Markets for Secrets?

In a world without intellectual property, would it be possible to buy and sell secrets? I suggest the answer is yes. In this post, I provide both a theoretical framework for such markets, as well as pointing to real life examples of such markets already existing.

Introduction

In a previous post, we talked about why information is the only public good. But of course, it’s possible to keep information private. Such private information is called a secret. Currently, entrepreneurs and inventors have two choices when they have what they believe is a profitable secret: they can either keep recipe, industrial process, or so on, a secret, and be protected by “trade secret” laws; or they can “publicize” their secret in exchange for a patent (which they can use to either issue injunctions against competitors or to extract royalties).

But there has been a lot of economics literature in recent years that challenges the status of intellectual property (IP). Most famously, there is Michele Boldrin and David K. Levine’s book Against Intellectual Monopoly, where they detail both an empirical and theoretical case against the economics of intellectual property. Furthermore, patent lawyer Stephan Kinsella’s book Against Intellectual Property gives a principled legal and ethical case against IP.

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Physical Goods, Immaterial Goods, and Public Goods

Public goods in economics have been a contentious theoretical issue since Paul Samuelson introduced the concept in 1954. The main sources of contention are what real world things are public goods, and who should provide them. In this post I propose a new way of looking at goods that will shed light on why public goods have posed such a problem. In particular, I propose that there is an important distinction between physical goods and immaterial goods; that public goods can only be immaterial goods; and that this unique feature of public goods does not preclude the market to provide the “socially optimal level.

Introduction

Economists define a public good as something that is “non-rival” (meaning that one person’s consumption does not affect another person’s), and “non-excludable” (meaning that one person cannot stop another person from consuming the good.) Public goods are often contrasted with private goods, which are rival and excludable.

The implications are that public goods cannot be provided by a free market, because no one would have to pay for such a good, and so there would be so incentive to produce it. Therefore, the argument goes, the government ought to provide public goods.

Features_of_goods

An example of a private good is an apple. Imagine a world with just you, me, and an apple. If I take a bite out of the apple, there is now less apple for you to consume. That means it’s rival. If I put the apple in a locker to which only I know the combination, then again you are prevented from consuming the apple. This makes it excludable.  Continue reading

The Economics of Hard Choices

In economics, there are two types of numbers that we use. Cardinal numbers express amounts. For example, “one”, “two”, “three”, etc. are all cardinal numbers. You can add them, subtract them, or even take them to an exponent.

Money prices are cardinal, which is why you can calculate precise profits and loss.

On the other hand, ordinal numbers express ranks. For example “first, “second”, “third”, etc. are all ordinal numbers. It doesn’t really make sense to talk about adding (or subtracting or exponentiating) ranks.

Almost all economists believe that utility is ordinal. This means your preferences are ranked: first most preferred, second most preferred, and so on. Here is a made up value scale:

1st. Having a slice of pizza
2nd. Having $2 in cash
3rd. Having a cyanide pill

Someone with the above preferences would give $2 in cash in order to get a slice of pizza. But would rather keep their $2 than to have a cyanide pill. By the same principle, they would also prefer to have a slice of pizza to a cyanide pill.

This is in contrast to cardinal utility, which requires the existence of something like “utils”. It’s just as nonsensical to say that “Sally gets twice as many utils from her first preferred good than the next best thing,” as it is to say “I like my first best friend twice as much as my second best friend.”

Usually, this is where most discussions of ordinality as it applies to economics end. But I believe I have a new extension of this concept that affect utility theory.

A New Perspective on Ordinal Preferences

Some people are dissatisfied with the ordinal approach to utility. “Sure, I prefer pizza over cyanide,” they’ll say, “but I really, really prefer pizza. You can’t show this intensity of preferences ordinally!” In other words, they believe the ordinal approach is lacking something real that a cardinal approach could approximate.

Well, it’s true that in a specific moment when I observe you choosing pizza over cyanide, I can’t really tell “how much” you preferred it.

But one way I can model it is that in your mind, you have a value scale of all things you wanted in that moment. And that the thing that you “really, really” wanted is ranked “much, much” higher relative to the other thing.

Let’s say pizza was first on your value scale, and cyanide was 1000th. So while it’s wrong to say you preferred pizza “one thousand times” as much as cyanide, it would be correct to say you would have preferred 999 other things to cyanide.

In other words, you would rather have any one of these 999 other things instead of instead cyanide—with pizza being chief among them. This is the sense in which you “really, really” prefer pizza to cyanide. We’ve been able to express the “intensity” sentiment without resorting to cardinal numbers.

Let’s extend the example. If your choice was between pizza and sushi, and sushi was your 2nd ranked good, then we can say several equivalent things: (i) you’re closer to indifference (i.e., viewing them as the same good) between pizza and sushi than pizza and cyanide; (ii) your preference for pizza over cyanide is stronger than your preference for pizza over sushi; (iii) you prefer pizza less intensely to sushi than to cyanide; and (iv) it’s easier for you to choose between pizza and cyanide than it is to choose between pizza and sushi.

Of course, we don’t walk around with an exhaustive list of all the goods we could possibly want at any time. This fact may make it virtually impossible to empirically test this account of psychology. But this way of thinking about “intensity of preferences” is at least consistent with ordinal preferences, meaning we can better understand this phenomena using mental tools we’re already familiar with.

I believe this way of thinking is also useful in interpreting “hard choices”. Everyone is familiar with being in a situation where you don’t know what to choose between to seemingly attractive alternatives. An easily relatable example might be choosing a drink at the self-serve cola machines that are in most fast food restaurants now. You might really like both Vanilla Coke and Cherry Coke, but you can only choose one. Because you feel as though you like both of them equally, this is what makes it a hard choice.

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In other words, I’m proposing the reason that this is a hard choice is because these two goods are positioned very close together on your value scale. So close, in fact, that you have a difficult time determining which outranks the other. This is what makes the choice hard.

Applications of this framework

You might object. “This might be fun to think about, it might even be a contribution to psychology. But what implication does this have for economics—that is, the science of human action?”

My answer is this: when presented with a difficult choice, a person will choose to wait instead of choosing instantly. Waiting allows them to collect more information, deliberate more, and consider other options.

(More formally: a person facing a choice between two goods that are indistinguishably close on their value scale will not choose either good in the present period; instead, they will postpone the choice to a future period where they expect to have a larger information set.)

How can we apply this framework to the real world? Before we begin, note well that hesitation is itself an action. And as an action, it has a place on the individual’s value scale. For an entrepreneur, this has at least two implications.

First, the entrepreneur’s consumers may be facing hesitation because they can’t choose between the goods on sale. Think back to the cola examples. It’s possible that you’re in such a rush that the hesitation is not worth your time. The consumer may choose not to buy cola at all.

Second, I believe this approach can shed new light on the issue of so-called “transfer pricing”. While transfer pricing typically is used in the context of tax ramifications to a firm that is trying to buy or sell assets from a subsidiary, we can generalize the concept by considering how a either a very large firm that has “horizontally integrated” by buying and selling inputs for its final product from itself, either because it has grown so large that it’s merged with all its competitors and suppliers, or it has a government monopoly where no other firm is allowed to produce that input. In short, if a firm has monopolized the production of inputs to the extent where no market prices exist for them, how should he calculate his own costs (and therefore profits)?

Murray Rothbard was the first to observe that in effect a firm that has grown so large where this is a problem has become a socialist economy. And just as how a socialist economy can’t produce efficiently without market prices, neither can this hypothetical firm. (For more on this point, see pp. 659-660 of Murray Rothbard’s Man, Economy, and State with Power and Market.)

And so while the standard story of why a socialistic economy can’t rationally calculate profits and losses is based on the cardinal notions of money—without money prices, you literally cannot subtract costs from revenues—I approach from a different angle. Namely, action becomes “harder” because the lack of a market does not allow the firm (or socialist government) to observe its own ordinal rankings for its inputs. And so, the firm faces a “hard choice” in how to optimize its own production schedule.

Firms and governments also demonstrate that they’re engaging in hard choices, by establishing bureaucracies. Firms hire “transfer pricing specialists”, governments set up councils that “determine” prices, and so on. This is analogous to an indecisive person hiring a consultant to help them pick between Vanilla Coke and Cherry Coke.

Conclusion

In summary, a “hard choice” is when a person cannot distinguish where two heterogeneous goods rank on their own value scale. This can be demonstrated through hesitation and/or deliberation. The harder it is to establish a market price for goods, the more hesitation and deliberation will be required.

I believe this approach, if correct, can be insightful for both entrepreneurs and research. A new question that is raised is, “how do individuals, firms, and governments respond under different circumstances when faced with a hard choice?”

In a future post, I hope to extend this framework of ambiguous ordinal rankings to probabilities as well. In the meantime, I look forward to any feedback on this post.

 

A Right is Not an Obligation

Precision of language in matters of science is important. Speaking recently with some fellow libertarians, we got into an argument about the nature of rights. My position: A right does not obligate anyone to do anything. Their position: Rights are the same thing as obligations.

My response: But if a right is the same thing as an obligation, why use two different words? Doesn’t it make more sense to distinguish them?

So here are the definitions I’m working with. A right is what is “just” or “moral”, as those words are normally defined. I have a right to choose which restaurant I want to eat at.

An obligation is what one is compelled to do by a third party. I am obligated to sell my car to Alice at a previously agreed on a price or else Bob will come and take my car away from me using any means necessary.

Let’s think through an example. Under a strict interpretation of libertarianism, a mother with a starving child does not have the right to steal bread from a baker. But if she does steal the bread, then what? Do the libertarian police instantly swoop down from Heaven and give the baker his bread back?

Consider the baker. The baker indeed does have a right to keep his bread. But he is no under no obligation to get his bread back should it get stolen. The baker could take pity on the mother and let her go. Or he could calculate the cost of having one loaf stolen is low to expend resources to try to get it back.

Let’s analyze now the bedrock of libertarianism, the nonaggression principle (NAP). There are several formulations. Here’s one: “no one has a right to initiate force against someone else’s person or property.” Here’s a more detailed version, from Walter Block: “It shall be legal for anyone to do anything he wants, provided only that he not initiate (or threaten) violence against the person or legitimately owned property of another.”

A natural question to ask is, what happens if someone does violate the NAP? One common answer is that the victim of the aggression then has a right to use force to defend himself. But note again, the right does not imply an obligation. Just because someone initiates force against you, does not obligate you or anyone else to respond. Pacifism is consistent with libertarianism.

Consider another example. Due to a strange series of coincidences, you find yourself lost in the woods in the middle of a winter storm. You come across an unoccupied cabin that’s obviously used as a summer vacation home. You break in, and help yourself to some canned beans and shelter, and wait out the storm before going for help.

Did you have a right to break into the cabin? Under some strict interpretations of libertarianism, no. But even if this is true, all it means is that the owners of the cabin have the right, but not obligation, to use force to seek damages from you after the fact. (They also had the right to fortify their cabin in such a way that you would have been prevented from ever entering.) But they may never exercise that right; you could ask for forgiveness and they might grant it.

Furthermore, under a pacifist anarchocapitalist order, the owners might not even use force when seeking compensation. They might just ask politely; and if they don’t like your excuses, they’ll simply leave a negative review with a private credit agency (making harder for you to get loans, jobs, etc.).

The nonaggression principle, insofar as it is strictly about rights (and not obligations), is about justice. It is not about compelling people to do anything. Hence, I propose a new formulation of the NAP: using force to defend yourself from initiations of force can be consistent with justice.

This formulation makes clear that using force is a choice. Initiating force does not obligate anyone to do anything. “Excessive force” may be a possibile injustice.

In short, justice does not require force.

A Tax is Not a Price

Auto_stoped_highwayAccording to The Economist, the latest US federal budget includes incentives for “congestion pricing” of roads.

Ostensibly, this is about reducing congestion. But some municipalities like the idea of charging for roads because it represents a new revenue stream. This creates an incentive to charge a price above cost. When a firm does this, we call it a “monopoly price.”

But when a government monopoly forces you to pay a fee to use a good or service, do not call it a price. It is a fee that a government collects by fiat. In other words, it is a tax.

A price is a voluntary exchange of money for a good or service. The emphasis on voluntary is important, because it is this aspect of the price that enables economic calculation for what people really want.  Even a free market “monopolist” (however unlikely or conceptually vague it may be) engages in voluntary exchange.

On the other hand, a bureaucrat “playing market” by imposing fees on government-controlled goods and services will not have the same results as a market process. For starters, unlike a person making decisions on their own behalf, a government bureaucrat has to guess at costs. Under a voluntary system, a cost is the highest valued good or service you voluntarily give up in order to attain a goal. But the bureaucrat is dealing with other people’s money.

To “objectively” determine costs, in order to set “fair” prices, is a chimera. In the words of Ludwig von Mises, “[a] government can no more determine prices than a goose can lay hen’s eggs.”