Life, Liberty and the Pursuit of Wealth:
On the Economics of Liberal Rights
By Jason Soon

Imagine the highest possible amount of individual freedom that can be enjoyed consistent with others enjoying the same amount – defining ‘freedom’ as negative liberty, or non-interference by the state with the actions of an individual. Let us define a claim to such freedom which compels recognition as a liberal right.

Upon what grounds can such a claim compel recognition? Consequentialist liberals answer this question by linking enforcement of these claims with the maximisation of fundamental goods (evaluator-neutral goods in the sense that all people recognise them as goods) (Pettit 1988: 175). That is, they justify liberal rights on the basis of beneficial consequences that they promote.

Arguably, the most fundamental good of all for any individual is the satisfaction of that individual’s subjective preferences for particular bundles of attributes (e.g. goods and services, though not necessarily restricted to these). Such preference satisfaction yields utility to the individual. Preference-based utilitarianism is a system that attempts to maximise the total amount of this utility in society and can be our starting point for a consequentialist defence. The higher the total utility in a society, the higher the probability that preferences are being satisfied.

The Problem With Utilitarianism

One problem with preference-based utilitarianism so defined is that if there is a majority who want to see a minority arbitrarily punished or have their freedoms infringed in some way then the correlation between maximising utility and respecting liberal rights can falter (Posner 1979:116). Take the following example:¹ it is possible that some ‘monsters’ may derive utility from seeing other people tortured. If they were a sufficient proportion of the population for the satisfaction of their preferences to make a substantial difference to the sum of utility, it might be justifiable to hold tortures occasionally because the utility loss suffered by the tortured and the people who disapproved of torture might be more than compensated for by the utility gains of these monsters.

However, using a different maximand (the variable we try to maximise) from utility need not mean abandoning the strength of utilitarianism, which is the strong evaluator-neutrality of the ‘good’ it promotes – a high sum of preference-satisfaction.

The criterion of ‘wealth’ as defined by Posner (1979) may be the best maximand in this regard. That is, a system which attempts to maximise wealth may yield rules that respect liberal values better than any other consequentialist approach.

Wealth Maximisation

Wealth is defined by Posner as the value in dollars or dollar equivalents of everything in society, measured by what people are willing to pay for something or what they demand in money to give it up (1979:119). ‘Everything’ here can refer to the realisations of preference sets as previously defined. We can designate these as ‘goods’ for short, inclusive but not consisting solely of physical goods.

However subjective these ‘goods’ are, they are only derived through the exercise of property rights in one’s own person or external objects. Thus it is meaningful to speak of property rights attaching to ‘goods’ as defined. As we shall see, this link suggests that all social choice dilemmas can be reconceptualised as ‘economic’ problems – and conversely that even the most concrete economic problems (like pollution) are ultimately subjectivist in nature.²

Leave aside for the moment those goods without a ‘properly functioning’ market. We mean by this a market where property rights are sufficiently well defined and enforceable or where the costs of transacting (transaction costs) in that market are close to zero. Transaction costs encompass the material expenses and opportunity cost of time and energies involved in two or more parties reaching agreements regarding their respective property rights (Parisi 1995:608).

In the absence of transaction costs there should be no barriers to all effects of conflicting property rights usage being resolved through intricate contracts formed by mutually beneficial bargains (Coase 1960).³ For simplicity we shall refer to markets where the above conditions are present as Coasian markets.

Let us start by looking at the normative implications of wealth maximisation given an initial distribution of endowments, leaving aside for a moment issues relating to the efficiency and justice of these initial allocations.

The level of wealth in society increases where opportunities for trade are captured. This is because trade involves the transfer of goods to those who value them the most. Thus the sum of valuations that add up to wealth increases with the number of intended trades satisfactorily concluded.

Assume A values a table owned by B at $10, B is willing to part with it for $8, and A agrees to buy it for any price up to $10. The consequence will be that the table then belongs to A who is willing to part with it only for $10, which increases the sum of valuations, adding to wealth according to our definition (before the trade it belonged to A who only valued it at $8, hence there is a $2 gain in the sum of valuations).

This example demonstrates how the presence of a voluntary trade is a sufficient condition for value and hence wealth to be enhanced. Two other possibilities are where there is a voluntary transaction that we would not intuitively see as a trade, such as gift-giving, and the case of involuntary transactions, where one party coerces another into doing something.

The same arguments that applied to trade would apply to all voluntary transactions; that is, voluntary transactions are likely to be value and hence wealth enhancing. If A donates $x to B, a tramp, then A can be said to value the $x in B’s hands more than in any alternative use of that $x. This may be so for a variety of reasons, ranging from A being genuinely altruistic to A being repulsed by the sight of B in shabby clothes.

Thus a necessary condition for a transaction to be wealth maximising where transaction costs are negligible is that the parties agree to it. It is therefore wealth maximising that ‘involuntary’ transactions be prohibited. We can also infer that the closer the market comes to being a Coasian market, the more the conclusion that voluntary transactions are wealth maximising holds true. What is ‘voluntary’ cannot be defined precisely, but the sense in which it is used here suggests the commonsensical understanding that a transaction effected through the use of physical coercion (e.g. your money or your life) or fraud is not voluntary.

Forced Exchanges and the Social Calculus

Dworkin (1980) has argued against Posner’s wealth maximisation approach on the basis of the following story.  A has a book which he values at $2. B is willing to pay $3 for it but transaction costs (e.g. the cost involved in B going to A and making a deal with him) exceed $1. Thus the transaction is frustrated because the total costs B must incur in getting the book are higher than the value she places on the book, even though she is a higher valuer than A. In that case wealth is maximised by seizing the book from A and giving it to B.

Note that here the problem is one of an imperfect market, where transaction costs eat up a significant part of the value of the potential trade. A satisfactory response to Dworkin must address the case of what to do for that subset of ‘goods’ where transaction costs are substantial.

If, despite these imperfections, we can ascertain that a good is worth more to B than to A, then an uncompensated transfer of the good from A to B will increase the level of wealth and by the criteria of our system is justified. But such a conclusion only follows from Posner’s definition of wealth, which implicitly equates wealth maximisation with allocative efficiency: given data about valuations of different goods by different individuals, wealth is ‘created’ by matching the good with the individual who puts the highest value on it. This assumes away the problem of productive efficiency.

Productive efficiency is achieved when ‘more’ is got out of ‘less’, where individuals try to increase the value of their goods, such as where a businessperson tries to extract maximum returns out of his capital equipment (Johnsen 1986:270-1). Productive efficiency adds to wealth because the fewer resources that can be employed to satisfy certain preferences, the more is available for others. Uncompensated transfers will only make a society wealthier if the method of achieving allocative efficiency does not affect productive efficiency. Otherwise we must also take account of the effect of uncompensated transfers on productive efficiency.

In doing so we move away from a definition of wealth as a summation of values at a given point in time, to wealth defined as a flow of values over time, discounted to the present at an appropriate interest rate.Under such a definition, wealth is likely to be reduced by the use of uncompensated transfers (Johnsen 1986:271-2). A proliferation of uncompensated transfers reduces the certainty that individuals will capture all benefits from an increase in value that they have invested in their property (some of it will go to whomever the uncompensated transfer favours), thus it will reduce incentives for productive efficiency.

Realistically, all transactions incur some transaction costs. Where transaction costs hinder the value-revelation properties of markets, as in Dworkin’s example, one solution may be for an outside party (the state) to broker a forced exchange (Johnsen 1986:272). This would involve replicating the result that would eventuate in a Coasian market where transaction costs are zero. This would involve, in Dworkin’s example, A getting compensation at market values ($2) for the book being transferred to B. This is easier said than done in most real-life cases. How does the outside party (the state) know how to distinguish the ‘real’ market value of a good from its price inclusive of transaction costs? Yet the presumption that the state has this particular informational advantage necessarily underlies theories of market failure.

The ultimate forced exchange is the formation of the state itself. The state compels transfer of property through taxation or ‘takings’ to itself, as representative of all social interests, in return for services (public goods) which are said to increase the wealth of all social interests but which are being undersupplied or are not being supplied at all because of high transaction costs.⁴

Given the sceptical note expressed, the ubiquity of transaction costs does not warrant the use of forced exchanges in every conceivable market. This scepticism is strengthened once the costs of implementing forced exchanges through the political system, which are also transaction costs, are factored into our comparative institutional analysis. These include administrative costs, remaining disincentive effects on productive efficiency from the levying of these costs, effects on allocative efficiency from mistaken valuations, and rent-seeking costs. Rent-seeking costs refer to the long term effects on individuals if a political system is observed to be too willing to undermine voluntary agreements or enforce transactions which benefit one party at the expense of another. Individuals in this situation are likely to redirect some of their resources towards influencing the system to their benefit. For reasons already explored, the resulting instability of property rights is likely to be detrimental to all interests in the long run. Thus the problem of the Hobbesian ‘war of all against all,’ which is a traditional rationale for bringing in the state to facilitate social order, is reintroduced.

There is therefore likely to be a presumption against the use of forced exchanges, much less uncompensated transfers – despite the imperfections of real world markets. Everything said about forced exchanges applies also to regulations which restrict voluntary transaction possibilities, as these regulations restrict the scope of property rights in the same way that a forced exchange would.

Coase, the pioneer of transaction costs theory, saw law as coming into the picture precisely because positive transaction costs hindered the spontaneous contracting of parties. He thought that the normative content of his theory lay in the insight that legal rules that minimised transaction costs were to be preferred.

However, the setting up of a coercive monopoly (government) in order to establish and enforce the preconditions for voluntary transactions (law), and hence maximise wealth, also incurs transaction costs. Such a monopoly may also pre-empt the evolution of possibly more efficient, voluntary institutional responses. Thus, it is not against the tenor of Coase’s ideas to suggest that perhaps the problem of establishing the preconditions of voluntary exchange could be turned over to the market process to a greater extent than has so far been contemplated. (Those familiar with the benefits of intergovernmental competition through federalism and globalisation pressures should not regard this idea as such a giant conceptual leap.)

In conclusion, our system might warrant government intervention only if transaction costs are so prohibitive that social wealth can confidently be said to increase from intervention, taking into account its total costs.

Rights and Wrongs

So far we have demonstrated the usefulness of the wealth maximisation norm and its correspondences with a libertarian system given an initial allocation of endowments or property rights. We can now proceed to show how it can also specify the best initial allocation of such rights.

On the basis of efficiency and hence wealth, the Coase theorem states that with zero transaction costs, the initial assignment of rights is irrelevant. With positive transaction costs, rights are best assigned to those who value them the most. This was qualified in the Dworkin example by pointing to possible effects of reallocating rights on incentives towards productive efficiency.

No such problem arises in the case of rights to the use and disposal of one’s own person (call these autonomy rights) because we are not reallocating anything – bodies and minds come attached to their natural owners. Even if it were feasible to call an auction of autonomy rights, there would be enforcement costs incurred if the highest bidders were not the natural owners and costs in terms of productive efficiency. Natural owners are likely to make the most productive use of the faculties inhering in their own persons, including investments in building up human capital. Such incentives would be weakened in the case of what would effectively be a slave system (Posner 1980:246-7).

How then would we proceed to allocate property rights outside one’s own person? A convenient rule is that of first possession or ‘take what you can get’ (Epstein 1995:59). This rule simply states that the first person to lay a claim to an unowned object (for instance a plot of land) will hereby be treated as its natural owner. This means that anyone wishing to make use of that particular object will need to make a voluntary bargain with the person who has first claimed it.

Detractors of this rule point to its moral arbitrariness. Why should the first-comer trump other interests? But what is the alternative? A second comer rule? The drawing of lots? All these alternatives involve some regime of centralised authority in order to administer the allocation (Epstein 1995:61-2), with all the cost disadvantages we have already explored – hardly a feasible option when property rights outside one’s body have yet to be settled. Furthermore, while first possession is morally arbitrary, the alternative is a moral bias or partiality, which again must be sorted out through a political process (de Jasay 1991:71-2).

Conclusion

A wealth maximisation approach produces a system which satisfies moral intuitions in accordance with libertarian values. Such a system prefers voluntary exchange and coordination to coercion. It respects individuals’ rights to life, liberty and property, subject to those cases where employment of a coercive political mechanism may yield increases in social wealth.

Very strict standards are set for the legitimate use of political coercion under this approach. Transaction costs abound and hence the valuation properties of markets are imperfect. However, the human artifact we call the state may have no greater insight into valuation problems than market participants. The state itself is not a frictionless mechanism and its use also involves transaction costs.

References

Coase, Ronald H. 1960, ‘The Problem of Social Cost,’ reprinted in Ronald H. Coase 1988, The Firm, The Market and the Law, University of Chicago Press, Chicago.

De Jasay, Anthony 1991, Choice, Contract, Consent: A Restatement of Liberalism, Hobart Paperback 30, Institute of Economic Affairs, London.

Dworkin, Ronald M. 1980, ‘Is Wealth a Value?’, Journal of Legal Studies 9: 191-226.

Epstein, Richard A. 1985, Takings: Private Property and the Power of Eminent Domain, Harvard University Press, Cambridge, Mass.

Epstein, Richard A. 1995, Simple Rules for a Complex World, Harvard University Press, Cambridge, Mass.

Johnsen, D. Bruce 1986, ‘Wealth Is Value,’ Journal of Legal Studies 15: 263-288.

Parisi, Francesco 1995, ‘Private Property and Social Costs,’ European Journal of Law and Economics 2: 149-173.

Pettit, Philip 1988, ‘Liberalism and its defence: A Lesson from JS Mill,’ in Knud Haakonsen (ed.), Traditions of Liberalism, Centre for Independent Studies, Sydney.

Posner, Richard A. 1979, ‘Utilitarianism, Economics and Legal Theory,’ Journal of Legal Studies 8: 103-140.

Posner, Richard A. 1980, ‘The Value of Wealth: A Comment on Dworkin and Kronman’, Journal of Legal Studies 9: 243-252.

Endnotes
1  This example is meant solely for vivid illustration, not to suggest that such an outlandish possibility is necessary for the problem to arise.

2  For example, ‘pollution’ would not be a problem where all affected parties consented to it or, equivalently, where there were no non-consenting third parties whose property rights were affected by it.

3  Though the idea will not be pursued any further here, the reasoning above suggests that all instances of market failure discussed in welfare economics such as externality effects and holdout problems can be traced back to high transaction costs.

4  For an exposition of the theory of public goods reconceptualised in wealth maximising terms using the transaction costs approach described here, see Epstein (1985:Chapter 1).

Jason Soon is Assistant Editor of Policy.

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