Summarized in a few sentences, his thesis is that many new problems have, like termites, undermined the market and made it less free and less equitable—sometimes because of state intervention. The state itself, victim of its own termites, has become less efficient at solving these problems. Yet we must look to the state for solutions.
The termites of the state are “various elements that enter into the political system and that corrupt, or distort, the legitimate economic role that governments try to play.” Similarly, the termites of the market are factors that “distort the legitimate functions of markets.” Inequality and externalities are two big market termites.
Something rotten in the state / Termites of the State can be read as arguing that the state must mend its ways and that the market is desirable to ensure prosperity and protect individual freedom. The state, Tanzi suggests, has become so complex and so capturable by special interests that it has turned the free market into crony capitalism. Further, public policy has contributed to redistributing income from ordinary individuals to the rich and well-connected. He has a point.
He makes an interesting case against intellectual property rights as they are now protected by the state. Patents only became widespread in the second half of the 19th century, well into the Industrial Revolution. Copyrights developed from the 17th century on but were not fully protected until the 19th century. For a long time, the U.S. government did not protect foreign copyrights; Alexander Hamilton was all in favor of stealing industrial secrets from the British, for instance. But today, trademarks, concerts, sport games, and even the images of famous athletes or entertainers are protected.
Tanzi argues that the proliferation of these little state-sanctioned monopolies has contributed to the rise of income inequality over the past three decades. He does not provide much empirical evidence for this, but the hypothesis looks reasonable: many of the super-rich—who are found not only among CEOs of large companies and high-tech entrepreneurs, but also among entertainers and athletes—would not be skewing the income distribution as much if the government did not protect flimsy intellectual property—and both “intellectual” and “property” deserve to be put in quotes.
Tanzi, who earned his doctorate in economics from Harvard University in the roaring 1960s, is familiar with the economic literature. He also seems to have duly read the defenders of what he calls “market fundamentalism”: Milton Friedman, Friedrich Hayek, Robert Nozick, and many others he cites. He believes that “some libertarian aspirations suffer from lack of realism” and that laissez-faire is “naive.” He is not easy to pin down on the usual (and not very useful) left–right spectrum but, as we will see, he suffers from his own naiveté.
Contrary to many economists—and a vast multitude of non-economists—Tanzi understands and explicitly recognizes the implications of Kenneth Arrow’s Impossibility Theorem. (See Arrow’s 1951 book Social Choice and Individual Values.) Arrow later shared a Nobel Prize in economics for his work in this area. The theorem fundamentally challenged the concept of “public interest,” except in the rare cases when it is a common interest. It is generally impossible to aggregate divergent interests without imposing the preferences or values of some individuals on other individuals. Yet Tanzi often slips into invoking the notion of public interest. For example, he calls for “an income distribution closer to the one that society would consider desirable.” Considering something desirable is precisely what society cannot do, as per Arrow’s theorem.
I think that Tanzi is critical of economic freedom for two reasons. His main normative value lies in some ideal or preferred income distribution that only the state can establish. And he sees the termites (or failures) of the market as worse than those of the state.
Market termites / The market, Tanzi argues, is highly imperfect: it “does not work well enough, especially in some sectors.” Consumers are often irrational and, if only because of information asymmetries, badly informed. Nowhere, however, does he explain how the state is more rational and better informed, and why we should expect it to promote some common interests—instead of, say, favoring its cronies. Moreover, the proliferation of laws and regulations, which Tanzi himself criticizes, must generate tremendous asymmetric information—not to speak of political deceits, which are in the interest of politicians.
Tanzi repeats the oft-cited statistics on how income has become more unequally distributed during the past three decades in developed countries. He focuses on relative shares instead of the absolute levels of income, and probably underestimates the growth in middle class incomes. (See “The Unintended Case for More Capitalism,” Fall 2014.) He neglects the many legitimate reasons that have influenced recent trends in the distribution of income, such as rapid technological change or, as research indicates, changes in the marriage market. Whom people choose to marry (assortative mating has been on the rise: physicians marry physicians instead of nurses) and how many people remain single may explain one-third of the increase in the Gini coefficient, according to recent research.
Another factor in growing income inequality lies in the actions of the state itself, as we have seen in the case of intellectual property. Tanzi also recognizes that cronyism—the state helping large corporations at the detriment of consumers, for example—has fueled income inequality. But he continues to focus on the need for new government interventions as if the state could be termite-free.
In his view, negative externalities are another huge class of market termites. Negative externalities, we may recall, are costs that bypass the market and are shifted to people without compensation. Air pollution is a standard example; antibiotic resistance is an even clearer case. Externalities are usually defined to exclude non-physical and (in some sense) non-significant effects. The mere awareness of what is happening to others is generally not considered an externality, nor is the lighted cross on your property that your atheist neighbor may deem to be photon pollution. Extending the concept of externalities renders it useless, especially because private property is precisely a means of reducing negative externalities in society. Anybody can do what he wants on his own property, except for significant physical spillovers onto somebody else’s private property.
But Tanzi adopts a very wide concept of externalities, which includes “psychological” and “aesthetic” ones: things that some people don’t like to see, or negative perceptions even if mistaken (that some foods are not safe, for example). He views relative poverty and the envy it generates as a negative externality: “the spending habits of some of today’s rich and super rich … are likely to create externalities of a psychological nature,” he writes. By making differences in wealth more visible, the new communication technologies have multiplied this envy externality. The state must thus intervene against this “market failure.”
The distribution of income has become more equal over the whole world. Shouldn’t everyone across the political spectrum be happy about this?
If we follow Tanzi’s approach, greater social complexity multiplies negative externalities that call for government intervention. In The Road to Serfdom, Hayek objected to Mussolini’s statement that “the more complicated the forms assumed by civilization, the more restricted the freedom of the individual must become.” On the contrary, Hayek argued, it is because, and to the extent that, society is free that it can become complex. Tanzi borrows Mussolini’s quote from Hayek but opines that “we must recognize, though we may not wish to accept” the idea it conveys. In practice he often seems to accept it, which I think is not warranted.
Bleeding hearts / Tanzi frequently repeats that laissez-faire is not a solution. He seems to want both a not-too-intrusive state and a state that corrects everything that “society” thinks is wrong.
Focused on the distribution of income in rich countries, Tanzi plays down a stunning story of the past few decades: thanks to liberalization and trade, many poor countries have started to grow. The proportion of the world population living in extreme poverty has fallen from 42% to 11% between 1981 and 2013, according to World Bank data. The distribution of income has become more equal over the whole world. Shouldn’t everyone across the political spectrum be happy about this? Wasn’t dire poverty a huge negative externality à la Tanzi?
I have other quibbles with Termites of the State. The author claims that the move of manufacturing to less developed countries “has led to the deindustrialization of advanced countries.” This is an exaggeration. What happened is that traditional “dirty” manufacturing has moved to poor countries and been replaced in developed countries by more sophisticated, automated, and efficient manufacturing. Higher productivity has reduced manufacturing employment since the early 1950s in America, but it has also increased manufacturing output. Official federal figures show that America’s real manufacturing output has nearly tripled since 1972. Value added in manufacturing, which measures the sector’s contribution to GDP, is up 40% in real terms since 1997 (the first year available for this series) despite the dip caused by the Great Recession.
Which presumption? / Tanzi’s favored policies to reduce income inequality include a more redistributive tax system and a basic minimum income, besides the good but underplayed idea of abandoning the state’s activities that fuel inequality. In the last chapter of the book, he invokes “the new wisdom for a new age” that Keynes was calling for in The End of Laissez-Faire (1926). This new wisdom, writes Tanzi,
would allow both democracy and the market to continue to operate closer (in reality and not just in theory) to the way they should ideally operate. … Wise experts, from different disciplines, should focus on generating that wisdom.
Tanzi, it now seems, is after an ideal state that will bring about the ideal market: the ideal fox in the ideal henhouse. And we will owe this nirvana to the rule of experts? This is not consistent with the skepticism toward the state that Tanzi showed at the beginning of the book.
The author of Termites of the State entertains a strong presumption for the state. I would argue the exact opposite: we should defend a strong presumption for individual liberty and only accept state intervention when it is indispensable to protect liberty, to produce other public goods narrowly conceived, and to combat narrowly defined negative externalities. Strictly limiting the state is a condition for liberty.
