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Labor, Capital, and the Rigged Economy

No one likes being in a prisoners’ dilemma. The tragedy of the prisoners’ dilemma, as it were, is that all the players in the game can see the cooperative, Pareto-superior outcome, but they can’t reach it, at least not without changing the game. They can’t reach it even though it’s right there, seemingly within grasp, and even though they all agree they’d all be better off if they did reach it.

Because of this, there’s a tendency to think that prisoners’ dilemmas are generically bad things. And so, if one exists, it needs to be solved (if possible) so the players can reach the cooperative outcome they all want to reach. But that’s incorrect. The suboptimality of the equilibrium characterizes only the players in the game; the bad, noncooperative outcome for the players can sometimes (only sometimes) be good for society more generally. Simply consider the game’s eponymous story, it’s a good thing for society that the prosecutor induces the two criminals to rat each other out by placing them within the game’s incentive structure.

So, too, with markets. In its classic formulation, price competition induces a prisoners’ dilemma among business and factor owners in a given market. Competition results in prices that just cover costs. (These costs include what economists term “normal profit” for entrepreneurs.) Owners would all prefer higher prices, but they can’t attain them, at least not without changing the rules of the game.

But while a problem for producers playing the game in a given market, the markets’ prisoner’s dilemmas inure to society’s benefit. Markets socialize the benefits of production. Price competition distributes to consumers what would otherwise be realized by producers as “economic profit” (which, for economists, is profit greater than normal profit). Without competition, this value would otherwise be captured for the benefit of the producers alone.

Producers don’t like to face prisoners’ dilemmas. (Indeed, none of us does.) They want to reach the Pareto outcome in the game; they want to keep the economic profit as well as the normal profit. Hence Adam Smith’s famous observation, “people of the same trade seldom meet together, even for merriment and diversion, but the conversation ends in a conspiracy against the public, or in some contrivance to raise prices.”

This is also the oft-repeated insight that there is a difference between being pro-market and being pro-business. Being pro-market means that one wishes to sustain the institutions and habits that place producers in market-based prisoners’ dilemmas with each other. Being pro-business means that one wishes to help businesses, or at least to help some businesses, to get out of playing prisoners’ dilemmas with other businesses. So, too, being pro-labor often means that one wishes to help workers, or at least to help some workers, to get out of playing prisoners’ dilemmas with other workers.

“Crony capitalism” is a means by which owners of capital, labor, land and entrepreneurial skill seek to get out of the prisoners’ dilemmas created by the market. The government intervenes on the owners’ behalf, protecting them from the full effects of the market, and allowing them to realize greater-than-normal, or economic, profit.

In an ideal world — a world in which markets existed without crony capitalism — markets socialize efficiency gains in production through prices and distribute those gains to society in general. The prisoners’ dilemma structure of markets induces capital owners to transfer efficiency gains to the public. Likewise, markets induce labor to transfer efficiency gains to the public. And landowners and entrepreneurs transfer their gains to the public in general as well.

While that’s bad news for owners of land, labor, capital and entrepreneurial ability, it’s not bad news for consumers. And it’s not bad news for the economy at large. After all, producers in one market are themselves consumers in many other markets. So they also gain as members of the public when efficiency gains in other markets are transferred to the public at large. To be sure, everyone loses a bit in the particular market in which they produce — at least in the sense that markets induce them to give away the value of efficiency gains that they’d prefer to keep for themselves – but they gain in the aggregate because of the net effect in all the markets in which they are consumers. This, plus the allocative efficiency of competitive markets, means that the pie is larger over all, and everyone shares in the gain because competition insures that these gains are socialized through price.

Such is the ideal world. But we do not live in an ideal world. We live in a world in which well-connected producers receive coercive assistance from the government to help them achieve the cooperative possibility in the markets’ prisoners’ dilemma games. While sounding benign — “cooperative outcome” — it’s not necessarily benign. After all, we do not want the criminals of the eponymous game to achieve the cooperative outcome. Likewise, we do not want producers to achieve their cooperative outcome either.

But the world that we want is not the world we live in. “Crony capitalism” exists when governments use their coercive power to help producers achieve the cooperative outcome in their market’s prisoners’ dilemma, thereby capturing value for themselves that would otherwise be distributed to the public through price competition.

Let’s now see what happens if we start with an imperfect world, a world in which crony capitalism already exists, and start to deregulate it. In our quasi-mercantilist economy, cronyist privilege extends to many, but not all, factor owners in many, but not all, markets. A lot of capital receives this protection, as do a lot of workers, landowners and entrepreneurs. And a lot do not.

It is worth emphasizing that protected factor owners constitute a privileged class within their respective classes of ownership. A lot of labor and capital, and many landowners and entrepreneurs, produce in markets that receive little or no government protection from the prisoners’ dilemma of the market. This creates, as it were, a dual economy in which a privileged class of factor owners receive higher-than-normal returns on their factors alongside an unprivileged class of factor owners whose efficiency gains are socialized through the market and shared with the public at large. Privileged capital and unprivileged capital. Privileged labor and unprivileged labor. Etc.

In this dual economy, let’s now start to reduce privilege and production — reduce crony capitalism — in the economy. In principle this is a good thing. But let’s add this twist: let’s not assume that government privilege and protection decrease at the same rate across the different factors of production. Let’s say the government reduces privilege and protection for labor. And privilege and protection for capital decreases at a slower rate, or even that capital continues to enjoy pretty much the same level of government protection it always had.

In that case, workers, at least the more-privileged workers, are now, relative to capital, asymmetrically exposed to the effects of the prisoners’ dilemma created by markets and market competition. Their incomes decline. Although, to be sure, incomes decline because now the market induces these workers to distribute efficiency gains to the public at large that they used to be able to keep in significant part for themselves.

In one sense this decline in protectionism, even though asymmetrically affecting labor, is a good thing for society as a whole. The public benefits from price decreases and increases in allocative efficiency because of the reduced protection. (There may be some exceptions here, but we’ll tiptoe around those qualifications.)

At the same time, however, it is unfair that labor sacrifices its privilege when capital does not. Indeed, with continuing protection, capital owners who receive protection are making out as well as ever. More so, with lower labor costs resulting from the elimination of government protection for workers who previously enjoyed protection, capital is making out better than ever. Labor, on the other hand, increasingly struggles, at least those workers who benefitted earlier from government protection. These workers may have had it pretty good earlier, and now they see their overall standard of living decreasing in absolute as well as relative terms.

This asymmetry – less for workers yet more for capital – creates the sense that the system is rigged against them. And in a real sense it is rigged. It begs the question, why does labor need to sacrifice privilege, even if for the public’s gain, when capital does not?

One might think that a solution is to privilege everyone. Leave no one out of a reinvigorated mercantilist system. This is what the original “dual labor market” economists of the 1970s advocated. This ignores that while people don’t like being in prisoners’ dilemmas in the markets in which they participate as factor owners, we nonetheless all enjoy more benefits overall when everyone produces in free markets. Privileging everyone means impoverishing everyone.

Another temptation is to argue for the reestablishment of the privileges labor lost in selective markets. This is what many Progressives advocate today. Donald Trump of course does not advocate the full agenda, but does advocate some of it, particularly with respect to international trade and globalization. (Illegal immigration is a part of this, but scoops in a lot more beyond merely economic effects.)

And, who knows, perhaps in a second-best world in which privilege cannot be eradicated overall, the best we can do is to create selective systems of privilege and protection in each of the factor areas, even if this privilege is not shared equally by all in those factor areas. Privileged labor offsetting privileged capital, and more. Yet this almost certainly compounds the unfairness overall, with those left out of the privileged subsets of factor producers even worse off than before.

Still, losing one’s privilege and being forced into the market’s prisoners’ dilemma in the name of the common good, especially when others do not equally share the loss, naturally provoke anger and resentment at being made the patsy. If conservatives are serious about dealing with crony capitalism, then a requisite is that opposition to it apply with equal intensity to privileges enjoyed by the different factor owners, and opposition not be limited, in theory or in practice, to disconnecting labor asymmetrically from government protection while other factor owners continue to enjoy it.

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