Transcript

Aaron Ross Powell: Welcome to Free Thoughts from Lib​er​tar​i​an​ism​.org and the Cato Institute. I’m Aaron Powell.

Trevor Burrus: And I’m Trevor Burrus.

Aaron Ross Powell: And today we’re joined by Edward Peter Stringham. He’s a Davis Professor of Economic Organizations and Innovation at Trinity College and the author of the new book Private Governance: Creating Order in Economic and Social Life.

So, most of our listeners hear the term “governance”. They probably think of government of the public sort. So let’s start with what you mean by private governance.

Edward Peter Stringham: Well, I want to thank you and Trevor for inviting me on the show. I talk about governance to refer to rules and regulations, whether they’re formal rules or whether they’re informal norms or even just completely informal mechanisms that people use to try and do things like facilitate exchange or protect property rights.

Most people assume that government needs to do those things, protect property rights and enforce contracts. But historically what I found, tons of examples of private parties doing that without relying on the state, without relying on the use of force and I refer to that as private governance.

Trevor Burrus: Would government be a form of governance with some different qualifications to it?

Edward Peter Stringham: Yeah. I guess one could use the word that way. I like to distinguish between governance, private governance as distinct from what we could call coercive government. Most people don’t use the term “private governance”. So I’m trying to use it as distinct from government.

But yeah, if you want to use the word “govern” in that broad sense, surely you could say there are different ways of governing, whether it’s through private voluntary means or through coercive state means.

Trevor Burrus: Now there are a lot of rules in a lot of situations. There are rules in the family and there are rules about walking down the street or going to the swimming pool. People wouldn’t say that there’s an absence of rules out there. So is the question here basically where the rules come from or are we looking at social rules or any type of rules, who enforces them or any type of rule is fair game here?

Edward Peter Stringham: Yeah. So I would say that’s exactly right and there are tons of rules in society that come from all types of sources independent of government. The government uses a certain way of enforcing them. Private parties can create rules and enforce rules in all different ways, whether it’s the rules of a family. When you’re under my house, you follow my rules. To the rules of a college, the rules of a company.

There are plenty of rules in society that people follow that are independent of government and so I think that’s the issue and the aspect that I would really like to highlight to people.

Trevor Burrus: Do you think that there’s a bias in the way that people think about rules toward sort of thinking about them as only coming from government or government‐​like things?

Edward Peter Stringham: Yeah, definitely. So the government always tells people that it exists to protect their property rights or facilitate exchange. So people have basically assumed that that’s what they’re doing and assume that without government, those things could not take place. But if you look around historically and in modern times, there are tons of examples of people interacting independent of government, in certain cases at the edges of government or in other cases operating in societies with government. But government choosing not to enforce certain rules or government being unable to enforce certain rules and nevertheless you see private rules and regulations that are there regardless of what the state is doing.

So yes, most people just assume, “Oh, there’s a contract. It must be because of government,” or a lot of people assume the corollary of that. Without government, you can’t have contracts. What I would like to highlight is that’s just completely false.

Aaron Ross Powell: So this bias in favor of – at least thinking we need public governance. We need the state to get involved. Is it limited to I guess certain categories of rule‐​making or is it more – is it based on I guess importance? So the question is people – there seem to be certain areas where we don’t – it would never occur to us to ask the state to get involved. Like if we’re kids making up the rules of a game on the playground, we don’t tend to think that the federal government should do that.

Trevor Burrus: At least not yet. Maybe. We will see …

Aaron Ross Powell: So is the distinction there that stuff that is really important – because arguably the rules of the game on the playground are not all that important. We tend to say, “Well, if it’s really important, then public governance is what we need or is it that there are just specific categories we’re kind of independent of the importance?” So whether it’s contracting or property exchanges or whatever, we think public governance is the way to go, period.

Edward Peter Stringham: Yeah. So I think that the rules of the playground are a great example. You in theory could have the federal government enforcing those rules. You in theory could have the local town police enforcing those rules. But historically, a lot of people, psychologists, have said it’s better to let kids kind of, within reason, figure out how to play nice on their own, not be a helicopter parent.

So that is a choice of socialization that most people recognize. There are exceptions however. So there are cases where the federal government is increasingly getting involved with different types of private rules that historically were done not through the state. In many jurisdictions, they’re starting to impose sexual harassment laws to seven‐​year‐​olds and all types of things. You’re arresting little kids.

At a college level, they have a bunch of set of private rules and regulations to deal with order on campus and the government unfortunately in my opinion has become increasingly involved with that.

Trevor Burrus: Well, does it seem to be the case to – on Aaron’s question that when people start to think something is really important or maybe they just start to think something is not going the way that they happen to prefer it’s going, such as campus sexual relations, then that’s when they call government in to change …

Aaron Ross Powell: Public government …

Trevor Burrus: Public government.

Edward Peter Stringham: Yeah. So Adam Smith referred to certain people as the men of system who like to manipulate people as if they’re pieces on a chessboard. I think unfortunately there are a lot of people who like to do that. So many people will look out in society. They will observe something that they might not like and then they say, “OK. Well, let’s just pass a law.” I’m going to mandate my preferences or my ideal way of doing things on these people, oftentimes not really thinking about whether it’s going to be effective or thinking about whether it’s going to have certain unintended consequences.

So yes, there is this tendency which I refer to as legal centralism and that’s the idea that all order comes about because of the state and people who are legal centralists, whenever they observe problems in the world, will then say, “Well, we need to have additional rules and regulations to deal with them.”

Oliver Williamson, a Nobel Laureate from 2009, questioned that world view and he said there are all different ways of enforcing contracts, facilitating exchange, and we need to really move beyond the idea that government is going to be able to solve problems in a low‐​cost way.

So I like to highlight that government enforcement at a minimum is costly. Oftentimes they don’t have the incentive to solve a problem or the knowledge to solve a problem. So many unmet needs are going to exist and that leaves private properties with a decision of either doing nothing, dealing with the problem or trying to find ways to solve it privately.

Trevor Burrus: The unmet needs is a really interesting example that a lot of people don’t think about, that there’s just a level where you just don’t sue or there’s a level where you don’t call the cops at all because you know they’re not going to do anything.

My favorite example of that in a movie is a part in The Big Lebowski where he asked the cops if they have any leads on finding his eight‐​track tapes that are missing. The cop laughs at his face and he says, “Leads? We got the guys in the crime labs working in shifts.”

Everyone laughs at it because they know that the cops just will not do anything in that situation. So maybe we have to re‐​conceptualize what cops actually do.

Edward Peter Stringham: Yeah. So even when there’s potential threat to property and one calls the police, they have a prioritization scheme where they will say, “OK. If it’s this type of category, we will try and send someone right away.” But there are all types of calls that they just list as a low priority event and at best, they will send somebody after 45 minutes or oftentimes not at all.

So for example in San Francisco, if you are a store owner and you have an unruly customer who’s on drugs and refuses to leave, they classify that as a low priority event and even if it’s going to really damage the store’s livelihood, scare the other customers, potentially turn into a bad situation, the police have to – they choose to prioritize their time. And when they choose not to prioritize in favor of that, well, what are you going to do?

The private parties in San Francisco, some people just deal with it. Other times, they rely on different forms of private security. So you’ve got private stationary security guards in San Francisco. You also have a group called the San Francisco Patrol Special Police who are allowed to police multiple properties and you call them up and they will send somebody rushing in right away. So the idea that government is going to be there even with a major event, it’s just not the case.

Trevor Burrus: Do you think we can infer from those situations that it’s a failure of government on some level? I mean on some – if you see a lot of people buying private security, maybe it’s a failure of government. But alternatively, we wouldn’t say that because people are locking their doors, it’s a failure of government. It seems like there would be an equilibrium point that you would hit between what you could reasonably expect the government to do and then what other people have to do to take security for themselves.

Sometimes we can say it’s a failure but if you’re locking your doors, it’s very low cost to use. So it’s not really a failure of government. Something in between that, you have a symbiosis there.

Edward Peter Stringham: Yeah, I wouldn’t call it a failure of government but just a recognition. I like to use the analogy that government is not a deus ex machina. So in the ancient Greek plays, a lot of people would get into trouble and then nobody figured out – knew what was going to happen at the end. In the very last couple of pages of some of these plays, there would be a god who would be wheeled in on a machine and then say, “OK, I’m here to save the problems. Don’t worry about anything.”

In the real world, we don’t have a government, anything like that. So personally, I would not call it a failure of government. I would just say it’s just a fact of government. Government doesn’t have the ability to solve all of the world’s problems. But most people assume oftentimes, many people assume that it does and I think we need to start questioning that whole mindset.

Trevor Burrus: Let’s get to some of the examples here because that’s most of what the book is and …

Edward Peter Stringham: Yeah. So I would like to differentiate between the enforcement of contracts and the enforcement of property rights. Most people will talk about how they need to do those two functions, police and courts, and there are tons of examples where government doesn’t have the ability to enforce contracts or the interest of enforcing contracts. In many cases, they view certain market activities as suspect and they say, “We’re not going to enforce that.”

The biggest example of this in history that I highlight is stock markets. So stock markets have existed roughly for – a little over 400 years and in most of the early stock markets, the government courts didn’t understand advanced financial contracts. They thought they were forms of gambling. They thought they were types of speculation where people were using them to manipulate prices.

They said this is wrong and we’re going to pass an edict against it. They did that in 17th century Amsterdam. They did that in 18th century London. They did that in 19th century New York. So there are whole classes of advanced financial contracts where the government did not enforce them and the private parties in theory could have said, “Well, I’m going to go to government courts.” But in reality, the government courts said, “No, we don’t endorse this type of contract. It’s illegal.”

So these contracts, even thought they were unenforceable, people engaged in them anyway and it wasn’t because of government. They found private ways to make these things work. So taking matters into their own hands, they relied on all types of private rules and formal ones, sometimes private, formal rules, to make very sophisticated contracts including short sales, forward contracts, options contracts. We’re talking about in the 1600s when none of them were enforceable in courts of law.

Aaron Ross Powell: So something like a stock exchange or a market in these sorts of financial products is very large and very complex. It doesn’t seem like the kind of thing that could even – I mean even from coming in privately could just form overnight, the mechanisms for creating these contracts and enforcing these contracts and exchanging these sorts of financial properties. How does something like that evolve from nothing to a full‐​blown market in stocks without say the government saying we’re going to create a set of regulations and some legislation that gets this thing off the ground?

Edward Peter Stringham: Yeah. So you just – your analogy got me thinking about the creationists who would say the world was created in one day or seven days and then all of a sudden now, everything moved forward. So in stock markets, there wasn’t day one or day zero where government didn’t enforce contracts and the next day they did, and then now we have markets.

Instead government wasn’t really involved with enforcing contracts and so private parties came up with various rules and various mechanisms that evolved over time very slowly. So in 17th century Amsterdam, they relied a lot on reciprocity and reputation mechanisms at first. So with that, if you cheat somebody, that party is not going to want to deal with you.

So in social science, they talk ab out the world being fraught with prisoners’ dilemmas, which is this idea that two prisoners would like to cooperate but they’re both going to rat on each other and they’re both going to be worse off.

Well, if you do that in business, you gain once but you sully that relationship with the other party forever. In addition to that simple mechanism of repeat dealings, they also relied on reputation mechanisms. So if you have the ability to find out if somebody else cheated, everybody who knows is going to now be very wary about dealing with that cheat. So they would basically boycott those parties who were unreliable.

Moving forward in England, so basically 100 years after the first stock market in Amsterdam, they too relied on reputation reciprocity but they started creating more formal rules. So they started meeting in coffeehouses and over time, they decided to transform coffeehouses into private clubs that could create and enforce rules.

Aaron Ross Powell: I have to ask here because – so coffeehouses come up here and they also come up a fair amount in intellectual history as places where great movements got off the ground. Where are these coffeehouses and how do I find them?

Trevor Burrus: Yeah. Aaron has been looking for one for a long time.

Aaron Ross Powell: Because I hang out in coffeehouses quite a lot and it’s usually just students studying and then millennials showing each other their start‐​ups.

Edward Peter Stringham: So back then, this was a couple of hundred years ago. The coffeehouses were a little bit more rowdy as far as I could tell. There’s one magazine referring to a coffeehouse where they would serve alcohol. One of them even said, “Sometimes they don’t even serve coffee.” I think he was exaggerating as a joke but it was kind of like a meeting place, a bar. In New York, they refer to the first coffeehouse, which was the precursor to the New York Stock Exchange. It was called the Tontine Tavern and Coffeehouse.

So people would go to these coffeehouses each day all day. Some people in England would put out ads in the newspaper to say, “If you want to buy stocks, come to this coffeehouse where I’m available, to meet me there.” So I think they were a little bit less sedate than the modern Seattle one.

Trevor Burrus: So you mentioned the reputation effects and people playing the game over and over again, mattering for creating a trustworthy system. It seems in that system though that the guy who comes in to try and want to trade for the first time is going to have a difficult time because no one knows who he is.

This is sort of like trying to start an eBay account at the very beginning and having no ratings, whatsoever. Wouldn’t it be good if the government or a government can – to sort of help guarantee that those people were safe? It expands trading opportunities. It broadens the mat and it keeps them less localized.

I could believe that a small little community with reputation effects could work. But what about the outsider in that situation?

Edward Peter Stringham: Well, eBay works so well because it allows people to develop their reputation and these stock markets worked so well for the exact same reason. So to become – early on, anybody could go into the coffeehouse and start trading. Then over time, they said, “All right. We need to kind of clamp down on this problem, potential problem of cheating.”

So they would start saying, “All right. We’re going to let people in. But if you cheat, we’re going to put your name on a blackboard.” That was basically their first rule, one of their first rules that they did. Then over time …

Trevor Burrus: That’s what they did in second grade when they had me put my name on the board too. So I guess it’s like a time‐​honored tradition.

Edward Peter Stringham: Yeah. So just sharing information about people can often be a very important mechanism of encouraging good behavior. So in these markets, you will actually see people talking. There are all these different dialogues written and one guy – in one, it was kind of written as like an FAQ for stock markets in 17th century Amsterdam.

One guy was saying, “Well, how do I get involved with the market and how can I interact with people when I don’t have established credit?” The people say to him, “OK, here’s what you should do. Start small and start building up a reputation and then go from there.”

We have that in modern times in modern markets. You can – anybody can open up a simple stock account, but not everyone can open up an options account. When you open up an options account, you’ve got to start with a very small margin and as you have more experience, more capital, the brokerage will start extending your margin account.

So I think that the idea that we should just let all beginners come in and say, “All right, here’s a million dollars. Do with it what you want,” or we’re going to guarantee your exchange up to a million dollars. I mean that’s a recipe for disaster.

Instead, let people earn that responsibility. When you get to go and borrow mortgage, you can’t just for the first time in your life go to the bank and say, “I’ve never dealt with a bank before, but I want to borrow $100,000 or $500,000.”

They’re more likely to say, “Well, what’s your credit history? Do you have experiencing paying back credit cards? Do you have experience paying back car loans or other loans?” and the people who have built up that reliable rating are more likely to get a loan. I think that’s a great thing and it encourages contractual compliance without actually using government force.

Trevor Burrus: Now someone just doesn’t pay in those situations. You said the contracts were unenforceable. But if someone has lost someone a bunch of money for example or owe someone a bunch of money, I mean there’s some point with these stock markets, whether it was Amsterdam or London or New York City – did they have Bob the pipe‐​hitting guy who would come in and break your knees and throw you down a couple of staircases and say, “Give us your money”?

Edward Peter Stringham: No, I have seen no evidence of Mafia‐​like tactics. Instead what they would do, it was a much more gentlemanly club, and they would have basic proceedings where they had the equivalent of bankruptcy proceedings.

So if you were insolvent and you owed a bunch of people money and there were a bunch of other contracts that you had with other people, they would say, “All right. What does this person have? We’re going to split this up among the remaining creditors.” So it would kind of make it a little bit more orderly.

Then they would say to the person, “If you’ve acted willfully, malevolently, with bad intention, you’re kicked out of the club forever. There’s not going to be any chance.” But in many other cases, the default or non‐​contractual compliance was unintentional. So some people, if they’re a short seller, they just might not have had enough shares on hand and gotten into a lot of difficult situations, which it’s kind of their fault. They messed up.

But it wasn’t necessarily malevolence driving their decisions. So in those cases, they said, “You can get readmitted back into the club if you basically make good on what you owed.” So you see lots of cases of that where people – talking about how people are selling off their last possessions to pay off their debts in the stock market.

Aaron Ross Powell: So this story sounds good for what’s ultimately I mean still a fairly small and crude financial market by say the standards of the global economy today or even just Wall Street today. So does there come a point when things become complicated enough or large enough or moving fast enough that this kind of informal or private government breaks down? Did we see that say with the financial crisis?

Edward Peter Stringham: Well, I think the cool thing about this history is at the time, these were the most sophisticated contracts by far the world had ever seen and they were developed privately, not by government. So relative to what was going on in the world at the time, these are the most sophisticated and it was done privately.

Moving forward, yes, there are many very sophisticated contracts today that are even larger, even more complicated and here too I would argue we can look and find a lot of the same exact mechanisms that were in place in 17th century Amsterdam, in 18th century London.

So let me highlight a really cool market which is futures market. In a futures market, there are lots of contracts which have the potential. You could have unlimited downside risk. So people could very much screw up and mess up their other party and say, “I’m sorry. I don’t have your money.”

Well, in those cases, even the best government courts cannot recover damages that are unlimited. So this poses a lot of problems and in stock markets today and in futures markets today, the amount of volume that takes place is just staggering.

I used to work on a trading floor a few years back and we were making tons and tons of trades every single day and the idea that you could go to the government courts and get these adjudicated if something went wrong is very questionable.

So what a – for example, a modern futures exchange does is if you and I form a contract with each other and one of us is worried about the other party’s reliability or unreliability, we actually don’t form a contract with each other. We form independent contracts with the futures exchange.

So if one of us gets into trouble, the futures exchange is going to assume and manage third party counter default risk. So we’ve got tremendously complicated contracts and the futures exchange is stepping in and making sure things don’t go wrong.

I will tell you how good they are at this. That’s basically their job that they’ve managed it so well that in pretty much no case does – do people encounter problems.

Trevor Burrus: What do you think of – when someone says basically the constant refrain that Wall Street is a lack of regulation. It’s a Wild West and everyone kind of does what they want and just pursues their own interest selfishly, Gordon Gekko style. What’s your reaction to that, that kind of critique of Wall Street?

Edward Peter Stringham: Well, I think people do – in most of all cases, often pursue their self‐​interest. But there are mechanisms in place that people basically design deals to make them – the contract self‐​enforcing. So I would argue that even with the 2008 economic downturn which was certainly problematic for many people – first of all, I will suggest that most of the major problems were caused by government. But let’s just ignore those for the moment.

I would say even in this major economic downturn, tons and tons of these financial instruments were actually working as designed. So if you have a contract and you think that the other party might not be able to follow through with that contract and you know rightfully so that the government can’t get money out of a – they can’t squeeze blood – what’s that analogy? You can’t squeeze blood out of a stone?

You could say, “Oh well, I won’t make this contract,” or “I’m going to wait until the government courts figure out how to do that.” Instead they’ve developed all types of private mechanisms and one of them – I think it has been vilified in the press, but I think we should be celebrating it. But the credit default swap is basically insurance and they say, “We know there’s a probability that you’re going to default and because of that, we are going to buy insurance in case you default.”

Now you’ve got people analyzing this and estimating the likelihood of default for each transaction before they occur and then assigning this to different types of debt, different types of corporations and saying, “Hey, here’s the probability that this corporation is not going to be able to pay back.” If that happens, you’ve got this private third party who’s going to pick up the damages and pay for them.

So even in the midst of the financial crisis when AIG was nationalized and Fannie and Freddie were nationalized, there were private credit default swap markets on those debts and it was a huge event because there were lots of credit default swap contracts written about that debt. The ISDA came in and said, “All right. We’re going to figure out how to make sure that everybody who has one of these contracts is getting exactly what they owed.” It was a quite orderly procedure.

Trevor Burrus: What does the ISDA represent …

Edward Peter Stringham: Oh, it’s the – I forget the abbreviation right now. It’s the international …

Trevor Burrus: Securities something probably.

Edward Peter Stringham: And derivatives association.

Trevor Burrus: But it’s private.

Edward Peter Stringham: Oh, yeah, yeah. Sorry, it’s a private organization, the ISDA, where they say they want to bring security into markets and what they will do is they have an auction procedure where they figure out, “OK. If this company is in default, we can’t have all of these people who are owed money, trying to buy these bonds and then sell them.”

So they figure out the value of the bonds and then they say everybody who is owed money on that is owed the difference of the reference debt and the current market price of the debt. So they basically oversee the procedure in case of defaults.

Trevor Burrus: Now outside of the abstract world of options and futures and all these things, does private governance work on a more physical neighborhood …

Aaron Ross Powell: Personal.

Trevor Burrus: Yeah, neighborhood level?

Edward Peter Stringham: Yeah. So I think that the great thing about private governance is it underpins very sophisticated, advanced financial markets. Oh, I’m thinking – going back, it’s International Swaps and Derivatives Association I was talking about a minute ago. It works in that case. It also works in very simple cases. So if you look at a school or a college, there are private rules and regulations.

If you look at a homeowner’s association, if you look at a – any type of sports club, a chess club, there’s going to be rules that are not quite as sophisticated as you see in a financial market. But you’re still going to see a lot of the same types of mechanisms where people opt in to a system that they like. There’s going to be people evaluating rules and regulations in this system and people are going to choose whether they want to be part of systems that are beneficial to them. So in the case of the homeowner’s association, a developer will say, “We’re going to have very strict rules or we’re going to have very few rules,” and they’re going to then show those potential rules to potential customers and then market the homes to people in various ways.

So Disney has an entire town called Celebration Florida which has 10,000 to 15,000 residents and they have very strict private rules and regulations, private zoning rules, rules about the color of your fence, even the colors of your drapes inside the windows. A lot of people wouldn’t like that but a lot of people love it and the result of this is property values in Disney Celebration are higher.

So I would say this is just one example that you can look around the world today and there are tons of them.

Aaron Ross Powell: I’m struck as you list these examples say of college campuses and HOAs. So the – it’s very clear throughout this book that you’re not just simply making the argument that – look, private governance can work to handle certain situations that we typically think we need public governance for. But that it either often does or in every case does work better than the public governance. But HOAs tend to be rife with pettiness, overly strict rules. Basically …

Trevor Burrus: Their own sort of public choice problems too.

Aaron Ross Powell: Yeah, people don’t tend to point to like – no one is like, “I love my HOA,” and then as we mentioned at the beginning with people starting to bring in public – planning to bring in public governance to address interpersonal disputes and not being nice to each other on college campuses and things. The rise of the politically correct left on college campuses. I mean we’re watching colleges, institute, draconian rules and what amount of kangaroo courts and all sorts of things that look – I mean in many ways, much more awful than what our public governments in the US at whether you – your town government or your state or your federal government are up to. So are these instances of public government or private government not working? Is there some reason that they seem to be this way?

Edward Peter Stringham: Well, the first thing we want to emphasize about the kangaroo courts in colleges unfortunately, they’ve been mandated by the federal government to follow certain procedures to be compliant with Title Nine regulations where the government is now mandating that they have to adopt the preponderance of evidence standard for these things.

So if there’s 50.1 percent chance that somebody could be guilty, well, you have to find them guilty. Otherwise, you’re going to get in a lot of trouble. So a lot of this badness that has been going on in recent years has been mandated by the state and I think it’s a terrible outcome where you’re taking a system which was working fairly well and now the government is using it as the handmaiden of imposing a certain set of outcomes that they would like, so really undermining what had been tied to education, the educational experience and making it a political potato.

So I do agree with you that there are a lot of problems in college campuses. On the other hand, I wouldn’t say that the government courts are close to being perfect in any way. So even with a horrible private trial, it’s not at all clear that the government is anywhere better than that. They have lots of problems on their own.

Getting back to your suggestion and pointing out of other examples of problematic private groups such as the HOA, to be sure, you’re going to see lots of people doing maybe less than optimal things in various HOAs in the exact same way that you’re going to see various companies being run less than optimally.

So not every company is run as well as Google or Apple or Microsoft and the problem is going to be ever present. However the question is, “Which system is more likely to have a problem?” I would argue that even HOAs, which in many cases are highly imperfect, have a major advantage over government rules and regulations where the government rules and regulations are imposed citywide or statewide or federal‐​wide.

So whether or not we think that Dodd‐​Frank rules and regulations are a good idea or whether or not we think a particular set of zoning regulations that govern California’s coast of the California Coastal Commission are a good idea, we have to follow them. In many cases, these rules are very, very draconian.

So yes, there are going to be imperfections and all types of arrangements. The question is, “What is going to be worse? What is going to be better?”

Trevor Burrus: Does it just come down to size though? You mentioned that size is a problem. But when I think about an HOA and the powers of an HOA, it’s very hard to make it seem categorically different than a government. You can move into an HOA and be suddenly subject to its rules, which you can with a government that you didn’t vote for. Therefore they can impose rules on you non‐​voluntarily except for your movement into the HOA.

Then they can extract taxes from you and if you refuse to pay your HOA fees, they can either kick you out, using at some point force. So it seems to me that an HOA is really close to a government. So is the question just that it’s smaller? So are you really just saying a smaller government is better than bigger government or is there something …

Edward Peter Stringham: No, actually. I’m going to make a different argument than that. So first, I’m going to defend HOAs in a minute. But I will suggest – Spencer McCallum has got a great set of arguments where he critiques HOAs and says it’s a quasi‐​market‐​organization and arrangement, but it has got a lot of problems and there’s going to be – there already are a lot of better private arrangements and we should be trumpeting those instead.

So his preferred method is basically the land lease model which you see in a hotel where the hotel is the residual claimant. They are renting out the rooms and they constantly have to worry about the demand for the tenants. You can have a proprietary community which is also renting out the land to the tenants.

So the landlord always has to think about what’s the current demand for existing tenants and what’s the future demand of current and potentially new tenants. They’re going to be very wary about implementing bad rules and regulations because it would be money out of their pocket.

But back to the HOA, I’m going to defend it for a minute. Even though it has got a lot of problems, the arrangement ultimately was created by a developer or whoever put together these pieces of property into a neighborhood association and said, “Here are 10 units,” or “Here are 100 units. We could have them be by themselves and the potential problem of that is X, Y and Z. So and so is not going to cut their grass. So they’re going to leave their garbage out.”

So those are a bunch of problems. Now, we’ve got other bunch of problems that people are going to get too involved with their business once the HOA is doing things. Then people have to ultimately weigh which sets of problems they think are worse and what are better.

So if the developer decides to put something into an HOA, in all likelihood they’re doing it to maximize the profits, maximize the value of the land, maximize the future value of the land. So this is a good thing. It’s not – you can point to any company in the world and say, “Well, look at this company. There are certain imperfections in it.”

Yes, I’m going to agree with you. You can point to lots of companies and say there’s a – there’s this problem that arises in many different large corporations and I will say, “Yes, I agree with you.” But the question is, “What is the alternative?” and I would argue that it’s better than not having these agreements.

So to me, the major agreement and difference between an HOA and a government is the developer got 100 percent of people to agree to say, “Here’s a deed. I’m going to sell you this property with this deed that says you’re going to be governed by this HOA. Future people are also going to be bound by these rules.”

So it’s basically a covenant that people have agreed to. Whenever you want to be a contractual member of this community or for example a shareholder and a corporation, you’ve agreed to a certain set of ground rules.

Trevor Burrus: But it’s not like the constitution of the United States because you can make the same argument.

Edward Peter Stringham: Right. I’m going to contrast that with the constitution which basically was mandated on all people, all properties regardless of whether they agreed to it. So many dozen people signed the constitution but 99 percent of the people who didn’t sign the constitution became bound to it and then 100 percent of everybody’s descendants became bound to it and 200 years later, there’s this permanent body which has claimed the monopoly status over the entire North America which says, “Well, you agreed to it. If you don’t like it, leave it.”

I would say this is an argument which would justify any type of government coercion by saying, “Well, you agreed to live in Nazi Germany and if you don’t like it, leave it.” Yeah, there are some difficulties of leaving it but we’re in charge and you’ve signed the social contract. So I think there’s a fundamentally wrong way of thinking when people liken the government to a contractual club, just a large one.

Trevor Burrus: Now it seems that you’re not – you don’t know – they’re very reticent to make the nirvana fallacy because you’re saying that they’re – you’re not saying that – always private governance is – or is perfect. Do you think it’s always likely to be better? And why? What are the characteristics that make private governance better?

Edward Peter Stringham: Yeah. So I think that avoiding the nirvana fallacy approach is very important and Harold Demsetz first argued this in the realm – in the context of people advocating government rules and regulations. Oftentimes people think of a problem and then they say, “Aha! Imagine that the government can solve it,” and not actually looking at whether they’re likely to solve it. You have to compare real world situations and likely outcomes compared to just some – your imagined nirvana.

I think that we should recognize that private parties are not deus ex machina either. We can’t engage in nirvana thinking and I think unfortunately some people who don’t want to do the difficult analysis just are content to say, “Well, let’s imagine that this is not a problem.” So somebody might say, “Well, how would these futures contracts be enforced?” and someone saying, “Well, ideally, in my ideal world, all contracts would be enforced.”

Well, I don’t think that’s as good of an answer as somebody who comes along and says, “Well, here’s how they privately were enforced. Here’s how they privately are enforced.” So this worry that you have is not as big of a worry.

Now that said, there are going to be certain issues private parties might not be able to solve. They might yet to have solved. So we shouldn’t just assume problems away. But I would say the major difference between private governance and coercive government is private governance, whenever there’s a problem, that is a potential profit opportunity and the bigger this potential need, the more people can potentially gain if somebody can figure out a way of solving it.

So yes, there are problems but think – let’s think about ways that we can solve them. Government in contrast is not motivated by profits and losses. They’re not motivated by – there’s no residual claimant. If somebody creates a set of bad rules, they don’t lose – if a government official creates a set of good rules, they don’t gain. They’re imposing their costs or their burden on society. So Dodd‐​Frank are retired and they don’t have to pay really close to a cent to the billions of dollars of compliance cost that they’re imposing on society for their regulations.

So I would say that’s the major difference than the voluntary nature and the profit and loss nature of market and private transactions are going to lead to systematically‐​better outcomes than with coercive government monopoly.

Aaron Ross Powell: So someone listening to this might be thinking, “Great. So I can see how we might have stock markets and some contractual disputes dealt with by private corporations or organizations or clubs. I can see how an HOA might be better than a local government.”

But one area that lots of people think absolutely has to be handled by coercive public government and in particular where profit motives and competing firms would be particularly – a terrible solution would be private – would be policing in courts, that that level, that kind of basic rights protection and enforcement is something that we need a public government that applies to everyone and is paid for by everyone to handle. You have a pretty interesting chapter in the book saying maybe not.

Edward Peter Stringham: Yeah. So I will do one caveat to your statement a minute ago. But courts as well, there’s private arbitration, private mediation. Most things don’t go to trial. So for contract enforcement, I think it’s very clear. There are lots of evidence. So all I want people to do is everybody to agree that we don’t need government to enforce contracts.

Now, let’s get to the second one here with police. Even police which in many ways is a different situation, there are tons of examples of private security and all the way up to the most formal private policing. So in certain areas in history, there have been examples of basically fully deputized private police in some cases operating alongside of government police. In certain cases, operating above government police and so the …

Trevor Burrus: What do you mean by above?

Edward Peter Stringham: Well, the chapter describes some interesting historical episodes where in San Francisco, after the gold rush, it was the Wild West and at first, people saw things in a pretty gentle way and things were going fine even though there was pretty much no – there was no jail. There was no police station. There were hardly any government or private police and that was working well for a while.

But eventually, so many people started moving in to San Francisco including different people with criminal tendencies who were threatening others, getting angry at others when they couldn’t find as much gold as they wanted.

So from its very early days, you had a system of private policing evolving in San Francisco. So you can see merchants hiring private police to protect their stores. We can see groups of citizens getting together to act against rampant private gangs or private crime and then the interesting thing coming in 1856. The people were upset. The merchants were upset with government crime against private citizens.

So in one case, a politician killed a businessman, a newspaper editor who had published negative things about the politician and the people were like, “Well, we see what you do. We see that you let all of your cronies off.” They viewed the police and the political cronies as worse than the criminals themselves.

So in this case, they actually formed a system of private justice where they were creating laws against government officials. So my favorite thing they did was they actually enacted gun control against government police.

Trevor Burrus: Wow. Fascinating. So a libertarian, a person who’s not very full libertarian will say this would crudely think, “So you’ve outlawed this private policing thing and sure, I will grant that private security can be the entirety of security and therefore rich people will have security and poor people will not.” How do you respond to that criticism?

Edward Peter Stringham: Yeah, I think the biggest victims of government policing in the world today are inner city residents, oftentimes people who are in different minority communities who are looked on poorly by government law enforcement. So I think this recent Black Lives Matter movement is very important and people who are interested in libertarianism should be interested in this movement because police historically for many years have not cared really about protecting the property rights of inner city residents. They don’t really care about making law and order in a sense of reducing crime.

Instead, they’re oftentimes viewing them as sources of revenue. So in many cities, they will have ticket quotas. In other cities, they will have arrest quotas, where the government police are basically acting like people in the Soviet Union with gross output planning models where they’re not looking at the customer whether the customer is happy or satisfied. They’re like, “Oh, well, if we arrest a bunch of people, we can be better off and we can get raises and tell people that we’re doing things.”

In many cases, the police spend their time looking for asset forfeiture and a lot of these people are unfortunately victims of the police and are starting to act up I think in a great way. The poor gentleman in Staten Island who was killed for selling untaxed cigarettes, he said, “Look, I’m sick of you guys harassing me every day. Enough is enough,” and then they strangled him which was really a terrible outcome.

But I think the people kind of getting upset about this, I think they’re completely justified. Unfortunately, I think certain people are acting out in ways which I would argue are counterproductive oftentimes. But the idea that government police are on the side of poor people is just a completely false assumption. If you look at the amount of trust rates of police among different racial groups, it’s very low for example among African‐​Americans because they’re the ones who are mistreated the most by police.

Trevor Burrus: This seems like an example of what you were saying, that – right now under the political system of policing, there’s no one who can capture the gains from doing a better job of policing the poor neighborhoods and there’s no other incentive to do it, so maybe what they really need is a little bit more profit motive and a little bit less political because right now, the only thing they can do is try to – politically try to get people to vote for – or respect the Black Lives Matter movement, try to get people on their side politically as opposed to holding out some dollars and saying, “Hey, come do a better job than the government is doing.”

Edward Peter Stringham: Yeah. So there have been cases where there were different examples of community policing in certain projects. One group is associated with the nation of Islam where there were volunteers, police privately patrolling the security projects and the governments comes down and says, “No, we are the people who are going to enforce the property rights and the rules of this area, and you’re not allowed to do that.”

So I think just moving to a system of volunteer neighborhood watch and then adding in some of these profit incentives that you’re talking about. Either one of those could be huge steps in the right direction.

Aaron Ross Powell: So if private governance works so well, is so much more efficient, seems to be able to handle everything you might throw at it, why are people so skeptical of it?

Edward Peter Stringham: Well, government has for a long time told people that law and order comes from government. They’ve told people that they exist to create law and order and so, if everybody or the vast majority of people believe that and then they say, “Well, if we weren’t here, we would have chaos,” that is a basic assumption that has been ingrained into so many people and even many free market economists have adopted that assumption and what I would like to point out, it’s not based on empirical evidence but it’s basically an assumption based on in many cases government propaganda.

Aaron Ross Powell: Are there any areas where either public governance is necessary or seems to clearly work better than private?

Edward Peter Stringham: My own position is government is not created to benefit the citizenry. I don’t believe that government was ever voluntarily agreed to, to work on behalf of the citizenry. I believe that government was created and we can look at this in history to raise revenue for government officials. So you can see this in England a thousand years ago. They had a largely private form of law enforcement. It was restitution‐​based, which meant that if there was a problem, the perpetrator had to pay back the victim. So it was trying to make people whole again, kind of like a torque system.

But the government officials saw that system after the Norman invasion especially. They said, “Oh, well, you know what? In addition to paying back the victims, why don’t you pay back some of that money to me, the king, for violating my peace?” So we saw this system evolve from one that was private and largely voluntary to one that government was using to raise money for the state.

I think that story pretty much sums up governments throughout. They might tell people that they’re around to solve various problems for the citizens. But in reality, we can see them doing it time and time again to extract resources from the public.

Trevor Burrus: The question that again popped in my head just now is, “How would you respond to the person?” So you just sort of made a very big indictment against government and then someone says, “OK. Well, if that’s what you think, then go live in Somalia and I will stay here in America where there’s more government.”

Edward Peter Stringham: Yeah, there’s a great, funny video critiquing libertarians on the internet for saying that. It says that. It says, “Oh, why don’t you go to Somalia. It’s such a great paradise.” But I think that the comparison is – basically assumes that a government is making everything good in North America and the lack of government in Somalia is making everything bad in Somalia.

But some of my friends, Peter Leeson and Benjamin Powell, have done studies of Somalia and pointed out that Somalia has tons of problems. But so do their neighboring countries and government used to exist in Somalia and they had tons of problems in Somalia. Government still exists in its neighboring countries and they have tons of problems in its neighboring countries.

So we can say that government itself or lack of government itself in Somalia is the problem or the solution, without doing comparative analysis and what they have both found is that Somalia has gotten more investment in lots of areas since they haven’t had a government and they’ve gotten more investments in lots of areas compared to their neighboring countries with governments.

So I don’t want to live in Somalia ever. Well, never say never. But I have no plans to ever live in Somalia. But that’s because there’s a lot of issues there that we don’t luckily have to deal with here.

In terms of whether or not somebody in the United States who’s unhappy with the current setup should have to leave, I think this is – this is one of these love‐​it‐​or‐​leave‐​it types of arguments, which really could apply so broadly that would shut up – attempt to shut up all criticism and so people could say that in the – you know, Soviet Union. Oh, if you don’t like the government here, love it or leave it. Why don’t you just leave?

I would argue to that. Why does somebody who is a resident of Russia and now they’re subject to the Soviet state, why do they have to leave, pick up all their property – actually, they can’t even pick up their property. And uproot their families just because they are under the control and unhappy with these despots.

I think that the question is now whether the resident should have to leave. Why are the politicians asserting that authority to begin with? I will make that same argument about the United States. My family came to New Amsterdam a long time ago and they weren’t asked by the British when the British took over New Amsterdam and said, “All right. You’re under our control.”

If anybody says love it or leave it, I would say, well, the British should need to leave New Amsterdam. So I don’t see why that argument should be binding on my ancestors in the 1660s. I make that argument today. There are tons and tons of bad things that the government has done over the past couple of hundred of years.

Love it or leave it, my own position is well, they should leave it. I was here first.

Aaron Ross Powell: So would it be fair though to call your book an argument for political anarchism?

Edward Peter Stringham: Yeah, if you want to call it that, I would have no objection to that. I tend not to use that word in certain settings because it has multiple meanings. Some of them positive connotations, most of them very negative connotations and because the dictionary has two very different meanings of that word, I think there are better words that exist.

Trevor Burrus: But perhaps –

Edward Peter Stringham: But yeah, I’m OK with that.

Trevor Burrus: Perhaps people – one of the real benefits of your book is that people can kind of see that so‐​called anarchism or statelessness is not always disorder. Quite often a good type of order and also all around us in a way and maybe that’s a good way of getting outside of the state is just noticing what has always been there and is still around us today. So in that theme, do you see private governance growing in the future? What sort of possibilities do you think we can govern ourselves privately into the future?

Edward Peter Stringham: Yeah. So the reason I like to use the term “private governance” is because it’s a positive word. If we focus on “an” in terms of “anarchy,” it’s a negative word without an overarching state and then people start thinking about, “Well, what’s going to exist without this?”

Well, here, I want to focus on the positive things that already exist throughout history and in modern times. They exist when we don’t have states. You have private governance. They also exist when we do have states. We have private governance. They exist for simple markets where people are dealing with small trading in a third world country. They exist for very large, complicated, sophisticated markets, securities markets, futures markets.

So they exist in all cases and I am suggesting that it’s all around us. It has done a tremendously effective job at creating order in the past. It’s doing a tremendously effective job at creating order today and the more people can notice that and appreciate that, they’re going to have to rethink this idea that all order in the world is owed because of the state. Instead, I’m going to suggest that it comes about privately, voluntarily and it comes about through markets.

Aaron Ross Powell: Free Thoughts is produced by Evan Banks and Mark McDaniel. To learn more about libertarianism and the ideas that influence it, visit us on the web at www​.Lib​er​tar​i​an​ism​.org.