Good morning! Labas rytas!

     I am pleased to be talking to you today about apparatchik economics.

     This is a special personal occasion for me, because it was ten years ago, back in 1993, that I finished a year of teaching economics in Latvia. During that year I visited the Lithuanian Free Market Institute several times. I also participated at a week-long seminar for students here in 1995. So I am glad to be back in Lithuania and renew friendships I established as well as to meet new freedom seekers.

     I don't think I need to explain what "apparatchik" means to those of you who lived inside the Iron Curtain before its collapse. In the Soviet Union, an "apparatchik" was a member of the government, especially a loyal subordinate of an organization or a political leader.

     The Russian term "apparat" was derived from the German term meaning a political organization, in turn taken from the Latin "appartus" meaning preparation. The word "apparatus," from the same root, means the instruments needed for a specific use, or a system designed to achieve some desired result. So, "apparatchik economics" designates the apparatus approach common in conventional economics, where the analysis consists almost entirely of examining how various policy instruments achieve some result within the existing governmental policy structure.

     Every economy on earth today is apparatchik. And, unfortunately, economics as most economists practice it today, is also apparatchik.
     The main reason we don't have free markets today is that the public, the politicians, and even the economists are blinded by apparatchism.

     So to move towards a future of free markets and free societies, we need to understand how economics today is hobbled by apparatchism, and how we can free economic science from its crippling constraints.

     Apparatchik economics is incomplete, since the apparatchiki not only ignore methods that are not so widely practiced, but also do not question the existing and conventional premises and institutions.

     Apparatchik economists seek optimal solutions within the current systems but do not investigate whether entirely different systems would be better or worse.

     As we know, all economies today have massive amounts of government socialist ownership and intervention. And, if you consult economics textbooks and published research and theory, these texts are almost all apparatchik. They treat the existing governmental structures like facts of nature, and any questions or debates are about variations of interventionism. Even worse, apparatchik economics misrepresents markets. Students get a distorted picture of how markets work, and this gets propagated to the public.

     To remedy this problem, my colleague at Santa Clara University, Prof. Daniel Klein, has founded a new online journal called Econ Journal Watch. I am an associate editor of the journal. One of our aims is to review the economics literature and point out the apparatchism of academic articles.

     Dan Klein also originated the Aapparatchik@ designation, and I personally will be dealing with the apparatchism of economic writing on public finance.

     I will illustrate apparatchik economics with some examples. I think the clearest example is in money and banking.

     As most of you know, most countries today have central banks, such as, in the United States, the Federal Reserve system. The central banks issue and control the money, which in all economies today is fiat. Fiat money is there by government command, rather than being based on some commodity. Just as God declared "let there be light," government declares "let there be money," and poof! government creates money out of nothing.

     But the universal use of fiat money created by government central banks is rather new in human history. It goes back only to 1971, when the U.S. formally ended the international convertibility of the U.S. dollar into gold.

     An alternative to central banking is either currency boards or free banking. Some countries, such as Estonia and Lithuania, have based their money on the currency of some other country. A currency board holds reserves in the other currency and converts it to the local currency at a fixed rate. But the other currency is fiat money issued by a central bank, so ultimately all currencies are central-bank-created fiat monies.

     Several countries, including Scotland, Sweden, and Canada, once had free-market banking, or free banking. With free banking, there is a base money such as gold, and the private banks issue money substitutes such as bank notes and checking accounts, redeemable into gold. Money supplies along with interest rates are then determined by the market rather than being manipulated by central banks.

     Now, if you look at how money and banking are treated in textbooks and the academic literature, almost all presume the existence of fiat money and central banking.

     They apparatchikly analyze policy options within this system, such as having the central bank expand the money supply according to some fixed rule, or else by discretion in response to varying economic conditions. But the policy of not having a central bank at all, and leaving money and banking entirely to the market, is completely missing from these texts.

     Yet, free banking is not only a theoretical possibility, but was actually practiced historically. Free-market economists, especially of the Austrian school, have analyzed how central banking and fiat money have inherent problems.

     Central banks create distortions in interest rates that destabilize an economy. There is no possible way to fix this within the apparatchism of central banking because, aside from political pressures that influence monetary policy, the optimal growth of the money supply is utterly unknowable. Only the market can equilibrate interest rates to sustainably balance savings and investment, consumption and investment.

     The problems with fiat money are better known, as fiat currencies world wide have been plagued by costly fluctuations, inflation, devaluations, and even collapse.

     So by not confronting free banking, economics text fail to provide the full spectrum of economic theory. Because the free-market part of the theory spectrum is missing, even scholars remain ignorant of policy options that would result in more stability and prosperity.

     The same applies to other fields. For international economics, apparatchism seeks to examine how for example the International Monetary Fund functions, and how it could function better. But the full spectrum of international economics would go further and examine whether the IMF should exist at all, whether the world would be better off without an IMF.

     In my specialty, public economics, there are two phenomena that are almost always handled in an apparatchik way in economics texts.

     First is externalities, or external effects.

     An externality is an uncompensated cost or benefit to others.

     Pollution is the prime example of a negative externality, imposing a cost on others.

     What is a market in its purity? The pure free market does not mean "anything goes." In a pure market, all activity is voluntary for everyone in the economy. The meaning of voluntary human action is that a person may do anything that does not coercively harm others. So long as one does not invade the domain of others, there is no legal restriction or cost imposed on human action. That implies that there be no tax on human action: no sales tax, no income tax, no value added tax. As libertarians say, taxation is theft.

     The meaning of what is voluntary is determined by an ethic, a set of moral rules that tells us which acts are evil or wrong and which are not wrong. In a free society, a society with liberty, all acts which are not morally evil are unrestricted and untaxed.

     This ethic, that gives the market its meaning, applies universally to all humanity. Where does this universal ethic come from? As the natural-law philosopher John Locke stated, this law of nature comes from two premises of human nature, our equality and our independence. Human beings think and feel as individuals, and thus have subjective values, and there is nothing inherent in human nature that makes some masters and others slaves, so that by default there is a moral equality of worth among human beings, giving us equal moral rights.

The universal ethic has three basic rules:

1) Acts which are welcomed benefits are morally good.

2) Acts which invasively harm others are morally evil.

3) All other acts are morally neutral.

     The universal ethic determines what are our natural rights. We have the natural right to do anything that is not evil. Evil consists of an invasion into another's domain, coercively harming others. This harm is distinct from a mere offense, for which there is no invasion. So if one is offended by speech, or someone's religious practice, or by nakedness, or gambling, or prostitution, or the consumption of alcohol or drugs, by the universal ethic, that offence is, by the universal ethic, morally neutral, and the act is not restricted in a free society.

     We can thus see that to truly, truly, truly understand, what a free market means, is not a simple thing. It requires a deep understanding of ethical as well as economics, and it has to be a full spectrum understanding and not a constricted apparatchism.

     We can now see what's wrong with the apparatchik view of externalities. In a pure market, pollution is recognized as an invasion into the domain of others, a coercive harm that is not voluntary to the victim, and therefore requires compensation. The compensation payment internalizes the cost, so it is not no longer an external effect. So where uncompensated pollution exists, it is not a failure of a non-existent free market, but rather the failure of government to let the victims be compensated.

     The other major misunderstanding in public economics is public goods, those which are being used collectively. Apparatchik doctrine tells us that the market fails to adequately provide public goods, because once the good is there, users can be free riders. People can benefit from a park or street or public safety without paying for it, because there is no practical way to exclude them. So, say the apparatchiks, government must tax people to force them to pay their fair share.

     What conventional, mainstream, apparatchik theory overlooks here is the simple fact that the public goods typically provided by government exist in physical space, rather than in ether.

     This has two implications. First, most users are not free riders. They pay for these public goods in the extra rent and land value they must pay for. If the users are wage-taxed to pay for the goods, they get double billed. First they have to pay taxes out of their wages to finance the goods, and then they have to pay extra rent.

     Secondly, the extra rentals generated by these collective goods provides the means by which entrepreneurs can amply provide these services, in a market.

     Indeed, this is precisely how entrepreneurial private communities finance their collective goods. The hotels we are staying at are a prime example. They provide collective goods such as the hotel lobby, security, recreation, transit, pathways, and the common elements of the building by charging a rental. Condominiums, residential associations, and shopping centers are other examples where the same principle is applied.

     Full spectrum public finance therefore not only concludes that there is market success in public goods but that public finance theory itself should apply as well to the finances of entrepreneurial communities along with governmental operations.

     Moreover, we can see here a big difference between the financing of private communities and of government.

     Private communities are voluntarily financed by basing the fee on benefits. The benefits are reflected in the rent that tenants are willing to pay.

     Governments are financed by force based on ability to pay, meaning government's ability to extract. Taxes on income, sales, and value added have no direct relation to any benefit.

     Governments could act more like private communities if they at least financed their services according to the benefit principle. Since land value reflects the capitalized benefits, a tax on land value would at least pay back land values generated by civic goods, and without imposing the excess burdens caused by taxes on capital and labor. Since the land has a fixed supply and has no cost of production, charges based on land value do not hurt productivity.

     But, unlike classical economists such as Adam Smith and David Ricardo, apparatchik economists ignore the important role of land in the economy. They claim that land rent is a tiny portion of gross domestic product. Why do they say this? Because national income accounts say this. Who calculates GDP? Government. So we have bad apparatchik doctrine based on false and misleading government data! Even free-market economists have been fooled!

     Unfortunately the Baltic states and the other countries in the former Soviet empire have adopted dysfunctional western tax systems, taxing income, sales, value added, and enterprise. This has limited the full flowering of the economies of Lithuania and other misdeveloped states. The economy of Russia and some of the other former Soviet republics have been crippled by apparatchik fiscal policies.

     There are other examples of apparatchik economics I can mention briefly.

     Many agricultural economists claim that some government intervention is beneficial, especially support for research, government-provided financial credit, protection against fluctuations in prices, governmental crop insurance, export subsidies, help for small farmers, the preservation of farm land from urban development, and agricultural colleges.

     Apparatchik environmental economists think command and control policies are effective in protecting wild species, including bans on products such as ivory, and the establishment of governmental parks that exclude human activity. Full-spectrum environmental economics would recognize the benefits from the property rights to wildlife such as elephants, and the benefits of economic incentives, such as revenue to locals from environmental tourism.

     The economics of transportation is dominated by the statist presumption that highways, airports, bridges, and urban transit should be governmental operations, and that there need to be governmental subsidies for rail and other transport services as well as for transportation research.

     Dan Klein and I recently co-edited a book, The Half-Life of Policy Rationales, just published this year, which shows how advancing technology is making more and more goods such as highways, electricity, and water better able to be provided by private enterprise as costs decrease and property rights can be better enforced.

     I think a free market has always been possible and optimal, but our case for economic freedom is strengthened by new technology that makes private enterprise more effective and at the same time, makes government less effective as the economy becomes ever more complex.

     Apparatchism extends beyond economics into political science. The field of public choice in economics recognizes that political incentives lead to privilege and subsidy seeking by special interests with concentrated benefits, with voters having little incentive to gain better knowledge in order to resist being exploited. But public choice itself has been somewhat apparatchik in studying such problems as they exist with current centralized governments elected via mass voting.

     Full-spectrum public choice theory would include the antidote to rent seeking: shifting from mass democracy to voting only in small groups. Just as the building blocks of the human body are cells, the governmental body is best divided into tiny local cells. Power would flow bottom up from neighborhood cells to cities and then to provinces and finally a national or continental legislature. Free market economics must therefore recognize the political basis in which a free market can operate. It is a contradiction to advocate a free market in the context of a mass democracy in which it cannot operate.

     The economies of the former Soviet empire have emerged from totalitarian apparatchism to copies of the mixed economies of North America and Western Europe. That has been a major movement towards freedom.

     But to continue on the path to freedom, we need to go beyond the apparatchism of economics, ethics, and political theory as taught and practiced today. We need to go to a full spectrum understanding. In particular, these are the elements that will bring us to freedom:

1. In ethical philosophy, an understanding of the universal ethic that provides the meaning of the market.

2. In governance theory, the public choice analysis of radical decentralized democracy.

3. In economics, the recognition that civic services generate land rent, and that free-enterprise can use this rent to finance public goods, eliminating the justification for taxation.

     Lithuanians and their neighbors have blindly copied not just western statist institutions but also western apparatchik economics. But it is in countries such as Lithuania, where people suffered under a totalitarian apparatchism imposed by force from the outside, that the less obvious western apparatchism can best be appreciated. So I think this forum at the ISIL conference here in Lithuania, has been the perfect opportunity for us to turn around not just the economies of this region but to liberate economics itself from the clutches of apparatchism.

Fred E. Foldvary
Dept. of Economics, Santa Clara University, California 95053, USA
ffoldvary@scu.edu