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1967 - The Welfare Costs of Tariffs, Monopoly, and Theft - WEJ

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THE WELFARE COSTS OF TARIFFS, MONOPOLIES,

AND THEFT

GORDON TULLOCK

RICE UNIVERSITY

In recent years a considerable number of studies have been published

that purport to measure the welfare costs of monopolies and tariffs.’ The

results have uniformly shown very small costs for practices that economists

normally deplore. This led Mundell to comment in 1962 that “Unless there

is a thorough theoretical re-examination of the validity of the tools upon

which these studies are founded... someone will inevitably draw the

conclusion that economics has ceased to be important.”’ Judging from

conversations with graduate students, a number of younger economists are

in fact drawing the conclusion that tariffs and monopolies are not of much

importance. This view is now beginning to appear in the literature. On

the basis of these measurements Professor Harvey Leibenstein has argued

“Microeconomic theory focuses on allocative efKciency to the exclusion

of other types of efiiaencies that, in fact, are much more significant in

many instances.”’

It is my purpose to take the other route suggested by Mundell and

demonstrate that the “tools on which these studies are founded” produce

an underestimation of the welfare costs of taras and monopolies. The

classical economists were not concerning themselves with trifles when

they argued against tariffs, and the Department of Justice is not dealing

with a miniscule problem in its attacks on monopoly.

STATICS

The present method €or measuring these costs was pioneered by Professor

Harberger.‘ Let us, therefore, begin with a very simple use of his diagram

to analyze a tariff. Figure 1 shows a commodity that can be produced

‘These studies are convenientlv listed with a useful table of the welfare losses computed in

each in Harvey Leibenstein, “‘hocative Efficiency vs. ‘X-Efficiency’,” Am. Eron. Rev., June

1966, 56, 392-41s.

a. Mundell, Review of L. H. Janssen. Free Trade, Protection and Cns:oms Union, Am.

Eron. Rev., June 1962, 52, 622.

‘Op., p. 392. In this article Leibenstein consistently uses the phrase “allocative efficiency”

to refer sokly to the absence of tariffs and monopolies.

‘A. C. Harberger, “Using the Resources at Hand Mote Effectively,” Am. Econ. Rev., May

1959, 49, 134-46 should be noted that Harberger suggested the method for the measurement

of the welfare costs of monopoly, but its extension to cover tariffs was the work of other scholars.

The more careful scholars who have measured the welfare costs of tariffs have not all used this

very simple application of Harberger’s method, but a method such as illustrated in Figure 2.

I have chosen to begin with this method of measurement partly because it simplZa the expo-

sition and partly because this procedure is the “conventional wisdom” on the matter. CCf.

Leibenstein, op. rit.)

224

TULLOCK: WELFARE COSTS Q

domestically at the constant cost of Pi and imported at Po. With the given

demand and no t a d Qo units will be purchased at a price of Po. If a

prohibitive t a r 8 is imposed Q i units will be bought at a price of P I. The

####### increase in price, it is argued, is merely a transfer from some members of

the community to others, and the only welfare loss is consequently the

shaded triangle. The studies purporting to measure the welfare costs of

####### taras have simply computed the value of this triangle. From the geom-

etry it is fairly obvious that the amount would normally be small.

Price Quantity

There are a considerable number of costs that are ignored by this

procedure. As a starter, collection of a tarif3 involves expenditure on customs

inspectors, etc., who do the actual collection and coast guards who prevent

smuggling. Further, customs brokers are normally hired by the shipper

to e t e the movement of their goods through customs Normally we

pay little attention to collections costs because they are small, but in this

case they may well be larger than the welfare triangle which is also small.

####### Thus by simply adding in collection costs we significantly increase the

####### “social cost” of the tarif€.

####### For a more si@cant criticism of this method of measuring the welfare

####### cost let us apply the procedure to a standard excise tax instead of a tariff.

####### Assume that Figure 1 shows a constant supply cost and a declining demand

for some commodity in some country. Qo units are bought at a price, Po.

Now suppose that a tax is imposed, raising the price to Pi,and reducing

sales to Q,.The welfare cost of this tax is measured by the shaded triangle.

But suppose further, that the revenues raised by this tax are completely

wasted, building tunnels, for example, which go nowhere. Now the social

Strictly speaking, the customs brokerage should be added on to the tax thus producing a larger welfare triangle.

TULUMC: WELFARE COSTS 227

Do

'llart Figure 2 Domesticproduction cost Tariff Foreign Price T, Po Commodity

Let us, however, consider the situation in which there is some domesbc

production before the imposition of a tarif€. Figure 2 shows a commodity

part of the consumption of which is imported and part produced domes-

tically. The supply elasticity of the commodity from foreign sources is

assumed infinite, but domestic production is carried on in conditions of

increasing costs. Without the tarif€,the price is Po, domestic producers

turn out Do units and Qo - Do units are imported to make up the tota

consumption of Qo. Suppose now, that Mr is prime minister and

imposes a tar8 on imports and an excise tax of the same amount on do-

mestic production. With the new price, PI, consumers will want only QI

units, and the shaded triangle measures the excess burden. Domestic

production will remain Do, but imports will shrink from Qo - Do to

QI - Do. The government will receive a tax revenue equivalent to the

entire redangle bounded by the two price lines, the vertical axis and QI.

Let us now change our example by assuming that the domestic excise

tax is repealed, so that we have only a protective tariff. Domestic consump

tion and price would remain the same, but domestic production would

expand to D, and imports would shrink accordingly. There would be an

inefficient use of resources in producing things which would be better

imported represented by the dotted triangle. Governmental revenues would

shrink to the rectangle marked Taand the owners of the resources in the

domestic industry would receive an amount of resources equal to the area

of the trapezoid T,.' Clearly the social cost of the tariff is not just the

shaded triangle, but also the dotted triangle which shows a net waste of

resources in inefficient production.

####### 'See J. Wemclsfelder, "The Short Turn Effect of the Lowering of Import Duties in Germany,"

fion. JOYC., Mar& 1960, 70,94104.

228 WESTERN ECONOMIC JOURNAL DYNAMICS: THE COST OF TRANSFERS

The trapezoid T,,however, would appear to be a pure transfer, and

####### hence not to be included in the computation of the cost of the tariff. Strictly

####### speaking this is so, but looking at the matter dynamically, there is another

####### sociai cost involved, and its magnitude is a function of the size of this

####### transfer trapezoid. Generally governments do not impose protective tariffs

on their own. They have to be lobbied or pressured into doing so by the

####### expenditure of resources in political activity. One would anticipate that

####### the domestic producers would invest resources in lobbying for the t a r 8

until the marginal return on the last dollar so spent was equal to its likely

return producing the transfer. There might also be other interests trying

####### to prevent the transfer and putting resources into influencing the govem-

####### ment in the other direction. These expenditures, which may simply offset

####### each other to some extent, are purely wasteful from the standpoint of

####### society as a whole; they are spent not in increasing wealth, but in attempts

to transfer or resist transfer of wealth. I can suggest no way of measuring

####### these expenditures, but the potential returns are large, and it would be

####### quite surprising if the investment was not also sizable.

####### Monopolies involve costs of a somewhat similar nature, and it follows

that I will not be able to produce a method to measure their social costs.

I will, however, be able to demonstrate that the welfare triangle method

####### greatly underestimates these costs. The argument is customarily explained

####### with the aid of a figure like Figure 1. The monopolist charges the monop

oly price P1 instead of the cost Po for the commodity, and consumption

is reduced from Qo to Q l. The welfare triangle is a clear loss to the commu-

####### nity but the rectangle to its left is merely a transfer from the consumers

####### to the owners of the monopoly. W e may object to the monopolist getting

rich at the expense of the rest of us, but this is not a reduction in the

####### national product.

####### In order to demonstrate that this line of reasoning ignores important

costs, I should like to take a detour through the economics of theft."

####### Theft, of course, is a pure transfer, and therefore might be assumed to

have no welfare effects at all. Like a lump sum tax, it produces no welfare

####### triangle at all, and hence would show a zero social cost if measured by

####### the Harberger method. This would, of course, be incorrect. In spite of the

####### fact that it involves only transfers, the existence of theft has very substan-

####### tiaI welfare costs. Our laws against theft do not deal with a trivial and/or

####### unimportant problem any more than our laws against monopoly.

'The economics of illegal activities is an underdeveloped area, but Harold Demsetz discusses the subject briefly in "The Exchange and Enforcement of Property Rights," ] o w. of L?w and Eron,, October 1964, 7, 11-26. J. Randolph Norsworthy's Doctora! Dissertatiou, A Tbaory of Tax Evasion and Collection, Virginia, 1966, is a more comprehensive examination of one type

####### of illegal activity. Two unpublished items have bcen circulated among a few xholan. Garg

Becker's "A Theory of Government Punishments and Rewards." aad my own Lnu and Morals, the unfinished manuscript of a book which I began four years ago and which has lmguished in draft form for almost all of those four yean.

250 WESTERN ECONOMIC JOURNAL

####### depended upon the resources being invested in attempts at theft by the

rest of the population. When a potential thief invests money, say, in an

improved lock pick, the R curve for people trying to protect their prop-

####### erty moves downward. Similarly, hiring an armed guard to watch your

valuables moves the R curve for potential thieves down. Putting a new

lock on my door reduces the chance that I will be robbed, but whether

the gain will be worth the cost will depend upon the dart the thieves

are willing to put into getting in. Over time the interaction between the

investment in locks, the payoff on lodc picks and the investment in nitro-

glycerine and safes would come to equhbrium.

This eqdibrium, however, would be extremely costly to the society in

####### spite of the fact that the activity of theft only involves transfers. The cost

####### to society would be the investments of capital and labor in the activity of

theft and in protection against theft. If we consider Figure 3 as representing

the entire society instead of individuals, then the social costs would be

the area covered by the rectangle AA’DC. Transfers themselves cost

####### society nothing, but for the people engaging in them they are just like

any other activity, and this means that large resources may be invested in

attempting to make or prevent transfers. These largely offsetting commit-

####### ments of resources are totally wasted from the standpoint of society as

####### a whole.

This lesson has been learned by almost all societies that have adopted

a collective m e t h d of reducing this sort of income transfer. This collective

####### procedure, laws against theft and police and courts to enforce them, can

also be shown on Figure 3. On the horizontal a x i s we now have resources

invested by police and courts, with their opportunity cost shown as a

####### horizontal line. The “protection” given by each unit of resources invested

in these activities is shown by the R line. The society would purchase A

####### amount of protective services, and the total cost would be the usual rec-

####### tangle. The effect of this would be to reduce the expected returns on

####### theft and the savings to be made by private investment in locks, etc. The

new returns are shown by R‘ on Figure 3, and there is a corresponding

reduction in the resources invested in each of these fields to B’. Whether

####### the establishment of a’ police force is wise or not, depends upon an essen-

####### tially technological question. If police activities are, for a range, more

efficient than private provision of protection, then the R line will have

####### the shape shown, and the police and court rectangle will have an area

smaller than the s u m of the two “savings” rectangles, for theft and locks.”

####### This is, of course, what we normally find in the real world.

Note, however, that we do not carry investment in police protection

####### to the extent that it totally replaces private protective expenditures. Clearly

’:It may be suggested that society should not be interested in the saving of the resources of thieves, and hence that the value of the protection afTorded by the police should be measured by the lock rectangle only. This, however, would be correct only to the extent that the resources would not be reallocatah to socially acceptable production.

TULLOCK: WELPARE COSTS 9;

it is more & a a t to have some protective expenditures by the owners of

property. Automobiles are equipped with locks and keys, presumably

####### because the expansion of the police force which could be paid for from

the cost of leaving them off would be less effective in preventing theft than

####### they are.'" The total social cost of theft is the s u m of the efforts invested

####### in the advity of theft, private protection against theft, and the public

####### investment in police protection. The theft itself is a pure transfer, and has

####### no welfare cost, but the existence of theft as a potential activity results

in very substantial diversion of resources to fields where they essentially

####### offset each other, and produce no positive product. The problem with

####### income transfers is not that they directly inflict welfare losses, but that

they lead people to employ resources in attempting to obtain or prevent

such transfers. A successful bank robbery will inspire potential thieves

to greater efforts, lead to ,the installation of improved protective equip-

####### ment in other banks, and perhaps result in the hiring of additional police-

men. These are its social costs, and they can be very sizable.

But this has been a detour through the criminal law, our major subject

is monopoly. To return to Figure 1, the rectangle to the left of the welfare

triangle is the income transfer that a successful monopolist can extort from

the customers. Surely we should expect that with a prize of this size

dangling before our eyes, potential monopolists would be willing to

invest large resources in the activity of monopolizing. In fact the invest-

ment that could be profitably made in forming a monopoly would be larger

than this rectangle, since it represents merely the income transfer. The

capital value, properly discounted for risk, would be worth much more.

####### Entrepreneurs should be willing to invest resources in attempts to form

####### a monopoly until the marginal cost equals the properly discounted return."

The potential customers would also be interested in preventing the transfer

and should be willing to make large investments to that end. Once the

####### monopoly is formed, continual efforts to either break the monopoly or

muscle into it would be predictable. Here again considerable resources

might be invested. The holders of the monopoly, on the other hand, would

####### be willing to put quite sizable s u m s into the defense of their power to

####### receive these transfers.

As a successful theft will stimulate other thieves to greater industry and

####### require greater investment in protective measures, so each successful estab-

####### lishment of a monopoly or creation of a t a r 8 will stimulate greater diver-

####### sion of resources to attempts to organize further transfers of income. In

####### Gladstone's England few resources were put into attempts to get favorable

"James Buchnnan and Gordon Tullodr, "Public and Private Interaction Under Reciprocal k t e d t y , " in Tbc Publir Eronomy of Urban Communities, Julius Maqolis, Ed., Washington, 'The margin here is a rather unusual one. Additional units of resources invested in attempt- ing to get a monopoly do not increase the value of the potential monopoly, but the likelihood of getting it. Thus they change the discount rate, rather than the payoff.

####### D 1964, pp. 52-73.

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1967 - The Welfare Costs of Tariffs, Monopoly, and Theft - WEJ

Course: State and Local Public Economics (ECON 743)

University: West Virginia University

Was this document helpful?

THE

WELFARE

COSTS

TARIFFS, MONOPOLIES,

AND

THEFT

GORDON

TULLOCK

RICE

UNIVERSITY

In recent years a considerable number of studies have been published

that purport to measure the welfare costs

monopolies and tariffs.’ The

results have uniformly shown very small costs for practices that economists

normally deplore.

This

led Mundell to comment

1962

that “Unless there

is a thorough theoretical re-examination

the validity

the tools upon

which these studies are founded

. . .

someone will inevitably draw the

conclusion that economics has ceased to be important.”’ Judging from

conversations with graduate students, a number of younger economists are

in fact drawing

the

conclusion that

tariffs

and monopolies are not of much

importance.

This

view

now beginning to appear in the literature. On

the basis of these measurements Professor Harvey Leibenstein has argued

“Microeconomic

theory

focuses on allocative

efKciency

to the exclusion

of other

types

efiiaencies that,

fact, are much more significant in

many instances.”’

It is

purpose

take the other route suggested

Mundell and

demonstrate that the “tools on which these studies are

founded”

produce

underestimation of the welfare

costs

taras

and monopolies. The

classical

economists were not concerning themselves with trifles

when

they argued against

tariffs,

and the Department of Justice is not dealing

with a miniscule problem in its attacks on monopoly.

STATICS

The present method

€or

measuring these costs was pioneered by Professor

Harberger.‘

Let

us,

therefore, begin with a very simple use of

his

diagram

to analyze a tariff. Figure

shows a commodity that can be produced

‘These studies are convenientlv listed with

useful

table

the welfare losses computed in

each

Harvey Leibenstein, “‘hocative Efficiency vs. ‘X-Efficiency’,”

Am.

Eron.

Rev.,

June

1966,

56,

392-41s.

Mundell, Review of

Janssen.

Free Trade, Protection

and

Cns:oms

Union,

Am.

Eron.

Rev.,

June

1962,

52,

622.

‘Op.

cit.,

392.

this

article Leibenstein consistently

uses

the

phrase “allocative efficiency”

refer

sokly to the

absence

tariffs and monopolies.

‘A.

Harberger,

“Using

the

Resources at Hand

Mote

Effectively,”

Am.

Econ.

Rev.,

May

1959,

49,

134-46.

It should

noted that

Harberger

suggested

the

method for

the

measurement

the welfare costs

monopoly, but its

extension

to cover

tariffs

was

the

work of

other

scholars.

The more careful scholars who have measured the welfare

costs

tariffs

have not

all

used

this

very

simple application of Harberger’s method, but

method

such

illustrated in Figure

I have chosen to begin with this method

measurement partly because it simplZa the

expo-

sition and

partly

because

this

procedure

the “conventional wisdom”

the matter.

CCf.

Leibenstein,

op.

rit.)

224

1967 - The Welfare Costs of Tariffs, Monopoly, and Theft - WEJ

State and Local Public Economics (ECON 743)

West Virginia University

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Preview text

THE WELFARE COSTS OF TARIFFS, MONOPOLIES,

AND THEFT

GORDON TULLOCK

RICE UNIVERSITY

In recent years a considerable number of studies have been published

that purport to measure the welfare costs of monopolies and tariffs.’ The

results have uniformly shown very small costs for practices that economists

normally deplore. This led Mundell to comment in 1962 that “Unless there

is a thorough theoretical re-examination of the validity of the tools upon

which these studies are founded... someone will inevitably draw the

conclusion that economics has ceased to be important.”’ Judging from

conversations with graduate students, a number of younger economists are

in fact drawing the conclusion that tariffs and monopolies are not of much

importance. This view is now beginning to appear in the literature. On

the basis of these measurements Professor Harvey Leibenstein has argued

“Microeconomic theory focuses on allocative efKciency to the exclusion

of other types of efiiaencies that, in fact, are much more significant in

many instances.”’

It is my purpose to take the other route suggested by Mundell and

demonstrate that the “tools on which these studies are founded” produce

an underestimation of the welfare costs of taras and monopolies. The

classical economists were not concerning themselves with trifles when

they argued against tariffs, and the Department of Justice is not dealing

with a miniscule problem in its attacks on monopoly.

STATICS

The present method €or measuring these costs was pioneered by Professor

Harberger.‘ Let us, therefore, begin with a very simple use of his diagram

to analyze a tariff. Figure 1 shows a commodity that can be produced

‘These studies are convenientlv listed with a useful table of the welfare losses computed in

each in Harvey Leibenstein, “‘hocative Efficiency vs. ‘X-Efficiency’,” Am. Eron. Rev., June

1966, 56, 392-41s.

a. Mundell, Review of L. H. Janssen. Free Trade, Protection and Cns:oms Union, Am.

Eron. Rev., June 1962, 52, 622.

‘Op., p. 392. In this article Leibenstein consistently uses the phrase “allocative efficiency”

to refer sokly to the absence of tariffs and monopolies.

‘A. C. Harberger, “Using the Resources at Hand Mote Effectively,” Am. Econ. Rev., May

1959, 49, 134-46 should be noted that Harberger suggested the method for the measurement

of the welfare costs of monopoly, but its extension to cover tariffs was the work of other scholars.

The more careful scholars who have measured the welfare costs of tariffs have not all used this

very simple application of Harberger’s method, but a method such as illustrated in Figure 2.

I have chosen to begin with this method of measurement partly because it simplZa the expo-

sition and partly because this procedure is the “conventional wisdom” on the matter. CCf.

Leibenstein, op. rit.)

224

domestically at the constant cost of Pi and imported at Po. With the given

demand and no t a d Qo units will be purchased at a price of Po. If a

prohibitive t a r 8 is imposed Q i units will be bought at a price of P I. The

the community to others, and the only welfare loss is consequently the

shaded triangle. The studies purporting to measure the welfare costs of

etry it is fairly obvious that the amount would normally be small.

There are a considerable number of costs that are ignored by this

procedure. As a starter, collection of a tarif3 involves expenditure on customs

inspectors, etc., who do the actual collection and coast guards who prevent

smuggling. Further, customs brokers are normally hired by the shipper

to e t e the movement of their goods through customs Normally we

pay little attention to collections costs because they are small, but in this

case they may well be larger than the welfare triangle which is also small.

for some commodity in some country. Qo units are bought at a price, Po.

Now suppose that a tax is imposed, raising the price to Pi,and reducing

sales to Q,.The welfare cost of this tax is measured by the shaded triangle.

But suppose further, that the revenues raised by this tax are completely

wasted, building tunnels, for example, which go nowhere. Now the social

Do

Let us, however, consider the situation in which there is some domesbc

production before the imposition of a tarif€. Figure 2 shows a commodity

part of the consumption of which is imported and part produced domes-

tically. The supply elasticity of the commodity from foreign sources is

assumed infinite, but domestic production is carried on in conditions of

increasing costs. Without the tarif€,the price is Po, domestic producers

turn out Do units and Qo - Do units are imported to make up the tota

consumption of Qo. Suppose now, that Mr is prime minister and

imposes a tar8 on imports and an excise tax of the same amount on do-

mestic production. With the new price, PI, consumers will want only QI

of the trapezoid T,.' Clearly the social cost of the tariff is not just the

costs, I should like to take a detour through the economics of theft."

it is more & a a t to have some protective expenditures by the owners of