promote the general welfare and deal with morals, which are not involved in this particular case. And so then the question became as to whether or not you can justify the 10-hour work week as a protection of the health and safety of the workers. Now, this is where it gets complicated again. There had been, in 1888 or 1889, a case called Holden and Harding, where the Supreme Court held that a limitation on the amount of work week that miners in coal mines could have was in fact justified under the police power as a health and safety measure. Now, some of us may be skeptical about that, but if you think about it in terms of just the physical observation, coal mines are dark places, they are dusty places, they are dangerous places, so you can see why working too long would create real hazards. On the other hand, we don't know a hell of a lot [?] about the means of production in these mines. We don't know whether or not the work rate has gotten better or worse. But you can see--this becomes the benchmark after we create freedom of contract for the justification of state control over the system. So that's fact of law [?]. Now the question then is: What about these bakers? Do they have the same kind of interest as the coal guys? And what happened is, all of the progressives, like Frankfurter and company who wrote about these things, not exactly in that year but a little bit later--Frankfurter was only 23 at the time--they were convinced that this was a health and safety measure. And so therefore even if you believed in liberty of contract, there was nothing to do abrogate[?] it. Peckham, and a lot of other people like myself, said, you know, to the ordinary mind this doesn't look like a wildly difficult job; and more importantly we know who is behind it. So this statute should be discussed as one of two categories, outside the police power. Either it's a paternalist piece of regulation which is designed to say: We the state know better than you do about how you ought to conduct your life. Or, it was treated as a labor regulation, which essentially was a statute designed to suppress competition by one group against others. And so the huge battle then came: was it on the health and safety side of line, or is it on the other side of the line? Now, the split in the Supreme Court was three-fold. Peckham essentially said: to the ordinary understanding there is no safety and health issue here. He was a little bit cavalier about it but not terribly so. And so what he says: I'm striking this down; and he gets four conservative Justices to go along with it. Justice Harlan, who is something of a libertarian--this is the first John Marshall Harlan--he looks at a bunch of history relating to 17th century French bakers and everything else, and he says: you know, I really do see a health risk here and I'm going to support this legislation. And Harlan actually meant what he said. Because when it came to the question of whether or not you could force an employer to bargain with a union where there is no health issue [?], he says freedom of contract for the employer, I'm striking this statute down; no mandatory collective bargaining agreements on my watch. And he did that 3 years later in a case called Adair against the United States. The last guy was Holmes, who wrote by far the most eloquent and influential opinion and also by far the worst opinion, if you actually take it apart. And what he said is-- Russ: In the minority--he was in the four. Guest: A minority of one. Russ: Okay. Guest: It's five to four but the opinions were 5, 3, and 1. Nobody conferred in the Holmes opinion. And this is a combination of his pragmatism and his Constitutional skepticism coming out there. And so what he says is this measure can be justified on the score of health. Period. Full stop. And the only precedent he cites is a case called Jacobson against Massachusetts, which had to do with a vaccination law, which is obviously a very different kind of problem. And also it turns out wasn't the health statute when you actually peel away all the layers of the onion. So he cites that. And then what he says is something that the progressives love and the classical liberals hate. He said: a Constitution is not intended to embody any particular philosophy, whether of paternalism and the organic relationship of man and the state or of laissez faire. That's roughly what he said. Now, so he's saying, [?] this Constitution does not enact Mr. Herbert Spencer's social statics. Now, a Constitution may embody anything. You have the Soviet Constitution, can be a very totalitarian regime in which everybody has got positive rights to housing and very good food. The problem is the political order can stop you from getting it at will. But the American Constitution is not just a Constitution; it's this Constitution. It has a very different bearing and demeanor about it, and does for its success rest upon principles of limited government in which the suppression of labor in order to promote class conflict is something which is perfectly possible[?] to put out of power. But the same Peckham who struck it down was smart enough to realize, I don't have to when we[?] allow free labor in competitive markets I'm not going to have to commit myself to say there'll be no antitrust laws with respect to the production of goods that move in interstate commerce. So the guy got it about right. He was not what we would call modernly sophisticated on any of these issues. But be fair to them. The system of marginal cost pricing and the full understanding of monopoly really dates only from about 10 years before, right, in Marshall's Principles of Economics from 1890 and maybe Jevons, so forth, a little bit earlier. So it's a great intellectual achievement. But to the progressive, this thing went absolutely crazy. And it wasn't that they were anti-monopoly, or pro-monopoly. Their view was: Now, we'll figure this out on a case by case basis. And so they'll create labor monopolies, they'll exempt labor monopolies from the antitrust laws and they'll impose monopolies on businesses, because as far as they are concerned, they can figure out which of these things are good monopolies and which of them are bad monopolies. I don't think they are that clever. And the basic distinction between them and somebody like myself is I think that the anti-monopoly principle is sufficiently strong with respect to the ordinary production of goods and services both that it is entitled to Constitutional protection. So that you do not want to let the Constitution be organized when you protect freedom and contract and property in a way which allows the states to form cartels. Which essentially excludes some individuals, raise prices for the rest of them, and permit, as for example labor unions in the transportation industry, massive destruction of goods and services by the unilateral action of a union that can strike. And this of course to people like Felix Frankfurter was an absolute anathema. And you ask about ideas. It was guys like Witt[?] who was a famous labor professor at Wisconsin in the 1920s who shaped a lot of the stuff on labor, which took effect in the 1930s, where essentially the case of organized labor increased in leaps and bounds between 1926 with the passage of the Railway Labor Act--this is under Calvin Coolidge--which essentially allows for cartelization of the unions, by the unions of the railroads, going through 1938 and the Fair Labor Standards Act, which essentially has mandatory minimum wage and overtime provisions.

45:44 Russ: So, I brought up Lochner because you referred to it on a recent article you wrote on these issues. You were talking about the ability of people to voluntarily associate--which Lochner clearly championed. And allowed. Why else is it important, or how does it--why is that right, or at least then that right--it doesn't seem to me it lasted very long. I don't understand why Lochner is so important if shortly after that we get the Fair Labor Standards Act, which seems to me interferes with due process, at least as interpreted in Lochner. Right? Guest: Well, you are absolutely right about this. But it was a huge tumultuous Constitutional revolution, that was needed to dethrone the decision. And what happens is, your account misses the [?] amount, the sturm und drang that took place during the New Deal periods, culminating with this series of cases, which essentially said that minimum wage laws were to be appropriate. And you know there was a lot of stuff in the interim. For example, there is a case called Adkins against the Children's Hospital, from about 1923, in which Chief Justice Taft in a dissent says, You know, we are not allowing a minimum wage law in Washington--that is, D.C.; how could we be so blind as to the social realities that require [?] introduction. And this is, you know, a Republican President. And it turns out of course that in many ways the progressive Republicans actually were champions of the minimum wage, which I like to remind myself and everybody else one of the early great labor statutes was the Norris-La Guardia Act, which limited sharply the ability to obtain an injunction to a labor dispute in Federal court. And who passed this? Well, it was Hoover who signed it in 1932. And its two champions were Fiorello La Guardia, who was Republican and Norris, who was a Senator from Nebraska or some such place who was also a plains progressive Republican. Herbert Hoover was a progressive. So what happens is the dominant intellectual mode of that period was going the other way. And what's so clear is anybody who was a classical liberal then was regarded as kind of an intellectual dullard. And that all the really smart people of the world understood the wisdom. This is not true, in fact, the ablest of the judges in my view in this period was a man named Mahlon Pitney, widely forgotten today, who essentially at the state-side version struck down a collective bargaining statute on grounds that were similar to those of Harlan in the Adair case in 1908. Only [?] Kansas[?] actually has a more sophisticated account of how it is that if you believe in freedom of opportunity which will produce improvements to both sides of a deal, which he understood, you will get improvements which will improve both sides and increase the level of inequality. A lesson which is not remembered today. So if you have two people starting at 10 and you have a contract, one could go to 12 and the other could go to 15. If you worry about the gains and sum them, roughly speaking it's 7. If you are worried about the gap you say: Oh, my God, now we have a gap of 3 whereas before we had a gap of 0. So there is a deep mortal tension between Pareto improvements with unequal gains that will often happen in contracts and the notion of parity between parties. And there's no question that the progressives of that time regarded the parity as the dominant element. And they assume that if you were a big guy and you could enter into a contract with a little guy, you could leave him worse off. Which is their definition of exploitation. When in fact you can't do that. Nobody is going to enter into a contract if they are free to walk away, if in fact they are going to be left worse off. Which is why, as I indicated earlier, the wage patterns during this period were moving smartly upward at a time of relatively little regulation. So, the Progressives who prided themselves on their scientific approach and their deep empiricism and so forth, never bothered to look at the way these things worked on the ground. And by the time you got to 1930, after 1900, and women were in the workforce, overall wage levels did increase the amount of child labor, involuntary[?] ways that had gone down. And this was now a crisis required for the government intervention.

49:57 Russ: But to bring us back to our earlier discussion, you are skeptical that the freedom of contract and association which Lochner at least temporarily championed, is sufficient to bring about social order. So, talk about why you think we need more than that. Guest: Well, I mean, what happens is there are two kinds of contracts. Bilateral contracts--this employee, that employee--or multiple contracts with an employer with many employees. Market institutions backed by public force are sufficient to do it. But as it turns out, in many cases, for example, suppose you need to put the road together. It's very difficult through voluntary means to establish the various links that will allow you to do it. Bankruptcy is a very complicated procedure. And what you have to do is to marshal all the claims of the creditors. And if you can't put them into a common proceeding, what will happen is there will be a race to the bottom and everybody will try to exact their money before everybody else can. Which will force somebody into bankruptcy. Whereas, if you can stay the collection by individual parties, you might be able to work out a common plan so that the business will survive. And so bankruptcy laws don't work particularly well in that particular fashion. They are many kinds of production arrangements that you have which require coordination. So, checking systems, of course, banks, railroads, so forth, sometimes you can't put all the links together in these systems through purely voluntary arrangements because there are holdout issues in monopoly. And so maybe under some circumstances what you'd like to do is have an authority for example which would mandate an interchange between two parties on fair and equal terms. Not clear that you want to do it in many cases, but you may want to do it in some. So, what happens is, in the 19th century, at the same time that we have the celebration of freedom of contract with respect to these standard labor contracts, you are trying to figure out how you run a railroad system. And you go from Chicago to San Francisco--there are four ways to get there, and the cost will be x. You want to go from Omaha to Kansas City, which is a tiny portion of that journey, now, in effect, the cost is 4x. See, what happened is, you take the shorter journey and you have the higher cost. Now, somebody today who tells you about Ramsey Pricing would say, 'Oh, I understand why that's done.' Ramsey Pricing is basically a proposition developed in 1926 or so, by this guy, genius, named Frank Ramsey who promptly died at age 26, who essentially said that when you have to figure out how you allocate joint costs, put it on the inelastic portion of the demand curve. And so, if there are no substitutes going from Omaha to Kansas City, and you put the fixed cost on it, they'll pay as if they can't go elsewhere. And on the other hand, they have four choices. So rate regulation became a desirable feature in 1887. And they were extremely ingenious. What they didn't do is set the rates. What they said is: You cannot set the rates for the fraction at a higher rate than you can set it for the larger route of which it's a part. And since you apply this to just about everybody, you are going to raise the rates at the end. Is it a perfect system? No, it's not. Because it may well be that the ability to exploit on smaller groups is larger for one of these railroads than for others. So the one which can forgo relatively conveniently charging a lot for an instant[?] route, may be able to offer lower prices for the longer route that the other guy is in serious jeopardy. But at least at that point, experimenting with pricing controls and network industry is something that nobody had really thought through. And the simple freedom of contract model doesn't always get you to the right result. Russ: Well, of course it doesn't. Guest: And it's not clear-- Russ: Of course it doesn't. The question is: Does the rate setting top-down model-- Guest: Is it better or worse? Russ: Yeah. It seems to me it's an empirical question. Guest: And that's exactly what I would say.

53:31 Russ: Let me backtrack from that. It seems to me that one way you could assess this is an empirical question, is to look at the empirical question. I'm going to ask you if you have general principles. And maybe your general principle is that it's an empirical question--which is fine. So far it seems to me you've laid out a case for police. You've laid out a case for enforcement of contracts. I assume you'd agree to some national defense. Guest: Yes. Russ: You've conceded that usually these things take money--it's not enough to ask for voluntary contributions, although that's one way to go. Guest: Yeah, cops don't work. Russ: I don't know. But I'm open to the possibility that it wouldn't. So, we have--the limited government that you and I, I think, probably agree on is those three things. Guest: Well, I mean, also: I'll give you something else. There's no question you need a system of recordation of title. Which is not a huge thing. But it's a big thing. And it's so efficient as a collective solution that nobody really worries about it. Okay?[?] It also became clear in the 19th century that common pool resources were a subject that you had to have some degree of regulation in order to prevent over-fishing and over-hunting. Now, there are good ways of doing it, and there are bad ways of doing it. And the difference between the two of them could be as much as 5-fold. If you don't know what you are doing, you could make things easily worse. But I would say that there are a bunch of functions like this that crop up. And if you are doing with oil and gas in the 1890s, same problem: the extraction industry, either you have a unitization or a pooling system imposed by the state; which in fact the industry participants demanded. Or, the moment you get more than 5 service owners over a field it turns out that everything gets wrecked. Because they can't agree to the voluntary bargain. So, essentially the pattern is always the same: You need n people, n > 5, to cooperate for any of them to do anything, and it turns out bargaining breakdown is a very serious issue. And it turns out, by the way, in these areas, with the oil and gas, you can measure what the improvement is, because you know what the additional cost is of the regulatory system and you then can see the increase in the output. And it can be a 5-fold increase in output for a 2% increase in cost.

56:04 Russ: So, let me ask you about intellectual property. Do you think our current intellectual property regime, which enforces contracts in a very particular way, is a good thing or a bad thing? Does that fall under-- Guest: Well, I mean--this is, you know, it's a very large discussion. The question is: What is our current regime? The regime that I admired the most was the one that was put together in 1952 by, you know, a couple of guys who knew what they were doing. And it was a statute that lasted until about 2011 when we have this America Invents Act, which is much more complicated than the earlier statute and much more erratic in its [?]. I don't want to talk about the details of the two statutes, but the key feature is we do in the Constitution have what we call an intellectual property clause. Which says, in order to promote science and the useful arts we are going to give you limited terms for your writings and discoveries. Protection[?]. And, you know, they shouldn't be the same for copyright and patent. A lot of them mesh[?]. But essentially hardline libertarians like those from the fund Mises Society are writing books all the time which says we ought never to have patents. Because what a patent does is it makes it impossible for somebody to use his equipment in a way that he sees fit. So it infringes on private property. And then the same libertarians will say with respect to copyright, if you have a copyright law, I can't speak or say what I want to say under any circumstances. And that's equally indefensible. My view about it is that this is another illustration where the incentive effects from a decent system of copyright and a decent system of patents are so strong, that you are willing to create intellectual property; but again the design of the system is critical. There are many people who say, 'We'll do it all by trade secrecy.' So it is voluntary. The problem with a trade secret is you can use it for a process, but you cannot use it for a thing. Because the moment you put the thing out, somebody can look at it and just build it himself. They don't incur the fixed cost. And therefore they are only playing variable cost. So they will undersell the original producer who will drop out of the market. And innovation will stagnate. You surely need this in drugs, where the cost of a new drug is taking into the time, cost, and money--well over a billion dollars today. You probably need it even in areas like software, which are a little bit more complicated. And I think in effect there's a classic illustration where you cannot get everybody to come back and say, you know, 'We agree voluntarily not to use this particular device, which was invented by Mr. X, unless we pay him a royalty for it.' So you have to do it by statute. And you want to do it by limited terms, because information, once it's out there, can be reproduced at zero-cost. And you've got these elaborate tradeoffs. And a good classical liberal sitting there saying, you know: 'I think 20 years is probably about right for a patent, but I certainly think it may be a little bit longer for a copyright work--I'm not sure whether there shouldn't be exceptions for a copyright work, call that fair use. Maybe there ought to be exceptions for the patent kind of protections, say for certain kinds of research projects or one thing or another'--and you put together a very complicated body of law. And I think in effect the old body of law was pretty good on this. Now, where does contract come in? Well, if you don't like intellectual property, you are going to do two things. One is, when people violate your rights, you are going to give the owners of property very weak remedies. So, you are going to deny injunctions. And that's like saying, if somebody encroaches on your land, you can't throw them off. You can only get damages made. Well, there are going to be a lot of encroachments and a lot of infringements, if in fact you take that. And the second piece is you can say, 'You know, you want to license this thing to somebody else? We're not going to give you very strong remedies, if it turns out that they use the thing in violation of its license terms.' So, I license something to you to be used in XY&Z Equipment; and you use it in AB&C equipment, I can't enjoin[?] you: I can only get damages. A complete mess. And my position on these things is, once you start with the right definition of property, get the time limitation correct--which as I said for patents is about, say, 28 years--you want to give strong remedies for licenses and strong remedies for general infringement. The dominant Left/Right coalition is very much in disagreement with that. And they kind of want to socialize everything, looking at the short term benefits that you get from low marginal cost, ignoring, I think, or understating the level of innovative benefits. The argument gets more complicated. People say if you have injunctions you are going to block other people's innovations. That's the so-called 'patent thicket' theory: all these patents block everything. Well, we've had a thicket of patent fields[?] for a long time, and the pace of innovation has been very, very high. It turns out the mistake of that theory is, sometimes you develop a patent which renders so many earlier patents irrelevant, that far from being a thicket, it's like building a superhighway over a series of city streets. You get rid of the day-to-day traffic, and the stop signs, because this new process completely displaces the old one. And you really want to encourage those kinds of sort of quantum leaps in what the patent system wants to call Pioneer Patents.

1:01:09 Russ: That was very well said. I certainly--I'm pretty agnostic--I think I'm agnostic on this issue. And I'm sympathetic to the idea that there are barriers to entry that have been artificially put up by the extension of patent protection or copyright protection. But, as you point out, the pace of innovation is pretty good. Now, of course, maybe it could be a lot better. That might be the case. Guest: I mean, look, there's no question, for example, that patents should be subject to the Antitrust laws. But what that means, if two people have substitute patents, they can't put them in the same pool[?]. I think that's a very important insight. But it doesn't mean that if you have a patent--which is a state-granted monopoly--you can't discriminate in price amongst your customers. And the case law seems more or less to get that about right. So there's this huge level of intellectual dissatisfaction, which has now permeated up to the Supreme Court and so forth--it's in Congress. And a lot of the in-license fees--that is, those people who don't patent but take advantage of patents produced by others--in effect have become emboldened; and in effect say, 'I don't want to take a license. I know the technology is out there in the public. I'm going to use it. Sue me.' And this becomes essentially a real breakdown in sobriety[?]. One of the key reasons why it[?] wants wrong property protections is it encourages voluntary contracts. And if in fact you give strong patent protection, the thing to understand is the patent only covers the device. It doesn't cover a functionality. So, I mean: if somebody can figure out a same way to do the same thing with a different technique, you can't stop him. So the famous case on this is Samuel Morse could patent his telegraph device; but he could not patent the use of the electromagnetic spectrum so that nobody else could find a different kind of telegraph or telephone. And to keep all these distinctions right--and it's kind of murky--the system is pretty good. And that's what the earliest statutes have done. I have spent a lot of time teaching statutes. Like, the Patent Act of 1952, the Federal Rules of 1938, the Commercial Code of 1962. All in the last--all in mid-century, roughly speaking. And if you look at them really closely, you can always find some little nitpick. They get it wrong: some vagueness, kind of [?]. But if you start to back off a little bit and you ask yourself, 'Is this a system-wide improvement?' and did they do a pretty good, darn good job on it? My view is these statues become kind of quasi-Constitution. Because they are so good in terms of their basic intuitions that the correct thing to do is to figure out how to make incremental modifications of them rather than to blow them up and to keep them down. So, Federico and Rich [P. J. Federico and Giles Sutherland Rich--Econlib Ed.] were the two guys--two guys, mind you--who put together the whole 1952 Patent Act. Which was approved by a voice vote. Now, those guys were the two ablest patent lawyers in their generation. Hats off to them. They actually knew what they were doing. Most of the people today are rank amateurs. Everybody in Congress is an expert on the patents.